Revenue Per Employee In Small Business
I recently read an excellent book, What No One Ever Tells You About Starting Your Own Business by Jan Norman. The book tells a bit about 101 entrepreneurs, their companies, and the advice these entrepreneurs would give someone just starting a small business.
For a few of the companies profiled, Norman mentions both the company revenue and the number of company employees. Whenever I see this type of information for a company, I usually calculate the simple ratio of Revenue Per Employee.
For example, for a video production company mentioned, with sales of $15 million and 130 employees, the Revenue Per Employee is about $115,000. For Optiva, a maker of a sonic toothbrush, and another company profiled, the revenue was $100 million. Optiva had 250 employees, giving a Revenue Per Employee of $400,000.
Revenue Per Employee is a key ratio for start-up companies. A low Revenue Per Employee in comparison to similar companies is a bad sign, often boding possible failure.
Companies usually fail for one of two basic reasons. Either, the companies fail at marketing their product or service and generating sales. Else, companies fail to keep the costs to produce and market their product sufficiently low.
Some new companies have problems generating any sales at all! There is a lack of basic revenue. Failure to make sales shows up as low Revenue Per Employee, though, as the owner of your business, you will instinctively know when your sales are too low!
But, if you are an outsider evaluating a business for investment, calculating Revenue Per Employee gives some measure of whether or not the business is generating adequate sales relative to its assets and people. As with all ratios, Revenue Per Employee puts similar, but different-sized companies, measured by their revenue, on a more equal footing to compare their relative efficiency.
If a company has a personal sales staff which approaches potential customers off site, the company probably calculates Sales Per Salesperson as a measure of each salesperson's efficiency. Such a number can vary greatly depending upon the salesperson's talents.
In Working With Emotional Intelligence, Daniel Goleman quotes a study of forty-four Fortune 500 firms showing that the top 10% of salespeople had $6.7 million in sales compared to the average salesperson's $3 million. So, the best salespeople were over twice as effective. Goleman attributes the super-sellers' greater performance to their having superior emotional intelligence.
The lesson is that while Revenue Per Employee ratios are easy to calculate, the underlying explanation for differences might be quite complex. For example, it would be extremely difficult, or maybe even impossible, to bring the entire sales staff up to the performance of a sales superstar. However, by careful hiring, you might be able to include a higher percentage of sales superstars on your team! Look behind the ratio to see how to improve a company.
Similarly, the explanation for the difference between two similar companies having different Revenue Per Employee ratios might not be obvious. Yet, as with Sales Per Salesperson, Revenue Per Employee is a good measure of relative success. However, correcting the deficiencies in a company with a low Revenue Per Employee might be difficult, because the ratio often points to a weakness in that murky, unquantifiable region of management.
Effectively generating sales in a profitable way is the key to success. As the saying goes, you can often sell a dollar for fifty cents! But, who wants such a money-losing business?
One example of generating unprofitable sales could be a mail-order company which produces and sends out catalogues prospecting for new customers. More catalogs will generate more sales. But are those sales profitable? This illustrates why measuring the success of each marketing avenue, when it can be done directly, is important.
This issue strikes at a company's sales' efficiency. Efficient companies tend to have high Revenue Per Employee. The hope is that if the company is efficient in its use of labor, it will probably be efficient in other areas, like purchasing and marketing.
Just as a mail-order company could calculate the dollars remaining from sales after all marketing expenses were subtracted, and what remained would need to cover all other non-marketing expenses, product costs, and provide a profit, you could subtract the average pay per employee from Revenue Per Employee to get a measure of how many dollars per employee are contributed to all other non-personnel expenses and provide a profit.
For example, if you had a computer consulting company with Revenue Per Employee of $160,000 and average programmer pay of $100,000, you would have $60,000 per employee remaining to cover all non-programming personnel expenses and to allow for profit.
A viable company might have a low Revenue Per Employee if the company is a service company, providing a labor intensive service, but with low labor cost. With 101 companies to choose from, we can find an example from Norman's book!
Norman writes about a company specializing in cleaning rocks, marble, and stones. It's labor intensive—thousands of employees, but only a few million in revenue. It seems such a business will always be competitive, based upon price, and low-margin. And, if labor costs were to rise, such a business could quickly run into difficulty. Yet, for such a business, calculating Contribution Per Employee, in addition to Revenue Per Employee, might give a better picture of operations.
Be aware of the labor costs for the industry. A guy cleaning a rock with a brush won't earn the same as a computer programmer! Comparing Revenue Per Employee across different industries could be misleading.
For service companies, invariably more people hours are needed to render the service as sales grow. But, for successful product companies, sales might show explosive growth with a much lower addition to payroll. This is why a video production company has a far lower Revenue Per Employee than the maker of a sonic toothbrush. Product companies leverage personnel more.
The lone computer consultant would be an extreme case. Billing 2,000 hours at $80 per hour limits Revenue Per Employee to about $160,000 per year! This is one reason some successful, but smaller, computer consulting companies move away from pure consulting and try to create their own unique software product. They realize Revenue Per Employee is limited with pure consulting. They want to leverage their talents more.
Yet, service businesses have advantages over product businesses in that it is easier to grow and establish a strong cash flow with less need for capital investment. Given this, some product companies seek to diversify into service areas.
Revenue Per Employee is an important ratio which business owners, entrepreneurs, and investors should consider when evaluating a business. It provides insight into a company when compared to other companies in the industry.