September 2001

Marketing

Implementing a Strategic Performance Management System. The third installment of this series explains how to measure the impact of strategic planning.

Implementing a Strategic Performance Management System.
Measuring Strategic Performance, Part Three

By Jon Hill and John Pullen

Editor’s Note: In this three-part series, the first part “Are You Ready for the Strategic Performance Revolution?” examined the questions of why a company should develop a strategic performance system and how such a system can support the strategic plan of a company. The second part “Developing Your Strategic Performance Management Framework” discussed how a performance management, or balanced scorecard system can be developed. This third part discusses how to create an integrated performance measurement system.

Figure 1

In the knowledge economy, a company’s success rests as much on its ability to measure the performance of its strategic initiatives (such as customer relationships, internal business processes and employee learning, etc.) as on its aptitude for monitoring traditional financial measures. Yet the tasks of evaluating performance measures and aligning corporate strategy accordingly pose serious challenges to managers who must balance daily business demands with long-term strategic goals. In our previous two articles, we discussed innovation in the aggregate industry, measuring strategic performance and creating a framework for measuring strategic performance as a management tool. These articles included how to develop strategy, how to analyze current and future informational requirements, and how to assemble a cross-functional team. Now let’s discuss how to create an integrated performance measurement system or balanced scorecard framework to assist in publishing your strategic road map. The goal is to drive strategy through the company so everyone can make sense of the long-term corporate strategic direction.

Developing a Measurement System

Developing and implementing an integrated measurement system is the final stage of strategic management. Measurement is the focal point of strategic evaluation or implementation. Peter Drucker stated, “You can’t manage what you don’t measure.” Also Robert Kaplan, the balance scorecard guru from Harvard, stated, “What is measured becomes visible, what is rewarded gets done.” Measurements are used to define how a company is measuring up to shareholder expectations, signal how well the firm is playing the competitive game and links past, present and future actions into a cohesive whole. The company’s strategies are all reflected in what it chooses to measure and how those measures are used to influence behavior. All levels of management are involved in creating a strategic measurement framework. Thus, our third article is about implementing a strategic performance management system.
To track the progress on strategic implementation, established measurements are communicated throughout the company. These measures should be forward-looking and predictive; providing a basis on which management can act. For those companies with thoughtfully crafted strategies, often implementation has failed because the strategies cannot be evaluated or measured.
A performance management framework considers the needs of employees assisting them in decision-making by providing them a hierarchical linkage between strategic and tactical and operational goals. This framework provides a balance between financial and non-financial measures and should assist in prioritization between alternate decisions. If implemented correctly, employees at all levels of the company can focus on these measures and understand how they can impact strategic direction.

Performance Measures

Most, but certainly not all, balanced scorecards will contain performance measures that fall into at least four main categories: financial, customer, internal business process, and learning and growth. The ultimate objectives of the company are usually financial, but better financial results cannot be attained without improving customers’ perceptions of the company’s products and services. In order to improve customers’ perceptions of products and services, it is usually necessary to improve internal business processes so that the products and services are actually better. And, in order to improve the business processes, it is necessary that employees learn.
The performance measures on the balanced scorecard provide motivation and feedback for improving. If an employee takes an action to improve a performance measure and the measure actually improves, the employee is encouraged. If the performance measure does not improve, there is an opportunity for learning. The employee can adjust what he or she was doing and try again to see if there is improvement. Only by seeing what works and what does not work can you improve.
For example, suppose employees work very hard and make dramatic improvements in internal business processes, but there is no increase in customer satisfaction or in financial results. Rather than throwing up one’s hands in despair, this is a golden opportunity to examine the company’s strategy. If improvement in one area does not lead to expected improvement elsewhere, there may be something wrong with the theory underlying the strategy. Indeed, strategy can be thought of as hypotheses about the effects of particular actions on desired outcomes. If those desired outcomes do not occur, the hypotheses, perhaps, should be discarded and the strategy reconsidered. If there is no attempt to systematically collect data that can disprove the assumptions underlying the company’s strategy, the company may stagger on indefinitely—unaware that its cherished assumptions are no longer valid. This is an extremely important aspect of the balanced scorecard that should be emphasized.
The performance measures on the company’s balanced scorecard should tell a coherent story of the cause and effect links that lead from actions by individuals to the objectives of the company (see Figure 1).

