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Successful strategy execution has two basic rules: Mastering the understand the management cycle that links strategy and Management System operations, and know what tools to apply at each stage of the cycle. by Robert S. Kaplan and David P. Norton

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Successful strategy execution has two basic rules: understand the management cycle that links strategy and operations, and know what tools to apply at each stage of the cycle.

Mastering the Management System

by Robert S. Kaplan and David P. Norton

Not long after its successful IPO, the Conner corporations—have learned how Gresham’s Corporation (not its real name) began to lose Law applies to their management meetings: its way. The company’s senior executives Discussions about bad operations inevitably continued their practice of holding monthly drive out discussions about good strategy one-day management meetings, but their implementation. When companies fall into focus drifted. this trap, they soon find themselves limping The meetings’ agenda called for a discus- along, making or closely missing their num- sion of operational issues in the morning and bers each quarter but never examining how strategic issues in the afternoon. But with the to modify their strategy to generate better company under pressure to meet quarterly growth opportunities or how to break the targets, operational items had started to pattern of short-term financial shortfalls. crowd strategy out of the agenda. Inevitably, Analysts, investors, and board members start the review of actual monthly and forecast to question the imagination and commitment quarterly financial performance revealed rev- of the companies’ management. enues to be lower, and expenses to be higher, In our experience, however, breakdowns in than targeted. The worried managers spent a company’s management system, not manag- hours discussing how to close the gap through ers’ lack of ability or effort, are what cause a pricing initiatives, capacity downsizing, SG&A company’s underperformance. By manage- staff cuts, and sales campaigns. One executive ment system, we’re referring to the integrated noted, “We have no time for strategy. If we set of processes and tools that a company uses miss our quarterly numbers, we might cease to to develop its strategy, translate it into opera- exist. For us, the long term is the short term.” tional actions, and monitor and improve the Like Conner, all too many companies— effectiveness of both. The failure to balance including some well-established public the tensions between strategy and operations OPYRIGHT © 2007 HARVARD BUSINESS SCHOOL PUBLISHING CORPORATION. ALL RIGHTS RESERVED. BUSINESS SCHOOLOPYRIGHT © 2007 HARVARD PUBLISHING CORPORATION. C

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Mastering the Management System

is pervasive: Various studies done in the past planning, operational execution, and feed- 25 years indicate that 60% to 80% of compa- back and learning. We present a range of nies fall short of the success predicted from tools that managers can apply at the different their new strategies. stages, most developed by other manage- By creating a closed-loop management ment experts and some of our own design. system, companies can avoid such short- (See “A Management System Tool Kit” for falls. (See the exhibit “How the Closed-Loop further reading on the tools discussed.) We Management System Links Strategy and will show how these can all be integrated in Operations.”) The loop comprises five stages, a system that links the management of strat- beginning with strategy development, which egy and operations. involves applying tools, processes, and con- cepts such as mission, vision, and value state- Stage 1: Develop the Strategy ments; SWOT analysis; shareholder value The management cycle begins with articulat- management; competitive positioning; and ing the company’s strategy. This usually takes core competencies to formulate a strategy place at an annual offsite meeting during statement. That statement is then translated which the management team either incre- into specific objectives and initiatives, using mentally improves an existing strategy or, on other tools and processes, including strategy occasion, introduces an entirely new one. (Our maps and balanced scorecards. Strategy im- experience suggests that strategies generally plementation, in turn, links strategy to opera- have three to five years of useful life.) Devel- tions with a third set of tools and processes, oping an entirely new strategy may take two including quality and process management, sets of meetings, each lasting two to three reengineering, process dashboards, rolling days. At the first, executives should reexamine forecasts, activity-based costing, resource the company’s fundamental business assump- capacity planning, and dynamic budgeting. tions and its competitive environment. After As implementation progresses, managers con- some homework and research, the executives tinually review internal operational data and will hold the second set of meetings and de- external data on competitors and the business cide on the new strategy. Typically, the CEO, environment. Finally, managers periodically other corporate officers, heads of business and assess the strategy, updating it when they regional units, and senior functional staff learn that the assumptions underlying it are attend these strategy sessions. The agenda obsolete or faulty, which starts another loop should explore the following questions: around the system. What business are we in and why? This A system such as this must be handled question focuses managers on high-level carefully. Often the breakdown occurs right at strategy planning concepts. Before formulat- the beginning, with companies formulating ing a strategy, managers need to agree on their grand strategies that they then fail to trans- company’s purpose (mission), its aspiration late into goals and targets that their middle for future results (vision), and the internal and lower managers understand and strive to compass that will guide its actions (values). achieve. Even when companies do formalize The mission is a brief statement, typically their strategic objectives, many still struggle one or two sentences, that defines why the because they do not link these objectives to organization exists, especially what it offers to Robert S. Kaplan ([email protected]) tools that support the operational improve- its customers and clients. The pharmaceuti- is the Baker Foundation Professor at ment processes that ultimately must deliver cal firm Novartis presents a good example: Harvard Business School in Boston. on the strategy’s objectives. Or, like Conner, “We want to discover, develop and success- David P. Norton (dnorton@ they decide to mix discussions of operations fully market innovative products to prevent bscol.com) is the founder and director and strategy at the same meeting, causing and cure diseases, to ease suffering and to of the Palladium Group, based in a breakdown in the strategic-learning feed- enhance the quality of life. We also want to Lincoln, Massachusetts. They are the back loop. provide a shareholder return that reflects authors of The Execution Premium: In the following pages we draw upon our outstanding performance and to adequately Linking Strategy to Operations for extensive research and experience advising reward those who invest ideas and work in Competitive Advantage (Harvard companies, as well as nonprofit and public our company.” Business School Press, forthcoming sector entities, to describe the design and The vision is a concise statement that de- in 2008). implementation of a system for strategic fines the mid- to long-term (three- to 10-year) harvard business review • january 2008 page 2

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Mastering the Management System

How the Closed-Loop Management System Links Strategy and Operations Most companies’ underperformance is due to breakdowns between strategy and operations. This diagram describes how to forge tight links between them in a five-stage system. A company begins by developing a strategy statement and then trans- lates it into the specific objectives and initiatives of a strategic plan. Using the strategic plan as a guide, the company maps out the operational plans and resources needed to achieve its objectives. As managers execute the strategic and operational plans, they continually monitor and learn from internal results and external data on competitors and the business environment to see if the strategy is succeeding. Finally, they periodically reassess the strategy, updating it if they learn that the assumptions underlying it are out-of-date or faulty, starting another loop around the system.

