Translating Good Governance into Operational Excellence: Does your Organization have the Capability to Execute its Strategy?

Do Directors have visibility to operational weaknesses that elevate risk, sometimes to disastrous levels?

Dr. John W. Alden

10-09-2007
2006, 2007

Recent Headlines
Washington Post:
The Saga of a Bent Spear
On Hill, Toy Firm Officials Apologize and Promise Changes Fixing the Smithsonian

USA Today: Lead in Mattel toys was 180 times the limit Business Week: Not So Smart

Wall Street Journal:

Most Science Studies Appear to be Tainted by Sloppy Analysis At Ford, CEO Mulally is Optimistic

Capability Measurement, 10-2006, 2007

Top management may not know

WSJ: So your strategy is allowing people to tell you bad news without coming down to hard on them? Mr. Mulally: Absolutely. One of the first meetings we had, I asked how its going and most of it was all green and a little yellow. I said, Hey, we lost like $12 billion, it cant be all green.
Capability Measurement, 10-2006, 2007

Open Standards Frameworks Focus

Does your Organization have the Capability to Execute its Strategy?

Capability Measurement, 10-2006, 2007

Improving process capability benefits

Technology Improved margin Deployment Speed

Leaner Ops

High Maturity Capability Organization-wide Outcomes

Improved Enterprise

Risk
Management

Agility Culture based on trust and facts

Improved Compliance

This set of complex interactions is measurable!

Capability Measurement, 10-2006, 2007

Operational challenges
Enterprise strategy risks* External
Customers dont like the offering Competitor actions Game changing technology

Internal to the organization

People: Knowledge and skills HC process management Technology integration Business Process: Variation in work group activities Cascading rework
*Source: The Halo Effect
Capability Measurement, 10-2006, 2007

Risk & Capability: a core relationship

Low

High

Best

Operational Risk
Worst

Operational Capability

High

Low

These relationships are not new!

Capability Measurement, 10-2006, 2007

The Five Capability Levels

Capability Maturity Model: A Framework for Measuring Organizational Capability

Level 5 Innovating

Change management

Level 4 Capability Predictable management Level 3 Business line Standardized management

Level 2 Managed Level 1 Initial

Work unit management

Inconsistent management
8

Capability Measurement, 10-2006, 2007

Low Maturity Organizations

People capability variation

Transaction workers: +/- 100% Knowledge workers: +/- 1000%
Capability Measurement, 10-2006, 2007

Management Visibility
Level 5
In

Out

Level 4 Level 3 Level 2 Level 1

In

Out

In
Exception(s)

Out

In

Out

In

Out 10

Capability Measurement, 10-2006, 2007

How the MMs Works-General

Level 5
Innovating Implement continual proactive improvements to achieve business targets Manage process and results quantitatively and exploit benefits of standardization Capable processes Perpetual innovation Change management Predictable results Reuse/knowledge mgt. Reduced variation Productivity growth Effective automation Economies of scale

Level 4
Predictable

Develop standard processes, measures, and training for Standardized product & service offerings

Level 3

Level 2
Managed

Build disciplined work unit management to stabilize work and control commitments Motivate people to overcome problems and just get the job done

Reduced rework Repeatable practices Satisfied schedules

Mistakes, bottlenecks Ad hoc methods Hero worship
11

Level 1
Initial

Capability Measurement, 10-2006, 2007

How the MMs Work-Measurement

Level 5
Innovating Implement continual proactive improvements to achieve business targets Manage process and results quantitatively and exploit benefits of standardization Deep/unique process insight supported by numbers/analytics Manage by the numbers/analytics Process and data standards Aggregation possible Work group/project quality Aggregation difficult/costly Ad hoc methods No data standards No aggregation
12

Level 4
Predictable

Develop standard processes, measures, and Standardized training for product & service offerings

Level 3

Level 2
Managed

Build disciplined work unit management to stabilize work and control commitments Motivate people to overcome problems and just get the job done

Level 1
Initial

Capability Measurement, 10-2006, 2007

Case Study: $2B Software/FS Services

Vague Requirements Fixed Date, Budget Deferred Items

Sales Technology Services

Increased Rework Increased Service Calls

In
IT
Defects Ineffective Execution of Product Strategy
Technology Solutions

Out

Liquidated Damages
Client Services

Immature Products

Customer Dissatisfaction

Without end to end process visibility, the hidden costs grow down stream
Capability Measurement, 10-2006, 2007

13

Summary: Capability Building Yield Dramatic Benefits

Benefit
Rework Estimating accuracy Delivered defects Pretest defect detection

Level 1
Baseline
40% +30% to >100% X

Level 2
20% +10% to +20% X

Level 3
10% +5% 1/4 X

Level 4
6% +3% 1/10 X

Level 5
3% +1% 1/100 X

<30%

60%

80%

90+%

99%

Productivity
Component reuse

X
negligible

1.5X
negligible

2X
occasional

3-4X
>30%

>4X
>50%

*Based on Bill Curtis extrapolations published research

Capability Measurement, 10-2006, 2007

14

Measurement
Item
To what extent is operational information available to directors?

