Most business owners are obsessed with it.
Early stage entrepreneurs focus on top line revenue. As they gain experience some of them shift priority to profit. As they gain more experience, some veterans shift back to revenue (or back and forth.)
Many entrepreneurs focus on vanity metrics like headcount.
For the past five years, I’ve managed a small team and been stuck under the $300,000 revenue ceiling. The entire time I’ve worked diligently to grow the company and have continually invested in sales and marketing.
Superficially, it doesn’t seem like much has changed. We certainly haven’t grown from the perspective of revenue or number of employees.
But we’re actually much more profitable than we were five years ago.
We’re more productive at creating value.
What We Mean By Productivity
What do you think about when it comes to productivity?
- Maybe you think about it from a personal standpoint and your mind goes to getting a lot done in your day: work, exercise, cooking, chores, spending time with your loved ones.
- Another lens might be a natural one, where you think about an especially abundant apple harvest in an orchard.
- Or maybe your mind goes to a business like Starbucks where millions of people are served 24/7 around the world.
In each of these scenarios, productivity is a measure of effects in relation to resources.
Every person gets 24 hours in their day (resource) and some people do everything (effect) and are perceived as highly productive.
An orchard is a plot of ground (resource) that may or may not produce a large amount of fruit (effect.)
And Starbucks takes a tiny section of real estate and a handful of employees (resources) and feeds and caffeinates around 140,000 visitors each year.
Productivity’s Two Drivers
There are two drivers that dictate any resource’s productivity: effectiveness and efficiency.
Peter Drucker gave us a pithy definition of these as, “Efficiency is doing things right; effectiveness is doing the right things.”
Though these two drive productivity, they are not equal.
Consider your apple orchard:
If you wanted to increase the yield in fruit (effect) you might maximize the space usage of the field the trees were planted in, implement the perfect pruning process, and install automated drip irrigation to guarantee the trees receive just the right amount of moisture. Doing this you increase the yield by 30%.
Or you might chop the orchard down and build tomato hot houses that produce four times as much fruit year round.
The first method is efficiency applied, the second effectiveness.
Optimization Chasing Innovation
Effectiveness trumps efficiency, but both are important.
Making improvements in effectiveness is innovation. Innovation is often a challenging, wasteful, murky, high risk process.
Making improvements in efficiency is about optimization. Optimization is accessible and clear. It’s filtering out waste and reinforcing what’s already working.
Effectiveness leads, but efficiency must quickly follow and exploit whatever ground was gained through innovation.
Effectiveness is Starbucks figuring out how to change the cafe experience to sell espresso as if it were a McDonalds cheeseburger. Efficiency is refining that innovation into a system you can replicate to 31,000 different stores worldwide.
Productivity in Business Value is Wonky
When it comes to productivity in value it gets a bit wonky, because value is subjective.
As it relates to business, customers set prices because they’re the ones who value products and services. Beauty is in the eye of the beholder.
When I moved to Japan my mind was blown because I would see cantaloupes in gift boxes selling for $50 in the produce aisle. The Japanese were willing to pay a premium for certain fruits, which as an American, I didn’t value that highly.
It doesn’t matter what a product costs to create or what you, the entrepreneur, thinks it is worth, it’s what the customer values.
But that’s not the end of the story.
Because business is an exchange of value. There are two sides to it. On one side is what your customer values and on the other is what you value.
The customer values whatever you offer more than what it will cost them and you value their money higher than what you’re selling.
The Profit Window
To sum up:
- Profit is the capture of excess productivity in value creation.
- To be more productive there are two high level strategies of being more effective or more efficient.
- Because value is wonky, we can improve the production of value from either the perspective of a customer or from our perspective. Both are valid.
This gives us four quadrants of opportunity:
- You could focus on making gains in effectiveness in producing value for yourself.
- You could focus on making gains in effectiveness in producing value for your customers.
- You could focus on gains in efficiency in producing value for yourself.
- You could focus on gains in efficiency in producing value for yourself for your customers.
How My Agency Produced More Value
While we’ve been under the $300,000 ceiling, I’ve worked diligently to improve our situation.
Gains in Effectiveness in Producing Value to Us
Early on, I had a problem where past clients would disrupt projects by reaching out for urgent help. Separately, I talked with a consultant about the agency and they recommended we find some way to create a subscription service to collect ongoing payments. I solved our problem by creating a support service that functioned as an ongoing retainer. This was a huge gain as it grew to 50% of our annual revenue.
Gains in Efficiency in Producing Value to Us
Project management is a significant role in producing custom work. I made three optimizations in this area that all increased our productivity:
- I hired a project manager and went down to a 2 day work week. I gained a lot of value in time and independence doing this.
- Unhappy with how much time project management took, I implemented new processes and policies which curtailed it. We produced more value in the form of free hours.
- I fired the project manager and captured that extra time in increased earnings.
Beyond management, I figured out how to better sell the projects we did. I learned how to raise prices while cutting down on scoping time. This resulted in increased profit per project.
I was able to raise our prices because I also figured out how to increase the value to clients on a per project basis. This was in the quadrant of improving the effectiveness in creating value for clients.
Easier to Make Money, More Options
From the revenue perspective, not much has changed. From the perspective of team size, not much has changed.
Within the business though, things look different. Five years ago we were moving as fast as we could. Now we have gaps between projects and work less hours. Many agencies and their owners work 60 hour weeks. We work 25 – 30.
Where You Should Start
While any improvement in effectiveness and efficiency for yourself or customers is useful, there is a natural priority.
If you look at our improvements, nearly all of them happened by increasing our efficiency in producing value for ourselves.
We’re not outliers in this. There is a reason why business books like the E-Myth or Work the System are popular (…however note that systematization is just one path to improve efficiency.)
Efficiency in creating value for your business is the most accessible and clear quadrant to work within. You know what you value and you have full control over the mechanisms you use to produce it.
From an 80/20 perspective, it’s likely that only 20% of your resources produce value for you. So not only is this quadrant full of accessible opportunities, it’s also full of unrealized value.
But Don’t Ignore the Other Quadrants
Our support service was an innovation that flattened out the valleys in our earnings and made our peaks even higher.
I tried all sorts of improvements in effectiveness to produce value that failed: products, services, marketing campaigns, and etc.
Improving effectiveness is tough, but the support service carried us through all those failures.
Start with your efficiency for yourself, but consider where you might generate the biggest gains according to the other three quadrants.
I’ll leave you with three questions:
- What value is being produced for yourself? For your customers?
- Are there key drivers of value that haven’t been optimized to the point of diminishing returns? Are you fully exploiting your resources?
- What is acting as a governor in each quadrant and limiting your effectiveness or efficiency?
Art Credit: John Tenniel, Through the Looking Glass