|
|
Saturday, 20th April 2024 |
| Identifying an integrated set of value drivers and linking them to reward |
Back |
Catherine Ryan and GearĂłid Deegan highlight why an organisation
must use integrated tools, like the balanced scorecard, to sustain growth
and set executive reward policies. |
Our previous article “Building a Value-Based Executive Incentive Programme” (Finance, September 1999) outlined a specific process whereby executives were rewarded for creating value. This second article develops the thinking around identifying and operationalising the value drivers and measures within a value-based incentive programme by using a balanced scorecard technique.
When we touched on operationalising the strategy we hinted that an organisation’s value drivers may not be purely financial; so what actually constitutes the wider drivers of value?
Organisations, the investment community and employees are recognising that traditional financial measures are historic and used alone cannot be indicative of an organisation’s future health or value. In addition, they are realising that once organisational performance has been achieved it has to be sustained and also capability has to be developed to ensure long-term, value creation. It is now acknowledged that long-term performance capability will come from an organisation’s business processes, its customers and its ability to innovate and develop its products, services and staff. As a result, organisations are adopting a balanced approach to corporate performance by incorporating measures across each of four corporate perspectives. (See figure 1 below).
Selecting the measures that impact company performance within each of the different perspectives varies according to each organisationĂs sector, current environment and specific strategy. In addition, whereas the financial measures will generally be set at corporate level, the other measures will be set at business unit or even functional level.
When identifying the measures that effect each of the corporate perspectives, it is often advisable to look at an organisation’s value chain and derive the measures from this - to drive financial results all components of the value chain need to be working effectively. Typically an organisation will have 8-10 broad processes that need to occur for it to perform successfully and achieve strategy. In the high-tech telecoms sector this will start with product research and design; in an insurance organisation it will start with service definition. Essentially each of the processes will have several measures driving it. Not all of these will be monitored by the same people or departments; some will be operational, some will reflect strategy and a minority will effect shareholder value. But how do these seemingly disparate measures effect financial performance and value creation? (See figure 2 opposite).
Firstly, focusing on measures that ultimately impact future financial performance enables an organisation to anticipate or correct shortcomings and so make timely adjustments. In addition, even though a measure may be derived from one perspective it may well effect all the other perspectives. For example in the insurance organisation, if improving customer satisfaction is a measure from the customer perspective it can end up impacting the other perspectives as follows:
• Call handling efficiency - internal/business process perspective
• Repeat business - financial perspective
• Nature of complaints - innovation and learning perspective
In the high-tech, telecoms organisation product innovation effects the other perspectives as follows:
• Market expansion and new sources of revenue - financial perspective
• Continuous improvement in product development - innovation and learning perspective
• Staff training and development plus motivation - staff satisfaction/internal process perspective
In addition to using an integrated approach to determine an organisation’s value drivers and manage performance, the process becomes a powerful tool to bring about other benefits. In terms of performance the benefits are as follows:
• The focus changes from past to current and sustained financial performance.
• The focus becomes a combination of short-, medium- and long-term performance.
• Focus is achieved among different initiatives and seemingly disparate measurement systems.
• Focus changes from purely relative benchmarking to absolute outputs.
In terms of decision making the benefits are as follows:
• Consistent and comprehensive decisions can be made as it becomes straightforward to identify how a decision in one area impacts performance within the other perspectives.
• Executive management can determine how effectively company strategy is being implemented at functional and operational level and identify blockages or necessary changes.
• Vertical and horizontal integration of company performance is achieved. Vertically each measure can be broken into into components to see where and if the components impact strategy. Used horizontally, it becomes easy to see where a change to product development can impact learning and development and customer perspectives.
For communication and ownership the benefits are as follows:
• Strategy becomes operationalised and driven down to the business units.
• It offers heightened visibility and transparency to different business initiatives.
• It is a clear and concise communication tool.
• it is a powerful change driver as the impact of operating changes on other areas becomes clear.
• it creates ownership for the organisation’s activities at all levels.
• it provides a broad perspective to division managers as focusing on
outputs enables business unit and functional managers to understand
their strategy, industry and its
forces.
In addition, the balanced scorecard approach to creating and driving value is a platform for variable reward programmes.
The link between the balanced scorecard and reward
From a performance management perspective, the appeal of the balanced scorecard is the reduced dependence on purely financial measures, which are not always directly linked to all employees or divisions. As a result, variable pay, both short- and long-term incentives, for all levels can be linked to the performance outputs within the different perspectives.
Linking reward to the balanced scorecard outputs is also an organisation specific decision. Some organisations will use short-term incentives as a tool for rewarding the achievement of the balanced scorecard objectives. Other organisations will use it to provide a link to executive long-term incentive programmes by examining measurements over a three-year period to see where, how and if they surpassed results from the previous three-year cycle. Yet other organisations integrate all employee long-term incentives with the scorecard.
In organisations that use short-term incentives as a tool for rewarding the achievement of balanced scorecard objectives, an element of the total short-term reward can be impacted by performance in each perspective. In such situations the impacts on the pool available for reward are often as follows:
• Financial perspective drives 40% of the scorecard-related compensation
• Operational perspective drives 20% of the scorecard-related compensation
• Customer perspective drives 20% of the scorecard-related compensation
• Learning and innovation drives 20% of the scorecard-related compensation
These weightings are only guidelines and will be impacted by the issues facing the organisation or business unit, the extent to which a group of employs can effect different perspectives and the inter-relationship between the different business processes.
In conclusion, the balanced scorecard provides an organisation with an integrated tool for evaluating its performance and linking pay to short- and long-term value creation. It does this by enabling an organisation to acknowledge that financial performance, focus on the customer, learning and innovation and operational processes.
GearĂłid Deegan is a partner and Catherine Ryan is an associate with PricewaterhouseCoopers global human resources team |
|
| Article appeared in the November 1999 issue.
|
|
|
