When I still was an athlete (about me) it was easy to measure performance. When you were first at the finish that meant you won. The first gets a gold medal, the second a silver one and the third a bronze. (By the way, gold medals are not really gold, my wife’s Olympic Gold is gold plated only. There are exceptions. The winners of the Dutch Varsity rowing championship get a real gold medal. I have one, it is not very big but still pretty cool.)
In principle there are two approaches to assess a result, in absolute terms (“6:06 is a really good time”) and in relative terms (“my result was the second best”). Most of the time we award the relative in sports. Of course achievements in absolute terms, as a new record, are also important but this doesn’t matter when deciding who gets the medals.
Measure Performance Against Peers, Not Budget
In business measuring performance is a lot more complicated. I don’t think this very useful. It tells us more about budgeting skills than performance. Real performance should be measured against peers in the market and not against some sort of plan that was drawn up 16 months earlier. I don’t mean to say that planning and budgeting are not important. They are very important and absolutely essential in implementing strategies. The allocation of always limited resources based on strategic priorities and expected results is an integral part of management. Discipline in the execution of plans is equally important but in the end the results matter.
Lowballing Budgets Is Bad For Results
What happens if an organization defines performance as overachieving against a budget? Everyone tries of course to negotiate a budget that is as low as possible. Because a budget needs to be consistent, lower budgeted revenues lead to lower costs and investments as well. Now what happens when we -surprise- overachieve by selling more. The extra sales need to be produced, managed, distributed etc. But because we didn’t budget for this we need to find ways to quickly boost capacity. How do we do this? By working harder, assuming more risk, by compromising quality and/or by spending more money. Is this really overachieving ? I don’t think so.
Aim High And You Might Get There
Isn’t it better to asses performance of a business or a bank by comparing its results with those of its peers? What would happen? We would budget realistic, because we know that that chances that we outperform others are better when we aim high. If in reality we don’t achieve the budget but outperform the market we know we have done a good job, much better than those that are satisfied with being over budget but didn’t outperform the market.
Not As Easy As It Seems
Of course it is not so easy to establish the exact criteria by which to determine the performance of a company vis a vis their peers. Not in the least because the required information about peers is not always available. For instance, the easiest thing to see about banks in Romania is marketshare in total assets and maybe this contributed to the practice to mistake asset growth for performance. I didn’t enjoy being criticized for a weak performance a few years back because we lost market share. Fortunately it became clear that marketshare cannot be a scope in itself and that elements like for example credit quality, customer satisfaction and profitability are also important. (Actually, the fastest way to increase marketshare in banking is by lowering credit standards and margins.). In banking risk was not fully understood and measured properly and the rest is history. Today we are outperforming our peers on most indicators. Another complicating factor is of course that market participants are very different in terms of size, resources and capabilities. Very important is also to correctly interpret what looks like a good performance. Why is someone, an organization outperforming the market ? Is this sustainable, is it really the management as we (of course) like to think or are we taking too much risk?
Another problem is that financial results are analyzed on a quarterly basis, management is assessed on a yearly basis but results of important decisions can have an impact much later.
Assessing performance against peers is more than a simple arithmetics exercise. Sound judgement is needed and the process cannot be totally objective. Maybe that is one of the reasons why so many companies prefer to compare simply actual to budget.
Despite these difficulties I believe in defining performance in relative terms, in comparison against peers, rather than to compare yourself against your own budget.
What Do You Think?
Would you like it when you came in first and you wouldn’t get a medal because you didn’t set a new record ?
Do you expect a gold medal when you set a new personal best but you were beaten by the rest of the field?
How should your bank or company be appraised, by how they are doing against others or how they perform against a plan? Which approach will give the best results in the long run? Would you prefer judgement of your performance against others over arithmetic objective comparison against budget ?