The relationship between nonfinancial and financial performance
In my last post I described the need to move toward performance management that is more analytical, rather than just reporting-based. Not many firms are doing it yet. A few leading companies, however, have made moves in this direction, although their efforts still fall well short of the ideal. They have at least some level of awareness of some quantitative relationships between nonfinancial and financial performance. Examples of these firms include:
- Hilton Hotels, where analysts have concluded that a 5 percent increase in customer retention yields a 1.1 percent increase in revenues the following year;
- Harrah’s Entertainment, where a 1 percent increase in customer gaming budgets was associated with a rise in share price of $1.10 (when it was still a public company—now it’s private);
- Best Buy, where a tenth of a point increase in employee engagement is associated with an increase in operating income of $100,000;
- Victoria’s Secret, where raising the conversion rate (the percentage of customers entering the store who actually buy something) by 1 percent brings more than $35 million in sales and more than $15 million in operating profit;
- Toronto Dominion Bank in Canada, which found that 19 percent of branch profitability was attributable to differences in customer service levels.
These firms are still at the early stages of analytical reporting, but their efforts are a model for other companies that will move in this direction. Note that almost all of these statistical relationships are only bivariate, rather than relating multiple variables to one dependent variable (which is usually financial performance for a private sector organization). Across a variety of firms they typically involve only a few common nonfinancial variables, in part because firms have not yet achieved standard measures of nonfinancial indicators such as customer satisfaction, brand equity, and innovation capability. To create such models would require a collection of time-series data (most likely quarterly) on a variety of nonfinancial indicators over time.
The few successful examples of analytical reporting all take place within the service sector. Research in the 1990s on the “service profit chain” (hbr.org/products/R0807L/R0807Lp4.pdf) by authors including professors who became Harrah’s and Victoria’s Secret executives suggested that there is a linkage between employee satisfaction, customer satisfaction, customer purchases, and financial performance. As yet there is no equivalent model for product-oriented firms, although particular intangible attributes have been shown to be important for particular firms’ performance. At Autodesk, for example, brand equity seems to be a key driver of performance, but “seems” is the key word—there is no quantitative analysis yet. At Shell in the downstream business, refinery uptime is a critical variable.
In my next post I’ll describe the stages of becoming more analytical in performance management. In the meantime, what do you think are the nonfinancial variables that drive your organization’s financial performance?
