The Evidence & Intuition.
In a recent blog post I outlined the 5 aspects that make our intuition unreliable and inconsistent. We need to consider the alternative to purely relying on human intuition in business. There are numerous factors in play in business from the various market forces to the various customer, direct customer base to internal team issues, government issues, economical issues etc. Even the simplest business has a number of factors at play and relying only on human intuition means that some flawed decisions are being made.
I must reiterate that I’m not saying that we must never use human intuition. My point is that leading & managing only by intuition is a problem.
As I have asked in recent days “how do you know”. We must look at data and understand what pattern is in the data. But it is not just any old data. Just because it is easy to get it does not necessarily mean that it is important.
The first step is to understand what is driving the business and then determine what we need to measure.
There are a raft of statistical techniques designed to find patterns and I don’t wish to complicate the management of small business in referring to statistically techniques however a number of these are very simple to utilise in a small business but can be extremely useful.
The use of statistically techniques can be applied to any setting including wine evaluation. Princeton economist Orley Ashenfleter predicts Bordeaux wine quality and hence eventual price using a model he developed that takes into account winter and harvest rainfall and growing season temperature. Massively influential wine critic Robert Parker has called Ashenfleter an absolute total sham and his approach is so absurd as to be laughable. But Ashenfleter was correct and Parker wrong about the 86 vintage. Also his way out on a limb predictions about the sublime quality of the 89 & 90 wines turned out to be spot on.
It’s not just wine that we can analyse the data to determine a more accurate prediction or to make a more informed decision.
But we need to measure what is important to the success of the business. This success factor will be found in the operations of the business not the financials.
To illustrate the power of looking at the evidence a paper in 2000 surveyed 136 studies in which human judgement was compared to algorithmic predictions. 65 of the studies found no real difference between the two and 63 found the equation performed significantly better than the person. Only 8 of the studies found that the people were significantly better predictors of the task at hand. If you are keeping score that’s just under 6% win rate for the people and their intuition and a 46% rate of clear losses.
So why is it that we continue to place so much stock in intuition and expert judgement. Overall it is clear we get inferior decisions and outcomes in critical situations when we rely on human judgement and intuition instead of hard cold boring data and measurement. This may be an uncomfortable conclusion but it’s the fact. We need to make better judgements thus we need to have those boring data and numbers.
Again I’m not proposing that we remove or dispense with the human expert or the human business owner but rather we couple the humans in the middle of an evidence based process. This has been the situation with medicine where the evidence conducted from numerous studies of techniques and processes and drugs pave the way for doctors to provide the correct diagnosis but it hasn’t removed the need for intuition of the expert specialist to make a judgement call. They are just being able to make it with the cold hard facts and the knowledge of the studies undertaken previously.
In a business if we have the information if we have the right numbers, if we have the right measurement then the management will be able to have this as their starting point for making decisions and determining the future of the business. Surely these decisions will be better informed as a result.
Rules of Thumb – Are they good or bad?
Often in business there are industry rules of thumbs for profits, costs and valuation. There are many examples of these however to illustrate professional service firms often use the one third rule which is 33% wages, 33% operating expenses and 33% profit. Commercial cleaning business try to only have wages as 55% of income. There are plenty of examples but are these useful.
My belief is that these rules of thumbs can be useful if they are used as a guide only. If we rely on them to make significant decisions they we can be led astray. The rules of thumbs can trap you into certain assumptions about the industry. These assumptions may become self limiting. To take the business to the next level it is important to think about business lessons from outside the industry that could significantly accelerate the business.
Before Fedex came into the delivery business it was considered normal to have a delivery rate of 95%. Fedex changed this. They were not happy with the industry norm. Now the delivery rate of Fedex and also the other companies is 99.95%. This does not sound a lot until you realise the number of parcels that are freighted each year. This difference has meant that millions more parcels are getting to where it is meant to.
In Australia financial planning firms have an industry rule of valuation of about 3 times recurring revenue. Financial planning firms are still being sold for these figures. This is despite the fact that there is significant regulatory changes coming to the industry which may significantly affect the recurring revenue. Also this is despite that this method of valuation gives no regard to what the business is actually earning. So the rule of thumb could be a starting guide but then we need to consider the hard facts.
The next area of rules of thumbs is those that a business creates over time for internally use. I have seen businesses where they have determined rules of thumbs for when they are pricing a quote. Again these rules are useful but we need to be constantly reviewing these rules against the hard facts. So for example when the quote is accepted we need then to examine the resulting job profitability and determine whether that pricing rules are still relevant.
So I see rules of thumbs like fire. In its place fire can be extremely useful but if it gets out of control it can destroy all. Use rules of thumbs as a guide but always check the hard facts on a regular basis.
KPI’s are not just financial measures.
