Performance Management Breaking the code

Performance Management Breaking the code OPERATIONAL EXCELLENCE How the right performance metrics can drive profitability in your organisation

Contents PERFORMANCE MANAGEMENT BREAKING THE CODE Identifying key performance metrics that drive profitability Design for balance Design for value Design for flow Design for customer Design for implementation 2 Implement Consulting Group

BREAKING THE CODE Breaking the code How the right performance metrics can drive profitability in your organisation by Nicolai Broby Eckert and Jan Lythcke-Jørgensen Identifying key performance metrics that drive profitability In our last newsletter, we focused on the elements of successful strategy development. One of the unavoidable consequences coming from the strategy process is the need to redesign the current performance management metrics in order to match the new strategic journey. The logic being, how can we expect to succeed with the strategy if we do not measure our progress? Or, as W. Edwards Deming once said: In God we trust; all others must bring data. However, translating strategy into a set of performance metrics is not easy. Very often we end up having too many metrics to be able to focus on what truly drives value creation, or too few of them to be able to take the right corrective actions before it is too late. One might say that performance manage ment is the art of translating strategy into action by finding the few metrics that really matter in the haystack of potential. Therefore, we feel passionate about introducing this analytically founded framework to ensure simplicity and focus on the ultimate purpose of performance management: true value creation. Our framework is designed to provide clarity and simplicity to performance management by addressing the five major challenges associated with designing and implementing performance management structures. 1. Maintaining balance Creating balance in the performance management framework is never an easy task, and very often one will tend to rely on metrics that everyone under stands and that can easily be measured. This may lead to an overrepresentation of financial metrics resulting in spending too little time on changing the business and too much time on running the business. Consequently, this may lead to a shortsighted quarter-by-quarter focus that reduces strategic agility significantly. 2. Understanding value creation The wish to measure a wide variety of areas, e.g. learning & development, customer satisfaction and strategic direction, leads to an inability to focus on the factors that truly drive value in the organisation, leading to falling margins in the worst case. Understanding value-creating metrics is key to avoid a misguided focus on secondary metrics that do not truly drive competitiveness and differentiation. THE IDEA IN BRIEF Performance management has always been one of the methods for aligning the organisation towards common goals. We all remember the period 10 years ago when Balanced Scorecard was part of the management agenda in every business unit. However, we must also admit that it is primarily the financial performance metrics that are still alive while the other metrics have been made redundant, or, even worse, are employed with no passion and attention from management. In our experience, there are five core principles that need to be addressed in order to design the right performance management structure and choose the right metrics to measure on. These are: Design for balance Design for value Design for flow Design for customer Design for implementation Operational excellence 3

BREAKING THE CODE 3. Selecting process metrics Core process metrics are crucial in any performance management framework, and measuring on the wrong metrics can easily disrupt otherwise efficient core processes. This is particularly true when process metrics are to be consolidated to higher levels in the organisation. Consequently, middle management might end up trying to take corrective actions on misleading performance metrics. 4. Listening to the customer Measuring customer satisfaction is an important area for most companies. However, if the measurements are based on internal definitions of what drives customer value rather than true customer experience-driven metrics, there is an imminent risk of measuring the wrong things. 5. Bringing it alive When designing performance management frameworks, there is often a strong focus on concrete Key Performance Indicators (KPIs). However, in our experience, a more holistic approach is often beneficial, looking at rules, regulations, processes and steering mechanisms that may push the organisation in the right direction. Having said that, the actual launch of a new performance management structure is a complex change process. Not only are people in the organisation often reluctant to be measured on new things, they are also often unaware of how to influence the new metrics they are measured and incentivised on. What is the right balance between hard & soft metrics and lead & lag indicators? Design for BALANCE What drives customer experience and thereby long-term value? In this article, we will elaborate on how to design a performance management structure that takes these challenges into account and present five core design principles ensuring that the performance management metrics support the strategic direction without losing sight of key operational metrics. Design for balance Design for VALUE What really drives your economic engine? Make it actionable Make it visual Design for FLOW Make it conversation Design for IMPLEMENTATION Make it formalised Design for CUSTOMER What drives flow and takt into your key processes? Figure 1. Implement Consulting Group s five design principles for performance management The first aspect to take into account when looking at your current performance metrics or when wanting to design new metrics is whether there is a balance in the way you measure your organisation today. Ask yourself: Is there sufficient focus on following up on our strategic direction or are we spending our time discussing operational performance metrics? Are we predominately measuring on lag indicators and, thus, losing the ability to take corrective actions at an early stage? Are we only measuring hard financial metrics or are we also measuring soft customer- and employeespecific metrics? 4 Implement Consulting Group

