Any good business manager can explain basic business outcomes like revenue and profit. A more important metric would be to know your business potential. To understand that, we would also need to measure the things that might hold us back. In this article, Tom Stimson of Stimson Group explains his view on the most critical business metric for small business.
Key takeaways include:
- The value of your business is in future earnings, not past performance.
- Your ability to excel in the future is dependent on your aptitude to learn from the past.
- Fear-based decisions yield weaker performance outcomes than educated choices.
Learning cannot replace fear, but learning can mitigate its effects and help maximize results.
The ONE Performance Indicator for Success
By Tom Stimson, MBA, CTS, President of Stimson Group LLC
Imagine you are preparing your grandmother’s favorite chicken casserole recipe. It’s on a three-by-five-inch note card with food stains and age spots. The writing is faded but clear.
The instructions read like this: Mix shredded chicken, celery, carrots, peas, macaroni, milk, flour, salt and pepper, and cheddar cheese. Top with fried onions. You should end up with a total of four cups. Bake until done.
There’s definitely a casserole in there somewhere, but maybe a few steps have been left out? This is exactly how most owners and managers look at financial metrics.
Here’s what that recipe looks like in business: Assemble management team. Declare that gross profit is down. Ask for ideas. “Raise revenue” says Operations. “Lower cost of goods sold” says Sales. All agree. Meeting ends.
Gross profit is not a Key Performance Indicator (or KPI) unless you are grandma and know all 27 ingredients by heart and how each one is applied in what order.
Which is more valuable? A $10 million business at 50% gross profit or a $50 million business at 10% gross profit? While there is some easy math here and it comes out to the same number for both companies, we intuitively know that we don’t have enough information.
What’s the market? Product or service? Risk? ROI? Effort? Overhead?
Gross profit performance is dependent on many individual decisions. By the time a problem is manifest in a metric like gross profit, the damage is already done.
Of course, I have asked you the right question in the wrong way. All financials look backward, so if we really want to know which of these companies is more valuable, we need to look into the future.
Value is in future earnings, not past performance.
How, therefore, is it possible to measure whether your business is working well? Could it be better? Probably. How much? Who knows?
We need a lot more KPIs to understand our current metrics. If gross profit is down, which KPI contributed the most? Once we have identified the offending metric, what indicators should we have been looking at to see it coming?
What About Trends?
What’s on your CEO dashboard?
Revenue? Yes, good. Gross profit percentage? Makes sense.
Should we measure cost of customer acquisition. Hmm, now things get interesting. In order to use this KPI effectively, we also need one that shows the value of a new customer. Maybe add the cost of customer retention.
What if you have the wrong customers? When will your dashboard tell you that?
What would predict the impact of poor decisions?
They say that we improve what we measure.
But we already know we cannot change the past.
When we unknowingly create negative impact, the result is first reflected in a remote metric – a child or grandchild metric. In turn, that affects a parent metric, which is reflected in a master metric like gross profit.
Lots of little KPIs can help you identify areas for improvement after the fact. If all child KPIs are under control, then we can simply monitor the parent metric.
In other words, we learn to optimize metrics instead of reducing or increasing them. Profit is the ultimate indicator.
Is profit the one metric to rule them all?
Not so fast.
Revenue and profit are outcomes, not indicators.
What we need is a measurement that predicts future success or failure. We need to measure something that tells us whether our decisions will help us do better or worse.
One Metric to Rule Them All
If you really want to understand grandma’s recipes, learn how to cook. Grandma and the person she wrote that recipe for have an intuitive sense about proportions, innately know which steps happen in which order, and the oven is always set at 350 degrees unless the recipe says otherwise, which it never does.
If you really want to understand your business metrics, measure one thing first: Fear.
Fear is the one thing that explains every result and trend in your business. When fear goes up, we naturally flee or fight. When fear goes down, we move with less caution.
The only measure in business that ultimately matters is to what extent fear influences your decisions.
Once you dissect any KPI: close rates, receivables, overtime – you can reduce it to its fear element:
- Our close rate is too high because we are afraid to lose business. Our close rate is too low because we are afraid to under-quote the project.
- Our receivables are high because we are afraid to ask customers for our money. Our receivables are too low because we are afraid to use our line of credit.
- We have too much overtime because we are afraid of adding employees. We have too little overtime because we are afraid of variable costs.
A little fear is healthy. Zero fear is irrational. Too much fear indicates a lack of knowledge.
Tell me what you are afraid of and I can tell you your future.
The Implicit Threat to Your Business
Fear is human nature. We won’t eliminate it and shouldn’t try. However, fear of knowledge is an existential threat to your business.
A KPI that does not trigger action is useless. Likewise, a KPI that triggers endless action is also unhealthy. For instance, you cannot reduce the cost of customer acquisition to zero – so why measure it at all?
Because it triggers good questions, such as, “What is the optimal investment in new business that yields the highest return?”
We will probably never know, but healthy fear means we can never stop asking the question.
When we are afraid to ask, fear has won. When we do not trust the answer, fear is in charge.
Being afraid to stop is as dangerous as being afraid to begin.
“Good questions asked and answered well increase applied knowledge while reducing unhealthy fear, which optimizes results.”
When you wake up every morning, acknowledge your fears. As you go through your day, assess their impact on your decisions.
When fear is winning, acquire knowledge until fear is healthy again. Then at night go to sleep knowing you did something that will have a significant impact on your future earnings.
Success is a journey. You can’t change where you’ve been, but you can decide where you are going.