The birth of performance management in organizational leadership

Note: This column is the second of a three-part series that examine how Lean Accounting and the emerging practice of Integral Operations Finance can converge into a whole-systems approach that provides the business advantages of the Toyota Production System, making it fully operational for business and organizational leaders. It is provided by Jahn Ballard, currently the chief process officer of Vinovation Inc. Jahn is founding director of the Performance Management Institute Inc. (PMI), creator of the Financial Dashboard and developer of Integral Operations Finance and Accounting Practices.
By Jahn Ballard

When Henry Ford set up the Highland Park Plant, he used all of the lessons learned from the industrial revolution to create one of the most efficient manufacturing operations in history. The Highland Park Plant eventually became a foundation for the Toyota Production System and remains one for almost every modern manufacturer to equal.

In the 1920s, Alfred Sloan wanted to beat Ford and make his company, General Motors Corp., the largest car manufacturer in the world. He asked Donaldson Brown, a protégé of GM Vice President John Raskob, to help him figure how to track his own performance so he would know if he actually was improving the way he ran his business. Brown came up with a formula that allowed him to measure GM’s efficiency, effectiveness and overall return on the total resources employed to make cars and deliver them to customers. His formula was revolutionary for the time and remained a competitive advantage for GM well beyond the time that it eclipsed Ford as the largest car company.

The idea was astounding in its simplicity and usefulness and has been the foundational tool for performance management for 80 years. GM found that it could continuously improve on last year’s performance by understanding a few basic facts.

For efficiency, GM focused on how much profit it made for every dollar of sales, represented by the ratio of net profit over sales (N/S). For effectiveness, the focus was on how much sales it had for every dollar of assets, represented by the formula of sales over total assets (S/A). When you multiply these two ratios, sales cancels out, giving the ratio net-profit-over-assets (N/A), which then shows how much profit is being made for every dollar of assets. This was the genesis of return on assets, which originally was called ROI, or return on investment.

Much of what I am going to share with you came from the direct experience of my late friend, mentor and colleague, Lou Mobley. Lou never tired of pointing out that the original purpose that drove the creation of the Certified Public Accounting profession by the Securities and Exchange Commission Acts of 1933 and 1934 was to protect the public and the government from dishonest businesspeople. As a result, generally accepted accounting principles (GAAP) financial statements are primarily designed and intended as a summary of financial results of a company that allow outside observers to compare management’s past performance and for tax compliance purposes — not as tools to manage an enterprise.

Lou saw that the very structure of accounting requires one group of people (client companies) to pay another group of people (CPAs and financial services professionals) to do work on behalf of third parties (bankers, IRS, shareholders and the public), using tools and practices designed only for those purposes. After 20 years of working with Lou’s ideas, it has become apparent to me that this situation sets up a series of un-resolvable double binds that subtly detract from every level of peer and direct-report relationships if attempts are made to use that same data for management purposes. (You will see more on the reasons and costs, plus the solution to this problem, in next month’s column).

Lou discovered the concept of operating cashflow (sometimes called cashflow from operating activities) and showed me how to resolve these double binds so that leaders can use financial data as the tool they need it be.

In 1952, Lou was present at the American Management Association (AMA) meeting where GM’s secret was revealed to the marketplace. His used an ROA (return on assets) chart as a basic visualization tool for an ongoing discussion / argument with DuPont’s treasurer. The treasurer made the formula public at the AMA, proposing that only the ROA (N/A) ratio by itself was sufficient as a measure of company performance. (This became the basic measure of performance in the capital markets for the next several decades, being superseded in the latter part of the century by concepts such as EVA and EBIDTA, which were valiant attempts to fill the gaps that Lou, as an engineer, saw that first evening at the AMA meeting.) Lou used the ROA chart to demonstrate that presenting ROA as a single percentage hid its most crucial value, which had been used by GM for more 25 years to assess and manage how well their short-term cost control tactics were working together with their longer-term market development strategies.

