The Performance Management Framework for Value Creation
One of the most ambiguous terms in discussions about business and government is value. Everybody wants value in return for whatever they exchanged to get value. But whose value is more important and who is entitled to claim it? Customers conclude that they receive value if the benefits they received from a product or service meets or exceeds what they paid for it (including time, investment, cost, etc.). But shareholders and stakeholders believe if their investment return is less than the economic return they could have received from equally or less risky investments, they are disappointed. Value to employees is another issue altogether, most likely tied to compensation and job satisfaction.
Three groups believe they are entitled to value: customers, shareholders/stakeholders and employees. Are they rivals? What are the trade-offs? Is there an invisible hand controlling checks and balances to maintain an economic equilibrium so that each group gets its fair share? Are some groups more entitled to receiving value than others?
Performance Management Operating as an Integrated System
Figure 1 illustrates the interdependent methodologies that comprise performance management for a commercial organization:
Figure 1: A Picture of the Performance Management Framework
Look at this figure and ask yourself: what are the most important words? The answer? It depends on who you are.
If you are the CEO, the answer must be "mission and strategy." That is the CEO's primary job, to define and constantly adjust organizational strategy as the environment changes. That is why CEOs are paid high salaries and reside in large corner offices. However, after the strategy definition is complete and maintained as current, then the core business processes takeover, with competent process owners held accountable to manage each one.
Customers would probably say that "customer satisfaction" is most important. Customer satisfaction encompasses four customer-facing trends:
1. Customer retention, a recognition that it is relatively more expensive to acquire a new customer than to retain an existing one.
2. Source of competitive advantage, gaining an edge by shifting from commodity-like product differentiation to value-adding service differentiation.
3. Micro-segmenting of customers, with a focus on customers' unique preferences rather than mass selling.
4. The Internet shifting power from suppliers to customers and buyers.
It is easy to conclude that a customer focus is critical.
Three arrows are at the center of the figure, starting and ending with the "customer satisfaction" ellipse. In practice, these arrows circulate counter-clockwise. The two fat green arrows represent the primary universal core business processes possessed by any organization, regardless if they are in the commercial or public sector: take an order or assignment and fulfill an order or assignment. These two processes apply to any organization: orders, assignments or tasks are received and then organizations attempt to execute them. The IT support systems needed to fulfill these two core processes represented by the green arrows are called front-office and back-office systems.
The customer-facing, front-office systems include customer intelligence (CI) and customer relationship management (CRM) systems. This is also where sales and work order management systems reside. The back-office systems are where the fulfillment of customer or work orders, process planning and operations resides - the world of ERP and Six Sigma quality initiatives. The output from this process planning and execution box is the product, service or mission intended to meet the customer needs. To the degree that that customer revenues exceed all of an organization's expenses, including the cost of capital, then profit (and free cash flow) eventually accumulates into the shareholder's ellipse in the figure's lower right.
The need to satisfy customers is the major input into senior management's ellipse in the figure's upper left: "mission and strategy." As the executive team adjusts an organization's strategy, they may abandon some key performance indicators (KPIs) intended to align work behavior with the outdated strategy. In this case, KPIs associated with outdated strategies are not unimportant but rather now less important. The team may also add new KPIs or adjust the KPI weightings for various employee teams. As the feedback is received from the scorecards, all employees can answer a key question: "How am I doing on what is important?" With analysis for causality, corrective actions can then occur. And note that the output from scorecards does not stop at the organization's boundary, but it penetrates all the way through to influence the employee behavior. This in turn leads to better execution.
An Automobile Analogy for Performance Management
All organizations have been doing performance management well before it was labeled as such. It can be argued that on the date all organizations were first created, they immediately were managing (or attempting to manage) their enterprise performance by offering products or services and fulfilling sales orders. If you will, imagine an organization at start-up as a poorly tuned automobile. We would observe the consequences of unstable business methods: unbalanced wheels, severe shimmy in the steering wheel, poor timing of engine pistons, thick power steering fluid and mucky oil in the crankcase. Take that mental picture and conclude that any physical system of moving parts with tremendous vibration and part-wearing friction dissipates energy, wasting fuel and power. At an organizational level, the energy dissipation from vibration and friction translates into wasted expenses where the greater the waste, the lower the rate of shareholder wealth creation and possibly destruction. In a different case, you may find a car that seems perfect in the mind of the customer in every way, but it is not priced to make a profit, making the shareholders unhappy. In another, the focus may be on producing an automobile at the lowest cost to the point of undermining customer satisfaction.
Now imagine an automobile with its wheels finely balanced and well lubricated. The performance framework (i.e., the automobile) remains unchanged but the shareholder wealth is more rapidly created because there is balance in quality, price and value to all. No vibration or friction. That is how good performance management integrates the multiple methodologies of the performance management portfolio of components and provides better decision analysis and decision making that aligns work behavior and priorities with the strategy. Strategic objectives are attained, and the consequence is relatively greater shareholder wealth creation.
Activity-based costing (ABC) data, a key component in performance management, permeates every single element in this scenario to help balance these sometimes competing values. ABC itself is not an improvement program or execution system like several other systems in the figure. ABC data serve as a discovery mechanism and an enabler for these systems to support better decision making. For example, ABC links customer value management (as determined by CI and CRM systems) to shareholder value creation, which is heralded as essential for economic value management. The tug-of-war between CI/CRM and shareholder wealth creation is the trade-off of adding more value for customers at the risk of reducing wealth to shareholders. Ultimately, businesses will discover that customer value management is the independent variable in the equation to solve for the dependent variable for which the executive team is accountable to the governing board: shareholder wealth creation. Performance management provides the framework to model this all-important relationship.
How does this work? When combined with effective forecasting and risk management tools, ABM enables the only financial calculation engine that can quantitatively translate changes in customer value to measure the impact on shareholder value. We know all these components connect, but we struggle with how they do it. Research and work remains to be done as described by this observation:
"Customer value can be regarded as the key driver of shareholder value ... (but) surprisingly, although being of obvious importance, literature taking a more comprehensive view of customer valuation has only recently been appearing. A composite picture of customers and investors is hardly found in business references."1
Is my figure the best diagram to represent of the performance management framework? I do not know. It is my diagram. Professional societies, management consultants and software vendors have their own diagrams. Perhaps a business magazine or Web portal can have a contest where diagrams are submitted and voted on by readers. But the key point is that performance management is not the narrow definition of "better strategy, budgeting, planning and finance." Clearly, it is also about balancing sometimes competing values.
1. Bayon, Gutsche and Bauer. "Customer Equity Marketing." European Management Journal. June 2002.