Why Smart Leaders Still Get Strategy Wrong
Most leaders get strategy wrong. Not because they are not smart or good at business, but because they lack a system that connects the strategic choices they make to the financial outcomes those decisions produce. Case in point, I recently had a call with a very capable CEO who runs a $50M company. He said to me, “I get the financials every month from my controller, but I cannot connect the numbers on paper to what I do in the business every day.” If that sounds like you, welcome to a very large club. Millions of entrepreneurs struggle with the exact same problem.
In my last article, How Do You Know if Your Strategy is ACTUALLY Working, I introduced return on invested capital, or ROIC, as one of the primary metrics we use at Coltivar to determine whether a company’s strategy is actually working. Now, before your eyes drift off the page to something more entertaining, like a crazy cat video, let me reassure you that I will keep the finance simple. At a high level, ROIC measures how much after-tax profit a company earns from its core operations relative to the amount of money invested in the business. More technically, ROIC is NOPAT, or net operating profit after tax, divided by invested capital, which includes working capital, net property, plant and equipment, and other operating assets.
So why is knowing ROIC and its formula helpful? Any time I come across a metric, I like to break it down into its component parts. With ROIC, that means understanding the numerator, NOPAT, and the denominator, invested capital. Once you do that, you can start to see how your decisions influence each side of the equation. To improve NOPAT, there are four primary levers: volume, pricing, cost of fulfillment (or COGS), and overhead (or operating expense). From there, a leader can prioritize which levers to focus on based on the size of the opportunity and the potential financial upside. This is where strategy actually shows up. Take volume and pricing, for example. These levers drive revenue at the unit level. Strategic choices about your ideal customer, market focus, and positioning directly affect how many units you sell and the price you can command.
Now consider the denominator, invested capital. Here, strategic choices shape how a company competes. One business may choose a model where it subcontracts most of its work and earns margin through design and project management. Another may choose to self-perform most of the work. These are two very different strategies with very different capital requirements. The first stays relatively asset-light, while the second requires trucks, equipment, and other hard assets. Or consider a company that pursues public work versus one that focuses on residential clients. Those choices affect how and when the company gets paid, which in turn affects how much cash is tied up in the business.
This is why approaching strategy through a financial lens matters so much. Without it, leaders make big decisions in the boardroom that sound exciting, but quietly place heavy pressure on cash flow, capital, and returns. Asking how you will measure the effectiveness of your strategy is a powerful place to start. As you begin to understand the components of those measures, you will also begin to see how the decisions you make and the levers you pull translate into real results for you, your business, and your team.
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