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Profit per employee vs. Revenue per employee

Ed Kless - 02/28/2007

In a recent article by Lowell Bryan, a director in McKinsey & Company’s New York office, the author postulates that the “new metric of corporate performance” is profit per employee. He begins “Let’s get right to the point: companies focus far too much on measuring returns on invested capital (ROIC) than on measuring the contributions made by their talented employees.”

True enough, but while I believe he has seen the tree, he has still missed the forest. Profit per employee is based on the assumption that profit is an accurate measure of return on intellectual capital. In a dialogue with Ron Baker via Skype he noted, “I’m dubious. They seem to take GAAP at face value, and the problem is GAAP! GAAP doesn’t deal with intellectual capital. Intellectual capital is a theory, GAAP isn’t. So dividing profit by employees doesn’t tell much.  [It would be] like using a ruler to measure the temperature of your oven.” Classic Bakerian wisdom that.

I, however, humbly posit the following:

Revenue (not profit) per employee (RPE) is meaningful especially when the change in RPE is measured over a consistent time period and when compared to other companies in the same industry.

Here is my argument. Revenue, per Peter Drucker, is the captured value that an organization provides to its customers. Number of employees is the number of human brains (usually) at the company. So, dividing captured value by number of brains is a measure to at least some degree of the usage of intellectual capital. It is not predictive, nor does the customer care about it, so it has two strikes against it from a Measure What Matters point of view.
It does, however, have meaning to the employees of the company. I believe it could be used to gauge how smart we are as a group, especially when compared to others. The two ways of affecting it would be to either a) capture more value while not increasing braincount or b) capturing similar value while decreasing braincount. Either way a Professional Knowledge Firm would have to see value pricing as a way to deliver on this.

This is not to say that we should ignore profitability. Doing so would be foolish. But looking at Profit per employee does not make much sense to me.

Fellows, readers, your comments please. 


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Comments

Craig Brown

Hi Ed.

Just found your site and am enjoying it as I sit here and build my intellectual assets.  I thought I’d offer an opinion on your profit/revenue per employee comment.

Bother revenue and profit per employee is useful in consulting/knowledge business.  Most of what you are selling is people’s talent and experience.  Even if you have a highly systematised delivery model, talent and experience are what makes the execution successful.  Hence your cost of people capital is an important way of measuring your effectiveness.  Over time you should also be able to track when ppe/rpe has changed and observe what changes were going on at the time.  This will help you make better management decicions about managing change, hiring, firing etc.

Dennis Howlett

I don’t buy this. The separation of people in one part of the value equation when you attribute so much “value” to ‘brainpower’ is illogical.

If people contribute to revenue than how can you logically discount their contribution to profit?

How can you assert intellectual capital is a theory when you attribute practical usage?

Ed Kless, Senior Fellow, Verasage Institute

Craig and Dennis,

Thanks for your comments. In reply, I would say that I agree with Craig that change in RPE is also a decent measure to look at. It is still latent, that is unpredictive of the future.

Dennis, I don’t discount anything (sorry a little pricing humor). Seriously, I see what you are saying about people’s contribution to profit. However, since most firms can easily manipulate the number that ends up being called profit, I would say that PPE is significantly less reliable than RPE. In short, I trust revenue because it is more closely related to the customer than is profit which is more subject to the whims of accountants.

I am not sure I understand you second question, but all theories are MEANT TO BE subjected to “practical usage”. That is how you prove or disprove your theory, you test it. Accounting is not a theory precisely because it is not subject to this kind of testing. If I misunderstood, please clarify. This web site is for open debate about exactly this kind of exchange.

Eric Fetterolf

Revenue per Employee or Profit per Employee (or EBIDTA per Employee for that matter) is an internal looking metric that replaces the crutch of timesheets. 

If you measure something, then that is what your team will pay attention to.  How will this be any different that sales quotas?  Will we “discount” to make our quarterly/yearly goals?

And what about training?  It does not contribute directly to immediate revenues or profits.  It is an investment in the future of both the PKW and the firm.  It represents the potential for greater value for the company.  But only the customers will prove out whether that potential becomes actual value.  Under a metric of Revenue per Employee or Profit per Employee the training becomes very disposable very quickly (especially in lean times).

I propose it is an efficiency metric.

I propose a different metric, Customer Value Achieved (Customer ROI) per Employee (CVApE) and Revenue Captured as a percentage of the CVApE.

What does the group think?

Ron Baker

Eric, I’m very much aligned with your thinking on this. Any number that comes of an income statement is, by definition, lagging, and can be gamed. In fact, any measurement can be gamed.

I wrote about this in Measure What Matters, but Charles Handy, the UK’s Peter Drucker, thinks it’s insane to believe there is just one measurement. The Good Lord gave two eyes, so perhaps we can be more multi-dimensional.

I really like the premium price achieved as a metric, like Interbrand uses to value brands. Customers that reveal their preference by paying more to you than the competition speaks volumes!

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