Long before a crisis hits;
Long before it shows in the Financials;
Or in the KPI’s;
The signs are there for the Chief HR Officer . . .
Changing them has a profound affect on the bottom line.
They came in quickly, silently – Harry the CEO, Dan the CFO. Alice immediately felt their tension. Dan looked ashen, Harry flushed. Something had happened.
There were now eight people in the room, she counted them: CEO and CFO; then Manufacturing, QA, Marketing, Warehousing, Engineering, and Human Capital – herself. But she counted another entity there too: The Ninth Entity; The Company, who was there whenever the management team met. Now it was hurting.
Without his usual greetings and looking straight ahead, Harry said to Dan, “Why don’t you tell them.” It was not a question.
Dan was Chief Financial Officer. He had been with them for five years. Just last month at the board meeting he had replayed their progress in that time, from $50 million annually to more than $250. Alice had mentally translated that to her terms, 450 people then, 2100 now; one plant then, three plants now. An accomplishment everyone was proud of.
In a tight voice Dan began. “Late Friday we got the preliminary results for last quarter. It was the fastest, earliest we have ever produced them.” He glanced nervously at Harry. “I spent most of the weekend going over them with our controller. They’re accurate.
“Our sales have declined precipitously, costs are increasing in both SAG and production and income has declined by 35%. With interest rates climbing, we barely made cost of capital. It looks like we will not make that this month.” Seeing the puzzled look on a couple of faces Dan went on, “Cost of Capital is what we pay for the money we use to do business. That means . . .”
Harry interrupted; his flush was gone but his voice was much too quiet; he was obviously making an effort to hold his temper. “Not making cost of capital means we are in Early Decline. And the board will know it. And I don’t care how fast the financials were prepared.”
Dan felt stung and said, “Harry I’m just the messenger.”
“That’s not good enough.” Harry was now looking at them all. “Dan and I have our signatures on the financials but you are all responsible for the P&L with us. I need managers who keep me ahead of the curve, not ones who join me sliding down it. I don’t know if we are having a mild case of angina or a corporate heart attack.”
He walked to the door. “I don’t care how you do it,” he was now addressing both Dan and, to her surprise, Alice. “I want to know three things from you by the end of the week. First, what happened; second, why it happened; third, why didn’t I know about it before. I have to start calling board members and our shareholder services area to get in front of this. So get me my answers. Now!”
The meeting had lasted nine minutes.
Silently they left. Troubled, anxious, feeling guilty. Asking, how could they have known? How could they have warned Harry? It wasn’t their job to predict. They looked at Dan. That was his job.
Dan and Alice remained. Both numb. Dan looked sick.
How serious was this. Were they looking at a corporate heart attack or something more benign – like angina? Dan didn’t know. He didn’t have the numbers. Nor did Alice. Looking at Dan she said, “Talk to me.”
As with most human diseases, a corporate heart attack–or even angina–doesn’t really strike out of the blue without warnings. They may be silent, they may be subtle, they may be hidden from the casual observer, but the signs and symptoms are there–often for many years.
All you need to see them–to bring the problems to light–are the correct instruments, which are for business the equivalent of the EKG, the MRI, blood tests. And, of course, the courage to look.
The Phases of Corporate Decline
When a company declines from its peak performance to its end, it goes through three well-documented, clearly identifiable phases:
- The Hidden Phase
- The Subtle Phase
- The Overt Phase
In each phase the company loses a full third of its competitive value. (See Figure 1.) And, as Dan explained, the second and third phase each had its own clearly defined symptoms and characteristics.
Dan sketched the curve on the green ledger pad he favored. He began to discuss it from the bottom up. And from right to left.
Phase III Decline – The Overt Phase
When Dan presented the financials that morning to Harry, he had been careful to say that even though GreyCor was still profitable, the company was no longer making cost of capital, something that would, and should, trigger intense board concern. Frequently in finance circles this stage is referred to as “Early Decline.” But both Dan and Harry and now Alice recognized it as definitely a misnomer. It was the earliest stage of Phase III Decline; two-thirds the way down the curve. Their board, being all professionals, would know this, too. The analysts too, when they found out about it.
