The 1 reason ‘Profit per X’ is the ‘nub’ of your strategy
Can you describe your strategy in a sentence?
We would define strategy under Michael Porters description “A unique and valuable position involving a different set of activities (from competitors)”
How is it possible to move from your current position to a ‘unique and valuable position’?
I think I know what you’re thinking, ‘that’s what I want, how can I get that from this ‘1 reason’ blog post!’ Well the bad news is that it is a process of Evolution, not Revolution. The ability to describe your strategy in a sentence, to have a crystal clear understanding of what you do in order to obtain a unique and valuable position comes about after a tried and tested application of the “Hedgehog Concept” as Jim Collins puts it, over time.
What is the Hedgehog Concept?
The Hedgehog concept is a simple description of the intersection of three circles as described by Jim Collins in Good to Great. “The essential strategic difference between the good-to-great and comparison companies lay in two fundamental distinctions. First, the good-to-great companies founded their strategies on deep understanding along three key dimensions-what we came to call the three circles. Second, the good-to-great companies translated that understanding into a simple, crystalline concept that guided all their efforts-hence the term Hedgehog Concept.” These three circles are Core Purpose, Brand Promise and Profit per X. When developing your BHAG we consider the disciplined application of the Hedgehog Concept over 10 to 30 years.
Your Profit per X or Economic Denominator is one of the 3 key elements of the Hedgehog Concept from Jim Collins and is a strategic metric, and not an operational one. The Profit per X is a key driver in your financial engine, and when you consider how to spend money (e.g. how many people to hire, where to open new locations, new products to launch) the answers should be determined by knowing which would maximise Profit per X.
Having a deep understanding of your Profit per X can provide an advantage, even during a downturn. The question Jim Collins offers in Good to Great to help you come up with this strategic metric is “If you could pick one and only one ratio – profit per x (or, in the social sector, cash flow per x) – to systematically increase over time, what x would have the greatest and most sustainable impact on your economic engine?” (p. 104).
By developing this single strategic metric that becomes the measure by which significant, strategic decisions are measured, a team is enabled to improve it’s discipline and focus as well as decrease the likelihood of spending on initiatives that end in failure or don’t align with the business strategy.
Profit per X definition
To create a successful Profit per X we use the following 3 criteria
- It must impact revenue, whilst controlling cost
- More X must be desirable
- It must be unique within the industry
The last of these “It must be unique within the industry” is the primary reason the your Profit per X is so critical when developing your strategy. If the key driver in your economic engine is the same as your competition, and you are all focussed on pursuing the same outcomes from the same customers, are you likely to appear unique, or are you likely to appear a commodity?
Profit per X case study
Imagine you own a lawn mowing company.
Just like your competitors every month one of your team members attends a customers house and mows the lawn. For this service you charge $50 per month. Because you are on a fixed price per lawn mowed, you would be leveraging your team of lawn mowing staff. The faster they can complete a houses’ lawn mowing the quicker they can move onto the next lawn and the more lawns a team member can mow in a week the more money you would make in that week. This would represent a Profit/X of Profit per Employee. This Profit per Employee would lead to such strategic decisions as only employing the fastest lawn mowers, paying lawn mowers per lawn mowed rather than per hour, buying faster / more efficient machinery and spending time planning the most efficient routes for lawn mowing staff each day.
Now imagine you changed your Profit per X to Profit per customer garden. This new focus would lead you to such strategic decisions as charging per hour rather a fixed price per lawn, providing gardening services, lawn fertilisation services and generally focussing on the quality of the garden and endeavouring to maximise the profit from every customer garden.
Thirdly imagine you changed your Profit per X to profit per serviced suburb. If your staff have significant downtime driving between customer jobs, this would increase the efficiency of the business. It would lead to such strategic decisions such as referral programs for neighbours, bulk servicing offers (e.g. fertiliser week offer), Autumn leave collection etc.
Of course a key part of the question is what business model do your Core Customers need? If your customers are all landlords who don’t care about the gardens it is likely they will be more motivated by price.
This is why the selection of your Profit per X is so important and the nub of your strategy. If it meets the 3 criteria above it will provide the answers to strategic questions you have concerning new investment and growth of your firm well into the future.
Walgreens Profit per X
The metric Profit/Customer Visit is the key driver for their financial engine. The industry standard metric of profit/store actually was contradictory to their purpose – convenience.
If they based decisions on store location on profit/store, they would not be able to justify putting the stores so close together; the economics would not make sense.
But, since they were committed to convenience, they discovered that their financial engine actually ran on profit/customer visit. Therefore, they make strategic choices that increase the likelihood that people coming into Walgreens because it is conveniently located will spend more money each time they visit.
Profit per X examples
Here are some examples of Profit per X to help you determine your Profit per X
- Profit/customer experience or customer visit
- Profit/geographic region
- Profit/part manufactured
- Profit/life of customer
- Profit/local population
- Profit/market segment
- Profit/square foot
- Profit/fixed cost
- Profit/recurring revenue client
- Profit/product line