Managing By the Numbers: Penny Wise, Pound Foolish?

Every good business manager loves metrics. After all, the old adage, “You can’t manage what you don’t measure” still holds true in most management circles.  However, a singular focus on metrics and worse, concentration on wrong metrics, keeps getting executives in trouble. Can solely running a business “by the numbers” cause managers to be over-careful about trivial things and under-careful about more important factors?

In the June 22, 2011 issue of the Financial Times, columnist John Kay laments how some companies are focused on financial measures to justify business and IT projects without looking at other factors such as opportunity costs and risk management concerns.  Kay writes; “Large companies think their investment appraisal techniques are sophisticated if they compute internal rate of return (IRR). And it is more and more common for them to highlight the rate of return on their equity (RoE) in annual reports.”

And to be sure, IRR and RoE aren’t the only metrics trumpeted as signs that a business is managed properly. There’s also intense interest for public companies to increase earnings per share (EPS) via stock buybacks, or increasing earnings while keeping shares constant.

Are these metrics indicative of first class management techniques, or they can be manipulated? In the same Financial Times column John Kay writes:

“One way of improving return on equity is to increase profits. But other methods are equally effective, and often easier. Raising the level of risk will increase expected earnings. Shrinking the equity base increases the return on capital. Neither of these latter actions adds anything to the expected wealth of shareholders. But they may add a lot to the wealth of managers, if that wealth is linked directly or indirectly to return on capital employed or earnings per share.”

Because of various metric maneuvers, focusing on 1-2 key metrics may not be the best method of evaluating a company’s performance. Even worse some entities focus on the wrong metrics altogether.

Take for instance numerous hedge and pension funds, that prior to the 2008 Financial Crisis, chased higher returns by investing in complicated and convoluted structured products sold by investment banks. Eager to prove their portfolios were strong and healthy, these funds eagerly invested in structured products that promised higher returns—but carried tons of risk. Most investors were blind to the risks of these derivatives and chose to focus only on promised returns. And when global markets crashed in 2008, many of these derivatives could only be sold for pennies on the dollar.

As we enter the age of terabytes and petabytes, and as “Management by Data” techniques become trendier, as executives let’s also be sure that we look to more holistic and possibly less quantifiable considerations in running a business such as risk and reputation management.

Focusing solely on the speedometer, tachometer, and fuel gauge on our dashboards, we may end up missing the freshly planted, “Road Closed – Bridge Out” signs ahead.

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