Business metrics: A key to competitive advantage.

INTRODUCTION

Business metrics and performance measures serve as dashboard gauges that help in guiding the strategic direction of a firm (Rubin, 1991). The dashboard consists of appropriate gauges, metrics, which indicate the current performance, baselines, directional trends, and targets. These gauges indicate where a business is headed if the current strategies were to continue unchanged. Any change in the environment in which the firm is competing in will affect the performance of the firm. This lowered performance of the firm should then be captured as measurements by the gauges, metrics, as long as the proper metrics are being deployed.

These measures would be the pivotal sparks leading to changes in the firm's business strategies. Timely and appropriate steering of a firm's business strategies is a key matter for any firm in sustaining business success. Such tight management of an organization's strategies, however, is possible only by the knowledge and measurement of the appropriate metrics.

Different metrics serve different purposes. In general, there are business metrics for accountability purposes and others for organizational improvement purposes (Irwin, 1997). Some measures are used for the efficient strategic steering of a firm, while other measures are used for communicating the proper worth of a business to all interested parties. Business metrics serve the different interests of different stakeholders. Some business metrics are used as the basis for an organizational tune-up, quality improvement, or business process reengineering. In such cases, the stakeholders are generally internal to the firm. There are other business metrics that provide accountability measures used by shareholders, customers, vendors, or creditors in evaluating the general quality of a provider or estimating the future growth of a firm.

The employees within a firm are the ones who ultimately implement the business strategies. Proper individual performance measurements help define and promote desired behavior, activities, and attitudes within an organization (McChesney, 1996). The right behavior must be consistent with and in support of the strategies an organization has adopted to move it towards its preferred future. According to McChesney (1996), people do what is inspected and not what is expected, thus requiring the proper channeling of the various metrics to employees at all different levels, (Aggarwal, 2004).

Unfortunately, many people do not understand what the information presented by the business metrics means. Most employees are not mid-level and senior managers and therefore are unlikely to have a grasp of core financial concepts, performance improvement practices, and the tenets of operational excellence. To help in clarifying the proper usage of business metrics, this paper presents a survey of the application of business metrics in various business activities, highlighting the various constructs that guide the adaptability of the metric to the business application, ultimately providing managers and practitioners with guidelines for the selection of the proper metrics that serve the strategic direction of the firm. The paper presents some of the limitations of the traditional use of metrics, followed by some guidelines for constructing and selecting good business metrics. Following this, the paper presents examples of the applications of business metrics and their implications in the steering of corporate strategic directions. Finally, the paper concludes by highlighting the importance of business metrics and providing guidelines for managers and practitioners for selecting the proper business metrics to steer corporate strategic directions.

LIMITATION TRADITIONAL BUSINESS METRICS

Traditionally, businesses have used financial performance measures as their mainstay in (a) tracking their gains and losses, (b) formulating business strategies, (c) communicating market value to shareholders, and (d) analyzing competitors' strengths and weaknesses, Figure 1.

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While the traditional metrics have served adequately for the contexts they were designed for, they increasingly fall short of reflecting today's business environment. Examples of shortcomings of such metrics evaluated in light of today's powerful business drivers as provided by Campbell (1997) are:

* In software companies, the real assets include the people, software, and R&D. Traditional accounting methods do not record these "off-balance-sheet" assets. Hence, traditional metrics do not reflect these assets.

* In automotive companies, sales revenue and customer satisfaction are not always correlated. Within the industry, one of the most important metrics that signals future sales growth and market-share formation is "customers' intent to purchase." This is a non-traditional metric and is never revealed in traditional accounting information.

This metric is measured and reported by organizations such as J.D. Power based on customer surveys.

* In food companies, the metric "brand equity" reflects the degree to which a product has differentiated itself from the competitors' products. This again is a nontraditional metric. It is not reflected in traditional financial statements.

The notion that traditional financial metrics reflect less and less current strategies has been argued throughout the literature (Rangone,1997). A study conducted by Ernst & Young LLP's center for Business Innovation concludes that two-thirds of the allocation decisions financial analysts make are based on non-financial metrics. Specifically, the three non-financial metrics that matters the most are (a) quality of product, (b) quality of management, and (c) market position of firm. Calabro (1996), in discussing the results of this study, concludes that "the market evaluates a company based on the perception of its non-financials. To realize full value for your company, you have to communicate non-financial information." Unless a construct is defined and measured, it cannot be communicated.

DESIGNING NEW METRICS

In coming up with new metrics, it is best to specify the properties desired in that metric and then define the metric. As an illustration, consider the link between strategy and performance of a business. The metrics in use will ultimately reflect the strength of the strategy performance linkage; however, different metrics will invariably reflect different levels of this linkage. For example, in studying the impact of total quality management (TQM) programs, different metrics may reflect different effects. A study conducted by Hendricks and Singhal (1997) that compares quality award winners with other control firms shows that as quality increases (a) operating-income increases, (b) sales-growth increases, but (c) costs do not decrease. Depending on which of the three metrics are being used, the impact of the TQM program could be measured differently. Thus, based on the metric being used, one could end up with a biased conclusion regarding the efficacy of that strategy.

There are several properties inherent in a good metric that has been identified throughout the literature. A list of these properties can be summarized as follows:

* Metrics, designed for purposes of accountability (Cooper, 1996), should be constantly reviewed based on the changing standards of accountability.

* Good performance metrics need to reflect progress against a plan (Fleisher and Mahaffy, 1997). This property allows a metric to go beyond being just a measure. Metrics with this property are vehicles for organizations to clarify, communicate, and manage strategy.

* Good metrics should closely reflect long-term organizational success and not just short-term financial gains. A survey of 420 practitioners (Dempsey, 1997) suggests that analysts go well beyond traditional financial measures and use a broad range of strategic leading indicators to assess long-term organizational success. Thus, it makes sense that organizations use the type of metrics analysts use to evaluate them.

* Any good metric should be part of an integrated performance measuring system (Ghalayini et al., 1997). Metrics, no matter how well defined they are, if interpreted in isolation, can lead to problems. It is best to construct metrics by fragmenting the measurement system.

* Good performance metrics should be properly aligned with business strategy (Stainer, 1996). It is not uncommon to find an organization redoing its business strategy but without concurrently redefining its metrics. As discussed earlier, changing business strategy, without updating the metric, can lead to serious problems in measuring the strategy--performance link.

Building on these properties, the next sections present several managerial applications for using business metrics and how the proper selection of business metrics can help steer the strategic direction of the company towards enhancing its competitive advantage.

MANAGERIAL IMPLICATIONS OF BUSINESS PERFORMANCE METRICS

Senior executives understand that their organization's measurement system strongly affects the behavior of managers and employees. Therefore, they need non-financial measures besides the traditional financial measures in their organization's measurement system. The inadequacy of traditional metrics is clear when it comes to measuring the performance of different organizational functions. For example, there is a need to develop non-financial measurements to evaluate the performance in functions like sales and marketing, manufacturing, information systems, purchasing, R&D, or any other organizational function. In this section, we will discuss, from a functional point of view, the managerial implications of utilizing inadequate traditional metrics. The discussions will suggest how new metrics are helpful in such managerial functions.

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