Metrics: The Writing on the Wall

Sep 7, 2016

Sep 7, 2016

“There are two possible outcomes: if the result confirms the hypothesis, then you’ve made a measurement. If the result is contrary to the hypothesis, then you’ve made a discovery” – Enrico Fermi, Nobel Prize winner in Physics

Metrics are crucial in clarifying which issues are most important to a business. The best companies have their metrics written on the wall — quite literally. Our top companies often keep their important metrics up on large screens in the office updating in real time. The best metrics are more than measurements; they are a rallying point and a cornerstone of the company’s culture.

Therefore, one of the first things we do when we meet a company is sit down with the founders and discuss the key performance metrics as well as the framework the company uses to track and report these metrics in a systematic way. This gives us as investors a better ‘vocabulary’ with which to discuss the business with the founders, and it also produces insights into ways the company can improve its processes internally.

While these discussions vary greatly based on the type of business model involved, the stage of the business, and the experience of the entrepreneurs, there are some common points of discussion that frequently come up. Below we highlight a few of the things we frequently discuss with founders, in hopes that they can help you as you build or improve upon your own metrics and reporting frameworks.

Operational vs. reporting metrics

A common mistake companies make is confusing reporting metrics (e.g. headline metrics) with operational metrics: the actual levers and dials executives can pull and turn to create changes in their business. A pitfall of many executives is that they try to operationalize around reporting metrics, which is both ineffective and potentially harmful.

Consider a common area of focus today for many companies: Gross Margin. Gross Margin is obviously a very important reporting metric because it’s part of a common business vocabulary which allows you as a founder to explain and think about the business with respect to thousands of others — but it’s fundamentally a derivative of decisions your leaders make. It might be helpful to talk to your investors about, but trying to use it to run day-to-day activities will be a disaster.

Instead, you need to unpack the variables which determine Gross Margin. If you’re a SaaS business, this might be attributable customer support/success costs, which might further break down into the amount of engineering time spent doing custom integration. If you’re a physical CPG company, Gross Margin might break down into commodity costs, labor, packaging, delivery costs and discounting.

So while you and your board might set the goal of increasing Gross Margin, you and your executives are really trying to reduce the time spent on custom integration — and therefore you invest in productizing certain parts of your platform. Or you make the strategic decision to study the price sensitivity of your customers in the hopes that you can reduce the discount rate.

Generally, focus on reporting metrics in the board room. The rest of the time, have a clear understanding the operational metrics which ‘roll up’ into these reporting metrics, and set internal operating objectives around these.

Interdependence and non-linearity

Breaking apart headline metrics as discussed above presents a troubling complexity (that hopefully you deal with before charging forward on taking action on metric improvement). That complexity is that nearly all the parts of your businesses are connected in some way. Therefore, it’s not enough to break apart a headline metric into operational components and start optimizing. Reducing discounting might increase margins, but it could also negatively affect customer acquisition, which (beyond reducing revenue) reduces density and increases delivery costs. This negatively impacts Gross Margin.

Additionally, these relationships are almost never linear or continuous. This makes it especially difficult to have a high degree of confidence in the way your business will change when you start adjusting things.

While this complexity may seem impossible to deal with — and it is very hard — it’s feasible to map out the relationships between the key drivers of your business. Initially, you may be confined to general heuristics, intuition, and paranoia. But as you mature as a business, you can be far more sophisticated. Start by having unified systems (processes and internal software tools) which structure and store your company’s’ operational data, and make this data far more robust by having an internally focused data science (or even operations research) team.

Regardless of the stage of your business, the key is thinking deeply about the choices you make while chasing improvements across metrics, and attempting to quantify the unintended consequences of your actions — or at least quantify your uncertainty about the consequences.

Metric reporting as QA on operations and process

A robust reporting framework is explicitly valuable because it level-sets the organization, aligns company leaders, and distills highly complex systems into a common idiom. And the process of implementing this kind of framework has the added benefit of testing your organization’s operations and processes.

A private equity fund we deeply respect once mentioned something about their diligence process which struck us as insightful. They would ask a company to produce salesperson-level commission data across the organization. If the company couldn’t produce it in 24 hours, then they wouldn’t invest. Why? They took this as a sign that either the firm’s management wasn’t disciplined enough or their systems and processes were unsophisticated. Either way it was a deal breaker.

You can use metric reporting as a similar test of your own business and expose possible weaknesses or gaps well before it becomes a problem. Start small; would you be able to produce the same report on your metrics within a 24-hour window every month? Every week? What about within a 30-minute window? Pushing yourself to improve on the consistency, accuracy and completeness of your reporting is a good way to stress-test your business and improve as management team.

The importance of DRIs (Directly Responsible Individuals)

Ultimately the CEO is responsible for their company’s success, and therefore it’s natural that they feel responsible for the performance of key metrics and the systems that monitor them. That being said, the role of a CEO is to delegate operations to their executives, and it’s important to make sure that as your company scales you make your executives directly responsible for reporting and monitoring their respective business units. And this applies to the metrics by which these units are judged.

If you don’t feel one of your leaders is capable of being responsible for at least one of the metrics you measure, this should act as a major red flag. If you catch yourself explaining away or making excuses for them, it’s probably a sign they aren’t capable and/or senior enough to get the job done. You should find someone who is.

Metrics and board dynamics

Metrics and formalized reporting are inevitable for any successful start-up. Some day (whether now or when you go public), you’ll likely have a board of investors who represent shareholders to whom you are legally responsible, and consistent transparency into the performance of your company becomes a legal responsibility.

Regardless of this eventuality, reporting metrics to your board can often times be annoying, time consuming and lead to “rabbit hole” discussions. It can feel like your board is either clueless (asking basic questions) or misguided (asking the wrong questions). Sometimes this can lead founders to resent full reporting to their investors.

You will often be correct in suspecting that your investors are out of the loop — most of the time we are confused or uneducated on your business relative to you. But ultimately the reporting dynamic with your board is your responsibility. If you are logically consistent, transparent, and clear, then your board will develop trust in your process and everyone will be on the same page more frequently. If you are sloppy or unsophisticated then they will likely become scared and give you headaches.

Lastly, no business or methodology is perfect. You will make mistakes and miss your goals. The best entrepreneurs (and investors) recognize this and aren’t afraid to be honest about shortcomings. Sometimes less experienced founders will hide mistakes and misses from their board. This is a huge mistake. It breeds a culture of mistrust within your investor base, which undermines your authority as CEO. Even worse, it prevents you from learning and improving your business over the long term.

The process of building a successful company is slog of iterative improvements interrupted periodically by moments of epiphany. But both mundane and genius advances require an understanding of the past and present state of your businesses fundamentals — past and present. A robust and well-designed metrics framework mitigates downside by eliminating surprises while producing insights that position you for exponential growth. So if you haven’t done it already, sit down with your leadership and establish the core metrics that drive your business. And then grab the biggest screen you can find and put them up in lights!

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