CHAPTER 7

Strategic Performance Management

Falconer Mitchell, Hanne Nørreklit, Lars Braad Nielsen, and Lennart Nørreklit

Insights from This Case Study

A company’s financial end-result performance is determined by two interrelated factors: operational performance and strategic performance. The aggregate measurement of the two types of performance implies that there is a lack of observation of the management’s strategic performance. This chapter articulates a conceptual meaning and tools for strategic performance measurement. Drawing on pragmatic constructivism, strategy is conceptualized to be about creating and enacting an overarching business model that aims to create strategic coherence among groups of operating actors over time. Strategic performance measurement involves an ex ante evaluation of whether the strategic narrative will be able to succeed (proactive truth) and ex post reflections as to whether the strategy was successful (pragmatic truth). Such function of strategic performance measurement presupposes that the strategy is formulated and the ongoing feedback created by the monitoring system forms the basis of strategic managerial learning.

Introduction¹

The purposes of this chapter are to articulate a conceptual meaning for strategic performance measurement as a leadership tool and to identify a conceptual framework for its development. It is perceived as a means of not only assessing leadership performance but also as a basis of providing constructive feedback that will enable improvements to be made in strategic performance.

The chapter takes as its starting point the need to distinguish strategic performance from operational performance and some external influences on organizational performance. Exhibit 7.1, although in itself a simplification of reality, illustrates the complexities of this task. End-result performance is determined by a number of interrelated factors, one of which is strategic performance. Thus, the end result may be improved by good strategic performance. However, there may also be a good (or bad) end result, despite poor (or good) strategic performance as a consequence of the positive (or negative) influence of all or any of the other influential factors. Accordingly, in this analysis end-result measures are, at best, regarded as partial or incomplete indicators of the quality of strategic performance. To provide reliable leadership assessment and feedback, conceptions of good (or poor) strategic performance therefore require to be made independently of end-result performance (Mitchell et al. 2013).

The lack of observation of the management’s strategic performance in the dominant strategic performance measurement models implies that the models can neither contribute to assessing top management performance or improving its strategic decision-making capability. This is problematic as there are large amounts of money involved at the strategic level. It is important for any organization to be aware of whether the issues faced are of operational nature or strategic nature. Within certain limits, top executives can always try to put operational results in the place of strategic performance. If the strategic performance is poor, extraordinary pressure on operational activities can compensate for a failing strategy. Thus, there is a need for a strategic performance measurement tool that can be used to assess the strategic performance of the top executives and to provide constructive feedback to improve management’s strategic practices.

Mainstream literature on strategic performance measurement focuses on helping top management when implementing company strategies and policies (Kaplan and Norton 1996; NØrreklit 2000). The models imply that strategic goals and activities are formulated by the senior management and then translated into performance targets for managers and employees at the operational levels. Feedback information is concerned with the implementation of strategy at the operational level but is silent about the ability of top management in formulating a robust strategy. Techniques for analyzing the strategic performance of top management are thus underdeveloped in the models.

The chapter is structured as follows. First, pragmatic constructivism is employed to identify the nature and purpose of strategic performance. Second, key information concepts upon which systems of strategic performance measurement can be built are outlined. Finally, some conclusions are drawn and ideas are presented.

Strategic Performance

When defining strategic performance, we consider the notion of strategic fit in the context of pragmatic constructivism coherence, which underlies most of the dominating strategic literature as a vital concept for company performance (Chandler 1962/1998; Miles and Snow 1978; Heijltjes 1995). It is stated that strategy is concerned with creating a match between a company’s external business conditions (market demands, competitors, suppliers, institutions, regulations, etc.) and its internal structures that constitute chain of activities and resources (R&D, manufacturing, logistic, sales and marketing, etc.). Strategic coherence is a quality of these relationships, which enables the company to operate effectively in creating and meeting environmental expectations and achieve numerical results. Lack of coherence creates chaos, and things become unpredictable because the activities have conflicting consequences and therefore destroy each other.

