Entrepreneurs have no trouble focusing on how to build a product, and the good ones know how to find and nurture those first critical customers. Many, however, don’t know how to take their small business to the next level. What I’m talking about here is a level of discipline and skill necessary to collect and analyze the relevant business data, known as metrics.
As the end of the year approaches, it’s a good time for every startup to assess the metrics, technology, and platforms they’re using to manage the business. Maybe it’s time for an upgrade to get you to the next level. For starters, here is my selection of some key metrics that every six-sigma joint like GE tracks without thinking, but that too many small businesses haven’t yet formalized:
- Sales revenue. Sales is simply defined as income from customer purchases of goods and services, minus the cost associated with things like returned or undeliverable merchandise. Of course, everyone is happy when the numbers keep going up, but the data needs to be mined constantly for deeper meanings and trends.
Sales data needs to be correlated to advertising campaigns, price changes, seasonal forces, competitive actions, and other costs of sales. More sophisticated metrics in this domain, like the Asset Turnover Ratio, Return on Sales, and Return on Assets, can tell you how your company’s performance stacks up against others in the same industry, or same geography. In the long run, these tell you whether you will live or die.
- Customer loyalty and retention. Customer loyalty is all about attracting the right customer, then getting them to buy, buy often, buy in higher quantities and bring you even more customers. You build customer loyalty by treating people how they want to be treated.
There are three common methods for measuring customer loyalty and retention: 1) customer surveys, 2) direct feedback at point of purchase, and 3) purchase analysis. All of these require a systematic and regular process, rather than ad hoc implementation. According to Fred Reichheld and other experts, a 5% improvement in customer retention will yield between a 20 to 100% increase in profits across a wide range of industries.
- Cost of customer acquisition. This metric is a measure of the total cost associated with acquiring a new customer, including all aspects of marketing and sales. Customer acquisition cost is calculated by dividing total acquisition expenses by total new customers over a given period.
This tells you whether your marketing and advertising investments are paying for themselves. Over time, you cost of acquisition should go down as growth and your brand image go up. Again, be sure to check industry norms for your type of business to see if you are competitive.
- Operating productivity. Obviously, measuring staff productivity is important, and the reasons why are obvious. If you do not know how your staff is doing, how can you truly know the inner workings of your own company? Staff discontent can put your company in serious jeopardy, while on the other hand, high staff productivity can be your best company asset.
Productivity ratios can be applied to almost any aspect of your business. For example, sales productivity is simply actual revenue divided by the number of sales people. Compare your productivity to industry norms by consulting industry statistics, or check yourself for continuous improvement by accumulating your statistics over time. The process works the same for manufacturing productivity, marketing productivity, or support productivity.
- Size of gross margin. The gross margin is calculated as a company's total sales revenue minus its cost of goods sold, divided by the total sales revenue, expressed as a percentage. The higher the percentage, the more the company retains on each dollar of sales to service its other costs and enjoy as profits.
Tracking margins is important for growing companies, since increased volumes should improve efficiency and lower the cost per unit (increase the margin). Improving productivity requires effort and innovation, and many companies charge ahead, not realizing that margins are going the wrong way. What you don’t measure probably won’t happen.
- Monthly profit or loss. Profit is not simply the difference between the costs of the product or service and the price being charged for it. The calculation must include the fixed and variable costs of operation that are paid regularly each month no matter what. These include such items as rent or mortgage payments, utilities, insurance, taxes, and the salary that you and your partners are not taking just yet.
Beyond reducing your cost of operation, the biggest lever on profit is usually the price you can charge for your product or service. This amount you charge, over the base cost of an item, is called “the markup,” and the difference between cost and price is the “margin.” Investors realize that small companies with margins below 60% will likely have a tough time growing.
- Overhead costs. In economics, overhead costs are fixed costs that are not dependent on the level of goods or services produced by the business, such as salaries or rents being paid per month. In any growing business, these can creep up and out of control if not tracked carefully.
By tracking them on a monthly basis, you will be able to see more clearly where spending occurs in your business. Use this information when updating your business plan or when preparing yearly budgets. Because overhead costs are not influenced by how much your business earns or grows, you need to track them separately and diligently. Moving to a location that is less expensive or switching utility suppliers are ways to reduce the fixed costs of running a business.
- Variable cost percentage. By definition, variable costs are expenses that change in proportion to the activity of a business. Fixed costs and variable costs make up the two components of total cost. These include the "cost of goods sold" and other items that increase with each sale, such as the cost of raw materials, labor, shipping and other expenses directly connected to producing and delivering your goods or services.
The value of tracking these as a metric is to assure that they are decreasing as your volume is growing, and assure that they are consistent with industry norms and competitive offerings. If your variable costs go up, your business won’t grow, even if sales are up and the number of customers increases.
- Inventory size. Inventory is the raw materials, work-in-process goods and completely finished goods that are considered to be the portion of a business's assets that are ready or will be ready for sale. Inventory represents one of the most important assets that most businesses possess, because the turnover of inventory represents one of the primary sources of revenue generation and subsequent earnings for the company's shareholders/owners.
For growing companies, this is an important area to manage. You will find that you either have too much inventory (cash tied up, high storage costs, obsolescence, and spoilage costs), or not enough (lost sales, lower market share). The challenges include forecasting inventory requirements, buying in cost-effective lot sizes, and just-in-time delivery systems.
- Hours worked per process. Beyond ratios, you need to keep metrics on total labor hours expended for various functions. Labor is likely to be your most important and most expensive raw input, especially in manufacturing, assembly, and support operations. The one constant in small business is change, so the excuse of “we have always done it that way” is not one that a growing company should ever want to hear or use.
These days, most labor-intensive operations can be replaced with automation, and as you grow the business, you need to recognize when the cost of automation is justified. At some point, the return on investment (ROI) of more computer systems, and automated manufacturing operations, is well worth the cost and time to change.
Leveraging the latest data can uncover new opportunities and help you measure the results of your efforts. I believe every small business owner should monitor these metrics constantly, and take time to chart, review and carefully examine them at least once a month.
Tracking key business metrics is important for a bunch of reasons, but probably the most important reason is cultural. It leads to a culture of success when you see the key business metrics moving in the right direction. Don’t miss the opportunity to celebrate your successes as you reach new milestones.
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