Lou went on to found and run the Sands Point Executive School for IBM’s Tom Watson Jr. in 1955. His students applied the ROA chart to running IBM, starting with the Profit Planning initiative, which began the company’s ascendancy over the next 20 years to become one of the most successful, most respected and best-managed businesses in history. In profit planning, the goal is to create balanced growth in both return and capital turnover, which then results in the most-efficient growth in return on assets. As you can see, it took the leadership at IBM from 1957 into the early 1960s to get their business model “tuned” in order to achieve the optimum 45-degree angle that shows balanced planning for both efficiency and effectiveness improvement.

(For a 50-year version of this chart, go to www.financialscoreboard.com/history.html and double click on the graphic down the page to the right at the bottom of Lou Mobley’s bio.)

Over the next several decades, the influence of the capital markets on the practices of the accounting profession in service to private and smaller companies continued to play out in generating the ongoing tensions of operations-versus-finance-department mandates. (In the next column, we will explore the cash flow aspect of this ongoing situation.)

Meanwhile, for over 50 years the CPA profession, in a market-wide poll, garnered the distinction of the most trusted profession. With emergence of personal computing and the Internet, the poll added another question: Who is the most valued profession? In this, the accountants were nowhere near No. 1, causing a major self-assessment to take place. Carried out in the mid-1990s, the CPA Vision Project: 2011 and Beyond represented 18 months of work with the participation of thousands of CPAs from all 50 states.
The CPA Vision Project: 2011 and Beyond emerged from the National Future Forum, attended by delegates from the entire profession. What they grappled with was the need to be competitive in a new economy, especially by transforming accounting data and practice to add more value for clients and colleagues. The leadership understood that they needed to bridge into a new paradigm of value creation and delivery. When the way things have been done is no longer going to work and the new way is not yet created, everyone is then being driven to shift from an old paradigm to a new one.

Tom Hood, executive director of the Maryland Association of CPAs (MACPA), who also served as the chair of the American Institute of Certified Public Accountants’ (AICPA) Vision Team, has been instrumental in supporting the adoption of Lou Mobley’s breakthroughs, which will be introduced the next two months columns. He and many others within the profession have laid the foundations for cogent and effective response to colleagues, clients, and customers who demand that financial data provide value. The promise of the Lean Accounting movement is to be the cogent and compelling voice of that demand, which will allow financial professionals to employ the new tools that are available to make what they do a highly valued, respected, and pivotal part of every lean initiative. Only when this bridge to the new paradigm is crossed will the promise of Highland Park and Toyota’s shining example be accessible to companies throughout the world.

Jahn Ballard, founding director of the Performance Management Institute Inc. (PMI), spent more than 10 years with Louis Mobley and Chuck Kremer, helping to develop the Financial Scoreboard and adding additional value through multi-level systems analysis, plus additional visualization and educational tools. Jahn delivers Integral Operations Finance and Accounting practices training for the MACPA and other state CPA societies through the continuing education seminar "Executive Finance for Operating Leaders: Engaging Management, Associates, and your Clients in Cashflow, Return and KPI Development." He is doing three events within the Lean Netwirk, two at the Lean Accounting Summit with Tom Hood — a half-day pre-conference called "Executive Finance for Operating Leaders: Aligning the Whole Leadership Team through Operations Cashflow and KPI Development," and a breakout group called "Vision and Cash Accounting" linked by KPI Development. The third is "Measures which Matter for Innovation and Growth," an accounting innovation "skunkworks" with Scanlon Leadership Network.
PMI delivers MBA-level executive briefings for finance and operations executives, building a common language across departmental silos and customizing the Financial Scoreboard to fit each organization’s current business mandates.
For additional information, and to read a full history of the Mobley Matrix, see www.financialscoreboard.com and www.financialdashboard.com and PMI’s 12-Step Path to the development of Integral Operational Finance.

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