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Measuring Corporate Innovation Capabilities

 

Innovation emerges when people are allowed to give free rein to their creative talents within a set of simple rules. In the case of the music, the “rules” were the tempo and melody and the deadline for completing the recording.
“Out of the box” thinking fosters innovation. But the boxes that most people operate in are focused on activities, computers, people, or departments within a company. However, it is the lines, the interconnections and interdependencies between the boxes, where innovation emerges. Innovative thinking comes from making connections. Connections between boxes. Connections between ideas. Connections between companies. Or connections between industries. Focusing on the lines frees an organization to improve within the guidelines of the simple structure.
Innovation is both a means to an end and an end in itself. It should be a firm’s core capability that delivers superior value—generating growth and delivering high returns. At the same time it is a stand-alone state of mind that investors look for in public companies. Firms perceived as adept at innovation benefit from the “innovation premium,” the extra value that analysts factor into the shares of the most flexible companies merely because they are consistently able to renew, reshape, and refocus their ener- gies to meet new competitive challenges.

Within business, it is necessary to focus on outcomes. Giving people the creative freedom that fosters innovation requires that management give up some control and allow the individuals to run the business.
Unfortunately, most businesses today still operate without the free-style creativity that nurtures innovation. Measures are largely confined to numbers: the annual balance sheet and the profit and loss account, and the management accounts that companies maintain for internal purposes. These statements were designed to indicate how a company was performing financially, month to month, year to year. Although money still talks today, it is not the only outcome businesses need to consider. And more importantly, it is usually not the one that fosters innovation.
Many companies do recognize the fact that their measurement systems are not up to snuff. A recent study found that 96 percent of bricks-and- mortar, 96 percent of clicks-and-mortar, and 100 percent of dot-com companies said they wanted to improve their measurement systems.
But if so many companies know that there is a need for better measures, and they know that they are not performing well, why are they still in such sad shape? I suggest that there are two reasons. First, it is often difficult to determine what are the right things to measure. Second, even when companies can decide what their strategy is, they don’t know what priority to give each measure. One manufacturing company’s mission statement, for example, says: “This organization provides products and services which consistently meet or exceed standards set by our customers, on time and at the lowest cost.” An admirable sentiment. But when the chief executive was asked how he knew whether he was on target, he had to admit that he had no way of knowing how to rank his degree of success or even whether he was being successful.

There are several basic uses of measures:
1. To communicate a range of performance targets and to report on their achievement.
2. To compete successfully by making strategic decisions on the basis of hard data.
3. To compare the company’s performance with that of others and to target where innovation and improvement should be initiated.
4. To compel corrective action by identifying variances beyond acceptable limits and to innovative solutions.
5. To comply with the law, with regulatory standards, and with risk- related internal policies.
6. To complete projects within planned horizons, including delivering the anticipated benefits.
7. To commit employees to the company’s priorities through recognition and reward mechanisms.

Most managers agree that a good business measure must be both accurate and objective. Accuracy does not imply that it must be precisely right to four decimal places. It means that the data it provides must be trustworthy and not the subject of dispute. It must be good enough for managers to be able to form the best possible judgments and make good decisions with confidence.

Managers also must ensure that there are sufficient measures in place that look beyond the “walled garden” of the organization—for example, don’t just measure the firm’s performance at shipping on time from its warehouse, measure whether customers actually receive deliveries when they want them (and when the firm promised them). Wherever possible, work with factual data rather than opinion. Subjective measures are only helpful when objective measures are not available, and they should only be used only as a proxy for the unattainable. Nevertheless, remember that perceptions have a way of becoming reality and must be taken into account.

Measures of a particular outcome should assess more than one dimension. For example some of the dimensions of quality are consistency, reliability, conformance, durability, accuracy, and dependability; of quantity, volume, throughput, and completeness; of time, speed, delivery, availability, promptness, and timeliness; of ease of use, flexibility, convenience, accessibility, and clarity; of money, cost, price, and value. The success of every one of these dimensions will depend on perpetual innovation by the responsible employees.

