Remember the Productivity Ratio

Here is a tremendously useful experiment:  The next time you attend a business conference, or have the opportunity to brainstorm with extremely successful start-up company executives, ask them for the most noteworthy success formulas they monitor in their businesses.

If you ask this question repeatedly, you are likely to get many different answers.  Some of the most common ones will be ratios: Return on Equity, Return on Investment, Net Profit Rate, Gross Margin Rate, Current Rate, and other less obvious formulas.

One answer you are less likely to hear is the Productivity Ratio — sales divided by number of employees.  The objective is to have a large sales number and a small number of employees. Admittedly, this is not a terribly sexy calculation.  After all, if you are growing, should not your employee base be growing proportionately?  Is not the number of individuals you employ a barometer of success?  Is it not risky to leave your company vulnerable by under staffing it?

The answer to all of these questions is … “not necessarily.”

Inc.com, the online magazine with an enormous following of start-up entrepreneurs, recently published the following examples that argued this case eloquently:

COMPANY: Nature’s Cure, in Oakland, Calif.
DESCRIPTION: Produces a line of acne medicine
REVENUES: $6 million
EMPLOYEES: 13
RATIO: $462,000 per employee
PRODUCTIVITY STRATEGY: Outsource like crazy

The reason for the company’s low head count is simple: CEO Amy Baker deliberately built the company to function with few rank-and-file workers. The staff is incredibly top-heavy: 7 of the company’s 13 employees are executives.

Baker gets away with her unorthodox management structure by outsourcing nearly everything. For instance, whereas many consumer-products companies would employ rank-and-file workers in sales and marketing, Baker has farmed out most of those functions to brokers and outside strategists. The executives in sales and marketing operate more like relationship managers.

To be fair, Baker’s penchant for outsourcing artificially inflates her company’s productivity ratio. But Baker argues that the outsourcing makes it easier for her employees to maneuver or make changes without fixed overhead. Take, for example, her four sales executives. Three of them manage a regional group of sales brokers, and one serves as an inside sales coordinator. If the VP who’s in charge of the Atlanta region finds that sales are slow, then that VP can simply fire the broker and find another.

Strictly speaking, Nature’s Cure is a manufacturer of acne medicine. Yet the company even outsources the making and packaging of its product. The company also relegates its distribution to a warehouse-cum-shipping center in Chicago. One of Baker’s execs, based in Chicago, oversees the entire distribution process. Another VP, in the Oakland office, coordinates every aspect of manufacturing: quality standards, packaging, and inventory management.

Baker acknowledges the risks of building a manufacturing company this way: Nature’s Cure has few hard assets, such as equipment or real estate. A valuation of the company would involve only an appraisal of the soft stuff: the company’s medicine patents and the Nature’s Cure brand.

And because Baker’s exit strategy is to sell Nature’s Cure to another consumer-products company, she believes that she ought to spend her time and capital on building assets that her acquirers would covet — namely, a big-time brand.

COMPANY: Legacy South, in Atlanta
DESCRIPTION: Provides wealth-management services
REVENUES: $3 million
EMPLOYEES: 5
RATIO: $600,000 per employee
PRODUCTIVITY STRATEGY: Automate key functions with technology

Legacy South grosses an impressive $3 million a year with only five employees, but that feat is even more impressive given that two of those staffers are administrative. The other three, including CEO John Viani, do the actual wealth management, each handling about 35 clients. Some clients speak to Viani quarterly, while others talk to him a few times a week. And Viani’s two partners communicate with clients just as frequently.

The perpetual challenge for Legacy South is striking a communicative balance: maintaining high-quality personal interactions while preventing a daily deluge of calls from needy clients.

For Viani, the answer is technology. In addition to sending clients their quarterly statements from discount broker Charles Schwab, Legacy South sends its own statements, which are “in a more friendly format,” according to Viani. The company generates the statements through a software program called Advent, which automatically downloads information from the Schwab Web site, then rejiggers it to Legacy South’s easy-to-understand style. For daily access to the information, clients can log on to the password-protected Legacy South Web site (www.legacysouth.com).

For the most part, Viani and his partners communicate with their clients through phone calls and face-to-face meetings. But there are occasions when Legacy South feels the need to communicate with its clientele as a group. Say the Fed hikes interest rates, or the stock market plummets. Clients often want to know how such events will affect them. In such cases Legacy South relies on the relatively low-tech combination of a client database and E-mail to efficiently communicate en mass.

Although technology eases some of the communicative burden from Legacy South, customer selectivity and management decisions play a part as well. Viani says there have been “two or three instances” when the company has had to “fire” excessively high-maintenance clients. Viani and his partners have agreed that they will take on no more than 40 clients each. When the principal-to-client ratio surpasses 40, Legacy South will look to bring in its sixth portfolio manager.

COMPANY: U.S. Energy Services, in Wayzata, Minn.
DESCRIPTION: Provides energy-management services
REVENUES: $22 million
EMPLOYEES: 22
RATIO: $1 million per employee
PRODUCTIVITY STRATEGY: Use open-book management and profit sharing to instill efficiency

U.S. Energy Services makes $22 million a year from a client base of 150. The company examines every aspect of its clients’ utility bills, scouring them for cost savings. After diagnosing problems, U.S. Energy acts to solve them for its clients — for instance, by renegotiating rates with the utilities. U.S. Energy charges clients a percentage of the total bill, usually around 2%, and a fee ranging from $400 to $10,000, depending on how labor-intensive the solutions turn out to be.

But how does a paltry staff of 22 master the post-regulation-era billing intricacies of thousands of energy suppliers in 48 states? Over the years, employees gain an intimate knowledge about clients’ billing particulars. Generally speaking, the longer U.S. Energy has had a client, the less labor-intensive it becomes for the company to assess that client’s utility bill. That is why the company has been able to beef up revenues in recent years without adding legions of employees.

CEO Bill Bathe also credits the interplay of two management factors — open-book management and profit-sharing bonuses — for the high revenues-to-worker ratio at U.S. Energy Services. He and his partners share all the company’s financial information (except individual salaries) with their workers. The employees, in turn, have a clear understanding of how their productivity can affect the bottom line. In other words, the employees know they’ll receive larger bonuses if their individual revenue-generating efforts are fruitful. Conversely, the employees also understand the cost burden of any non-revenue-generating employees, which is why, as Bathe says, “there are no secretaries here.” Employees type their own letters and spreadsheets, but they also know better than to spend hours on such non lucrative tasks.

Bathe believes that the open-book system, which cultivates a culture of knowledge sharing, motivates greater group productivity. For example, say that an experienced U.S. Energy employee, while analyzing a corporate client’s utility bill, finds an error on the statement that he’s never seen before. The employee then shares his discovery to help his coworkers discover similar errors in the future. That information sharing saves money for U.S. Energy’s clients, increases the company’s total revenues (some of which come as a percentage of any savings the company secures for the client), and, by extension, boosts the size of the profit-sharing bonus.

There is, however, a downside to running such a tight ship. The company can’t easily take on new work since it lacks what Bathe, using a sports term, calls “bench strength” — high-quality backup performers whom it can enlist at times of increased demand. Also, he says, the company culture’s emphasis on efficiency at all costs often prevents workers from even casual socializing. “We’re so efficient, we spend almost no time together,” he laments.

“Big Money, Small Payroll, Growing Your Business Article – Inc …” Inc.com. 25 Nov. 2009. Read the article here.

Jericho Technology wholeheartedly embraces the Productivity Ratio as a key factor in success.  In it’s fifteen year history, the company has never employed more than four individuals full time.  It is a success formula that we consistently recommend to our clients.