5.4 Maintain Control: Managing the System

A clear picture of the organization’s overall performance and underlying strategic architecture provides valuable insights into how decisions should be guided. The first observation is that using financial outcomes to guide decisions is likely to be hopeless. Clearly, the immediate consequences must make sense: You do not want to spend what you cannot afford, or price your product so high as to kill current sales or so low as to destroy margin. But this is not strategic control.

A simple principle guides how strategic decisions should be viewed: Strategic managementA process concerned with the key objectives of an organization, the use of its resources, and enhancing the organization's performance in its environments. Flow rates are key aspects of an organization's strategies. is all about flow rates!

To appreciate the implications of this view, think about how our airline team might set a rule of thumb for its marketing spending. Some of the possibilities from which to choose include:

• Marketing spending should not exceed a set fraction of revenue.
• If profits dip too low, cut marketing by a fraction.
• Check that marketing does not exceed a specified cost per passenger journey sold.
• Spend more on marketing if planes are not full.
• Spend more on marketing if regular customers are being lost.

However, marketing directly affects just two main items: the frequency with which existing passengers travel with your airline and the rate at which new passengers are won. Marketing is not the only factor driving these values, but these values are the only significant things being driven by marketing! These, then, should be the focus of the decision rule for marketing because they are closely coupled to the decision variable.

The further you move away from this principle, the more likely it becomes that your decision rule will cause serious problems. It is astonishing, for example, how many organizations stick to “percent of sales” ratios to decide their spending on everything from research and development (R&D) to marketing, training, and maintenance. Just think how this would work for your restaurant:

• Labor cost must not exceed 15% of sales.
• So, if sales fall for some reason, you cut staff.
• So service quality drops, and sales decline.
• So you cut staff again to keep within your 15%!

You become trapped in a cycle of decline. This makes no sense, and in practice, managers usually avoid such foolish consequences. But why start with a decision guide that makes no sense in the first place? Pressure from investors who may not understand the structure of the strategic architecture often does not help.

So which performance metricsMeasures of the difference between an organization's targeted and actual performance. guide decisions best? Many organizations now use some form of balanced scorecard: an integrated approach to performance measurement and management (Kaplan & Norton, 1996). This recognizes that financial factors alone provide inadequate targets and incentives and so adds measures relating to

• customers: satisfaction, retention, market share, and share of business;
• internal performance: quality, response times, cost, and new product introductions;
• learning and growth: employee satisfaction and availability of information systems.

Only if these additional factors are in good shape will the firm deliver strong financial performance. The balanced scorecard offers important advances over traditional reporting approaches in recognizing the interconnectedness within the business and the importance of measuring and managing “soft” issues. Increasing training of staff about products, for example, will improve sales effectiveness, which in turn will improve sales and margins.

There are limits, though, to the control that a balanced scorecard can achieve if it is not designed to take account of the dynamic interactions that run through the organization’s architecture. There are two particularly common failings:

1. What may be good for an indicator under one condition may be bad under other situations. A common example is the winning of new business when the organization cannot cope with what it already has.
2. The optimum balance between different parts of the architecture often shifts substantially as situations develop. Early in the growth of a business, service capacity may need to be a rather minor part of the organization’s total activity, but later it can come to dominate as business builds up. Similarly, you may want to keep staff turnover very low when trying to build capability in a rapidly developing organization, but some rate of staff losses may be positively helpful when growth slows in order to make room for new people to develop.