Nearly everyone agrees that there is a need to focus on measures.  The key questions will, then, concern motive, opportunity, and means. So it should be with measurement data in business. What are the key questions? What do we need to know in order to understand how well the business is doing?

Focusing on the Outcomes
To properly drive and measure innovation, you must start with the measures and design everything to reach your objectives. And true objectives focus on outcomes, not on the means of achieving them.

Charles Koch, Chairman of Koch Industries, tells the story of a refinery employee whose job was to turn a valve when the pressure reached a certain level. This was clearly a prescriptive approach to managing the work that was done and left little room for innovation. When an outcome-based approach was applied, the operator was told to use judgment and experience in controlling the process, so long as it was within the tolerances of the equipment and it met the needs of any dependent processes (again, focusing on the lines rather than the boxes). After this change, the performance of the refinery unit shot up 20 percent, which is considered a quantum leap in a commodity business in which 1 percent gains are joyously celebrated. It’s a good demonstration of measures stimulating innovation. Koch’s incentive systems are designed to foster innovation by covering more than just employee contributions to current profits. They also cover contributions to long-term success, including contributions to culture and communities.

Many companies delay quantifying the results they wish to achieve because measures can be difficult to design and agree upon. But this is a mistake. The establishment of measures and targets cannot be done after the fact. They need to be established early on in the change effort in order to provide clear goals that people can aim for. In the first place, it is virtually impossible to design a process without the “specifications” of how it is intended to perform. And it is impossible for employees to be innovative when they either don’t know what they are expected to achieve or are constrained by prescriptive measures.

Only by measuring outcomes is it possible to determine whether a Capability is achieving its goal, because excellence is focused on producing outcomes of real value to stakeholders. A major beverage company, for example, tracked the number of repair calls on its vending machines because it was concerned about the rising cost of maintaining the equipment. While its measurement produced some interesting numbers, it didn’t help much because it failed to show whether the company was attaining the outcomes it wanted—such as increasing the overall time that the machines were functioning properly. When the measures were changed to focus on outcomes, the company’s costs dropped and the satisfaction of its customers increased.

Of course the performance of operations must also be measured. Only then can an organization be sure that a procedure is operating within the expected parameters of time, cost, and quality while producing the required results. In other words, there’s not much point in producing the planned number of widgets if they’re overbudget, late, and shoddy.
At one major entertainment company, it was an unspoken rule that if a new television show turned out to be a hit in the ratings (the outcome), all was forgiven on cost overruns or late schedules (the performance). Over time, though, this lack of attention to performance led to the company’s costs running dangerously out of control. It also meant that programming schedules had to be juggled because new shows were not ready by their expected release dates. Eventually, the company was forced to adopt a more balanced set of process measures that included performance as well as outcomes.

Amid all this measuring, it is important that companies make sure they avoid measuring things for the sake of it—especially if the measures do little to guide behavior. As the quote at the beginning of the chapter implies, companies can get by measuring much less. The key is to measure the things that matter most.
Of course, in order to set measures on results, it is critical for the overall company goals to be understood. If an organization’s desired outcomes are unclear, it should stop and clarify them. Efforts to redesign businesses flounder sometimes because of a lack of understanding of (or lack of agreement on) what organizational outcomes are desired or what strategies should be used to achieve them.
There is no handy template for measures that would suit all situations. Each company will have its own objectives and therefore its own measurement requirements. Take British Airways (BA) and EasyJet. British Airways is a provider of full-service air travel targeting business customers as well as economy travelers. EasyJet, on the other hand, is a provider of lowcost air travel only. Both are in the business of transporting people from one place to another, and, of course, both are going to have measures around safety and timeliness. But BA also focuses its distinctive measures on comfort and convenience for business travelers, while EasyJet focuses primarily on price and convenience for holiday travelers. Nearly all of BA’s business is booked through travel agents, while nearly all of EasyJet’s business is booked through its Internet site. Different strategies demand different measures.

