8
Selecting the Right Performance Measures

“The most serious mistakes are not being made as a result of wrong answers. The truly dangerous thing is asking the wrong question.”

—Peter Drucker

The purpose of this chapter is to explain the reasons for selecting the right performance measures and how to do so. The overarching questions to answer include, How can we

• build realistic measures that drive needed change and behaviors?

• articulate firmwide objectives through an integrated measurement system?

Vision, Strategy, and Objectives

We are often asked by professional services firms to supply them with a list of the right performance measures. It seems they want to be transported magically to the end of the process rather than take the required journey through the process. Unfortunately, no single list is right for all firms. We have certainly created a number of these lists over the years and must stress that the right list for your firm is one that supports your firm’s vision, strategy, and objectives. Clarifying vision, strategy, and objectives is the enabling process that allows a firm to select the right performance measures.

The Role of Performance Measures in Driving Behavior

Over the past few decades, people have referred to performance measures by different terminology. Some call them performance indicators; others call them key performance indicators; others refer to lag measures. Certainly, these terms indicate some type of measurement.

When a firm selects the correct measures, two things happen. People understand what they are individually responsible for achieving, and they understand what their team is responsible for achieving. In some cases, the measures are accompanied by the behaviors needed to accomplish the measures.

The measures can be raw numbers or percentages and should help the firm track progress toward strategic objectives or reflect improvements in revenue, profitability, productivity, and so on. They can tie to the budget (for example, percent of budgeted target achievement) or serve as an improvement over a prior period (for example, realization increase from 85 percent to 88 percent). They can also have minimum thresholds (for example, participants must achieve at least 80 percent of the target to be eligible for a portion of the bonus). Beyond the preceding, these measures and their targets can and should be different for each level (group) in the firm and can be different within a level (group). As examples, senior owners may have different measures than junior owners (different targets for different groups), and new managers could have different measures than senior managers (different targets within a group).

Firm leaders should also realize that measures alone do not motivate people. When leaders focus only on measures without considering other aspects that can motivate or demotivate employees and owners, success may be short term, reduced, or nonexistent.

According to Psychology Today, “Motivation is literally the desire to do things. It’s the difference between waking up before dawn to pound the pavement and lazing around all day. It’s the crucial element in setting and attaining objectives—and research shows you can influence your own levels of motivation and self-control. So figure out what you want, power through the pain period, and start being who you want to be.”¹

We agree that motivation is primarily intrinsic, and each individual must take ownership for pounding the pavement. We also believe strongly that motivation can be heightened by aligning employee and owner roles and tasks with their unique abilities and desires. Motivation is further engendered by helping team members understand their part in accomplishing the shared vision.

Without the right performance measures in place, employees could actually be demotivated. However, if measures are properly defined, and employees and owners see alignment between expectations and how rewards are earned, there is likely greater passion and motivation for accomplishing them. Clear and well-defined performance measures, aligned with talents and desire, can create a culture of confidence.

The process of selecting measures is as important as the measures themselves, and we know selecting them is not an easy task. We believe firms can work smarter, not harder, to reach higher performance levels. They can simply ensure that owners’ and employees’ performance measures support further organizational objectives.

Why Choose Performance Measures That Are Linked to Firm Objectives

Many firms fail to do a good job of selecting the right performance measures or managing performance. Yes, they are beginning to look at hard data to tell how well an employee has performed—whether he or she has done things right. This is an excellent first step. What is often missing in the performance evaluation process, however, is whether the employee is actually doing the right things. Back to measurement selection!

It does no good for a team member to spend time doing a great job on a project that does not further the firm’s objectives. This is why we put so much emphasis in this book on alignment. The better aligned people are with the firm’s objectives, the better performance will be. A laser focus on the ability to answer the following question is needed. How well does this employee’s objective support or ensure accomplishment of the firm’s objectives? If you can’t answer this question specifically or find yourself saying under your breath, “Pretty well,” it’s time to revisit what you are asking employees to do. So, let’s look at how to do so.

