Your Profit/X or financial engine is one of the components of Jim Collins’ Hedgehog, and one of the three key areas to consider when working on your BHAG. Your profit/x is how you choose to make money; it is a strategic metric, not an operational one. This ratio is a key driver in your financial engine, and when you make decisions about how to spend money (which products to launch, where to open new locations, how many people to hire), you should be guided by asking how it maximizes your profit/x.
Insight into the right financial driver can help your company succeed even if you are in a failing industry. 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).
Forcing yourself to identify one denominator by answering the question above will provide insight into what drives your economic engine. Digging in to really understand the economics of your company is supposed to get you to think differently rather than choosing what seems like the obvious answer. The exercise of thinking strategically about your profit/x should generate debate among your team members. In Collins’ study, the companies that took the time to discuss, debate, and agree on one key driver for their financial engine are the ones that went from good to great.
What makes this strategic metric useful is that it is so specific to your business and to your company. One of the examples in the list below that is absolutely right for someone else could be absolutely wrong for your company. But, hopefully these examples will get your brain working.
Here are some examples:
To give more context to these examples, a couple of case studies may be helpful:
- Walgreens: The metric Profit/Customer Visit is their 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.
- Rhythm Systems: Our profit/x is Profit/Recurring Revenue Client. We are not a transaction-based company; we don’t focus our efforts on selling a one-time event or product. Our economic engine is built on lasting relationships with clients who will continue to work with us over time. So, when we think about product development, we think about building new features in our software that will be valuable to our clients over a long period of time and increase our client retention. When we think about hiring, we think about bringing in expert consultants who can offer great insights over time and ask questions to help clients grow rather than trainers who can give a lot of information quickly and then leave. We think as much (or more) about delighting our current customers as we do about attracting new ones.
Hopefully these examples and brief case studies will be some food for your strategic thinking as you and your team work to uncover insights about the key drivers in your financial engine. Once you have an idea of what your Profit/X may be, record it in Rhythm software, and begin using it to see if it helps inform your strategic decisions.
Does considering your Profit/x make it easier to decide where to invest your resources? If not, then you may need to go back to the drawing board and put this in your team’s Think Rhythm.
Looking for some more information on BHAG to help get you started? Check out our additional resources:
Editor's note: This blog was originally published on Oct 29, 2014, and has been updated.
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