July 2005 – performance measures make a difference

The Work Foundation held one of those stage-managed report launches last week. You know the sort, where people find a posh venue – in this case the new London Stock Exchange near St Paul’s Cathedral – only to experience all kinds of technical glitches that send foreheads plunging disconsolately in to cupped hands.

The venue itself was difficult enough. After entering it in my diary I went to London without my aide memoir and wandered first in to the Work Foundation headquarters just off Pall Mall. A colleague on another newspaper faired slightly better in finding his way to the old Stock Exchange Building.

Once in situ we were entertained by the volatile cocktail that often results when people and technology combine in an effort to be slick and presentational. Microphones cut out and the on-screen presentations of chief executives were reduced to the vocal power of a shrew with a sore throat.

None of this mattered because the Work Foundation had come up with a robust study of nearly 3000 companies with the aim of taking companies one step closer towards finding the missing link between productivity and profit.

Cracking the Performance Code*, as Steve Bevan, the foundation’s director of research admits, does not quite deliver this elixir of business. But it does present enough guidance, supported by meaty evidence, to put any companies that are prepared to sit up and take notice on the right path.

The report was born of a national neurosis about productivity that continues to undermine the UK government’s confidence in the international competitiveness of British companies.

For some time the Work Foundation has been working on a formula that it might use to assess corporate performance. It has settled on something it calls its Company Performance Index that evolved from consultations with chief executives aimed at selecting a combination of factors that underpin financial success.

To test the success of the index it was applied to predict the share returns of companies at either end of the scale in the past year. Those that performed poorly against the index returned a six per cent increase in share value against a 26 per cent average gain among those at the top of the index. This was during a 13-month period when the average price gain for the UK stock market as a whole was 14 per cent.

With a formula as predictive as that, you would think the Work Foundation would be tempted to switch its emphasis from think tank to fund management. “Unfortunately we didn’t actually invest in the shares or we would be rich,” says Marc Cowling, the foundation’s chief economist, who created the index.

The index measures corporate effectiveness in five areas: customers and markets, shareholders and governance systems, stakeholder relationships, human resources practices and the management of innovation and creativity. Within these five measures, says Mr Cowling, the indices covering people and innovation were the best predictors of operational performance.

This is by no means the first study to make the link between HR and corporate performance, but the Work Foundation is bullish about its robustness. It points out that, unlike many other studies, it has factored in other contributing areas to organisational success. This enables it to deal, at least in some part, with the sceptical responses of executives who might ask, for example, about the relative impact of advertising, brand exposure and new products and markets.

As Mr Cowling points out, the real skill of running a business consistently is understanding the interrelation of the various factors that make the enterprise successful. “Most companies will have a board meeting and notice that their absenteeism levels are higher than the sector average, then tell their HR department to fix it. But the real problem might have something to do with boredom because employees have too little opportunity to express their creativity,” he says.

While the report urges companies to keep their processes simple, allowing higher degrees of informality, the degree of complexity and weightings given to the index suggests that the relationship between corporate strategies can be equally complex. The report will not satisfy those companies seeking an easy fix.

One or two individual findings might cause some surprises. Many companies are forever working on their organisational structure yet structure was found to be far less important than management style. Open communications, less formal processes, a value of quality over quantity in work and a concentration on long-term outcomes were highlighted for their positive impact.

Such issues tend to be recognised by the most successful companies and these include those used as case studies in the report. What I continue to find puzzling, however, is the failure of some companies to raise their management systems beyond the mediocre.

It would be helpful, therefore, to see the duffers exposed. Virtually all large academic studies of companies, however, have an arrangement where companies are only featured when they give their consent. Companies that are among the poor performers highlighted in the research are likely to be embarrassed by the findings so their names are not featured. But if an index such as the CPI is used against the whole stock market it will lead inevitably to performance rankings where laggards are identified.

This may be no bad thing since it will force more companies to pay attention to issues other than their profit and loss account. Executives at the report launch had mixed views on the use of some generic measure, say, of human capital management. But I see this as the only way to ensure that companies will raise their game in the crucial area of employee involvement.

The idea of the OFR is to provide investors with ways of assessing the future prospects of a company. One good way to do so is to provide the means to compare companies. Various organisations, including the Financial Times, rank “best companies to work for”. But this is not enough for investors who want to see a clear relationship between employment policies and profit.

The markets need some consistent, broadly accepted measures. Ultimately there needs to be some global standards in human capital measuring. The emergence of the OFRs has provided the UK corporate sector with a rare opportunity to lead the international corporate community if its response is to develop and adopt such measures.

The Work Foundation index might be one solution. Another might be a bundle of generic measures that are common to all businesses. An employee turnover measure, for example, might be unsuitable because of the variable needs of different businesses. All businesses, on the other hand, could be rated on their profit per employee. One outcome of that, however, is that companies could be tempted to get rid of their less profitable employees, choosing to outsource as an alternative.

The most significant feature of the Work Foundation research is that it has found a cocktail of indicators that can differentiate the best performers from the rest. The implications for investment and the challenge for businesses to respond are clear, but only if the markets are provided with a valid basis to make comparisons.

* The report can be downloaded from www.theworkfoundation.com