Performance measurement provides a systematic line between the company’s strategy, revenue generation and resource allocation. It is a comprehensive management process framing the continuous improvement journey by ensuring that everyone understands where the company is and where it needs to go to create sufficient shareholder value. Financial measurement is an integral part of the performance management system, but it is not enough simply to measure financial performance. Financial measurement in isolation is incomplete (see Figure 2).
Traditional Approaches to Performance Measurement
Traditional approaches to performance measurement fail for several basic reasons. First, traditional financial output measures alone are incomplete as management tools. They fail to tell management and the work force how to improve because their focus is on external reporting and not on the activities performed to deliver products and services to their customers. Second, traditional methods of performance measurement often do not help identify or increase understanding of the core issues driving current performance. Third, in most cases, these measures tend to be retrospective (i.e., historical measures or lagging indicators) rather than proactive (i.e., economic forecast or predictive indicators). While knowing the score is undoubtedly important, it would be better to be able to change a poor outcome. Finally, traditional methods of performance measurement review results instead of causes for those results.
One point of controversy is that performance management systems do not need to adhere to the “rules” established for external reporting or Generally Accepted Accounting Principles (GAAP) required by the Financial Accounting Standards Board (FASB) and the Securities and Exchange Commission (SEC) for publicly held companies. They should provide, however, as close a depiction of reality as possible. Accounting systems must adhere to GAAP, and the performance management system must be reconcilable to accounting system results. GAAP rules exist within another framework that evolved for a different purpose.
The recognized weaknesses of traditional accounting systems (i.e., management reporting based on GAAP) are driving companies to implement performance management systems. This implementation brings several major benefits. First, a performance management system helps management deploy and institutionalize its strategy and performance measures by associating the activities performed within the company to the delivery of products and services to external customers. Then the company communicates this association to the work force so they understand how to support the company’s strategic direction. Once the work force understands how they can affect strategy then they become a valuable resource in measuring and continuously improving the company’s strategy. Second, a performance management system provides focus for, and measures that support, continuous improvement (i.e., total quality management, six sigma, lean production, etc.). Third, a well-designed performance management system provides a link between the efforts it measures and the achievements it rewards. Finally, an effective performance management system helps a company gain a competitive advantage by keeping everyone focused.

Figure 2

Non-traditional Approaches to Performance Measurement

In contrast from a GAAP accounting system, management accounting is used internally to measure performance based on the company’s unique set of rules that support strategy. These rules, management accounting and reporting policies and procedures, focus on the company’s long-term future. Management accounting policies and procedures are developed by senior management to assist in aligning their operational activities with strategies they have formulated. As mentioned in the first article, strategy formulation includes developing a business mission, identifying external opportunities and threats, determining internal strengths and weaknesses, establishing long-term objectives and choosing which strategies to pursue.
Management accounting and reporting policies and procedures enhance conventional GAAP-based financial reporting or historically calculated operating results and converts it into internal information to support business decision-making. Applied consistently, management accounting policies and procedures provide a basis for measuring economic performance or profitability and internally establish a common language around the activities the company performs. This common language is taught and communicated throughout the company and enables management to implement their formulated strategies to the work force. Management accounting and reporting is the cornerstone to supporting the performance management system and the implementation of strategy or the balance scorecard framework.
It should be possible as the company goes through the business plan process (see Figure 3) to infer the company’s strategies and the assumptions underlying these strategies. The business plan should emphasize continuous improvement rather than just meet present standards or targets and support the performance measures on the balanced scorecard, both financial and non-financial. Financial measures tend to be lagging indicators, rather than leading indicators. In contrast, non-financial measures are easier to understand for most employees because they are directly associated with the activities they perform on a daily basis. While there will be a comprehensive balance scorecard for the entire company, the business plan should contain only those performance measures the business unit can actually influence. As you go lower in the company, you are likely to observe fewer strategic performance measures in business plans. These business plans will contain many tactical and operational performance measures that align to the company’s strategy. These measures will be more non-financial than financial and directly correlate to the business unit’s operational activities.

Performance Measures in the Aggregate Industry

The aggregate industry management information requirements are changing rapidly and will continue to do so at an ever-accelerating pace. This rapid change will require dynamic information that is flexible, credible and coordinated with the management accounting policies and procedures.
Management accounting concepts like cost-volume-profit analysis (i.e., contribution margin and break-even) and activity-based management (i.e., activity-based costing, activity-based analysis and activity-based budgeting) will have to be implemented to provide management with information to support decision-making.
Sales managers require integrated management information to support multiple views of profitability, including profitability by product, business unit, channel and customer for business decision-making support.
Operational managers need integrated management information as well to support multiple views of resource cost by activities performed within business processes. With this information, operational managers can allocate their resources to support customer requirements and optimize costs.
Thus, understanding the cost implications of resources allocated vs. resources consumed is a key to analyzing, controlling and systematically reducing or optimizing cost in future periods. The economic benefit from using this information in business decision-making becomes a competitive advantage (see Figure 3).
Finally with a strategic management system in place, executives can keep a constant pulse on the company, test strategic assumptions and respond swiftly to strategic changes. As was discussed in the previous articles, adopting a strategic management system requires a significant shift in current management practices, which in most companies are centered on tactics and short-term operations performance. Executives’ time must be refocused on strategic development and thinking.
However, the best strategic management system cannot replace the ability of leadership to develop solid strategic thinking skills. We know that strategic thinking is the beginning point as well the ending point of a strategic management system. In this regard, strategic thinking is continuous.

Figure 4

Strategic thinking is the thought process that goes on inside the mind of executives who are trying to determine the future “look” of their companies. And that look, or composition, of the enterprise in the future may be different than it is today.
A viable strategic thinking process has to start with the company’s leadership, its top management. When executives meet, instead of discussing operational issues, they should look at the future environment and talk about the company’s future direction. They should develop a strategy and articulate their vision or future profile of the company.
Strategic thinking can be compared to picture painting. It is the process that helps executive teams draw pictures or profiles of what they want the company to look like at some point in time. It is this picture, along with a well-designed strategic management system, that will determine the direction and composition of the business and its success (see Figure 4).

John Pullen serves as the managing director of Aggregate Research Industries.
Jon B. Hill is a professor of financial and management accounting systems at the University of Richmond, Richmond, Va.