1 STAGE DEVELOP THE STRATEGY

Define mission, vision, and values Conduct strategic analysis Formulate strategy E G TRANSLATE Strategic TEST AND ADAPT TAGE TA 2 5 S S THE STRATEGY plan THE STRATEGY

Define strategic Strategy map Conduct profitability performance objectives and themes Balanced analysis metrics Select measures scorecard Conduct strategy and targets StratEx correlation analysis Select strategic Examine emerging initiatives strategies

results E G PLAN Operating MONITOR TA 3 4 STAGE S OPERATIONS plan AND LEARN Dashboards Improve key processes Hold strategy reviews Budgets Develop sales plan Pro forma performance Hold operational reviews Plan resource capacity P&Ls metrics Prepare budgets

results

Execute processes and initiatives

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Mastering the Management System

A Management System Tool Kit Where to learn more about the concepts and frameworks described in this article

Develop the Strategy the New Business Environment, Harvard Business School Competitive Strategy Press, 2000 Michael E. Porter, Competitive Advantage: Creating and Sus- Robert S. Kaplan and David P. Norton, Strategy Maps: Con- taining Superior Performance, Free Press, 1985 (republished verting Intangible Assets into Tangible Outcomes, with a new introduction, 1998) Harvard Business School Press, 2004 Michael E. Porter, Competitive Strategy: Techniques for An- Robert S. Kaplan and David P. Norton, The Execution Pre- alyzing Industries and Competitors, Free Press, 1980 (re- mium: Linking Strategy to Operations for Competitive Ad- published with a new introduction, 1998) vantage, Harvard Business School Press, 2008 Michael E. Porter, “What Is Strategy?”, Harvard Business Re- view November–December 1996 Plan Operations Process Improvement Chris Zook and James Allen, Profit from the Core: Growth Wayne W. Eckerson, Performance Dashboards: Measuring, Strategy in an Era of Turbulence, Harvard Business School Monitoring, and Managing Your Business, John Wiley & Press, 2001 Sons, 2006 Resource-Based Strategy Michael Hammer, Beyond Reengineering: How the Process- Jay B. Barney, Gaining and Sustaining Competitive Advan- Centered Organization Is Changing Our Work and Our Lives, tage—3rd edition, Prentice-Hall, 2006 HarperBusiness, 1996 Jay B. Barney and Delwyn N. Clark, Resource-Based The- Peter S. Pande, Robert P. Neuman, and Roland R. Cavanagh, ory: Creating and Sustaining Competitive Advantage, Oxford The Six Sigma Way: How GE, Motorola, and Other Top Com- University Press, 2007 panies Are Honing Their Performance, McGraw-Hill, 2000 David J. Collis and Cynthia A. Montgomery, “Competing on James P. Womack, Daniel T. Jones, and Daniel Roos, The Ma- Resources: Strategy in the 1990s”, Harvard Business Re- chine That Changed the World: The Story of Lean Pro- view July–August 1995 duction, Macmillan, 1990 Gary Hamel and C.K. Prahalad, Competing for the Future, Budgeting and Planning Resource Capacity Harvard Business School Press, 1994 Jeremy Hope and Robin Fraser, Beyond Budgeting: How Blue Ocean Strategy Managers Can Break Free from the Annual Performance W. Chan Kim and Renée Mauborgne, Blue Ocean Strategy: Trap, Harvard Business School Press, 2003 How to Create Uncontested Market Space and Make the Robert S. Kaplan and Steven R. Anderson, Time-Driven Competition Irrelevant, Harvard Business School Press, 2005 Activity-Based Costing: A Simpler and More Powerful Path Disruptive Strategy to Higher Profits, Harvard Business School Press, 2007 Clayton M. Christensen and Michael E. Raynor, The Innova- tor’s Solution: Creating and Sustaining Successful Growth, Test and Adapt Strategy Harvard Business School Press, 2003 Dennis Campbell, Srikant Datar, Susan L. Kulp, and V.G. Narayanan, “Testing Strategy Formulation and Implemen- Emergent Strategy tation Using Strategically Linked Performance Measures”, Gary Hamel, “Strategy Innovation and the Quest for HBS Working Paper, 2006 Value”, Sloan Management Review Winter 1998 Thomas H. Davenport and Jeanne G. Harris, Competing on Henry Mintzberg, “Crafting Strategy”, Harvard Business Re- Analytics: The New Science of Winning, Harvard Business view July–August 1987 School Press, 2007

Translate the Strategy Anthony J. Rucci, Steven P. Kirn, and Richard T. Quinn, “The Robert S. Kaplan and David P. Norton, The Strategy-Focused Employee-Customer-Profit Chain at Sears”, Harvard Busi- Organization: How Balanced Scorecard Companies Thrive in ness Review January–February 1998

