Benchmarking and Business Value
How Good is Your Business?
Is there a link between benchmarking and business value? As a business owner you want to think you are the best in your industry. Have you ever done any benchmarking of your business?
Anyone looking to buy your business WILL compare you to the industry leaders and best practice. It’s worth knowing what they are going to find out about you. When was the last time you looked at comparisons within different areas of your business? It’s all benchmarking and it impact business value.
In this article we are going to explore external benchmarking against others in your industry and across businesses as a whole. You may be excelling and not know it. Or struggling and need some extra guidance to realise that there’s more potential there to do better.
Insights from industry benchmarking
The objective of benchmarking is to understand and evaluate the current position of a business in relation to best practice. Then to identify areas and means of performance improvement.
Benchmarking is often seen as a corporate exercise for when you don’t know what to do. Check to see what your peers are doing instead of trying something new.
Benchmarking against best practices is a great way of testing your assumptions. Then developing better practices within your business. Using experience, you can objectively look at activities that led to successful outcomes. Ask what needs to happen to replicate this in the future.
Benchmarking is an opportunity to identify strengths that add business value. It’s also a chance to critically appraise areas for improvement. Testing your assumptions means you ask, “is there a better way?”
Benchmarking involves four key steps:
- Understand what’s happening NOW in your business
- Analyse what others are doing (or not doing)
- Compare your “now” with the analysis
- Take action to close the performance gap
Benchmarking should not be a one-off exercise. It’s an ongoing improvement process to allow your business to keep improving and testing what’s best practice.
Benchmarks are great, but they’re only useful if they are:
- followed with appropriate actions
For example, look at average customer order value between industry sectors. For eCommerce beauty stores, in 2018, it was $70.71. It’s not going to compare favourably to the average order value in travel ($375.05) for example. But that doesn’t mean it’s bad. If the benchmark isn’t relevant to you or your business, then it’s not helpful in any way. Knowing what’s relevant is key.
Just seeing what other businesses are doing can open your business to new ideas. New ways of doing things. What to stop doing and what to start. As with all knowledge, the real power is in the action taken.
Understanding of the business value of benchmarking
Benchmarking has the potential to be a powerful tool to develop a culture of continuous improvements in your business. If you rely on only internal measures, you risk limiting your perspective. High performing companies strive to identify and improve processes, product and services that are important to their customers. Evaluating your efficiency and effectiveness against others who lead your industry or who innovate in other sectors leads to step change in performance. It’s important to take care of who you compare yourselves to. A big company may be aspirational in terms of turnover, but they may very well be inefficient as a result of their size. Critical analysis is key.
There are many different types of benchmarking:
- Strategic: looks at core competencies, developing new products and services, and changes in the external environment. This is long term thinking and actions may be difficult to implement. This is why so few businesses do it. The focus is re-aligning business strategies that have become inappropriate or irrelevant.
- Performance or Competitive: utilises data analysis through trade associations or third parties to protect confidentiality. This allows you to assess performance in key areas or activities in comparison with others and finding ways of closing gaps in performance.
- Process Benchmarking: focusing on processes and operations by seeking out best practice organisations that perform similar work or deliver similar services. It helps identify improvements in key processes to obtain quick benefits.
- Functional Benchmarking: where there are no specific or easy comparisons, looking at business sectors and areas of activity is a great way of improving similar functions or work processes. This often leads to innovation and significant improvements.
- Internal Benchmarking: assessing operations from within the same organisation. For example business units in different locations or countries can lead to quicker and easier implementation. This may lack in innovation or seismic shift in improvements BUT some improvement is better than none. The old saying “An inch is a cinch; a mile is a trial” comes to mind. Many team or business has got to the top by using 1% increases in performance.
- External Benchmarking: is analysis outside organisations that are known to be best in class. Learning from those who lead the field is an opportunity to reflect and move the business forward. It takes time and resources. The credibility of the findings relies on having comparable data and appropriate information. It’s a good way to develop an action plan.
