Narrowing the Region of Darkness: An Approach to KPI Setting

This week’s blog is from our guest contributor, Mark Lupton from Amplify COO. Based in Austin, TX, Amplify COO helps business owners connect the dots between their vision for the future and their current reality by building custom growth plans and projections. Amplify’s desire is to bring order out of chaos so business owners can more quickly enjoy the reasons why they started their business in the first place.

A business’s KPIs (Key Performance Indicators) and its financial projections are inextricably linked. Business projections look into the future and paint a picture of what could be, and KPI’s are the tracked metrics that align your pace and direction with that picture of the future. These definitions may be simple, but putting these things into practice is a classic “easier said than done” predicament. In reality, painting a picture of the future can feel more like throwing darts blindfolded. And, with every e-commerce meetup/podcast proclaiming the latest, greatest, metric, picking KPI’s can be confusing and overwhelming.

Well, as you likely know: there is no silver bullet KPI, and financial projections are not an exact science. Especially in a small business! So, how do we approach this crucial topic? By zooming way out. Let’s not focus on a one-size-fits-all solution, but instead, a way of thinking.

Narrowing the Region of Darkness

There’s a tension that many business owners experience deeply (no matter how big the business) — they have some vision of where they want to be in the future, but are uncertain that the path they are currently on will lead them there. This usually, one way or another, leads a business owner into the daily grind of fighting fires and treading water.

Forgive the philosophical comment, but we think of the future as an area of time not yet illuminated: a region of darkness. In creating plans/projections, a business owner cannot predict the future, but she can narrow the region of darkness. She can illuminate milestones and shine a flashlight down a few possible paths. In order to build useful plans and choose practical KPI’s, business owners must shift their mindset from the overwhelming task of predicting the future, and instead focus on shining light on some of the “unknown” spots through assumptions based on what is true today.

As a business owner, the most important milestone to illuminate is your dream-state relationship to your business. The more vivid and defined this vision, the more illuminated it becomes, and the easier it is to illuminate a path to walk down. In business speak: the clearer your goal, the easier it is to build a projection/plan, then equip yourself with the right KPI’s for the journey. We are going to walk through a couple steps to narrowing this region and then finish up with some specifics on KPI’s to help navigate the fog.

The first step in narrowing the region of darkness is to specifically define the ideal relationship you will have to your business in a dream world (aka, the future). In other words, what does a day in the life of future-you look like? Pick a specific date in the future; actually write it down, picture what may be happening with the country, city, neighborhood, technology, etc. Now begin to visualize your workplace scene in your mind:

  • Are you in an office building or your house?
  • Are you in a meeting or alone?
  • Is it light or dark outside?
  • Are you tired or alert?
  • Are you dressed formally or casually?
  • How many employees do you have?
  • What does your calendar say? Both work and personal?
  • What is your task list for the week?
  • What are your responsibilities and roles (yes roles is plural)?
  • Is this your only venture or is there another?

Imagine your real dream life, the fun, and the obligations. This exercise, if done thoroughly, will tell you most of what you need to know about the type of organization you must build, and additionally how much cash flow is required to support it (queue the financial projections).

One warning: don’t be so fixated on your dream-state that you ignore red-flags about the direction you are headed. Keep your ears perked for trustworthy warning signs along the way. Have drive, resolve, AND open ears (queue the KPI’s).

The second step: identify what to delegate and the job description of who will take it on. Record each of your responsibilities in your dream state and in your current life in a spreadsheet. Force-rank each responsibility from least enjoyable to most, and from least important to most, with the least receiving a rank of one. Then add the two rankings (joy and importance) together to create a delegation score. A high score means that the responsibility brings you joy and is vital to the operation of the business. Low numbers should be delegated well before the high numbers. This will take some time to make the lists, but it will help you visualize the difference between here and your dream and provide a compass for delegation.

Now it’s time for some numbers.

The third step: define how much cash flow is needed to support your dream state. This is where our key performance indicators start to come in. They should directly be tied to your specific vision for the future. The most important numbers to know in solving this equation are as follows:

  1. Overhead expenses at dream state (best guess)
  2. An Order’s contribution to overhead costs = Average Order – Variable costs
  3. Variable Costs = Customer Acquisition cost + Materials + Manufacturing + Shipping + Variable Labor + (any other sales specific variable cost)
  4. Orders to break-even now and at dream state

This exercise can take days or minutes on the back of a napkin, the goal here “done-not-perfect”.