Innovation and measures go hand in hand. Measures should tell employees what they need to achieve, not how to do it. And they tell management how well the business is moving toward its objectives. But as we are reminded by Koch Industries, measures force management to give up some control. Even when Koch managers know where things stand today, because of the entrepreneurial nature of their measures, they have little idea of exactly where they will be tomorrow. Risky, yes. But it has enabled the company to grow 200-fold in less than three decades.

Stretching Performance Goals
Stretch goals can have a powerful influence on the way businesses are designed and executed. If performance targets are left ill defined, the company sacrifices an important tool for motivating people to innovate. Setting stretch goals is a key area for sparking innovative ideas. Jack
Welch once said: “The thing that is always wrong with measurements is that you set them to a place where you can meet them.” Companies proclaim victoriously that they have met the targets that they set themselves the previous year. But if those targets were undemanding and easy to achieve, where’s the victory? If ambitious targets are set, then measures can themselves drive innovation. Ambitious targets—stretch goals—can force people to think innovatively, to think out of the box, and literally force them to find new ways of doing things. Setting a stretch goal means calling for a 50 to 100 percent improvement in performance rather than an incremental 5 to 10 percent gain. Stretch goals are based on what should be attempted rather than on what can be accomplished.
When they set ambitious targets, companies should reward good performance, even if the targets are missed, because this is better than shooting low and rewarding only those who achieve relatively modest goals. The employee who aims for a 10 percent improvement and achieves 15 percent deserves only a bronze medal. A silver medal should go to the one who aims for 30 percent and hits 40 percent. The gold goes to the one who aims for 100 percent and achieves 50 percent.

Setting stretch goals is a driver of innovation. With incremental goals (5 to 10 percent), you tend to focus on small parts of your business. You can afford to change 1 to 2 percent of your business, and if you do it three or four times, you might hit your goal. With stretch goals (let’s say greater than 50 percent), you can’t do that. You can’t look at the boxes, because you’ll never get there. You have to focus on the lines of the organization as a whole and make radical change. That drives innovation.

A company that made the impossible happen was a greeting- card firm whose senior executives set a stretch goal of getting new cards from concept to market within a year. In the past, cards had taken from 18 to 24 months to move from their original conception to shop shelves. Individual departments within the firm—the designers, writers, artists, printers, shippers, and so on—were aghast at the idea. Surely the executives did not understand what it took to produce cards? But the target became a rallying cry, and so successful was it that in the end the company managed to get its cards to market in only four months. The “impossible” goal had forced people to abandon their conventional approaches and to try something completely new.

Measuring Performance Capabilities
Interest in performance measurement and its management has skyrocketed over the past few years. Different frameworks and methodologies—for example, the balanced scorecard, the business excellence model, the shareholder-value-added model, activity-based costing (ABC), cost of quality, and competitive benchmarking—have all generated great interest and activity, not to mention consulting revenues. But they have not always generated the innovation needed for business success.

The best known of them all is probably the balanced scorecard, a framework that grew out of the widespread dissatisfaction in the late 1980s with the tight focus on the financial dimension. The idea was popularized by Robert Kaplan, a Harvard Business School professor of accounting, and David Norton, a management consultant, in the Harvard Business Review in the early 1990s. Behind their concept was the recognition that only if you look beyond financial results, and measure things from other perspectives, will you be able to achieve other goals. Kaplan and Norton argued that there are four elements that should be included in measurement architecture. Companies that take into account all four types will have what they termed a balanced scorecard and, by implication, all-around well-balanced results.
The four measurement categories they identified are financial, customer, internal/operational, and innovation/learning. The popularity of the scorecard can be explained partly by its simplicity and partly by the fact that it can be applied to almost any business situation. A significant problem with it is that managers become obsessed with the wrong question, the same trap I mentioned earlier. They ask, “What can we or should we measure?” What they should be worrying about is the more fundamental question: “What questions do we want to be able to answer when we have access to our measurement data?” As a result, too many managers have focused primarily on what can be measured, instead of what must be measured. Of particular relevance is the fact that the innovation/learning dimension was typically reduced to measuring employee satisfaction. Data on employee satisfaction may be interesting, but as this chapter shows, it doesn’t answer the right questions.

