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Assessing theEffectiveness ofOrganisations:

Is your CompanySuccessful?

6 July 2006 Kent House, Knightsbridge

post meeting notesPerformance & Reward Centre

CountyMark House 50 Regent Street

London W1B 5RDTel: +44 (0)20 7432 4565

Fax: +44 (0)20 7470 7112E-mail: [email protected]

Web: www.parcentre.com

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Copyright © 2006 PARC Ltd. All rights reserved.Published by PARC Ltd CountyMark House, 50 Regent St, London W1B 5RD, UK Telephone +44 (0)20 7432 4565

Apart from any fair dealing for the purposes of research, private study, criticism or review, as permitted under theCopyright, Designs and Patents Act 1988, this publication may only be reproduced, stored or transmitted, in any form

or by any means, with the prior permission in writing of the publishers. Enquiries concerning reproduction outsidethese terms should be sent to the publishers at the above address.

Assessing the Effectiveness of Organisations: Is yourCompany Successful? - Thursday 6th July 2006 - MG v2

PresenterSir Andrew Likierman is Professor of Management Practice at the London BusinessSchool (LBS), non-executive Director of the Bank of England, Barclays Bank plc andthe Tavistock and Portman NHS Trust. His previous posts at LBS have includedDeputy Principal of Accounting and Financial Control. He is currently researching,lecturing and consulting on how organisations can improve their choice and use ofperformance measures.

Sir Andrew previously worked in both public and private sectors. In the private sectorhe ran a textile plant in Germany and was Managing Director of the overseas divisionof Qualitex Ltd. He also started and then sold his own business selling businessbooks. He has been non-executive Chairman of the Economists' Bookshops Groupand of MORI Ltd. In the public sector he was a Member of the Cabinet Office CentralPolicy Review Staff (the "Think Tank") and recently completed a ten year period asone of the Managing Directors of the UK Treasury. In his professional capacity,Andrew is a past president of the Chartered Institute of Management Accountants andhas been a member of a number of official enquiries, including the "CadburyCommittee" on corporate governance. He has written three books and over 150articles."

Contents

Introduction 3

What does "success" look like? 3

TSR - "the indicator to beat" 4

Checklist exercise 5

Contents

Contents continued...

Implications for HR 6

HR: facing up to the analysts? 7

Measuring human capital 7

Measurement v assessment 8

Conclusion 10

Footnotes 11

Forthcoming events 11

Appendix 1 12

Appendix 2 17

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Assessing the Effectiveness of Organisations:Is your Company Successful?

IntroductionAccording to Professor Sir Andrew Likierman who led this Masterclass, "measures oforganisational success are primitive" and views vary between different interest groupson how to define "success". He also argued that lack of robustness and coherencehere gives HR an opportunity to define its own role in determining what constitutessuccess for the organisation and so influence assessments of business value.

This paper discusses these interrelated issues, drawing on Professor Likierman'sanalysis and the experience of PARC members on what his ideas really mean for HRprofessionals.

What does "success" look like?The underlying presumption when seeking to define success, Professor Likiermansays, is that the organisation knows what success looks like through clearly definedobjectives which are shared and accepted by shareholders. This is not always thecase however. In some instances, objectives are not clear; while in others the viewsof the management and the expectations of the market differ - leading to volatility inthe share price and overall market value.

He suggests that a useful starting point for defining organisational success is to askourselves what it really looks like. Criteria such as size, as expressed through marketcapitalisation1, provide a headline guide; while rankings based on whether theorganisation is admired by others2 are purely subjective "feel good" indicators andhave no real substance. Notions of "excellence" do not help determine what successlooks like either. Some of these derive from the organisation having robust supportsystems. Others stem from the fact that an organisation has a charismatic leaderwhose strong characteristics have captured the imagination - but with no evidencethat such attributes have actually enhanced organisational performance. In fact , overtime, they may well have detracted from success.