To be effective KPI’s can not just be composed of financial metrics. Metrics derived from the financial statements have a place but they need to be complemented with other measures that are derived from a true understanding of what is important to the customer.
The financial statements are records of history. Thus financial metrics also reflect what has happened. They are not in any way predictive of what is to come. Financial measures have important uses including cashflow management, efficiency, productive use of resources. But financial measure must not dominate the KPI’s as the focus will be distracted from delivering value to the customers.
We need to focus on what is success in the eye of the customer not just past profitability.
The first step in this process is to have a complete understanding of the customer and what they value. A business must invest the time and effort to be armed with the facts and data on the customer. From this the business needs to ask the customer and to observe their behaviour to get the understanding of what is important to the customer. Once this information is to hand then indicators that measure this value delivery can be designed and implemented.
The key measure of this post is not just have financial metrics as KPI’s.
5 Reasons why businesses end up with poor KPI’s
Unfortunately performance measures or KPI’s can get a bad impression because the prevalence of some terrible KPI’s in many businesses. The phrase “what you can measure you can manage” which came originally out of a McKinsey strategy has been belittled by many. I am not saying that you can measure everything (that is for another post). The failure of KPI’s and perception that has been generated I believe has come about from poor implementation of performance measurement.
The reasons that business have poor KPI’s include:-
- They do not exactly know what is success in the eye of the customer. We must start with the customer to know what we should be focusing on measuring and tracking.
- Lack of a complete understanding of the operational drivers of the business success.
- Having KPI’s that are at odds with each other. For instance if there is a KPI on customer value delivered and then a KPI on employee productivity then there can be a tension as to which one is the most important.
- Too many KPI’s. Some businesses I have encountered have had more than 50 KPI’s at senior management level. This just means that none of them will be focused on.
- The design of the KPI has been delegated a low level person in the finance department. The KPI’s are too important not to designed by CFO or senior management.
I am sure that there are many other reasons why inappropriate performance measures end up being designed and implemented however these are five I have seen to0 often.
Your thoughts please.
5 Reasons why businesses don’t have performance measures
There are many reasons given by business owners for why they don’t have performance measures. In this post I have outlined five reasons
1. Already know – no need to measure it. Often when business owners don’t have KPI’s it because they believe they know what is going on This might be the case when the business is very small however it definitely not the case when the business expands. It is the little things that the KPI’s will reveal. Little things that added together will make a huge difference.
2. Got real work to do - There can be an attitude that having a few targeted metrics distracts people away from doing the real work. But, it is the business who is willing to spend the time to work out how to do things betters is the business who will succeed. Just because it seems like unproductive time it will lead to consistent improvements which will mean a better business, better profit and more enjoyable for all.
3 Bottom Line is good enough. There could actually be two reasons within this statement. Some business owners believe that it is possible to manage a business from the profit and loss statement. These statements are just history and by the time the information is in the P&L Statement it is too late. Also the other part of the statement is that if the profit of a business is growing it can make management complacent. This can then lead to the focus being put on the wrong things. Some key metrics will keep the focus of the business on what is important.
4. Don’t like or understand numbers. Unfortunately I have heard this one too often. But it is simply impossible to manage the business without knowing or understanding the numbers. But it does not need to be a list of complex numbers. Numbers can be graphically presented to make them easy to understand for everybody.
5. Don’t have the data. Whilst this may be the case it should not be used as an excuse not to redesign the systems so that data is available. Take the time and ensure the data can be collected so the metrics will be useful.
It is necessary to understand the key numbers of a business so correct management decisions can be made. 01
Two profound statements on team managment.
I recently heard a business owner state that “it is easy to get what you want when you are clear on what you want”.
Following on from this I saw a blog post from Andy Sernovitz in which he stated “want to get people to change their behaviour? Take away the excuses.” (Andy was primarily talking about managing customers.)
Both of these statements are full of gold in managing and engaging team members.
We need to be very clear and precise about what we want from the team and how they will be measured. Also if we remove the excuses the results will follow.
Often management complain about the team not doing aspects of their job or not thinking of the customer. But have they been clearly told what is expected. I mean clearly. Management may think they have told the team but is it in writing showing exactly the obligations, the measurements and the bonus upon achieving this.
It is necessary to teach the team the benefits of treating customer the way you would. The team are there to make money for themselves. It is necessary to show them the connection between the fact that way for the business to make money is to serve the customer. This sound trite and obvious but have a look at the exact messages that the management is sending to the team. What is being reward or recognised? Is it customer service or something else.
Remove the excuses. To often I see management accepting excuses from the team or having the systems set up so that it provides excuses to the team. Review all systems and procedures and KPI’s to ensure that customer service can never be ignored.
So remove the excuses and detail exactly what you want.
The problem with benchmarking.
Often I here businesses saying that they are better or worse (not often they admit to worse) than the industry. But there is a problem here.