By the time the signs of decline first show in the financial statements (right column of Figure 1) Phase III Decline has arrived. And with its arrival, fully two-thirds of a company’s competitive value has been lost.
Their company had gotten there without apparent warning and without any of them knowing how. Everyone knew that running a company from the financial statements–however timely the statements are–is like driving a car by looking only in the rearview mirror: By the time problems show there, the car is already deep in trouble.
No difficulties had shown up in the previous period’s financials either. No hint, no suggestion. If the company’s systems had been better, Dan said he just might have been able to get some kind of warning from sophisticated analyses like the Z or ZZ scores. But in their case it wouldn’t have been much–a couple of months perhaps–and those measures were iffy for their industry anyway.
Phase II Decline – The Subtle Phase
Things would have been different, Dan said, if they had recognized earlier, perhaps a year before, that they were in Phase II Decline (Subtle Phase) and heading down. But Phase II can’t be seen from the financials, even with the most sophisticated analysis possible. Detection of Phase II requires different measures.
Phase II Decline shows in the Parametrics or Key Performance Indicators (KPIs); things like Time-to-Market versus the Competition, Customer Satisfaction, Relative Pricing. Like the financials, these factors are historic expressions of performance, but at least they are earlier historic measures. KPIs are things that a really good professional due diligence would have picked up if the company had been for sale.
There was plenty of information available in the literature about KPIs and their measures. Dan knew what needed to be measured and how. But corporate priorities had always found them too time consuming, too expensive, and anyway they knew these things. So he hadn’t been able to develop the measures.
The KPI’s the company had been measuring before he came were conflicting and had set the goals of one department against another, particularly between Manufacturing, QA and Sales. The proper ones were difficult and expensive to measure. They had been on his department’s wish list for the last two years, but now the company wouldn’t have the resources to develop them.
Dan did admit to Alice that there were guesses the senior staff could have made about some of the KPIs that would have raised alarms – guesses that would have been close to the truth. But he hadn’t asked the senior managers to do that: Perhaps because he had not felt the pain – obviously others had not felt it either; perhaps because he hadn’t felt empowered as CFO; or perhaps as a CFO he would not have been comfortable looking at “guesses”.
Yet, he admitted, managing a company from the KPIs, even timely KPI’s, is no better than driving a car by looking out the side window. Yes, it’s better than the rearview mirror, but you are still not looking in front of you.
By the time the earliest stage of Phase II shows up, fully a third of a company’s competitive value has been lost. Dan had been in this situation before, and he knew that the loss had already occurred in Phase I. While not quantifiable by a due-diligence in terms of money, the deficiency would show up the moment the company needed to respond to a crisis or mobilize itself for a new endeavor. A demoralized team was the analogy Dan used.
“What the company really needs.” Dan said, “is a set of measures that will indicate problems when the company is still in Phase I, preferably at the earliest (“Stable”) stage of Phase I. Such measures would allow someone like HR (he was looking at Alice) to go with him to Harry and say, “Here are the financials; they look good.” Maybe also, when they could afford them, “Here are the KPIs; they look good, too.”
But then she needed to be able to add, “Here are some numbers that show a problem coming, a problem that will manifest itself in the KPIs and in the financials soon after that … unless we do something.” Alice knew that this was the kind of challenge most leaders, and especially Harry, could not resist.
As Alice thought about it, signs like these had been evident in the way the company had been running since she arrived. She suspected they had been there for years – since before Harry had arrived, too. She had been uncomfortable about them, knew they were unhealthy. But had just not seen them as directly affecting the financials. And certainly not related to the nasty runoff of their more profitable customers that had shown itself suddenly.
As she saw the size and scope of the problems now, she said to Dan that the customer run-off had to be driven by the deterioration in management attitudes and behaviors she had seen. She admitted some responsibility in this. She had brought it up at management meetings; people even had agreed it existed. But she had just never been able to prove (even to herself) how bad that was. Everyone, especially Dan and Harry, had wanted “hard” numbers.
She would now have to take a much stronger stance on it. And take the heat. But Harry was a CEO with enough guts to look reality in the eye and have his team look at it, too.
