Managing the short term/long term tension: how small changes to traditional strategic planning processes can make a big difference.

Every organization faces an ever-present tension between short-term and long-term results. What promotes the one often hinders the other. Yet every manager must strive for both: performing well today and, at the same time, building for a strong future. As Peter Drucker put it, "He must ... keep his nose to the grindstone while lifting his eyes to the hills--which is quite an acrobatic feat." In most organizations, performing such a deft double act is the job of the annual planning cycle.

The process on paper looks something like this: The corporate center issues guidance to the business units on desired overall financial results and invites managers to develop multiyear plans. Managers are asked to submit plans with the highest net present value and to bid for the resources they need to implement them. Each business unit discusses its strategy with the corporate center, which then adds up all the resource requests and performance projections.

Inevitably, there is a gap: more resources requested and less performance promised than the top-down guidance requires. Managers are encouraged to revise their plans. Resources are prioritized according to payback rates and whether they are discretionary or not. Attention is given to the long term by developing multiyear plans and considering net present value. Pressure is put on the short term through upfront guidance, by using payback rates and isolating discretionary spending. The result is an accommodation between short-term results and long-term investment.

Well, that's how it's supposed to work. But for many companies, the reality is quite different. Perhaps the following will sound familiar. The center positions its upfront guidance as just that--guidance. Yet everyone knows that it is a top-down target that dare not speak its name.

The business units know what strategy they want to pursue from the outset, and so spend their "strategy development" time developing a case for their preferred plan. Managers make sure to add in extra resources to their investment requests because they know they will be cut back anyway. The "discussions" with the corporate center are presentations, not discussions.

Adding up the proposals yields an attractive longer-term performance that is apparently achievable only by accepting an embarrassing hit to near-term earnings. The center then cuts back the resource requests automatically because it knows that the business units have padded them.

A maneuver called "gap allocation" imposes targets on the business units that add up to the desired level of short-term and long-term performance in ways that cannot clearly be reconciled to the preceding discussions. This occurs mostly in the form of plans for near-term actions and rough forecasts for future performance, with no concrete plans for how they will be achieved. Everyone suspects that the most politically skillful get away with the lowest "stretch." As for the multiyear plans--they are never opened again.

This annual dance of "sandbagging" and gap allocation is a poor substitute for a genuine solution to the short term/long term tension.

Two Blind Spots

Most planning processes suffer from two critical blind spots.

Sustainable earnings. In the search for better performance today and tomorrow, companies must prioritize earnings with a future life over earnings that cannot last. But most planning exercises shed little light on the crucial distinction between sustainable and unsustainable earnings.

Earnings are unsustainable when they involve borrowing between timeframes--for example, when they come from skimping on investment. You can find them in postponed projects; marketing and R & D cuts; asset sales where the capital gain can be booked this year; reclaimed investment funds; stock pushed on to customers; repurchased shares (to increase per-share earnings); and so on. All such actions can grow earnings, but do so by borrowing from the future.

Equally unsustainable are earnings generated from squeezing more performance from a business model whose time has passed. This happens when the assets and capabilities that generated earnings in the past have become obsolete and need to be replaced.

Established telecommunications companies around the world have had to face waves of asset obsolescence following the introduction of new communication technologies--for example, 2G mobile phone technology becoming redundant with the advent of 3G, and traditional fixed-line calls giving way to Voice over Internet Protocol (VoIP). The assets these companies used to generate earnings can no longer compete with assets providing more benefit to customers or lower costs--and, often, both at the same time.

Thus, large swaths of their current earnings have become unsustainable.

When such changes are slower, they can actually be more pernicious. The gradual shift of advertising revenue from offline channels (such as newspapers and TV) to online ones, the move of retail traffic out of town and then to the Internet, the shift between established airlines and low-cost carriers--all these have been taking place over many years.

Here, companies can succumb to what has been called the "boiled frog syndrome." The water gets hotter so gradually that there is never a point at which the frog notices that it is being boiled--until it's too late. The rate at which previously sustainable earnings become unsustainable is so slow that by the time the situation is clear, it's too late to avoid a painful choice between results today and investing for the future.

