Master your Metrics

The bottom-line matters. The key question: What is the right bottom line for our business?

We often hear leaders announce plans to cut expenses without impacting the customer experience. Great concept, which rarely produces expected results. In fact, according to recent Gartner research, fewer than half (43%) of leaders achieve the level of savings they set out to attain in the first year of cost reduction. This is due in part to setting unrealistic cost reduction targets. Another contributing factor is making profitability a “math-first” exercise. Math-first discussions start with “we know the margins we need in our business; reducing expenses by 10% will get us there”. This approach falls short unless math elements are deconstructed into activities creating revenue and expenses.

There is nothing wrong with math. Financial analysis is essential in diagnosing conditions. But the bigger question is: what activities (or lack thereof) created the conditions reflected in our financial results?  Mastering your metrics means knowing which measures best reflect the root cause of results. For instance, profit margin reflects a business’s cost of delivering its offering to customers at a point in time; total revenue earned from customer purchases, less total costs. On its own, profit margin tells only the cost of generating revenue. It does little at the surface level for answering “why” questions about results.

In a sense, traditional financial performance metrics like profit margin are blunt instruments when it comes to answering “why” questions. Greater meaning comes from understanding what caused customers to buy what we’re selling, and how effectively we applied our resources to deliver our offering. On the revenue front, metrics to master emanate from relevance – the level of pertinence, meaningfulness, importance customers ascribe to our offering.

Revenue and Relevance

In my book Leading from Zero, I speak to the need for balancing resolve for relevance with results. In the world of cause and effect, revenue is a result of earning relevance with stakeholders. Businesses that earn and sustain relevance are rewarded with valuable repeat customers, deeper relationships, referrals, positive word-of-mouth, and recurring revenue. Those that overlook this essential metric see revenue deterioration, margin compression, decline, and even eventual demise. So, how does a business measure relevance?

While each business is different, most organizations have insight into common leading and lagging indicators of relevance with employees and customers. For example, changes in customer satisfaction trends or engagement measurements, increase in complaints, unfavorable online and social media traffic, or pricing deterioration are leading indicators relevance may be in jeopardy. Customer attrition, decline in repeat customers, fewer new customers, decreasing average sales, and margin deterioration are lagging indicators of diminishing relevance.

Focusing on the right bottom line informs leaders about which activities have the greatest impact on outcomes. This enables them to enhance operating efficiency, with the goal of earning and sustaining relevance.

Rather than making a case for a target efficiency ratio or pre-tax profit margin as the goal, this approach helps answer the question: How are we serving our clients? The “how” touches on things like effective resource allocation, pricing strategy, and relationship value, all toward the purpose of earning and sustaining relevance with customers. Looking below the surface leads to deeper understanding and new ideas to fulfill the organization’s vision.

When Relevance is at Risk

What can leaders do when earning or sustaining relevance with customers is at risk? Step one is deconstructing activities to assure alignment with the company’s vision. Who is our target customer? How are we serving them? Are customers’ expectations changing? Do we understand what they want and are willing to pay for? Are we serving the right customers?

In Islands of Profit in a Sea of Red Ink, MIT lecturer, Jonathan Byrnes wrote – “Nearly 40% of every company is unprofitable by any measure, and 20% to 30% is so profitable that it is providing all the reported earnings and cross-subsidizing the losses. The rest of the company is only marginal”. The most frequent root cause? Serving the wrong customer. Earning relevance, ergo revenue, with customers your business model isn’t designed to serve is a losing proposition.

Mastering your metrics is anchored in understanding root causes and means measuring what matters most to create results you expect in your business. Leading by Cause is one of the Seven Elements of Earning Relevance of the Leading from Zero approach.