How to Choose Performance Measures That Are Linked to Firm Objectives

Now we think about how the right performance criteria come into play at both the organizational and individual levels. For example, if your vision includes becoming the dominant firm in your geographic area, then the performance measure may be the number of new business opportunities the firm closes during the year. As this measure is filtered throughout the firm, individuals in each department (for example, assurance, tax, consulting, and so no) or on niche or industry teams must have performance measures (objectives) that align with the organizational objective. If no one in the firm has an objective to generate new business opportunities, you can imagine how well (or not so well) the firm would achieve its vision of becoming the dominant firm in the geographic area. We are constantly reminded of the old saying, “What gets measured gets done.”

When considering which measures to use, it may be helpful to select measures that help the firm accomplish general objectives, such as

• improve performance.

• improve profitability.

• improve client relationships.

• increase realization.

• develop niche or industry services.

• improve accountability.

We provide in this chapter a listing of many performance criteria but caution you about the importance of choosing the right ones for your firm and then aligning your people to them. Even more importantly, the metrics must be built into each performance measure, so individuals and groups understand the behaviors and activities needed to accomplish firm objectives. This is the critical link between employee performance and organizational success.

What then should firm leaders begin to think about before establishing appropriate measures for their performance-based compensation plan? Consider the following:

• You can’t pay more unless the firm makes more, and the way to improve profits is to improve performance.

• The plan must pay for itself. In other words, when creating the budget at the beginning of the year, you can’t have a plan that calculates a larger payout than the net income of the practice. If net income is less than budgeted payout at the end of the year, the plan must pay out less. If net income is above the budgeted plan, then the firm can make a higher payout.

• To improve profitability, most measures should be related to production, business development, and operational improvements. Our experience has been that approximately 75 percent of the weighted objectives should be in these areas; the remaining 25 percent can be in areas that will build capacity in the future.

Potential Dangers When Using Performance Measures

Because no system is perfect, we warn you about potential dangers when using measures. Consider the following:

• There is no guarantee that hitting the measures will result in the profitability you estimate. Remember, you are making an assumption (a bet) based on historical data, best practices, benchmarking, and intuition that, when individuals spend more time doing “X,” it will translate into higher profitability.

• You should identify a minimum profit target before any incentives are paid.

• Employees and owners may try to “game” the system. For example, if you are measuring charge hours, individuals may strive for as many hours in work in progress (WIP) as possible, not caring whether they could be billed. If you measure new business revenue and do not also measure the profitability on those dollars, then a business developer could bring in a variety of unprofitable work. In both cases, employees achieve their objectives (measures) but create an unintended consequence elsewhere.

• To make a particular month or quarter look better, employees or owners may not report everything in that period and may carry it over into the next. This can also affect the firm’s profit objectives.

• Not only are measures and firm objectives often misaligned, but measures may not align with an employee’s competencies. For example, owner A does a great job fulfillin billable hours, yet one of his or her key measures may be related to business development. Either of two things will likely happen: partner A will not hit the business development objective and become demotivated, or he or she achieves the objective and may not be fulfilled because business development is not his or her passion.

The key to building a set of performance measures is to do so in stages. Clear firm objectives are important because vague objectives create impractical perspectives and metrics. Consider what is currently measured and how these measures are aligned with firm objectives. Do you understand the clear cause-and-effect relationships?

Using Scorecards to Categorize and Clarify Performance Measures

Firm Scorecard

Many firms use a scorecard or dashboard to document the firm’s objectives, as well as the actions that lead to the accomplishment of the objectives, including who is responsible for not only the objective but each of the actions. The balanced scorecard is a proven approach for categorizing firm objectives and helps you look at the firm from at least four perspectives: financial, client, systems, and growth and learning. Firms need not embrace the balanced scorecard approach to take advantage of the template illustrated in table 8-1.

Table 8-1: Sample Firm Scorecard

Department Scorecard

Departmental objectives must be aligned with the firm’s objectives and specific to the department. Table 8-2 shows that, for the most part, department strategic objectives mirror the firm’s strategic objectives. The measures and actions become specific to the department in question. Some examples include

• new business generated.

• gross profitability on new and existing business.