By contrast, sustainable earnings are those not influenced by such borrowing or lending between timeframes. They are repeatable because they are based on business assets and capabilities that have a future life. Examples include earnings from patented products, from strong brands that stand for strong customer benefits and difficult-to-replicate process capabilities, such as excellent customer service or a particularly difficult manufacturing process.

The problem is that most planning processes shed very little light on how company earnings divide up among these three types: unsustainable because they borrow from the future; unsustainable because they borrow from the past; and sustainable because they are based on assets and capabilities with a viable future life. Planning, therefore, usually adds little to the struggle to prioritize sustainable earnings over unsustainable.

Excess investment. In addition to borrowing between timeframes, another distortion standing in the way of overcoming the short term/long term tension is lending to the future--investing more than is needed for future profits. This is investment--in money, people, effort and time--above the minimum level needed to achieve targeted future profits. The less investment a company needs to build tomorrow's business, the less often it will have to choose between long-term and short-term earnings. In mastering the short term/long term tension, companies must minimize excess investment.

Excess investment comes in many forms. Managers often ask for more funds than they need because whatever they ask for is always cut back anyway, so why not start with a higher number? After all, it is easier to report a positive variance from plan than to return, hat in hand, to ask for more. Naturally, most managers prefer options that invest for future growth and profitability over less investment-intensive ways of building for the future. We all hate to give up our own projects, even if they are not working. And leaders often hate to say no.

If the job of the leader is 80 percent saying no and 20 percent saying yes, then the difference between saying no 80 percent of the time and 70 percent of the time is major source of excess investment. The accumulated result of all these behaviors is large amounts of excess investment in most large organizations--but of a type that is not always easy to see and touch.

A company with a low percentage of earnings that are sustainable and a lot of excess investment will find that producing better results today conflicts sharply and routinely with building for longer-term results. Conversely, a company with a high percentage of earnings that are sustainable and with low excess investment will find it much easier to push on short-term and long-term performance at the same time with less conflict.

Small Changes, Big Difference

So how can strategic planning be altered to help managers increase sustainable earnings and minimize excess investment?

Shift from lagging to leading indicators. Norm Bobins, chief executive of LaSalle Bank, the Chicago-based subsidiary of ABN AMRO, cites an example of a planning discussion that will sound familiar to many: "One of my managers came forward and proposed a $180 million profit plan. I had in my head that $200 million should be possible. The manager's response when I challenged him was, 'Just tell me what you want and I'll deliver it.' I said to him, 'You don't get it. It's not what I want; it's how I want it achieved.'"

What should you measure to understand the long-term picture behind the short-term numbers? Traditional financial measures are lagging indicators of company performance. What companies need to help them diagnose and guard against conflicts between short-term and long-term performance are leading indicators of future performance.

Typically, when current earnings mask a longer-term health problem, relative share of investment in the market falls; relative share of market and relative pricing falls; the ability to both grow revenue and maintain profitability falls. It's not until then that earnings growth is finally choked off. In using planning to judge how the company is producing its short-term numbers, managers must pay close attention to leading indicators of whether earnings will be sustainable: investment, market share, pricing and costs--all relative to competitors.

Incorporate a post-earnings review. The idea of post-investment reviews for new acquisitions and major projects is well known. But post-earnings reviews are rare. Few organizations use their planning process to ask, "What are we learning about the life span of our earnings?"

As part of their standard planning submissions, managers should be asked to disaggregate their unit's earnings into categories: one-offs vs. repeatable, existing customers vs. new customers, market share vs. market growth, change in relative price vs. change in relative share, performance on core brands vs. non-core brands, and so on.

Then, senior management can use such information to debate three questions: Where did our earnings come from? What does that tell us about how much of them are sustainable? What can we do differently to grow sustainable earnings?

Demand alternatives, for the path, as well as the destination. In a recent survey conducted by Marakon Associates and the Economist Intelligence Unit, only 14 percent of executives said they were consistently presented with alternative choices when making decisions. In fact, leaders are all too often presented with a fait accompli.

