I want to talk about revenue. Specifically, I want to talk about how it’s sometimes difficult to talk about revenue. Don’t worry. We’ll use an example, so it doesn’t get too meta.
My fake plumbing business
Say I run a plumbing business: Jeff’s Plumbing. Moving right past the uninspired name, let’s imagine I have five locations in your town, one each near the following landmarks:
- The warehouse district (WD)
- The town square (TS)
- The public library (PL)
- The court house (CH)
- The post office (PO)
Now, imagine I offer three different services:
- One-off repairs, such as declogging residential drains
- Large commercial projects, such as renovating the plumbing in a building downtown
- Consulting, such as working with a business to design an optimal plumbing configuration in its new facility
Not every location offers all of these services. The table below shows the details. All locations can perform one-off repairs. My TS and CH locations can execute large commercial projects. But only my TS location offers consulting services. That’s my headquarters.
The workflows in my fake business
Now we have the structure of my business in mind. In most cases, one of my offices will work with a client from beginning to end. A homeowner might call my PL location and ask for help with low water pressure. The PL office will send one of its plumbers over to that person’s house, make the repair, and collect payment. That’s easy.
In another case, say a growing local business is building a new facility. They might get in touch with my TS location. The TS folks will consult on the project, helping to design the system. Then the TS folks will actually perform the work in concert wit the builder. And again, the TS team handles payment, overseeing the whole engagement life cycle.
My fake plumbing business doesn’t always work like this, though. Sometimes, a customer might get in touch with one office, but another office will do the work. Say that a customer gets in touch with our PO location and requests maintenance on their water heater. But the PO team is already swamped with other work. The PO team might send the request over to the nearby WD location. The WD team will then dispatch a plumber, do the work, and collect payment.
Here’s another example. The TS team will consult with a client, since that’s our only consulting branch. But because the work is much closer to our CH location, the CH team will do the work. This is another instance where a project touches multiple locations.
Two ways to track revenue
I can immediately think of two ways I’d like to track revenue in my fake plumbing business:
- Look at how much revenue each location billed
- Look at how much revenue each location should get credit for
Why would those numbers be different? Because we have scenarios where one location refers work to another location. As the business owner, I’d like to give some credit to the first location. They engaged the customer, documented the customer’s request, and communicated the job requirements to the second location.
Knowing how much revenue each location billed is critically important. That helps me understand how much work each location is doing. The billed revenue won’t tell me, though, how the work came to us. That’s why I need a model that assigns credit to the different locations, depending on whether they were involved in the sale or not.
How to assign revenue credit to different locations
When it comes to revenue, we start with our invoices. From our invoices, we know what work we did and which location did the work. We don’t need any assumptions. We don’t need any models.
Now, as we move onto how much credit each location should get, we have to make decisions. Let’s look at two scenarios.
Two locations collaborate on a one-off repair
The first scenario is the one above, where a customer needs water heater maintenance. The customer calls our PO team, who then records the water heater model and captures a little information about its performance and maintenance history. With all of its own plumbers already in the field, the PO refers the case to our WD team, where we have an available plumber. The WD plumber performs the work and bills the customer.
How much credit should the PO team get? Reasonable people can disagree. Some people would say the PO team shouldn’t get any credit at all. If the PO location didn’t exist, wouldn’t the customer have called another location themselves?
Maybe. Maybe not. It depends on how the customer learned about our PO team. Maybe another customer, having had a great experience, referred our PO team. Maybe they even passed along the name of a specific person on our PO team. If the new customer didn’t have that information, maybe the new customer would have turned to another plumber from another company. Word of mouth can matter a lot when it comes to home repair.
We would assess these kinds of scenarios and decide on a reasonable model. After internal deliberation, say we settle on an 80%-20% rule. In cases where locations refer one-off repairs to each other, for any reason, the referring location gets credit for 20% of the resulting revenue. The location that did the work gets credit for the remaining 80% of the revenue.
Two locations collaborate on a large commercial project
The second scenario is where a business client needs help retrofitting an old building. The client bought the building but needed to rework the plumbing.
My TS team worked with the client, designing the new plumbing system. Parts of the old system could be refurbished. Other parts needed to be replaced.
Remember that the TS location is the only one that offers consulting services. Our engineering experts office in that location. We also have our regulatory and compliance experts there. In this scenario, we’re working inside of an old building. We’ll have some serious permitting questions to resolve.
In this scenario, let’s assume the TS location was already engaged on a lengthy project. So the actual plumbing work was referred to the CH location, which can also handle large commercial projects. Now we have the same dilemma as above: how should the revenue be split between the offices?
In the one-off repair case, we split the revenue 80%-20%. The location doing the work received 80% credit. The location engaging the customer and documenting the request received 20% credit.
In this case, the split will be different. The TS location did a considerable amount of work on the consulting side. We brought serious design and regulatory expertise to bear on this problem. After internal deliberation, say we settle on a 50%-50% split between the two offices. They get equal credit for whatever revenue we eventually collect.
As we can see, revenue isn’t revenue
We have two ways to look at revenue. When we’re talking to our investors, we rely on billed revenue. It’s simpler to communicate. We don’t get any arguments about what the invoices mean. Everyone stays on the same page.
Internally, when we’re thinking about our sales and marketing efforts, we rely on the split revenue. We run our billed revenue through a model, telling us how much credit each location gets. When a single location is responsible for the whole project, the numbers are identical. When two or more locations collaborate, they’ll share credit for a particular invoice.
That means we have to be careful when we ask, “how much revenue did the TS location generate last year?” Are we talking about how much they invoiced? Or are we talking about how much credit they received for all the work they touched, regardless if they invoiced it themselves or not?
Even this simple example gets a little confusing
The point of my example is to show that even simple concepts can be difficult to communicate clearly. Revenue is revenue, right? Wrong. Different groups inside or outside our company may think of different things when they hear “revenue”.
And my example is about as simple as can be. Real companies have much more complexity than what I made up here. Strangely, this kind of issue is at the core of a ton of miscommunication.
We’re all smart people. We all generally know what we’re talking about. When we miscommunicate, it’s very rarely because we’re ignorant. We’re just operating under different assumptions. I assume we’re talking about invoiced revenue. You assume we’re talking about revenue credit split between locations.
Be aware of these sources of miscommunication at work. Develop a sense for when different people might default to different assumptions. Ask some clarifying questions when necessary. Offer some seemingly obvious disclaimers, if only to ensure everyone is on the same page.
It’s painful enough when we miscommunicate about obscure, challenging issues. Let’s not add to our plight by messing up the simple stuff. Communicate clearly. Consider any unstated assumptions. You’ll make your own life, and the lives of the people around you, much, much less frustrating.