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Performance Management: Making It Work:
Can Performance Management Accomplish What Einstein Could Not?

online columnist Gary Cokins     Column published in DMReview.com
June 30, 2005
 
  By Gary Cokins

This is the one hundredth anniversary of the amazing year when Albert Einstein, then only a 26-year-old patent clerk in Austria, published four profound research papers. In one paper he arrived at his famous E = MC2 equation; and for another on his explanation of the photoelectric effect, he was subsequently awarded the Nobel Prize in physics. Despite these early successes, Einstein spent the rest of his life working but ultimately failing to solve what physicists refer to as the Grand Unified Theory which reconciles the four fundamental physical forces of nature: gravity, electro-magnetism, the strong nuclear force that holds nucleons together in the atomic nucleus and the weak nuclear force commonly seen in beta decay and the associated radioactivity.

Likewise, performance management in commercial organizations has its own huge intellectual challenge - to reconcile customer value improvement with shareholder value creation. (Performance management in public sector organizations presents different challenges which I will address in a future column).

Quantum Mechanics Physics and Performance Management

Einstein's contribution to knowledge was to advance the already great work of arguably the greatest physicist who preceded him, Isaac Newton. Einstein refined Newtonian principles by theorizing that space, time and mass are interrelated - his famous theory of relativity. His work dealt with the large-scale behavior of the universe.

Meanwhile, other physicists such as Neils Bohr and Edward Schrodinger were researching the other extreme of scale: sub-atomic physics. At this micro level, physicists examining quantum mechanics theorized and subsequently proved mind-boggling phenomena in our physical world, including the theory that mass could be simultaneously both a particle and a wave. The theoretical equations of quantum mechanics physicists were proven valid by applied physicists using powerful particle-accelerating atom smashers.

The problem, however, is that physicists have yet to reconcile the equations of quantum mechanics at the micro level with the Einsteinian equations at the macro level - yet the properties they both describe are part of one seamless, physical universe. Physicists are still working to make the equations converge and mesh.

What the heck does this have to do with performance management? In business there is a comparable perplexing problem in reconciling customer value with shareholder value creation. Value is an ambiguous, relative term. Hypothetically, suppliers can increase customer satisfaction (value perceived by the customer) by providing additional product features and service offerings, but if they do not raise prices, increase their market share or grow the market, then they may have increased value to their existing customers, but they will have destroyed their shareholders' wealth.

Value according to finance. The capital markets apply economic value equations based on free cash flow that are based on decomposition tree modeling of future revenue and expense streams. Financial analysts working for the CFO attend conferences learning about economic value management with complex equations that ultimately divide projected future period net operating profit after tax (NOPAT) in the numerator by risk-adjusted weighted average cost of capital from equity and loan financing in the denominator. Today's Einsteins of finance's macro world seeking a proverbial single economic equation to answer this question: "What is the return on investment - the ROI?"

Value according to sales, marketing and customer service. Meanwhile, analysts in sales, marketing and customer service examining customer relationship management (CRM) are playing around with equations that measure customer lifetime value - treating each customer (or more manageable customer segment groupings) as if they were an investment in a portfolio. In other words, they measure value today vs. tomorrow or ten years from now to develop the appropriate customer strategy. These are the "quantum mechanics physicists" of finance's micro world.   

Which is the Dependent and Independent Variable - Customers or Shareholders?

The book Angel Customers & Demon Customers1 by Larry Selden and Geoffrey Colvin is sub-titled "Discover Which is Which and Turbo-Charge Your Stock (Price)." The simple idea is that companies can no longer just strive to simply grow sales, but rather they must grow sales ... profitably. Companies are realizing two connected factors related to customer economic value. If they could accurately measure the current profit contribution from their different types of existing customers - a calculation surprising in its tendency to range widely based on the product mix of what customers buy plus their cost-to-serve maintenance level - and reliably predict and calculate the potential long-term stream of revenues and expenses from existing customers, then companies would view existing customers with an additional factor - a financial one. Then they could be segmented for differentiated service-level treatment strategies (including support, self-service, loyalty and retention programs) and targeted more appropriately for up-sell and cross-sell opportunities. They would also be more prudent about which new types of customers to acquire via their marketing.

The pressure is on to increase value to customers. It is more expensive to acquire a new customer than to retain an existing one. Also, as products and standard service lines become commodity-like, thus neutralizing any competitive advantage from them, then suppliers must shift to differentiation of value-added services to customers. But since different types of both existing and new customers will yield differing long-term financial returns, then differentiated treatment levels are required to gain profit lift. It will be essential to have the analytical tools, such as for customer segmentation, forecasting and activity-based costing for calculating customer value, reducing internal debates and making trade-off decisions. 

The broader question regarding the reconciliation of customer value with shareholder value appears to me to start with customers, and the rate of shareholder wealth creation results as the derivative. However the realization of shareholder value creation will be executed by the interdependent component methodologies of performance management.

The Data and Math Exist - What is Needed is the Thinking

Einstein did not witness the completion of the Grand Unified Theory of physics, but I expect to see the unification of customer and shareholder economic value creation in my lifetime. The business intelligence tools, computing power and analytical talent in companies exist today. All that is left to do is to create the modeling algorithms and to establish more collaboration between finance and customer-centric lines of business. Getting to the numbers - the overall value - is in the best interest of all involved.

John Nash, the great Princeton University mathematician and Nobel Prize winner profiled in the Academy Award-winning movie A Beautiful Mind, researched how rational people behave when faced with conflicts. He said:

"I like numbers because with numbers, truth and beauty are the same thing. You know you are getting somewhere when the equations start looking beautiful. And you know that the numbers are taking you closer to the secret of how things are."

It is inevitable that a company's executive team will navigate shareholder wealth creation based on facts, not hunches and intuition. And performance management will provide the vehicle for doing it.

References:

1. Selden, Larry and Colvin, Geoffrey. Angel Customers & Demon Customers. New York City: Penguin Group, 2003.

 

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For more information on related topics visit the following related portals...
Corporate Performance Management (CPM).

Gary Cokins is a strategist for SAS, a market leader in data management, business intelligence and analytical software. He is an internationally recognized expert, speaker and author on advanced cost management and performance improvement systems. He is the author of five books, An ABC Manager's Primer, Activity-Based Cost Management: Making It Work, Activity-Based Cost Management: An Executive's Guide (Wiley), Activity-Based Cost Management in Government and his latest work, Performance Management: Finding the Missing Pieces to Close the Intelligence Gap (Wiley). You can contact him at gary.cokins@sas.com.



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