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Get your goals right: using benchmarking in setting performance targets

Yann Pastor and John Hall
PA Consulting Group
Business Performance Management
1 March 2009

Today — more than ever before — executives need to be sure they're calling the right pitch when setting their organization's strategic objectives. A custom benchmarking process offers insight into appropriate, realistic performance goals.

Business leaders often feel their control on their business is slipping. They put in place processes and measures designed to help them manage the organization, yet they continue struggling to maintain competitive advantage. The key reason is that processes and measures sit in a vacuum unless, through benchmarking, they directly compare the company's performance with what competitors are doing. Without a clear view of how it compares with external entities, an organization may suffer from tunnel vision and thereby lose focus on the measures that matter most to its customers and stakeholders.

For example, one of our clients, who leads a major oil and gas company's call center operations, told us at the end of 2007 that he was struggling to regain control of his organization. Most of the leaders and employees in the organization believed they were delivering value; however, our client was receiving alarming reports from customers and other stakeholders about a decline in service quality.

One of the key reasons for the disconnect between the organization and its stakeholders was that the organization's goals and targets were inward-looking. Metrics that managers tracked regularly did not take into account the performance expectations of the market; the company was not benchmarking its performance against metrics that were commonly accepted in the industry. For instance, the first-tier call center was assessed only in terms of employees' speed in answering calls. Managers had no indication of the speed and quality of the resolution of the problem that led to the call. Even if the organization's scorecard showed positive performance, that did not mean the call center was adequately addressing the issues customers deemed important. Customers might prefer to have calls answered quickly, but the more important question to them was “How well was my problem resolved?”

The leader of this call center asked us to review the group's performance management framework. Our analysis highlighted gaps and overlaps in benchmarking metrics, and led us to the conclusion that the focus of the organization's metrics was too myopic to reflect the call center's performance in the areas that were most important to stakeholders. The company revamped its performance management framework to emphasize benchmarking of resolution-focused metrics for its first-tier call center, rather than simple measurement of the speed at which employees answered the phone.

How Benchmarking Helps Managers Regain Control
For managers facing situations like that of our call-center client, a value-based performance management framework can help assess the health of the organization. What makes these frameworks different from most performance management frameworks is their focus on the value the company delivers to shareholders, customers, and other stakeholders. The methodology stems from a financial valuation technique known as value-driver analysis. The key benefit of this technique is that it provides a set of performance indicators that are mutually exclusive and collectively exhaustive. An additional benefit is that value-driver analysis limits to the bare minimum the number of metrics a company uses.

The sidebar Selecting the Right Metrics describes the process of choosing performance measures in a value-based performance management framework. One key consideration in the selection of metrics should be whether benchmark data is available. Various definitions exist, but benchmarking is generally understood to be the process of comparing the performance of one organization against that of one or more other organizations. This is not to say that a company cannot have any metrics which it doesn't benchmark against other organizations (or against other divisions or functions within the company), but a company deciding between two comparable metrics should consider whether benchmark data is available for either. In a value-based performance management framework, performance benchmarks are the true catalysts for change. They provide a non-negotiable view of what an organization needs to change in order to become more competitive.

As a company moves through the process of selecting metrics, performance managers must determine where they will acquire the external data with which they'll compare their organization. The right answer depends on the company's industry. Benchmarking based on the Balanced Scorecard metrics is quite common, but corporate performance benchmarks must match the industry's value drivers. For instance, it would not make sense for an asset-intensive business to use the same performance metrics that are appropriate for a professional services firm with relatively small capital investments. It usually makes sense for a business to benchmark itself against best-in-class performers within its industry. At the same time, the comparison of an organization's performance against that of its peers in the market can help it determine the level of performance common in its competitive environment.

Regardless of which metrics a company uses and where it acquires comparative data, the end result of a benchmarking process is to list performance gaps between the company doing the benchmarking and the organization or organizations against which it's comparing itself. These gaps then translate into a set of revised business targets or a business case for making changes to improve performance. Benchmark data in areas such as cost, quality, and productivity often helps define performance improvement initiatives.

