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April, 2005

Making Scorecards Actionable Newsletter # 14 (2005)

Content of Making Scorecards Actionable Newsletter # 14 (2005)

» Making Scorecards Actionable in new translations
» Book release activities in Russia
» Rewarding success, not short term financial returns



MAKING SCORECARDS ACTIONABLE IN NEW TRANSLATIONS

In the beginning of May the Russian translation of Making Scorecards Actionable will be released. This adds up to the fifth translation of the book and another four are on their way (Thai, Orthodox Chinese, Japanese and Portuguese).

BOOK RELEASE ACTIVITIES IN RUSSIA

When the book is released in Russia our publisher will arrange a full day seminar on how to make scorecards actionable. The seminar will be held on May 25 (for more information see www.intalev.ru). The seminar will feature professor Nils-Göran Olve, who will speak about the background of the BSC concept, why it has caught so much attention (especially in the Scandinavian countries) and what “design issues” must be managed systematically to assure that the strategy map and the scorecards contribute to the organisation realising its strategies.

The same week, Jan Roy will run a second seminar in Russia, focusing in the benefits of the balanced scorecard concept. The seminar will be held on May 27 in Yekaterinenburg.

REWARDING SUCCESS, NOT SHORT TERM FINANCIAL RETURNS

The first edition of the book “Making Scorecards Actionable – Balancing Strategy and Control” was published in February 2003. In connection with the release of the book professor Nils-Göran Olve and Dr. Carl-Johan Petri published a provocative article in Scandinavia’s leading business paper on the relationship between companies’ reward systems and their financial “performance”. The article attracted a lot of interest and resulted in an animated debate on the role of the management control systems, the incentive schemes and “who” in the organisation is responsible for the business strategy and its execution.

After publishing our thought-piece we were happy to see so many opinions on the topic, so we think it is about time to share this article (in translation) with a greater audience of non-Swedish speaking readers:

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Give the CEO a bonus, even if the numbers are red!

Some years ago it was common to criticise executives in financially successful companies when they received too high bonuses. Then the economy plunged, and most companies struggled to survive. Voices are now raised that managers and employees in financially unsuccessful companies should not receive any bonuses.

Regardless if the company shows a profit or loss, it is dangerous to link salaries and incentives to the company’s “result” as it is described in the external profit and loss statement. Profit is an assessment of what the company has done in the past. Or, in the worst case, just a result of a boosting economy or other fortunate circumstances. In the short run, it is even possible to increase the profit through radical cost reductions. But this will often prove to be counter productive – top-management may downsize and abandon important investments and risk to burn-out important employees. When we today see that companies start to show profitability; owners, analysts and minority share-holders should think of what the reason might be: bright, long-term initiatives that are beginning to bloom, or that top-management has been forced into an anorectic behaviour.

Because profit, as it is defined in the P/L statement is not purely a description of the company’s performance. Laws on financial accounting and tax rules influence which profit the company will show. Not even the income side in the P/L statement, which should be fairly easy to check, is completely immune against deceitful influence. The Enron scandal, and our own Swedish Prosolvia affair, shows that neither the income statement is always correct.

But, even if we ignore deceitful accounting and share price influencing reporting, both the income and the profit statements are too shaky indicators to use when judging whether the company has been successful or not – and if the managers and employees should be rewarded for their efforts. A manager may have done an exceptional and appreciated effort during a year – well worth rewarding – even though these efforts do not come across in the two trivial indicators income and profit.

Managers and employees should instead be rewarded for their efforts to realise the company’s business strategy. It might even be that they should be rewarded the most when the company they lead is making a loss. But this will require that it is possible to monitor if the company is preparing for the future in a wise way.

The business strategy is the responsibility of the board. The owners stand the risk of the strategy and should be aware of the venture they take part in – private companies are constructed around the notion that different ideas are tested in the market, and that the shareholders are rewarded when the idea they have bet on has proved to gain acceptance. Therefore, the employed executives and the company’s employees should be rewarded with regards to the degree to which they execute the intended business strategy, not whether it is financially successful or not.

