Wharton Professor Len Lodish says, "It's better to be vaguely right than precisely wrong." And he's right -- until it's time to get precisely right. Amazingly enough, if you want to understand what's going on below the surface of your organization, and why it's happening, you have to get very precise and dig into the details.
One of the classic oversimplifications has to do with unit-level economics. Way too many business people do not understand the difference between marginal and total costs. (Marginal costs accrue with each unit of production, like the cost of lemons, sugar and cups at a lemonade stand. Total costs include those costs plus the fixed costs that do not change, like the cost to build the lemonade stand solely by itself.)
Unit-level profitability is a non-trivial matter in determining the right price for your product or service. If you price below your marginal cost, then the more you sell, the more money you lose. If you over-allocate fix costs and try to price to cover those costs, your competitors can undercut your pricing and take business that should have been yours.
East Coast Wings & Grill CEO Sam Ballas understands this. He applied his financial background to his family's restaurant business to "move the needle with numbers." His insight was that profit and loss statements, balance sheets and cash flow statements are retrospective pictures of what happened. To understand what is happening now and why requires a deep dive into micro-level data as close to real time as possible.
Ballas figured out that it's not good enough to look at numbers on a monthly basis. It's not even good enough to look at them on a daily basis. He and his team worked to understand variances within the day. He wanted to understand traffic count -- who was coming back or not coming back and why. They looked at the menu mix by day part. They looked at food cost, recipe costs, and how product moved through their stores.
After 38 quarters of same-store-sales growth, Ballas and his team hit a wall in August. Same-store sales were trending down. To understand it, they looked at the entire system and picked five units through key performance indicator overlays that resembled much of the system. These stores were doing okay. Four had sales increases. One was flat.
The real discovery was that these stores' traffic was down 3 to 6 percent, but their sales per transaction were up. A new loyalty program had increased sales per transaction by $2.80 across the chain. But these five stores sales per transaction were up $4.10. Their loyal customers were spending more.
So Ballas and team adjusted their short-term efforts to maximize the impact of the loyalty program across the chain, leading to their 39th quarter in a row of same-store sales increases.Ballas knows he can grow business with existing patrons, recapture lapsed patrons, or attract new patrons. To do this, he and his team dedicate assets to understanding and leveraging unit-level economics. His prescription:
- Identify and understand key performance indicators and benchmark them internally and externally.
- Dedicate assets so that you have professionals looking at logistics and accounting.
- Be transparent with your franchisees, employees, or partners. Get them on board.
You get what you can measure. The simpler and more focused you can keep your core measurements, the more likely your team will deliver those. But do not shy away from more complex measurements if your business is complex. In the end, it's not about making it easy for your franchisees or employees. It's about creating and capturing real value.
This blog post originally appeared on Forbes.com.