Benchmarking can also be helpful in sourcing, or outsourcing, decisions. In particular, benchmark data can indicate whether pricing and service levels of an outsourcing contract are reasonable in the context of the market. A best practice in writing sourcing contracts is to mandate benchmarking at regular intervals, then to adjust pricing in the contract if the benchmark data supports a change. For example, a large pharmaceutical company we work with recently renegotiated its contract with a vendor that manages technology for the pharmaceutical company's sales force nationwide; the new contract includes a benchmarking clause. Data collection on sourcing contracts can be done via specialized data providers or via a request for proposal (RFP), especially if the contract is due to expire. This type of benchmarking can also help settle pricing disputes because it provides independent and objective comparisons.

Performance benchmarking may be a one-off event. However, a company is most likely to achieve lasting results if it integrates benchmarking activities within its permanent performance management framework. Among other benefits, regular benchmarking helps an organization ensure that its metrics remain absolutely relevant within its industry and market. The appropriate frequency of a benchmarking process varies depending on four factors: the industry, the type of metrics being compared, how the organization uses the benchmark data, and the cost of obtaining that data. In an ideal world, senior management might like to benchmark customer satisfaction daily, but the internal cost of doing so would be prohibitive and external data is highly unlikely to be updated that frequently.

Many companies looking to set better performance targets end up buying standardized benchmark data and using it as is. Although rapid to implement, this approach has a significant flaw: Standardized benchmarks do not take into account individual companies' specificities. For instance, economies of scale typically skew benchmarks, so what's appropriate for a large organization is drastically different from what's appropriate for a small company in the same industry. Much of the available standardized benchmark data may be irrelevant for a given organization.

A preferable approach is to construct a custom benchmarking methodology, especially as part of a scorecard-development project. However, creating custom benchmarks requires a deep understanding of the company's industry and the value drivers within that industry. An entity providing custom benchmark data must have experience in developing corporate scorecards and applying benchmarks within the market of the company doing the benchmarking. In addition, of course, effective benchmarking requires detailed business intelligence on all the right metrics. A provider of custom benchmark data must have access to information regarding both core business processes and support functions such as finance and procurement. In addition, a provider of custom benchmarking should have a dependable process and a proven track record.

Clearly, buying standardized data is easier than finding a provider of custom benchmarks, but going the custom route can pay dividends by helping companies set better performance targets. The process for developing metrics, acquiring comparative data, and setting performance targets varies somewhat among providers of custom benchmarking services, but it's important for the scope of the benchmarking project to be clarified among all participants before the project begins. Exhibit 1 illustrates one approach to the benchmarking process. It consists of seven steps:

Many companies looking to set better performance targets end up buying standardized benchmark data and using it as is. Although rapid to implement, this approach has a significant flaw: Standardized benchmarks do not take into account individual companies' specificities. For instance, economies of scale typically skew benchmarks, so what's appropriate for a large organization is drastically different from what's appropriate for a small company in the same industry. Much of the available standardized benchmark data may be irrelevant for a given organization.

A preferable approach is to construct a custom benchmarking methodology, especially as part of a scorecard-development project. However, creating custom benchmarks requires a deep understanding of the company's industry and the value drivers within that industry. An entity providing custom benchmark data must have experience in developing corporate scorecards and applying benchmarks within the market of the company doing the benchmarking. In addition, of course, effective benchmarking requires detailed business intelligence on all the right metrics. A provider of custom benchmark data must have access to information regarding both core business processes and support functions such as finance and procurement. In addition, a provider of custom benchmarking should have a dependable process and a proven track record.

