10 of the largest 15 bankruptcies in history have occurred
since 2001.
Is
it so difficult to strike a balance between the short and long term?
This is an edit of
an article published in McKinsey Quarterly of August 2005
Authors : Richard
Dobbs, Keith Leslie, and Lenny T. Mendonca
"Performance
and health" is derived from a simple comparison with the human body. Some
people may seem performing well for today but they may not be in a position to
keep on performing well over time and may not enjoy long and active life.
Companies too must make plans and allocate resources to both the tasks :
performing well for today and lasting to perform well year after year. Managing
a company across time frames is a challenge; are the boards and senior managers
up to it? Are they focusing on quarterly results and give little attention and
money to actions that create longer-term value - particularly if they depress
today's profits?
This is not due to lack of tools. The problem is that these
tools are either being applied too mechanically or ignored due to intense focus
on survival and by (perceived) pressure from investors. Of course we understand
that short-term is important because only by delivering it will the management
build confidence in its ability to realize longer-term strategies. But
companies must also act today to ensure that they can convert their growth
prospects, capabilities, relationships, and assets into future cash flows. A
survey had revealed that more than 80 percent of the executives would cut
expenditures on R&D and marketing to ensure that they met their quarterly
earnings targets—even if they believed that the cuts were destroying long-term
value.
A
major European financial-services company achieved an impressive turnaround from
2001-2004 but found to its dismay that side effects have been falling customer
service levels, a huge increase in staff turnover, and a fall in its share
price. Management complained that the financial markets didn't understand what
the company had achieved. But in reality they understood, all too well, that
its short-term success had been purchased at the expense of its underlying
health.
Many companies talk of “health” but only superficially. The "scorecards" that are supposed
to balance short and long term often consist of disconnected metrics that
confuse the organization and lack any real impact. A company came up with 96
key performance indicators – which was bound to be dead on arrival!
What Seems To
Go Wrong?
What breaks down long-term initiatives is the tendency of
managers to defend the performance of their own silos instead of debating and
helping to shape action across the whole organization. In silo-structured
companies, managers typically argue about the virtues of one metric as opposed
to another (especially if transfer prices are involved), deflect debate to
other parts of the organization, and set up barriers to change. This kind of
behavior isn't deliberately malevolent; it is driven by deeply held beliefs
about a manager's roles and boundaries and reinforced by the idea that the body
corporate is the sum of many discrete units, each with independent
characteristics, that should be monitored with a battery of metrics.
Emerging
Awareness Of Health
In a McKinsey survey IN 2005 of 1,000 board directors, most made
it clear that they want to
·
Devote less time to discussing the
latest financial results and much more to setting strategy, assessing risks,
developing new leaders
·
Markets, customers, competitors and suppliers.
·
Organizational issues such as skills
and capabilities
·
Relations with outside stakeholders
: regulators, media, wider community.
Above all, they wanted their companies to seize prospects
for long-term growth and avoid exposure to risks from organizational blind
spots or from any unwillingness to acknowledge external change.
Here
is a list of 5 important things that make companies healthy
1. Strategy
2. Metrics
3. Communication
4. Leadership
5.
Governance
Strategy
First, a company's strategy should be reflected in a
portfolio of initiatives that consciously embraces different time horizons. A
typical large company does, of course, include business units with distinct
strategies, but few of them could really help it adapt to events or capitalize
on new products / services / markets / processes / value chains. Such a portfolio of strategic initiatives should
not fall prey to the issues associated with strategy
·
Resources and capabilities are needed
not only for planning and communication but also for execution.
·
Not only to (reactively) plan for
the future but instead (proactively) plan the future. By developing and
managing a portfolio of initiatives—rather than a single approach to
strategy—companies can lower the risk that unpredictable events will place them
on the wrong foot.
Metrics
A vast assortment of metrics is self-defeating and the
company must choose is a manageable number of metrics that strike a balance
among different areas of the business and are linked directly to what creates value
for all major stakeholders.
·
Financial metrics ( most already
have them)
·
Operations (quality and consistency
of key value-creating processes)
·
Organizational issues (the company's
depth of talent and ability to motivate and retain employees)
·
State of the company's product
markets and its position within them (including the quality of customer
relationships)
·
Nature of relationships with
external parties, such as suppliers, regulators, and nongovernmental
organizations (NGOs).