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TSR - "the indicator to beat"For Professor Likierman, the total shareholder return (TSR) model provides the mostrobust measure of success. It distinguishes itself from other models, based on abroader range of stakeholders (including employees and Society as a whole) or amanagement model (which is exclusively company focussed) simply because TSRconstitutes "the ultimate signal in a market economy".

However, TSR is not a perfect tool because of a number of interrelated factors i.e.:

• "Success" is relative - it depends not just on how well the organisation are doing, but on howcompetitors are performing;

• It also depends on the organisation's ability to identify and compare itself with genuine comparatorsi.e. organisations with broadly similar business models. This is not always easy because a truecompetitor may not exist (as in the case of Microsoft) or the basis of comparability may have changedover time (which, say, makes comparisons between Coca Cola and Pepsi Cola difficult today becauseof moves into different product ranges);

• Past performance is not an indicator of future success. One member commented, "using TSR is likedriving by looking in your rear view mirror". In fact, Professor Likierman argues, there may well be aninverse correlation between past and future success, insofar as, it is often easier to perform betterfollowing a bad year.

• Markets do not reflect current value accurately because of lags between when a managementdecision is made and when it impacts on the profitability of the organisation. Thus, it can be arguedthat today's management is benefiting (or indeed suffering from) the decisions made by itspredecessors. This makes paying for performance problematic.

• The robustness of targets and plans and, in particular, whether management is able objectively toassess its own performance against them is open to question. This is because of our "repeatedcapacity to rewrite history and justify why things went differently than we thought they would at thetime plans were drafted";

• Our perceptions about the opportunities for the organisation at any point in time are usually unclearbecause, regardless of the quality of our intelligence and ability to interpret what may be, perfectknowledge of the future is not achievable. Aero engine manufacturers, Pratt & Whitney, provide oneexample here. In 1973 it decided that it was too risky to make engines for the new Boeing 737. As aconsequence of this decision, this company gradually lost its dominant market position to Rolls-Royce. A further example of an unseen opportunity is provided by the enormous growth anddominance of the internet in our lives. It is hard to conceive that 1991 was the first time any messagewas sent using the world wide web3.

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• Different perceptions of risks and their likelihood of occurring as defined by management andanalysts also play a part here. According to Professor Likierman, in most cases managers are morecautious than analysts in these assessments. This is because managers will usually focus onhistorical performance as a guide for the future, whereas analysts will look more at opportunities.

Professor Likierman suggested that seeking to determine whether a company is"resilient" might provide a useful measure of success. He defined this notion as "theability to dynamically reinvent business models and strategies as circumstanceschange". This is the subject of a new research project he is undertaking withProfessor Gary Hamel at LBS. PARC will follow this work as results unfold. He alsopointed to use of Price/Earnings (PE) ratios and BETA volatility as solid indicatorsrespectively of how the organisation is performing in relation to the sector and howvolatile shares are in the market. He did not, however, explain specifically how HRprofessionals could make practical use of such knowledge in the way they plan ordevelop policies, processes and procedures. TSR will be explored further at theOctober PARC meeting when we will discuss "What Works in Executive Incentives?”

Checklist exerciseProfessor Likierman ended his Masterclass by asking delegates, working in groups,to assess the success of a particular organisation against a range of criteria, underthe following broad headings:

• Success for whom?

• Time frame for success

• Type of measure?

• Comparisons

• Risks

The full checklist is given in Appendix 1.

Each group selected one company to assess. These companies were Royal Mail,Serco, Sainsbury's, Gallagher and BT. Two broad conclusions emerged from thesediscussions:

• Different success criteria apply to different organisations e.g. the perceived influence of risk for the

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Royal Mail, a nationalised organisation, vis-à-vis competitors and the wider market was much lowerthan among the commercial private organisations selected.