Clearly, buying standardized data is easier than finding a provider of custom benchmarks, but going the custom route can pay dividends by helping companies set better performance targets. The process for developing metrics, acquiring comparative data, and setting performance targets varies somewhat among providers of custom benchmarking services, but it's important for the scope of the benchmarking project to be clarified among all participants before the project begins. Exhibit 1 illustrates one approach to the benchmarking process. It consists of seven steps:

Step 1: Collection of internal data
Before it begins to collect external benchmark data, a service provider must fully understand the definitions and processes, volumes, performance levels, and delivery scenario within which its benchmarking client does business. The provider must work with the company to collect, catalog, and define its present state of performance, which should involve fully describing in marketplace terms the functions, tasks, and services that will be included in the benchmarking process. Without this information, it would be virtually impossible to customize benchmark data in a way that makes it truly relevant to the business.

A benchmarking service provider may use a variety of tools and techniques to collect data on the company's operations and current performance. It may hold meetings with stakeholder teams to review data-gathering functions and processes, and to gain agreement on methods and on who will be responsible for the activities. It may conduct face-to-face interviews with appropriate personnel to garner summary data, along with in-depth information where more detail is required. The service provider may review paperwork that provides insight into the business's operations, including documents regarding ongoing operations; contracts and addendums that state the company's rates, volume commitments, geographic coverage, terms and conditions, and service levels; documents outlining the business' strategy and vision; invoices, monthly reports, and other billing documents; annual reports; organizational charts; and/or maps of corporate sites. The benchmarking service provider may want to observe operations and may want details about IT and business projects that are either planned or under way. And it will definitely want to collect information about the company's performance metrics, its targets, and how well it has performed relative to those targets in the recent past. To ensure that it efficiently collects all of the information it needs, the service provider may use standardized data-collection documents or interview guides.

Step 2: Service definition
The first step in selecting metrics and benchmarks is to identify which activities need to be monitored through the benchmarking process. Within the areas that will be benchmarked, the performance manager must clearly identify each service that the business engages in. Every service that results in business value should be considered separately. For example, in the oil and gas company call center mentioned earlier, the tier-one call center is assessed differently from the billing service. The performance manager needs to be assisted in this process by subject matter experts in the areas that will be benchmarked. The head of HR, for instance, should be engaged as early as possible in decisions about which services related to employee satisfaction should be benchmarked.

Step 3: Discovery of performance drivers
In the third step, the benchmarking team uses the service definition results from the previous step to choose the baseline service metrics that the company will benchmark (see also Selecting the Right Metrics). The team needs to prioritize the company's performance drivers based on their impact on shareholders, customers, and other stakeholders, then choose metrics that reflect the company's success with regard to those drivers.

Of course, in choosing performance metrics for its benchmarking project, the team will need to remain cognizant of which types of performance information are available through its service provider's database. Typically, the provider can offer a template that indicates which information it has for the group of companies it deems appropriate for benchmarking comparisons. These templates do not specify company names but show characteristics such as industry or sector, services offered, and geographic region. The service provider should also be able to offer summary data, as required, to bolster and support the findings of the benchmarking process.

Step 4: Development of cost and pricing data
In order to align a company's data with the information in a benchmark database, the benchmarking service provider may need to review the cost to the company of the processes being benchmarked. If the processes are associated with specific prices for external customers, pricing data should also be collected. For instance, suppose that we are benchmarking the performance of a call center. We need to assess and document the cost of each service-request resolution; if customers are charged for resolution of their service requests, then we should also assess the price to the customer. Collecting this cost and pricing data is the first step in normalizing — i.e., making comparable — the data from our two different sources. In this process, the benchmark team for our call center may discover that the available best-practice data measures cost in terms of each call-center ticket or each resolution, whereas their organization measures only cost per call (and resolution of tickets usually requires more than one call). Aligning the cost and pricing definitions of measures is crucial before companies enter the next phase of benchmarking.

Step 5: Normalization
All kinds of differences may exist between an organization's performance metrics and those of its competitors. One of our clients, for example, delivered a portion of a maintenance service to gas stations. However, when it began the benchmarking process, it realized that the available best-practice data included the supply chain for the entire maintenance service. Step 5 requires the normalization of marketplace data using the metrics defined in step 3. Factors that require normalization can include scope, scale, service levels, terms and conditions, and geography.