The overall strategic task of top management is therefore to develop the strategic profile that results in the best fit possible between the internal and external factors and, hence, high strategic performance. Society is itself a structure of high complexity that functions through endless relationships of coherence, constantly driven by coherency problems to be solved by companies and other activity centers. The company has to find its place in the complex network of relationships of coherency. Exhibit 7.2 illustrates a problem of coherence in the case of a large Danish company, HEALTH.

Coherence can be analyzed at different organizational levels. At the operational level, there is the coherence between specific chains of activities. Within the operative units, integration of the four dimensions is controlled by specialized, professional way of reasoning. The integration within the operational units is the condition for the creation of construct causality and for the activities to be performed successfully. The coherence between the functional units is a result of the merger of overall operational planning with strategic performance to create the internal–external fit; therefore, it is the strategic coherence when seen from a top-down perspective in the company. The development of strategic coherence concentrates on practical aspects of creating an overarching form of construct causality throughout the whole value chain to make a set of interrelated ways of reasoning running the company successfully together. Specifically within the Danish company HEALTH, the development of strategic coherence relates to connecting the functions of R&D, manufacturing, and marketing and sales. The functional departments are all integrated around their individual ways of reasoning, and, thus, coherence is to be viewed as the ability to create an overarching business model that aims to make the specialized departmental ways of reasoning to create construct causality in interaction with their environment.

In order to establish overall coherence between all operating units of the company and its environment, strategic leadership aims at creating strategic coherence between operating units through the creation of strings of output–demand relationships. Essentially, strategic coherence is closely tied to effectiveness. While efficiency measures the degree of input–output target fulfillment in operational activities, effectiveness indicates the degree to which the operational activity output meets the overall company goals. Thus, operational performance is linked to efficiency and the relationship between input and output, while strategic performance is linked to effectiveness and the relationship between output and company goals. An organization is a complex mix of activities, each of which can be seen as an operation that transforms input into output that should subsequently help meet the company goals. In coordination between the operating units, the output of one unit is to be coherent with the demand of another unit. For instance, in HEALTH, the service output of product development and design activities has to meet the demand of manufacturing and sales. When using effectiveness as a performance measure, it is pivotal to distinguish between the goal and the purpose of the output. The purpose of the output is to fulfill the need of the next operating unit in the chain. The goal is a relevant measure of effectiveness only if it expresses the need of the receiving unit. Accordingly, the objective that is relevant to effectiveness is not a function of planning as such but of the needs of the receiver of the output.

The coherence between parties, in the market (e.g., companies) as well as within the company (e.g., departments), must occur across four dimensions: facts, possibilities, values, and communication. Coherence does not mean that the facts, possibilities, and values of the interacting parties must be identical but rather that they must complement each other. Coherence should be expressed conceptually in the communication that connects the units. The value is whether the recipient actually wants to use the delivered service. The factual possibility issue is whether it is able to deliver the number of output products and services that are capable of doing things needed by the recipient. Finally, communication is concerned with the recipient’s ability to explain and understand the service delivered. Failure of coherence may simply be an issue of misunderstanding, because the units speak different languages; for instance, production may describe the product in a technical way of reasoning that differs from the ways of reasoning used by sales staff and customers. For instance, in HEALTH, the strategy is formulated around fulfilling the needs of people with a particular illness and the value of efficient manufacturing processes. Among others, the internal coherence of R&D activities with the external market request relates to whether R&D can and will develop such a product. Thus, it should be factually possible for R&D to develop a product that meets the demand and the R&D personnel should have values that motivate them to develop such a product. Finally, they should be able to participate in communicative interaction with other units to explain and understand the service they have delivered to other units.

When strategic coherence across the four dimensions is not in place, top management must seek to reconstruct the pattern of coherence in order to reestablish the effectiveness by reshaping the chain of operating units and aiming at solving new coherence issues in the market. In a short-term perspective, strategic activities can accept certain incoherencies in present operations in order to create new structures that display higher degrees of coherency. Accordingly, strategy must maintain and improve coherence over a long-term perspective. The need for integration of multidimensional ways of reasoning across time implies that the establishment and measurement of strategic coherence between operating units are highly dynamic and complex matters.