• client satisfaction factors.

• billable hours.

• revenue per employee.

Table 8-2: Sample Tax Department Scorecard

Table 8-3: Sample Individual Tax Senior Scorecard

Individual Scorecard

Individual measures may include, but not be limited to

• personal billable time.

• business developed for self or others.

• developing a new service line or niche area.

Please refer to table 8-3 for an illustration.

Categories of Objectives

Although objective categories (and their weighting) vary from firm to firm, we believe each firm should have, at a minimum, the following basic objective categories:

• Financial goals

• Client service goals

• Internal systems and business process goals

• Employee growth and learning goals

• Business development and marketing goals

How these categories are weighted for the computation of year-end performance ratings varies from firm to firm and, often, person to person within a particular firm. Each is discussed in the following sections.

Financial Measures²

The proof, as they say, is in the pudding. The financial perspective tells a firm if its strategies are working. If the firm is hitting or exceeding its growth and profitability objectives, then it is likely implementing its strategic plan well. If financial objectives are not accomplished, the firm is compelled to examine underperforming areas and make needed changes to get better results. Although most firms are good at setting financial objectives, neglecting what is behind the numbers often gets them into trouble. The most common performance measures in the financial area include

• staff cost as a percentage of net revenue.

• revenue from new services introduced.

• revenue growth.

• gross profit margin.

• net income per owner.

• return on investment.

• return on marketing investment.

• operating margin.

• market share.

• return on equity (earnings available to shareholders or shareholders’ equity).

• profits per professional.

• profits per full-time equivalent.

• revenue by service mix.

• cash flow from operations.

• receivables as a percentage of working capital.

• days outstanding in accounts receivable (A/R) and WIP.

Client Service Measures

Client service objectives tell you how well you service market segments in which you have chosen to compete. To determine how well they are achieving the firm’s client objectives, firms often select one or more measures from the following list:

• Number of personal interviews with clients

• Client service guarantees implemented

• Profitability by client

• Number of clients inside the target market segment

• Number of profitable clients

• Share of client’s wallet

• A/R adjustments

• WIP adjustments

• Client retention rates

• Satisfaction scores in problem areas

• Service attributes

• Percentage of clients that rate the firm as 4 or 5 (on a scale from 1 to 5) in client service

• Retention rates or percentage of clients who are repeat

• Number of client complaints

• Number of redos in work products (error rate)

• Number of clients exercising service guarantee

• Number of new services sold to existing clients

• Service quality

• Turnaround time

• Percentage of delivery deadlines met

• Percentage of total revenue that comes from repeat clients

• Percentage of lost clients

• Net clients gained

• Percentage of clients providing referrals

Internal Systems and Business Process Measures

Many business leaders believe a great strategy is the key to getting desired business results. One statement that has had a profound impact on us as consultants is, “A grade C strategy with grade A execution is far better than a grade A strategy with grade C execution.” Systems and processes follow closely on the heels of strategy. Systems and processes cause or motivate people to engage (or not engage) in the behaviors needed to accomplish the objectives.

Although some accounting firms and many consulting firms provide process re-engineering for their clients, few do it for their own firms. Simply stated, a process is a series of steps that change input into an output. There are many processes in a firm, but the most important are those that have an impact on the client’s experience with the firm and the firm’s financial results. The ultimate objective in every business process is to help the firm achieve its objectives. Most firms have a goal to provide excellent client service or effective and efficient service, but work review (quality control) processes that are redundant and ineffective will not help the firm achieve its client service objective.

Process improvement requires a firm to identify, document, and ultimately refine the process, so it furthers firm objectives. It is an ongoing endeavor. By capturing and improving process consistency, however, firm objectives are more likely accomplished.

We encourage firms to assign individual stewardship for existing systems and process review and refinement. These stewardships should be documented as written performance objectives in individual scorecards. We suggest you clarify desired results and allow the stewards to determine the approach and methodology for conducting the reviews and revisions. In some cases, however, we also suggest a flowchart of the tasks and activities that are included in the process, as well as decision points along the way—those steps that convert the input into an output. A flowchart can tell you how well the system is currently working. Figure 8-1 illustrates a sample (incomplete) flowchart for engagement management in a CPA firm.