Phase I Decline – The Hidden Phase
The signs and symptoms that show Phase I Decline (Hidden) are attributes of a company called the Drivers of Performance (left column of Figure 1). Collectively they constitute the Operating Dynamic. Some people think of this as the soul, the spirit of the company. It is entirely within management’s control. It is the very cause of performance. And, since no problem can be predicted further ahead than itscause, the Operating Dynamic is the very first predictor.
The constituents of the Operating Dynamic, the Performance Drivers, fall into three categories: Critical Functions, Generators, and Blockers.
CRITICAL FUNCTIONS: The Balance Sheet for the Effectiveness of Management
Critical Functions are those functions within a company that have a huge effect on productivity for very little effort – An analogy might be the speed lever in a locomotive.
There are only six but we will deal with three here:
- Talent Management
- Lean Operations
- Performance Management
Talent Management refers to purposeful hiring, development, and turnover.Performance Management refers to goal setting, rigorous follow-up, rewards related directly to performance, and the like. Lean Operations includes cost containment, lean manufacturing, etc.
We chose these three because they are important. And also because, a few months ago, the results of an eight-year study of 100 companies by the London School of Economics and McKinsey & Co. showed conclusively the extraordinary impact these three Critical Functions have on the bottom line. (See When IT Lifts Productivity – Stephen J. Dorgan & John J. Dowdy – © 2005 McKinsey & Co.)
All companies have these Critical Functions. They are independent of all systems and processes, and, as is worth mentioning again, they are entirely within management’s control. In other words, it costs the same to do them well as do them badly.
For a long time, Alice had been aware at some level that these Critical Functions were faltering in Greycor. The quality of their execution and enforcement of all three was generally poor throughout the organization.
Quantifying just the three factors listed above provides a clear assessment of where a company stands. And if the company is in decline, they show broadly whether it is in Phase I or II or III. (They also show where a company is on the growth-development side, but we won’t cover that here.)
Measuring the Critical Functions provides a value for the effectiveness of manageMENT (as a whole) as that impacts the company. (Note, not managers. Managers can individually be excellent – as GreyCor’s were. ManageMENT refers to the resultant effect of their collective leadership on the company — after all the dissonance, misdirection and miscommunication are accounted for.
This measured value is the full analog of the Financial Balance Sheet. The difference being:
- While the financial balance sheet is a historic measure,
- The effectiveness of ManageMENT today is what is creating the performance of the company tomorrow. As the speed lever on a locomotive is set, so will the train go.
If Alice (she now saw why Harry had made her responsible) had measured the Critical Functions the month before, when the financials showed no trouble, they would have told her the company was somewhere near the bottom of Phase II even though there were no measurements of KPIs to ring bells. And that would have been a signal to at least canvass management and key staff as to where they thought the company was heading. She could do that, though it would ruffle feathers.
If she had measured the Critical Functions a year before (maybe even two or three), they would have shown clearly that the company was already in Phase II decline and to what extent.
PERFORMANCE GENERATORS: The P&L for the Effectiveness of ManageMENT
Underlying the Critical Functions and determining their effectiveness are nine corporate attributes we call Generators. As with the Critical Functions, they are entirely within the control of management, it costs no more to do them well as to do them badly, and they can be measured easily. While the Critical Functions are the analog of the balance sheet, the Generators are the analog of the P&L. They show both the trajectory and the rate of change of the Critical Functions. Think the accelerator of a car.
For simplicity, we will deal with just three here:
- Acknowledgment of Work
Decisiveness here refers to the decisiveness of the company: the speed with which issues are brought to the table, decided upon, and executed. It does not refer to the decisiveness of the CEO or manager nor to the quality of decision-making. For the same quality of decisions there is a huge variation available in the rapidity of decision making. – e.g. it is possible to make 10 decisions or 20 decisions of the same quality in the same timeframe, depending on the decisiveness of management.
Acknowledgment of Work may seem like an odd factor to examine. This generator refers to the amount, frequency, and quality of discussions between workers, between workers and supervisors, between supervisors and management, and between all of these individuals and clients and suppliers – about the work. When Acknowledgement of Work is poor, supervisors are not talking with their subordinates about that work. Therefore there is no feedback or hope for improvement. Accountability doesn’t require a definition.
