As the old saying goes, “If you can measure it, you can manage it.” Firm (or business) performance is no exception. But what does it actually mean? According to Milton Friedman’s shareholder theory, firm performance is about maximizing return on capital invested. This definition has been in vogue for quite some time, particularly because it aligns with Wall Street’s view of economic growth. Unfortunately, this approach to performance falls short of the real challenge, as evidenced by General Electric’s and others’ recent demise.
Before examining how to measure business performance, it’s important to understand what performance is all about. This requires answering four generic questions:
- For whom is business performance measured?
- What is the purpose of measuring business performance?
- Whose performance is measured?
- How is business performance defined, quantified, and measured?
Successfully approaching performance measurement requires putting it in the context of someone (answering question 1) and wanting to solve a problem (answering question 2) within the constraints of a well-understood definition (answering questions 3 and 4).
THE SHAREHOLDER-FIRST ERA
The most common definition of performance is based on firms’ financial metrics such as earnings per share, net profits, or return on capital invested. It primarily serves the shareholders to measure to what extent the CEO’s managerial decisions are in the investors’ best interests. The ultimate goal is to maximize shareholder wealth regardless of how this is accomplished.
As managers should know by now, the one-dimensional shareholder-first approach to performance is short-sighted. It is easily gamed, for example, through buying growth. Another of its flaws is that it considers employees to be a cost rather than a value. More importantly, it ignores the customer. Without a customer, there is no business; without a business, there is no profit to measure.
OVERCOMING THE ONE-DIMENSIONALITY
The balanced scorecard, made famous by Kaplan and Norton, addresses the shortcomings of measuring performance solely through financials by considering the four dimensions financials, customers, processes, and growth. The balanced scorecard provides a more holistic picture of a firm’s overall performance by considering customers and employees (though the processes dimension) and long-term growth, in addition to financials (which focus on short-term profits). However, it still falls short because it takes a firm-centric approach to performance measurement rather than concentrating on the customer and their demands.
CHANGING THE PERSPECTIVE
Peter F. Drucker advocated putting customer-centricity at the core of measuring and managing business success. He wrote, “Results depend not on anybody within the business nor anything within the control of the business. They depend on somebody outside—the customer in a market economy, the political authorities in a controlled economy.” Although his call for action was heard, managers still struggled to translate customer-centricity into actions beyond marketing. Even today, proponents of customer-centricity are regarded as marketing scholars rather than strategists.
Too often, strategy foresight focuses on the firm, its distinct resources and capabilities, and its competitive positioning. The customer-centric mindset only entered the corporate world with the introduction of Fred Reichheld’s Net Promoter Score (NPS) framework. Performance measurement began focusing on measuring customers’ happiness based on the causal assumption that happiness leads to higher profitability.
Furthermore, it provided managers with feedback and offered employees insights on how to improve. As a one-dimensional performance measurement, the NPS suffers from the easy-to-game syndrome. More importantly, it fails to link customer happiness to actual customer purchasing decisions. The NPS framework underlying causality between happiness and future profitability is easily challenged.
UNDERSTANDING WHAT CUSTOMERS WANT
Taking a customer-centric approach to business performance measurement follows the right track. However, there is still a steep hill to climb to the top. As Christensen suggests, successful firms understand which jobs their customers want to be completed and address them in a compelling and differentiating way. The demand generated by the jobs they seek to complete is the cornerstone between the customer and profitability. As such, performance measurement should prioritize measuring customer demand by answering three complementary questions:
- How much is a customer willing to pay to satisfy their demand? How much is getting their job done worth to the customer?
- How many customers exhibit the identified job to be done and are willing to seek help from the firm to satisfy the associated demand?
- What does it cost a firm to satisfy a specific demand in a way that customers prefer over alternatives?
Successful performance measurement requires understanding and quantifying the causalities that relate a customer to a purchase.
KEY INSIGHTS
Successful performance measurement supports management in making superior decisions. It must first and foremost focus on the customer and their needs. Helping customers complete their jobs makes them happy and willing to spend more money, and they refer their solutions to friends and acquaintances. While processes and costs must not be overlooked, performance measurement should be designed around how value is created for the customer and, consequently, how the firm can capture value.