Pick best cost structure that adds value to your clients

Shoppers at a supermarket in Nyeri. Businesses must consider the value cost-cutting measures will add to customers before adopting a given model. Photo/Joseph Kanyi 

By Scott Bellows

In Summary

• Although saving on operational expenses is key in business success, bear in mind benefits for customers.

Using the example of the JamboJet launch in Nairobi, let us examine costing your products and services as an entrepreneur.


 

By now, you should have already determined your business model over the past 10 weeks of the Business Talk series on social entrepreneurship in the Business Daily.

As you prepare for the final launch of your business, determine all costs you expect to incur to operate your business model. Let us face a hard fact with business: you must spend money to make money.

Essentially, what are your most important costs to create and deliver value to your customer segments, maintain your customer relationships, and generate revenue?

In order to answer the question, we ask Osterwalder and Pigneur’s questions in Business Model Generation: which key resources are most expensive? Which key activities are most expensive?

Clearly, an entrepreneur should minimise costs at every turn. However, do you desire to define your business by the costs you save or the value you create?

Think not in terms of what you charge your clients, but what costs you generate. The big debate in entrepreneurship: whether to incorporate a cost-driven model or a value-driven model.

When looking here in Kenya, Naivas clearly tries very hard to save costs seemingly at every turn. Compared to Nakumatt, there appears to exist less selection, less aisle width, longer queues, and less cleanliness.

However, Naivas’ cost savings seems to enable the supermarket to attract a large and loyal customer base precisely because Naivas credibly passes along its cost savings to its customers.

Similarly, the Methodist Guesthouse in Kileleshwa buys wooden beds with typical mattresses, small televisions, tiny soap, and few frills.

Just walk into the dining room at the guesthouse and then, on the other hand, walk into the dining room of the Serena Hotel chain’s Nairobi branch.

The austerity versus opulence will shock you. However, if the Methodist Guesthouse’s value proposition to its customer segments incorporates a comfortable and safe place to spend a night, then why would the guesthouse pay exorbitant amounts of money on high-end finishing?

Since the Serena Hotel in Nairobi clearly has a different value proposition for its clients, then paying for an lavish client experience is necessary for the hotel.

Now, specific to JamboJet and the airline industry, how do the market players identify with their customer segments?

If Ethiopian Airlines positions itself as the Toyota of air travel, then Kenya Airways likely places itself as the Mercedes of air voyages in East Africa.

Inasmuch, it should arguably provide more on time, cleaner, and safer services than Fly540 who positions itself with a cost savings value proposition to its customer segments.

However, if Kenya Airways finds itself losing customers to Fly540, how should it respond? If it lowers its prices to compete directly with Fly540, then it risks changing its brand image.

Again, Kenya Airways’ brand image exists as a key value proposition to its clients. So, like North American, Asian, and European airlines have done for years, a logical course of action may entail starting a no frills budget airline with a different brand, but which still enjoys the cost purchasing advantages of belonging to a larger airline.

Kenya Airways seems to have done just that through its investment in JamboJet. This author telephoned both Kenya Airways and JamboJet Thursday morning to talk through the reservation and payment options. Without a doubt, Kenya Airways was easier to make a booking and pay.

The JamboJet experience, now granted the call occurred on the opening day, was more difficult and payment options bordered on the ridiculous.

However, friendly customer service agents did their best and in the end, the author purchased extraordinarily cheap airfare to Mombasa.

Given JamboJet’s anticipated lower costs in its own purchasing, the airline passed those cost savings on to me. I would gladly repeat the purchase from JamboJet for those same astounding prices.

Now, JamboJet may alternate its cost structure between the following four types. First, variable costs vary proportionally with the volume of goods and services.

If you serve fewer clients in a given month, then your costs for that month become lower. Music festivals, such as Kijiji Entertainment’s Spread the Love in Nairobi, incur mainly variable costs. An airline, on the other hand, likely cannot take advantage of variable costs.

Second, fixed costs remain the same no matter what volume of customers you serve. Such costs include rent, machines, or salaries for permanent employees.

Manufacturers in Athi River’s Export Processing Zones need manufacturing, assembly, and packaging equipment regardless of the volume fluctuations each week or each month.

The company still must pay for the equipment. Similarly, mobile carrier yu must pay for cellular towers whether having one client in an area or a thousand. Therefore, too, JamboJet exists in a fixed cost business model.

Economies of scale

Third, some firms may benefit from economies of scale. In the yu example, the more the mobile phone carrier increases its customers, the more clients yu may spread out its costs. So, yu may find it inexpensive to add a client once the infrastructure is in place.

Also, large companies benefit from discounts given to bulk purchases. So, Nakumatt likely pays a lower price for Geisha soap than does your neighbourhood kiosk.

Fourth, other firms may experience economies of scope. East African Breweries Limited (EABL) enjoys cost advantages because of its wide scope of operations.

EABL may utilise the same distribution channels or marketing channels for Tusker as it does for Alvaro, for example.

Similarly, KQ’s investment in JamboJet means JamboJet likely enjoys discounts through reservation systems and airport facilities that it would not if it operated as a standalone small local airline.

In summary, determine a cost structure that best speaks to how you can deliver the value propositions to your customer segements.

Interested to dig deeper? Free training for the USIU, Colorado State University, MIT, Business Daily, and USAid Jamii Social Business Plan Competition continues FRIDAY at 10:00am at USIU’s Chandaria School of Business and every Friday and selected Saturdays until April 4.

Email the author for further details.

Professor Scott serves as the Director of the New Economy Venture Accelerator at USIU’s Chandaria School of Business and Colorado State University, www.usiu.ac.ke/gsse, and may be reached on: bscott@usiu.ac.ke or follow on Twitter: @ScottProfessor.