Protiviti’s Jim DeLoach discusses one of the more pervasive issues falling within senior management’s and the board’s purview. Performance relates to virtually everything important: execution of the strategy, the customer experience, investor expectations, executive compensation and even senior management and the board itself. Accurately measuring it is critical.
Performance management is so integral to the functioning of executive management and to the oversight of the board of directors that it’s easy to forget that it, too, is a process. Like all processes, it can be effective or ineffective in delivering the desired value. Given the complexity of the global marketplace, the accelerating pace of disruptive change and ever-increasing stakeholder expectations, how should executive management direct and the board oversee the performance management process so that it is effective in driving execution of the strategy and incenting the desired behaviors across the organization?
As the ultimate champion for effective corporate governance, the board engages management with emphasis on four broad themes: strategy, policy, execution and transparency. Effective performance management touches each of these themes by focusing outwardly as well as inwardly and looking to the future as well as to the present and past. The message is that, in today’s environment, the focus on performance must be anticipatory and proactive as well as reactive and interactive in focusing company resources on the pursuit of its performance goals.
Many organizations use some variation of a balanced scorecard that integrates financial and non-financial measures to communicate what’s important, focus and align processes and people with strategic objectives and monitor progress in executing the strategy. With that as a context, we are observing in the marketplace six important areas of emphasis for measuring performance:
1. Return on Expectations
Performance management must embrace the appropriate metrics, given the strategy that management seeks to implement and expected investments. Alignment of performance with the critical strategic priorities is both an imperative and a challenge. For example, many organizations have yet to bridge the gap between efforts to attract and retain employees and efforts to engage and align them. The traditional strategic priorities relate to such matters as quality, cost, time, innovation, customer loyalty and talent strategy. More recently, sustainability objectives are being integrated into the performance management process as more institutional investors incorporate the linkage of corporate sustainability performance and financial performance in their rationale for evaluating investment and portfolio allocation decisions.
The challenge comes from managing the balance between short-term and long-term performance. Bottom line: Executives must be compensated and long-term shareholder interests must be preserved – two objectives that must be aligned. Performance management should be linked to the storyline articulated in the communications to the street.
In addition, proactive outreach to major shareholders is sometimes necessary, creating a dilemma about how to communicate long-term imperatives for areas such as culture, innovation and customer experience when the stock price is depressed. With appropriate board oversight, the company’s leaders should not allow stock price performance to so dominate the spotlight that it detracts from their focus on the business and its fundamentals and strategy.
In aligning organizational performance with strategy, the performance management process must focus on excellence in the operational structure, or business model, in place to execute the strategy. Alignment starts with defining performance expectations as set forth by the strategy and communicating those expectations across the organization.
For example, performance expectations should be incorporated into the roles, responsibilities and authorities defined for key personnel in job descriptions and reinforced through training and appropriate metrics, measures and monitoring. Performance measures should be used to track the execution of the strategy at the organizational, process and employee levels so that accountability for results cascades downward into the organization and necessary midcourse adjustments can be made on a timely basis to achieve performance targets.
The reward system is key. Are people being incented in the right way, consistent with the strategy? How do executive management and the board know? How should executives and directors assess incentive compensation and whether some incentives spur unacceptable behavior? Over time, management should be sensitive to the vital balance between incentives and appropriate behavior, because it can be affected as markets change. The board should adopt an ownership mentality in providing guidance and direction on this point.
We’ve noted that culture has become a key concern in the boardroom. While most boards assess and understand the tone at the top, they neither assess nor understand the tone at the middle. However, our experience is that an increasing number of board members want to do so. Health and effectiveness surveys to gauge how employees perceive the current leadership culture and compare that perception to the culture they desire can be useful in this regard. Gaps almost always provide informative insights into what’s really happening in the business and what people below senior management really think and how they act. They reveal opportunities for leadership development and improving the tone at the top and in the middle, as well as aligning the two. The board should be privy to the results of such surveys.
Performance management should drive the type of organization – inclusive of employee values and expectations – that management and the board would like stakeholders to experience when they interact with it. Conversely, it should not influence improper behavior and inculcate a dysfunctional culture. When the board evaluates and approves goals, directors should consider how those goals will be achieved by management. For example, growth is always a worthwhile goal, but does the board really understand how management will make it happen?
Culture issues can be raised indirectly through the ongoing performance management process. For example:
- When attrition is unusually high, do executives and directors ask why? Obtaining an understanding of the specifics as to why people are leaving could pinpoint problems embedded in the organization’s culture.
- When performance levels are way above the industry norm, are there inquiries as to why? Leaders should not let the excitement of marked superior performance override the need to probe deeper or ignore warning signs. In light of well-publicized, high-profile examples of dysfunctional cultures, a fundamental question arises: “Does the company’s culture emphasize treating people with respect and support individuals challenging something that is wrong or not safe?” Supporting contrarian views should be encouraged and supported, even in the face of significant organizational or peer pressure.
Management should consider culture-related measures and come forward with an approach that makes sense. To that end, the board should encourage and, if necessary, push management to do this. It’s that important. What gets measured matters. Human resources should be proactively engaged in the process so that it is not an impediment and, when culture issues are identified, progress is made toward sourcing the root cause.
4. Customer Experience
Metrics should segment the customer base and focus on the needs of each targeted segment. They should address the attributes of the value proposition underlying the customer’s choice of the company’s products or services over other alternatives. For many organizations, success in sustaining customer loyalty can make or break their success in the marketplace; therefore, it is important that the focus on financial results not detract from the need to serve and delight customers and monitor performance in that regard.
