The October issue of Harvard Business review included an article by Legg Mason Strategist and Columbia Business School Professor Michael Mauboussin titled “The True Measures of Success”.
About a dozen years ago, when I was working for a large financial services firm, one of the senior executives asked me to take on a project to better understand the company’s profitability. I was in the equity division, which generated fees and commissions by catering to investment managers and sought to maximize revenues by providing high-quality research, responsive trading, and coveted initial public offerings. While we had hundreds of clients, one mutual fund company was our largest. We shuttled our researchers to visit with its analysts and portfolio managers, dedicated capital to ensure that its trades were executed smoothly, and recognized its importance in the allocation of IPOs. We were committed to keeping the 800-pound gorilla happy.
Part of my charge was to understand the division’s profitability by customer. So we estimated the cost we incurred servicing each major client. The results were striking and counterintuitive: Our largest customer was among our least profitable. Indeed, customers in the middle of the pack, which didn’t demand substantial resources, were more profitable than the giant we fawned over.
What happened? We made a mistake that’s exceedingly common in business: We measured the wrong thing. The statistic we relied on to assess our performance—revenues—was disconnected from our overall objective of profitability. As a result, our strategic and resource allocation decisions didn’t support that goal. This article will reveal how this mistake permeates businesses—probably even yours—driving poor decisions and undermining performance. And it will show you how to choose the best statistics for your business goals.
The article is based on Professor Mauboussin’s new book The Success Equation:Untangling Skill and Luck in Business, Sports, and Investing which was released last week.
Both the article and book mention Michael Lewis’ Moneyball. I think this clip from Moneyball provides a perfect analogy for Professor Mauboussin’s premise.
Meanwhile, in concert with my last post, I will begin adding material to the VI Resources, SI Resources, and Security Analysis pages. Not all additions will make it to the front page of the blog, so check back to see what is new.