Good alternatives give the leader more options for producing good performance in the short and long term, simultaneously. Alcan's former chief executive, Travis Engen, required business unit managers to present at least three alternative business strategies when asking for corporate resources. Alcan separated the discussion of alternatives from the decision on which one to choose, to ensure that managers put all viable options on the table and allowed time to properly evaluate each one.

If business units have been asked to generate options, there is always the risk of constructing ones that put a preferred option in the most favorable light--a maneuver characterized by one corporate strategy director as "Do Nothing" vs. "Slaughter Our First-Born" vs. "Alternative Gold."

To prevent this, leaders should establish the criteria to be used to judge alternatives, reject alternatives that are not up to scratch, share good ones around the company as examples and add to managers' appraisals the skill of "producing high-quality alternatives." Alcan's executive development programs included a module on how to develop high-quality alternatives.

For the minority of companies already enforcing such a standard of three to five alternatives, the focus is almost always on the "destination"--what or where we want the business to be in x years' time--rather than on the different ways to get there. This is a missed opportunity for exposing ways to reduce excess investment.

When you have agreed on the best alternative strategy, you should then ask for alternative paths to achieving it. For example, what options are there to go faster, share funding with others, reduce the investment required and conduct pilot projects to reduce the risk? Getting managers to consider alternative paths to their preferred strategic destination can stimulate ideas for long-term performance that minimize damage to short-term performance.

Add a middle timeframe. A simple but potentially very effective way to understand how to reduce unnecessary tension between the short term and the long term is to spend more time considering the medium term. Financial services group Barclays plc abandoned the traditional two-timeframe approach of a single-year and five-year planning horizon in favor of three timeframes: long-term direction, short-term priorities and what connected them--medium-term themes.

For them, long-term direction described the future shape of the portfolio and the company's assets and capabilities in five to 10 years' time. Short-term priorities covered the first year and were articulated as specific action plans. The medium term was a middle position between plan and vision covering the timeframe two to five years out. Top managers described the objectives for this middle timeframe as strategic themes or decision rules that would govern how to use the resources and capabilities of the short term to get to the envisioned capabilities, revenues and profits of the long term.

Such a simple device has important benefits. It forces more focus on the right path, not just the right destination. It makes the decision on long-term strategy more consequential and increases the likelihood that short-term priorities will be "strategic" rather than "tactical."

Chief executive John Varley believes that an important side effect for Barclays of this third (middle) timeframe was directing the company's attention to a critical requirement for growing sustainable earnings--increasing benefits to customers.

Dividing the problem of today vs. tomorrow into three timeframes rather than two doesn't make it go away. But doing so should better concentrate management's attention on how to link the short term and the long term more productively.

It is not only through the annual planning cycle that reconciliation between short- and long-term results should be forged. Much is necessary and possible outside the strategic planning process to help companies grow sustainable earnings and minimize excess investment.

For example, executive pay structures should be designed to reward tomorrow's performance as well as today's, goals should be set for growing sustainable earnings rather than merely sustaining earnings growth, and planning itself should be made more continuous and less of an annual review event.

On its own, even the most cleverly designed annual planning process will be insufficient. And, of course, while it would be wonderful never to have to choose between earnings today and earnings tomorrow, often, managers must choose.

However, with a few small changes, the typical planning cycle can be made much more effective in helping senior management sidestep avoidable conflicts between the short term and long term.

Dominic Dodd ([e-mail]) is a Director of Marakon Associates, an international management consulting firm headquartered in New York. Ken Favaro ([e-mail]) is Marakon's Co-chairman and recent Chief Executive. This article is adapted from their upcoming book, The Three Tensions: Winning the Struggle to Perform Without Compromise (Jossey-Bass, January 2007).

RELATED ARTICLE: takeaways

* Too often, planning becomes an annual dance in which managers simply add extra resources to their investment requests because they know they will be cut back anyway. "Discussions" with corporate become presentations.

* Managers need to focus on the distinction between sustainable and unsustainable earnings, but most planning processes shed very little light on how company earnings divide up between these types.

* A simple but potentially very effective way to understand how to reduce unnecessary tension between the short term and the long term is to spend more time considering the medium term, perhaps two to five years out.