Overall, the strategy is concerned with developing an overarching integrated way of reasoning that is able to create coherence by bridging the specialized ways of reasoning of the cooperating units. The relationship between the delivered service and the demand itself constitutes the cooperation of larger integrated units. Strategic performance relates to establishing best possible coherence between the ways of reasoning of the external environment and internal operations. The strategic performance of a given period is represented by the actions carried out to improve the strategic coherence of the company–environment relationship. Accordingly, managerial strategic performance reflects the changes in the strategic situation, that is, the changes in the coherence of the strategic profile that take place over a certain period of time.

Strategic Performance Measurement

Strategic performance measurement assumes the ability of management to formulate a realistic strategy; it is a system of implementing and monitoring the achievement of the strategy and learning and revising the strategy (Asch 1992; Simons 1995). Strategic performance measurement that is applied to drive strategic performance therefore involves an ex ante evaluation of whether the intended strategy will be able to succeed (proactive truth) and ex post reflections as to whether the strategy was successful (pragmatic truth). Such a function of strategic performance measurement presupposes that the strategy is formulated and the ongoing feedback created by the monitoring system forms the basis of strategic managerial learning.

In the following, we describe the key dimensions for constructing a strategic performance measurement system that involves the formulation of a strategic planning narrative, evaluation of whether the narrative is proactive truth, methods of measuring change in strategic coherence, and a learning theory of truth.

Strategic Planning Narrative

To organize the strategic process consciously, leaders have to formulate a narrative of the strategy for their managers and employees to know what to do and what to expect. The narrative should be able to explain the issues in relation to developing an overarching integrated way of reasoning in order to bridge the gaps between specialized ways of reasoning of the cooperating units over time. Therefore, it needs to include a description of the intentional future situations in which the main functions of strategic focus at that time have to be coherent and the strategic method saying something about the present situation and how to move from the present to the future situation. To strategically connect units that are driven by different specialized ways of reasoning and, therefore very different conceptual logics, is a complex cognitive process that involves developing an overarching way of reasoning that is understood and accepted by all interacting units.

The strategic narrative formulation also includes an outline of the general structure of goals and activities that function as basis for the specific goal setting in operational planning (see Exhibit 7.3). Thus, based on the strategic narrative, a system of goals connecting the operating units can be formulated. Goal setting is a planning instrument that aims to influence the operating units to coordinate the output–need relationship and enable effectiveness. There are two performance issues in goal setting: the ability to fulfill the goal (implementation) and the purpose of the goal (ability to fulfill the need). The executing operating unit prefers goals that can be implemented efficiently, while the receiving operating unit prefers goals that serve its needs so that it can function efficiently. In this way, goal setting related to effectiveness is a process of mediation between operating units to create a coherent system of goals. Hence, even though specific goals are established through operational planning, they are guided by the overall system of goals established by strategic performance management. Also, the goal formulation must be subjected to performance evaluation. This assumes that there are performance targets for the organizational unit determined independently of the defined goals. The set of goals can and should be formulated and monitored to form a control mechanism of the strategic planning. Measurement can indicate the degree of targeted coherence achieved.

The formulation of a coherent strategic narrative that connects goals across specialized organizational units with multiple actors’ intentionality and strategic methods involves a management process of coauthorship and, hence, an actor-based approach. Here, the formulation process is organized in such a way that the organizational actors participate as linking pins in the goal formulation effort of the top management. The formulation process is initiated from the top, but the interaction among the various constituencies involved takes place as a dialogue­­. On one hand, this gives the multiple operational actors a bottom-up opportunity to contribute to the goal formulation process. On the other, the top management through its communicative processes influences their subordinates’ intentional values and cultivation of strategic methods.

