If What Gets Measured Gets Managed, Measuring the Wrong Thing Matters

Management guru Peter Drucker is credited with the much-used phrase: “What gets measured gets managed” — a truncated version of the full and much more powerful quote: “What get s measured get s managed — even when it’s pointless to measure and manage it, and even if it harms the purpose of the organization to do so.”

1-Fullscreen capture 19022015 191036_edited.jpg

These words can be read as a warning that was ignored. What we have measured, and continue to measure, is not just pointless, but also dangerous — and played a par t in causing the global economic crisis of 2007–2008. But we have not yet learned the lesson. We continue to use pointless measures of the performance of businesses.

Economist Martin Wolf of the Financial Times said: "Almost nothing in economics is more important than thinking through how companies should be managed and for what ends. Unfortunately, we have made a mess of this. That mess has a name. It is shareholder value maximization". The term, of ten expressed as maximizing shareholder value, or MSV, was the brainchild of economist Milton Friedman, espoused in his book Capitalism and Freedom in 1962.

As the authors of a recent report note, the mantra that the purpose of a company is maximizing shareholder value “became ever more pervasive, taught as an article of faith in the world’s business schools,” and has been “asserted in corporate boardrooms as a non-negotiable.”

Previously, CEOs typically managed companies for the benefit of their stakeholders — not just shareholders . The Johnson & Johnson credo, written by its chairman in 1943, is an articulation of the previous approach. It even listed shareholders last in the list of stakeholders whose interests should be served.

After serving customers, employees, and communities first, it said: "Our final responsibility is to our stockholders.Business must make a sound profit. We must experiment with new ideas. Research must be carried on, innovative programs developed and mistakes paid for. New equipment must be purchased, new facilities provided and new products launched. Reserves must be created to provide for adverse times. When we operate according to these principles, the stockholders should realize a fair return".

Robert Wood Johnson II recognized the primacy of customer value as the first priority of a business. He recognized that delivering value depends on employees and that business cannot be independent of the community it serves. These are key points that I hope the reader will consider. Also consider this:

He thought shareholders should receive a “fair return.” He did not believe that the business should exist to maximize shareholder returns. The Johnson & Johnson credo no doubt determined what measures the business used to assess its performance, and we might expect that indicators of customer satisfaction would be high on the list.

Since businesses don’t survive without them, putting customer interests first, and making customer satisfaction the first measure of performance, would make common sense, but research by KPMG found that only 7 percent of companies provided performance data on customer focus or satisfaction in a survey of annual reports. It does not mean that they do not collect the data, but I suggest that it does reflect the level of importance they attach to it since they do not consider that it worth sharing with investors.

The point to be stressed is this: Maximizing shareholder value as a measure of the performance of a business is, as its past champion Jack Welch (former chief executive of General Electric) later said, “the dumbest idea in the world.” But, as Michael Skapinker of the Financial Times said, it is “likely to endure as a powerful idea” because “it gives managers something against which they can be measured. Other managerial responsibilities — to employees, customers or the community — are numerically less precise.”

Operating companies with the aim of maximizing shareholder value leads to what Martin Wolf called misbehavior. It does so by determining priorities and what gets managed. By effectively reversing the order in which stakeholder interests are considered in the Johnson & Johnson credo, the maximizing shareholder value concept pushes management to focus on the wrong priorities.

This is in itself bad enough, but the damage is amplified by stock-based compensation for CEOs, designed to align their interests with shareholders.

-------------------

This is an extract from a feature article I wrote for the January / February issue of Corporate Finance Review. I will publish further extracts in the coming days, or you can email me for a pdf of the full article: pbarnett@strategicmanagementforum.org

The strategic Management Forum is launching a number of Focus Groups (Think Tanks) on issues related to those raised in the article. They include: