The numbers don't always tell the full story of how a business is performing. Photo / Getty Images
The numbers don't always tell the full story of how a business is performing. Photo / Getty Images
Tying performance metrics to strategy has become an accepted best practice over the past few decades. Strategy is abstract by definition, but metrics give strategy form, allowing our minds to grasp it more readily.
But there's a hidden trap: A company can easily lose sight of its strategy and instead focus strictly on the metrics that are meant to represent it. For an extreme example of this problem, look to Wells Fargo, where employees opened 3.5 million deposit and credit card accounts without customers' consent in an effort to implement its now-infamous "cross-selling" strategy.
The costs from that debacle were enormous, and the bank has yet to see the end of the financial carnage. The CEO who'd taken the helm after the scandal, Timothy Sloan, resigned in March 2019.
Closer examination suggests that Wells Fargo never actually had a cross-selling strategy. It had a cross-selling metric. In its third-quarter 2016 earnings report, the bank mentions an effort to "best align our cross-sell metric with our strategic focus of long-term retail banking relationships." In other words, Wells Fargo had — and still has — a strategy of building long-term customer relationships, and management intended to track it by measuring cross-selling. With brutal irony, a focus on the metric unravelled many of the bank's valuable long-term relationships.
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It turns out that the tendency to mentally replace strategy with metrics — called surrogation — is quite pervasive. And it can destroy company value.
THE SURROGATION SNARE
Here's a common scenario: A company selects "delighting the customer" as a strategic objective and decides to track progress on it using customer survey scores. The surveys do tell managers something about how well the firm is pleasing customers, but somehow employees start thinking the strategy is to maximize survey scores, rather than to deliver a great customer experience.
It's easy to see how this could become a problem, because there are plenty of ways to boost scores while actually displeasing customers. Yet surrogation can lead those charged with delighting the customer to use them anyway.
Surrogation is especially harmful when the metric and the strategy are poorly aligned. The greater the mismatch, the larger the potential damage.
WHAT HAPPENED AT WELLS FARGO
Several explanations have been provided for how things went awry at Wells Fargo. The most widely accepted theory lays the blame on the company's incentive system.
But was the compensation approach actually the root of Wells Fargo's problems? Another culprit might have been the combination of challenging sales quotas and relentless pressure to meet them. Another possible cause was a permissive sales culture. A key finding of an internal investigation was that management espoused the philosophy that "it was acceptable to sell 10 low-quality accounts to realize one good one."
Incentives, pressure to meet quotas and sales culture were all tied to a system employed throughout Wells Fargo at the time. In fact, it's one found at almost every company. It's the performance measurement system, used to monitor everyday business activities, from the organizational level on down to the individual-employee level. There could be no sales incentives at Wells Fargo without rigorous tracking of sales numbers.
It has become common for businesses to tie their metrics to strategy. Photo / Getty Images
When Wells Fargo decided to actively track daily cross-sales numbers, employees rationally responded by working to maximize them. Throw in financial incentives, a permissive culture and intense demands for performance, and they might even illegally open some unauthorized accounts, all in the name of advancing the "strategy" of cross-selling.
Metrics provide clearly defined direction where strategy may otherwise seem too amorphous to have an impact. Because they can coordinate behaviours and actions, metrics are crucial. But as the Wells Fargo case shows, unless the inherent distortions of metrics are understood, they can be dangerous — and the distortions can be amplified precisely because the flawed metrics coordinate behaviours.
GUARDING AGAINST SURROGATION
Two recent studies on surrogation suggest that it is a common subconscious bias: Whenever metrics are present, people tend to surrogate. Nobel Prize winner Daniel Kahneman and Yale professor Shane Frederick postulate that three conditions are necessary to produce the type of substitution we see with surrogation:
2. The metric of the strategy is concrete and conspicuous.
3. The employee accepts, at least subconsciously, the substitution of the metric for the strategy.
Surrogation can be suppressed by cutting off one or more of its key ingredients. Here's how to do that:
— GET THE PEOPLE RESPONSIBLE FOR IMPLEMENTING STRATEGY TO HELP FORMULATE IT. Those involved in executing the strategy will then be better able to grasp it, despite its abstract nature — and to avoid replacing it with metrics. It's particularly crucial to bring the executives and senior managers who are charged with communicating strategy into this process. Simply talking about strategy with people is not sufficient.
— LOOSEN THE LINK BETWEEN METRICS AND INCENTIVES. Tying compensation to a metric-based target tends to increase surrogation — an unfortunate side effect of pay for performance. Besides tapping into any monetary motivations people might have, this approach makes the metric much more visible, which means employees are more likely to focus on it at the expense of the strategy.
— USE MULTIPLE METRICS. People surrogate less when they're compensated for meeting targets on multiple metrics of a strategy rather than just one. This approach highlights the fact that no single metric completely captures the strategy, which makes people more likely to consciously reject substituting it for the strategy. Multiple yardsticks do add complexity to the task of performance evaluation, but they're essential to keeping people focused on the true strategy and avoiding surrogation.
WELLS FARGO REVISITED
To see if Wells Fargo remains vulnerable to surrogation, let's look at the actions it has taken in the wake of its crisis.
First, the new management's emphasis on rebuilding trust with customers after the scandal has made the long-term relationship strategy much more clear and prominent. Second, the bank has stopped paying employees to cross-sell and has eliminated all sales goals. Finally, Wells Fargo now gauges strategic success using at least a dozen metrics related to its customer focus, emphasizing that no single number tells the whole story and encouraging employees to consciously reject surrogation.
At the very least, the new steps Wells Fargo has taken seem likely to remind tomorrow's managers and employees that performance metrics are mere representations of strategy, not the strategy itself.
Many managers learn the hard way that surrogation can spoil strategy. If you're using performance metrics, surrogation is probably already happening — the mere presence of a metric, even absent any compensation, is enough to induce some level of the behaviour. Take a hard look internally to see which metrics might be most prone to surrogation and consider where it might cause the most damage. As the Wells Fargo case illustrates, preventing the disease is far preferable to treating its symptoms.