The problem is most often to describe this “assignment” in enough detail to be able to assess whether the executives and the employees have been doing a good job. One way is of course to wait and see. But motivation typically requires that the employees are rewarded sooner. And if the strategy fails, the board and the owners should take the consequences, not the management team that carried out the assignment they were given. They should be rewarded on short term results, based on how they contribute to the long-term success.

A couple of weeks ago we published a book about strategies and management control together with two colleagues. In the book, we discuss which kind of information and control systems management and owners need. Management’s responsibility is multidimensional. It is possible to describe this responsibility in four goal dimensions: financial results, market development, internal efficiency and renewal and development. Hence, it is reasonable that a CEO is rewarded for her contribution in all four dimensions, even if the efforts have not yet had full effect in the financial perspective. A manager who has invested the company’s scarce resources in the right product development projects, that has increased the company’s internal efficiency such that it can – with the same capacity – handle bigger volumes, and that has expanded the market for the company’s products, deserves recognition as well as a bonus. Even if these improvements, in three out of the four dimensions, have not yet showed up as a visible financial result. A skilled board, acting in the interest of the owners, should therefore reward the manager, her team and the employees for their contribution, resting assure that these efforts will pay off over the coming years.

But isn’t it safer to wait and reward the managers and employees for their contribution when we really know what their efforts have resulted in? We believe there are two reasons for not waiting:

1. Business is a venture and it is the company’s owners that should stand the risk. It is also the owners that should be rewarded when the bet – their venture – becomes successful. The owners, admittedly in a dialogue with the management team, define the strategic hypotheses (strategic bets) they believe will create success. The management’s and the employees’ assignment is to carry out these courses of action, according to the owners’ intentions. The owners are thus rewarded if the hypotheses prove to be correct, while the manager and employees should be rewarded for how well they execute the intended strategy. Hence, a CEO that has carried out the assignment she has been given should be rewarded for this, not whether the owners’ guesses were right or wrong.

2. When managers are rewarded for the financial result they report to the market, there is an obvious risk that they will make decisions to influence the figures that are reported to the market, rather than making decisions that create business success in the long run. Management literature gives us numerous examples of managers who stopped pivotal investment programs because these only generated costs – but no income – in the short run. The easiest way for a manager to increase the profit is to stop paying for such things that are not directly related to today’s production and delivery to today’s customers. But sooner than these managers think, today’s products are outdated and the customers will turn to some of the company’s competitors.

Someone might oppose to our view that it is the board that is responsible for the strategies and that the management team “only” implements them. Of course, the management team must engage in the strategy development and discuss it with the board. But the employed management only prepares and suggests the strategy – the actual decision on which strategy to pursue is made by the board. The board’s assignment to the CEO is broader than just making a financial profit. To reflect this, goals and monitoring procedures in other dimensions beside the financial outcome are important.

A manager who has developed new products and services, made the internal processes more efficient, expanded the company’s market – all according to the board’s expectations – should be appreciated for this. Even if the effects can not be traced in the financial result yet. While a manager who is only harvesting what previous decision makers and employees have done – without engaging in the company’s innovation for the future, its processes and customers – should not receive a bonus even if the company is making a profit.

/Nils-Göran Olve and Carl-Johan Petri

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We wrote the above article two years ago, in the time of a falling economy. Since then, many companies have changed CEOs as a result of bad financial performance. It is interesting to note, that in many of these companies the new CEOs have been compensated heavily for the fast turn around they have been able to show. But, we can not but wonder, if it is the new CEOs who have – in some cases in less than 12 months – been able to develop new successful products, increase the internal efficiency and reach out to new customer segments, or if this is not rather a result of their predecessors’ hard but unrewarding work. Predecessors who should have deserved appreciation for their strategy realising efforts.






MAKING SCORECARDS ACTIONABLE NEWSLETTER is a bi-monthly update on our experiences and opinions on how scorecards and strategy maps can be made actionable – to help organisations realise their intended business strategies. The newsletter is compiled and distributed for free by the authors of the book “Making Scorecards Actionable – Balancing Strategy and Control”. Also make sure to check out www.makingscorecardsactionable.com to get up to date information about our seminars, to evaluate your organisation’s BSC skills according to our computerised BSC Analyser and to download presentations from the document archive.
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