01 Feb 2000  Research & Ideas

Keeping Track: Performance Measurement, Control & Strategy

Beginning with the influential work of Professor Emeritus Robert N. Anthony in the 1960s and 1970s, Harvard Business School has given a prominent place to research and course development focusing on the intersection of strategy and management control systems. For the past sixteen years, HBS professor Robert Simons has been adding to that body of knowledge and practice through an extensive research agenda that has resulted in numerous books, articles, and case studies.

Working Knowledge editor Jim Aisner sat down recently with Professor Simons to talk about his latest work, Performance Measurement & Control Systems for Implementing Strategy, published by Prentice Hall.

Q: What's the context for the development of this book?

Simons: My colleagues and I in the School's Accounting and Control Unit have spent a lot of time creating new course materials based on the ideas and systems that managers put into practice in the late 1980s and 1990s. Most recently, we have tried to develop a holistic view of how performance measurement and control systems function in the new economy. A considerable amount of new theory has come out of this work. Throughout this process, I have taken new materials into the classroom and refined the concepts and models through discussions with students in my MBA course, Achieving Profit Goals and Strategies. The result is the fourteen chapters of this book, which includes contributions by [HBS professor] Bob Kaplan and former doctoral student Antonio Dávila, now on the faculty of Stanford Business School. Some thirty case studies are also available in a version of the book geared toward students as well as managers who want to tap more extensively into examples of best practice.

Q: Business is booming for corporate America, and Internet companies are in the midst of what is often described as a gold rush. Is there any danger that firms will fly so high that they may spin out of control?

A: The book is built around a number of the tensions that are inherent in all businesses — profit and growth versus control, for instance, or short-term results versus long-term capabilities. The first four chapters try to help the reader understand that managers are playing a very delicate balancing act. And perhaps the most fundamental tension is the one between profit, growth, and control. Everybody these days is looking for growth, but sooner or later you have to generate sufficient profit to support market expectations. The problem is, if top management pushes too hard for profit and doesn't have the right controls in place, employees may start to do dumb things like misstating revenues or making unethical decisions. When that happens, companies typically respond by putting in all sorts of controls. But if they go overboard in that direction, their businesses can become too internally focused and lose the growth engine. The ultimate challenge for managers is to maintain balance among a variety of forces.

Q: How do you help them do that?

A: We offer a number of useful tools in the book. Take a mechanism we call the "risk exposure calculator," for instance. Keyed to elements of growth, culture, and information management, it alerts managers, even as they're toasting their success, to beware of errors or breakdowns that could threaten their company's franchise or strategy. Is the firm hiring lots of new people who may not be well trained? Is the culture so internally competitive that employees may be tempted to do the wrong thing? Are information systems in place that can support the whole business, even as it is decentralized to be more responsive to markets? The risk exposure calculator helps answer these questions.

Another powerful tool we describe in detail is the "profit wheel," a model of the flow of operating profit through a business that enables an organization to understand whether its strategy creates economic value. [Please see [graphic.] A unique aspect of profit wheel analysis is that it interlocks with two other wheels that analyze cash flow and return on equity. Many companies are paying attention to one of these wheels, or maybe two, but if they're not setting goals against all three, they're missing an opportunity to turn a good business into a great one.

Q: You emphasize that it's more important than ever for managers to communicate business strategy and performance goals effectively to employees. Why so?

A: This is a much bigger consideration than it's ever been in the past, because more and more companies have adopted a service management view of the world, which means being locally responsive to customers. As a result, firms have to decentralize and encourage their frontline employees to make decisions on their own. To do that effectively, workers must understand the strategy of the business. At the same time, they want to know what their bosses think is important and what metrics are being used to measure their contribution to the enterprise. That's a primary role of performance accountability systems, which send a signal to the work force every day as to how they should go about their activities to make sure they're in sync with where the boss is trying to take the business.

Q: To traditional ratios like return on assets and return on equity, you add a new qualitative measure called return on management (ROM), which you express as the equation:

Q: productive organizational energy released / management time and attention invested.

Q: Why do managers benefit from "calculating" the results of this device?

A: Not all that long ago, life was different for most of us. We didn't have to deal with globalization or ubiquitous technology, and things weren't moving anywhere near as quickly as they do today. Accordingly, the range of issues managers had to think about was much narrower. But the emerging opportunities in today's market are so limitless that managers have to figure out what they're going to deal with and what they're going to delegate or ignore. We've always faced constraints on financial resources or production capacity, but now more than ever, management's time and attention are the most critical constraints. We have to think much more strategically about how to focus people's efforts. ROM is a useful way to help managers understand if they're making the most of every hour they're investing in implementing their business strategy.

Wheels of Fortune

Three cycles managers must analyze to create a plan for generating profits.

diagram with three intersecting wheels: Cash Wheel, Profit Wheel, and ROE Wheels

From Working Knowledge: A Report on Research at Harvard Business School, Vol. III, No. IV.