Tuesday, December 13, 2011

Strategic Planning Analogy #427: Reporting Documents Vs. Managing Documents

Back when I was in college, I was a DJ on the college radio station. Near the end of one year, there was a student who suddenly realized she was about to graduate without any marketable skills. She decided to put in some time on the radio station to get some free experience.

The only position she could get on short notice was to announce sports news. Unfortunately, she knew absolutely NOTHING about sports (her passion was classical music). Before going on the air, she would ask me questions, like which sport did a particular team play, or what was the name of a sports team in a particular city. She literally knew NOTHING about sports.

As a result, her sports reports were the worst I ever heard. All she would do is state the name of a city and its score. One after another after another after another after another, with no commentary, no insights, no additional statistics, no excitement. It was painful to listen to.

Sports scores are important. They tell you who won and who lost. But that’s about it.

They really don’t give you a feel for how the game was played. You don’t know what happened to create the score. You don’t know how many near-scores were prevented by great defense. You have no idea what any of the players did. You don’t know the team strategy. If all you have are the scores, you are missing a lot. And as a result, that woman’s sport’s report was missing a lot—which made it a terrible report.

The same is true in the business world. There are financial metrics which can tell you the results of how well a company did, like Net Earnings or Earnings per Share (EPS). These types of metrics are like the final scores in a sporting event. They are important to know, but they really don’t tell you a lot.

For example, did EPS go up because earnings went up or because outstanding shares went down? Did earnings go up because of increased volume, decreased expenses, or a one-time accounting adjustment? Are the results repeatable, or based on unusual one-time circumstances? None of this can be discerned from just looking at earnings.

What if you had a sport team coach who never watched the game he was coaching and only looked at the score? He wouldn’t be able to coach well, because he would not have any knowledge of what was happening on the field of play. He wouldn’t know how well individual players were playing or how effective particular plays were.

Similarly, how can you expect business managers to execute well if all they do is look at final results? They have no idea of what’s happening out in the marketplace. They don’t know who is performing well. They don’t know which tactics are working. Worse yet, they may be satisfied with final results, not realizing that they were obtained illegally, unethically, or by means of tactics which will destroy long-term performance.

You wouldn’t expect a coach or a sports announcer to only look at final results. Yet, so often we tolerate this in the business world.

The principle here is that, by definition, “results” are the result of something which occurred in advance. Results are merely outcomes produced by prior actions. Earnings don’t magically appear by themselves. They are the result of a lot of prior activities. Therefore, if you want to impact results, you have to manage those prior activities.

As we saw in a prior blog, if all a coach does is yell at his players to “Make a higher score,” he has not provided any insight into how to get a higher score. His yelling is fairly worthless. If you want better results (a higher score), you need to dig deeper into how the game is played.

Similarly, if all we tell an employee is to “Get higher sales,” we have not provided any helpful insights. If you want higher sales, you need to dig deeper into how sales are made.

Reporting Tools are Not the Best Management Tools
Part of the problem is that businesses often use the same metrics to manage reported results (outcomes) as they do to manage operations (inputs).

“Results Reports” are the scoreboards of business. They are typically income statements, balance sheets, cash flow statements, or some variation of these. They tell the external stakeholders how well you did. They let the shareholders, debt holders, and government agencies “know the score.”

These are great reports. However, their focus is primarily on the outcome, not what caused the outcome. They let you know the score, but not what created the score.

Sports scores may be great for telling the external world how the team did, but they are not the best tools for helping the team improve that performance. To do that, they look at different data, like who is making errors, how successful are particular plays being executed, are people playing with the proper form, do they know what to do, are they cooperating as a team, and so on. You won’t find those answers in the final score. That’s why sports teams use tools other than the scoreboard to improve results.

Similarly, the reported results in an income statement or balance sheet won’t give an adequate enough picture to know how to improve those results for a business. They tell you the “what” but don’t tell you the “why.”

Therefore, businesses should be more like sports—use one tool to report results and another report to manage the process to get those results.

We can see this in the example of a retailer. One of the key results a retailer wants is sales. Yet, as we saw earlier, just wishing for sales or yelling at employees to get sales will not create sales. Sales are the result of prior activity.

What are the prior activities which create retail sales? The formula looks something like this:

SALES = (# of customers) X (# of trips to the store) X (# of items bought per trip) X (the average price per item purchased)

In other words, if you want to increase sales, you need to do a combination of the following:

a) Get more customers;
b) Get the customers to come more often;
c) Get the customers to buy more items; and
d) Get the customers to buy more expensive items.

You can measure these items by looking at:

a) Customer Counts
b) Customer Frequency (which is easier to measure now that customers have loyalty cards).
c) Size and Composition of the Average Transaction (in units and currency)

Then you can design tactics to improve these activities. And then you can measure your success with these types of metrics.

However, none of these metrics can be found on an income statement. The first line on the income statement is “sales.” The sales are already assumed to exist and are reported as a done deal. It gives the “sales” score, but no insight on how to improve it. The income statement is a miserable way to manage sales. Instead of using that results report mechanism, one needs a management report with these other measures.

How Did We Get Here?
Although it may now seem obvious that different tools are needed to manage a business than to report results, many businesses tend to use results documents for both. Budgets are usually based on result metrics. Bonuses are based on result metrics. Management meetings focus on result metrics. It’s as if everyone is yelling about the size of the sales without ever bringing up the measures which truly impact sales.

How did we get to this situation? I think a lot of it has to do with the tight connection between the accounting function and the strategic analysis function in many companies. They are often the same people or exist in the same department.

The accounting orientation has a predisposition towards result reporting (it is what they were trained to do). In addition, it is a lot easier to report everything if everything uses the same report. Therefore, there is a temptation to force all reporting into a result-oriented template.

Yet this is not the ideal format to understand what is happening in those activities which really create those results. It is not the right tool to manage what causes those results. A different monitoring system is needed…a strategic one.

Although results reports, like income statements, are useful (particularly for external stakeholders), they are insufficient. If you truly want to manage the important internal activities which cause these results, you need a different tool. You need a tool which monitors how well people are performing on the key inputs to that performance. Otherwise, all you are doing is shouting the score without any clue as to how to improve the score.

Sports media like ESPN, Sports Illustrated, and EuroSport spend only a small percentage of their time reporting scores. Instead, they focus their time on trying to understand the performance behind the scores. Is your reporting approach more like these companies, or more like the woman I knew back at the college radio station (who didn’t have a clue as to what was behind those scores)?

No comments:

Post a Comment