Imagine getting your first car as a teenager—was it an older model? Maybe one equipped with a tough-as-nails engine but lacking in horsepower at times? Did you have to turn off the A/C in the summer to make it to the top of a steep hill sometimes? Similarly, while working with business owners and executive teams, we often come across companies facing comparable situations. They might possess a strong value proposition and a competent team, but their engine fails to produce enough horsepower to propel their heavy chassis. In these cases, it becomes necessary to make modifications.
The first crucial modification involves shifting the focus from revenue to gross profit when running the business. Revenue might seem impressive, but what truly matters is what remains after settling the direct non-labor costs—this is the gross margin. To optimize the engine, analyze your business to determine which segments, products, business lines, and locations generate the best margin rather than merely aiming for the highest revenue.
The next step involves tuning in labor efficiency. You achieve this by measuring how much you generate in gross margin for each dollar spent on your direct team—the members directly involved in delivering your service or product. It's not about headcount but about the return generated from their compensation, a metric known as the Direct Labor Efficiency Ratio (dLER). We calculate this for historical periods and strive to achieve the highest level as your first target.
Through these exercises, you'll identify the areas with the most significant impact on horsepower production. By focusing on high-margin activities and adjusting the team size based on current gross margin levels, you can increase your horsepower, ensuring you no longer need to turn off the A/C while going uphill!