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MEASURING SUCCESS - WHY PROFIT AND CASH ARE NOT ENOUGH
Andrew Likierman
12.11.08
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Andrew Likierman 12.11.08
MEASURING SUCCESS IS CRUCIAL TO ANSWER KEY QUESTIONS
“How do we know we’ve succeeded?”
So …“What are our priorities?”
“How well are we doing?”
So .. “What do we do now?
“What are the implications for the longer-term?”
“What do we tell people outside?”
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Andrew Likierman 12.11.08
WHY PERFORMANCE MEASUREMENT IS NOT WHAT MANY ASSUME
Most people assume
- there is an established framework
- it is quantitative
- there is an answer to every question (or if there isn’t, hard work will give an answer)
In practice
- there is no established framework or the answer
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THE MENU
How much choice on measures?
Cash and profit
Measures for different stages
Non-financial measures
Comparisons
Risk
Tomorrow morning
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Andrew Likierman 12.11.08
HOW MUCH CHOICE ON MEASURES?
With no outside requirements, lots
But these usually mean there isn’t a choice
Companies need to distinguish between objectives, means to objective and constraint
eg - profit or cash may be any of the 3
- in a recession, cash constraints usually dominate
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Andrew Likierman 12.11.08
SO WHAT ARE THE CHOICES FOR OVERALL MEASURES?
4 TYPES
Company financial
Cash
Profit
Company non financial
Market
Share price
and for non-quoted companies, personal objectives
Satisfaction
Vanity
Not covered
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Andrew Likierman 12.11.08
CASH
The ultimate objective (usually) is an ability to generate
It’s also the ultimate constraint
But only one measure of success
Because it gives only part of the story
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Andrew Likierman 12.11.08
WHY NOT THE ONLY MEASURE?
Mainly
- hopeless on fixed capital
- doesn’t register working capital
- serious timing issues
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Andrew Likierman 12.11.08
PROFIT
An essential measure
But only one
Because it gives only part of the picture
And it’s based on so many judgements
So can’t be “right”
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Andrew Likierman 12.11.08
WHY ONLY ONE PART OF THE PICTURE?
Inherent problems
eg: annuality, inflation, cost of capital, international dimensions
Prediction problemseg: depreciation, contracts, pensions
Problems of definition
eg: “normal” trading, profits/capital gains, extraordinary/ exceptional items, stock options
The cost basis of accountseg: asset definition (brands), opportunity costs
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Andrew Likierman 12.11.08
FINANCIAL MEASURES - POINTS TO BEAR IN MIND
1. All organisations need them
2. Financial success is a characteristic of a “good” company
3. There is no universally accepted financial measure
4. The main measure does not have to be financial
5. All measures are subject to manipulation. A financial measure will also be subject to financial manipulation
6. A financial measure may be a constraint, not a target
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Andrew Likierman 12.11.08
NON-FINANCIAL MEASURES
Clear and useful
But can’t be the bottom line
And can only be overall measure with “protection”
Since they need to be financed
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Andrew Likierman 12.11.08
DIFFERENCES TO LARGER COMPANIES
Owner/key shareholder dominance
Reconciling objectives of owners/managers
Fewer constraints on objectives
Greater propensity to confuse constraints with objectives
(Sometimes) more non-financial objectives
Greater degree of ambiguity
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Andrew Likierman 12.11.08
Profit
CashCash
DIFFERENT STAGES – DIFFERENT PRIMARY INTERMEDIATE MEASURES
MaturityRecovery
Crisis
Expansion
Startup
Non-financial
Pre-startup
Resumedgrowth
Profit
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Andrew Likierman 12.11.08
DIFFERENT STAGES, DIFFERENT MEASURES (1)
Pre start up
Progress against plan (gathering information and support from potential stakeholders (including finance, suppliers, customers and key staff)
- non-financial measures dominant
Early phase
Progress against plan (including basic assumptions, start-up expenditure, growth of revenue, cash burn)
Progress against milestones (including break-even)
- cash dominant
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Andrew Likierman 12.11.08
DIFFERENT STAGES, DIFFERENT MEASURES (2)
Expansion from proven base
Performance against others
Performance against plan (including budget and longer-term plan)
- profit-based measures dominant
Maturity
Performance against opportunity cost of activities
- cash dominant
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Andrew Likierman 12.11.08
MEASURES NEED TO CHANGE
To reflect changing phases and stages of growth
They usually change too late
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Andrew Likierman 12.11.08
PRE CRUNCH - Profits growth
EARLY - Proportion of assets on vulnerable (ie sub-prime) categoriesProportion of funding from wholesale sources
LATER - Basel and regulatory ratiosLiquidity
AND CIRCUMSTANCES CHANGE
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Andrew Likierman 12.11.08
NON-FINANCIAL MEASURES
Underpin financial measures
…help to• Focus on key strategic aspects• Provide useful signals • Get behind basis of financial decision-making• Benchmark internally and externally
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Andrew Likierman 12.11.08
NON-FINANCIAL MEASURES- SOME EXAMPLES
Markets repeat purchases sales datareputation survey
Capacity hotel occupancy rate room data oil replacement rate (geological) survey
People turnover people datacommitment survey
Product/reject rate production dataService appreciation survey
(complaints)
Yes, but…
How good is the measure?
