Determine Your Economic Engine With 2 Metrics
Determine Your Economic Engine With 2 Metrics
In our work with leadership teams, we use proven frameworks to consistently build, validate and evolve strategic plans. The Hedgehog concept from Jim Collins is one of them, helping our clients explore their strategic core, acting as a guardrail as they climb their growth mountain towards the summit, or as Jim Collins calls it, the BHAG.
In his book “Good to Great”, Jim Collins explains the Hedgehog as a concept to focus an organisation’s efforts on the intersection between three circles.
- What are you passionate about?
- What are you best in the world at?
- And finally, and this is the one we’ll explore further now; what is your economic engine? Or Profit per X.
We often see leadership teams not only struggling to define their Economic Engine, but also understanding how to use it to enrich their strategic conversations.
To better understand this concept, let’s break that down into two metrics, your Impact Denominator (your X) and your Financial Numerator (your Profit per).
Your Impact Denominator
Collins suggests the following question: “If you could pick one and only one ratio – Profit per X – to increase systematically over time, what X would have the greatest and most sustainable impact on your economic engine?”
One of our clients in the consulting industry initially agreed on ‘Project’ as their impact denominator. During our quarterly planning workshops, the conversations were focused on how to increase the number of projects, how to increase the revenue and reduce costs associated with projects, and how to galvanise everyone around that impact measure.
After a while, the leadership team found a constraint in their business model having marketing costs increasing to generate new leads that will turn into projects, and an operational turmoil in maintaining a profitable schedule of projects and resources. That Profit per X ratio was difficult to scale.
After validating a monthly retainer model in their market, a new impact denominator emerged, Monthly Recurring Clients. That led to better aligning the business’s key functions and processes to that new retainer model and keeping everyone focused on that new economic engine.
A non-monetary measure helps everyone connect to what makes money in your business (as opposed to pure financial measures), and galvanise them around the impact you want to make in the world.
Here is some guidance to identify and validate your company’s impact denominator. Start by identifying the widgets that flow through your business model and generate money. Some examples could be Customer, Project, Transaction, Returning Customer, Man/Hour, Employee, Contract, widget you sell.
Then discuss with your leadership team if you could impact revenue and costs by focusing on that impact denominator. And if your business model would be scalable as you increase the number of X’s. If so, you’re on the right path.
Your Financial Numerator
For the financial result (our Profit part of the ratio), finance people might consider a different interpretation of ‘Profit’, such as Gross Profit, EBIT, EBITDA, Net Profit. Whilst any profitability measure is theoretically correct, you might want to consider a practical and easy-to-measure financial numerator to start with.
How To Use Your Profit Per X
Once you identified your impact denominator (your X) and financial numerator (your Profit per), you can include them in your P&L annual forecast, showing a month-on-month view of the company widgets and providing perspective on the actual-to-forecast as you move forward.
During your quarterly planning sessions, discuss with your leadership team the company’s performance on the Profit per X, and what priorities need to be agreed on for the next quarter to improve.
Some questions that will prompt a debate are:
- How can we better impact our revenue on our impact denominator?
- How can we better control our costs on our impact denominator?
- How can we get more X’s (your impact denominator)?
- What processes and systems do we need to better align with our Profit per X?
- How can we better align and focus our employee’s efforts on our impact denominator?
To learn more about how you can define, validate and evolve your Economic Engine to create momentum in your business, please contact us.