Systematically identifying and tracking health metrics that
reflect the strategy of a business—and the forces driving its value—is
difficult. A useful framework is to think of value creation in the short,
medium, and long term.
·
SHORT TERM (KEY : MOMENTUM OF
EXISTING ACTIONS) : Looking at trends, benchmarks and cause-effect relationships
to see if there is adequate momentum in existing initiatives to enable us to
deliver what we want over the next 1-2 years. Examine issues like whether profits increased due to raising prices, new
campaigns, new markets, new products. Whether profit were achieved by encouraging
dealers to increase their inventories. If revenue growth per store and revenue
per square foot is better than its competitors.
·
MID TERM (KEY : CHANGES IN THE
PIPELINE) : The key questions here is whether there is enough innovation and
experimentation and initiatives in pipeline to deliver results over theThe time
frame ought to be longer for industries, such as pharmaceuticals, that have
long product cycles and must obviously focus on the number of profitable new
products in the pipeline. Metrics that compare a company's product launches
with those of competitors (perhaps the amount of time needed to reach peak
sales). For an online retailer, customer satisfaction and brand strength might
be the most important drivers of medium-term health.
·
LONG TERM (KEY : ARE WE READING THE
ENVIRONMENT RIGHT AND IF OUR PRIORITIZATION IS CORRECT) Opportunities and threats
: new technologies, new customer preferences, new ways of serving for current
businesses. And to ensure enough growth opportunities to create value when
those businesses inevitably mature, they must monitor the number of new
initiatives under way (as well as estimate the size of the relevant product
markets) and develop metrics that track the initiatives' progress.
In addition the senior managers should also address (A)
Retention of key employees (B) True
depth of management talent (C) if right skill sets are being delivered :
business overseas will need people who can work in new countries and negotiate
with governments.
For a business unit, top management and the board should
monitor no more than three to five metrics, representing different areas of the
business for each time frame. To make sure that the metrics are appropriate,
the finance department or the performance-management group should regularly
reexamine the way the company creates value.
Companies must avoid the erroneous thinking that too often
juxtaposes "hard" metrics for performance with "soft" ones
for health. They can and should attach hard numbers to health metrics, such as
the motivation and capabilities of their employees. Similarly, they can and
should track their current performance with softer metrics, such as the quality
of their latest earnings or of their relationships with opinion formers.
Communication
It is important to change the nature of their dialogue with
key stakeholders : capital markets and employees. It is important to identify investors
who will support a given strategy and then attract them. Management teams
should also spend serious time with analysts who follow their companies, in
order to explain their views on the industry and to show how strategies will
create sustainable advantages.
Reaching out to employees is just as important. The
complaint that "we don't know what's going on" often indicates that a
company's leaders are communicating results rather than long-term intentions.
Leadership’s
Role In Providing Direction
Board members and C Suite customers must involve budding
leaders in dialogues of the company’s development which also enables their own
development. The senior leaders also must be aware that what they say (and do
not say) in such meetings will get “enormously amplified” and casual or random
remarks and themes at such meetings will run the risk of making the
organization schizophrenic. The senior leaders must not create an overload of initiatives.
They must produce a simple and coherent agenda.
Focusing the leadership on personal behavior is also crucial
to maintaining a company's health. Companies can likewise encourage a wider
perspective on the business, and stronger linkages across boundaries, by giving
senior managers a portfolio of roles. Alternatively, some companies have
successfully developed peer groups of business unit leaders who share a
collective responsibility for their businesses. Other companies are
strengthening their core functions and reversing the trend toward corporate
atomization into a number of semiautonomous business units.
Companies must take a longer-term view of the way they
manage talent and career tracks and of the incentives created by money,
recognition, and promotion. One company's approach is to implement a long-term
incentive plan for top management—a plan that has weakened the direct link
between remuneration and short-term earnings. By contrast, the current trend of
making people change roles every two or three years isn't necessarily good for
long-term corporate health.
Governance
The growing demand for corporate probity and better
governance has reinforced the CEO's pivotal leadership role. Board meetings
therefore represent a useful opportunity—and discipline—for testing the
organization's resilience to pressure and change over time. The need for
resilience is greatest when investments take a long time to pay off, as they
generally do for natural-resource and pharmaceutical companies and
public-sector bodies. CEOs and boards lack rapid performance feedback in such
cases and thus need to keep a close eye on a range of considerations: regulatory
influence, marketing and supplier partnerships, and organizational skills.
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