The balanced scorecard’s shortcomings also include the fact that many stakeholders—suppliers, intermediaries, regulators—are not included. Hence it is not uncommon to end up with what has been dubbed a “biased scorecard”—that is, a scorecard biased towards only certain, often easy to measure, stakeholders.

Other companies have adopted shareholder-value-added frameworks that plug the cost of capital into their equation but ignore everything (and everyone) else. Both activity-based costing and the cost-of-quality frameworks are views that ignore other perspectives on performance— such as the interests of customers and employees. And none of them puts the emphasis on innovation as an effect of the measures.
The popular practice of benchmarking, on the other hand, takes a largely external perspective, often comparing the performance of business operations with that of competitors or best practitioners. However, this kind of activity is frequently pursued as a one-off exercise aimed at generating ideas for—or gaining commitment to—short-term innovation or improvement initiatives. It is not, by and large, used as part of the design of a formalized ongoing system for performance measurement.

These widely varying measurement frameworks can coexist in the business world because they all add some kind of value. They all provide their unique perspectives on performance, furnishing managers with a different set of lenses through which to assess their organizations.
In some circumstances, an explicit focus on shareholder value—at the expense of everything else—will be exactly the right thing for an organization to do. In other circumstances, or even in the same organization but at a different point in time, it would be suicide. At times, the balanced scorecard or the business excellence model (or some combination of the two) might be the answer. For example, the new CEO of a company that puts too much emphasis on paring down costs and the short-term interests of shareholders may find the balanced scorecard or business excellence framework a useful way to switch the company’s attention toward the interests of customers, the improvement of operations, and the development of innovative products and services.

Distorting Measures
Risks appear when one part of the business is improved dramatically while other parts are allowed to deteriorate. This can be a result of too much focus on financial measures to the detriment of process measures; a heavy emphasis on one dimension, quality, for example, that has a negative affect on another, such as time; or a focus on one process without considering its impact on other processes. For example, in a move that improved the appearance of its books, a large beverage company kept fully depreciated vending machines in operation well beyond their normal useful life. The firm’s customers suffered, however, because as the machines got older, they broke down more frequently. What looked good on the books was in fact evidence of a deteriorating business. Or consider the manufacturer that found it was losing business and had an extremely low rate of customer retention (a nonfinancial measure) because of its poor service. That insight spurred the company to find innovative ways to improve its service, and as a result its sales (a financial measure) increased.

A misguided focus on any one measure is sure to distort behavior. A few years ago, for example, a well-known retailer measured the performance of its auto centers on volume alone. This led to massive fraud, as the centers started billing customers for repairs that weren’t necessary and that sometimes were not even performed. The fraud eventually landed the company in court. While this is an extreme example, it does show how true it is that you get what you measure.

Another classic mistake is sales being measured on revenue rather than profit. A company that sells electronic goods, for example, that wanted to create an incentive system for its salespeople, decided to create a reward if the salespeople were able to get the customers to purchase five add-ons, like modems and mousepads. It was later realized that the incentive should have been based on the overall margin of the shopping cart, not the number of items it contained. It is tempting for the customer to fill a cart with a pile of low-margin, cheap products that bring nothing to your bottom line.

It is not always necessary to have a multitude of measures to achieve a balanced outcome. It is possible for a single measure to provide the necessary balance. For example, the purchasing department of one company used to measure its success in terms of how successful it was at buying the lowest-cost items available. Over time, however, the department found that low initial costs sometimes meant long lead times, less frequent deliveries, and large minimum orders—all of which contributed to increased inventory levels. So the department modified its measures in a way that allowed it to track costs over the entire life cycle of the items. This was a single measure, but one that encouraged people to balance low cost with quality.

A vivid example of the failure to balance costs with quality occurred at an American municipality that suddenly became painfully aware of the large sums of money it was spending every year on filling potholes. In order to control these expenditures, the municipality encouraged its staff to use cheaper materials. They did so, only to find that these materials lasted for a much shorter time than the more expensive variety. The municipality found itself spending even more than it had done previously because it had to repair the potholes more frequently.

