Based on the mantra that ‘you get what you measure’, managers have long sought to identify the right metrics to track the performance of departments and individual employees. Since most businesses are ultimately responsible to shareholders, there have been attempts over the years to introduce metrics based on economic profit or other high level financial concepts. This paper will argue that while businesses are accountable to shareholders, the metrics used internally should result from a cascading of objectives through a narrative rather than a cascading of metrics. The result? This very quickly leads away from using financial metrics for performance tracking and, instead, to using operational ones.
Corporate objectives require a narrative. A narrative drives departmental objectives. Departmental objectives define activities. Activities and their outcomes are measured.
Think of how a car works. Its purpose is to transport people from one place to another. How then should you track the performance of the individual components of the car? Should the battery be assessed on its contribution to the forward movement of the car? It is possible for a battery to be used for forward motion but, unless the car is electric or hybrid, the battery’s role is to store energy for starting the engine and powering the electrical systems. Instead, the performance of the battery should be assessed based on its ability to start the engine consistently over a long period of time. Similarly, the headlights, although necessary to the safe forward motion of the car, don’t propel it and should be assessed based on their intensity and longevity. This is all blindingly obvious and yet when the conversation moves from cars to businesses, there is a long history of wrong turns.
Let’s imagine a company that makes widgets and sells them to distributors. The value of the business is determined by its ability to produce widgets at low cost, sell them at a high price, and do so in large volumes over a period of time. If we wished to set a target for economic profit, then we could do so by identifying the assets invested in the business and calculating the profit that would be needed to earn an expected return based on the risk profile of the business. Armed with that number, we can communicate to stakeholders that we are targeting a specific profit or rate of return. So far, so good. However, it is the next step that tends to trip up managers. There are three common pitfalls that this author has observed at this stage.
- The most common mistake is to communicate the target for the overall business and then assume that everything will automatically fit into place. This mode of leadership doesn’t just apply to metrics. ‘Management by wishful thinking’ fails in many ways, but it becomes very obviously wrong when you have a stand-alone target and a multitude of performance indicators that are going in different directions.
- The second most common error is to treat every part of the business as a separate profit center and apply the rate of return for the entire business to that function or business unit. The theory is that each part of the business should act like a stand-alone business and generate sufficient returns to justify its existence. That’s a little like arguing that a car headlight should justify its existence by propelling the car forward. There may be business units or subsidiaries that are run like stand-alone businesses but functions can’t be viewed this way. They are part of the business, not independent of it. Attempts to have functions operate as businesses leads to an inordinate amount of wasted time spent arguing about internal billing.
- The third most common error is to break down the target into its components and cascade these down through the business. For example, a target return on assets may be broken down into assets, revenue and cost targets that are then broken down further by department. If two business units exist then they each get a proportion of the revenue target and subsequently break that target down further by product line, geography, customer group, or sales rep. Everyone is focused on their element of the calculation. What this misses are the trade-offs that need to take place. For example, there may be a supply chain management department that is responsible for inventory levels. If one sales group sees a potential increase in sales for a specific product group, those sales may not be realized if the supply chain department has to exceed its inventory targets in order for the business to meet the sales. When targets are strictly numerical and expressed as dollars then rigidity quickly sets in. This is the dreaded ‘management by spreadsheet’ where the correct answer is always there if you look at the numbers for long enough.
This author once consulted to a paper company with separate divisions for sourcing pulp, operating the paper factories, and selling the finished product. The factories were assessed on Return on Assets, to mimic a stand-alone business. Given that they had no control over the cost of pulp, no control over selling volumes or prices, and no control over their assets (building a new machine is a corporate decision) they had no ability to impact this metric.
What then should a company do to cascade its target through the organization? It should start by determining what its story is going to be. If the company has targeted a specific increase in its economic profit, then it should also identify how it is going to achieve that target. Will the asset base be reduced? Will sales increase and, if so, how? Will costs be cut and how will this impact revenue? There has to be a story associated with the increase in economic profit. People understand stories and can align with them. Once the basics of the story are determined then the company’s objectives can be cascaded down through the organization and everyone will understand how they contribute to that story.
If leaders in the organization don’t control the narrative, then someone else will. There is informal storytelling in every organization.
The car metaphor shouldn’t be needed at this point but, just for fun, imagine that a car is designed for use in large cities. It is primarily for commuting, with a back seat that isn’t expected to see daily use. This is enough of a narrative to begin the design and decide on the contribution of each element of that design. If it is to be used as a city car then aerodynamics isn’t particularly important but maneuverability and visibility are, which would argue for compact, high sided styling. Speed isn’t important, so a small engine can be used. High speed crashes are unlikely but fender benders will be a constant issue, so robust and easily replaceable bumpers should be designed in. I could go on. All it takes is a short narrative and we can develop objectives for each element of the design.
Similarly, with a business we can develop a story on how it is going to meet its goal and then fill in the details as we go through the organization. If the company is going to meet its economic goal by increasing sales volumes and prices in one business unit while holding costs steady, then we can use this narrative to develop a story for each department. Support function costs need to remain constant so hiring should be at no more than a replacement level and we need to find a way to cover pay increases. Manufacturing has to ramp up production capacity for the product lines that are expected to provide the revenue increase. Sales need to develop and roll out the selling approach needed to realize price increases. And so it goes. There is an element of the story relevant to each function.
Note that storytelling is not the same as branding. Branding has its place but employees have generally had their fill of initiatives named Pegasus, Everest and Enterprise Effectiveness.
FROM STORYTELLING TO METRICS
Let’s come back to the metrics that started this discussion. To get from a story to a set of metrics, we use objectives. If the narrative says that the sales department is going to roll out a new selling approach in order to increase prices, then we need to create objectives related to the activities and the results. Activities might include the development of the approach and teaching it to the sales force. Results might include altered product perception in the minds of key customer groups. Results will definitely include realized sales increases. If we had simply cascaded the sales goals down as metrics, then we would have missed the ‘how’ in the narrative and wouldn’t track our success in developing a means of altering customer perceptions. This would leave employees wondering what impact they were having on the company’s goals.
Businesses often struggle to define lead indicators. Objectives tied to the narrative provide the ‘how’ that is needed to identify relevant activities and measure them.
Now that we have a series of objectives, we can develop metrics specific to those goals. In our example, with an objective to develop and roll out a new selling approach, the metrics might include the number of training sessions held, the percentage of sales reps who were trained, and the products’ perceived attributes in the minds of customers. These are metrics that are meaningful to the employees involved and they drive behavior that is beneficial to the organization. If we find a part of the organization that isn’t contributing to the narrative, then we have to ask if there is an opportunity to reorganize employees so they can contribute.
This process is akin to the kind of conversation that goes on all the time in companies large and small. When one person is told of another’s plans, they respond with a “what can I do to help”. When we look at the company as a whole, we develop a story and then ask how departments are expected to help to make it come true.
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