Customer-related metrics should provide insight as to what a company needs to do once issues are identified. They should reach beyond non-financial areas and address quality, responsiveness and other critical aspects – expressed or implied – of the brand promise. Our perspective is that improvement is needed in many companies to integrate customer experience metrics into performance dashboards.
Data tells the story. The strategy drives the business model that creates the necessary alignment across the organization to deliver the desired customer experience. Data is collected at the appropriate customer touchpoints, including direct customer feedback, to monitor the effectiveness of customer-facing processes in delivering the desired experience. Based on analysis and synthesis of the data, process adjustments are made to improve the customer experience. The cycle continues unabated.
When it comes to the customer experience (and even culture), it is incumbent on senior executives and directors to also be observant and “do some homework.” For example, they should seek information about competitors and, when possible, talk directly with customer-facing personnel in the organization. Visits to company locations and personal assessments how people behave can be instructive. Anecdotal insights can add color to the numbers.
Disruptive change and unexpected surprise have become the norm rather than the exception. Accordingly, metrics should focus the organization on innovation, changes in technology and the business environment, emerging disruption and market opportunities. Innovation is a source of new revenue-generating opportunities in the market and a driver of a positive culture.
With the board’s encouragement, management should incorporate innovation-related metrics into the performance management process. In measuring innovation, management should consider business processes as well as products and services. For example, an innovation pipeline should be established, and reporting should address progress through the pipeline. When appropriate, the board should establish innovation as a performance metric for the chief executive officer (CEO) and other C-suite executives. If innovation is not a performance goal, the CEO and the board likely will not observe the desired engagement. Furthermore, with the wrong culture, innovation can create significant issues and possibly lead to loss in market valuation; thus, metrics provide a way of “getting it right.”
Innovation is more than just technology. Other innovation opportunities reside in financial re-engineering, portfolio management and new product ideas. Executives and directors should be mindful of the different ways in which organizations can be innovative and embrace them.
The C-suite and boardroom composition should include “innovation experience.” Innovation oversight can be difficult for executives and directors who haven’t been part of an innovative, entrepreneurial culture. The key question is, do these leaders require entrepreneurial experience within the group to ensure diversity and the proper mindset to assess and drive innovation, or is it enough to have the necessary knowledge and perspective to ask the right questions and frame the right requests? The former approach is vital if innovation is essential to survival.
6. Metrics, Measures and Monitoring
When it comes to performance management, there is always a risk of gaming the system. It is human nature for management to instinctively want measurements to reflect positive results, as compensation weighs in the balance. This is why there are several key attributes of effective performance metrics to consider: Metrics should be realistic, understandable, objectively determinable, believable (meaning a “single version of the truth”) and actionable. There should be a balance of forward-looking lead metrics to complement the traditional retrospective lag metrics.
Here is an interesting quote from a seasoned director at a roundtable discussion I facilitated: “Flawed stories are better than perfect ones.” It’s a positive when the performance management process identifies one or more areas requiring attention and improvement. “Perfect narratives” tend to raise questions about the rigor in which performance is measured and monitored, as well as the authenticity of the results. As long as operating managers are forthright in seeking the facts and telling the true story with an eye toward improving products and processes continuously, executive management and the board can stand behind them with confidence when results are communicated to shareholders.
So, the question is, do the CEO and executive team really want to know the unvarnished truth? About the culture? The customer experience? Innovation? When executive management commits to manage by fact and earnestly seeks genuine performance reporting results with an eye toward continuous improvement, there is no holding back.
In summary, with today’s competitive global marketplace being all about quality, speed and continuous improvement, an organization’s ability to transform, innovate and change is paramount to its survival and success. An effective performance management process can help make the difference in differentiating winners and losers in the digital era. A properly structured and balanced family of measures can help companies align critical processes and the people that manage them with the desired organizational culture and goals to differentiate performance, effect incremental change, transform the business and deliver sustainable business value.
Questions for Senior Executives and Boards of Directors
Senior executives and their boards may want to consider the following questions in the context of the nature of the entity’s risks inherent in its operations:
- Are we satisfied that the performance system is fully aligned with the strategy and effective in identifying issues and driving timely corrective action? Does performance management:
- Focus on the customer experience, including direct customer feedback?
- Provide insights on culture (e.g., alignment of the tone at the top with the tone at the middle)?
- Facilitate efforts to address the forces of disruptive change affecting the industry and provide early warning of key issues through sufficiently anticipatory and forward-looking metrics that track key market drivers and factors?
- Assess the relevance and effectiveness of innovation practices by tracking the results and outcomes of investments made to innovate processes, products and services?
- Benchmark performance against competitors?
- Link to shareholder returns and the narrative to shareholders?
- Are we satisfied with the quality of performance reporting for the executive team, the full board and its standing committees? Is the performance system efficient, or does management have to engage in fire drills to prepare the performance information that executives and directors need in advance of meetings in the C-suite and boardroom?
- Do directors take the initiative to gather information and insights from a broad range of sources and not rely solely on the company’s internal metrics?
- Do incentive plans for the CEO and executive team incorporate appropriate long-term performance metrics linked to the strategy and preserving the interests of shareholders?
- Are there inherent conflicts within the metrics structure (e.g., aggressive sales metrics or the inherent tension between cost and schedule metrics versus safety metrics), and are we satisfied with how those conflicts are being managed?