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Business Journal
Enron's Misguided Metrics
Business Journal

Enron's Misguided Metrics

Want real growth? Measure the right things.

by William J. McEwen

Much has been made of the recent Enron debacle, and that's understandable. A major energy company, once trumpeted as a Wall Street darling, just melted into bankruptcy court. And not just any company, but the seventh largest in the nation in revenue -- and a company heralded by Fortune as "most innovative" not once, but six years in a row. What had been a beacon of business success and leadership became, almost overnight, a poster child for alleged fraud, greed, and gross mismanagement.

As a result, people are pointing fingers. They're pointing at regulators and politicians entrusted with performance oversight. They're pointing at company leaders and at all those who somehow failed to notice or assess the problems of an over-extended company with an allegedly "failed business model." People are also raising questions about the wisdom of having consulting organizations report on the success of their own recommendations.

These are important questions. But are they the right ones?

How can economic disasters such as the Enron collapse be avoided? How can investors protect their investments?

Is the solution a closer watch on each company's complex web of "secret" partnerships, subsidiaries, and accounting manipulations? Or is the problem deeper than that? Are companies plunging headlong down a path, guided only by a compass that cannot reflect their actual direction? Does the compass need to be more finely tuned, or is the problem that companies are using a compass that points inexorably in the wrong direction, and always will?

Risky business
There is a core problem revealed here, and it reflects the attitudes and values of Wall Street analysts. Companies such as Enron are regularly praised for their apparent revenue growth. Bigger is always better. Stock prices and "buy" recommendations directly reflect a company's track record in reported income and profits. Thus, companies urgently need to show analysts and investors a continually increasing stream of cash.

If revenue and earnings are the principal metrics by which analysts and investors evaluate corporate performance, it's a small wonder that companies might succumb to the pressure to report or restate profits in what seems the most favorable way. This singularly focused pursuit of revenue can lead companies to all manner of creative accounting practices when reporting business performance. For Enron, it certainly did. And Enron is not alone.

Company leaders will aggressively pursue the outcomes praised by those whose actions and recommendations influence their company's measured value. That's what they're paid to do. Build the worth of the company, in line with the accepted metric that indicates its worth. If the critical outcome is growth, then company leaders will focus on growth. And at least for some, this focus can lead to the pursuit of growth by any means.

Is this really necessary? Is it even desirable? As Milton Friedman put it, "We don't have a desperate need to grow. We have a desperate desire to grow." There's an important difference.

Is growth in earnings per share a reliable indicator of a company's health? Enron provides an answer to that: not always. Growth is important, but reported revenue growth may not reliably indicate the success of a company's business model. Reported growth, it appears, can be creatively enhanced.

If it's not growth in income or reported profits, then what is a reliable indicator of the health of a company? What measurement should analysts and investors focus on when they make their investment decisions?

Measures that matter
Ultimately, the true health of any company is not reflected in its reported revenue growth, but in the health of its customer relationships. Healthy customer relationships assure long-term growth. Real growth. Acquiring new customers is important. Revenue growth is important. Keeping customers and assuring future growth is even more important.

Companies that seek to monitor the health of their customer relationships need a different yardstick. Management requires measurement. And if there is to be meaningful oversight, analysts and accountants will require that same sort of yardstick.

In short, companies need a reliable and objective means to assess the real strength of their customer connections. The Gallup Organization has pioneered just such a metric, and in light of recent events, it could not be more timely.

Over the past few years, Gallup's extensive research and development has led to an important measure of the bond between company and customer -- a measure of customer engagement, the CE11 -- that provides a vitally important bellwether of business performance. Gallup has shown that this metric strongly relates to profit performance -- and even to stock price resilience.

Importantly, CE11 , a metric that reflects the strength of a company's customer relationships, is not artificially inflated by secret partnerships, overstated earnings, questionable mergers, or dubious brand or line extensions. Rather, it measures what is critical to the ongoing success of any company's business model: the degree to which a company creates, enhances, and protects its customer relationship assets.

How do we avoid future Enrons? How do we redirect the attention of company leaders and investment analysts to that which truly matters -- and away from what Jack Trout has termed a "greenhouse for trouble"?

We need this new customer metric and what it implies: a new and meaningful focus. We need a new compass, one that can guide companies and Wall Street -- and those who invest their 401(k) earnings -- on the real path to enduring business performance.

Customer engagement represents an important challenge and a critical opportunity for companies to redirect their measurement toward outcomes that count. This new metric gives company leaders and industry analysts the means to recalibrate their corporate compass.

Analysts need no longer look just at the stated profits and cash flow reported in a company's current balance sheet. They should be demanding, and carefully monitoring, solid evidence regarding a company's connections with its customers. The time has come.

William J. McEwen, Ph.D., is the author of Married to the Brand.

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