Quantum Leap: Definition and Measurement

Now we can come up with a proper definition of a quantum leap – and with a proper procedure for measuring this quantum leap:

A ‘quantum leap’ in this context refers to a radical increase in (1) the amount of aggregate value – financial, functional and operational – generated by your company for your stakeholders and (2) the value-generating power of your ‘corporate machine’. ‘Quantum’ means that this radical increase is measured in ‘times’ (double, triple, quadruple, etc.) rather than in percentages.

To maximize something, you have to manage it. To manage something, you need to measure it. Therefore, to make this quantum leap, you will need to find a way to measure both aggregate value and the value-generating power of your ‘corporate machine’.

Fortunately, there is a way to do that. It is the optimal system of corporate key performance indicators (KPI) that you need to develop, deploy and use. Financial, functional and emotional KPI. You can find basic classification of corporate KPI in Exhibit 1.

KPI can be either quantitative or qualitative. Financial KPI are exclusively quantitative; functional can be either while emotional KPI are almost exclusively qualitative. To properly measure and optimize the qualitative KPI, you must first ‘quantify’ them (i.e., convert to quantitative) using the optimal KPI conversion (‘valuation’) methodology.

Speaking of valuation. Measuring a quantum leap in financial value of a public company is easy – you just need to look at its stock price. Measuring a quantum leap in financial value of a private company is quite a bit more involved – you will need to develop a financial valuation model for your company (which I will cover in detail in the next section of this book).

However, financial value (usually referred to as ‘intrinsic value’) calculated in this model is an estimated value. And, therefore, not a completely accurate measure of a ‘quantum leap’. Therefore, in addition to the financial value proper, you will need to use additional KPI: free cash flow (FCF) and economic profit (EP) which I will also cover in the next section.

Your FCF determines if your business makes financial sense (if FCF is positive, it does; if FCF is negative, it does not). Your EP is the difference between your return on investment capital (ROIC) and your weighted-average cost of capital.

If your return on your capital exceeds your cost of funds (WACC), your EP is positive and your business makes economic sense; if your WACC exceeds your ROIC, your EP is negative and your business (although it may still make financial sense), does not make economic sense.

To measure a quantum leap in financial and emotional value, you will need specific KPI that I will cover in Part II of this book. Measuring an increase in the value-generating power of your ‘corporate machine’ (your business system) is a bit more challenging. And requires the right choice of an appropriate paradigm for your business system. 

Why? Because value-generating power of your business system depends on (1) how comprehensive and lean is its structure – a collection of ‘building blocks’ and how well they are structured in a coherent system; (2) performance of each individual component and (3) how well these components work together.

The optimal paradigm allows you to develop a comprehensive, well-structured, accurate and up-to-date description of you system and attache the appropriate KPI to these ‘building blocks’. These KPI you will subsequently use to measure the value-generating power of your business system – including all three of its components (see above).  

In one of the next sections, I will show that the optimal paradigm for making and measuring the ‘quantum leap’ is the aircraft paradigm.