Pardon the visual pun...
What I am referring to is asset turnover, which is commonly defined as net sales divided by the asset base. New accounting and finance students learn this ratio when doing financial statement analysis to understand the components of a firm's return on equity. The equation looks something like this:
Most companies spend a great deal of time focused on profit margin, and their finance departments look closely at financial leverage, but I propose that professionals in the information services industry should focus much more closely on asset turnover.
Why? Because selling data is different than selling widgets in two key areas:
Data businesses want a big data asset; having lots of inventory is a good thingData businesses can keep that "inventory" and sell it over and over
Unlike manufacturers, which frequently seek to reduce their asset base to increase asset turnover, or financial services companies, which manage their balance sheets carefully to optimize financial leverage, information services companies don't view having a big asset base as a bad thing. Instead, the best ones focus on increasing sales of their growing data asset.
Asset turnover is key because information services is a highly fixed cost industry. Gross margins are often well over 80% (meaning that the actual costs of good sold is <20% of sales) and fixed costs -- usually people-related -- are often 60-70% of revenue, yielding industry-average margins of around 19-20%. When you have a fixed-cost business, every additional dollar you sell is highly profitable (i.e., it drops ~80% to the bottom line). Conversely, declining revenue is very painful, with ~80% of each dollar in revenue decline hitting your profit numbers.
With these economic dynamics, the goal should be to increase your sales so that you can build an attractive asset turnover ratio to cover all those fixed costs. Of course, you should always watch your fixed costs and find efficiencies through scalable, low-cost technology and processes wherever possible, but turnover is still the name of the game. Sell more data to more customers at an ever-increasing rate, and you will win the data business game.
But how?
Develop and sell data products that encourage large-scale data consumption. The brilliance of the FICO score is that it is a ravenous consumer of data. By developing a simple credit scoring number, Fair Issac created a beast that churns through millions and millions of bytes of credit data every day to generate one of the single most important data elements in financial services. Any data business than can create tools, models, analyses that consumes a great deal of data are creating the foundation for attractive data velocity, asset turnover, and profitability.
Get the data in as many users hands as possible, and make it easy for them to consume mass quantities. Instead of relying on seat sales or per-use charges, I am a supporter of flat fees or value-added pricing that encourage increased data usage. The more the client consumes, the more he/she generates value, the more revenue potential exists. The key is to avoid "taxing" data velocity through mismatched pricing schemes and to find ways to properly charge for the economic value you have created.
Focus on ROA versus traditional profit margin measurements. Margins matter, but when even the also-ran data companies generate 80% gross margins, they don't tell you very much. When you combine your margins with your assets, then you start to see how much the data asset is generating for you. Does it really matter if you have only 2% net margins if you are turning over your asset 100X per year? In the 1990s, Michael Dell proved that you can generate billions on 2% margins by managing the assets better than anyone else. Information services companies could profit by viewing the world in a similar way.
The bottom line for me is that information services companies would be well-served to focus on asset turnover as a key metric in assessing their business. Too many times, companies focus on the same metrics as everyone else, which can lead to misleading conclusions or, even worse, bad strategic choices. Profit margins alone don't tell the story -- look the amount you generate versus the asset you have and use that to better assess the health of your data business.
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