PM structure Sales capabilities PM structure The Balanced Scorecard methodology developed by Kaplan and Norton back in 1990 is still the most commonly used method for ensuring balance in the performance metrics and definitely a useful one. However, in our experience, it is easy to lose sight of what truly drives value by using a fixed framework that might inadvertently result in describing a set of metrics that do not drive value creation in the organisation. Supply chain capabilities PM structure Economic engine Employee capabilities PM structure Service capabilities A recent study looking at 29,000 enterprises over a period of 14 years shows that true value creation is predominately reached through growth. When looking at what had driven growth, it turned out that: Internal factors have five times more effect on growth than external factors. PIMS, Profit Impact of Market Strategy Figure 2. Example of how to illustrate the company s performance management structure Are we measuring performance in our core value-creating processes or have we lost sight of what truly drives value in our organisation? Answering these four questions often gives a good indication of whether there is a need to redesign the current performance management set-up. In our experience, there is no right or wrong way to approach the definition of a performance management framework. It is, however, crucial that the aforementioned questions are answered in a satisfactory manner before moving into the actual definition of specific performance metrics. Designing a balanced performance management structure is not only about being able to measure on the progress of key commercial and operational processes. The perhaps most important function is to capture the essence of the company on one page, thus visualising the strategy and core value-creating processes in one simple communicative framework. After all, there is a reason why the following quote is so often used: What gets measured gets done. What gets rewarded is repeated. John E. Jones Common to companies like H&M, Wal-Mart, Ikea and GE is that they have outgrown competition for more than a decade and continue to do so. They have successfully identified their growth DNA and have designed performance metrics that enable them to continually purify this DNA. This is the reason why we have our second design principle, Design for value. It has been developed to ensure that the performance management structure does not lose sight of the ultimate purpose: value creation. Operational excellence 5

BREAKING THE CODE IDEAS FOR HOW TO ENSURE BALANCE Try to identify your economic engine or growth DNA and what factors influence the performance of this engine. Then link this to your strategy and make sure that you measure both strategic and operational metrics. Double-check that you do not only have lag indicators but also lead indicators that make it possible to take corrective actions. This applies to soft as well as hard metrics. Design for value In Implement Consulting Group, we use the term economic engine to describe the company s growth DNA, and it is something that we try to identify not only in performance management projects, but in any strategy project. The economic engine is the essence of one s business model and, hence, describes the company s key revenue streams and cost structures and the key factors that influence these. However, identifying one s economic engine is not easy. Most corporations today have complex business models that are hard to break down into one simple formula for success. Nevertheless, we deem it essential to do so. If one loses sight of what truly drives value creation in the company, there is a risk of forgetting to put oil on the engine, leading to increased deterioration and in the end complete engine failure. To make this issue even more complex, many organisations belong to industries where the formula to the economic engine changes over time due to shifts in competition or technological developments. One of the most recent examples of such a change is Nokia s announcement that they are pouring billions of dollars into changing their business model from developing and producing mobile phones into becoming a mobile software solutions company. Imagine the drastic change that this entails in terms of culture and processes, not to speak of their performance management framework. 1. Building key hypotheses to understand the economic engine When looking inside any company, there are success and failures. By taking a closer look at these, we can learn a great deal about the conditions for success or failure. If it is a project-based organisation, it is the analysis of successful projects that will give you critical insight. If it is in relation to retail, it is the identification and analysis of successful stores. At the same time, analysing what went wrong in non-successful endeavours will give you critical insight into what was missing when things went wrong. Having analysed these factors, it is possible to build the first set of hypotheses of what drives successful growth and profitability. This insight combined with input from interviews at all levels of the organisation on what drives value creation DEFINITION The economic engine is a simple formula that describes the company s key revenue streams and cost structures and the key factors that influence these. Identifying the economic formula and the key capabilities that one needs to optimise performance is a process of trial and error. We usually see three stages in identifying the economic engine. Figure 3. Illustrative example of value driver analysis: earnings vs. manager experience 6 Implement Consulting Group