The fourth step: build financial projections to bridge the gap. After defining how many orders you need to support your dream state organization, you need to build a plan to get there. There are four primary components to this phase:

1. Sales growth (Revenue) plan to achieve the order target

  • What advertising/marketing investment is required to fuel this growth?

2. Production capacity (COGS) expansion plan

  • What are the bottlenecks in your process/business?
  • At what order quantity will they be reached?
  • With new order targets, how much must I order each month?

3. General & Admin (G&A) Plan

  • What admin/HR roles will be required to support operations?
  • How much will they cost?
  • Can my hires free up my time too?

4. Financing / Investment (Debt / Equity)

  • Is my current cash flow enough to support the pace of growth I want?
  • How fast can I grow without seeking investment?
  • Do I want to take on funding?

Each of these components has libraries of books written about them, and companies built around them (kind of like ours). As a small business owner, you are resourceful and must utilize what’s at your fingertips to do what is most important for your operation.

Navigating the Fog

The milestone is illuminated, the flashlight is lighting a path, and it’s time to walk. But, if it were that easy, everyone would do it. The path you lit turned out to be very foggy, and you ran into several “dead-ends” you could have sworn were shortcuts to your milestone. Before you think “why did we do all this work in the first place?”, stop and look back on how far you have come and be thankful, few have this opportunity. Then, remember that in your goal-setting and planning process you identified some numbers that are key to your business achieving its potential. They were the key numbers that drove sales, production costs, overhead expenses and overall cash flow. They are your KPI’s.

For sales, they may have been numbers like: ROAS ($ revenue per $ ad spend), CPA (cost per customer acquisition), customer satisfaction ratings.

For production costs maybe it was: materials cost by volume, shipping costs by volume, production labor by volume.

For overhead: number of support employees, ratio of support salaries to operations salaries, software costs, etc.

For cash flow: accounts payable, monthly loan payments, inventory levels compared to sales forecasts.

KPI’s like these tell you if you are on track. They give you the right questions to ask, help you pinpoint where the problem in your business is and show you if the dead-ends you encounter are actually dead-ends or just predictable road-bumps. Ultimately, your KPI’s and your business’s decision makers are your compass when navigating the fog.

Specific Examples

In our experience, we find ourselves evaluating these four things on a consistent basis with clients. They may not be the most important for you, but they sure do help some of our clients. See KPI and explanation below.

1. ROAS (Revenue) – define a profitable return on ad spend and track it in each channel individually and combined between all channels. Include organic as part of your calculation, this will help account for lifetime value benefits over time, and un-attributed revenue. Tracking the total ROAS between every channel is vital, even if all of your efforts are not direct response.

2. Gross Margins (Variable COGS)seems obvious but it’s ever-changing, always know the answer to the question: “how much money does each unit order or order placed contribute to covering my overhead?”

3. Sales mix % and Units per Order over time (Inventory) – in growth mode, the past is not an indicator of the future. So we must connect the dots between predicted ad-driven orders based on our growing ad spend budgets and how many of each SKU/product will be sold. So here we go:

  • Future Ad Spend  /  Acquisition Cost  =  # of Orders
  • # of Orders  *  Units per Order =  Total Units
  • Total Units  *  Sales mix %  =  Predicted Unit Solds by Product
  • Compare that number against your past sales and your “gut” to make a more educated guess at ordering stock

4. Capacities and what’s the next bottleneck? (Overhead + Project/Development Costs) – every part of your business has a capacity to handle a certain number of orders/clients. Map out the capacity of each thing. Then record how long it will take and how much it will cost to increase those capacities. Finally, anticipate when to upgrade based on your projected revenue. Examples of bottlenecks: your staff’s time, your manufacturer’s capacity, your distributor’s capacity, your manufacturing capabilities, your materials provider, your website, your design, etc.

Wrapping Up

You know your business better than anyone, so if you have spent the time to paint a clear picture of your vision and to build out your plan, your KPI’s will organically reveal themselves. By setting clear targets for yourself and your team along your path, and scheduling weekly/monthly rhythms to review each KPI, you will be set to navigate the fog safely to your milestone.

This note was focused more on mindset than specifics, because we believe that smart, resourceful business owners can do far more with a way of thinking than with a set of facts.