The Idea in Brief
By filling in gaps left by financial accounting, nonfinancial measures (such as customer loyalty and employee satisfaction) promise to complete the picture of your company’s performance. This fuller picture, the theory goes, gives you and your employees the information you need to achieve your company’s strategic objectives.
But few companies realize these benefits. Why? They don’t identify, analyze, or act on the right nonfinancial measures—those that will advance their strategies. And they don’t demonstrate clear connections between improvements in nonfinancial activities and financial outcomes, such as profit or stock price. Results? Misdirected investments and unfulfilled strategies.
How to realize the promise of nonfinancial performance measures? Identify the major nonfinancial drivers of long-term economic performance for your firm. Then measure—and act on—the drivers behind those drivers.
The Idea in Practice
Doing It Wrong
Not linking measures to strategy. Few companies tie measures to strategic goals or develop a causal model linking nonfinancial drivers and financial performance. Consider this exception: A fast-food chain aimed to be its industry’s premier cash-flow generator and lead stock-price performer. The company defined a causal model linking nonfinancial measures to those goals: “Better employee selection will increase employee satisfaction and performance. These will drive customer satisfaction, purchase frequency, and retention—improving growth, earnings, and cash flow.”
Without clarifying such links, managers can’t select the few appropriate metrics from hundreds of possibilities. Result? They measure too many—and irrelevant—things.
Not validating the links. Among companies that do develop causal models, many never verify the assumptions behind them. For instance, what kind of supervision and support drive employee satisfaction? How do satisfied employees increase customer satisfaction?
Setting the wrong performance targets. Firms that do test their assumptions often set targets too high. One aimed for 100% customer satisfaction, although 100% satisfied customers spent no more than 80% satisfied ones. Other companies use nonfinancial measures to launch initiatives promising short-term financial results when other initiatives would generate higher long-term payoffs.
Measuring incorrectly. Many companies use invalid measures, which don’t capture what they’re supposed to—for example, customer surveys with too few questions. Unreliable measures introduce contradictory results—e.g., three internal teams using different techniques to measure corporate reputation.
Doing It Right
Develop a causal model. Propose causal relationships between selected nonfinancial drivers of strategic success and specific outcomes related to that success.
Gather data. Inventory your company’s information systems (such as purchasing and customer service) to see which useful nonfinancial metrics you’re already tracking. Then develop concrete, consistent measures for your entire organization.
Turn data into information. Use established quantitative methods (correlation analyses, multiple regressions) and qualitative analyses (focus groups, individual interviews) to validate links in your causal model. Sears used regression analysis on data from many stores to test if employee relations, customer satisfaction/loyalty, and shareholder results drove financial performance.
Continually refine the model. Deepen your understanding of nonfinancial drivers. For example, low employee absenteeism may improve financial performance. But what decreases absenteeism? Satisfactory pay? Excellent working conditions?
Base actions on findings. Act on conclusions promising the greatest financial reward. One finance company based capital-allocation recommendations on the relative importance of three major drivers: employee satisfaction, number of processing mistakes, and customer satisfaction.
Assess outcomes. Determine if your action plans produced desired results. Even disappointing “postaudits” can help you revise your model and expose data-gathering mistakes.
In the past decade, increasing numbers of companies have been measuring customer loyalty, employee satisfaction, and other performance areas that are not financial but that they believe ultimately affect profitability. Doing so can offer several benefits. Managers can get a glimpse of the business’s progress well before a financial verdict is pronounced and the soundness of their investment allocations has become moot. Employees can receive better information on the specific actions needed to achieve strategic objectives. And investors can have a better sense of the company’s overall performance, since nonfinancial indicators usually reflect realms of intangible value, such as R&D productivity, that accounting rules refuse to recognize as assets.