Measures should not drive improvements in one area at the expense of others or (especially) at the expense of the organization as a whole. To avoid this, organizations need to be aware of the way their operations interact. A major American HMO tried to keep a holistic perspective when it reengineered its primary-care delivery. This level of care was delivered to patients either over the phone or in a doctor’s office. The managers were careful not to “optimize” the call center to the point of hyperefficiency. They set flexible targets for the length of time the nurses could stay on the phone with patients. They allowed longer calls because they knew that handling a patient’s complaints by phone costs about one tenth of the cost of giving the same advice in a doctor’s office. Allowing longer calls enabled the nurses to handle a greater number of patient complaints and thus minimize the number of expensive visits to a doctor’s office. By keeping their eye on the overall goal—the delivery of good- quality patient care at lower cost—the designers developed two separate operations—call center and office visits—that complemented and enhanced each other.

Measuring the Future
Measures must describe not only what has happened, but also help determine what should happen in the future. A common fault of measurement architecture is to focus only on those things that have already occurred— the number of sales, total costs, and so on. These backward-looking measures are important, but they need to be balanced with forward-looking ones. For example, how many sales leads are in the pipeline? Which expenses are projected to be over- or underbudget? What proportion of customers intend to make repeat purchases?
When developing a measurement architecture, consider the ratio of backward-looking to forward-looking measures, and rethink the architecture if the ratio is too heavily weighted toward one or the other. Then, with a healthy stock of future-oriented measures in place, it is much easier for corrective action to be taken early and for problems to be addressed while they are still relatively small. A problem that is on the horizon can be fixed before it can cause any harm. Once a problem has already occurred, however, the damage has been done.

A team redesigning the primary-care delivery process at a large HMO found itself struggling to identify the right measures. Historically, the HMO had counted the number of procedures that doctors performed and what those procedures cost. In the future it wanted to measure things such as the overall health of its member population, the degree to which preventive health procedures were reaching the community, and the relative success of different protocols on a given health problem. The HMO knew that it was difficult to define measures for such things and that it would require extensive new procedures for collecting data. But it also knew that it had to have the new data in order to assess whether its desired outcomes (lower costs per member and better health for the member population) were being achieved, so it proceeded to develop the wider measures.
Future-oriented measures also help identify new opportunities. While they cannot actually measure the future, they can spot trends. For example, the recent shifts from the automobile to the sports utility vehicle, from beef to chicken, from vacations at home to vacations abroad all represented innovative business opportunities. The company that routinely measures where things are going stands a good chance of capitalizing on such trends before its competitors do.

Aligning Measures and Rewards
The organization’s overall reward system must be aligned with the measures so that the implementers are motivated to perform. Individual compensation packages should be linked to outcomes. Compensation should be linked only to those things that employees can control and influence. They must be able to produce an improvement in the results by adjusting their behavior. It is unfair, and ultimately demotivating, to give people responsibility for results over which they have no control.

The focus on individual performance (and individual rewards) runs deep in some cultures. When a large U.S. utility became concerned that it was taking up to two years to get relatively simple new products to market, it realized that an individual product manager was in charge of designing, developing, and launching every new product single-handedly. But that manager invariably needed the cooperation of people from finance, sales, IT, training, and the legal department, and he often had to beg them for help. When they didn’t deliver, the manager had to hunt them down and beg for cooperation. In the end, only the product manager was being held accountable for the product’s timeliness and success. When its new-product procedures were redesigned, the company created cross-disciplinary product-development teams. An entire team was then held accountable for each product’s success.

This kind of excellence depends vitally on teamwork. If a team fails to produce the expected outcomes, but individual members of that team receive stellar performance reviews, the foundation of the team and the prospects of success for the process will be undermined. Team members have to learn to succeed and fail together. When a computer company set up a new call center, it arranged for 80 percent of the performance measures to be team-based rather than individually based. The 30-member team, motivated thus to support the work of their teammates, became so adept at working together that they only required the supervision of a manager for less than a half day a week.

 

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