How to find out where do you sit in your industry
Are you drinking your own cool-ade?
If you are preoccupied with your own business, you easily lose sight of competitors and innovations across your industry. Keeping a finger on the pulse of the changing demands of customers means you are more prepared for change in general. Maybe even positively ahead of the curve.
Looking outside your own industry for best-in-class performance of specific processes, services or approaches challenges your assumptions and tests your business practices.
For example, Southwest Airlines famously analysed Formula 1 racing pit crews to improve their airplane turn-around time at the gate. The outcome? Southwest reconfigured its gate maintenance, cleaning, and customer loading operations. It has saved the company millions of dollars per year.
Trade associations often publish comparative data invaluable to the benchmarking process.
Improving your customer service, for example, may result in comparison of processes and key performance indicators of successful competitor or shining lights in other industries. By identifying differences, you can start improving processes to strengthen your performance.
Pal’s Sudden Service
For example, Pal’s Sudden Service is a small hamburger and hot dog chain. It is so successful at achieving best-in-class performance for drive-thru and overall restaurant operations, that it has opened an educational institute to train other organisations. Many companies in the fast-food market use Pal’s as a best-in-class benchmark for their own operations.
MacDonald’s has its own University for serving and business management- and according to the press, it’s harder to get into than Oxford or Cambridge! (source: Mirror newspaper; 25th October 2015)
How investors will be looking at your business
Any investor or potential buyer will always compare your business to others. They may be looking for opportunities to add value. Alternatively, they may see great practices in your business that they can apply to other businesses they are invested in.
Benchmarking uses largely financial data, because it’s most commonly available. Use of statistics such as the number of employees, floor space utilised, total equipment or assets are also key to understanding your business efficiency. Many of these measures of efficiency don’t stand out from your management accounts. A buyer will want to understand how you are positioned in the market to assess your relative value.
If, for example, you operate an accounting firm. Your profit depends on billing time for services. Benchmarking would look at billable hours, total fees earned per full time employee (or equivalent) and overheads. Is debt collection slower than the industry average, which may lead to cashflow issues? Is average net profit after tax (NPAT) per principal is lower than the industry average?
Improvement in Performance?
Benchmarking gives us a good starting point that highlights where we need to look deeper to improve the future performance of the business. Benchmarking also shows where business value can be improved.
When we benchmarked one of our clients, a professional services firm, we found the IT costs were significantly higher than its industry competitors. Digging deeper, we saw that all of the firm’s computers and systems were 15 years old. This meant the maintenance contractor was coming in almost every day to fix something. On the other hand, depreciation was much lower than the competitors as the assets were all fully written down long ago.
A buyer considering this business will need to factor in significant capital outlay to replace the IT assets but can expect to spend less in maintenance costs as a result, therefore increasing profit. When we benchmark a business, we calculate the potential profit gap — the profit you could achieve if you were operating at industry average levels.
What’s the Average?
On a simple level, if you produce a product at £1 and sell it at £2 you are making £1 or 50% margin. If your competitor is selling the same thing for £2 but it costs £0.75 to produce, he is making £1.25 or 62.5% margin. The profit gap is 12.5% or 25 pence. Benchmarking assumes that you should be able to operate at roughly the same level as industry averages.
Sometimes there is a significant gap between the current profitability and profitability that could be achieved at maximum efficiency. Once we work out where the business is over or underperforming or overspending, we can help you focus on resolving individual issues to close the gap, improving profitability and impacting value.
Benchmarking is a process of comparing your business metrics with other similar businesses. Not many business owners think of benchmarking their business, and most do not have access to data to be able to do this. At Succession Plus we identify the key performance indicators in your business and benchmark them against industry averages to identify areas of improvement, or ‘the profit gap’ between where you are and where you could be. Benchmarking and business value are closely linked.