The One Economic Driver in Your Business

“If you could pick one and only one ratio (profit per X) to systematically increase over time, what X would have the greatest and most sustainable impact on your economic engine?”

– Jim Collins, Good to Great

I have worked for and analyzed many businesses in my 20-year career. I have reviewed and built countless financial models, and one of the commonalities I see is this: a proliferation of economic and financial ratios. Once you have a business up and going, there are many different ways to slice and dice it: revenue per customer, revenue per headcount, profit per location, profit per business unit, profit per piece of equipment, etc. etc.

The trouble is that there really is only ONE that matters to the long-term success of that business. The real trick is to figure out what it is and then relentlessly focus on how to steadily improve it over time.

This is a piece of the Hedgehog Concept, which Jim Collins made famous in his book Good to Great. While the concept is simple, as with many things, it is not easy to pinpoint with clarity. And it is incumbent upon Founders and CEOs to stay in relentless pursuit of knowing what it is and how to positively affect it.

The concept is best illuminated with real-life examples. While these business models have been around a while (and put to the test over the years), use them to help think about how you can apply the concept to your own business.

Walgreens switched its focus from profit per store to profit per customer visit. Their strategy hinged on convenience and convenience is often costly (how many stores can they pack into a densely populated area?). Had they continued to focus on profit per store, they could easily have increased the number by reducing the total numbers of stores and found less costly locations. However, that would have run counter to their strategy of convenience.

Southwest Airlines’ strategy is centered on the concept of “wheels up.” The more time planes are on the ground, the worse off their business is. Many airlines will focus on profit per passenger or profit per seat, but Southwest has chosen to make the frequency with which their planes are arriving and departing the focal point of their strategy, and therefore, the profit per plane becomes the key economic driver.

Fannie Mae adopted a less than obvious, but keenly insightful, metric of Profit per mortgage risk level (vs mortgage). The real driver in their economics is the ability to understand risk of default in a package of mortgages better than anyone else. Then it makes money selling other vehicles and managing the spread on that risk.

RedBalloon, which offers hot air balloon rides and other experiences as gifts, realized their customers were using their site to browse for ideas and then purchasing them directly from the vendors (which meant RedBalloon was likely overcharging). To combat this, they adjusted their prices accordingly and guaranteed customers would pay no more than they would at a competitor. The point was they were now focused on the experience itself and doing all they could to drive that ratio in the upward direction.

In short, the Profit per X metric must tie directly into your strategy and your long-term orientation.

Collins mentions the notion of the BHAG (a familiar concept to many). What is critical to keep in mind: the X denominator in your Profit Per X must also be something you can craft your vision around (i.e. in 10 years, we want to see X: visits, planes flown, experiences). You want to be able to rally your organization around that key metric and responsibly measure and monitor your progress towards it with the Profit per X measure. The X must be the same in your Profit per X and in your BHAG.

You can in theory use a variety of financial measures in the numerator (revenue, gross profit, EBITDA, net income). I strongly recommend a profitability measure, since not all revenue is created equal and may lead you astray if you fail to acknowledge the cost side of equation. You can find ways to drive up volume or sales through massive amounts of marketing and/or discounting. That will not make for a long-term sustainable business.

The Profit per X metric may not be obvious, and you may not get it right for a number of years. You must constantly assess what the market is telling you, what your customers are telling you, and what you discover to be your organization’s true strengths and passions.

Once you have found it, you will have found clarity. You will have found your focus, your passion. You and your teams will obsess over it, it will drive your actions and decisions on a daily basis. This is powerful, it will help separate you from your competitors, and help you maintain that separation on the road to an ever-increasing valuation and profitability.