The building blocks of a management system
Stretch Global CEO John Stretch takes a deep dive into the planning behind every business strategy.
The iceberg is a useful metaphor for a management system. Below the waterline is an invisible or partly understood process of planning, budgeting, forecasting and reporting. This supports the financial result – the visible outcome – comprising only 10 percent of the iceberg.
When it comes to planning an annual cycle, many businesses have moved to continuous planning and introduced more advanced planning and control processes. These companies measure results through performance measurement systems, scorecards, dashboards, and management accounts. The human resource area champions performance appraisals, incentive schemes, promotions and compensations packages.
When I asked the director of a global mining group how important strategic planning is, he tersely replied that “strategy is everything”. He explained that his organisation’s planning process is the key to its long-lasting success.
Every manager understands and supports the principles of strategic management. These include ongoing strategic planning, formal control systems, a strategic priority to be the safest producer in each region of the world, and a passion for action and results.
Performance is measured by a few carefully selected financial ratios, particularly free cash flow and return on capital.
Some companies still budget once a year, and use this budget as the benchmark for judging monthly performance. Other companies have shorter planning horizons, and rolling quarterly forecasts are common.
Companies that can update plans and forecasts quickly are in a better position to take advantage of opportunities and respond to threats.
When a business lacks a clearly communicated strategy, managers develop budgets by adding a percentage to the previous year’s figures.
In a rolling forecast, each business unit sets a monthly or quarterly target and reports actual performance against this target. Assumption variances are eliminated or reduced because these targets are based on current information.
After companies realised that monthly management accounts don’t always capture many of the realities of their organisation’s performance, managers began using key performance indicators and other non-financial metrics to measure performance.
In 1992, professor Robert Kaplan of Harvard introduced the “Balanced Scorecard”, which suggested that key performance indicators could be categorised under four generic headings:
- Shareholder measures
- Customer measures
- Internal measures
- Innovation and learning
Read more: What should you measure in 2019
Management incentive schemes are used to implement strategy, retain good people, and improve financial performance.
The incentive scheme should be separated from any absolute target, to avoid the temptation to negotiate these targets as low as possible.
Basing incentives on achieving budget means you end up paying for the best negotiating skills. A well-designed scheme induces managers to make decisions as though they were the owners of the business and is linked to the relative targets set out in the strategic plan or scorecard.
Managers must be able to exert significant influence on their targets through their actions and the reward should be a major part of the total package.
Generating commitment from middle managers
It is up to middle management to make the strategy work. The strategy won’t be implemented unless the middle management group believe it is in their and the company’s best interests for the strategy to succeed.
If the top management group lacks consensus about the strategy, the organisation is headed for trouble. The best way to communicate the strategy is leading by example. The top management should “live” the strategy and demonstrate their commitment through symbolic actions and behaviour.