Video"Language is a city to the building of which every human being brought a stone." —Mark Twain
Growing numbers of organizations — including banks on both sides of the Atlantic, a global natural-resources group, and a leading U.K. retailer — are adding an important new "stone" to the 21st-century business lexicon. "Performance and health" is a metaphor that derives its power from a simple comparison with the human body. Just as people may seem reasonably well today but may not have the physical condition for the rigors of a long and active life, so too companies that are profitable in the short term may not have what it takes to perform well year after year.
Managing companies for success across a range of time frames — a requisite for achieving both performance and health — is one of the toughest challenges in business. Recently, it has been especially hard: turbulent economic conditions, for example, have concentrated the collective minds of many executives on pure survival. The fact that 10 of the largest 15 bankruptcies in history have occurred since 2001 is a strong deterrent to business building, playing up its inherent risks.
Businesses complain that financial markets increasingly focus on quarterly results and give little credit to strategies for creating longer-term value, particularly if they depress today's profits. Empirical evidence largely contradicts such claims (see "The Stock Market Values Health as well as Performance," at the end of this article). But some noisy analysts undoubtedly do focus on short-term performance and thus unwittingly drive wedges between managements, boards, and investors.
Management teams must urgently take the lead in showing their boards and the capital markets that they are nurturing the long-term health of their companies. They must act not only to improve corporate performance in the near term but also to lay the foundations today for consistent and resilient growth in years to come.
Companies out of Balance
Tools intended to encourage a more balanced approach and to promote "systems thinking" have been available to managers for some time. But our experience suggests that these tools are either being applied too mechanically (and therefore ineffectively) or being squeezed out by the focus on survival and by perceived pressure from investors. And that's to say nothing of the increased near-term demands created by new regulations on financial reporting, particularly in the United States.
Good short-term results are important, of course; only by delivering them will management build confidence in its ability to realize longer-term strategies. But companies must also act today to ensure that they can convert their growth prospects, capabilities, relationships, and assets into future cash flows.
One major European financial-services company recently discovered how easy it is for performance and health to get out of balance. After the company had achieved an impressive turnaround in its short-term financial performance in the three years to 2004, it found to its dismay that this success had been accompanied by falling customer service levels, a huge increase in staff turnover, and a fall in its share price. Management complained that the financial markets didn't understand what the company had achieved. But in reality they understood, all too well, that its short-term success had been purchased at the expense of its underlying health.
Such shortsighted behavior is widespread. In one recent survey, (John R. Graham, Campbell R. Harvey, and Shivaram Rajgopal, "The Economic Implications of Corporate Financial Reporting," NBER working paper number 10550, January 11, 2005), a majority of the managers polled said that they would forgo an investment offering a decent return on capital if it meant missing their quarterly earnings expectations. Indeed, more than 80 percent of the executives responding said they would cut expenditures on R&D and marketing to ensure that they met their quarterly earnings targets — even if they believed that the cuts were destroying long-term value.
This survey shows that even if more organizations are now talking the language of health, many address the issues only at a superficial level. For instance, "scorecards" — a favorite approach of many companies to balancing near- and long-term considerations — too often consist of disconnected metrics that confuse the organization and lack any real impact. One public-sector agency we know — an extreme case, to be sure — came up with 96 key performance indicators at the end of a two-year initiative; the list was effectively dead on arrival when it was rolled out for implementation. The chief executive of an international bank was recently shocked to find that members of his senior-management team were responding only to revenue targets and deliberately ignoring broader metrics of performance and health.
What underlies the breakdown of many long-term initiatives is the tendency of managers to defend the performance of their own silos instead of debating and helping to shape action across the whole organization. In silo-structured companies, managers typically argue about the virtues of one metric as opposed to another (especially if transfer prices are involved), deflect debate to other parts of the organization, and set up barriers to change. This kind of behavior isn't deliberately malevolent; it is driven by deeply held beliefs about a manager's roles and boundaries and reinforced by the idea that the body corporate is the sum of many discrete units, each with independent characteristics, that should be monitored with a battery of metrics. Unfortunately, this mind-set undermines any systemic understanding of how to manage activities coherently, across the whole organization, to underpin healthy growth.
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