Metrics That Matter: How Quantifying Good Can Lead to a Better Bottom Line

12th in a series of excerpts from the book The HIP Investor (John Wiley & Sons, 2010). See other articles in the series here.

A company’s fiduciary responsibility is to drive profit, but profit is only evident after the fact. To predict the winners, an investor or executive needs to focus on the long-term indicators that are not yet fully embraced in the financial statements. What kind of metrics might predict financial success?

Customer Satisfaction Drives Profit

Obviously, customer satisfaction is one such measure. If customers are happy, they will return to buy more, and really happy customers will refer new customers to the business. JD Power, a customer satisfaction measurement firm, built its business on showcasing the linkages between customer delight and profits. JD Power’s book Satisfaction, reveals how highly satisfied customers drive increasing top-line revenue, which translates to bottom-line profit and ultimately to shareholder value.

Best Places to Work Outperform

Since customers are served by employees, keeping staff satisfied is critical to long-term success as well. Fortune’s annual list of Best Companies to Work For, created by The Great Places to Work Institute in San Francisco, provides regular ratings and rankings. When Wharton School Professor Alex Edmans back-tested the financial performance of these employee-friendly firms, he found a positive correlation between high employee ratings and shareholder value outperformance.

Which Metrics Matter

Sustainability factors—including human, social and environmental impacts—are also leading indicators of profitability and financial outperformance, which has been described in this series and the HIP Investor book. Thus, when companies integrate customer, employee, and impact metrics into a cohesive scorecard that managers can easily use, they benefit from a more HIP management system.

A common measurement system called the “balanced scorecard” was popularized by Harvard professors Robert Kaplan and David Norton during the 1990s, based on General Electric’s (NYSE: GE) performance management systems in the 1950s as well as early 20th-century French process engineers. This approach looks beyond mere financial profits, which tend to be lagging indicators of results that have already occurred. Kaplan’s and Norton’s Balanced Scorecard includes perspectives like “Customer,” “Process,” and “Learning” in addition to “Profit.” This typically produces a more comprehensive and proactive view of the business and requires “leading indicators.”

How Many Metrics Are Too Many Metrics?

Besides being measurable, metrics must be meaningful to business executives and managers. The GRI (Global Reporting Initiative), originated by CERES.org, lays out an encyclopedia of 100-plus measures and descriptors across 10 categories. Approximately 1000 companies worldwide report to some level of GRI standards, mostly corporations with very large staffs and large-cap valuations.

These measures do quantify, but don't necessarily reveal what is meaningful. It is difficult for a manager to juggle more than a handful (literally, five to 10) performance measures. Thus the GRI, while comprehensive, falls short as a practical tool for managing the business.

A HIP investor looks for companies implementing a manageable set of performance measures that aligns both Human Impact and Profit. This is most effective when deployed from the front line to the Board of Directors. The comprehensive HIP Scorecard for investors tracks up to 20 metrics. However, leading companies generally integrate a few (up to 5) measures adapted to be meaningful to them. These leading indicators can help investors seek both positive growth and human impact in their portfolio.

Creating a Balanced Scorecard

NIKE (NYSE: NKE) looks at its product development with a wide-ranging scorecard. The “NIKE Considered Index” evaluates new products for their total life-cycle impact, from solvent use to waste volume, to the use and chemical treatment of materials. By looking end-to-end, NIKE can select the most optimal product design for performance, cost, and sustainability.

Or consider the company Herman Miller and its successful product, the Aeron chair. Based on the 10 measures of its Balanced Scorecard, including the environmental lifecycle costs, Herman Miller (Nasdaq: MLHR) evaluated Aeron in the early 2000s. The scorecard informed the company's decision to add an expensive but durable material to the chair, because doing so would add to the product's appeal. Herman Miller offset the expense by increasing the price - and the profit margin.

A balanced scorecard of measures examines multiple stakeholders and what they value. Starbucks’ (Nasdaq: SBUX) six categories are (a recent example is here)

1. Product, the coffee mainly.

2. Partners, the suppliers and farmers.

3. Customers, who generate revenue.

4. Stores, and the employees who work in them.

5. Neighborhood, and the communities the company facilitates.

6. Shareholders, the co-owners of the company

As Ben Packard, VP of Sustainability, explains, Starbucks sees business value in a multi-stakeholder approach. The best coffee is grown and picked when the farmers are paid a fair price and operate high-quality farming techniques. Customers are enamored of the premium quality, willing to pay higher prices and return to stores more often, not only for the product but for the friendly baristas, who are also dedicated because of Starbucks’s generous benefits, including health care coverage. The neighborhood benefits from the close connection of customers to employees, and shareholders benefit from the virtuous cycle of all stakeholders pulling together.

In Conclusion

Just as the economy has leading and lagging indicators, so do companies. The challenge is to understand which companies are managing proactively using leading indicators of performance. These firms then tend to outperform by looking ahead rather than into the rear view mirror for financial results.

Once companies begin to measure and manage these impact metrics, we can start to look for them to align their measurements with the financial implications and reporting. Next, we will discuss how leading companies seek to align and map these impact metrics with their revenue, profit and financial aspirations.

Photo by Patty O'Hearn Kickham/flickr/Creative Commons

To navigate this series, please use this table of contents.

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HIP Investor supports Spring of Sustainability.  For three months, the Spring of Sustainability will feature 100 “stars” of sustainability, from Jane Goodall to Bill McKibben to Van Jones, in free interactive teleseminars throughout the spring of 2012. Live events will also be held in cities across the globe.

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R. Paul Herman is CEO and founder of HIP Investor Inc. Herman is the author of “The HIP Investor: Make Bigger Profits by Building a Better World,”  published by John Wiley & Sons in 2010. Herman is a registered representative of HIP Investor Inc., an investment adviser registered in California, Washington and Illinois.

NOTE: This feature, excerpted and adapted from the HIP book, is not an offer of securities nor a solicitation. The information presented is for information and education purposes, and is not an investment recommendation. Past performance is not indicative of future results. All investing risks losing your principal. The author may invest in the companies mentioned above, and several are included in the HIP 100 Index portfolio. Details and full disclosures are at www.HIPinvestor.com

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