• Overall assessments seem to have been made on "gut feel", or as Professor Likierman put it: "Itseems to me that there is little connection between how groups scored against the ["analytical"]checklist and what they actually felt about the company". This, he observed, "was not untypical ofthe way analysts behave"!

Implications for HRTwo broad issues were raised here by Professor Likierman and discussed byparticipants i.e.:

• The opportunities created by the above analysis for HR; and

• The effectiveness of HR based metrics as evaluators and predictors of organisational success.

Professor Likierman believes that this analysis, coupled with his discussions withsenior managers and analysts, suggest that improved assessments of success couldbe achieved through greater involvement of HR professionals in the process,specifically because of his view that analysts focus on "sustainability of companyprofit based on quality of management". It must be said that this view came as asurprise to some PARC members whose organisations have witnessed sudden fallsin overall share value because of short-term assessments of a company's viability byanalysts. As Paul Willaims from Smith & Nephew said: "My experience is that analystsare only interested in the short-term. They want to know about the age of the CEO,how charismatic he is and whether there is a succession plan in place." ProfessorLikierman clearly did not share this view. Speaking later on, in response from aquestion by Vicky Wright of Watson Wyatt, about the impact of time scales onsuccess, he said: "Let's take an extreme view and assume that all of a company'sshareholding is dominated by a hedge fund. Does this really mean that they wouldsimply have a one month time frame when focusing on shareholder value? Surely not.Their view is similar to that of management. They want a sustainable businessbecause they want the ability too sell shares on to another buyer at a profit."

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HR: facing up to the analysts?However, Professor Likierman's thesis bears further investigation because HR shouldbe in a strong position to assess the quality of management in depth. There are, wesuggest, some doubts about the practicalities of HR engaging with analysts in thisway. In reality, an HR Director will only have access to the City through a ChiefExecutive or Chairman who would clearly want to vet any comments before they weremade. They would be rightly concerned about market perceptions of credibility basedon glowing assessments of the management team - as well as such assessmentsencouraging competitors to poach key talent. On the other hand, they would also beconcerned about the potentially negative impact of any management assessmentswhich were "nuanced" in some way. We would argue that a nuanced evaluation willmore often be the case in practice, especially where an intelligent analyst asks: "Canyou demonstrate how the management team could have been more successful todate?" As David Lincoln from PARC noted: "We need to be able to quantify andvalidate assessment of influential factors when talking to analysts." In summary, wedo not believe that direct interaction between the HR Director and the City isnecessarily a positive development. This is because it opens up a range of risks forthe organisation and the individual HR professional.

Measuring human capitalProfessor Likierman also argues that while "intangibles" i.e. the value of people are amajor exclusion in conventional accounting, he does not believe that current efforts tomeasure the value of human capital will work because of the level of complexity.

This view is of interest to PARC members because it raises two important questions:

• How valid are current approaches to measurement?

• To what extent does it matter if we cannot measure accurately?

There are a wide range of current approaches to measurement, some of which need,in our view, to be applied with caution. Take for example the Watson Wyatt HumanCapital Index (HCI) which purports to have established a clear link between how anorganisation manages its human capital and its financial performance through itsdevelopment of "a simple set of measures quantifying exactly which HR practices andpolicies have the greatest correlation"4. This tool is based on Tobin's Q, whose ratio

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is calculated as the market value of a company divided by the replacement value ofthe firm's assets. This is not an easy concept to grasp. Furthermore, in ourexperience, some, if not most, of the respondents to HCI surveys are HRprofessionals assessing themselves. This can hardly be seen as an independent ormeaningful measure. Further, the question of cause and effect is not established i.e.has shareholder value increased because of the contribution of human capital, or isthe reverse true? HCI does not tell us.

The PARC view is that simplicity in measurement is the key and that any measuresused should be clearly focused on valuing people in the business as a whole, not theHR function. Furthermore, as Professor Likierman argued, measures can only beeffective if there is clarity about what the organisation's objectives are because thereneeds to be a clear line of sight between the objectives and the system ofmeasurement.

