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The Hierarchy of Metrics

At its core, wealth creation is about finding value differences in the endless stream of global transactions and positioning yourself to capture that value. But how do we make sense of it all?

Strip everything away, and you'll find that every money-making endeavor is essentially a function - an input that produces an output. The simplest examples are:

  1. Trading time for a wage
  2. Combining assets and time to create increased value

Here is a short excerpt that is what inspired this post, it opened my eyes to how businesses are fundamentally optimizing for different metrics:

During a university case consulting competition, my team pitched expansion plans for a milk drink company. Like many other teams, we proposed partnering with supermarkets for shelf space. An idea that made sense at the time, and we justified this by offering some compensation to the stores. After all the presentations, one judge - the former CFO of Fonterra, one of the world's largest dairy exporters - gave us a reality check. Supermarket shelf space, was far more competitive than we realized. These businesses have one primary goal: maximizing revenue per square foot of floor space.

This led me to think about different businesses, and the metrics they optimize:

  1. Airlines chase revenue per seat mile
  2. Hotels focus on revenue per room
  3. Software companies revenue try to maximize revenue per user
  4. Consulting firms maximize revenue per billable hour
  5. Restaurants optimize revenue per table turn
  6. Manufacturing plants target revenue per machine hour
  7. Farms pursue yield per acre // Look closely, and you'll notice that businesses often optimize around their most constrained resource - frequently land. A supermarket isn't just selling products; it's selling the space to display those products. The price you pay includes both.

The most successful businesses follow a pattern:

  1. Identify their true constraining resource
  2. Optimize around that constraint
  3. Find ways to multiply the effectiveness of that resource
  4. Create moats to protect their efficiency advantage

While the ultimate metric is always dollars earned per dollar spent, businesses often focus on their constraining resource because:

  1. It's more actionable in daily operations
  2. It's easier to measure and optimize
  3. It's usually what prevents scaling

Trying to understand the metrics that a business optimize is not a revolutionary way of thinking, but it is a fun exercise I do when I hear about a new business.