Mean

1&2

4&5

3.5

17

25

+ +

To what extent is operational information linked to the financial performance of the organization?

3.5

10

28

To what extent does your organization participate in external benchmarking?

2.8

14

20

+
15

To what extent are you presented with nonfinancial measures of business performance (e.g. customers, competition, people, technology)?
Capability Measurement, 10-2006, 2007

3.3

10

16

22

Operational Risk

Item
To what extent is operational information available to directors?

Mean

1&2

4&5

3.5

17

13

Capability Measurement, 10-2006, 2007

16

Organizational Capability
Item
To what extent is operational information available to directors? To what extent do you have knowledge or insights about the capability level of your information technology organization? To what extent are you involved in efforts to understand how well aligned the organization is to the strategy as enunciated by the board and executives?

Mean

1&2

4&5

3.5

17

16

+
+

3.2

24

15

3.7

18

28

+
17

Capability Measurement, 10-2006, 2007

People Processes

Item
To what extent is operational information available to directors? To what extent do directors have visibility into the performance of the workforce against objective external standards? To what extent do you have knowledge of the recruiting, development and retention processes for talent management?

Mean

1&2

4&5

3.5

17

26

+
+ +
18

13

20

14

3.2

10

20

18

Capability Measurement, 10-2006, 2007

Panel & Discussion

2006, 2007

Summary Questions: Process Operations

What level of visibility do you have to operations? Whats the correct level? How do you gain an understanding of operations? How robust are your processes for managing/tracking operational risk? What is your role in surfacing issues where you lack detailed understanding of operations? What level of evidence based management is practiced in your organization?

Capability Measurement, 10-2006, 2007

20

Discussion Questions-McKinsey
1. Are major trends and changes in your business units environment affecting your strategic plan? Specifically, what potential developments in customer demand, technology, or the regulatory environment could have enough impact on the industry to change the entire plan? 2. How and why is this plan different from last years? 3. What were your forecasts for market growth, sales, and profitability last year, two years ago, and three years ago? How right or wrong were they? What did the business unit learn from those experiences? 4. What would it take to double your business units growth rate and profits? Where will growth come from: expansion or gains in market share? 5. If your business unit plans to take market share from competitors, how will it do so, and how will they respond? Are you counting on a strategic advantage or superior execution? 6. What are your business units distinctive competitive strengths, and how does the plan build on them? 7. How different is the strategy from those of competitors, and why? Is that a good or a bad thing? 8. Beyond the immediate planning cycle, what are the key issues, risks, and opportunities that we should discuss today? 9. What would a private-equity owner do with this business? 10.How will the business unit monitor the execution of this strategy?
Capability Measurement, 10-2006, 2007

21

Discussion Questions-Deloitte
1. Do we know the overall risk profile of the companys assetsi.e. people, products, processes, and facilities as well as the interrelationships among these risk? 2. Have we integrated risk management processes throughout the enterprise? 3. Are we constantly reviewing and tweaking our business continuity plans? 4. Can security processes be improved so the company enjoys fallout benefitslike increased efficiency and improvement customer services? 5. What technologies and metrics are available to evaluate and improve risk management processes? 6. Is adequate security training in place? 7. Do we have an environment where employees feel free to speak out about potential problems to upper- level managers.
Capability Measurement, 10-2006, 2007

22

Dealing with operational complexity links to profit

4% of global CEO says they are very good at measuring complexity. And only 5% say they have a corporate-wide framework for managing complexity. (PWC Global Report on Complexity) 7 of 10 directors are satisfied with their access to financial information but their satisfaction tails off noticeably when the subject turns to strategic and operational information. Not surprisingly, internal board members are more satisfied than external directors. (McKinsey Quarterly, 07) Management focused improvement initiatives appear soft to some executives and board members. However, McKinsey and Accenture research links profit and operational performance. (McKinsey Quarterly, 07 and Accenture Outlook, 07)
Capability Measurement, 10-2006, 2007

23

IT Risk is not well understood

Capability Measurement, 10-2006, 2007

IEEE Spectrum-Compilation by Robert Charette

24

Institute of Internal Auditors

Boards, in particular, non-executive directors, simply dont have the inherent practical experience of IT risk, as one of our internal audit heads reminds us and this means that they are unlikely to understand the full extent of the risks and opportunities that technology presents to their companies. Over a third of senior management respondents and almost half of the internal audit heads feel that IT professionals lack the ability to communicate IT risk and its potential business impact in a way that the board understands.
Source: UK PWC, LLP and Institute of Internal Auditors

