How to measure profitability has long been a contentious argument between accountants and store operations. The standard P&L has lost effectiveness as the primary tool used for measuring and incentivizing store operating performance. Add in today’s rocky economic climate, and it is more important than ever to define what success is, making it clear to everyone how to navigate that road to profitability. Given these complex circumstances, retailers ask, where do we go from here?
Understanding the various approaches is a first step to identifying common ground. For instance, some retailers use controllable margin for measuring performance, excluding expenses like rent and depreciation. Other retailers produce a cash basis P&L to avoid rules that accountants must use. The problem with both modified P&L approaches is that the company sees two versions of profitability, and such inconsistent perspectives can produce disagreement when making business decisions.
A new wrinkle for multi-channel retailers is the disintegrating concept of a P&L by channel, as customers increasingly shop across channels (consume costs) before committing to buy (generating revenue). Also, retailers still struggle with accountability versus responsibility. For example, stores complain of being charged with expenses they cannot control, believing home-office personnel assuage their own accountability by allocating unplanned expenses to the stores.
Incentive pay is affected by these issues as well because retailers have developed an overabundance of metrics, sometimes conflicting across an organization. Although metrics may be aligned with strategic intent, if incentive pay is tied to a P&L, the target is murky at best.
Regulatory changes for and confusion about accounting treatment of data (e.g. revenue recognition, accruals) can cause store personnel to inefficiently spend time each month reviewing and validating numbers that are different than the stores’ records.
Lastly, stores and corporate personnel still spend a significant amount of valuable time questioning incoming data. This is unnecessary since today’s systems and controls provide an improved means of validating data accuracy.
It’s an uphill battle. In the end, the winning theme is often diluted and miscommunicated to the people who need to execute the company’s strategy. Furthermore, the difference in results produced by accounting rules will likely become more complex if the introduction of International Financial Reporting Standards (IFRS) is mandated.
What’s a retailer to do? The assessment that many companies are undertaking to determine the impact of IFRS implementation is the perfect time to consider a shift in performance management approach. We recognize that no single solution works for all retailers, but some guiding principles hold true:
Retailers must focus on doing only what matters. Change what is measured and how to improve the precision of performance management.
Align employees to the appropriate goals. Associates must focus on the results they can control; employees with clear, achievable goals are more motivated to achieve these goals. An added result may be a more efficient corporate office operation, with fewer interruptions for data processing and validation.
Integrate to succeed. Combine the best features of a store P&L and a balanced scorecard to create a simple performance measurement tool that supplies one version of the truth enterprise-wide. Accountants and executives will continue to use the P&L and offer a smaller subset of metrics for the stores’ and departmental focus.
Get everyone on board with the right behavior. Align the incentive program with key performance metrics.
For sophisticated environments, retailers should allocate performance metrics much as an assortment plan is developed—aligning the strengths of store attributes with the strategic metrics, providing a customized plan by store to optimize overall results.
In the end, a truly integrated performance management design will provide the performance-oriented team with the tools it needs to drive the business toward success, in a sustainable way.
Pam Wilson is the director of Deloitte Consulting LLP; Rahul Gautam and Eric Vroonland are senior managers. Please see www.deloitte.com/us/about for a detailed description of the legal structure of Deloitte LLP and its subsidiaries.
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