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goals of the organization. Cigna Property and company’s resources with at least the same vigi- Casualty, an insurance company division we lance that we would use to guard and conserve worked with in the 1990s, stated its goal this our own personal resources. way: “to be a top-quartile specialist within 5 • We are believers in the Golden Rule. In all years.” Though short, this vision statement our dealings we will strive to be friendly and cour- contained three vital components: teous, as well as fair and compassionate. • Stretch goal: “top quartile” in profitability • We feel a sense of urgency on any matters re- (at the time, Cigna P&C was at the bottom of lated to our customers. We own problems and we the fourth quartile). are always responsive. We are customer-driven. • Definition of market focus: “a specialist,” The reaffirmation of mission, vision, and val- not a general-purpose underwriter, as it was at ues puts executives in the right mind-set for the time. considering the rest of the agenda and setting •A time line for execution: “5 years” the company’s fundamental guidelines. (a heartbeat in the slow-moving insurance What are the key issues we face in our busi- industry). ness? With mission, vision, and values estab- The stretch goal in the vision statement lished, managers undertake a strategic analysis should truly be a difficult reach for the com- of the company’s external and internal situa- pany in its present position. The CEO has to tion. The management team studies the indus- take the lead here; indeed, one of the princi- try’s economics using frameworks such as pal roles of an effective leader, as Jim Collins Michael Porter’s five forces model (bargaining and Jerry Porras noted in Built to Last, is to power of buyers; bargaining power of suppli- formulate a “big, hairy, audacious goal (BHAG)” ers; availability of substitutes; threat of new that challenges even well-performing organi- entrants; and industry rivalry). The team zations to become much better. The classic assesses the external macroeconomic environ- example is Jack Welch’s challenge for every ment of growth, interest rates, currency move- GE business unit to become number one or ments, input prices, regulations, and general two in its industry. In determining a stretch expectations of the corporation’s role in soci- goal, it pays to look at the financial market’s ety. Often this is described as a PESTEL analy- expectations as a benchmark, since the com- sis, encompassing political, economic, social, pany’s share price usually contains an implicit technological, environmental, and legal factors. estimate of future profitable growth, which Managers can then dive into competitiveness can be well beyond that achievable through data and consider the dynamics of the com- incremental improvements to existing busi- pany’s financial, technological, and market nesses. If a company is setting a new goal, performance relative to its industry and rather than reaffirming an established goal, competitors. managers may need to undertake pre-offsite After the external analysis, managers research and engage in extensive discussion at should assess the company’s internal capabili- the meeting. ties and performance. One approach is to use Finally, the values (often called core values) Michael Porter’s value chain model, catego- of a company prescribe the attitude, behavior, rizing capabilities used in the processes that and character of an organization. Value state- create markets; develop, produce, and deliver ments, which are often lengthy, describe the products and services; and sell to customers. desirable attitudes and behavior the company Or the internal analysis could identify the wants to promote as well as the forbidden distinctive resources and capabilities that conduct, such as bribery, harassment, and give the firm a competitive advantage. Finally, conflicts of interest, that employees should unless managers are introducing an entirely definitely avoid. These excerpts from the new strategy, they will want to assess the per- value statement of the internet service formance of the current strategy, a topic we provider Earthlink illustrate the components discuss more later. of value statements: The next step is to summarize the conclu- • We respect the individual, and believe that sions from the external and internal analyses individuals who are treated with respect and in a classic SWOT matrix, assessing the ability given responsibility respond by giving their best. of internal attributes and external factors to • We are frugal. We guard and conserve the help or hinder the company’s achievement of

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Mastering the Management System

its vision. The aim here is to ensure that the better than competitors and can leverage into strategy leverages internal strengths to pursue multiple markets and segments. Clay Chris- external opportunities, while countering weak- tensen has identified how new entrants can nesses and threats (internal and external disrupt established markets by offering an factors that undermine successful strategy initially less capable product or service at a execution). This analysis will reveal a series of much lower price to attract a large customer issues that the strategy must address: the best base not targeted by the market leaders. role for new products and services; whether We are agnostic with respect to these frame- new partners need to be acquired; what new works; we have seen each one we’ve described market segments the company might enter; be highly successful. Which among them is the and which customer segments are contract- right choice probably depends on a company’s ing. These issues will become the focus of the circumstances and its competitive analysis. The strategy formulation process, which often Porter and resource-based frameworks help takes place at a subsequent meeting. companies leverage existing competitive posi- How can we best compete? Finally, manag- tions or internal capabilities, whereas the Blue ers tackle the strategy formulation itself—the Ocean and disruptive technology frameworks statement describing the strategy and how the help them search for entirely new positions. company proposes to achieve it. In this step managers decide on a course of action that Stage 2: Translate the Strategy will create a sustainable competitive advan- Once the strategy has been formulated, man- tage by distinguishing the company’s offering agers need to translate it into objectives and from competitors’ and, ultimately, will lead to measures that can be clearly communicated superior financial performance. The strategy to all units and employees. Our own work on must respond, in some form, to the following developing strategy maps and balanced score- questions: cards has contributed to this translation stage. • Which customers or markets will we The strategy map provides a powerful tool target? for visualizing the strategy as a chain of cause- • What is the value proposition that distin- and-effect relationships among strategic ob- guishes us? jectives. The chain starts with the company’s • What key processes give us competitive long-term financial objectives and then links advantage? down to objectives for customer loyalty and • What are the human capital capabilities the company’s value propositions. From required to excel at these key processes? there, it links to goals related to critical pro- • What are the technology enablers of the cesses and, ultimately, to the people, the tech- strategy? nology, and the organizational climate and • What are the organizational enablers culture required for successful strategy execu- required for the strategy? tion. Typically, a large corporation will create Managers can draw upon an abundance of an overall corporate strategy map and then models and frameworks as they formulate the link it to strategy maps for each of its operat- strategy. Michael Porter’s original competi- ing and functional units. tive advantage framework, for example, pre- Even though a strategy map reduces a com- sented the strategy decision as a choice plex strategy statement to a single page, we between whether to provide generic low-cost have learned that many managers find the products and services or more differentiated multiple objectives (typically, 15 to 25) on a and customized ones for specific market and map, along with their corresponding mea- customer segments. The Blue Ocean ap- sures and targets, somewhat complex to proach, popularized by W. Chan Kim and understand and manage. Some of a map’s ob- Renée Mauborgne, helps companies search jectives relate to short-term cost reduction for new market positions by creating new and quality improvements while others re- value propositions for a large customer base. flect long-term innovation and relationship Resource-based strategists (including those goals. Managers often find it challenging to in the core competencies school) emphasize balance these myriad objectives. critical processes—such as innovation or con- In our recent work, we’ve found that com- tinual cost reduction—that the company does panies can simplify the structure and use of a

