Such systems typically include:
- long-term strategic plans,
- short-term budgets,
- capital budgeting systems,
- performance reporting and reviews, and
- compensation frameworks.
The rigor and honesty of implementing the system is at least as important as the system itself.
Implementing the system includes
- choosing the metrics,
- composing the scorecard, and
- setting the meeting calendars.
1. Choosing the right metrics
Choosing the right metrics means identifying the value drivers.
Typically the ultimate drivers are
- long-term growth,
- ROIC, and
- the cost of capital.
Short- , medium-, and long-term value drivers determine growth, ROIC and the cost of capital.
Short-term value drivers
Short-term value drivers are usually the easiest to quantify, and examples include
- sales productivity,
- operating cost productivity, and
- capital productivity.
Medium-term value drivers
Medium-term value drivers consist of
- measures of commercial health,
- cost structure health, and
- asset health.
Long-term value drivers
Long-term value drivers address strategic issues such as
- ways to exploit new growth areas and
- the existence of potential market threats.
Understanding the value drivers allows the managers to have a common language for their goals and to make better choices of trade-offs between critical and less critical drivers.
2. Composing the Scorecard
Balanced scorecard approach
This was introduced by Robert S. Kaplan and David P. Norton in "The Balanced Scorecard: Measures That Drive Performance" (Harvard Business Review, February 1992).
This approach can reflect many aspects of the firm and its goals.
The choice of critical drivers should be tailored to the firm's businesses.
A tree based on profit-and-loss structure approach
This is often the most natural and easiest to complete.
The targets need to be challenging and realistic, however, and should not consist of only a single point.
One recommendation is the use of base and stretch targets, where achieving the latter reaps a reward for the manager and not a penalty.
3. Organizational Health
In addition to determining the drivers and targets, managers should assess organizational health, which is determined by
- the people,
- skills and
- culture of the company.
Managers should help set the targets to better understand these issues.
Fact-based reviews with appropriate rewards should depend on:
- stock performance where macroeconomic and industry trends have been removed,
- long-term assessments that might mean deferring rewards, and
- measures of performance against both quantitative and qualitative drivers.
The firm should harness the power of nonfinancial incentives, such as creating a culture that attracts and motivates quality employees.