For each of a company's metrics, step 5 involves an analysis of how much the benchmark data should be increased or decreased in order to be truly comparable to information gathered by the benchmarking company. For our client that provided maintenance dispatch services to gas stations but outsourced the actual service delivery, normalization of the industry benchmark data involved an adjustment so that the benchmarks reflected only the fraction of gas station maintenance services the company provided. The effectiveness of the normalization process depends on the depth of the service provider's understanding of the company being benchmarked, as well as its marketplace and industry sector. Subtle differences in a company's services can significantly impact the accuracy of the performance management framework.

Step 6: Statistical analysis
After normalization, a company (or its service provider) is ready to statistically evaluate the benchmark data. It can calculate quartile break points for each metric or service and quantify the performance gap between the benchmarking organization and its peers. This analysis will drive the formulation of performance improvement initiatives or, in the case of sourcing benchmarking, may serve as a basis for price negotiations. Bar charts can be used to highlight quartile breaks and areas needing improvement in the benchmarking organization. They make the statistical analysis easy to understand and provide a clear basis for setting targets for the benchmarked metrics.

Step 7: Finalization of project deliverables
A service provider's final deliverable for a benchmarking project should be a report providing ranges of performance for metrics in each of the defined services, along with recommendations for changes suggested by the analysis. The report typically also includes backup documentation consisting of a situation overview; a description of the approach to benchmarking; identification of the factors considered in normalization; comments on the adjustment of these factors; a template of the benchmarking framework, which summarizes the services being benchmarked; assumptions underlying the analysis; and the findings of the benchmarking process. Opinions and recommendations for improvement initiatives should be included wherever they are relevant, or wherever differences are stark between the benchmarking organization and its competitors. The process should be fully inclusive, and conclusions and findings should be shared throughout the process. The final report should include no surprises.

Because of the number of variables it entails, custom benchmarking is one of the few reliable methodologies available for validating the metrics and targets within an organization's performance management framework. Having a third party manage the benchmarking process, and analyze the results, helps ensure that the study is done objectively and that it encompasses all relevant factors in making the comparisons.

The unique circumstances in which a company operates make any generic or off-the-shelf benchmark report suspect. No standardized report can fully accommodate the individual situation within a given company. As pressure on business performance continues to increase, companies will find it increasingly crucial to be able to recognize how they are doing. Truly comparable benchmark data will be the only way to appropriately adjust their activities to changing market factors. Customized benchmarking is one of the key tools any business can use to ensure sustained long-term performance.

Selecting the right metrics
Managers struggling to choose metrics for their organization should consider a value-based approach. Such an approach helps focus the company's performance management processes on the activities that actually impact stakeholder value. There are as many facets of performance as there are stakeholders in the business, so it's useful to sort candidate metrics by stakeholder group. For instance, an organization might categorize its metrics into four buckets: value to shareholders, which would include measures of profitability, cost, and revenue; value to customers, including measures of customer satisfaction or service-level performance; value to employees, such as OSHA metrics or a satisfaction index; and operational excellence — e.g., quality, compliance, productivity.

To ensure that you select the right metrics, follow these rules when designing your performance management framework:

  1. The metrics should be mutually exclusive and collectively exhaustive. They should neither repeat between scorecards nor overlap.
  2. Each lower-level metric should align with a key companywide metric. We use a technique called value-driver analysis to map metrics in a hierarchical “value driver tree.” Especially when corporate metrics are financial in nature, lower-level metrics — both financial and operational — should link to them mathematically in a clear hierarchy.
  3. All metrics should be easy to understand, both by the employees who are accountable for them and by those responsible for reporting on them.
  4. Keep the number of metrics to an absolute minimum. If two cover the same area, remove one or look for an alternative that can replace both.
  5. Where benchmark data is available, align metrics with benchmarks to ensure that external data is an integral part of the target-setting process.

 John Hall (john.hall@paconsulting.com) is a principal consultant with PA Consulting Group, specializing in performance and asset management and organization design.

Yann Pastor (yann.pastor@paconsulting.com) is a principal consultant with PA Consulting Group, specializing in strategy and value-based management. 

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