In part one of this post I presented a very simplistic value model and showed how the fourth way to grow your business, increasing the effectiveness of each process in your business, provides opportunities, though limited, in growing value. What about the third way, increasing the average sale?

How can the average transaction size be increased? Basically two ways:

First you can cross sell or up sell an existing transaction. Dell does this every day by offering upgrades, add-ons, installation, expanded support and warranty programs during the on-line shopping experience. So do the big box retailers, when they try to sell extended warranty and maintenance plans on electronics and appliances.

Second, you can raise your prices. Most business owners react to that suggestion with the response, “I’ll lose customers!” That may or not be true. And unless you know which customers you might lose and how many (or what economists call elasticity of demand), you can’t know if this is a viable strategy. For example, if your price-sensitive customers purchase the lowest margin products or services, and they’re the ones who will leave, raising your prices will increase your profit margins two ways…first by eliminating the low margin transactions, thus raising your average margin, and second, by increasing the margin on the customers who are not as price sensitive. The key is measuring whether or not the increase in margin for the remaining sales is greater than the loss of margin on the lost sales.

So how will increasing average transaction size affect value?

Let’s look at what happens to the financial performance of a business if average transaction size goes up:

  • Revenues increase
  • Gross profits increase (because of increased volume and/or better pricing)
  • Net profits increase (most operating expenses will not be affected by this strategy, so much of the benefit goes right to the bottom line.

Given such (and again assuming a stable operating company environment) you’ll increase the economic benefit (in this case profits), which grows the numerator in the value model and you’ll increase the growth rate, which decreases the denominator in the value model – both of which will increase value.

This is part two of a three part series of blog posts on this topic.