forms the basis of 15-25 hypotheses of the key building blocks in the economic engine. 2. Testing the hypotheses on what drives value creation The hypotheses are analysed based on a set of quantitative data in order to see a correlation between the specified value drivers and actual value creation, supported by qualitative input from the organisation. The purpose of the analysis is to identify whether the hypotheses are truly a primary profitability driver or merely a secondary or tertiary influencer to the true valuedriving metric. This stage of the process often brings about some rather drastic changes to the universal truth of what drives value creation in the organisation. 3. Building the economic engine The results are translated into one economic formula which explains the key factors that drive profitability in the company. Furthermore, secondary value drivers that are key for making sure that the engine runs smoothly, e.g. the right weather conditions or the driving experience of the chauffeur, are added to the framework to give a complete picture of the metrics that drive our economic engine. The power of this is the immense simplicity by which one can describe the key factors that drive company success, making it an excellent communicative tool for top management. IDEAS FOR HOW TO IDENTIFY YOUR ECONOMIC ENGINE Use interviews and hypotheses to drive your analysis. Challenge common truths about what drives value in the organisation. Often a quick look at the profit and loss statement can indicate which cost drivers are essential to control and, hence, critical in maintaining profitability. Validate hypotheses based on correlation analysis of 2-3 years data. E.g. is hypothesis A truly a primary driver of profitability? Having identified the key factors that drive value creation, the next step is to translate these factors to specific metrics that can be measured on a regular basis. For this purpose, we have created the third design principle which helps us ensure that our new metrics do not create sub-optimisation in key processes. Design for flow Efficient processes with a short lead time and a minimum of waste are by any standard crucial value drivers for profitability. According to experience from Lean, flow and takt are key metrics to efficient processes. Value stream mapping of key processes in order to identify key metrics is often a very valuable approach. Key metrics should reflect: Takt and number of delays in processes Waste in the processes, e.g. rework, waiting on somebody else, handling of customer complaints, penalties caused by delays etc. Throughput time for processes and projects Value-creating activities as opposed to non-value-creating activities The key to process metrics is that they need to be lead indicators following key process steps so that it is possible to take corrective actions at an early stage. This is, however, not an easy task as there are a number of operational metrics that isolated might be relevant to measure on. Imagine the following scenario: A company has the strategic target of growing sales by 40% and improving operational efficiency by 20%. They decide to measure the success of this strategy by employing the following metrics in production: Cost per product (average total production cost) Throughput capacity (how many products they can produce per day) The consequence of these isolated metrics can be fatal, because it may initiate the wrong management decision. In order to improve these metrics, one might increase the batch size in production to minimise set-up cost. This would reduce the cost per product and also increase the unit output per day. However, this will also entail that the Operational excellence 7

