It could be argued that revenue is the single most important aspect of your business. Many asset managers and analysts of all kinds spend most of their time modeling out revenue drivers, which illustrates how important it is for management to understand them. And revenue drivers can get a lot more complicated than you think.
What Drives Product Demand?
This should be the first question that you ask, and can involve many things as broad as GDP to something as narrow as the discretionary spending habits of your customer base. Two basic ways to approach this question include a top down approach and a bottom up approach, and the method you choose should depend on your business.
A company like Walmart probably won’t use a bottom up approach since they have so many products that it would be near impossible to forecast sales for each one. Walmart is going to look at broad indicators such as trends in the retail industry, GDP per capita, their geographic mix, and discretionary spending habits of consumers (top down approach). A company such as Caterpillar, on the other hand, would not get as much value out of that approach since they can get much more specific. They might look at how many tractors farmers will need this year given crop demand and farmer profitability. They could probably break their product mix down and forecast each segment with relative accuracy.
A few key trends to be aware of in Utah’s economy:
- 2014 GDP was $123 billion, up 5.1% from last year.
- The four largest contributors to that GDP figure are government, finance and insurance, real estate, and durable manufacturing.
- Employment growth is flat-lining
- Unemployment is about 4%, below the national average
Are You a Price Taker or a Price Setter?
In economic terms, you are a price taker if you compete in a perfectly competitive industry (such as a commodity like corn), and you are a price setter if you compete in a monopolistic environment (such as OPEC in the oil and gas industry) or are able to create a real competitive advantage and maintain it. OPEC is able to essentially set oil prices wherever they want since they control 33% of the world’s oil output. Most companies, however, compete in something closer to a perfectly competitive market and are thus price takers. In this case you have to compete on the customer experience, customer service, or offering the best value for the price.
There is a laundry list of other factors that should be taken into consideration when trying to forecast revenue growth through revenue drivers. Some other key ones include understanding your inputs and the market dynamics from which those come, your competitive positioning, and your geographic mix.. Most businesses I have advised in Utah as an outside CFO don’t compete internationally, but understanding what regulatory risks and other factors affect you in other states and areas can be important.
It is also important to remember that every company is different and that there is no silver bullet for anyone. These guidelines provide a great head start and will get you asking the right questions. Understanding what drives your revenues will give you a much clearer perspective of where you stand and where you might be 12-24 months from now. Taking the time to realistically forecast growth can save heartache down the road.