The Importance of Data
As each new year passes many people spend time reflecting on what they’ve accomplished the previous year. Businesses, of course, do the same. They look at their financials, asking questions like `how are we performing?` The analysis can deliver incredible value but all too often organizations get stuck in analysis paralysis and fail to derive any real actionable insights. They instead report on numbers that only have marginal practical implications for improvements. One part of finding the right type of data to leverage is knowing the difference between vanity metrics and actionable metrics.
One clear example of a vanity metric is revenue. If an organization tells me `Hey, I did 50M in business last year, things are looking up!` there are immediate questions someone should be asking. The 50M is what I call a `Vanity Metric.` It looks nice, it sounds great, but what’s underneath the data is what really matters.
Modern organizations need to be constantly on the lookout for actionable metrics and constantly asking themselves is this the right data point to look at to improve, or am I looking at a vanity metric?
Gross Margin is a great example of an Actionable Metric for many organizations and it starts to give us more clear guidance on how to improve the organization. You can slice and dice Gross Margin any number of ways and it’s applicable in many parts of the business. At its various levels (customer, product, region, class), Gross Margin helps organizations understand how their capital is being used. It can showcase which products may make up an underwhelming portion of the profit. It can highlight how you are spending way too much time on orders that aren’t proportionally adding to your margin.
Let’s take the airline industry and a notable tech company as examples. Alphabet had 2020 revenue reported as $182.5B, an incredible number. The ENTIRE US airline industry has combined annual revenue of $190B, just a bit more than one massive organization. The Airline industry averages a gross margin of 1.41%, while Alphabets floats comfortably above 50%.
What questions should you be asking?
Having the ability to identify changes or even stagnation, in Gross Margin, allows organizations to start asking questions. It’s an incredibly important number for any organization. For example, If you are able to increase Gross Margin by 1% for a company doing 50M in revenue you just made that organization 500k. But, how do you actually increase gross margin by 1%? It comes from knowing your overall gross margin and having the ability to apply that same logic at a more granular level to customers, products, etc.
What is my gross margin by product category?
How is my gross margin changing?
Of the thousands of products I’m selling, which ones am I making the most on?
Is my good customer actually a good customer or am I giving away too much margin?
You can now start to ask the right questions because you are optimizing for the right thing.
So the ultimate question here is not whether or not you can track metrics, but knowing that you are indeed focusing on the right ones: are your KPIs Vanity Metrics, or are they Actionable Metrics?