A single metric for business: Profit per x?

I’ve been profoundly affected by a book: Good to Great by Jim Collins which has studied hundreds of companies to understand what made some of those good and others great. The findings are just incredible and the way the book is written allows any business person to reflect on its own attitude and approach and try to pursue the path of greatness in business.

I won’t go into every points addressed in the book, although I wanted to call out one of the thing Collins noted: great companies have a very clear metric they were following relentlessly. It’s the denominator of the formula: Profit per x. Each of the great company had a clear profit per x. For example, profit per visit for Walgreen, profit per employee for Abbott, profit per region for Circuit city, etc.. It seems very simplistic but it drove billion dollars businesses’ strategy and became the heart of their culture. The shift of revenue metric from one denominator to another was often time the starting point of fantastic results.

As I was reading this I asked myself what could be the right denominator of a profit per x of a very small business, and how could this drive the strategy of the company. I was fortunate enough to run such a small business, Iniflux, in the past and I was trying to think what it should have been.

The first step is to determine what metrics we have and that is probably the biggest issue most small businesses are facing. When you are small, you often live day by day, each deal is important, be it outside of your realm of skills, focus is not a virtue, and because management is so close to the field there is no time to think too broadly about culture, strategy, hiring and investment. Accounting is outsourced to a CPA which role is mostly to help filling taxes and make sure the company pays the right taxes to the state and the visibility of the cost structure is very weak.

Building those metrics takes time initially but they are crucial to growing the business. You need to ask the right questions:

– What are my costs? How much does every employee cost really? What’s my total overhead cost (attributing overhead correctly is also very important)? What is my cost per profile of employee? per employee? per deal? What is my sale cycle length? by type of deal, by size of deal, by sales person? How much hours of each profile have been put in on each deal? How much do I spend in marketing? where? for what return? what is my support cost? How much is debt costing me? etc..

– What are my revenue? What margin do I make by type of product, by deal size, by sales guy? How much revenue by practice if you have several? by region? compared to last year? and the year before? etc..

The idea is to have a perfect picture of your cost and revenue structure. The goal of this exercise is not to just do it once but also to be able to track those metrics over time and see trends appear. Once this is in place, the company has to compare itself to the market, and comparable companies in particular if this data is available. For example, what’s a good revenue per Sales in the first year? the second year? Hopefully you will realize that you are good in certain areas and weak in others but overall, you will know, from now on, how to plan for the future. By understanding your core metrics, planning becomes much easier. Later you can always compare your plans with your metrics to see if you are on track. Another to know more is to talk! talk to other small business owners, go to networking events, ask questions, talk.. IT is in fact incredible to realize how much first hand conversation can bring, and often times how people are open to talk about their company and experience. Who does not ask gets nothing. Talk.

So, as you are planning, what should be your denominator? The x of profit per x. Force yourself to think about a single one. What should it be?

I will take a few example to illustrate the impact that such an approach could have on your business.

As a service company, the denominator could be: Customer. Profit per customer. If you are set on this what does it mean: The number of customer is not that important, what you want is increase the profit for each of them. That might drive you to go see your current customers more. It might drive you to drop customers with which the type of deals you have are not in line with your strategy (service versus pure software/hardware sales for example). It might drive you to expand partnerships with a single partner. It might drive you to diversify your offer into a more complete or global offering. You will try to find ways to cross-sell or up-sell products with existing customers. At the same time you will try to reduce the cost allocated to each customer which means you might want to have someone dedicated to each customer that knows them in and out and can be efficient, spending less time on each new deal. You may want to incentivize your sales team on this metrics as well.

Now as the same service company, the denominator could be: Practice. profit per practice. Let’s imagine you have a security practice and a database practice and you want to maximize the revenue per practice. To achieve that goal you will have to develop certain expertise that justify higher sales costs, maybe find product in those practices that have bigger revenue and margin, your training costs will be distributed differently to maximize for this denominator. You may even want to drop one of the practices all together. Overall your strategy will be quiet different that is your denominator is “customer”.

If you are a SaaS software vendor, you denominator could be “visitor”, “paying customer”, “server”, “marketing campaign”, etc.. and each of them will call for a different focus, culture and strategy.

Finding your denominator is going to be very hard and will certainly be the source of many debate internally. Be honest with yourself, face the hard reality of your situation. Don’t just come with a denominator, try to figure out what is going to be the strategy to increase it (using the great tracking you have put in place earlier). You might realize that this focus will be what takes your company to the rank of great company.

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