Measurement v assessmentThe problem, and the challenge, for HR, is that the concept of measurement as suchseeks to impose a set of tangible, concrete indicators on what is essentially intangible- such as, the quality of people, their past behaviours and their potential performance.Our view is that this difficulty does not mean that we should stop trying to developmetrics which are at least indicative of changes in performance on a range of frontsso that we can assess and evaluate (rather than measure) how people contribute tothe organisation and whether the trend is positive or negative.

Some of these indicators will clearly be based in subjective notions, such asimprovements in "behaviours that support objectives", but if they are evidence basedby being linked to the delivery of individual targets, the contribution of the individualcan be assessed. Indeed, there is every reason to assume that by examining trendsin a range of such indicators over time, it should be possible to demonstrate a linkbetween what individuals do and how the organisation performs - on theunderstanding that such information provides a guide to performance and contributionrather than a fully fledged analytical tool.

We believe that such assessment tools do exist and are widely used. They arereflected to an extent in the Sears' Employee Customer Profit Chain5, the EFQMexcellence mode6 and the Balanced Scorecard7.

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Genuine 360 degree feedback also has a role to play here. It includes input fromexternal stakeholders, such as customers and not just subordinates peers and linemanagers. We acknowledge that this is not a perfect tool because, for instance it saysas much about how respondents see the world as it does about how the individualhas actually performed. However, such bias can be reduced by increasing samplesize beyond just a few individuals. Other "soft" metrics include staff attitude surveys,customer and supplier focus group outputs and assessments from cross functional"fish bowl" group exercises. There are some "harder" metrics too, including statisticson retention of top talent, the organisation's health and safety and diversity records,as well as the number of customer recommendations and complaints. All thisinformation helps the organisation and HR in particular to take a more roundedsnapshot of how people contribute to organisation success and how the organisationis viewed externally. Although this focus may not be sharp, it is preferable to not takingany snaps at all.

The approach adopted by the financial services company RBS provides a pragmaticdemonstration of how a range of measures can be used to assess rather thandefinitively measure how employees contribute towards business results. As theextract below shows, this includes, most notably, income per full time equivalentemployee and results from regular employee opinion surveys.

Linking staff performance to business results: the RBS approach*

“Underlying income per full time equivalent employee has grown from £646,000 in 2004 to £718,000 in2005…

“Feedback from the employee opinion survey showed a significant improvement in engagement andmotivation across Manufacturing, after more than 1,500 people attended workshops on coaching,developing and motivating their teams…

“The Group’s confidential global employee Opinion Survey is externally designed, undertaken andanalysed annually on behalf of the Group by International Survey Research (“ISR”). The surveyenables employees to maximise their contribution to the Group by expressing their views andopinions on a range of key issues. The results from the 2005 survey, which 86% of Group employeescompleted, demonstrated significant improvements for the fifth successive year. This year, for thevery first time, the Group scored above the ISR Global Financial Services Norm in every singlecategory. The survey results are presented at Board, divisional and team levels. Action plans aredeveloped to address any issues identified. With continuing year-on-year improvement, strongdivisional results and improvements in all leading indicators, it is believed that results aresustainable, particularly given the Group’s focus on continuous improvement…

“The Group recognises that staff performance is central to the successful delivery of its overallbusiness strategy. Accordingly, the Group focuses on maintaining an employee proposition thatattracts, engages and retains the best available talent…

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“Utilising a wide range of recruitment channels, including anopen internal jobs market, talent forums and detailedsuccession planning, the Group ensures that therecruitment and development of employees is closelyaligned to organisational requirements…”

* Source: RBS Annual Report and Accounts 2005

In the accompanying box, Mike Haffenden of PARCproposes a list of practical actions for members totake these issues forward. We suggest it is usedalongside the "Thinking Model" (Appendix 2)developed by PARC for member organisationsseeking to introduce new/review existing tools toassess how employee contribute towardsorganisation performance.

