How Do You Know If Your Strategy Is ACTUALLY Working?

Strategy can be a bit of a black box for some leaders. That is because it is often taught in such a visionary or abstract way that no one really knows what it is or how to measure it. Sure, it can be fun to get away from the day-to-day during an offsite and dream about all the possibilities that exist for the company. But those feelings of excitement can quickly fade when a company starts struggling financially and is forced to make cuts to course correct. Knowing how to measure the effectiveness of your strategy in a straightforward way can help you avoid the trap of thinking you have a good strategy when, in reality, it is a bad one.

There are many well-intentioned strategy facilitators in the world today, often backed by popular entrepreneurial systems. But when you look behind the curtain, you often find that after the excitement of a few vision day exercises and the start of execution, not much changes in the company’s financial performance. Why is that? Because there is often a disconnect between strategy and the true economics of the business. If this is new to you, do not worry. You are not alone. Too many companies are misguided and approach strategy the wrong way. Rather than getting into the mechanics of an enduring strategy framework, which we will save for another article, it is more important to talk about how to measure the strategy you already have. This is your real starting point. You do not need to begin with a vision day. You need to start with a reality check.

So how do you measure the effectiveness of your strategy? There are many ways to do this, but to keep things simple, we will focus on one of our favorites: return on invested capital, or ROIC. It may sound like a big, fancy term, but in reality it is quite simple. It measures the amount of after tax profit you earn from the core operations of your business, divided by the amount of capital you have invested in the business. Invested capital includes working capital plus net property, plant, and equipment.

ROIC = NOPAT / Invested Capital

Now that you know how to calculate ROIC, you may be wondering why this is the right ratio to use when measuring the effectiveness of your strategy. Think about it. The whole point of strategy is to maximize the value of your company. I know this may create some pushback from those who argue that business is about more than maximizing returns on capital, and I agree. Business is one of the greatest vehicles in the world for improving and blessing people’s lives. As a company grows in value, it creates more resources and more opportunities for others to grow as well. When people grow, they have more to give. And since giving is at the core of what brings joy and fulfillment to most people’s lives, it is only made possible when growth occurs.

But not all growth is good growth. That is where return on invested capital comes into play. ROIC puts returns into a relative format, allowing you to see whether your growth is actually creating value or quietly destroying it.

For example, imagine you have the option to own one of two companies, but you can only choose one. Company A generates $1 million dollars per year in profit, while Company B generates $500 thousand dollars per year. Which company would you rather own? Most people would choose Company A because we are taught early on that business is about maximizing profit. But this is where that thinking breaks down.
Business is not about maximizing profit. It is about growing value.

Now let’s look a little deeper. To earn $1 million per year in profit at Company A, you had to invest $20 million into the business, which results in a 5 percent return. Company B, on the other hand, earns only $500 thousand per year in profit, but requires just $2 million dollars of invested capital. That is a 25 percent return.

Same business decision. Very different outcome. That is why measuring your strategy matters. If you do not, you will end up judging the health of your business, like most leaders do, based on a simple metric like profit, instead of profit relative to everything you have put into the business. To avoid deceiving yourself, one of the easiest ways to benchmark your company is to compare your ROIC to the overall performance of the market. For example, if you look at the average returns of the S & P 500 over the last fifty years, it has generated nearly ten percent returns. This means that when you calculate your company’s ROIC, and it falls below that ten percent threshold, you may be underperforming the broader market. That does not mean you should throw in the towel, shut down your business, and move all your money into the stock market if your ROIC is in the single digits. It does mean you should step back and honestly evaluate whether all the hard work, risk, and sacrifice you are making are producing the returns on invested capital you truly want.

I don’t know about you, but the older I get, the more I value my time, especially because it goes by so fast and my kids seem to be growing up at an accelerated pace. I remember reading a story about the late Kobe Bryant, a legend in the sport of basketball. His wife reminded him that she would support him and take care of the household and the kids, no easy feat in itself. In return, he had to promise that he would give everything he had to improving himself and becoming the best basketball player he could be.

The same idea applies to business. If we are going to commit ourselves to something as demanding as building an enduring and valuable business, why would we not want to measure what matters most? Doing so allows us to know whether our time, energy, and sacrifices are actually producing the results we are working so hard to achieve.

That is my challenge to you. Calculate your ROIC and see how you stack up. Keep in mind that for some businesses, such as capital-light companies or businesses with uneven investment cycles, ROIC may need to be replaced with other measures. Even so, this should be enough to show that there is a clear way to measure your strategy. You no longer need to operate in the dark, making blind decisions and wondering whether you are on the right path.

Once you calculate your ROIC, let us know how it turns out. And if you ever need help putting a system in place that gives you tools like this to scale your business, you can reach out to us.

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