Wednesday, August 15, 2007

Better Than Last Year

What would you think of a CEO if he said the following:

“Last year, our product defects killed 20,000 people. This year, our product defects killed only 10,000 people. I cut the deaths related to our defective product design in half. That’s a tremendous improvement! I should get a huge bonus for that. In fact, I should have a parade given in my honor.”

Now, what would you think of this CEO if you also knew this:

The reduction in deaths had nothing to do with improving the product design. Instead the reduction in the death count was due to the fact that so many people had heard of the deaths related to the defects in the prior year that the number of purchases of the product this year was also cut in half.

Businesses tend to exist in a world that likes to measure progress versus the prior year. The general logic is that if your performance this year is better than last year, then you have done a very good job and should be rewarded for it.

In the story above, the CEO chose as his measurement the number of deaths related to product defects. Since this year’s results were better than the prior year (i.e., he cut the deaths in half), he felt he deserved a big reward.

However, there were a couple of flaws in his logic. First of all, he assumed that 20,000 deaths last year was an acceptable standard, and that any improvement on that standard was an added bonus. In reality, any deaths caused by defective product design should be considered intolerable. The goal should not have been “achieve less than the 20,000 deaths last year.” Instead, the goal should have been “no deaths from defective design.”

Second, he wanted to be rewarded for beating last year’s performance on this measure, even though the means by which he achieved it was ruining the company. This CEO did not try to eliminate the defect in the design. Instead, deaths were dropping because many people became aware that the defect still existed and therefore stopped purchasing the product. This CEO was ruining the brand image, ruining sales, and ultimately ruining the long-term viability of the business. Yet he wanted to be rewarded for it.

Obviously, just trying to beat last year—by any means possible—is not always worthy of being rewarded.


The principle here is to understand the risks involved in rewarding behavior impacting the future based on looking at looking at the past. Past performance is not always the best benchmark for grading future performance. Some of the key factors to consider are the following:

1) Was the achievement of the past at acceptable minimum levels of performance?
2) Is this the appropriate benchmark to measure?
3) Can we achieve success in the future by merely doing the same things better, or do we need to do something different?
4) Is this a time when taking a step backward is called for?
5) Can the goal be met by doing the wrong things?

These points are discussed in more detail below:

1) Was the achievement of the past at acceptable minimum levels of performance?
As we saw in the story above, the CEO assumed that 20,000 deaths due to a defective design was an acceptable benchmark to improve upon. In reality, the acceptable minimum level of deaths due to defective design should have been zero. Anything less than zero should have been punished, even if it were a great improvement over the prior year.

Now you may not have done anything which killed people, but what if you were “killing” a company’s return on investment? What if your division had been losing money for 5 years straight or providing a sub-standard return on investment for 8 years? At some point, just saying “Well at least I lost less money than the prior year” does not suffice. At some point, the minimum standard needs to be set significantly higher than the past. At those times, providing an adequate return on investment needs to be demanded at a minimum, even if past behavior has been well below that standard. And if you cannot do it, we will have to find someone else who can.

For more on this topic, see my prior blog “We Suck Less is Not a Strategy.”

2) Is this the appropriate benchmark to measure?
Not all measurements criteria are created equal. Some are more appropriate at this point in your business’ life cycle than others. For example, at the beginning of a lifecycle, getting recognition and acceptance in the marketplace may be more important than profits. During the growth phase, growth in sales, market share or capacity may be the best measure. In maturity, profit margins may be the best measure of success. In decline, reduction in expenses may be a better measure.

It does no good to hit a target, if it is the wrong target to be aiming at. For example, if you focus too much on profit margins too early in a lifecycle, you may permanently stunt the long-term growth potential for future profits. If you focus too much on growth in the mature phase, you may be destroying value by making poor investment choices at a time when there is not enough growth to support them. Just look at the problems Wal-Mart is having trying to remain a high growth company. They finally decided to curtail some of their expansion plans, because there was not enough market growth potential to support it. For more on this subject, see my blog “Management by Growing.”

In general, the best criteria to measure success are the ones most closely tied to your current strategic objectives. In other words, are you closer to your strategic goal than you were last year? Every year, you may have different near-term strategic objectives. Therefore, you may need to change your measurement tool annually as well. What you want to get better at is achieving your strategy. If that is not something that gets measured, then there is a good chance it will not be achieved, as people instead do whatever it takes to meet the measured goal for the year.

3) Can we achieve success in the future by merely doing the same things better, or do we need to do something different?
If changes in the marketplace are making what you do no longer competitive, or worse yet, obsolete, then just doing it better than last year may not be good enough. Measuring success as making analog camera film more efficiently in a world of digital photography may not be the best goal.

If you are a small hardware store, and a big Home Depot or Lowes decided to build across the street, perhaps this is a good time to reassess what you are doing. Perhaps doing what you did before—only a little better than last year—may no longer be appropriate. It may be time to try something different.

In our little story above, the CEO was trying to be more efficient at building a defective product, instead of focusing on fixing the defect. He needed a new product design, not a more efficient way to kill his customers.

Maybe this is the year for reengineering rather than just improving on status quo. And sometimes when you reengineer, you take a short step backwards during the changeover, which leads to our next point.

4) Is this a time when taking a step backward is called for?
Sometimes you have to take a step back in order to leap forward later. Ramping up R&D or investing more in technology might temporarily cause profits to dip from the prior year. However, it may be the only way to insure greater long-term success. If you continue to under-invest every year in your core business in order to squeeze out an incremental profit, you may eventually choke the business and kill off your future cash flow stream. For more on this topic, see my series on “Cutting Yourself to Prosperity?” Part 1, Part 2 and Part 3.

5) Can the goal be met by doing the wrong things?
Yes, it is true that if you want to change behavior, you should measure that behavior. However, improper measurement might cause them to change their behavior to the worse. In our little story above, the CEO was measured on reducing the killings related to defective design. But rather than improving the design, he achieved the goal by cutting sales in half.

You can improve sales by destroying profit margins. You can improve profit margins (at least for a little while) by cheapening your offering. You can increase market share through acquisitions for which you pay so much that it never provides an adequate return on investment. Therefore, when setting targets, make sure that there are some controls on the methods used to achieve the target, so that bad practices are not rewarded.

Although we like to pat ourselves on the back and congratulate ourselves whenever we improve on last year’s performance, often times just “beating last year” is simply unacceptable. Perhaps last year was a bad benchmark (e.g., influenced by hurricane Katrina). Perhaps we chose the wrong measure to improve on. Perhaps we achieved the goal in the wrong way. Rather than always looking backwards, we need to set goals more with the future in mind.

Goals need to be set well in advance. It does no good to wait until near the end of the year to pick what you want to be measured on for that year. After all, you can always find at least something on which you improved over the prior year.

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