These three Generators profoundly determine the effectiveness of the Critical Functions. For example, if Accountability is deficient, neither Talent Management nor Cost Containment (critical Functions) can operate well.
Measuring just these three shows clearly, if not in the fine detail nine would give, the competitive trajectory of the company – down or up, slow or fast. And also the rate of change of the Critical Functions – how fast or slow they are improving or deteriorating.
To Alice, Corporate Decisiveness was the major issue among the Generators; it affected all the Critical Functions. If she had identified and quantified that, she could have told how quickly competitive and financial problems were approaching. And she could have gotten very good answers from the managers and supervisors if she had just asked the right questions. Supervisors usually see the Generators very clearly, even if managers don’t like to think about them.
Once the Critical Functions and Generators are measured, it is very difficult for the management team or the board to ignore them. The measurements provide the basis for reward and intervention.
Only 6 Critical Functions and 9 Generators need to be measured to get the current value (Balance Sheet) and trajectory (P&L) for the effectiveness of management, and the future of the company.
But now for the bad news: There are more than 100 possible factors within an organization that can block or impair the Critical Functions and the Generators. They are known as Blockers – the organizational factors that suck the energy, the lifeblood out of a company. There is no analog for these in the financial statements.
The profile of Blockers is unique to each organization and even to each unit within an organization. Because of the complexity in dealing with Blockers, we’ll mention only three here – they need no definition: Distrust, Complacency, andBureaucracy. Alice thought that Complacency might be the biggest one for Greycor; it blocked decision-making, which crippled all the Generators, and all the Critical Functions.
Quantifying the Critical Functions gives the value (balance sheet) forManageMENT Effectiveness. Quantifying the Generators gives the trajectory of the Critical Functions (P&L). Quantifying the Blockers explains why the Critical Functions and the Generators are as they are. It also shows how to fix them.
So, how do we measure these Critical Functions and Generators? All you need is a simple survey; its construction is easy:
- Create a questionnaire. To do this properly, each driver requires between three and 10 questions (statements) to capture its full spectrum. But one or two will do for a start. Alice wanted all 15 measured.
- Issue the survey to all managers, supervisors and key staff, from CEO down, by team. Ensure that it is anonymous within each team. Alice had 10 teams to survey.
- Score so that the Critical Functions and Generators are expressed in a range from -5 to +5.
- Sum and average appropriately.
- Have the senior team (CEO plus direct reports) confront the responses together. Have the subordinate teams confront their issues in separate sessions. A professional outside business catalyst is desirable for this. Note, not all facilitators are catalysts.
THE ROAD TO RECOVERY
For many years, C-level executives may have believed that there were no instruments or measures that would provide them with a clear picture of the current effectiveness of management, that would show its trajectory, that would enable them to predict future workforce or financial performance. They also may have thought that there were no tools for them to use to change that performance.
For many years they were right.
But in 1980 we discovered that the very causes of performance – the organizational and human factors that are the wellsprings of all business performance – could be quantified.
The tools we created measure the effectiveness and trajectory of manageMENT, unit by unit and for the whole company; just as the KPI’s and the financials do. This was the first time ever such measures were possible.
Even more interesting, the measures PREDICT a company’s performance and bottom line far into the future. And most interesting of all – a discovery of extraordinary potential for any CEO – the factors measured have within them the seeds of their own improvement. Management can, and often does, ignore financial warnings as well as those from KPI’s. Measures of manageMENT effectiveness however, (particularly the Blockers) generate the energy and willingness to make changes.
Without these measures, CEOs, CFO’s and line managers must travel blind. With them, the CHRO can be a prophet. Together they can change the future.
Alice set to work. The accounting department prepared the financials, which showed the performance of the company – as it had been. Now the CHRO would develop measures that would enable the company to predict the future. She would issue the survey along with the LSE-McKinsey study; that would take care of any legitimate reluctance among managers because from it they would know that improving just three functions by 25% would get them a 40% improvement in profits. Even a 10% bottom-line improvement would take them out of trouble.
Alice knew what to do. She had a roadmap for a successful journey. And the destination was a vibrant, healthy, growing organization.