Linking Actions to Profits in Strategic Decision Making

Many companies find that it's not enough to "increase customer satisfaction" or "raise product quality." They must know conclusively how such departmental pursuits affect the profitability of the company as a whole. Typically, this requires some kind of profitability modeling, in which links are established between specific actions and the resulting profit to the organization. Although the concept is not new, profitability modeling, to date, has been limited to individual departments or business functions. Although firms develop models that are more comprehensive and cross-functional, these efforts are sporadic, relatively expensive and time-consuming. More companies might attempt this kind of modeling if they had an explicit framework and procedure for establishing links to guide them.

Marc Epstein and Robert Westbrook, professors at Rice University's Jones Graduate School of Management, have studied companies' efforts to develop models that link action to profit and have devised a general model that managers can use to link any departmental action to overall corporate profitability. By customizing their general model, firms can more quickly arrive at specific links between an action and its impact on profitability. The action-profit linkage model helps managers identify and measure key drivers of business success and profit, develop causal links among them and estimate the impact of actions to bring them about. This process forces managers to narrow their strategies to the areas with the highest payoff. Attention shifts from a preoccupation with individual performance metrics to an awareness of how those metrics work as a system and how they lead to increased profit and more shareholder value.

The process of getting to the final model is valuable because managers gain tremendous insight into how their organizations' various metrics interrelate. The model also fosters a common management focus on the variables that matter most in achieving success. More importantly, it helps develop disciplined thinking about profit drivers by tracing them through the customer, product offering and ultimately the company's actions. Focusing the management team on a common thought process is among the most important things a CEO can do to improve management decision making in both strategy and its implementation.