In a recent article I share the insights I gleaned from my visit with Bob Block on his formula for "Do the right thing and do things right" and I promised that I would follow up by sharing how Bob uses this formula to understand what a company has been doing and what it should be doing.

Bob began by explaining that he likes to draw the two ratios from last week's formula in graphical format. For those of you who might have missed last week’s formula, it’s a way to define how well a company is doing in terms of marketing effectiveness and internal efficiency, and provides a figure for Return On Investment (ROI). Here’s the formula once again:

The figure below shows how Bob draws the two ratios of this formula on a graph:

The vertical axis describes the company's internal efficiency in terms of percent of net profit per dollar of sales. The horizontal axis defines the company's marketing effectiveness in terms of how many times the company's sales equals assets (a company with $100,000 in assets and $200,000 in sales would equal a 2 on the horizontal axis).

The company's Net Profit/Assets or ROI is the gross margin multiplied by the asset turnover. The graph below shows many possibilities for ten, twenty, and thirty percent ROI. A ten percent ROI, for instance, can be achieved with a 2 in asset turnover and 5% gross margin or a .5 in asset turnover and a 20% gross margin.

So this is all well and good, but what does it tell you? According to Bob, where a company lands on the chart tells you something about the personality of the management. For instance, the green X in the upper left part of the graph on the 10% line demonstrates a manager who is strong in internal efficiency (note the 20% gross margin) but weaker in marketing effectiveness. This person might be an accountant or engineer. The green X in the lower right part of the graph defines a manager who is strong in marketing and promotion, but less effective in cost control. The company's position on the graph tells you where the company has been (i.e. strong in marketing but weak in cost control or vice versa).

But that's not all. As Bob elaborated on his graph he demonstrated how it also tells you where the company is heading and where it should be heading. For instance, if you told both managers that they needed to get from the 10% line to the 20% line, how would each of them react? According to Bob:

"Well, they've already showed us what they would do. The guy on the bottom right is going to try to get more marketing effectiveness. He'll try to get more advertising. If he does research and development he'll try to develop more features that he can sell. Whereas the guy on the left upper side he is going to try to cut cost and increase his gross margin, and if he was doing research and development he'd be focusing that on how he can cut his costs."

Now, what should these managers be doing? Rather than trying to leverage even more out of their strengths, they would take a more direct path by shoring up their weaknesses. Rather than trying to increase his internal efficiency to 25% (which becomes more and more difficult due to the law of diminishing returns) the cost control manager should double his asset turnover from .5 to 1. And the marketing effectiveness manager should double his gross margin from 5% to 10% instead of trying for greater market effectiveness.

To sum it all up, Bob says, "This type of a chart and the concepts that go with it provide a great deal of information about how the company has been run and a great deal of information about how the company ought to be run."

Read other articles about Bob Block:

Lessons from the Entrepreneurial Journey
Bob Block on Doing the Right Thing and Doing Things Right