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strategy map by chunking it into three to five tiatives often have no clear owner or home in strategic themes. A strategic theme, typically a the organization. Starved for resources and vertical slice within the map, consists of a lacking clear accountability for execution, the distinct set of related strategic objectives. strategic initiatives wither away, thwarting the (For an example, see “Mapping Strategic strategy’s execution. Themes,” a generic strategy map organized Companies with theme-based strategy maps by three vertical strategic themes and a hori- avoid these problems by assigning a senior ex- zontal theme to cluster the learning and ecutive to lead each strategic theme. In this growth objectives.) way, the company gains an accountability and Strategic themes offer several advantages. At reporting structure even for cross-business and the business unit level, the theme structure al- cross-functional-unit objectives. The executive lows unit managers to customize each theme assigned to own each theme assumes the re- to their local conditions and priorities, creating sponsibility for devising and executing an en- focus for their competitive situation while still tire portfolio of initiatives selected to achieve keeping their objectives integrated with the the theme’s performance targets. The execu- overall strategy. Second, the vertical strategic tive team authorizes the resources required for themes typically deliver their benefits over the various portfolios; we call the designated different time periods, helping companies funds strategic expenditures (or StratEx). Com- simultaneously manage short-, intermediate-, mitting funds to StratEx is similar to budgeting and long-term value-creating processes. Using for research and development: Both categories themes, executives can plan and manage the represent spending on near-term actions key elements of the strategy separately but still expected to deliver mid- to long-term per- have them operate coherently. formance, and both are separate from the Once managers have developed the strategy operating and capital expenditures (OpEx and map, they link it to another tool of our design: CapEx, described in the next stage) that sup- a balanced scorecard of performance metrics port current operations. and targets for each strategic objective. We be- lieve that if you don’t measure progress toward Stage 3: Plan Operations an objective, you cannot manage and improve With strategic metrics, targets, and initiative it. The balanced scorecard metrics allow execu- portfolios in place, the company next develops tives to make better decisions about the strat- an operational plan that lays out the actions egy and quantitatively assess its execution. that will accomplish its strategic objectives. This A third step at Stage 2 involves identifying, stage starts with setting priorities for process and authorizing resources for, a portfolio of improvement projects, followed by preparing strategic initiatives intended to help achieve a detailed sales plan, a resource capacity plan, the strategy’s objectives. A strategic initiative and operating and capital budgets. is a discretionary project or program, of finite Process improvements. The strategic initia- duration, designed to close a performance gap. tives developed in Stage 2 consist of the short- It might focus on, say, developing a customer term projects (lasting as long as 12 to 18 loyalty program or training all employees in months) selected to help achieve the strategy Six Sigma quality management tools. map’s objectives. However, to execute their In our original conception of the strategy strategies, companies generally must also map and the balanced scorecard, we encour- enhance the performance of their ongoing aged companies to select initiatives indepen- processes—measured, for example, by their dently for each objective. We came to realize, responsiveness, speed, quality, and cost. Com- however, that by doing so, companies would panies will get the biggest bang for their fail to benefit from the integrated and cumula- buck when they focus their business process tive impact of multiple, related strategic initia- management, total quality management, lean tives. Achieving an objective in the customer management, Six Sigma, and reengineering or financial realm generally requires comple- programs on processes directly related to mentary initiatives from different parts of the the objectives on their strategy maps and organization, such as human resources, infor- scorecards. The goal is to align near-term mation technology, marketing, distribution, process improvements with long-term strate- and operations. Also, stand-alone cross-unit ini- gic priorities.

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Mapping Strategic Themes This generic strategy map illustrates how a corporate strategy can be sliced into four themes, each with its own cause- and-effect relationships.

Real-life maps will be more complex but will still have the desirable property of making strategy much easier to understand and manage. The strategic themes provide a common structure that unit managers can use to develop their own maps within the big picture and a governance structure that assigns accountability for actions.

VISION: By 2013, become the leading company in our industry

Increase return on capital

Increase revenues in Financial Grow revenues in new Improve productivity existing segments Perspective products and services and markets

Improve Operating Quality Grow High-Value Accelerate and Efficiency Customer Relationships Product Innovation

Customer Perspective Provide valued service, Introduce innovative, Be a leader in quality applications expertise, high-performance and reliability and support products and solutions

Process Perspective

Improve supply chain Optimize customer Excel at technology, efficiency and effectiveness profitability product development, and life cycle management

Improve quality, cost, Expand channels, and flexibility of offerings, and markets Identify next-generation operating processes market opportunities

Build and maintain strong customer relationships

Learning Create a High-Performance Culture and Growth Perspective Expand and build Enable and require Develop leadership and an strategic skills, capabilities, continuous learning and execution-driven culture and expertise sharing of knowledge

