Attacking a Profitability Problem

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I’m amazed by the myriad of “tips” and “secrets” you can find on the web, lists of things you could do to solve virtually any problem. The experts creating these lists mean well, its good food for thought. But most would also admit that there is no magic, one size fits all, recipe for success, particularly when it comes to solving a profitability problem.

Be it a company with 10 employees or 500, success in attacking a profitability problem is almost totally a function of having an accurate definition of the problem, and coming to that definition is easier said than done. Common pitfalls when doing the needed analysis include: confusing symptoms with the root cause, defensive thinking, and a scope or focus that is either too narrow or too broad.

Moreover, it’s very important that the definition also be actionable. Analysis may have identified the problem as one product, a clear money loser on its own, but dropping that product may risk losing key customers who buy multiple products and prefer to use one supplier to fill all their needs. The problem needs to be redefined so that the solution avoids assuming a high risk of undesirable results, such as creating another profitability problem.

If profitability is a concern, wise CEO’s will invest in the analysis required to come to an accurate and actionable definition of the problem. It is equally wise to consider the value of using an outside expert who can bring a high level of analytical skills to the table, and provide greater assurance of independence and open mindedness in the analytical process.

JCJCo., Inc. provides business and financial consulting services to companies in transition. We tackle financial management challenges commonly caused by high growth, rapid changes in the marketplace, business combinations, employee turnover and other unusual or disruptive events, filling the need for expertise on an interim or outsourced basis.

Should You Invest in Performance Metrics?

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In the post titled “Common Reasons Not to Use Performance Metrics”, I outlined a few of the justifications used by businesses for not making an investment in developing and monitoring a strategy centric set of performance metrics. I also offered some opposing arguments, suggesting an owner or CEO should question those justifications, especially if business growth is a key objective.

Extreme examples can help put the growth point in perspective, so let’s consider Microsoft and Facebook. Both were once total startups, then small businesses, and now they are anything but small. Granted, each had an unusual growth opportunity by virtue of playing in a new, large and unfulfilled market. But, their evolution was no different than any other company seeking growth. They started with a product that solves a problem, then sold that product to a group of customers. Once established as a small business, they then attacked the hardest part of the growth challenge, business expansion.

The evolution from small business to growing company is very hard to achieve, largely because it requires shifting from being run by a single horse or small leadership group, to a decentralized broad based company. In other words, success in the growth phase of a business’s development is dependent on the business’s ability to develop organizational capacity.

Developing and employing metrics is an integral if not essential part of building organizational capacity. Employing a formalized set of strategy centric performance metrics serves not just to keep leaders informed, but also to communicate what people need to do for the business to succeed. The selected metrics package defines the execution plan imbedded in your business strategy, and is a highly effective means of maintaining focus on that strategy throughout the organization.

What if you’re not Microsoft or Facebook, you don’t play in a new, large and unfulfilled market? Irrespective of business growth prospects, all companies must deal with changes in their external marketplace or internal operations. And the smaller the business, the fewer the moving parts, so adjusting to change can be tantamount to a wholesale change in the business model. Making such a wholesale change can be both difficult and time consuming.

For smaller businesses, if a need to adjust to market or operational change is not recognized early, it can threaten the business’s survival. Perhaps a talented leader or a barebones performance monitoring system focused on revenue or customer satisfaction will recognize problems before they become disasters. But the risk can be reduced by investing in and regularly monitoring a well devised set of strategy centric performance metrics.

So what is a well devised set of performance metrics? As pointed out in my first post on this topic, and as suggested by Robert Kaplan and David Norton in their writings about a “Balanced Scorecard”, selected performance metrics should be balanced among 4 key areas of concern:
• financial performance,
• operational performance,
• the customer’s view of performance, and
• innovation, improvement and response to fundamental market changes.

The selected metrics in each of these 4 areas should reflect the business strategy, be measured regularly, compared to industry benchmarks or competitive intelligence, and shared with key employees throughout the company. Irrespective of business size, investing in a strategy centric set of performance metrics can be important, but it is an especially important, if not critical, for any business that wants to grow.

JCJCo provides outsourced CFO and business consulting services to entrepreneurial and high growth companies. We help our clients develop performance metric measurement and management systems that reflect the client’s strategy, and delivers essential information needed by the business owner or CEO to monitor performance, make business adjustments, and meet growth objectives.

