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Posts Tagged ‘Goal Alignment’

One of the business world’s most repeated truisms is that you get what you measure.  So it stands to reason that, if the goal of an organisation is to maximise profit, a unit’s contribution to that profit maximising effort should be the primary measure against which it is evaluated. 

Instead, it is common to find a wide range of diverse measures being used to evaluate and direct teams.  These measures are usually assigned using a traditional top-down budgeting approach.  The CEO might start the budgeting process by aiming to deliver a specific return on equity to shareholders.  Then, together with the other directors, she might identify a number of strategies that they believe will deliver that return.  Those strategies are then broken down into goals to be achieved by each of the business units that make up the organisation.  For example, the marketing team’s goal might be to generate new loan applications.  Similarly, the product team’s goal might be to increase the average revenue-per-account.  These goals are converted into specific measures and success is defined by the team’s ability to meet and exceed those measures.

This approach seems logical but it has several important weaknesses.  In this case, the marketing team might offer loans to potential customers at a reduced interest rate in order to increase demand.  As logical – and rewarding – a move as this might be from their point-of-view, it would also be in direct conflict with the product team’s goal of increasing the average revenue-per-account.  Alternatively, a change in the prevailing market conditions might reverse the need for market share growth.

Profit Model Analytics offers a solution by improving goal alignment in two ways: it co-ordinates the activities of disparate teams with each other and with their environments.

Firstly, consider the interaction between teams.  Individual profit levers seldom reinforce one another.  In fact, the improvement of one profit lever is often only possible at the detriment of another.  So, when teams are given goals based on individual profit levers, conflict is the norm.  For as long as the full impact of a strategy is divided across two or more teams some of those teams will remain overly conservative and the others overly aggressive.

However, the profit model looks beyond a team’s narrow area of interest and considers the impact that a strategy will have on the broader organisation.  It elevates the interaction of profit levers, or the profit model, above the performance of any individual profit lever.  Thus, it forces teams to share goals and co-ordinate their activities across reporting structures.

In the scenario above, the marketing team would now be incentivised to follow a different and more profitable strategy than simply increasing the number of new applications received.  A profit model would show that the number of applications a bank receives is a cost driver, not a revenue driver.  In fact, revenue is only derived from loans that are turned into good customers and this is a factor of the bank’s approval rate, the rate at which customers’ take-up approved loans, the customers’ attrition rate and the inherent risk of the target market.  In order to maximise profit therefore, the marketing team might decide to concentrate its efforts on appealing to a lower risk population whose members are more likely to be approved for loans or on encouraging customers who have been approved to take-up their loans.  Neither of these strategies would have a negative impact on the other teams.  In fact, if the marketing team chose to focus its efforts on reducing the rate at which customers left the bank, both the marketing team and the product team could benefit.

Secondly, consider the interaction between a team and its changing environment.  Goals set using the top-down process usually change in gradual steps – coming into being after one summit meeting and remaining in force until the next such meeting.  The environment, however, is more dynamic.  This can lead to confusion and conflict as team goals diverge from – and are emphasised at the expense of – organisational goals.  Fortunately the single, widely-held goal of profit optimisation not only reduces inter-team conflict, it also increases goal consistency and goal relevance over time. 

When times are good, the marketing team might be encouraged to increase market share by targeting slightly riskier populations.  However, risky growth becomes unprofitable as soon as the market experiences a downturn.  It is easy to see how a conflict between the interests of the team and the interests of the organisation could have arisen if they were measured against a static goal based on the growth in the number of new accounts while the environment changed around them.  Profit, on the other hand, is a fluid goal.  In this case, as soon changes in the environment make a conservative strategy more profitable, the marketing team could adapt quickly by, for example, abandoning their initial growth goal in favour of a risk-minimisation goal.  Although the goal remains the same – to maximise profit – the optimal means of achieving it will vary just as surely as a mountaineer attempting to summit Everest might need to adjust their route to compensate for changes in the prevailing weather conditions.

One simple way to visualise the profit model is as a pyramid.  Each layer of the profit model pyramid expresses the layer above it in finer detail.  So, on top of the pyramid is profit which is the result of all the activities of an organisation.  Profit can, most simply, be broken into revenue, variable costs and fixed costs and so the next layer down is made-up by these major profit levers.  Each of these profit levers is, in turn, made-up of more detailed profit levers and so on.

 

pma-pyramid

Regardless of the budgeting process employed, each team is likely to be given one overriding goal.  The success of each team is then measured by their ability to meet a pre-set target that is represented by a measurable metric that resides somewhere in the pyramid.  The further down the pyramid that a measurable metric resides, the more likely a goal based on it is to be counter productive across teams and to become variable over time.

Returning to the example of the marketing team, they might be measured on the number of new applications (level three), the number of active accounts (level two) or profit (level one).  A marketing team with the ‘level three’ goal of increasing the number of new applications will be in continual conflict with a risk team measured on the opposite and competing ‘level three’ goal of minimising the number of accounts in default.  There will be less conflict if both teams are measured on ‘level two’ goals – such as number of active and up-to-date accounts and accounts in default as a percentage of all account balances – but the conflict will only be resolved entirely when both teams are measured according to the ‘level one’ goal of profit.  The unified goal of profit optimisation will alter the relationship between these two teams from adversarial to cooperative.

Making profit the unifying goal of all teams does not mean that all teams are evaluated on the overall performance of an organisation, however.  The usual rules about effective goal setting still apply and such a broad-stroke approach would make it difficult for team members to identify the link between their efforts and the fruits thereof.  Rather, it means that each team should be evaluated on its ability to maximise profit by implementing projects that positively impact those parts of the profit model over which they exert some control.

To do this, the organisation must follow a simple three step process.  The first step is to reach agreement on the make-up of its profit model.  Teams should agree on which profit levers to include in the profit model as well as the way in which those levers interact.  The second step is to identify which teams impact which profit levers.  Most teams will have a primary impact for a small number of profit levers and a secondary impact on a few more.  (Note: A profit lever with no identified ‘owner’ points towards a weakness in organisational structure, as does a profit lever with too many owners)  The third step, once the breadth of a team’s potential impact has been established, is to ensure that every project implemented by a team includes processes to monitor and aggregate the performance of all of the profit levers under its influence.

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