Capability Measurement, 10-2006, 2007

25

Mercedes: near the bottom of the JD Power reliability survey

Mercedes is still reeling from a series of embarrassing recalls of its prestige sedan, the E-Class, which starts at $50,000. In May, 2004, the company suffered a spate of problems with its electronic brake control system, and it recalled 680,000 cars for inspections. This year, in late March, Mercedes announced the biggest recall in its history -- 1.3 million cars with faulty fuel pumps made by supplier Robert Bosch. Software bugs and the complex interfaces that allow the myriad electronics systems to talk to each other are to blame for many Mercedes defects. Getting such bugs out is a fiendishly hard job and can often take years. The problems have also pushed up costs and hurt profits. Last year Mercedes spent some $600 million to cover warranty costs, analysts say. Worse, the quality fiasco has taken a heavy toll both in Europe, which accounts for 76% of sales, and in the U.S., where the auto maker sells 21% of its vehicles. Mercedes' European market share slipped to 4.2% in the first half of 2005, down from 4.5% for the same period in 2004. And last year, BMW (BMW ) overtook Mercedes as the world's No. 1 luxury carmaker.
Source: Business Week 8-15, Cover Story, Dark Days At Daimler, p. 31-38
Capability Measurement, 10-2006, 2007

26

Business performance expectations

Even good managers can be notoriously bad when it comes to projecting the future performance of their companies. Many outstanding executives at large companies routinely promise to double their share prices in, say, five years or to beat market returns by margins that even upstart competitors would envy. Others focus on sustaining top- or bottom-line growth and profitability over long periods of time, seemingly heedless of the cyclical ups and downs in their industries. The intentions of these executivesto set high aspirations that encourage growth, innovation, and efficiencyare good. Lofty goals, however, pose special challenges, even for companies that already have strong market positions. Furthermore, they can tempt executives to make risky bets and demoralize employees charged with hitting unrealistic targets. Yet many senior executives, try as they might, still find it hard to shift their attention away from todays stock price and the next set of interim results. The forbidding presence of hedge fund and private-equity investors on corporate share registers and the increasingly short tenure of CEOs have only intensified the obsession with short-term performance.
Source: The Halo Effect
Capability Measurement, 10-2006, 2007

27

Estimation accuracy lacking

Only 9 of 1,077 large global companies outperformed their competitors on both revenue growth and profitability over a decade, a study findsconfirming that such strong performance is rare and that many executives impose unrealistic expectations on their organizations. If past is prologue, managers and boards wont forecast with any precision the timing of the next recession. But they should be asking themselves today whether they are building the financial, operating, and product flexibility to make the most of the next downturn.
Source: The Halo Effect
Capability Measurement, 10-2006, 2007

28

Dangerous Organizational Changes: Look Before Your Leap*

Type: 1. Mergers and acquisitions 2. Implementing new enterprise software 3. Switching to better HR practices Evidence of Success/Failure: 1. Mostly negative results, sell quickly

2. > 50% fail

3. Startups fail more often 4. Talk but not much walk 5. ~30% achieve stated goals 6. Create lasting problems 7. Extremely high failure rates 8. Death rates for new ventures is high

4. Quality Improvement efforts

5. Business process reengineering (BPR)

6. Layoffs
7. Launching a new product 8. Starting a new organization

*Source: Hard Facts, Dangerous Half-Truths & Total Nonsense: Profiting Form Evidence-Based Management, Table 7-1

Capability Measurement, 10-2006, 2007

29

Evolving capability and maturity frameworks

Brief history: 50s, 60s
Crosby--manufacturing process waste Demingstatistical process control

Mid 80s to mid 90s

DOD recognition of software development crisis

SEI publishes the Capability Maturity Model for software (CMM)

Late 90s to early 2000s

PCMM V1, V2 CMMI V1

October 2007: Business Process Maturity Model

Capability Measurement, 10-2006, 2007

30

References & Sources

Books:
Competing on Analytics-HBS Press The Halo Effect-Free Press Hard Facts, Dangerous Half-Truths and Total Nonsense-HBS Press Your Gut is Still Not Smarter Than Your Head-Wiley CFO Insights: Delivering High Performance-Wiley Harvard Business Review, Managing Human Sigma and 2005; Toward a Theory of High Performance, 2005 PWC CEO Complexity Study, 2006 PWC and UK Institute of Internal Auditors, 2007 Accenture Outlook, 2003-2007 Bain, Annual Management Tools Survey, 2007 IBM CEO Expanding the Innovation Horizon, 2006 The halo effect, and other managerial delusions. 2007 Number 1 Cracking the complexity code, 2007 Number 2 The link between profits and organizational performance, 2007 Number 3 Managing for quality: An interview with Armand Feigenbaum Managing your organization by the evidence, 2006 Number 3 The state of the corporate board- A McKinsey Global Survey 2007, Web-exclusive June 2007 Anatomy of a healthy corporation, Web-exclusive 5-2007 Washington Post-various Wall Street Journal-various Fortune-various Business Week 2007 Advertising citing The New Risk Environment, Conference Board Study on Enterprise Risk Management, 2007 Bios available on www.capabilitymeasurement.com

Business Journals and Reports:

The McKinsey Quarterly:

New Sources:

Experts: Dr. Bill Curtis (Process) and Dr. Robert Charette (Enterprise Risk Management)

Capability Measurement, 10-2006, 2007

31