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I break Startups down into their component parts and show you how to build for success.  

operational efficiency

I talk a LOT about what I do to help the companies I work with be more operationally efficient and that means I throw the term ‘efficiency’ around frequently.

It’s in most of the proposals that I write, it’s in every other conversation I have (sorry friends who are just trying to have dinner with me), I even have a (free) email course about how to become more operationally-efficient as you grow your business.

I talk about it so much that I think I forget that, especially for first-time founders or execs, it can be a confusing term. 

Like ‘macroeconomic’ or ‘disruptive’ or ‘vesting’ or my current favourite one that seems to have popped up out of nowhere ‘beachhead’, it’s one of those terms that takes such pride of place in the startup lexicon that newcomers are afraid to ask what it means for fear of looking like they don’t belong. 

I’m not about that ’silly question’ life, so let’s ask - what does ‘operational efficiency’ actually mean?

What actually is operational efficiency?

Investopedia (and silent crying) got me through the first rough weeks of my MBA, so let’s turn to them for a quote:

“Operational efficiency is primarily a metric that measures the efficiency of profit earned as a function of operating costs. The greater the operational efficiency, the more profitable a firm or investment is. This is because the entity is able to generate greater income or returns for the same or lower cost than an alternative.”

In slightly less dry terms - you’re operating efficiently when your costs are going down and/or your revenues are going up, and you’re relatively more efficient than a competitor if the positive gap between spend and income is higher in your company than theirs. 

operational efficiency

In a post-growth-at-all-costs world, operational efficiency is a particularly interesting metric.

Spending £100m to generate £50m in revenue used to just be the done thing in ‘high-growth’ companies (I’m looking at you, SaaS), now investors are more inclined to think that spending £50m to generate £100m is winning. 

Why is operational efficiency important?

Simply-put, if you’re spending more than you’re bringing in, then the continued existence of your business is going to have to depend on outside capital.

It’s not necessarily a bad thing to not initially be profitable - gotta spend money to make money, after all - but, these days, it’s harder and harder to raise equity investment and interest rates are on more of a rollercoaster than one fifth of Boyzone, making debt funding a scarier option than it has been. 

operational efficiency

Even if you find it relatively easy to access cash (i.e. you’ve won the demographic lottery and you have ‘AI’ on the ‘what we do’ slide of your investment deck), once you’re in the cycle of raise-and-deploy, part of your business model is always going to be about promoting shareholder or creditor interests - which can often be in conflict with the interests of your two other key stakeholders - your customers and your employees. 

In short, a business that operates efficiently from the off can have much greater post-exit upsides for its founders and, in many ways, can be a smoother ride on the path towards liquidity. 

What are the levers of operational efficiency?

I’m sure you’re familiar with the two key levers of operational efficiency - revenue and cost of goods sold (or COGS if you’re an acronym fan) - but there are a surprisingly large number of metrics that can be tweaked in your company to increase operational efficiency. 

Here are three of the most important metrics for operational efficiency in your growing company that you may not be thinking about - how many of these are you currently tracking?

Churn Rate and Gross Revenue Retention Rate

It’s not simply enough to secure a customer, for long term operational efficiency you need to retain that customer for as long as is feasible within your model.

In very simple terms, if it costs you £10 to secure a customer through sales and marketing efforts, you’re better off when you’re making £20 from one customer than two customers generating £10 each (the former being a £10 profit, the latter two breakevens). 

If you’re in the SaaS world, you may be more familiar with net revenue as a retention metric, rather than gross. It may seem like a small differentiation, but it’s an important one. 

Net Revenue Retention (NRR) measures total revenue from existing customers, including those customers that expanded beyond what you’d originally planned (e.g. they initially signed a smaller contract and then bought more products or services once they’ve started working with you). 

Gross Revenue Retention (GRR) measures just retained revenue without any upsells.