Proactive Truth of the Narrative

The first and basic evaluation of strategic performance concerns the quality and implementation of strategic narratives. The focal point is whether together they can create construct causality. The evaluation assesses the understanding, acceptance, and evaluation of the proactive truth of the narrative by the different unit leaders involved. A unit leader may for instance experience a narrative as fiction, irrelevant, impossible to implement, or as a poor interpretation of the possibilities and values of the company. A new strategy may be destructive for the efficiency of a unit, and the degree and duration of such effects must be taken into consideration. For instance, in HEALTH, the strategy of establishing manufacturing competences capable of meeting the output objectives might not be factually possible and might become counterproductive for R&D’s ability to create new products. The narrative may be biased because it is based on input from a few dominating leaders disregarding other leaders whose units are of equal importance. For the narrative to function, it should be subject to an open dialogue in which the concerns of the various units can be taken into account. This can be uncovered by an analysis of the formulation and acceptance of the strategic narrative by the unit leaders. Furthermore, the strategic narrative must reflect trends in various environments, for example, technological development, market demands, and so on. This can also be analyzed by having a qualified analyst interview the strategic leadership. An overall evaluation of the credibility of strategic narrative is whether it reflects and integrates the factual possibilities and values concerned as well as be able to function in communicative interaction with other units.

Measuring Changes in Strategic Coherence

The next step in strategic performance measurement is to create indicators to measure the coherence between the units connected directly by output–demand relationships. Strategic performance measurement requires information about the strategic performance related to the different operational units of the company and the flows between them as well as between these units and the market and institutional environment. Since the operating units create a chain of coherent links, it is possible to trace problems indicated at one place to other places in the chain from where they may originate. To obtain such traceability in the implementation of the linking goals, qualitative and quantitative performance measures can be applied to shed light on the achievement of the various aspects of the strategic goals outlined. The narrative and goal formulation play a crucial role in reasoning and justifying the specific choice of performance targets and measures.

Monitoring of changes in coherence can be used to reflect on the adequacy of the strategy to establish construct causality and to adjust the strategic behavior and thereby improve company’s performance in future. Accordingly, strategic measurement requires indicators that directly reflect changes in coherence. Therefore, to observe the internal–external fit, one may install a measurement of any output–goal link between operating units at any point of time. This establishes a measurement system that allows the leadership to monitor changes in the degree of coherence and thus guide strategic activities aiming at making incremental improvements in the internal relationships in an ongoing manner. The effects of new strategic goals on the operational efficiency of the units have to be taken into account. Therefore, it is vital to create a performance evaluation system that is based on analyses of some or all the various links of coherence in the system. Coherency goals can be formulated for each of these links to motivate the implementation of strategic coherence, and measurements of goal fulfillment may be used as drivers for the ongoing improvement of strategic performance by constantly incentivizing cooperating units’ learning how to create strategic coherence.

For this purpose, we suggest using real-time measurements of coherence issues. Thus, there is absolutely no need to use ex ante and ex post measurements to estimate the overall performance. Instead, measurements can be installed as real-time information systems that enable managers to estimate how they perform strategically during the process. The measurement system thus becomes a learning device and motivator for the strategic process. This constitutes a measurement of the implementation of the strategic idea in the company, that is, the internal coherence of the functions of the company activities. The real-time measurement of change in the strategic profile makes it possible to trace the problems to their various sources in two aspects: the place where the problem originates and the unintegrated dimension(s) that stops strategic action from taking place. Thus, it provides a basis for the assessment of strategic performance that enables the formulation of goals to drive the improvement of strategic profile.

We suggest the construction of an information platform that functions as the instrument for strategic performance measurement and learning. The platform may consist of a set of strategic scorecards, one each for the coherence relationships essential for the overall chain of activities and functions underpinning company’s performance. Each scorecard analyzes the degree of coherence between units in the performance chain. In case of coherence problems, the card breaks down the information with respect to the dimensions that must be integrated for the relationship to be coherent. For instance, was the problem caused by insufficient information or a clash of values or by the lack of factual possibilities? The platform contains a top-level integration scorecard that reflects the change in the strategic profile of the company, that is, changes in the internal–external fit. For each of the links between internal units, an integration scorecard is constructed to reflect the changes in coherence between the units. If operational problems in an operating unit are caused or influenced by the output from another operating unit then those problems must be recorded in the integration scorecard as a coherence problem. Each scorecard contains qualitative data concerning the strategic narrative as it is perceived in the units and quantitative measurements related to the strategic coherency goals connecting the units involved. Exhibit 7.4 sketches an overall strategic scorecard of HEALTH. It provides an overview of the strategic expectation and reality.

