Are you selecting the right strategic indicators? I

One of the key decisions of the CEOs and boards is to select the right key financial indicators to manage the company. Tipically, companies select EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization), EVA (Economic Value Added), Enterprise Value, among others. Although companies do not select just one indicator, they tend to use one as the cornerstone for the management focus (and their respective bonuses!).

As always, making a selection has its consequences (and of course, also its advantages...). Most of the companies I have worked for use EBITDA and they have a strong focus in this indicator.

Let´s start understanding how EBITDA is calculated:

EBITDA = Revenue – Expenses (excluding interest, taxes, depreciation and amortization)

As represented in the formula, it is a measure of the current profitability of the company, not taking in account the effects of interest (from loans for example), taxes, depreciation (the decrease of value in assets) and amortization (the payment of debts, for example). In the following table, you can see the main pros and cons of using EBITDA as the main financial indicator:

So, what can happen if we choose this indicator as the reason for living? There are several things that may happen:

- Reduction of the Return on Assets (ROA) or Return on Invested Capital (ROIC) -or getting inflated in assets and working capital. Due that the fact you are focused on profitability, you may decide to use more assets (for example, buy plants) to produce more revenues, or to have more inventory (in order to have more things to sell). However, at the end, a shareholder can complain that the money he invested is not having the right margin, compared with other financial instruments.

- Because you are not taking in account the effects of depreciation and amortization, you may have a distorted vision of the cash generated by the company. Tax and amortization can erode the cash generated.

- For the shareholders, it is not enough to use EBITDA to make his/her investments decisions. It does not take a vision of the use of the assets or working capital, it does not show the company valuation or show a trend of the future of the company, so it is difficult  for him/her to decide if it is a good place to put the money in.

As a conclusion, even though is a very common indicator and is used widely to compare companies, it should not be used in isolation to manage the destiny of the company.

When an EPMO is required? (I)

In the companies, typically there is a "universe of initiatives" which aim, directly or indirectly, to transform the company. However, there is a huge amount of energy and resources employed in such initiatives than then become projects. However, only a small part (the Pareto principle) of such universe generates most of the impacts to the organization.

 

 

Such projects should be the focus of the organization. These initiatives, seldom called "Strategic Projects" or "Strategic Portfolio" can be selected based in a criteria like: provides the biggest benefits, change the way the company operates, they have the relative bigger investments, realize synergies with other organizations among others. In any case, these initiatives must be managed using a Portfolio Management capability in order to select which of them will become projects (i.e. we will asign resources, a leader, and a start and end date). Then, the project will be executed.

However, how can we guarantee that the project will be executed as planed and will bring the benefits commited to the company? We recommend to have an EPMO.

The EPMO (Enterprise Programme Management Office) is the logical evolution of traditional PMO attacks the traditional model following disadvantages: *

• It is positioned at the top of the company and covers all program and project activities that occur in the company
• It becomes a permanent organizational structure, responsible for developing the program management capability at the company
• It is led by a Program Director (or equivalent) which is part of the top leadership of the organization and responsible to the CEO for the implementation of the strategy of the company through programs and projects
• Supports the development of business strategy and the strategic portfolio of programs and projects
• Coordinates the development of key organizational functions for program and project activity
• Establishes systems and project management programs, policies, methodologies and standards for the company as a whole
• Develop a "pool of talent" with deep expertise in the delivery of programs and projects

The problem is that you should not devote the same amount of "EPMO energy" to all projects. It is logical that Strategic Projects will need more dedication, because will generate a greater impact. With this in mind, you can have a structure that distributes the attention to the portfolio depending on the program and project importante, as shown:

* From "Enterprise Programme Management: Delivering Value" by David Williams and Tim Parr, Palgrave McMillan 2004.

How to define Key Performance Indicators (II)

The KPIs definitions by themselves will not solve a problem. We have to create an enterprise performance management capability to achieve the expected outcomes, using the KPIs as a key tool. This capability is comprised of processes, organization and tools that guarantee the cycle which starts with the business strategy,  clear and measurable goals, and the execution measured with by the KPIs.

 

It implies that the business strategy has been defined in measurable terms, i.e. EVA growth, market share growth, talent retention, etc. You can use a methodology for the strategic management of the company like Balanced Scorecard, Value Management, or any other and use them to define the KPI and the KPI tree. Then, you should establish goals to those KPIs. There are several techniques to establish such goals but at the end, they will be linked to the expected business outcomes for the year.

Then, the KPIs and goals defined must be "cascaded" to the tactical and operational levels of the company in order to make them consistent. In such way, every employee will know how he/she will contribute to the overall goals of the company.

As a result of the Operation, the KPIs will be affected and we measure their variations and how close they are to the established goal. Then, we take decisions to improve them. Eventually, the KPIs will help to reshape the business strategy.

In the following diagram, we illustrate how the KPIs cascade from the Strategy to the Operation. As you can see, you can have:

- Functional KPIs, related to measuring the outcomes of a specific function.
- Process or Cross-functional KPIs, which involves the collaboration of two or more functions.

When architecting the KPIs tree, make sure that your definition will help to:

- Implement the business strategy
- Align function and processes to the business strategy
- Identify if the KPI will be lagging or leading and why
- Establish the frequency of KPI measurement
- Define who are accountable(s) for the KPI results