The value in tracking gross over net comes down to the exposure of your business in the long term. If all your customers but one cancel and the one that’s remaining delivers a huge amount of turnover, you’re doing well in revenue but you’re exposed to the risk that that customer will leave and take all your revenue with them. Since you’ve torn through all the customers that you were first able to acquire, it’s going to become harder and harder to acquire new ones to ameliorate that risk. 

If, on the other hand, you’re consistently delivering revenue from a variety of different customers, you’re less likely (unless you’re providing very little value for money to anyone) to lose all income streams at once and to have to spend a lot of extra cash acquiring new ones. 

operational efficiency

To calculate a simple Gross Revenue Retention Rate, decide first on a timeframe (for the month, or for the year, for example), add up the revenue from this period's customers and divide it by the revenue from those same customers in the previous period. 

E.g. Revenue from customers in month 2 / Revenue from month 2 customers in month 1. 

Employee Engagement or Employee Retention Rate

When I create a Strategy for a company, I use my own 6-Point Framework that links every single action taking place in the company to the Mission Statement - everything is about driving the business to its most important goal. 

Contrary to many popular goal-setting systems, in my framework there is no difference between ‘Strategic Work’ and ‘Business As Usual’ - everything is a part of the Strategy because if it’s not powering your business forward then why are you doing it?

A question I’m often asked in this process is where employee-specific spend would then fit into this model - where do, for example, recruitment budgets and training &  development goals fit into the puzzle? 

For me, they’re both very much a financial metric. Let me show you why. 

It costs a lot of money to hire, train, and grow your employees - just like it costs a lot of money to find, acquire, and grow your customers. If you can retain and grow an employee, they can be a lever of both increased revenue and reduced costs and thus target both top and bottom line improvements to drive operational efficiency. 

Thus, an investment into your employees or a project that drives employee satisfaction (sometimes called Employee Net Promoter Score, or ENPS - a measure of how likely an employee would be to recommend you as an employer), and keeps good employees inside your company is an important driver of operational efficiency because it, in the long-term when done correctly, reduces spend on expensive hiring and training processes. 

operational efficiency

To calculate an Employee Engagement score, you need to create a measure of engagement - absence or deadline slippage or something that quantitatively assesses whether your people are showing up and putting in what you need them to.

It’s often easier to use an ENPS because you can just ask people if they’d recommend the company - though success in that process is predicated on the fact that they feel psychologically safe enough to do so. 

Current Ratio

This one’s a little mathsy, but it's worth it so bear with me whilst I break it down. 

Current Ratio is a measure of liquidity - i.e. a measure of how much cash a company has on hand to meet its short-term debt obligations. It’s asking “do you have enough money to pay all the bills you owe in the next year?” It’s often a relative metric - used by potential sources of funding to compare how much more likely your company is to meet its obligations than its competitive set is. A bank, for example, wants to know that they're lending money to a company that's going to be able to pay it back.

It’s an interesting metric, being one of the few that can convey information both about your business as an individual entity and about your business in the context of its industry competitors. Most of your metrics exist in the context of your business alone and act as idiosyncratic signals of change. 

A current ratio can be a fascinating insight into the inner workings of a company that’s showing outward success.

I’m a giant nerd so often when I see a company that’s clearly spending a lot on sales, marketing, and promotions, I’ll head to Companies House to read the financial statements and calculate a current ratio.

It can be a great motivator if you think someone else is crushing it and realise that they’re only crushing it by spending every penny they have as well as some other people’s pennies on top. 

To calculate a current ratio, you need to head to your balance sheet. Simply divide current assets by current liabilities to get a view on how easy it will be for the cash you have to meet the upcoming obligations. 

operational efficiency

As a general rule, a current ratio of less than 1 means that there isn’t enough cash on hand to meet the short term debt obligations. Since a balance sheet is only a snapshot and it’s unlikely that all obligations will fall due at the same time, it’s not an absolute statement on liquidity, but an interesting exercise nonetheless. 

Will you adopt any of these metrics when planning for operational efficiency in your business?

If you’re keen to do so, but aren’t sure how to start, why not book a free Discovery Call below and see how I can help?


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