Suppose I make you a job offer, or an offer to do business. It goes something like this: I want you to do some work for me and my organization. I want your best efforts — time, resources, energy, and materials. I want you to invest your energy in making things happen and meeting deadlines. I want consistent quality of effort and product, every day, throughout the time you are working.
Now, we have agreed that your efforts deserve compensation. (After all, you could be working on someone else’s behalf. You could put your time and efforts toward another project to receive another amount of return.) What you are doing has value, but how much value? Before you started working for me, we set a specific price for your efforts, as well as what would make me a satisfied customer.In the normal course of business, the up-front price we agreed upon would have covered your costs and included something more — your profit. Your costs would have taken into consideration the full costs of doing business, from making the product to selling it, financing operations, providing incentives and compensation to stakeholders (employees and investors), plus enabling you to reinvest in your core operations, a little something more to enable you to compete and respond to market changes, and a little something “extra” so that you could grow. Every once in a while you might have a project where you (because of special circumstances or a special customer or event) reduce your prices and eliminate some of those “extras” and choose just to cover your costs, or break even.But things change. The amount we agreed upon didn’t take into consideration a lot of things. For example, I need a lot of attention: My organization has a lot of questions, and it takes a lot of “handholding” and phone calls and “special effort” to obtain the information from me to do the things you need to do to make me a satisfied customer.
Sometimes, like in this example, we have things we don’t anticipate or things go wrong, or we have a customer that just doesn’t justify the high costs of doing business and we find that our costs far exceed the price we charged. We lose money. Think of it this way: If I asked you to come into work every day, but I told you that some days I would pay you to work, some days I wouldn’t pay you and other days I would ask you to pay me for the privilege of working for me, how would you respond?
The profitability of a business is the sum of all its projects’ profitability. It is the sum of how profitable each customer is. It is critical to know the full cost associated with each project and each customer, and how they do or do not contribute to the bottom line of your business. Are you paying them or are they paying you? Are they at least covering the costs of doing business with them or not?
Every sale is not equal. The quality of the sale differs based upon how it contributes to profits, cash flow, and other factors — not just top-line revenues, market share, or other single-factor measures. Often, businesses get caught up in traditional success metrics and find the business’ ability to sustain operations is actually impaired by growing revenues. Why? Because the quality of the generated sales do not correlate with growing profits and cash flows.
Capturing the Right Revenues — Differentiating Deals with Meaningful Metrics
Revenue cannot be the defining metric that determines whether or not to do a deal. Many other factors are important to the business, including capacity utilization, payment terms, costs, “lifetime” profit potential, and historical contributions. For a business to fully evaluate its market, customer, and individual sales potential, it must understand its strategic objectives and cost structures, AND establish metrics that are consistent with both.
What and Why We Measure
Traditionally, businesses have been taught to look at pure financial measures, most of which are historical, aggregate, and generated in terms that only accountants and other number-crunchers love. They have been not been “user-friendly” when shared or deployed into other areas of the organization. If anything, the use of financial metrics has been something that most functional areas view as a necessary evil. These financial metrics and their use have typically been viewed as something imposed by upper management and the “bean-counters.”
The perception that the numbers are for the finance and accounting types or for upper management and owners is something that belongs to the last century. The financial results of an organization are a product of ALL the activities and decisions of everyone in the organization. For a business to be sustainable, to grow continuously and profitably, and to know the best way to innovate in its business and with its customers and markets, it must be able to harness the knowledge of its entire organization. The results of the organization are captured and quantified in its financial results.
The more everyone in the organization has an understanding of their role in the organizations results, the better the organization works. Everyone in your business should understand how each activity drives costs and impacts revenues, how each sale contributes to profits or consumes profits already earned, how expenditures contribute to cost structures, and how discounts on pricing reduce top-line revenues. Every aspect of the business impacts at least one of the three elements of profitability: revenues, expenses, or customer behavior. The first two elements are directly captured in the financial metrics; the third is indirectly reflected over time and through analysis using non-traditional metrics, which assess the relational elements between customer loyalty and profitability, brand recognition and profitability, customer satisfaction and lifetime customer returns, and other long-term qualitative elements that are more difficult to quantify.
Performance Metrics Are for the Business and the Team Members
Whether using traditional financial metrics or non-traditional relationship value assessments and scores, the business must find meaningful tools that are deployable and usable. These tools can be put in place and used to impact operations without overburdening the “system” to generate measures or use those measures to make meaningful changes.
Numbers are just numbers until someone gives them meaning by interpreting and using them to improve performance (or discourage it). The metrics selected are tools to leverage performance up and forward. A missed target requires analysis to know why the target was missed and what will be done to make up the performance. It is an opportunity for corrective action and an understanding of actions — what worked and what didn’t in the real world on the execution. A missed target is also an opportunity to examine the target and see the difference between what was expected when the target was set and what occurred at the point when comparing the target to reality. Everyone in the business gets a reality check when true performance is known: expectations (targets), performance (individual and team), conditions (market, economy, competition), and totals (company). No single number stands alone. Everything is part of a system, so performance numbers must be managed and analyzed in context. Everyone in the business is responsible and accountable for individual performance, and the business must function together to make the system work. Alignment comes from the metrics, systems, and people working together toward profitability to achieve growth and long-term sustainability.