Avoid the four ‘deadly sins’

Avoid the four ‘deadly sins’

If a competitor or peer uses this measure, you need to use it too: By simply using a “prevalence test" of metrics used by peers, companies can fail to account for the differences inherent in their business (for example, stage of development and organizational strategy) or objectives (such as growth and cost management).

Each stage in a company’s life cycle has its own measurement priorities. Start-ups or organizations pushing for growth in new areas have different strategic and financial goals from established firms. As a result, growth-related metrics usually play a more prominent role in performance measurement in younger companies, whereas profitability or return-based metrics tend to become more important as a company matures.

Performance measures must be accepted and well understood by everyone—immediately: Companies often fall back on the simplest performance measurement systems—including subjective evaluation of performance after the fact—because they fear complexity will make the plan too difficult to communicate and administer. But there is a clear trade-off between accuracy and complexity; more complex metrics include additional information that more accurately captures performance results. Having simple performance measures may make plan administrators happy but an overly simple plan is unlikely to deliver the results shareholders expect. Start by designing your ideal performance programme first, then look for ways to simplify how the plan is administered and communicated. Also, remember that while the measures may be complex, the messaging need not be.

Illustration: Jayachandran / Mint

Your budget and strategic plan is your performance target: While many companies consider their annual budget and strategic plan to be common sense standards for assessing performance, using only internal measures often leads to under- or over-calibration of performance and then a misaligned payment of incentives. If you have a stretch budget and the budget is your primary performance measure, then you may be underpaying employees’ achievements if they achieve target results. On the other hand, if your company sets its goals based purely against its own historical performance, then it’s likely you’ve built incentive payments into the budget—even in poor years.

Informing targets using a number of different perspectives—rather than relying solely on the strategic plan and budget—can help you assess performance more accurately. Unlinking the budget from incentive plans takes the pressure off the budget-setting process and helps prevent executives from sandbagging their estimates of the company’s future potential.

All senior executives should be rewarded on the basis of the same programme: Most companies reward executives using largely the same performance vehicles and plan metrics. While this approach works well for small, homogenized businesses, larger, more diversified organizations may require more differentiation.

By analysing the similarities and differences across business groups, you can better determine to what extent the performance measurement approach should be consistent across the company or customized to specific business units.

Laying a foundation

By keeping the following “virtues" in mind, companies can avoid the deadly sins outlined and develop an effective performance measurement system:

• Identify what you need to accomplish to beat the competition and generate sustainable economic profits; design your performance measurement system around those factors.

• Pick internal and external performance measures that accurately reflect the outcomes you want to achieve, given your company’s current strategy and stage of development.

• Consider using standard performance measures such as earnings per share and total shareholder return, if helpful—but don’t rely on just one or two metrics to assess performance.

• Create a robust target-setting process.

• Make sure your goals and incentives are fairly defined and applied across business units and encourage the appropriate balance between collaboration and accountability.

• Be sure your short- and long-term incentive plans are aligned to avoid paying twice for the same performance.

• Be clear about what specific behaviour you want to encourage and what measurable outcomes you want to achieve and follow through with clear, consistent communication.

Padmaja Alaganandan is leader, human capital business, Mercer Consulting (India) Pvt. Ltd.

This is the concluding part of a two-part series on performance measurement

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