Executives and business owners are well acquainted with the Profit & Loss (P&L) statement. This is the accounting sheet that tracks revenue on one side and costs on the other, laying out a simple math formula to determine how successful a business has been.
Franciscan monk Luca Pacioli is credited with creating the P&L, which candidates are often asked about during job interviews to determine their level of authority. While managing a P&L is comparable to balancing a checkbook, it is viewed as a status symbol in corporate America. The P&L performance represents the adult version of the report card. Annual bonuses are based on the ledger’s balance. This record became the default focus area for management teams.
Individuals are hired to perform a job. They provide value or build value in some fashion. Along with materials, facilities, and utilities, people are tracked as a cost. Within the P&L structure, people will never be classified as a revenue stream. This is not a cold calculation. It is simply how the formula works.
Throughout economic cycles, executives must decide whether to lower costs or liquidate assets to increase profits. Typically, assets are not sold because they are needed to run the business. You cannot build houses if you sell all of the company’s hammers. While it is possible to purchase cheaper materials or lower supplier agreements, this is easier said than done and can require years of negotiation. This leaves management with the option of reducing headcount as the most convenient way to balance the P&L during rough patches.
Wall Street favors this approach, viewing workforce reduction as a long-term step in the right direction. However, the jump in perceived profit is an aberration that fails to account for lost production value. While labor cost is viewed as the most flexible profit lever, it represents the sacrifice of a core asset and is a one-time tool that breaks after use.
Spies have navigated complex organizations for centuries, existing throughout the history of warfare. Countries have thrived with the help of individuals willing to provide classified information. Such information can shift battlefields into more favorable conditions, or even provide insights to help avoid war altogether.
Critical to spy agencies are their assets, those people with whom agencies work to collect information. Substantial time is spent on recruiting and developing these assets to ensure they are safe and able to provide valuable information. The spy agency’s goal is to nurture these people as this will provide long-term value, ultimately benefiting the nation. A spy agency’s greatest fear is losing assets, potentially exposing its strategy and cutting off a vital information stream, its version of revenue.
Spy agencies were in their prime during the Cold War. Significant investments were made to recruit, develop, and nurture human assets, or HUMINT. With the fall of the Berlin War, agency budgets also fell, leading the US to invest more in satellite and signal intelligence. This was cleaner and perceived to be better at gathering intelligence. Yet, it resulted in large intelligence gaps; notably, a failure to raise the alarm for 9/11. While HUMINT is highly complex and costs more, such assets provide key puzzle pieces, just as they do in corporations.
This isn’t revolutionary thinking or rocket science. Most, if not all, “Management 101” classes highlight the importance of treating your people well and that long-term bets pay off. Saving a few bucks in the short run will only hurt you in the long run. So, if this is common knowledge, why does leadership continue to focus on the wrong things? This persists due to continual downward pressure to achieve P&L goals. Three levels removed, executives will be less concerned about the human impact and, often, do not believe their cost-cutting directives will impact production. Consequently, this forces managers to go against their instincts due to hierarchical pressure, even while knowing that such actions will have detrimental long-term effects on the organization. So, why do we still treat people as pawns? Lost in all of this are the people. They are not costs, but rather unsellable assets.
The true issue lies in the tool that dilutes the value an employee provides. Products cannot be made without raw materials; they are integral to the overall product. Yet, this is still a cost. Likewise, employees are viewed as an expense. To solve this problem, the structure of the P&L must accurately reflect employees’ lifetime value to the company and their cost.
These statements report revenue in the past, while costs are reported in the present. This gives a false impression of cutting costs while maintaining the same revenue. Occasionally, you can cut employees and maintain value. However, these moves typically clear out the low-hanging fruit, eliminating functions of the least value. This is the exception, not the norm.
Over the last decade, competitive intelligence and advanced analytics have become common business practices with widely available tools. Professional sports leagues employ advanced analytics; for example, baseball assesses players with the statistic of Wins Above Replacement (WAR). Why have we not adopted a similar approach in the C-Suite to determine the lifetime value of each employee?
While I cannot offer a definitive answer or silver bullet, I can dream of the future P&L. I envision a P&L that provides data points to project future revenue based on current costs; a P&L that offers a more accurate reflection and provides a better area of focus. How to drive higher value per employee should be the ultimate goal.
Copyright © 2021 9m Consulting - All Rights Reserved.