What are these wrong things that you might be reporting? Simple: revenue, costs and profits. These are elements of your standard management reporting, but let me take you through them and show how they can take you in exactly the wrong direction.
Start with revenue. Higher revenues are better, right? Actually, maybe wrong. My all-time most horrible case study here is the magazine publisher who had incentivized its advertising sales force on revenues. They had certainly grown the top line, but in a predictably counterproductive way. They had dropped prices to the point where they were charging 20% of what their competitors were.
There is a more subtle point about revenue as well. Very often what matters most is not the total amount, but where it comes from. Does it come from customers who represent the future, or the past? As an example, the CEO of a big data analytics company realized that the company needed to move from selling to medium sized enterprises to selling to large corporates. He established as one of their key performance indicators the percentage of revenues coming from large customers. Directing the focus there enabled them to grow the percentage from zero initially to 75% after five years. This would never have happened had they reported all revenue as of equal value.
Next, consider costs. Lower costs are better, right? Well maybe, except when higher costs are better. The answer to this conundrum comes from realizing that we incur costs to produce a result, and that what matters is not the absolute level of cost but the ratio between cost and value created. My Stupidity Hall of Fame entry here comes courtesy of someone I know who once needed to recruit a lot of software developers quickly. His HR department were very pleased with themselves when they negotiated an exclusive deal with a recruiter in exchange for a fee of 15% of salary rather than the usual 20%. This brilliant cost-saving deal however had an unpredicted consequence – my friend never saw the best candidates. After all, if you were a recruiter and had a really great candidate who could walk into any job, wouldn’t you send them first to somewhere where they would make you 20% not 15%? As a buyer, you need to be careful. If you are too good at negotiating low prices, you can end up claiming the “least favorite customer” award with your supplier. If you are Walmart that isn’t a problem because most of your suppliers don’t have anywhere else they can sell anything like that sort of volume. But if you don’t have Walmart’s level of dominance then lowest achievable cost could be self-defeating.
So what about profit? Am I going to claim that profit can be a bad thing? Yes I am, when $1 of current profit is won at the expense of $5 or $10 of future profit. I remember one year when I was commercial director of a marketing firm. We had reached the half year, and were behind budget. “Cancel that expensive business development recruitment you had planned,” our parent company told us. “It takes more than six months for new people to become productive, so it won’t cost you any revenue this year.” Of course it didn’t cost us anything that year, but it did cost us the following year. At budget time the question was “where is the growth?” to which the answer was “it was supposed to come from that new hire you told us not to do.”
In a nutshell; customize your KPIs to what you want the business to do, and pay attention to the consequences of the decisions you make. Lots of actions which look great in the current quarter’s P&L don’t look anything like as good when you take in the whole picture.
This article was written by Alastair Dryburgh from Forbes and was legally licensed through the NewsCred publisher network.