If a business compares its data to even best practice within their industry I believe are missing the point.
The business that succeeds in an industry don’t just compare themselves to others but rather they change the game. They look for ideas from outside their industry and innovate. Innovation does not happen by just comparing to other like companies.
It is important to have the correct key performance indicators and to regularly monitor these but to get ahead of the curve it is necessary to have measures focused on what is important to customers.
KPI’s and the financial data used to compare to industry show only the result they do not necessarily show the systems operating in a business. This is where the innovation will come. By looking at what the customers really want and value and then working a way to deliver this effectively.
A key ingredient for performance reviews
An area that always creates discussion is that of performance reviews for the team. Now if you want detailed templates and systems I would strongly recommend that you visit Heart Harmony where Ingrid Cliff has a very good Performance Review manual. This post is about an important element of performance reviews that I believe is handled poorly.
For there to be a true review of performance at some future point then both parties need to know exactly what is expected. How can there be a true review of performance if both parties have different ideas of what was expected.
It is a must that there are Key Performance Indicators in place from the outset that both sides clearly understand. There does not need to be a lot of KPI’s but just a few KPI’s that match the employee or team effort to the desired customer outcome. Without correct measures then it is purely a subjective performance review which usually means that the staff member will feel upset.
Importantly these KPI’s need to be directly related to what is important in the customers eyes. Don’t just use KPI’s that the employee cant influence or are just taken from the accounting data.
The team needs to understand what the management defines as success and what will be rewarded.
You can’t measure everything
“In mid-18th century London a mathematical prodigy called Jedediah Buxton was taken to see David Garrick perform Shakespeare’s Richard III at the Drury Lane theatre. When asked whether he had enjoyed the play, his reply was that it contained 12,445 words. His analysis did seem to miss some significant things. ”
This is the opening paragraph of speech given in September 2006 at the Annual Conference of the Australian Institute of Judicial Administration by New South Wales Chief Justice James Spigelman.
He then goes on to say “The purpose of my address is not to deny the beauty of numbers. Nor their utility. My purpose is to emphasis, as Jedediah Buxtons’s reaction manifested, the inability of numbers to always identify what matters.”
As the Chief Justice so aptly put numbers are not everything. So many businesses measure everything. Many accountants continue this with numerous measures focusing on everything that they can put a measure around. This focus is usually the traditional accounting focus and particularly orientated towards costs. But often many of these measures just create unnecessarily administration and do nothing to get to what matters.
What should be measured?
The Chief Justice was railing against the use of numbers to find some “quality indicator” of the Justice System. Unfortunately many businesses fall in the trap of measuring everything in the pursuit of a quality indicator.
A significant problem with the measures being using in business is that they are based on the traditional accounting practices. The accounting standards were developed in the industrial age when everything was focused on the efficiency of the factory. The assets were the machines, equipment etc. However we moved from this to the information or knowledge age where the assets are the people and the information that they have in their heads. However in the profit and loss statements the money spent on people is an expense.
Whilst the financial statements are often misunderstood they serve a purpose. The purpose of these statements is not to manage the business. The profit and loss statement is best said to be a history statement. Any measures that are based on aspects of the profit and loss statement are looking at history.
There is a place for some measures orientated on the financial statements or costs because it is imperative that costs are kept under control. A business will not achieve true success with only these measures in place. Success is defined by the customer / client. It is necessary to measure that which the customers views as important. We need to find the drivers of the customer behavior and measure those.
But remember not everything can be measured. How can we measure the lawyer / accountants ability (or lack of ability) to communicate. A criticism made of lawyers and accountants is that don’t return calls quickly, not speaking in layman’s terms. How can the lawyers / accountants professionalism be measured. These are judged not measured.
Thus we need to focus on measuring what matters and have measures that matter. These are measures aimed at what is important to customers / clients. There is still a lot of work to be done on designing effective measures that are not just focused on various elements of the profit and loss or balance sheet. It is necessary to have a change of mindset from the industrial age to the knowledge age. Nowhere presently on the balance sheet is the huge asset that the loyal committed clients are. Nowhere in the financial statements is any information about customers found eg repurchase rate, referral rate etc
With the right approach it is possible to design a quality indicator that will reflect what is important to customers. There are difficulties and it will take a fresh approach to measures. Some businesses have already devised interesting measures aimed at getting to what customers see as important.
One of these is Fedex with the SQI (service quality index) which came from the hierarchy of horrors (a list of things that upset their customers). From this they assigned importance to each item on horror and from this they then created an index. This index thus showed how often or how little they were upsetting customers. Since implementing this quality index they have taken the taken the ontime delivery from 95% to 99.7%.
Another company is Enterprise Rent a Car (USA) and their ESQi which is similar to Fedex but is from a simple customer survey. There are other successful companies who do not rely solely on the traditional accounting measures but are focused on the customer.