BREAKING THE CODE organisation starts building stocks triggering other costs such as operational costs, working capital and risk of obsolescence. Secondly, the products lead time will rise significantly compared to actual process time. By choosing these metrics we award the wrong management decisions which in the end will reduce our total performance and the agility in our key processes. According to our flow principle, we should measure on lead time from the start to end product. This measurement would give us a holistic picture of the actual efficiency and, thus, ensure the right allocation of resources and fast reaction time on market demands, i.e. build agility into the workflow. This example is relevant for all processes whether it concerns production or administrative work processes. Process Time/unit Stock Waiting time Another important area when designing process specific metrics is how to ensure that the steering metrics are designed according to the actual variation in the process metrics. According to steering philosophy, the variance in steering metrics should never be smaller than the variance in the actual process, i.e. if there is great variance in the actual processes, it makes no sense to steer according to small changes in periodic performance. Very often this steering philosophy is not taken into account when designing process specific metrics, which results in the wrong corrective actions being taken early in the process. The result is that these actions are useless regarding better performance. Process Time/unit Result Lead time Figure 5. Steering dilemma: variation in the steering metrics vs. variation in the actual process In the end, this often leads to duplicate performance structures as the people in operations design their own performance metrics to control everyday processes and only fill out the corporate performance reports to make management happy. At Implement Consulting Group, we call this the Rockwool layer, i.e. the emergence of two performance management structures due to the complete isolation between operational performance metrics needed to run the business and corporate performance metrics that are useless for managing operations. BATCH BxX BxY SLOW Having identified the right performance metrics, the next step is to ensure that these metrics support the ultimate purpose of running our business: maximising customer value. ONE PIECE X Y FAST Our fourth design principle helps us ensure that our new metrics are designed to optimise customer experience and, hence, the perceived customer value. Figure 4. Stand-alone metrics vs. flow metrics 8 Implement Consulting Group

IDEAS FOR HOW TO ENSURE FLOW IN PROCESS METRICS After having designed the performance framework topdown, turn everything around and design the actual metrics bottomup to see whether there is a clear link between the two. When having identified key processes, use lead time indicators as key metrics in the processes. Measure the variance in the key processes in order to make sure that the variance in the steering metrics is never smaller than the variance in the actual process. Design for customer Customer satisfaction is the driver of profitability and growth in most companies. Customer satisfaction is ultimately driven by the experience that customers have of key interactions with the company, and identifying these interaction points is therefore crucial for improving customer satisfaction. The most common mistake when it comes to designing customer-specific performance metrics is to use internal perceptions of what drives customer experience. Case example Recently, we had a client who had spent a substantial amount of money and resources on building a mystery shopping framework that was designed to evaluate the performance of each shop in accordance with a pre-defined list of customer-specific performance metrics. However, the metrics had one major problem: they were designed on the basis of the company s long tradition for what they believed was good service rather than the customers actual perception of good service. The company measured on whether the sales staff was smiling and polite towards their customers, but not on the length of the queue when the customers wanted to purchase a product. It might be easy to smile at this example, but the fact of the matter is that many companies make similar mistakes. In order to design the right performance metrics, it is necessary to map the customer journey through the company processes and define key points of interaction which are crucial for the customers perception of service levels and, hence, for their satisfaction. Figure 6. Inside-out vs. outside-in perspective on customer satisfaction This will give a very good indication of the customer-specific performance metrics that will truly drive customer satisfaction and, thus, loyalty to your brand. The trick is then to match these metrics with key lead indicators in the core processes, thus identifying the core processes that drive customer experience and, hence, long-term loyalty. However, customers often comment on what they would like to have without considering the costs of actually providing this! It is, hence, crucial to have the customer attach some kind of value and/or prioritisation to each service attribute. Value mapping At Implement Consulting Group, we use value mapping as a preferred method for identifying the actual value attached to the attributes that the customer wants. Value mapping is the process of listing all service attributes provided, not only by the company in question, but also by the competitors, and having the customer rate these attributes on a comparable scale. This process does not only give you a prioritised picture of what the customer truly sees as crucial service capabilities, but also a picture of where you are delivering above or below customer expectations and, thus, the metrics that are crucial to focus on. It is often the case that the benefits that matter to customers are different from what one might have thought initially. Operational excellence 9

