Is your company focused on the right priorities? How do you know?
Companies measure performance not only to learn where they’ve been, but also to figure out where they’re going. Since scarce resources often require setting priorities — doing more of one thing at the expense of doing less of another — knowing where improvement efforts are going to yield the greatest returns is critical to getting the most out of a given investment.
For example, when it comes to driving shareholder value, there are two fundamental components of cash flow: profitability and growth. Should you invest equally in both? If not, which of these two should get the nod? Should you focus on getting costs under control or expanding into a new geography? Should you invest in differentiation to command premium prices or work to secure more customers, even at lower margins?
Without a rigorous understanding of how you’re doing on each dimension, you risk focusing on the wrong things: You can end up trying to improve a measure that is already at the upper bound of what is reasonable or ignoring the low-hanging fruit that could make a real difference.
When setting priorities it is helpful to distinguish between absolute and relative performance. Absolute performance sets the minimum requirements — are you in the red or black, are you growing or contracting? Relative performance, expressed in percentile rankings, tells you where you have the most room for improvement and sets an upper bound on what is reasonable for you, given how well you’re already performing in comparison with other companies. (For more on assessing relative performance, see our earlier online article.)
How well or poorly companies are doing on absolute and relative performance says a great deal about where they are likeliest to achieve significant improvement.
Consider this chart, an analysis of the growth performance of U.S.-based, publicly traded companies. Start with companies in the upper left, those with positive absolute growth rates. Many appear to be doing quite well; some even show double-digit growth. The natural conclusion might be that these companies have no room left for improvement. Based on absolute figures alone, priorities for performance improvement are likely to be elsewhere; on the growth front, they’ve got it covered.
Yet when we augment the performance picture with relative standings, it becomes evident that many of these companies may still have significant opportunities for improvement. With growth rates that are below the median for their circumstances, these companies may have a great deal of growth headroom, if only they could see it. Their strong absolute results may be blinding them to the significant upside.
Note: Relative-performance numbers are based on the method described here. Percentages are the proportion of the total.
The challenge may be even greater for companies with the opposite performance profile, those in the lower right. Faced with flat or declining growth, they face the seemingly obvious task of focusing strongly on improving the top line. After all, in the face of such apparently poor results, their managers probably assume that significant improvement is largely a question of effort.
Not necessarily. Our analysis of relative performance suggests that some of these companies are already approaching the limits of what is feasible, given the structural constraints they face. For example, for companies in slow-growing industries, low or even negative growth might place them in the top quartile of relative performance. In other words, the mountain might be low, but they are already at or near the peak. Here, performance-improvement efforts risk mimicking Sisyphus, pushing his boulder uphill only to have it inevitably roll back down. An analysis of relative performance suggests that within their industries, absolute gains are unlikely.
The situations for companies in the remaining two cells are more straightforward. For those with low absolute and relative performance, the message is clear: All hands on deck. There is a need to improve in absolute terms, and there is plenty of headroom in relative terms.
Among those in the enviable position of having high performance in both absolute and relative terms, the challenge is to stay the course. This requires vigilance against complacency, but also the courage to resist the urge to “climb past the summit.” At the highest levels of relative performance, dramatic improvements are unlikely, and major growth initiatives are likely to fall short of expectations; they could even prove to be dangerous distractions from the important work of sustaining already-high levels of performance.
By extending this analysis of growth to other measures of performance — say, profitability — companies can begin to think more objectively about how they should set their performance-improvement priorities. Take, for example, a company with a 5% return on assets (ROA) and a 12% growth rate. Which should it seek to improve, and with what emphasis?
By translating those absolute performance measures into relative percentile ranks, companies can compare radically different dimensions of performance on a like-to-like basis. A 5% ROA might translate to the 85th percentile, while 12% growth lies at just the 50th. This suggests that there is more room to improve growth than there is to improve profitability — even as an unadjusted analysis of absolute measures suggests the opposite.
The implications of this sort of finding can be profound. For many companies, the initiatives most likely to drive growth — new-product introductions, geographic expansion, mergers and acquisitions — can look very different from profitability-driving initiatives such as R&D and improving operations and customer loyalty. And since you can spend a dollar — or an hour of executive time — only once, the choice of which path to pursue can have a significant and lasting impact on a company’s fortunes.
In our work with the C-suite executives of large, publicly traded companies we have found that a statistically valid analysis of relative figures often points in a surprising direction, even if the companies have been benchmarking by their industry peer groups.
You can apply our analysis of relative performance to your own company using our interactive tool. You might be surprised to learn that your low growth rate is actually quite respectable, given your company’s industry and size. Or you could learn that your double-digit ROA is merely middle-of-the-road. Similarly, you might find that there is more, or less, headroom available to you on the profitability front.
Either way, we believe that this additional perspective on your company’s performance will prove a valuable input in determining where you should focus your performance-improvement efforts.Go to Source