The Logic of Profit
It's tough to make money in any business if you don't know what your critical number is -- and how to use it
Ask most businesspeople what their critical number is, and they will tell you it's profit -- or possibly cash. The smartest ones I know, however, almost always look at something else, often something that drives both profit and cash, usually something unique to their business.
I know a guy, for instance, who owns a couple of very popular restaurants in Massachusetts. He can tell how much money he's going to make on any given evening by the length of time customers have to wait for a table at 8:30 p.m. It's simple, he says. He has only so many tables in each restaurant, and he knows his average profit per table. By looking at the 8:30 wait, he can estimate about how many tables he's going to serve during the evening. He's figured it out from experience. From there, it's just arithmetic. So once he gets his critical number, he can let his entire staff know how the evening will shape up, and how fast they'll have to move customers in and out.
Or take my friend who, for 37 years, had one of the best gear-making companies in the Midwest. It was a sophisticated business, with highly skilled machinists, a huge investment in machine tools, and incredible manufacturing precision. Yet there was only one number he wanted to see when he came in each morning: the weight of the gears shipped the day before. Not the dollars. Not the orders. Not the number or type of gears. The weight. Why? Well, he knew what he was paying per pound for raw steel. He could figure out -- and add in -- his per-pound labor costs, depreciation, supplies, overhead expenses, and so on, and come up with a total cost per pound of finished product. So when he got the weight number each morning, he was really finding out all his operating costs. More important, he could use the number as a red flag. If the weight unexpectedly fell below a certain level, he could quickly zero in on the problem and make sure it got fixed.
Of course, a lot of people who run businesses don't recognize their critical number. A couple of years ago I had lunch with a manager of a hotel in Indiana that was part of a big national chain. He thought that his critical number was profit, and that the way to earn a profit was to control expenses. He did that by making sure each employee understood what he or she was supposed to do, how to do it, and how much to spend in the process. The only trouble was, the hotel was losing money.
I said, "Tell me, how do you make money in this business?" He said, "We fill rooms." I asked him how many rooms he had to fill to break even. He said, "Seventy-one percent." Currently, he added, the hotel was running at 67%. "How many people know that?" I asked. He said, "Two." I said, "Maybe that's your problem."
So his real critical number was the occupancy rate. He knew it; he just wasn't focusing on it. More important, he wasn't getting other people to focus on it. I suggested he put together a bonus program around the occupancy rate and then start posting the numbers. He decided to give it a try. The plan he came up with kicked in when the occupancy rate passed 71%, with bigger payouts the higher it went, all the way up to 87%.
All of a sudden, I'm told, things started to happen. Cabs came quicker. Telephones were answered on the first ring. Maids passed out cards, telling customers, "The next time you stay here, be sure to come and see me." Everybody got into the action, and the occupancy rate shot up. Before long, the hotel was one of the stars of the chain.
The moral, I suppose, is that it's not enough to know your critical number. You also have to know how to use it. Maybe your company is running so smoothly that you can just use it as a handy tool for keeping track of how you're doing. Me? I sleep better when everyone in my company knows our critical number -- and is working to improve it.* * *
Jack Stack is president and CEO of Springfield Remanufacturing Corp., in Springfield, Mo., and the author, with Bo Burlingham, of The Great Game of Business. His column, Critical Numbers, will appear every other month. Readers are encouraged to send him questions care of Inc.* * *