Building healthy businesses in the 21st century

Managing companies for success across a range of time frames—a requisite for achieving both performance and health— one of the toughest challenges in business. Recently, it has been especially hard: turbulent economic conditions, for example, have concentrated the collective minds of many executives on pure survival. The fact that 10 of the largest 15 bankruptcies in history have occurred since 2001 is a strong deterrent to business building, playing up its inherent risks.

Businesses complain that financial markets increasingly focus on quarterly results and give little credit to strategies for creating longer-term value, particularly if they depress today's profits. Empirical evidence largely contradicts such claims (see sidebar, "The stock market values health as well as performance"). But some noisy analysts undoubtedly do focus on short-term performance and thus unwittingly drive wedges between managements, boards, and investors.

Management teams must urgently take the lead in showing their boards and the capital markets that they are nurturing the long-term health of their companies. They must act not only to improve corporate performance in the near term but also to lay the foundations today for consistent and resilient growth in years to come.

Companies out of balance

Tools intended to encourage a more balanced approach and to promote "systems thinking" have been available to managers for some time. But our experience suggests that these tools are either being applied too mechanically or being squeezed out by the focus on survival and by perceived pressure from investors. And that's to say nothing of the increased near-term demands created by new regulations on financial reporting, particularly in the United States.

Good short-term results are important, of course; only by delivering them will management build confidence in its ability to realize longer-term strategies. But companies must also act today to ensure that they can convert their growth prospects, capabilities, relationships, and assets into future cash flows.

What underlies the breakdown of many long-term initiatives is the tendency of managers to defend the performance of their own silos instead of debating and helping to shape action across the whole organization. In silo-structured companies, managers typically argue about the virtues of one metric as opposed to another (especially if transfer prices are involved), deflect debate to other parts of the organization, and set up barriers to change. This kind of behavior isn't deliberately malevolent; it is driven by deeply held beliefs about a manager's roles and boundaries and reinforced by the idea that the body corporate is the sum of many discrete units, each with independent characteristics, that should be monitored with a battery of metrics. Unfortunately, this mind-set undermines any systemic understanding of how to manage activities coherently, across the whole organization, to underpin healthy growth.

An emerging awareness of health

The good news is that a clear health consciousness is developing after the startling corporate-health failures of recent years, and convincing prescriptions for change are emerging. In responses to a McKinsey survey, conducted in early 2005, more than 70% of board directors made it clear that they want to devote less time to discussing the latest financial results and much more to setting strategy, assessing risks, developing new leaders, and monitoring other issues that underpin a company's long-term health.  While 30 percent of the directors want additional information on organizational issues, such as skills and capabilities and about markets: a more detailed analysis of customers, competitors, and suppliers etc. Above all, boards want to help their companies seize prospects for long-term growth and avoid exposure to risks from organizational blind spots or from any unwillingness to acknowledge external change. Thinking deeply about performance and health helps executives to address both aspirations.

What makes companies healthy?

Companies that attend to five different aspects of performance and health can build the resilience and the organizational capacity not only to deliver but also to sustain both.

Strategy

First, a company's strategy should be reflected in a portfolio of initiatives³that consciously embraces different time horizons. A typical large company does, of course, include business units with distinct strategies, but few of them could really help it adapt to events or capitalize on new opportunities. Some initiatives in the kind of portfolio that we recommend should bolster a company's short-term performance. Others should create options for the future—new products or services, new markets, and new processes or value chains. A key management challenge is to design and implement initiatives that balance the company's performance and underlying health on a risk-adjusted basis.

Such a portfolio of initiatives helps companies overcome certain traditional shortcomings of strategy, such as its episodic nature and a tendency to ignore the resources and capabilities needed for execution and to plan the future instead of for the future. By developing and managing a portfolio of initiatives—rather than a single approach to strategy—companies can lower the risk that unpredictable events will place them on the wrong foot.

Metrics

A robust set of organizational metrics allows executives to monitor a company performance and health. What's needed is a manageable number of metrics that strike a balance among different areas of the business and linked directly value creation. 

Companies should identify the health and performance metrics most important to them: product development, customer satisfaction, government relations, or the retention of talent. Most organizations track standard financial metrics but must expect some metrics to cover operations (the quality and consistency of key value-creating processes), organizational issues (the company's depth of talent employees), the state of the company's product markets and its position within them ( the quality of customer relationships), and the nature of relationships with external parties and stakeholders.

