Many CEOs and senior managers make fundamental changes to their organisations based solely on existing performance. They may divest or cease operations of a product or division that has not achieved, for example, the corporate ROI expected. Other measures may be chosen as the criteria that dictates whether an activity is continued or ceased.

The issue is not that such deliberations are made, because that is exactly what management is paid to do - to ensure the viability of operations. However, the reality is that management often makes these decisions in an inappropriate context. The following quote by Hamel and Prahalad illustrates this point:

“ROI (or return on net assets or return on capital employed) has two components: a numerator - net income - and a denominator - investment, net assets or capital employed. Managers know that raising net income  is likely to be harder than cutting assets and head count. To increase the numerator, top management must have a sense of where new opportunities lie, must be able to anticipate changing customer needs, must have invested in building new competencies, and so on. So under intense pressure for a quick ROI improvement, executives reach for the lever that will bring the fastest, surest result: the denominator.” [Gary Hamel and C.K. Prahalad, Competing for the Future, Harvard Business Review, July-August 1994]

One of the key issues about such decisions are managers who chase the wrong performance measures. More often than not, these performance measures have been internally determined (i.e. by management) and do not necessarily directly address shareholder objectives. This is because most organisations have no verifiable and quantified view of their own shareholder objectives and therefore need to make a subjective assessment of what will please shareholders. Such subjectivity inevitably leads to management comparing themselves to peers and setting generic ratios and performance measures as their own performance criteria. The chase for performance based on inappropriate performance measures will negatively impact upon real shareholder satisfaction.

The second issue is that in chasing the wrong measure, often core assets are cut or jeopardised. If ROI is determined by management as the key measure, then they may cut products and/or activities that the company has been seeding for some time and at considerable cost that haven’t as yet achieved the desired ROI. Management action may certainly enhance ROI, but it may also destroy shareholder funds invested in new product development over many years.

Thirdly, undertaking efficiency reviews and actions solely on the basis of current operational performance is not sufficient or adequate. One must also know where the organisation is “travelling” (or more specifically, where it would like to “travel”) in order to determine whether the intended cuts will aid or hinder the company’s future aspirations. All too often, corporations with no vision to the future, or a vision that is largely undefined, undertake significant organisational change only to find that that which has been eradicated or changed is that which is needed for future operations and success.

Corporate improvement must be determined by the context within which the corporation operates: i.e., what outcomes are needed to satisfy shareholders and what attributes of the current operations are required to satisfy the vision for the future.