Be careful though. I am not recommending the plethora of customer satisfaction surveys. These abound and usually are useless. In short these don’t work because they ask to many questions, the wrong people respond, are used for marketing purposes and probably the most importantly are not linked directly to what matters.
It is possible to develop a quality indicator but not using traditional accounting measures. A fresh look at the business is necessary. What the customer values in your product or service must be ascertained. Once this is understood then we need to devise a measure around this.
In conclusion what are you measuring? Measure what matters and have measures that matter. Remember not everything can be measured.
Five Steps to Make KPI’s work.
There has been considerable effort and attention given to all manner of indicators. Unfortunately three things end up happening :-
1. Too many indicators are created
2. Once created the information provided by the indicator is ignored (or not understood)
3. The indicators focus only on the internal performance of the business.
So should we be concerned about this? Yes absolutely yes. But why?
Because what you measure and reward is what you get. Recently the Australian Financial Review asked a number of successful business people for top 5 things that help business succeed and one of items that they stated was – know your numbers. Numbers can tell a story of the business.
But there are 5 key steps before KPI’s work :-
1. Decide what constitutes success
This sounds obvious but the success I am referring to is not your bank balance but what will make the business grow. Success must be defined the way your customer defines it. How the customer defines success or value will often include aspects that you may consider trivial. But it is these little things that the customer values. Often time the focus of measurement is on the cost or production. This is not where success lies. All it will bring is reduced costs or increased production efficiency but not necessarily customer delight. It is imperative to look at your business the way your customer does. What is important or valuable to your customer?
2. Measure the right things
Businesses fail because they want the right things but measure the wrong things. People are smart so even if you define success right but still measure and reward the wrong thing your team is going to give you what you measure eg if you were to measure employee adherence to an employee manual then you will have employees who abided by the letter of the internal rulebook but probably give lousy customer service.
When measuring the right things don’t go overboard. It is usually only necessary to have 1-5 items that are measured right across the business and that everybody knows and follows. There may be other measures for separate sections of the business but there will only a couple of headline measures. Too many measures lead to people losing focus.
3. Make sure everybody understands the goals and measurements.
If people either don’t know or understand the goals and metrics they will create their own which are probably nothing like what you want. The goals need to be communicated to everybody regularly. The team must understand what the goal is and how they form part of it. Every decision then needs to be made in the context of the goals. If an idea is brought up, before effort is wasted it needs to be determined whether it helps achieve the goals. The goals and the measure need to be presented in such a way so that it is easily understood. Numbers are not appealing to everybody so make it fun. Numbers can be expressed in many creative ways that everybody then understands. We need to keep the score in a manner that everybody can determine how we are going. The scoreboard must be available constantly. When we attend a game of sport we want to know at all times how our team is going and the scoreboard is always plain to see for everybody. Lastly the goals and measurements must be reasonable. An unachievable goal is no goal at all. It will only lead to dispirited and cynical team.
4. Reward
For behaviours to change the measurements need to be coupled with rewards. We only get what we reward. Gordon Bethune in his recount of turning Continental Airlines around states that this was one of the most important things he did. Each employee got a monthly bonus if they reached the onetime arrival target. The behaviours changed to meet the target.Once rewards are promised then they must be delivered if the target has been achieved. Keep your word. When people are given clear direction and clear rewards they will achieve. This is applicable to all levels of the team.When the rewards are given make it certain that they know they have got the rewards. For instance if there is a monetary bonus then instead of the funds going in with the normal wages then it should be a separate payment. This has more impact. Anything that can be done to intensify the experience of the reward makes the message stick. Don’t reward the wrong people. If a company wide goal that has been achieved then everybody gets the reward not just senior management. Everybody is necessary for the success therefore reward everybody.
5. Never stop
When driving a car we rely on a number of measurements which we are constantly referring to e.g. speed, fuel. If we decide that everything is fine or that we are too busy to look at the dashboard then this will only lead to disaster. We could run out of fuel, be caught speeding, have an accident through speed. We must refer to the dashboard to know what is going on.Never, never, never stop measuring what matters. The dashboard of the business will have a couple of important measures that must be constantly measured. There will be a number of other measures in the business just like the car e.g. km’s travelled, tyre pressure, coolant level, oil level etc. However the headline metrics (ie the dashboard) gives us a good indication of how everything is going. If you do keep an eye on the measurements, as soon as a problem shows up you’ll know about it and you can take action to fix it. It is necessary to ensure the accuracy of the measurements. If the speedo is out then this can give us a false sense of comfort. Over time the measurements in a business must be constantly refined and made accurate. Measure more and measure better. Measure everything that matters.
Conclusion
These five steps will ensure that measures work in your business and not just become despised numbers. To achieve success you must know your numbers. That is the numbers that matter. So in conclusion – MEASURE WHAT MATTERS.
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