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Managers need to deconstruct each strate- tions. (For an illustration, see the example gic process to identify the critical success of Towerton Financial in “Breaking Down factors and metrics that employees can focus the Sales Target” in the sidebar “What Re- on in their daily activities. Electronic and sources Do You Need to Implement Your physical dashboards, displaying data on the Strategy?” Towerton is a composite of various key indicators of local process performance, firms we’ve worked with.) Companies with will inform the actions of and provide feed- well-functioning ERP systems will have a back to employees attempting to achieve pro- historical record of product and customer mix cess performance targets. For example, one and transaction volumes they can draw upon large pharmaceutical chain has a dashboard to do this. A company can start by simply system that gives each store manager a cus- grossing up last period’s distribution of order tomized, single page display of financial and sizes by the desired percentage change in operating metrics—those that a statistical sales. Using this baseline, the company’s plan- analysis revealed have the highest correlation ners can modify the distribution to reflect ex- with aggregate store performance. The man- pected changes in sales and ordering patterns, agers’ dashboards also display monthly quar- such as an increase in minimum order sizes tile rankings among comparable stores for and the additional sales from new lines of six key metrics. products or services or new markets. Finally, Sales plan. Managers also must identify the data-rich companies can easily embrace sce- resources required to implement their strate- nario planning to explore the sensitivity of gic plan. Before they can do that, they need to their sales forecasts to alternative economic deconstruct their overall sales target into the and competitive assumptions. expected quantity, mix, and nature of individ- Resource capacity plan. Armed with data ual sales orders, production runs, and transac- about productivity from process improve-

What Resources Do You Need to Implement Your Strategy? It’s critical for companies to factor their strategic goals into their operational planning. Here’s how one company broke its sales forecast down into figures for each of the activities required to achieve it and used those figures to estimate the personnel and computing resources it would need in the next period.

Breaking Down the Sales Target Towerton Financial, a financial services company, broke down a monthly sales target of about $7.9 million into subtargets for its four product lines: stock trading, mutual fund trading, investment management, and financial planning. It then broke each line’s forecast down into the vol- ume and mix of transactions that the company’s most expensive resources (people and computing) would be expected to handle each month. That information helped the company’s managers calculate the resources needed to achieve their sales goals.

Stock Mutual fund Investment Financial trading trading management planning

Sales target $3,636,000 $2,031,000 $919,000 $1,323,000

Number of transactions 275,000 49,000 5,500 6,300

Number of new accounts opened 750 400 130 100

Number of calls to customer service center 11,000 20,000 21,500 84,500

Number of meetings opening new accounts 750 400 130 100

Number of meetings servicing existing accounts 400 200 250 450

Computing MIPS utilized 419,690 56,212 60,835 11,457

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ments and likely sales numbers, companies estimates of the demand for resources implied can now estimate what resources they will by the sales forecast. (See “Translating the need in the year ahead to execute on their Sales Plan into Resource Requirements” in the strategic goals. Our preferred tool for this step sidebar “What Resources Do You Need to is time-driven activity-based costing (TDABC). Implement Your Strategy?” for a simplified Activity-based costing’s original use was to example.) The company, seeing the capacity measure the cost and profitability of processes, required to deliver on its strategic plan, can products, and customers (as we will describe then authorize the quantity of people, equip- in Stage 5). The time-driven version of ABC ment, and other resources to be supplied, adds a new capability, the ability to easily including any buffer capacity to handle fluctu- translate future sales numbers into a forecast ations or short-term spikes in demand. of required resource capacity. At the heart of Dynamic operating and capital budgets. the TDABC model is a set of equations, based Once managers have determined the autho- on historical experience, that describe how rized level of resources for the future period, various transactions and demands consume the financial implications become easy to cal- the capacity of resources such as people, culate. In the Towerton Financial case used equipment, and facilities. A company that has in the resource capacity exhibit, the company such a model in place can update these equa- already knew the full monthly cost of each tions for any productivity gains that have kind of personnel—brokers, account manag- occurred or are anticipated from process ers, financial planners, customer service improvements (determined during the first representatives, and IT consultants—as well as step in this stage). Managers then feed the the monthly cost for each server, the unit of new detailed sales plans (from the second computing capacity. To obtain the budget step) into the updated model, to produce figures for each of the resources needed to

Translating the Sales Plan into Resource Requirements In this chart, Towerton Financial calculated the quantity of resources required to implement the sales plan at left, using a time-driven ABC model. The numbers under total hours show what Towerton would need from each kind of personnel or IT resource. (Note that the capacity of computing resources is measured by MIPS, not hours.) The next column indicates how many hours (or MIPS) are supplied monthly by one unit of each resource. The numbers for resource units required were obtained simply by dividing the total demand for each resource by the quantity supplied monthly by one unit of it. After examining the resource requirements under a range of assumptions, Towerton authorized the level of resource supply to be carried into the next period. In general, companies will want to supply somewhat more capacity than forecast, as shown in the column for resource units supplied; resource demands are not uniform throughout a period. As the final column shows, Towerton ex- pects to operate at close to full capacity during the upcoming period. Knowing the cost of each resource unit, Towerton can quickly translate its operating plan into an overall profit plan and individual product line P&Ls.

