A company has a strategy for pursuing certain goals and uses indicators to monitor its progress in achieving its objectives. Piece of cake, right?
"Yes and no," says Professor of Accounting Teemu Malmi of Aalto University.
Performance management should be about measuring both goal achievement and the means used.”
"Profitable growth, a common strategy, is essentially an objective, not a strategy. Strategy answers the question of how to achieve growth and profitability in crowded markets. Some people call the answers to these questions must-win battles and others talk about roadmaps, but what you call them is not that important as long as employees understand them in same fashion," says Malmi.
Malmi points out that profitable growth can often be measured by financial indicators – which are about monetary value. In many cases, actions cannot be measured adequately by monetary value. Performance management should be about measuring both goal achievement and the means used – i.e. the action taken to achieve a goal.
Indicators follow trends, but certain eternal questions, to which there is no single right answer, are more critical than ever.
1. How performance measurement is linked to strategy?
Linking indicators to a strategy is easy when executives know exactly what needs to be achieved and how.
"If you only know the target, set it and your organization will work out how to achieve it. That's when more traditional, goal-based target setting probably works best, without trying to link indicators to strategy."
Malmi stresses that strategy is a choice: you need to know what to prioritize at any given time.
"You need to start with proper strategy work and focus on what is essential. If everything is important, nothing is."
Malmi points out that indicators promote strategy implementation in two ways. First of all, by providing employees with measurable objectives based on the strategy, and responsibility for meeting them. This means accountability.
"The second effect is based on the fact that good indicators tell employees what is important. In many cases, too little time and effort are put into this communication aspect – into discussing what is being measured and why. "
2. What is the right number of indicators and how do they interrelate?
Balanced scorecard indicators have been used since the 90s, for measuring an organization's performance based on four perspectives. Between four and eight indicators are typically selected for each perspective. This often leads to too many goals and indicators – when everything is important, nothing is.
"The balanced scorecard was a good idea in that it encouraged companies to consider objectives in addition to financial ones. But it didn't solve the problem of how various objectives are linked: what comes first and what should follow," Malmi continues.
The key issue is to understand your ultimate objectives and the drivers to achieve them.”
If you link these various objectives, you create a cause-and-effect chain. For example, improving operational reliability as an objective can be viewed as generating increased customer loyalty, which in turn should be reflected in increased profitability.
"This means that you need to define the most important ways to develop your operations, like improving operational reliability in an example above. You need to create a hypothesis on how euros result from operational improvement, and then you have to measure the whole causal chain, or at least the both ends of it"
These causal chains should not be too long in practice, you need to keep things simple.
"The key issue is to understand your ultimate objectives and the drivers to achieve them. It may be enough to measure certain levels of activity that is truly crucial in terms of creating competitive advantage and the financial result, for example. Better avoid a situation where management tools, templates and theories do thinking for you."
3. Which is better, the simplest or the most advanced possible set of indicators?
Malmi points out that trendy new indicators keep appearing, such as the net promoter score which tells you how many customers are ready to recommend your product or service.
"Customer satisfaction surveys have been performed in every way imaginable. The net promoter score is an extremely simple version of this."
Firms often run into a practical issue: we know what we want to measure but collecting the required data is difficult, slow and/or costly.
"The question of what is measured, and how, is often industry specific. For example, the game industry uses a wide range of data – how many times does a customer play, for how long and with how big a spend. But data like this might cost a fortune in another sector."
This means that you need to think how much resources should you devote to producing information and ensuring its quality. Fewer or rougher indicators may be enough.
4. How is individual performance connected to indicators?
To make it off the drawing board, a strategy needs to be converted into goals at individual level, in addition to organizational and unit levels.
Individual performance management has become less forgiving also in Finland.”
"Performance measurement and performance evaluation are two different things – measurement is part of evaluation. You need to align organizational and personal indicators. Each individual should understand his or her role as part of the whole."
Malmi explains that not everyone needs the same indicators. Individuals need to be able to influence the indicators measuring their performance.
"Individual performance management has become less forgiving also in Finland. The performance management culture has changed in many organizations, with clear targets being set at individual level and roles being changed if the set targets are not achieved."
5. The world is changing fast, as is strategy, so what will happen to indicators?
People have recently woken up to the fact that firms can change strategy quickly in reaction to changes in the outside world, but changing indicators takes longer. Reward systems based on such indicators tend to lag even further behind.
Research has also cast light on the interrelationship between indicators, and between indicators and the things they measure. Although individual indicators can effectively measure the issues in question, the issues themselves often have complex cause and effect relationships with each other.
"In many cases, strategies change, but the indicators remain the same. Certain financial indicators are likely to remain with us for a long time to come. But in the case of process and employee indicators, we should ask how strategic they really are and do they take changes into account," Malmi suggests.
Teemu Malmi is a Professor of Accounting at Aalto University. He is instructing in various Aalto EE 's and Aalto PRO's programs eg. Aalto Financial Executive.