Benchmarking Your Way to Success
Benchmarking can provide your organization with a valuable measure of performance that is both qualitative and quantitative.
Benchmarking is one of the most powerful tools a business can use to manage and measure profitability across the supply chain. Properly applied within the appropriate parameters, benchmarking can enhance your competitiveness, increase shareholder value and provide your business with a long-term strategic focus. It can also identify opportunities for improving key components in the supply chain and optimize the allocation of resources.
Deloitte & Touche has been conducting an annual benchmark study of North American food processors since 1993, analyzing financial results, tracking industry trends and comparing Canada’s performance with that of the United States. Each year, the firm publishes the results of the study in a report, Benchmarking for Success that has become the industry’s best-known scorecard.
Benchmarking can provide your organization with a valuable measure of performance that is both qualitative and quantitative. Benchmarking checks and refines tactical and strategic objectives and management’s understanding of the business, and at the same time provides insights into the competition’s strengths and weaknesses.
Benchmarking can also shed light on an organization’s internal operations. It can identify breakthrough practices and innovations in areas such as technology, structure and measurement systems. It builds enthusiasm and commitment for change among employees by creating a corporate culture that carries a sense of urgency, builds confidence and encourages challenging the status quo. Finally, it helps a business to focus scarce resources more effectively by showing the magnitude of opportunities available, supplying a framework for prioritization and providing input into the action planning process.
The process of benchmarking comprises seven steps:
1. defining the objectives;
2. determining the peers;
3. identifying measurements;
4. defining sources;
5. gathering data;
6. analyzing results;
7. and drawing conclusions.
The first four steps — defining the objectives; determining the peers; identifying measurements; and defining sources — are fundamental to the successful completion of the exercise and must be carried out during the planning and scoping phase. Let us look at each one of these four steps in detail.
Step 1 - Defining the Objectives
You must first define the objectives you want the benchmarking to achieve. Do you want to measure profitability, efficiency or solvency, or do you feel the need to meet the benchmark or beat the benchmark? It is worth spending time on this part of the process because the ultimate success of benchmarking will depend on how relevant your objectives are to your overall corporate strategy.
At the same time, the scope of the benchmarking process needs to be defined — it should be tied to the benchmark objectives you have chosen. To narrow the scope, you need to consider a number of questions. What are the geographical parameters: city, country or continent? In order to understand your industry’s best practices, it may be necessary to move beyond your national borders. Are you interested in current information or historical, and if historical, how far back do you want to go? Do you want to discover best practices in your industry? Do you want to find the answers to tomorrow’s challenges by learning about leading-edge industries or companies and applying those insights to your own business?
Step 2 - Determining Your Peers
It is essential to choose the right peers or comparators for your benchmarking exercise. It may be that within your industry there is no suitable peer, and you may have to look to other industries to find an appropriate match. For example, a midsize regional brewer might find that trying to benchmark against large international competitors and microbreweries leads to unsatisfactory results, whereas a more logical benchmark might be companies of a similar size in a somewhat comparable sector, such as the beverage industry.
How many peers do you need? While Deloitte & Touche compiled data from almost 150 North American companies for its 2001 Benchmarking for Success study, you can effectively benchmark with far fewer — even one peer may provide the results you require. Far more important than the number of peers you choose is the fact that they are wholly relevant to your objectives.
Step 3 - Identifying Measurements
You may choose from a variety of measurements when you plan your benchmarking process. The seven most frequently used ratios fall into the areas of profitability, efficiency and solvency.
Profitability ratios indicate how successful the business is in providing a return to the owners.
BT On Sales Earnings before taxes and extraordinary items, expressed as a percentage of net sales. This ratio is a key measure of profitability, which indicates how efficiently a company has been able to transform annual sales into earnings.
Return On Assets (ROA) Earnings before extraordinary items as a percentage of average total assets. This is a key profitability measure that can be expressed on a before- or after-tax basis. It reflects the percentage profitability being generated on the assets employed.
Return On Equity (ROE) Earnings before extraordinary items as a percentage of equity. This figure can be expressed on a before- or after-tax basis and is the ultimate indicator of the company’s profitability.
Return On Equity (EBITDA) Earnings before interest, taxes, depreciation and amortization as a percentage of equity. This figure is used to assess a company’s financial performance before debt burden and taxation. EBITDA is often referred to as operating cash flow, due to its exclusion of depreciation and amortization, which are non-cash expenses.
Efficiency ratios will indicate how well a company is using its assets and can help you evaluate how effectively it is managed.
Gross Margins (GM) Net sales less cost of goods sold, divided by net sales. This reflects how well production costs are managed and whether pricing policies provide adequate coverage of fixed costs to earn a profit.
Solvency ratios demonstrate a company’s ability to meet short-term and long-term obligations, thus providing an indication of solvency or liquidity.
LTD To Equity Long-term debt as a percentage of total equity. This is an indication of the total amount of financial leverage employed by a company and is a key indicator of its capital structure.
Total Debt To Equity Total liabilities (long-term and current) as a percentage of total equity. This indicates how much of a company’s total liabilities are financed by creditors.
Step 4 - Defining Sources
The final step in planning the benchmark process is to define the sources of information to be employed. These can include industry and analyst reports, online databases, professional associations, personal interviews, structured surveys, on-site observations and interviews with customers and suppliers.
Once you have successfully completed the planning and scoping phase, you must then proceed to gathering and analyzing data, and drawing your conclusions. It is critical that you take the information to the next level, asking yourself the questions: What does the information mean? What do you do? When do you do it? How do you do it? From that, you can develop your action plan.
Be warned, there are pitfalls to benchmarking. The benchmark may be unfocused because the scope is too broad. The data required may be unreliable or unavailable — for example, selected peers may have different business models. Lack of qualitative data or best practices may result in a focus on numbers rather than concept during the analysis stage. In addition, there may be a lack of commitment to benchmarking by management and a failure to draw up an action plan after the process is complete.
If, however, you follow the steps outlined in this article, you will find benchmarking enhances your profits and shareholder value, provides guidance with your strategic planning and resource allocation, and improves your corporate confidence and culture.