14 May, 2017

The importance of knowing how you make money

If you’ve thought much about why your business exists, you’ve probably come up with some worthy statement of business purpose. Good; but what about making money? I’m not denigrating high ideals of business purpose, but a business that doesn’t make money can’t achieve those ideals. Some business leaders seem ashamed to explain this fact of life to their staff. Indeed, in many companies, most staff do not understand how the company makes money or their responsibility and role in that. That’s madness. If your people don’t understand your business model and its key metrics, any targets you set may seem capricious or arbitrary. That can mean wrong operating decisions and a high probability of staff not taking responsibility for their own contribution (or lack of it) to the viability of the business.

Let’s look at a very simple business - hourly-billed services (basic labour or top-end professional services):
  • You pay people for 52 weeks of 5 days = 260 days a year. At 8 hours per day, that’s 2080 hours of costs.
  • Let’s allow for, say, 20 days annual leave, 10 days public holidays, 5 days technical training, 2 days on company process training and 3 days off sick. That’s 40 days your people are not on the job.
  • That leaves 220 days or 1760 hours to do the job.
  • Assuming good productivity at say 80% (allowing for time on internal non-client stuff, proposals, waiting for new jobs to start, etc.) that’s ~1400 hours of billable work a year.
  • Spread over the 220 days, that’s ~6.5 hours billable every day.
I assume that you are in a competitive industry, but your pricing of those 1400 billable hours hopefully reflects your actual 2080 hour costs (don’t forget training, insurance, office rental, IT costs, sales, management, administration, etc, etc, etc.) plus a reasonable profit. That 6.5 hours a day is the minimum required daily billable time from your staff. Importantly, if someone has a quiet day, the shortfall has to be made up quickly - there aren’t enough spare hours in the year to catch up a long period of low billable activity. Yet many of the people who work in hourly-billed services (and even some who run them) don’t understand these relentless numbers and their responsibility for achieving them.

Some business leaders don’t share their business metrics with their staff, perhaps because of unnecessary embarrassment about the profit motive or a concern that staff won’t understand. My experience is that people respond well to knowing these things. I once explained the company’s cost of capital to a group of electricity network construction workers,  Simple examples, relevant to the team's work and personal lives, got across the idea of relating risk and return. That, together with an explanation of depreciation, maintenance and operating costs, saw them volunteering many suggestions for simpler line maintenance vehicles - the most dramatic being a change from the ubiquitous standard $250k line truck with HIAB (onboard hydraulic lifting arm) to more $30k utility vehicles!

Everyone who works for you needs at least a rudimentary understanding of:
  • Your business purpose, market offer, ethos and modus operandi
  • Your business processes
  • Your revenue model
  • Your cost structure (operating and capital)
  • The rationale behind them
  • Your people’s individual roles and responsibilities in making the business work.
PS. If your pricing doesn’t cover your costs and a reasonable return on capital, you have to change something (your price, your product, your operations, your promotion, your tough-mindedness in customer negotiations, something) to ensure that it does. Otherwise you have to somehow get out of the business, or you’ll go broke. As the US auto industry had to learn, harsh realities must be faced and overcome.

First published 25 May 2009

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