Measure for measure: new ways of looking at the long-term performance of firms

Such issues were very much in our minds when deciding on a new approach for our recent study, which examined the financial performance of 215 of the UK’s largest public companies, across 38 industries, from 1984 to 2003. What was striking was that only 13% of those firms achieved consistently superior performance when compared with their British and international industry peers.

Some of our qualifiers – such as BP, Cadbury Schweppes or Tesco – would have been named by the most casual observer. Others are far less well-known niche players, such as the Scottish soft drinks manufacturer AG Barr (producers of Irn-Bru) and Bespak, producer of medical devices for drug delivery.

The method we chose was frontier analysis, an input-output efficiency measurement technique more commonly used in economics and operations research. It has, however, proved valuable in evaluating the performance of organisations with no direct profit imperative, such as hospitals, and those with multiple inputs and outputs.

Frontier analysis undoubtedly offers real potential for companies looking to improve their strategic management. And it could prove equally useful for investment analysts, board directors, policy makers and others interested in how companies are performing.

It involves quite complex statistical processes, but essentially it is a sophisticated form of benchmarking. It focuses not on absolute measures of performance but on actual extremes of performance for the industry on any given measure. This enables you to define a frontier for each type of industry/peer group, against which you can then plot the relative performance of firms.

Plotting annual deviation to show how far a company is from the frontier each year provides a graphic picture of performance over an entire period, and makes it easier to pinpoint periods of superior or inferior performance. Even more importantly, it can reveal clearly how performance tracks over time relative to a defined maximum set by selected peers.

The logic is that a firm is being benchmarked not just against other firms’ performance in a given year but against any firm’s performance in any given year.

The beauty of the frontier approach is that it can accommodate any number and mixture of measures and still allow companies to be ranked against each other, even where they excel on different criteria. In this sense, frontier analysis can compare apples with oranges!

The mix of measures used should not only reflect the various interests of different corporate stakeholders but also be relevant to the strategic decisions being made by managers, and to what top managers can influence. The criteria will almost certainly differ for different firms, depending on their age and operating environment. What is vital is that the measures should be sufficiently broad and diverse – choosing ones that are too similar will yield less useful information about any ranking order.