Applying Value Drivers to Monitor Performance  559 2. Organizational health reflects whether the company has the people, skills, and culture to sustain and improve its performance. Diagnostics of organi- zational health typically measure the skills and capabilities of a company, its ability to retain its employees and keep them satisfied, its culture and values, and the depth of its management talent. Again, what is important varies by a company’s sector and life-cycle stage. E-commerce businesses need entrepreneurial and innovation capabilities in the start-up phase and require more managers and customer-service-oriented staff as they ma- ture. Semiconductor and biotechnology companies need deep scientific innovation capabilities but relatively few managers. Retailers need lots of trained store managers, a few great merchandisers, and in most cases, store staff with a customer-service orientation. Understanding Value Drivers Pays Benefits Clearly understanding a business’s value drivers has several advantages. If managers know the relative impact of their company’s value drivers on long- term value creation, they can make explicit trade-offs between pursuing a criti- cal driver and allowing performance against a less critical driver to deteriorate. This is particularly helpful for choosing between activities that deliver short- term performance and those that build the long-term health of the business. These trade-offs are material: increasing investment for the long term will cause short-term returns to decline, as management expenses some of the costs, such as R&D or advertising, in the year they occur rather than the year the invest- ments achieve their benefits. Other costs are capitalized but will not earn a return before the project is commissioned, so they too will suppress overall returns in the short term. Understanding the long-term benefits of sacrificing short-term earnings in this way should help corporate boards support managers in making investments that build a business’s long-term capability to create value. Clarity about value drivers also enables the management team to set pri- orities so that activities expected to create substantially more value take pre- cedence over others. Setting priorities encourages focus and often adds more to value than efforts to improve on multiple dimensions simultaneously. For example, reducing accounts receivable in telecom services creates value, but far less so than increases in customer retention levels. And improvements in customer retention might well require a company to refrain from cutting back on customer credit. Without an explicit discussion of such priorities and trade- offs, members of the management team could interpret and execute the busi- ness strategy in numerous and perhaps incompatible ways. In general, distinctive strategic management promotes a common language and understanding of value drivers that shape the way top management and employees think about creating value at each level of the organization. For ex- ample, in a pharmaceutical company, distinctive strategic management would encourage discussion and coordinated action across the organization about specific steps to increase the speed of product launches, thus accelerating value 560  Strategic Management: Analytics creation. In contrast, strategic management in refining and other commodity- based process industries would focus on operational excellence in terms of capacity utilization and operational expenses. Creating Actionable Metrics As we saw in Exhibit 29.4, most value driver trees start on the left side with financial value drivers such as ROIC and growth, and each of these is disag- gregated into more specific drivers of business value and operational value, moving from left to right. Where possible, managers and analysts should specify actionable metrics for the value drivers. The more a value driver tree is tailored to the business, the more insight it yields about a company’s key sources of value creation and how to influ- ence them. Exhibit 29.5 shows a basic value driver tree developed for a manu- facturing company. In this example, the key drivers for growth turn out to be sales force effectiveness and new-product pipeline, because of low mar- ket growth and strong competition. For return on capital, the key drivers of value are capacity utilization (measured as invested capital per unit) and the Exhibit 29.5  Basic Value Driver Tree: Manufacturing Company Value ROIC WACC Growth Manufacturing cost per unit SGA1 cost per unit Invested capital per unit Volume Revenues per unit Revenues per unit (year + 1) Volume (year + 1) Market growth Labor hours per unit Manufacturing error rate Unit labor cost Raw materials cost per unit Market share Sales force effectiveness Product quality Key value drivers New-product pipeline 1 Selling, general, and administrative.