The best benchmark is the competition, not the plan

“The real profit ultimately earned from a business is simply the realisation of relative advantage” – Kenneth Simmonds

How much value does a business need to add for this to count as a success? Performance is always relative – but relative to what? If we are to know whether performance is good or bad, improving or deteriorating, accelerating or decelerating, we need a standard of comparison. So with what benchmark or index should a business compare its results and its added value?

Traditionally, companies compare each year’s performance with the previous year’s performance. Financial accounts are generally laid out this way. The assumption is that the firm is doing well if the key accounting numbers are moving in the ‘right direction’ – increased sales, lower unit costs, higher productivity, enhanced margins, larger profits, and so on. There are several problems with using the past as the critical benchmark.

First, it is an inward-looking measure, with the result that seemingly good results can mask a worsening competitive position if at least some rivals are doing better still – and vice versa. Accounts do not pick up the fact that, by definition, every competitor except one is losing to at least one of its competitors at any stage in the game. In many industries, every player can be led to believe on the basis of their financial accounts that their competitive position is strengthening from year to year. Traditional accounts actively aid and abet this kind of deception.

Second, this approach sets the bar rather low. For most companies, particularly in a growing economy and ignoring inflation, beating last year’s results is not particularly heroic. As a result, the vast majority of companies use budgets to set a more demanding benchmark, taking into account changing economic circumstances and the declared aspirations of the executive leadership. But this is still an introspective exercise. Beating budget is by no means the same thing as beating competitors. Indeed, it is often observed that budgeting actively rewards managers of business units for aiming low so as to be sure of ‘making the numbers’ and avoiding the embarrassment (or worse) of failing to do so.

For a benchmark to provide a true measure of performance and the right focus of attention, it needs to be externally based. Two such benchmarks suggest themselves: performance relative to key competitors and performance relative to market opportunity or to potential.

The latter is particularly difficult to define: opportunity exists only in the mind of the entrepreneurial manager, and is therefore too subjective or too elusive to use as a benchmark. But the former is eminently suitable as a focus for performance. Is the firm winning or losing in relation to its closest competitors?

Except where the activity portfolio differs markedly among competitors, one particularly powerful measure is the firm’s share of the aggregate economic value added by all the firms competing for the same customers – and how this share is changing.

A firm can justifiably be said to be winning if its share of the wealth created by the strategic segment of which it is a member is growing faster than that of its rivals.

The task for accounting is to design and administer financial accounts that track competitive performance. If the accounting function is to contribute to the business it serves, it must be radically re-engineered to place the concept of economic added value at the heart of its measurement system and to use it routinely to track the ebb and flow of competitive position.

Edited extract from Uncommon Sense, Common Nonsense, by Jules Goddard and Tony Eccles, published by Profile Books Ltd. This article was taken from the June issue of Market Leader. Browse the archive here.