Determining Your Firm's True Economic Driver

In his excellent book, Good To Great, Jim Collins defines a firm’s economic driver as the single, most important factor on a company’s bottom line. Once the 11 companies featured in the book got a lock on this factor, all business decisions were geared toward sustaining, or enhancing, the key economic driver. So disciplined, these firms achieved a financial performance far greater than any competitor, or any Fortune 500 company, for a period of at least 15 years.

As a kitchen/bath firm owner, what is your Key Economic Driver? To be sure, during the recent 2008-2009 Great Recession, most kitchen and bath firm owners would probably answer “sales” because it was what they needed to stay open and have some semblance of a positive cash flow, even if it was just temporary. Indeed, ”sales” might be the dominant answer even in good economic times. But I have known for years that is not it.

I had been doing a lot of thinking about this topic since I reread Collins’ best-selling 2001 book a year and a half ago. From my perspective, I get to review a lot of financial statements which represent a wide array of business models in this industry. Despite the obvious dissimilarities in these models, there are critical elements of success and expense that are common to all. As a result, I was confident that there was probably one single economic driver that also would be common to all kitchen/bath owners.

At one point in my thinking, I thought the key economic driver would be Gross Profit Dollars/# of Employees. But the Great Recession had made me acutely aware that the number of employees wasn’t nearly as critical as the amount being paid out to them. If someone was being overpaid for a diminished performance, that would create a negative effect on a firm’s bottom line. Conversely, if the owner was underpaying himself or herself (as many do by 25-35%), it would have the opposite effect.

As a result, I came around to believing that the Key Economic Driver for most kitchen/bath firms, regardless of their business model, conceivably would be Gross Profit Dollars divided by Payroll Expense (see right):

To test this theory, I solicited the help of SEN Design Group members. If this theory proved itself to be true, SEN could establish a useful Economic Driver Benchmark for its members to model for their own operations. And if this information could help our members become more successful, they will likely buy more products from our SEN vendors …. leading to higher levels of rebate returns for everyone.

So late last year I asked the membership to do the following:

1. Break out their Income Statements for the last 3-5 years (the more the better!);
2. Calculate the Gross Profit Dollars/Payroll Expense Factor for each of the 5 years;
3. Calculate the Gross Profit Dollars/Payroll Expense Factor for 2009 through Oct. 31st;
4. Document how many times the Largest Factor also coincided with Higher Net Profits;
5. Forward their results to me. They would be kept in strict confidence, but used in a compilation report for the group.

A total of 14 firms furnished this information by the requested deadline date. Now, at first blush, the sampling of 14 companies might easily have been considered insufficient to develop an accurate benchmark that would have value in the industry. But upon closer examination, the analysis would cover 71 years of data supplied from a variety of business models, both large and small, located from coast to coast. (Only one firm’s data was excluded because it was founded as a granite and solid surface countertop fabricator that had only recently opened a cabinet department).

Ultimately, I felt quite comfortable that these 13 firms, with 71 years of data, would produce an accurate benchmark result.

Conclusions

The conclusions of this analysis are as follows:

Some 12 out of 13 firms achieved their greatest Net Profit when the Gross Profit $/Payroll Expense Factor under study was the highest.

The average Net Profit of the 13 kitchen/bath firms in their best years was $257,000.

The average Gross Profit $/Payroll Expense Factor was 2.211 in these firms’ best Net Profit years.

There is a compelling 92% probability that a kitchen/bath firm’s Key Economic Driver is, indeed, Gross Profit Dollars/Payroll Expense.

An Economic Driver Goal of 2.200 should be embraced as the most critical benchmark with all business decisions being made – such as budgeting, new profit center opportunities, etc – to insure a maximum Net Profit for kitchen/bath firms.

In keeping with the findings of the research documented in Good To Great, kitchen/bath firm owners going forward would be wise to make certain that all their business growth endeavors fall within the intersecting circles as shown in the graphic at bottom, left. Collins and his research team referred to this dynamic as “The Hedgehog Concept.” As long as kitchen/bath firm owners stay true to (1) what their passion is, (2) what they can do best in their marketplace, and (3) what their Key Economic Driver is, they will outperform their competition many times over for a sustained period of time, making a lot of profit in the process.

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