The Value of Performance Bench-marking
By Dave Costello, TCV Growth Partner,
As a business owner or entrepreneur, do you ever wonder if your business is doing as well as it could? Sure, you know how YOUR business is doing, but here’s a couple questions to think about:
Is your gross margin consistent with the average of your industry?
Is your net profit margin consistent with the average of your industry?
Are your inventory turns as good as the best in your industry?
The first step in working through this process is to make sure that you have good metrics and KPI measures coming from your accounting system. These won’t necessarily be reported by your accounting system, but your accounting system should provide accurate information to enable you or your CFO to calculate these metrics. For example, your Quick Books system may not tell you what your gross margin percentage is, but it should provide reasonably accurate revenue and cost of sales information so that you can calculate your gross margin. Gross margin is simply the calculation of revenue less cost of sales divided by total revenue.
OK, you have that number. What does it mean? If you only have your company to compare yourself with, you can’t really know whether you are doing well, or not so well. You need industry information that you can compare to your company. Here’s what I mean. Suppose your gross margin percentage is 35%. You may be thinking WOW, that’s fantastic! But, if you knew that the average gross margin for the industry in which you are competing in is 55%, you may not feel so good.
That’s when the questions start:
If the AVERAGE performance for my industry is 55% and I’m at 35%, what am I doing wrong?
How are those other companies achieving a 55% gross margin and I’m at 35%? What are they doing better than me?
What changes do I need to make to move the needle closer to achieving that 55% gross margin percentage?
If 55% is the average, what are the companies that are top performers achieving? And, how do I get into that category?
You see, the value of bench-marking really opens your eyes to the possibilities that exist. Or the information may say that you are doing a good job! Keep up the good work! Chances are, though, there are a few areas where you could achieve improvement.
When I was in the world of financial services, I was always comparing the bank I was with to the one down the street or across the state or the statewide averages. Of course, in that world, it was easy to get data on every other financial institution and the industry as a whole. The FDIC made it easy, and that information continues to exist today.
With other industries, it may not be as easy to get comparative information. One approach might be to identify a competitor in your industry that is a public company and get their annual report. It’s a little more work, but at least it would give you their financial information so that you could calculate their metrics for comparison to your metrics.
Another way may be to ask your accounting firm if they have access to data bases that provide industry statistics or metrics. If they do have access to such information, it should be easy for them to provide it, or to do a comparison themselves to be able to show you how you are doing. When I was in public accounting, we used to do that on a limited basis.
Although it would cost to use this source, the RMA provides information on many industries. It is called RMA Annual Statement Studies. If you are part of a professional association in your industry, it’s possible they may have access to this information and could provide it for you for a nominal fee. Your accounting firm also may use this as a source of information if they can provide this kind of analysis.
The next question to deal with is what metrics and KPIs should I be measuring? I advise my clients to use the most important 3 to 5 metrics when setting goals for budgets or strategic plans. The reason for this is that if you have more than 5 KPIs to focus on, your effort becomes too diffused and disjointed. You can only think of a few things while at the same time running your business, so make sure those things you are focused on are the most important things. You can always change metrics if it turns out you picked one that’s not that important after all.
When doing bench-marking I think it’s OK to use between 5 and 10 metrics or KPIs for comparison. One metric is not enough to focus on. We mentioned gross margin percentage above, but there are multiple processes that impact gross margin, so you need to have a handful of metrics you are using. Make sure your top 5 most important are included, but it’s OK to measure the next 5 KPIs in bench-marking that you think are important. Again, you can always make changes in your measures if it turns out the one or ones you picked aren’t providing relevant information for you. The exercise of bench-marking is to provide valuable information to help you improve the performance of your business. Make sure you are using the metrics and KPIs that do this for you!
One of the things I liked about the FDIC metrics is that they also told you what percentile you were in. For example, one of the metrics I measured was Return on Assets, which is a standard for measuring financial institution performance. I might have been at an ROA of 50 basis points and the average was 55 basis points. So you are thinking that’s not so bad. My percentile ranking was likely at or near the 50th percentile which says I was in the middle of the pack. But I knew there were institutions that were at 100 basis points or better for their ROA performance and I always wondered what are those teams doing that I should be doing? I was always seeking ways for improvement. And that’s one of the values of benchking.
If you need some assistance in getting started you can always reach out to me for a conversation.I’m happy to help or get you started on the right path.My email address is dave@techcomventures.com