What’s the link to profitability?
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Andrew Likierman 12.11.08
FOR EXAMPLE –SPENDING ON BRANDS
Spend onbrands
FormulaMore salesBlack
Box
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Andrew Likierman 12.11.08
LEADING AND LAGGING INDICATORS
Lagging
Focus historically and basis for decisionseg Market share, sales, employee satisfaction
Normally easier to identify and captureBut may lack future relevance
Leading
Measures that drive performance, often intermediateeg: proposals written, customers visited
Help the organisation to plan and decideBut difficult to identify and may lack credibility
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Andrew Likierman 12.11.08
SOME LEADING INDICATOR EXAMPLES
“If it’s raining in Brazil, buy Starbucks”
10-year/2-year US Treasury yields
R-word
Burger King
Insurance mis-selling claims
Humana
Net-Jets
Case-Schiller index
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Andrew Likierman 12.11.08
CONSIDER BETTER MEASURES ....
Profitable customer/regretted staff losses
Not just new customers acquired
And employee turnover
Committed/embedded employees
Not just satisfied
Net promoter score (customers and employees)
Not customer dissatisfaction (complaints)
Or employee satisfaction (turnover)
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Andrew Likierman 12.11.08
THERE ARE 4 WAYS TO COMPARE PERFORMANCE…
Last yearOthers
Objective/plan
This year
Opportunity
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Andrew Likierman 12.11.08
OPPORTUNITY
Whatwe’redoing
Whatwe could be doing
Opportunity
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Andrew Likierman 12.11.08
MEASURING OPPORTUNITY
Personal“Sliding Doors”House maintenance
At workWhen the successor to someone doing a job for many years shows what a great/lousy job he/she has been done
Having property lying idle (and possibly in the books at the wrong price) and which could be sold
Real examplesGEC – opportunities lost then thrown away
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Andrew Likierman 12.11.08
COMPARISON BASES - PROBLEMS
Last year Others
Objective/plan
This year
Opportunity
SAME BASIS? DISTORTED?
LEVEL?
RELEVANT?
BASIS?
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Andrew Likierman 12.11.08
Others
COMPARISON BASES – INTERNAL USES
Last year
Objective/plan
This year
Opportunity
Minimum Most powerful
If possible
So what?
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Andrew Likierman 12.11.08
COMPARISON BASES - DEVELOPMENT
Last yearOthers
Objective/plan
This year
Opportunity
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Andrew Likierman 12.11.08
PERCEPTIONS MAY ALSO BE DIFFERENT
Insiders may not be aware, may not understand or may have a different view of what outsiders want
- eg measures of, timescales for, performance
Outsiders may not be aware, may not understand or may have a different view of what insiders are doing
- eg providers and users of capital or on strategic direction
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Andrew Likierman 12.11.08
COMPARISON BASES – POTENTIAL DISCONNECTS
Last yearOthers
Objective/plan
This year
Opportunity
You Them
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RISK
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Andrew Likierman 12.11.08
RISK “HEAT CHART”
IMPACTLow High
High
LIKELIHOOD
Low
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Andrew Likierman 12.11.08
…WITH NUMBERS
24 64
30
16
1 6
IMPACTLow High
High
LIKELIHOOD
Low
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Andrew Likierman 12.11.08
MAJOR IT PROJECT
◘
IMPACTLow High
High
LIKELIHOOD
Low
Primaryrisk
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Andrew Likierman 12.11.08
MAJOR IT PROJECT
◘
IMPACTLow High
High
LIKELIHOOD
Low
Primaryrisk
Mitigating action
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Andrew Likierman 12.11.08
MAJOR IT PROJECT
◘
IMPACTLow High
High
LIKELIHOOD
Low
Residualrisk
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Andrew Likierman 12.11.08
SO… SOME SUGGESTIONS (1)
Understand fully how you are being measured- by those who analyse what you do- by those who provide your finance
Be aware of realities of freedom of manoeuvre
Performance measurement- shouldn’t be taken for granted - is not an optional add-on
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Andrew Likierman 12.11.08
Recognise definition as- a crucial management task- involving politics and communication- as well as economics
Externally- look coolly at misperceptions- use all your weapons
Internally, measures must be- clearly understood- linked to overall measures
SO… SOME SUGGESTIONS (2)
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A FINAL TIP
Numbers
Commentary
People
Important
Essential
Critical
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Andrew Likierman 12.11.08
IN THE OFFICE TOMORROW
Do I/colleagues understand how the organisation measures success?
Do I agree with colleagues on how success is measured?
Do we understand the implications of the choices?Gettin
g it right gives comparative advantage