What is your small business' critical number?

At the beginning of each year, individuals and organizations establish a range of resolutions and goals for the future. In some businesses, you may find so many goals are listed that it's difficult for employees at all levels to identify what is the most important for focusing on.

James Collins noted author of such books as 'Built to Last' and 'Good to Great' suggests firms identify their economic engine, or the one metric that "...connects operations of your business, coming up with subcomponents that roll up into it and beginning to put together a lot of parts that ultimately add up to the overall economic denominator." (link: https://www.jimcollins.com/media_topics/ThinkingAboutYourEconomic.html)

One example that Collins uses from 'Good to Great' is Walgreen's "profit per customer visit" as their economic engine metric, a shift from previously "profit per store". According to Collins, "The ratio enables management to make all sorts of decisions..."

When I discuss such a concept with a small business, I tend to get agreement on the importance of such a measurement but that's where it ends. On paper, it sounds great but trying to identify the 'critical number' is more difficult. Most clients give up on it.

As an alternative, I use the concept of the 'critical number' or critical numbers (CN). This concept was made famous in one of my favorite books 'The Great Game of Business' (GGOB) by Jack Stack, the remarkable turnaround story of Springfield Remanufacturing. (Line: https://www.amazon.com/Great-Game-Business-Expanded-Updated/dp/0385348339)

Stack outlines the story of taking over the engine remanufacturing division of a large multinational and the process of turning the venture into a long-term success. One piece of the story is the 'finding the critical number(s)' of the firm. A critical number is '...a technical process not to be taken lightly..' and

1. The Critical Number is a weakness or vulnerability.

2. The Critical Number is measurable.

3. The Critical Number is a performance yardstick.

4. The Critical Number is a rallying point.

Stack, in GGOB, notes that initially, the firm set up three to five critical numbers. One number, "EBIT as Percent of Sales", is a permanent critical number that sets a hurdle number that the company must meet or exceed each year. If met or exceeded, the company contributed to a profit pool that served as bonuses for the employees. The other critical numbers tend to change depending on opportunities or challenges that the company is facing. For instance, one year Springfield saw their Average Collection Period (i.e., the average number of days customers take to pay their invoices). Another year's focus was on inventory levels and inventory turns.

Several benefits can be experienced by the Critical Number concept. First, a Critical number can serve as a common goal to rally people, get their buy-in and educate them. Second, it provides focus to solve a major problem or exploit a major opportunity. Third, it can motivate all employees at all levels to think of innovative ways to improve operations in meeting the number. Finally, by tying it to the company compensation system and providing recognition for achievement, the company has a great opportunity to recognize exemplary efforts made by departments and individuals.

The question often arises about where to start in the Critical Number process. A starting point should be tying measurement to the mission, vision, and/or strategic objectives of the firm. For instance, at the University of Wisconsin - Madison, one of its major strategic priorities for 2020-2025 (https://strategicframework.wisc.edu) is 'Excellence in Research and Scholarship'.

One way UW monitors how well it's doing about the research component is to measure annual higher education R&D Expenditures as published by the National Science Foundation (https://news.wisc.edu/uw-madison-increases-research-expenditures-by-16-million-retains-top-10-research-institution-ranking ) (data: https://ncses.nsf.gov/pubs/nsf2231 for 2010-2020).

The annual R&D number is a number that is monitored and publicized both internally at the UW and externally to the taxpayer, alums, and other stakeholders. The university prides itself on traditionally being in the top 10 in the US based on research funds received. For UW, they incurred $1.382 billion in 2021 as compared to $1.363 billion and $1.029 billion in 2020 and 2010, respectively.

From a critical number perspective, at least on the surface, this is good news for UW. The amount increased from the previous year and is up over 30% from 10 years ago. But, is this a critical number that informs the reader of the trends taking place in a competitive marketplace? For instance, if you look at this number in a relative sense, UW-Madison comprised 7.26% of the total research spending by the top 20 in 2010 but is now at 6.14% in 2021. Yes, the overall R&D spending is up in total dollar amount (a good thing) but when looking at the relative trends vs. the top 20, UW appears may be losing ground in its research excellence as compared to other institutions.

When a trend like the aforementioned occurs, it doesn't mean that the 'sky is falling'. Instead, it shows that leadership needs to ask questions about the trends including how the numbers are calculated, what outliers may be in the data, is it truly representative of what they are trying to monitor. At a minimum, the leadership of the organization needs to constantly evaluate what critical numbers are being monitored and measured to make sure they are getting the most accurate information for decision-making.