ConclusionGiven all these potential tools and the challenges ofapplying them, we would argue that it is best toidentify a few, rather than many, indicators thatsupport the needs of the business. They need to beexplained to the Chief Executive so that heunderstands why they are important through a clearbusiness case that he can then articulate to others.There are some challenging but necessaryquestions HR needs to answer here, including: "IsHR strategy a source of competitive advantage andwhy?"

In the final analysis, organisations are communitiesof people, not balance sheet abstractions, and if weas HR professionals do not seek to evaluate howthose people are contributing to the success of theorganisation, we are surely failing in ourresponsibilities.

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Mike Haffenden's practical action plan forHR to contribute to organisation success

• Work out whether your organisation iscreating value and covering its cost ofcapital;

• Work to ensure that the organisationdevelops clear, well understood objectivesthat are communicated well;

• Ensure cause and effect analysis for allHR initiatives. Those withoutpredetermined outcomes cannot beevaluated;

• Underpin all HR initiatives with a theoreticbase. In particular, ask: why do we reallybelieve something will work? Is theexpectation that the activity will deliver theprojected output based on fact or just "gutfeel"?

• Professor Likierman's caution on lack ofproven efficacy in linking reward toperformance was well meant, but howrealistic is it to abandon entrenchedpractices where large amounts pfinternal politics, self-interest areinvolved?

• Ensure that HR activities ultimatelyunderpin TSR. This may be at asecondary level but businesses thatwant to succeed in the medium termhave superior TSR.

• Beware glib quick fix answers tomeasurement and performancequestions.

• Avoid over-complicating. Manyorganisation problems are relativelystraight forward and while we cannotmeasure the output we know what weare doing is right.


Footnotes1 See for instance FT global 500

2 Most Admired UK Companies in Management Today 12.05

3 See for instance, http://www.zakon.org/robert/internet/timeline/

4 http://www.watsonwyatt.com/research/featured/hci.asp

5 In Harvard Business Review October 1999

6 http://www.efqm.org/

7 In "Balanced Scorecard: Translating Strategy into Action" Robert S. Kaplan, et alHarvard Business School Press 1996

Forthcoming highlights from PARC's 2006/2007Programme include:

• 7 September - The Rising Suns: Business Opportunities & HR Challenges in the Emerging AsianEconomies, David Learmond, Tim Miller, Robert Ward,

• 12 October - What Works in Executive Incentives? John Beadle, Paul Jackson, Paul Williams, Vicky Wright

• Early 2007 - Reinventing Retirement: Conclusion of year-long investigation into the employer's rolein improving savings and retirement options following the pensions crisis."

For information about future PARC events:

Please contact Claire Dyer at PARC, CountyMark House, 50 Regent Street, LondonW1B 5RD, telephone: +44(0)207 432 4565, email: [email protected], website:www.parcentre.com

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Appendix 1: How would we know a company was successful? A checklist

1. Success for whom?

A view is necessary on which model to choose

- A shareholder model, where success is total return to the shareholders (TSR)

- A stakeholder model, success is measured for each stakeholder, including not only shareholders butemployees, customers, suppliers, Society and the Environment.

- A management model, where success is of the company.

2. What time frame?

There are three time dimensions to making an assessment

- The past provides evidence on the company's ability to deliver in the future, including againstobjectives

- The present provides an analysis of how the company is placed to deliver in the future, includingagainst current objectives and budget.

- The future is the relevant period for current choices, both for shareholders (and potentialshareholders) and for the company.

Decisions are needed on

- the weighting between past, present and future

- the number of years, backwards and forwards

3. Which measures?

External include

- market numbers - market capitalisation, share price, dividends, TSR.

- market views - price/earnings ratio, analyst views.

- league tables - Most Admired, Best Place to Work.

