Can Accounting Pivot?
The financial metrics for growing tech companies are very different from many other industries and the fact remains no financial accounting system today measures these metrics. It is a universal truth that what gets measured gets the focus and attention. The question is, can these measurement systems “pivot”?
Eric Reis introduced innovation accounting in “The Lean Startup” in 2011, and has spoken about it extensively. Dave McClure has a list of 5 metrics he uses to track progress which he refers to as innovation accounting.
So can accounting “pivot”, given to date these concepts have not been embraced by the mainstream accounting profession?
The current double entry system we use for accounting today is credited to a 15th Century Franciscan monk & mathematician, with several iterations since.
The system we use today has been around for 600 years and has shown extraordinary resilience & adaptability. Can it “pivot” again and what will be the catalyst?
My view is it can, based on one condition – the customer, not the product, becoming the primary unit of measure.
Why is this so significant?
When products are your primary focus, measurement is about how much it costs to produce & ship as many of them as possible. The product development lifecycle is prototype, then production, then marketing to create demand, then sales. Every accounting system today is geared to measuring this process.
Success is measured on the number of products shipped and the profit made from those shipments. For public companies in Australia this is done every six months, in the US it’s every 3 months. There is significant commentary on the impact this short term focus has on a company’s ability to innovate and adapt.
What happens when the (paying) customer is your primary measurement focus? The questions you ask change quite significantly.
How do you acquire that customer? How do you keep them engaged? How long do they stay with you? These questions have a direct correlation with the Life Time Value of that customer. The longer they stay with you, the more valuable they are.
Technology now means build once, ship an infinite number of times, with minimal incremental cost for each shipment. Hence the profitability of a technology product is mostly about the customer, and very little about the product:
The formula is as follows:
Customer Life Time Value –
Cost of Acquiring the Customer –
Cost of Retaining the Customer –
Cost of Delivery to the Customer
= Customer Yield
The “yield” is a return on the product development, which is a sunk cost. That yield will be far higher if the product development is done with acquisition and retention firmly in mind.
What about cashflow, you say? Very good question.
How many months does it take for (customer yield + acquisition cost) to pay back the acquisition cost. That shows the level of working capital needed to fund a long term growing business, on top of the investment needed to build the product.
The above model doesn’t just apply to technology business models, and with the eventual advent of 3D printers and similar technology, product focused cost analysis will become less and less relevant in other industries.
Can accounting “pivot”? Disruption of the accounting profession has already started with the move to cloud software as a starting point. Fintech will disrupt it further.
Change normally needs a catalyst, which often comes from outside the industry or profession. Financial reporting today is built around the capital markets cycle hence it could a change there becomes the ultimate trigger.
For now, you do need to report your results under the accounting rules as they stand. You also need to track these metrics, in a spreadsheet. Just don't mix the two up.