Available hours/month per Resource units Resource units Capacity Resource type Total hours resource unit required supplied utilization

Brokers 27,070 130 208.2 215 97%

Account managers 6,540 130 50.3 51 99%

Financial planners 7,300 130 56.2 59 95%

Principals 4,627 130 35.6 36 99%

Customer service representatives 14,654 140 104.7 110 95%

IT consultants 10,321 140 73.7 75 98%

Computing MIPS utilized 548,194 7,920 69.2 75 92%

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Mastering the Management System

meet the sales forecasts, Towerton’s planners meetings that review the performance of oper- simply multiply the cost of each type of re- ating departments and business functions and source by the quantity it has decided to supply. address problems that have arisen or persist. Most of the resource capacity represents They also should hold strategy management personnel costs and would be included in the meetings that review balanced scorecard per- OpEx budget. Increases in equipment resource formance indicators and initiatives to assess capacity (such as Towerton’s servers) would be progress and identify barriers to strategy reflected in the CapEx budget. The process execution. Those two meetings make up quickly and analytically generates operating Stage 4 of the system. In Stage 5, managers and capital budgets that grow logically and meet to assess the performance of the strategy dynamically out of the sales and operating itself and adapt it if necessary. The three meet- plans, rather than being imposed by fiat or ings have different subject matter, different through power negotiations. Since the com- frequencies, and, often, different sets of attend- pany started with detailed revenue forecasts ees. (See the exhibit “Management Meetings and now has the resource costs associated with 101” for a comparison of the meetings.) delivering on them, simple subtraction will Operational review meetings. Management yield a detailed P&L for each product, cus- groups need to meet frequently—perhaps tomer, channel, and region. Companies that weekly, twice weekly, or even daily—to review have shifted from an annual budgeting their operating dashboards and reports on cycle to one with quarterly updates can sales, bookings, and shipments, and to solve use this process to obtain resource capacity short-term issues that have recently arisen: plans for every period for which they have complaints from important customers, late a sales forecast. deliveries, defective production, mechanical In a final budgeting step, the company au- breakdowns, the extended absence of a key thorizes the discretionary spending that does employee, new sales opportunities. The speed not have an immediate relationship with sales at which new data are posted on operational and operations, such as process improvement dashboards is the central factor in determin- initiatives, advertising, promotion, research ing meeting frequency: If the company has a and development, training, and mainte- short operations cycle, with new data posted nance. The amount of such spending remains hourly and daily, then a daily review promotes a judgment call for experienced executives rapid learning and problem solving. But for and is not a decision that can yet be auto- a product development group, progress mated through an analytic model. against milestones and stage gates may be The company now has finished the inte- better evaluated monthly. grated planning of strategy and operations, The people attending an operational which encompasses the following steps: review typically come from within a single Formulate the strategy; translate it into linked department, function, or process. A unit’s objectives, measures, and targets; develop salespeople, for example, will meet (often via and fund the portfolio of strategic initiatives; conference calls and webcasts) to discuss the identify the process improvement priorities; sales pipeline, recent sales closings, and new forecast sales consistent with the strategic customer opportunities and problems. Opera- plan; estimate the resource capacities re- tions people review production problems, quired for those sales; authorize the spending including defects, yields, bottlenecks, mainte- on resources; and produce next period’s pro nance and repair schedules, equipment forma income and detailed P&L statements. breakdowns, downtime, scheduling, expedit- From here on, it is up to the managers to ing, supplier concerns, and distribution. execute, learn, and adapt, moving the man- Finance personnel address short-term cash agement cycle into its fourth stage. flow issues, including collections on receiv- ables, late payments to suppliers, treasury Stage 4: Monitor and Learn operations, and banking relationships. The As companies implement their strategic and top management group may meet monthly operational plans, they need to hold three to review overall financial performance. types of meetings to monitor and learn from Smaller companies, without functional de- their results. First, managers should convene partments, may have only a single monthly

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Mastering the Management System

Management Meetings 101 It’s important to distinguish clearly among the various kinds of meetings that form the feedback and learning component of the management system. They require different frequencies and have very different agendas and informational requirements. Companies that try to double up these meetings in order to accommodate the availability of senior staff run the risk of having discussions of operational crises drive out consideration of strategic issues.

MEETING TYPE

Operational review Strategy review Strategy testing and adapting

Information Dashboards for key perfor- Strategy map and balanced Strategy map, balanced scorecard, requirements mance indicators; weekly and scorecard reports ABC profitability reports, analytic monthly financial summaries studies of strategy, external and competitive analyses

Frequency Daily, twice weekly, weekly, Monthly Annually (perhaps quarterly for or monthly, depending on fast-moving industries) business cycle

Attendees Departmental and functional Senior management team, Senior management team, strategic personnel; senior manage- strategic theme owners, theme owners, functional and ment for financial reviews strategy management officer planning specialists, business unit heads

Focus Identify and solve operational Implement strategy Test and adapt strategy based on problems (sales declines, late causal analytics, product-line and deliveries, equipment down- channel profitability, changing time, supplier problems) external environment, emergent strategies, and new technology developments

Goal Respond to short-term prob- Fine-tune strategy; make Incrementally improve or transform lems and promote continuous midcourse adaptations strategy; establish strategic and improvements operational plans; set strategic targets; authorize spending for strategic initiatives and other major discretionary expenditures