Some Common Reasons Not to Use Performance Metrics

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In the post titled “Performance Metrics – a CEO’s Best Friend”, I described some observations made as a participant in a peer to peer “think tank” about performance metrics, sponsored by SmartCEO. The main takeaway was that the smaller the business, the less likely a formal set of performance metrics were employed by management to help make business decisions.

So why is this the case? Why don’t smaller businesses invest in defining a set of metrics that reflects their strategy, and take the time to set up a process to collect data and track those key metrics? In my experience, the most common justifications are:

• The smaller the company, the closer the owner or CEO is to the action, and the more likely he or she sees what’s happening in most aspects of the business on a daily basis. That owner or CEO is also likely to have a personal version of performance metrics embedded in their thinking. They have experience and knowledge, and are comfortable in relying on their own ability to gather, assess and make business decisions based on their own personal expertise.
• The smaller the business the less budget is available to invest in a data generation and reporting system, and the less time is available to feed the data collection process. With limited resources, the emphasis is on generating revenue, and making an investment in performance metrics is not categorized as a revenue generating expenditure.
• The most valuable asset in any company is arguably its customer base. And the smaller the business, the less likely it has significant other assets under its control. For these reasons, smaller business thinking tends to be very customer centric, focused on customer satisfaction, or things needed to attract new customers. While all sizes of companies should monitor customer centric metrics, the smaller the business the more likely they see customer metrics as being all that is needed.

It’s not that smaller businesses do not use some form of performance metrics, they do. An owner or CEO’s knowledge and experience is a form of metric, as is a focus on revenue or customer relationships. But relying on these justifications for not developing and employing a broader, strategy centric set of performance metrics has inherent risks.

A singular on non-strategically aligned focus for management decision making, be it revenue, costs or customer relationships, can result in critical changes in the business or its marketplace being overlooked. And most barebones methods of monitoring performance are inherently short term in their focus, which is inconsistent with managing toward achieving longer term objectives, and in particular, growth targets.

Also, while a talented owner or CEO’s closeness to the action and innate decision making ability can be an effective substitute for metrics, some words of caution are needed. That individual has only so much capacity, and if growth is an objective, he or she will soon be far less directly involved in all aspects of the business, and metrics are critical to supporting organizational growth.

Even if growth is not an objective, he or she will not be with the business forever. And as an aside, that individual’s decisions about the here and now can be tainted by the natural tendency to support past decisions. A wise owner or CEO will hire people capable of assuming decision making authority, share or test his or her own decisions among this team, and invest in performance metrics. Any business that is reliant on one individual to succeed is assuming an unnecessary level of risk, and performance metrics provide a roadmap for sharing decision making within a management team.

In a final post on this topic, I will expand on the reasons why all businesses should make an investment in developing and monitoring a strategy centric set of performance metrics, particularly if the business wants to grow.

JCJCo provides outsourced CFO and business consulting services to entrepreneurial and high growth companies. We help our clients develop performance metric measurement and management systems that reflect the client’s strategy, and delivers essential information needed by the business owner or CEO to monitor performance, make business adjustments, and meet growth objectives.

Performance Metrics – A CEO’s Best Friend

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I recently attended a Think Tank here in NYC, sponsored by SmartCEO, where the topic was “Data Analytics – Determining Measurements That Drive Business Success”. The questions posed to the assembled group of small, below middle market business leaders were very good ones:
• how often do you measure metrics?
• are metrics shared within the company?
• are metrics compared to benchmarks?
• are metrics tied to strategy?
• what specific metrics are used?
• do metrics drive your business decisions?

Despite all participants being smaller sized companies, everyone did look at some form of metrics. But the participants varied in their habits when it came to tying metrics to a defined strategy, communicating performance metrics within the company, comparing metrics to external benchmarks, and formalizing the use of metrics in their management process. Not surprisingly, the most vivid takeaway was that the smaller the business, the less likely management paid attention to formal metrics beyond a customer centric thought process that emphasized revenue, or customer retention or customer acquisition.

Using performance metrics does not require reams of data, or tracking a wheelbarrow full of ratios. But it does require thinking though the business strategy, identifying the keys to success, selecting a few ratios or other metrics that reflect those keys, establishing a process to collect needed data, and comparing your selected metrics against a target or plan on a regular basis.

Also, as Robert Kaplan and David Norton have proposed in their writings about a “Balanced Scorecard”, the selected metrics should reflect key performance objectives from four perspectives:
• the owners/shareholders perspective (financial performance),
• an internal perspective (operational performance),
• an external perspective (customer’s view of performance), and
• a future perspective (improvement programs, innovation, fundamental market changes).