Systematically identifying and tracking health metrics that reflect the strategy of a business and the forces driving its value—is difficult. A useful framework is to think of value creation in the short, medium, and long term.

  Short-term health metrics show how a company achieved its recent results and thus indicate its likely performance over the next one to three years. A consumer products company, for example, must know whether it increased its profits by raising prices or by launching a new marketing campaign that increased its market share.

 Another set of metrics should highlight a company's prospects for maintaining and improving its rate of growth and returns on capital. Medium-term metrics should be monitored as well—for example, metrics comparing a company's product launches with those of competitors. For an online retailer, customer satisfaction and brand strength might be the most important drivers of medium-term health.

  For the longer term, companies should develop metrics assessing their ability to sustain earnings from their current activities, identify and exploit new areas where they could grow. They must monitor any threats—new technologies, new customer preferences, new ways of serving customers—to their current businesses. And to ensure that they have enough growth opportunities to create value when those businesses mature, they must monitor the number of new initiatives and develop metrics that track initiatives' progress.

 Management should monitor no more than three to five metrics, representing different areas of the business for each time frame. To make sure that the metrics are appropriate, the Finance or the Human resource department  should regularly reexamine the way the company creates value.

Communication

Companies to change the nature of their dialogue with key stakeholders, particularly the capital markets and employees. For the capital markets, first identifying investors who will support a given strategy and then attracting them.Talking about corporate health to court hedge fund managers pursuing the next bid, for example, is pointless.

Management teams should also spend serious time with analysts who follow their companies, in order to explain their views on the industry and to show how strategies will create sustainable advantages. It may also be necessary to highlight metrics tracking performance and health. Vague talk about shareholder value without addressing the specifics of a business, just isn't meaningful.

Companies might also be wise to separate discussions of quarterly results from those focusing on strategy, as several major international businesses have recently done. And they should ensure that analysts spend time with operational managers, whose effectiveness is often the crucial factor in attempts to estimate a company's ability to sustain its performance.

Reaching out to employees is just as important. The complaint that "we don't know what's going on" often indicates that a company's leaders are communicating results rather than long-term intentions.

Leadership

Corporate leaders should remember their obligation to manage both performance and health. Thinking about health typically requires a range of new skills and characteristics. One hallmark of great, enduring companies is a willingness to involve future generations of leaders in their own development. A good leaders understand both the power and the attendant risks of "extraordinary amplification system." Those who casually or randomly articulate themes for action run a risk of making the organization schizophrenic. The combination of "initiative overload" and a reluctance on senior management's part to produce a simple and coherent agenda can be particularly damaging.

Focusing the leadership on personal behavior is also crucial to maintaining a company's health.  Companies can likewise encourage a wider perspective on the business, and stronger linkages across boundaries, by giving senior managers a portfolio of roles. Alternatively, some companies have successfully developed peer groups of business unit leaders who share a collective responsibility for their businesses. Other companies are strengthening their core functions and reversing the trend toward corporate atomization into a number of semiautonomous business units.

To create this kind of leadership, companies must take a longer-term view of the way they manage talent and career tracks and of the incentives created by money, recognition, and promotion. One company's approach is to implement a long-term incentive plan for top management—a plan that has weakened the direct link between remuneration and short-term earnings. By contrast, the current trend of making people change roles every two or three years isn't necessarily good for long-term corporate health.

Governance

The growing demand for corporate probity and better governance has reinforced the CEO's pivotal leadership role. Board meetings therefore represent a useful opportunity—and discipline—for testing the organization's resilience to pressure and change over time. As we have seen from our survey, directors are eager to redirect their attention to this task. The need for resilience is greatest when investments take a long time to pay off, as they generally do for natural-resource and pharmaceutical companies and public-sector bodies. CEOs and boards lack rapid performance feedback in such cases and thus need to keep a close eye on a range of considerations: regulatory influence, marketing and supplier partnerships, and organizational skills.

Given the current economic and regulatory environment, a focus on short-term performance is understandable, but it is nonetheless unbalanced. Companies must again learn how to meet next year's earnings expectations while at the same time implementing the platforms needed to deliver strong and sustainable earnings growth year after year. Achieving this dual focus involves thinking about strategy, communication, and leadership in new ways. And it calls for the creation of a carefully designed set of metrics—balanced across the business and linked to the creation of value over the short, medium, and long term—that can help management teams and boards monitor their ability to stay on course.