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operating meeting, corresponding to the fre- tial to set distinctly different agendas for the quency with which they close their books. two meetings. Otherwise, as in our opening In general, however, we recommend gearing example of the Conner Corporation, short- operating review meeting frequency to the term operational and tactical issues will drive operating cycle of the department and busi- out discussions of strategy implementation. ness, so management can respond to sales Like operational reviews, strategy manage- and operating data and to myriad other tacti- ment meetings should not be spent listening cal issues in the most timely manner. to report presentations. Managers should Ideally, operational meetings are short, come to the meetings already familiar with highly focused, data driven, and action the data to be discussed, thinking about the oriented. One company we’ve advised holds issues that the gaps in recent performance its operational reviews in a small room filled raise, and formulating solutions to problems. with whiteboards and flip charts but no At the meetings themselves, executive com- chairs. Attendees post agenda topics and look mittee members should discuss the issues, over dashboards before the meeting, which explore their implications, and propose lasts only as long as needed to discuss each action plans. issue, develop an action plan, and assign Executives have to make a trade-off be- responsibility for carrying it out. Forcing tween breadth and depth at these reviews. In everyone to stand signals that the meeting’s the early years of balanced scorecard imple- purpose is not to spend time together, pas- mentations, we encouraged a full discussion sively listening. It is to engage managers in of BSC measures at each strategy manage- active and brisk problem-solving discussions ment meeting. It soon became apparent that on the most pressing issues of the day. the normal time reserved for a monthly meet- One company holds its Strategy review meetings. The leadership ing did not permit a full discussion of all team of a business unit must meet periodically the objectives, measures, and initiatives on a operational reviews in a to review the progress of its strategy. Opera- strategy map and scorecard. The solution, we room with no chairs. tional issues, unless they are particularly discovered, came from the practice of using significant and cross-functional, should not be strategic themes to organize strategy maps: Forcing everyone to discussed at this meeting. Attendance at strat- devote most of the meeting to a deep dive egy reviews should be compulsory for the into one or two of the strategic themes. stand signals that the unit’s CEO and all members of its executive That is precisely what happens at HSBC meeting is not about committee. Rail, an operating unit of the HSBC Group, There’s no clear consensus around the opti- which purchases, leases, and maintains the passive listening; it’s mal frequency for these meetings, though locomotives and cars for the UK and other about active and brisk most companies hold a monthly two- to three- nations’ railroad systems. Its monthly two-and- hour strategy review meeting, to ensure that a-half-hour meeting brings together its strat- problem solving. strategy remains top of mind. That works well egy council, consisting of the CEO, the head when a management team works in one cen- of Finance, the head of Customer Service– tral location. Some companies, especially those Operations, the head of Customer Relation- with dispersed teams, hold their strategy ship Management–Sales, the head of Learning review meetings quarterly. Strategy is a long- and Development, and the strategy manage- term commitment, and strategic initiatives ment officer, who coordinates the data on the such as developing new workforce competen- strategic measures and initiatives for each cies, redefining the brand, innovating new strategic theme in advance of the meeting. products, building new customer relationships, The data go into a monthly report that has a and reengineering key business processes typi- section for each strategic theme. The section cally take more than a month to yield measur- contains the theme’s strategy map, objectives, able results. Quarterly meetings will probably targets, and initiatives, with each component require at least an entire day for active discus- color-coded green (if the objective’s target sion of all strategic objectives and themes. has been achieved), yellow (progress is slower Many company units hold their monthly than expected but doesn’t require immedi- operational financial review on the same day ate senior management attention), or red as the strategy review, since the same people (progress is off track and requires manage- attend both. If that’s the situation, it’s essen- ment attention to resolve critical issues). Each

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Mastering the Management System

theme’s section also contains evaluations and implications and to propose action plans, commentary from the theme owner about built constructively on the ideas presented any performance gaps and proposed actions during the meeting. The CEO questioned and for addressing them. probed, kept the meeting focused on the key The monthly meeting focuses on one (or issues, encouraged dialogue and debate, and at most two) strategic themes in depth. The ensured that the meeting stayed on schedule. agenda also allots time for one operational The strategy management officer recorded or strategic “hot topic” to ensure that urgent each approved action item and the desig- issues that fall outside the theme under dis- nated manager who would be accountable cussion will be addressed. The February 2007 for following up on it. strategy council meeting was a typical HSBC HSBC’s meetings—like all excellent strategy Rail strategy review. (See the exhibit “A Model reviews—focus on whether strategy execution Strategy Review Agenda.”) The strategy man- is on track, where problems are occurring in agement officer started with an update on the the implementation, why they’re happening, action items from the previous month, indi- what actions will correct them, and who will cating which had been accomplished and have responsibility for achieving targets. which were still under way. The CEO followed These meetings take the strategy as a given. with a quick review of the unit’s color-coded They are not used, except in unusual circum- strategy map and offered his perspective on stances, to question or adapt the strategy. the business. Then, the attendees gave in- That is what takes place in the final stage. depth consideration for about 60 minutes to the Customer Relationship Management stra- Stage 5: Test and Adapt the Strategy tegic theme. For the remaining themes, the From time to time managers will discover council spent about five minutes each on any that some of the assumptions underlying issues that had to be resolved before the their strategy are flawed or obsolete. When scheduled deep dive on that theme. The that happens, managers need to rigorously meeting participants, who were already famil- reexamine their strategy and adapt it, decid- iar with the data and ready to discuss the ing whether incremental improvements will

A Model Strategy Review Agenda

Time Item Detail Duration Responsibility 10:10 Action Log Review Status 5 minutes Paul (Strategy Management Officer) 10:15 OverviewReview Strategy Map 10 minutes Peter (CEO) Highlight Key Issues Review Initiatives Review Measures 10:25 Theme Assessment Customer Relationship 60 minutes Bob (Head of CRM–Sales) Management 11:25 Break 5 minutes 11:30 Theme Summary Learning and Growth 5 minutes Nick (Head of Learning and Development) 11:35 Theme Summary Capital Efficiency 5 minutes David (Head of Finance) 11:40 Theme Summary Operational Excellence 5 minutes Robert (Head of Customer Service–Operations) 11:45Hot Topic Resourcing Challenge 30 minutes David (Head of Finance) 12:15 Meeting Review Communication Summary 10 minutes Peter (CEO) 12:25 Meeting Review Feedback 5 minutes 12:30 Action Log Review of New Items 5 minutes Peter (CEO) 12:35 Any Other Business Paul (Strategy Management Officer) and Meeting Close Next Meeting 18/04/07 – Theme Assessment: Capital Efficiency