Are performance metrics any less important for smaller businesses? Perhaps, but even in smaller businesses, metrics can identify problems before they become disasters, and are essential to achieving growth. So why does a business not track and use performance metrics when making decisions? Why not create a formal set of strategy centric metrics that are regularly measured and shared throughout the organization?

In future posts, I’ll explore some typical reasons used by small businesses to justify not employing a broad, strategy based set of performance metrics. I’ll also expand on the reasons why any business, irrespective of size, should invest in developing and using metrics in their management process, particularly if it is a business that wants to grow.

JCJCo provides outsourced CFO and business consulting services to entrepreneurial and high growth companies. We help our clients develop performance metric measurement and management systems that reflect the client’s strategy, and delivers essential information needed by the business owner or CEO to monitor performance, make business adjustments, and meet growth objectives.

Qualitative Elements of Business Value:

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How much is your business is worth? Business owners often assume it’s simply a question of finding recent sales of similar businesses, or looking at industry averages, and using the implied market value multiple, such as a Price/Net Income, Price/EBITDA or Price/Sales ratio, to calculate a value for their business. That is a dangerous view to take, one that leads to bad decisions when buying or selling a business, or a loss of hard earned value when taking on a new partner or investor.

Importantly, while understanding value is aided by the use of market comparisons and multiples, the derivation of business value is based on corporate finance theory, all put into a series of mathematical constructs used in corporate finance analysis, and it’s not so simple. Those mathematical constructs were used to develop the dangerously oversimplified valuation ratios such as P/E and P/Sales, and proper use of these ratios requires a thorough understanding of the underlying corporate finance theory and math.

More importantly, simplified valuation ratios inherently imply an assumption that your business is exactly like the business or businesses you are comparing yourself to, that you are “qualitatively” exactly the same as all the others. Obviously this is not true, as each business has unique strengths and weaknesses, and unique market risks and opportunities. So, to answer the question “what is my business worth?” you must not just understand corporate finance, you must also have a thorough understanding of these qualitative elements of business value.

So, what are the “qualitative elements of business value?” To demonstrate, let me offer a list of some questions that need to be answered when assessing value, organized by the 4 core parts of any business enterprise: its customers, its products and services, its organization and its assets.

Strength of Customer Base:
• How many customers are in your market, and what share do you have?
• How reliant are you on one or a few customers?
• Are all of your customers exposed to the same market risks?
• How important are you to your customers’ success?
• Do you have unique knowledge of your customers’ needs?
• What is the length, depth and breadth of the typical customer relationship?
• What is the likelihood that typical customer characteristics and relationships will change?

Strength of Products and Services:
• How many similar products or services are available in the marketplace?
• Do you compete on the basis of quality or price?
• Can your product or service be easily copied?
• How important is brand or image to buying decisions?
• Does the need for your product have seasonal or cyclical characteristics?
• Is the market need for your product or service changing?

Strength of Organization:
• What is the relative level of knowledge and skill in areas critical to business success?
• How is capacity affected by the organization?
• How difficult or easy is it to expand or contract the organization?
• What is the likelihood of a critical individual or part of the organization being lost?
• How does management philosophy, process and controls impact likelihood of success?
• Is there a need for a type of manpower that is in short supply?
• To what extent does the organization have access to external knowledge and resources?

Strength of Assets:
• How do owned or controlled assets affect competitive position?
• How sensitive is capacity to ownership or control of assets?
• Is it difficult or easy to acquire or gain control of required assets?
• Is it difficult or easy to divest assets?
• To what extent do existing liabilities limit the business’s access to the value of assets?

Keep in mind that the simplicity of earnings or sales multiples makes it very difficult to capture the qualitative elements of business value in a multiples based valuation. On the other hand, a forecast of future financial performance is well suited to the task, with the forecast model designed to reflect all of your business’s unique “qualitative” characteristics.

Also, this list of qualitative questions is not intended to be exhaustive, and the appropriateness or importance of any given question is certainly impacted by the nature of the business, or its stage of development.

For example, organizational strength is likely to be more important to the value of an early stage, high growth business. In considering the value of a more established, moderate growth business, product strength can be key. And for a mature business, its value can be most sensitive to customer and asset strength. Finally, for a business in decline or distress, organization strength takes on heightened importance again, as it will define the business’s ability to change, address its problems and return to health. If the organization is not up to the turnaround task, business value is defined by asset value.

Thoughtful comments to any post here at www.JCJCo.net are always invited and appreciated.