BREAKING THE CODE Without this picture, one might risk to focus on improving service areas where the company is already way ahead of competition and above customer expectations, instead of identifying and improving key areas of weakness that are considered important by the customer. Using value mapping to identify differences between customer segments is also important. Often there is a small segment of customers that represents the majority of the turnover, and we strongly recommend that focus is on these customers before action is taken on smaller customers satisfaction levels as these are in many cases loss-making customers. This leads us to our last design principle about how to bring the new performance management framework alive in the organisation in such a manner that it becomes ingrained in the very fabric of the organisation. IDEAS FOR HOW TO MEASURE TRUE CUSTOMER SATISFACTION Map the customer journey throughout your organisation, from the first contact to aftersales activities. Identify key points of interaction and identify the key elements that need to be in place to maximise the customer experience and, hence, satisfaction. Measure performance in the different phases of the customer journey so that you can take corrective actions at an early stage. Watch out for common pitfalls when interviewing customers. E.g. do not ask the customer to prioritise between different experiences and attach a value to them, then everything is important to the customer. in order to succeed with the implementation. Make it actionable Too often, we see that new performance management metrics are launched without providing the organisation with the right level of knowledge and detail to take action on the new metrics. It is crucial for bringing the new performance management structure alive to break down the KPIs in a clear and simple structure that allows everybody in the organisation to see how each KPI is related to organisational performance. We recommend involving a large part of the organisation in this process to generate buy-in and ensure that the correct operational levers are identified for each of the key metrics. Perceived price B Equivalence line C Perceived benefits A Design for implementation When designing and implementing a new performance management structure, one of the most crucial elements is the ability to bring it alive in the organisation. Changing what people are measured on has drastic consequences for the organisation and often demands a radical change of conversation and culture. Em = A*B*C Figure 7. Value mapping, an excellent tool for identifying benefits that matter At Implement Consulting Group, we consider the below four factors critical Figure 8. Key metric breakdown 10 Implement Consulting Group

Make it visual In a recent study by HBR asking employees what makes them enthusiastic about work, they answered, the feeling that I am making progress. In other words, on days when workers have the sense that they are making headway in their jobs, or when they receive support that helps them overcome obstacles, their emotions are most positive, and their drive to succeed is at its peak. On days when they feel they are spinning their wheels or encountering roadblocks to meaningful accomplishment, their moods and motivation are lowest. This is the reason why we believe in visual management. Daily visualisation of key performance metrics including corrective actions is key to create ownership for key operational metrics and, thus, crucial for the successful implementation of any performance management structure. Create the conversation People are often misguided to believe that performance management is about figures, facts and incentive systems. The fact of the matter is that these are only supporting the purpose of performance management: to change conversations. Performance management is all about changing conversations. We spend quite some time ensuring that the metrics spark the right kind of conversations in the organisation and, hence, often recommend that the implementation is gradual to ensure sufficient training in creating the right conversation about each performance metric before moving on to the next one. We strongly recommend that you spend enough time to let the organisation change their conversation. IDEAS FOR HOW TO ENSURE IMPLEMENTATION Make the new performance measurement visible for everybody in the organisation on a daily basis. Make sure that both management and organisation train how to discuss the new metrics. Performance management is not about figures, but all about conversation. Break down each performance metric into a number of sub-kpis and identify the levers that will influence each KPI. Integrate the new performance management metrics into the daily business through reports and meeting routines. much more balanced discussion of the performance metrics. Make it formalised Formalising the new performance manage ment structure through reporting, incentive systems and meeting structures is decisive. Without a for malised structure for follow-up, it is impossible to ensure enough time for discussing the correct metrics and ensure that corrective actions are taken. Furthermore, some performance metrics like customer and employee satisfaction may be better for themebased discussion once or twice per year than a monthly discussion based on very similar data. Figure 9. Visual management Something as simple as breaking your management meeting up into two sessions, the first one discussing status on your strategic initiatives ( changing the business) and the second one discussing operations (running the business), will give you a Operational excellence 11

Contact For further information please contact: Jan Lythcke-Jørgensen Tel. +45 2338 0017 Email jlj@implement.dk implementconsultinggroup.dk