The Magic Number
This spring, my records-storage business was all geared up for a big growth spurt when I received the two-page report I get on each of my businesses every Monday morning. Among other things, the report tells me how many new boxes we put away each week. For months, the number had been increasing steadily as our Manhattan-based customers -- mainly law firms, accounting firms, and hospitals -- struggled to get their records off-site in the wake of 9/11. In one year we grew 55%. But as I looked at the report that morning, I was shocked to see that the prior week we'd put away almost 70% fewer new boxes than the week before.
That stopped me in my tracks. The new-box count is one of my magic numbers -- a reliable indicator of what my overall sales for the week actually were. Although new boxes represent only one element of my total revenue, I've learned over the past 13 years that our sales rise in direct proportion to the number of new boxes we add in any given period. Tell me on September 1 how many new boxes came in during August, and I can tell you our overall sales for August within 1% or 2% of the actual figure. The 70% decline in new boxes suggested that we could be looking at a significant slowdown.
That was, of course, important information -- information I never would have gotten so fast if I hadn't figured out a formula for calculating total sales based on new boxes. In the beginning, it was by no means obvious that new boxes would prove so significant. For one thing, they account for only a small percentage of our overall sales. We get revenue from many sources, including optional services, removal charges, and special projects, not to mention storage fees for boxes we already have. If I didn't have a key number, I'd have to add up sales from all the different sources to get the total. As a practical matter, that would mean waiting until we did our monthly billing.
But I don't want to wait that long, and fortunately I don't have to. Years ago, after much searching, I zeroed in on the new-box count as the bellwether of sales. Why that particular number? I have no idea. It's a little like extrapolating the sales of a department store from the number of shoes it sells, but for whatever reason, the new-box formula works for me.
I believe every business has magic numbers. A restaurant owner I know can predict his evening's receipts by the length of time customers have to wait for a table at 8:30 p.m. My friend Jack Stack, the father of open-book management, told me about a guy with a gear-making company who can determine his sales from the weight of the gears that have been shipped. Not the dollars. Not the orders. Not the number or type of gears. The weight.
Indeed, the best businesspeople I know all have key numbers they track on a daily or weekly basis. It's an essential part of running a successful enterprise. Key numbers give you the financial information you need to take timely action. Business moves too fast to wait for the monthly, quarterly, or annual statements. By the time you get them -- weeks or months after the end of the period -- you're already dealing with the consequences of whatever problems may have arisen when you weren't looking. You've probably missed out on a number of opportunities as well.
To operate successfully, you need real-time information -- and not only about sales. If you just track sales, you can get into serious trouble. Sales don't make a company successful. Profits and cash flow do. A lot of companies land in bankruptcy court because their owners focus so much on driving sales that profit and cash become an afterthought. I speak from experience here. I was one of those owners.
I might have avoided that fate had I paid as much attention to my gross margins as I did to my sales. Why? Because gross margins determine how much money you have available to spend on things like rent, electricity, telephones, salaries of salespeople and administrators, health insurance, bank interest, and the like -- everything, in short, that isn't directly involved in producing whatever it is that you sell. If you're thinking only about increasing sales as fast as you can, you'll be tempted to make decisions that could imperil your gross margins. That's what I did. My sales went through the roof, but my gross margins shrank dramatically. In the end, my company couldn't generate enough cash to pay all the bills. It wasn't long before I had to file for Chapter 11.
Ever since, I've tracked my gross margins like a hawk. To calculate them, you have to know both sales and cost of sales (also called cost of goods sold) -- that is, the direct costs involved in producing what you sell. In service businesses like mine, direct labor is usually the largest component of the cost of sales, and you can use it to get a quick read on changes in your overall cost-of-sales number. Accordingly, direct labor is the key number on the cost side that I monitor on a weekly basis.
The key number for sales, however, varies from business to business, and it's seldom self-evident. With new ventures, I often have to follow the numbers for years before I can identify a single indicator that will tell me quickly what my sales are.
Take the document-destruction business that I started in the spring of 2000 with my friend Bob Feinstein and his son, Trace. We get our revenue from two types of services that we provide. One service involves so-called cleanouts, wherein we destroy a large volume of sensitive documents that a customer has accumulated over a long period of time. Those tend to be one-shot deals. Other customers routinely produce material that needs to be destroyed on a regular basis. In those cases, we place locked bins around the customer's offices. The company's employees slide the material through a slot in the bin, which we then come in and empty according to a schedule that is worked out with the customer.
"One restaurant owner can predict his evening's receipts based on how long customers have to wait for a table."
The revenue from the cleanouts is easy to track, since we do only a few each week. The bin business is trickier. For openers, there are two different types of bins, and each type comes in different sizes. We charge customers different rates depending on the number of bins they have, the size of the bins, the type of service requested, the frequency of pickups, and other factors. So there are a number of variables that go into determining overall sales. I've been tracking them from the beginning, and I still don't know the key number for sales in the bin business. It could be the number of new bins added, or the total number of bins outstanding, or the number of pickups, or something else altogether. I'll have to track those numbers and others until I'm able to pinpoint the measurement that best correlates with sales as a whole.
That's going to take time. Even after three and a half years, we don't have enough experience, or enough bins, to understand the relationships between the numbers. But sooner or later, I'll come up with the number. How important is it to find that number? Consider the experience of my records-storage business this spring.
As I mentioned, I was taken aback by the decline in the new-box count. Up to that point, we'd been in constant hiring mode. It took lots of people to handle all the new boxes coming in, and we had to recruit four times as many people as we needed, since only one out of four new hires winds up staying with us. When I saw the drop in the new-box count, I was immediately concerned that our rate of growth might be slowing, which would mean we wouldn't have as much cash flow as we'd anticipated. To be sure, the drop might have been a one-week aberration, but I didn't want to take a chance. If our annual growth rate really had fallen as much as the drop indicated, we were already overstaffed by about 30 people. While we could let normal attrition take care of that problem, I didn't want to keep adding people at the planned rate. If sales didn't bounce back, we might be forced to do a layoff.
So, based on one week's numbers, I put a temporary hold on hiring. "Let's see how this plays out," I said. As one week turned into one month and then four months, it became obvious that we weren't dealing with an aberration. The market had changed. Evidently customers had finished clearing out the records they wanted to move off-site after 9/11. Our sales were still growing, but the rate had plunged from 55% to about 15% annually.
My caution was vindicated, which is the best part of having a magic number. Afterward, you look like a genius. My staff is still impressed that I saw the reduction in our growth rate so early and acted so quickly. I just tell them it was all in the numbers.
Norm Brodsky (firstname.lastname@example.org) is a veteran entrepreneur whose six businesses include an Inc. 100 company and a three-time Inc. 500 company. This column was co-authored by Bo Burlingham. Previous Street Smarts columns are available online at www.inc.com/magazine/columns/streetsmarts/.
NORM BRODSKY | Columnist
Street Smarts columnist and senior contributing editor Norm Brodsky is a veteran entrepreneur who has founded and expanded six businesses.