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suffice or whether they need a new, transfor- uct, however. In our experience, companies mational strategy. This process closes the loop find multiple ways—process improvements, of the management system. It generally occurs repricing, and redefining relationships—to at the strategy development offsite described reduce or eliminate the losses from unprofit- under Stage 1 but could occur during the year able products and customers, once a credible if the company experiences a major disruption costing system has identified them. or a new strategic opportunity. The strategy Statistical analyses. Companies, especially testing and adapting process introduces new those with large numbers of similar operating inputs to the offsite: an analysis of the current units, can use statistical analysis to estimate economics of existing products and customers, correlations among strategy performance statistical analyses of correlations among the numbers. Such analysis will usually validate strategy’s performance measures, and consid- and quantify links between investments in, eration of new strategy options that have for example, employee skills or IT support emerged since the previous strategy develop- systems, and customer loyalty and financial ment meeting. performance. Occasionally, however, the anal- Cost and profitability reports. Anytime a ysis can reveal that assumed linkages are not company reviews its strategy, it should first occurring, which should cause the executive understand the current economics of its exist- team to question or reject at least part of the ing strategy by examining activity-based cost- existing strategy. Companies that consistently ing reports that show the profit and loss of measure strategy performance through tools each product line, customer, market segment, such as the strategy map and balanced score- channel, and region. Executives will then see card have ready access to the data needed for where the existing strategy has succeeded and strategy validation and testing. Unprofitability doesn’t failed, and can formulate approaches to turn- Take Store 24, one of New England’s largest ing around loss operations and expanding the convenience store chains (now owned by mean that a company scope and scale of profitable operations. Tedeschi Food Shops), which in 1998 imple- should simply drop a Consider the experience of a large New mented a new customer strategy called “Ban York City bank with an overall profitable Boredom.” Store 24’s CEO believed that pro- customer or product. product line of demand and time deposits. viding an entertaining shopping atmosphere, Information from its aggregate profitability including frequent themes and promotions, Companies can find measurement system showed that all custom- would differentiate the shopping experience multiple ways to reduce ers with balances greater than $25,000 were at the chain from its competitors’. The com- profitable, so the bank launched a major pany created a strategy map and balanced or eliminate losses, once initiative to retain those clients. During the scorecard to communicate and help imple- a credible costing system initiative, however, the bank conducted a ment the new strategy. Within two years, more detailed ABC study to calculate the cost however, Store 24’s executive team learned has identified them. to serve and the profitability of all accounts. It that the strategy was not working. Feedback learned that 35% of the households targeted from individual customers and focus groups for retention were unprofitable, with cumula- led the chain to abandon the Ban Boredom tive losses totaling more than $2 million. Un- strategy and replace it with an updated ver- profitable customers could be found in every sion of its previous strategy, which featured balance tier up to $1 million, in fact. Manag- fast and efficient service. ers at first could not believe that high-deposit A Harvard Business School faculty team individuals could be unprofitable. Further (Dennis Campbell, Srikant Datar, Susan Kulp, analysis revealed that unprofitable customers and V.G. Narayanan) gained access to quar- did a large number of transactions in the terly data from Store 24’s 85 retail outlets and branches, the most expensive service channel, performed statistical analysis to see whether and kept most of their deposits in accounts the company’s executives could have recog- that yielded low margins to the bank. For- nized the flaws in the Ban Boredom strategy tunately, the bank discovered this error in its earlier. Looking at data from the first year of strategy before it was too far along in its the strategy, the study found that better im- client retention initiative. plementation of the Ban Boredom program Unprofitability doesn’t mean that a com- was indeed negatively correlated with store pany should simply drop a customer or prod- performance, exactly the opposite of what the

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Mastering the Management System

strategy had intended. The data also showed plan. The new strategic and operational plans that differences in profits were best explained set the stage and establish the information by variables not related to the strategy, in- requirements for next period’s schedule of cluding store managers’ skills, local popula- operational reviews, strategy reviews, and tion, and local competition. By uncovering strategy testing and adaptation meetings. those (and several other) simple correlations, • • • Store 24 management could have learned one Managers have always found it hard to bal- year earlier than it actually did that the ance near-term operational concerns with new strategy was not working. The managers long-term strategic priorities. But such a bal- would also have seen that the strategy would ancing act comes with the job; it is an inherent be successful only if all stores raised their tension that managers cannot avoid and must crew skills to high levels, something that continually address. As a senior strategic plan- wasn’t feasible given the 200% annual em- ner at a Fortune 20 company told us, “You can ployee turnover rate typical of retail stores. have the best processes in the world, but if Emergent strategies. The strategy offsite, your governance processes don’t provide the beyond examining the performance of exist- direction and course correction required to ing strategy, provides executives with a great achieve your goals, success is a matter of luck.” opportunity to consider new strategy propos- At the same time, a company can have the best als that managers and employees throughout strategy in the world, but it will get nowhere if the enterprise may have suggested. Henry managers cannot translate that strategy into Mintzberg and Gary Hamel, in fact, argue operational plans and then execute the plans against top-down strategy implementation, and achieve the performance targets. contending that the most innovative strategies Managers that carefully follow the recom- emerge from within the organization. Not all mendations we have laid out in this article such strategies are worth pursuing, however, will have a complete management system and even if several seem promising, the execu- that helps them set clear strategic goals, allo- tive team still needs to decide which, if any, cate resources consistent with those goals, set to adopt. priorities for operational action, quickly rec- If the executive team decides, based on ognize the operational and strategic impact of analyses of the internal data, the competitive those decisions, and, if necessary, update their environment, and emerging strategy ideas, to strategic goals. The closed-loop management alter the existing strategy, it should follow up system enables executives to manage both by modifying the organization’s strategy map strategy and operations, and to balance the and scorecard. That will launch another cycle tensions between them. of strategy translation and operational execu- tion, with new targets, new initiatives, a new Reprint R0801D sales and operating plan, revised process im- To order, see the next page provement priorities, changed resource capac- or call 800-988-0886 or 617-783-7500 ity requirements, and an updated financial or go to www.hbrreprints.org

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