Internal include

- financial - profit before tax, EBITDA (Earnings before interest, tax, depreciation and amortisation),profit after tax, profit growth, earnings per share, cash

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- non-financial - number of employees, market share.

Judgements are needed on the relative importance of

- internal and external measures

- non-financial measures.

On profit, judgements are required on which figure and adjustments to use/accept

On share price, a judgement is needed on market efficiency

4. Which comparisons?

A judgement is needed on the relative importance of history, objectives, comparatorsand opportunity

On comparators, a judgement is required on the choice of group

5. What are the risks?

A judgment is needed on the key risks faced by the organization, including the risksof not taking action.

6. What other factors should be taken into account?

There are huge number of other factors which could be taken into account. A sampleis given on page 4 and a judgments are needed on which are most important.

In all of the above, a judgment is necessary on how much weight to give to outsiderswho indicate that they are influential

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Checklist on success factors

One tick per line, a number at the bottom

Influence

High Medium Low

Success for whom (one high only)

Shareholders ______ ______ ______

Other stakeholders ______ ______ ______

Management ______ ______ ______

Time frame for success

Past ______ ______ ______

Number of years ……..

Present ______ ______ ______

Future ______ ______ ______

Number of years ……..

Type of measure

External - market ______ ______ ______

Impact of market efficiency ______ ______ ______

External - other ______ ______ ______

Internal - profit ______ ______ ______

Accuracy of profit ______ ______ ______

Internal - Cash generation ______ ______ ______

Non-financial measures ______ ______ ______

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Influence

High Medium Low

Comparisons

With objectives ______ ______ ______

With industry ______ ______ ______

With wider market ______ ______ ______

Risks

Relative to competitors ______ ______ ______

Relative to wider market ______ ______ ______

Other influential factors (examples on attached page)

___________________________________________________________________

___________________________________________________________________

___________________________________________________________________

___________________________________________________________________

Overall score/10 _________

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Examples of other possible influentialfactors

Market

Beta

Clarity of objectives

Composition of shareholder base

Corporate governance credibility

Growth potential

History of relationship with market

Index movement

Information quality

Management handling of risk

Movements by major shareholders

Newsflow

Opportunity for surprise

Perception of current relative price - eg p/e,price/book

Point in the cycle

Sector strength/weakness

Takeover potential

Transparency

Valuation (including "fair value")

Company

Accounting issues

Cash requirements

Clarity of objectives

Competitors moves

Country-specific factors

Credibility of objectives

Debt position

Dividend policy

Exceptional trading factors

Operational issues

Potential acquisitions

Price levels

Prospects for costs

Prospects for prices

Prospects for acquisitions

Quality of management

Strategic developments

Validity of comparators

Risk factors

Currency factors

Execution

Hygiene factors

People issues

Major changes (market, operations, people)

Major projects

Rating agency moves

Reputation issues

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Appendix 2: PARC Thinking Model for Deciding on Employee Metrics toAdopt©

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Does it help usdetermine how

things change overtime and make

judgementsabout thefuture?

Does theinformationprovided help

us take actionsto promote

improvedorganisation

performance?

Is the measureopen to bias ormanipulation and so

risks not beingcredible?

Is theinformation

requiredrelatively easy to

collect or is it justnot cost effective?

Effectivemeasures focus on:How leaders behave

Employee engagementHow work is organised

How employees are treatedAccess to internal knowledgeAbility to learn new ways of

working

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Notes

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Dedicated to improving the relevance and effectiveness of performance and reward

parc masterclass




post meeting notesPerformance & Reward Centre

CountyMark House 50 Regent Street

London W1B 5RDTel: +44 (0)20 7432 4565

Fax: +44 (0)20 7470 7112E-mail: [email protected]

Web: www.parcentre.com

Documents

masterclass parc Assessing the Effectiveness of Organisationsfaculty.london.edu/ALikierman/assets/documents/19a_Company_succe… · here gives HR an opportunity to define its own