Performance Against Budget Or Market

by Steven van Groningen on 8 March, 2012

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 ?

{ 7 comments… read them below or add one }

Andreea Enache March 9, 2012 at 15:58

Dear Steven,
Totally agree with your point that performance should be measured against peers, and not a priori targets. It is indeed hard to implement this at corporate level, because of the low level of transparency on KPIs of competitors.
But we do use this logic in sales optimization projects where this is exactly the main building concept: performance should not be measured against given targets, but against peers, and more precisely, against the top quartile of performers so that you manage to push all sales people towards reaching the best results possible.
If you are interested in more details about this, please send me a short e-mail and I will send you a presentation on this topic.
Best regards,
Andreea
Managing Consultant
Horvath&Partners

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SvG March 11, 2012 at 23:56

Thank you Andreea, indeed this is easier to do when you look at a population of sales people where the rules and participants are more or less similar. We are doing this for a significant part of our sales staff. The idea is to change the distribution of the reward based on performance against peers. Here it works, more difficult when you compare the performance of a whole bank.

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Radu Manolescu March 9, 2012 at 19:25

Dear Steven,

I am glad you brought this up and I find the topic of high importance and value for the business environment. I am fully aligned with you mentioning the budget related performance being almost irrelevant taken without considering other aspects. Profits alone measure the past performance and not the future health of the organization, measured both in the past and today by many more indicators than achieving/overachieving budgets.

Please allow me to add to your very good analysis, few of my thoughts:

Indeed performance/results is/are critical because at the end of the day it is the purpose of any business to produce financial results. I believe as well that performance may mean very different things for different people therefore we may have to ask ourselves what is performance?…

Creating Shareholder Value is clearly the main objective for any business but a reasonable dimension of the desired shareholder value and the solidity of customer experience/satisfaction together with employees’ quality, satisfaction and motivation, I find equally important.
One may have the largest market share and profits yet very dissatisfied clients, employees and partners and the performance in this case I see on the short run. Investing in customer care, employee retention, development and motivation require budgets that diminish the profits and some times market share as well therefore what is performance in business? Financial figures & market share alone or only measured together with loyal customers and employees?

I believe we are in this depression/recession also due to a high degree of greed from many shareholders as Shareholder Value was seen mainly in terms of absolute numbers, short term oriented and not in terms of positive Economic Value Added or other similar indicators in parallel with a solid focus on nurturing moral values, developing and retaining smart and ethical people, increased customer satisfaction, on hiring passionate, curious, common sensed executives and non-executives…aspects which require important investments of time and money and thus diminishing current profits.

Due to the market past continuous growth, I feel the last years focus has been on the “what” and very little on the “how”, I feel that performance was against the purpose and many bad things happening today are due to many executives being /preferring staying anchored in past habits and successes (in large extent market growth driven and not ethics and leadership driven) while we live today another economy that demands different behavior.

In many cases in banking and not only I felt that risk management was, with all due respect, more risk avoiding with strong impact in both customer care and in the efficiently of the relationship managers. And that may bring results but short term…..

I believe we have to take into account we live a different business life today due to a totally different economy and as leadership measurement was done in a certain way years ago and in a very different way today, it may be the case that performance to require, for a correct analysis, more indicators than 5 years ago. I think one company could be the number 2 or 3 or 4 in terms of profits, turnover or market share if it scores number 1 at EVA (or similar) growth together with great customer and employee experience.

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SvG March 12, 2012 at 00:13

Thanks Radu, I agree with you. The “how” deal more with the long term aspects. Indeed the pressure to deliver short term numbers was (is?) omnipresent in the market. Long term sustainable result will benefit from focus on the “how”. We can turn the question around. If a company shows good results (however defined) the shareholder should question the way they are achieved. If this was based (partially) on unethical methods and or measures that deteriorate customer satisfaction than these results will not last long. As I said, this is complicated business but I feel that there is a lot of room to improve defining and measuring performance.

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jhuitz March 11, 2012 at 12:22

I agree in general and I wish more people saw things this way.

My point of view (and I am a banker), performance is best evaluated from the perspective of the customer. They select the “best” bank in the market. Customer’s of course can be a finicky and demanding lot, but there are reliable methods to quantify customer satisfaction and understand its variables. I would even go so far as to say that strategic initiatives should always be put in this context; if initiatives are instead imposed, these are compliance or control related.

Now, looking as financial performance… I often here this or that one is the “best” bank when what is really meant is that it is in fact the largest bank in terms of assets. This I think is very poor way to judge performance. I prefer yield on investment or assets. What’s the point of booking large loans that generate large sums of absolute revenue if ultimately the yield from the relationship is weak?

And looking at salesman performance, one needs to link salesperson actions with a financial target that when calibrated took the customer experience in account, and then rank performance relative to colleagues. But, I am not sure whether local corporate culture is very open to this, I find here that a collective approach is preferred vs. individualism.

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SvG March 11, 2012 at 23:52

Focussing on creating customer value and being seen by the customer as the “best” bank is the best way forward and will lead to sustainable financial results. If we reward short term finical results we might never get there, especially when we define result in term of size. I am pretty sure there are a lot of banks less happy now about big loans at their books at low yields that helped them to show higher market share in the past.

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Florin March 15, 2012 at 22:29

Steven, I would go even further than you and ask, why do we have to have a measure of overall performance compared to peers? In sports, yes, it makes all the sense, in sales over a population of salespersons, it also makes sense, but for a complex institution as a bank is? Who are the peers of a certain bank? Even if we stretch the criteria, we cannot say that there is a homogenous peer group for the Romanian banks, because each one is materially different from the next one.

I’d say the same is valid for investment funds, we see top return performers over 1 year, 5 years, 20 years and 30 years and names are different all the time, I am not convinced that the statistical measures give a meaningful ranking.

Of course you need to aim high to get results, so you need to measure something, but it would be best to define a set of KPIs that cover as many aspects of the business of an entity as possible, including KPIs that are inversely correlated with assets and profits. Maybe then you can compare with previous performance and be happy when you reach a new personal best.

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