Using Metrics

I wrote this newsletter for BoardGrowth, a governing board oriented site, but felt it had valuable information for anyone working to assess the health of an organization through using metrics. Therefore, I offer it to our blog readers as well.

Hard data vs. stories

Those of you with whom I have worked know that I am a strong advocate for basing your decisions and assessment of the condition of the organization on hard data vs. stories, rumors, gut feelings. The two mistakes you can make are not seeing that you are in trouble and need to take action, and falsely judging that you are in trouble and taking action when you should leave well enough alone.

Years ago I read a book entitled Breaking the Bank, by Gary Hector, that told the story of the near collapse of the Bank of America (at the time it’s assets were equal to that of the sixth largest country on the planet). The bank was leaking profits big time in its South American operations. Despite a board consisting of the best and brightest, the board took six years to act on the problem, resulting in the near collapse of the bank.

For years, management, including a series of CEOs, would offer a plan for turning things around only to find that the strategies did not work.  The board never got to an understanding of the root causes and then to a plan of action to address them.

I see boards struggle with this.  Their CEOs have done well in the past, and directors don’t want to offend or communicate distrust, so they ride their trust line too long.  So, what to do?

Define vital statistics

Whether a for-profit or a non-profit entity, we recommend you work with management to develop a set of vital statistics or metrics that tell you the condition of the organization at any one time.  The data you select should be gathered and displayed monthly as trend data (a run chart).

In some cases you will want the data to go up (e.g. revenue) and in some cases down (overhead per unit of production).  The metrics you select will be unique for your organization based on your vision, characteristics that separate you from your competitors and vital systems that drive performance.

A normal condition would be slightly favorable statistics each month.  Any condition other than that should prompt inquiry from the board as to why.  Did the metric go up faster than in the past? Why? You may want to do more of whatever that is. Did it decline? What was the cause ?  Ultimately you will want a solution to that problem.

What’s the approach?

It’s hard to know what the B of A board failed to do, but here is my take on what should happen in the boardroom:

• Upon seeing the first unfavorable data point, inquire of management as to their take on the cause and whether anything should be done about it.  If the answer and proposed action/inaction make sense to you, go with it.  If not, ask for more data or whatever action is appropriate.
• Upon seeing the second straight unfavorable data point, ask the same questions, but be a bit more aggressive in getting to certainty that the organization understands the true “why” that explains what is occurring. Depending upon the importance of the metric and the slope of the decline, you may wish to initiate an independent investigation as to what is occurring. This would be the case after two negative data points in a row in only the severest cases.

An overreaction is what you are wanting to avoid here. It may be that you are experiencing normal down-trend cycles like a yearly seasonal downturn in revenue, unusually high expenses that occur at this time every year, bad weather impacts, etc.  In such cases, taking an action like cutting the marketing budget or lowering production could prove disastrous. You have to determine whether you are experiencing a normal, cyclical change or a structural change. A structural change  will not reverse itself, e.g.computers replacing typewriters or on-line shopping impacting retail.

• Three negative data points in a row indicate a likely structural change. At this point, some action is going to be required. In all likelihood, the trend is not going to reverse itself, and you need to take action based on what is the new operating condition or market reality.

A common mistake that I see is a board governing based on projections without understanding what is behind those projections. Boards need to be aware of the assumptions behind a projection and their validity. That will be the subject of next month’s newsletter. For now, be sure you have metrics in place that will give you a heads up when conditions may be changing.

Drivers, not results

One more point, month end financial statements are not the metrics we are referring to here. They reflect the results of work already done, decisions already made. The metrics for what we are discussing are those that reveal what is happening to the drivers of the numbers on financial statements – sales efforts, product quality, customer service. W. Edwards Deming once said that running your business looking only at results is like driving your car using only the rear view mirror. Financial statements tell you what has happened, but are not a predictor of the future. Acting on them alone can be hazardous, as the data often comes to you too late to take appropriate corrective action.

Are you interested in creating a set of metrics for your organization and/or board? We enjoy digging into the numbers with our clients to help them create the measures that matter in their ultimate decision making. We call it an Instrument Panel. If you would like assistance in putting together an Instrument Panel for your organization or learning how to use measures to evaluate your organization’s current status, e-mail us. We would be happy to help.