Analyses of coherence in the system of links can be used to identify problems and their causes by tracing coherence problems, that is, tracing the signs of incoherence in one operating unit back to their causes in other parts of the system. If one does not trace the problems to their origins they cannot be eliminated. Thus, a system of coherency tracing is a fundamental tool to improve strategic coherence. The analysis of such chains of causality connections enables the formulation of goals and measurements that can resolve coherency problems and thus improve overall strategic coherence.

Strategic Truth Gap and Learning

In order to promote strategic learning, the strategic scorecard should be used to analyze the truth gap. A large gap implies poor strategic performance in the sense that strategic plans are not realized. This analysis is therefore motivated by the drive to reduce this gap, which means the ability to control the strategic situation through strategic behavior improves. Thus, part of the strategic performance is to ensure strategic control, which includes the reliability of the measurements used in the integration scorecards and, thus, the very goal setting that interprets the strategic narrative.

In a strategic context, where changing conditions are an essential part of performance, the notion of proactive and pragmatic truths is important. Pragmatic truth consequently means that the proposition is true if the operations that implement the expectations do succeed. A problem with this pragmatic concept of truth is that one can only know the truth after events have taken place. Since it is absurd to wait for ex post testing of strategic statements, a concept of preliminary, or proactive, truth is needed to provide a basis for action. This proactive truth is then subjected to a continuous process of improvement that identifies and diminishes the difference, or truth gap, in the pragmatic truth (i.e., the outcome). The truth gap between what we expected to do and what we did includes two dimensions: strategy setting and strategy execution. The deviation between what we should have done and what we did is the gap in strategic execution. The deviation between what we expected to do and what we should have done is the gap in strategy setting. The truth gap is to be kept small and insignificant. If it is large, information that is only proactively true can mislead users.

To enhance information reliability the truth gap must be monitored. The truth gap is likely to grow unless the apparatus creating proactive truth is improved on an ongoing basis. Increases in the truth gap must be traced to their origins in neglected coherency issues, new influences, and previously unobserved data. Thus, truth gap monitoring becomes a basis for a continuous learning and improvement process. Without this learning, proactive truth is likely to lose reliability. Especially in the dynamic situations of modern business, success requires not only the measurement of existing strategic performance but also the use of the learning process to devise and implement new strategies. Overall, it forms the basis for focused strategic reflection. The coherence measurements suggest functions as drivers not only because they can be used to motivate but also because they become learning devices since real-time monitoring of truth gap makes it possible to pinpoint the activities that actually reduce the truth gap.

Conclusions

This chapter has outlined a conceptual basis for the derivation of strategic performance measurement to be used for assessing the strategic performance of top executives and to provide constructive feedback to improve management’s strategic practices. It is argued that strategic performance measurements should focus on issues of strategic coherence in relation to the pursuit and achievement of goals. Identifying the extent of coherence attained and ensuring that it is maintained and incrementally improved in the long term are taken as the prime aims of strategic management. To achieve this, the strategy adopted should also be valid and the measurement system adopted should support the validity of the means by which coherence is pursued. The achievement of validity in this sense requires strategic performance measurement to be based on a carefully constructed knowledge base or information platform specific to the internal and external circumstances of each organization. The generation of this intelligence base and its use to promote strategic coherence must involve the integration of facts, possibilities, values, and communication within and across the subunits of the organization and at the interfaces of the organization with its environment. Through its ongoing identification of strategic shortcomings, this approach is also designed to support strategic learning and improvement.

Discussion Questions

1. Drawing on pragmatic constructivism, evaluate the strengths and weaknesses of the balanced scorecard? How does balanced scorecard relate to the four dimensions of pragmatic constructivism (facts, possibilities, values, and communication)? What are the blind spots of integration embedded in the balanced scorecard? What might be the strategic consequences of the blind spots?
2. Drawing on pragmatic constructivism, you are asked to design a strategic performance management system for an organization! How will you orchestrate the production of a strategic scorecard? How will you produce the strategic scorecard? What measures will you suggest? How will you use the strategic scorecard?