This is “Monitoring Strategy Implementation: Choosing Metrics”, section 7.4 from the book Governing Corporations (v. 1.0).
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A key determinant of greater board effectiveness in the area of strategy is the set of metricsIn business, typically the measurements of a company’s finances or performance. the board selects to monitor a company’s performance and health. The goal should be to identify a manageable number of metrics that strike a balance among different areas of the business and are directly linked to value creating activities. In addition to the standard financial metrics, key indicators should cover operations (the quality and consistency of key value-creating processes), organizational issues (the company’s depth of talent and ability to motivate and retain employees), the state of the company’s product markets and its position within them (including the quality of customer relationships), and the nature of relationships with external parties, such as suppliers, regulators, and nongovernmental organizations (NGOs).This section is based on “What directors know about their companies: A McKinsey Survey” (2006, March).
In selecting an appropriate set of metrics, it is useful to distinguish between value creation in the short, medium, and long term. Short-term health metrics show how a company achieved its recent results and therefore indicate its likely performance over the next 1 to 3 years. A consumer products company, for example, must know whether it increased its profits by raising prices or by launching a new marketing campaign that increased its market share. An auto manufacturer must know whether it met its profit targets only by encouraging dealers to increase their inventories. A retailer might want to examine its revenue growth per store and in new stores or its revenue per square foot compared with that of competitors.
Another set of metrics should highlight a company’s prospects for maintaining and improving its rate of growth and returns on capital over the next 1 to 5 years. (The time frame ought to be longer for industries, such as pharmaceuticals, that have long product cycles and must obviously focus on the number of profitable new products in the pipeline.) Other medium-term metrics should be monitored as well—for example, metrics comparing a company’s product launches with those of competitors (perhaps the amount of time needed to reach peak sales). For an online retailer, customer satisfaction and brand strength might be the most important drivers of medium-term health.
For the longer term, boards should develop metrics assessing the company’s ability to sustain earnings from current activities and to identify and exploit new areas where it can grow. They must monitor any threats—new technologies, new customer preferences, new ways of serving customers—to their current businesses. And to ensure that they have enough growth opportunities to create value when those businesses inevitably mature, they must monitor the number of new initiatives under way (as well as estimate the size of the relevant product markets) and develop metrics that track the initiatives’ progress.
Ultimately, it is people who make strategies work, so a good set of metrics should also show how well a business retains key employees and the true depth of its management talent. Again, what is important varies by industry. Pharmaceutical companies, for example, need scientific innovators but relatively few managers. Companies expanding overseas need people who can work in new countries and negotiate with governments.