Because processes support many different functions, departments, niches, services, or strategies in a firm, you want the flowchart to depict all the cross-functional responsibilities. Creating effective internal processes is also important because it reduces inefficiencies, thus allowing more time for professional staff members to work on challenging and motivating client work.

When setting process improvement objectives that impact clients, consider the following broad questions:

• How does the firm need to be structured to meet client needs?

• How does the firm ensure a quality product that eliminates redos?

• How does the firm ensure a timely turnaround?

• What does the firm need to do from a process perspective to achieve its client and financial objectives?

• What processes does the firm need to develop or improve in the service innovation, operations, and postsale stages?

Figure 8-1: Engagement Management Flow Chart for CPA Firm

Here are examples of key internal systems and business processes you may want to examine:

• Marketing and sales

• Client acquisition

• Service delivery

• New service development (research and development)

• Postsales follow-up

• Client service (handling complaints, billing issues, and so on)

• Pricing

• Client billing and collection

• Improving utilization

• Turnaround time for projects

• Rework time

• Number of tax returns completed per day

• Number of new services developed

• Time to bring new services to market

Employee Growth and Learning Measures

The employee perspective in a professional services firm is perhaps the most important category of measures because the key differentiating factor among services firms is its people— the resources who actually develop and maintain clients relationships and provide product or service delivery. The professional services firm succeeds or fails in the other categories (client service, financial, internal systems and business processes, business development, and so on) based on the experience and expertise of its employees.

Employee measures help the firm determine how well it is doing recruiting and retaining the right people and enhancing the competencies of employees and owners. Here is a list of specific measures that determine how well you are achieving employee-related objectives:

• Number of professionals who are trained in more than one service area

• Number of professionals trained in new technologies

• Firm’s investment in technology as a percentage of net revenue

• Personal and professional employee satisfaction

• Professional perception of firm leaders

• Number of staff suggestions made

• Number of staff suggestions implemented

• Employee turnover ratio

• Average length of service for professionals

• Number of employees participating in retirement and profit-sharing plans

• Revenue generated per employee

• Percentage of professionals with CPA or other professional designation

• Number of professional, niche, and community organizations in which the individual actively participates

Business Development Measures

Most firms market themselves as just that—a firm. For example, “The Firm of Smith and Dale Does Nice Work.” The most effective professional services marketing and business development, however, is done for the parts of a firm. The performance objectives and measures of every niche, practice group, or service team should support the firm’s overall strategies.

There are several ways to measure whether your marketing and business development processes support your firm’s growth and financial objectives. For example, you can measure

• the number of new products or niches developed during the last year.

• the number of new geographic markets entered.

• the number of cross-selling opportunities created.

• the amount of cross-sold revenue.

• the cost of new client acquisition.

• the number of personal interviews with clients.

• the results of client satisfaction surveys.

• the number of client service guarantees implemented.

• client profitability.

• the number of clients inside the target market segment.

• the share of the client’s wallet.

• client retention rates.

• total marketing cost as a percentage of total revenue.

• the number of seminars presented.

• the number of ads placed.

• the number of interviews conducted.

• the number of articles placed.

• the number of press releases placed.

• the number of times firm members are quoted or mentioned in publications.

• the number of presentations made.

• the ratio of proposals won to total proposals.

• the number of pending proposals.

• the number of trade shows attended.

• the number of trade shows exhibited at.

• market share.

• the number of new clients.

• brand name awareness.

• average fees per existing client.

• average fees per new client.

• percentage of sales from new services.

• revenue growth rate by service.

Final Thoughts

Selecting the right performance criteria can be a daunting task. So, using a structured approach for thinking through what you’re trying to accomplish, how you will measure whether you’ve done so, and the actions necessary to get you there cannot be underestimated. The balanced scorecard or similar approach can be extremely useful to capture your best thinking. Don’t worry if you are not 100 percent right the first year; for all firms, there a learning curve. The important thing is to make incremental improvements each year.