Mark Twain said “There are lies, damned lies,…and then there are statistics.” In some instances he could have just as easily been talking about metrics.
We all understand the need for metrics when it comes to running a business. If you can’t keep score, how do you know if you are winning or losing? Just remember when you start basing compensation on these metrics that it is changing the game that is being played.
Here is a good case in point. A business I knew was running in the red. A look at the product prices (and costs) showed that it was almost 20% more expensive than the competition on a cost basis. However, based on the operational metrics they were running at the peak of efficiency (99+% on the production yield targets). How could this be?
A deeper dive into the metrics showed that over time the production yield targets had been lowered (to an 86% yield target!) so that the operational team could maximize their goal attainment and incentive compensation. They were actually achieving 99+% of an 86% target. The rest of the market was attaining true 99+% production yields. The incremental 14% disadvantage in production efficiency was the root cause of the product cost differential in the market.
Over time it had become easier for the operation to change the metric that it was measured (and paid) on, than it was to improve the process. This is obviously an extreme case, and it was a metric “creep” that had occurred over many years. But it does point out how a metric can affect how you look at a business’s performance. You can go from looking seriously at exiting a business because it is thought that it could not effectively compete, to looking at the root cause of the issue: how do you make the business more efficient and continue to compete.
When we run businesses we all walk in assuming that everyone in the business is on the same page and that everyone is pursuing the same goals – namely the success of the business. My experience has shown me that this is not usually the case.
Here is a quick test to prove my point: Does everyone in the business have the same compensation and incentive structures? Most likely not. Therefore it pays to review each disciplines (Sales, Marketing, Operations, etc.) incentive structure and make sure their goals are aligned.
A case in point: The sales team is normally provided incentives (commissions) based on revenue attainment. This is good. You need to have someone responsible for attaining the business’s the top line. However, this may not be enough. In a volume only incentive plan, price becomes the sales team’s primary differentiator. The sales team will now create friction within the business trying to drive the selling price down to make it easier for them to sell. If you have a sales team that is pressing that prices are too high, you might want to look at their compensation plan as one of the possible causes for this friction. (On the other hand you also need to make sure that you are not overpriced verses the rest of the market, and if you are how you quantify the incremental product value you claim to have. I’ll look at this in later blogs.)
A solution can be to make sure that the sales team has both revenue and gross margin target goals (sales cannot affect other costs of the business as directly as price and hence should have gross margin, not earnings targets) as their objectives. Provide compensation accelerators for business above target margins (this is business that is good for everyone and should be encouraged) and compensation decelerators for business below target margins (just because it is lower margin business doesn’t mean you don’t want it, it just means it is not as valuable to the business – and hence not as valuable to the salesperson, as higher margin business).
Targeting and attaining higher margin business will help exceed earnings targets for a target revenue amount. This is a very good situation and the sales team needs to be rewarded for their part in it. Taking lower margin business means you will need more revenue to meet your earnings dollar commitments. Your sales team needs to participate in this with you as well.
Welcome to my blog. I have often thought of writing about some of my experiences in the business world. I have decided that it is time to do it. Please let me know what you think. Please check back soon for new entries.