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In 2010, just before he died in 2011, I had the privilege to get a masterclass by Professor Horngren from the Stanford University. He is the godfather of modern Management Accounting. The masterclass was all about performance indicators for managers. His proposition was that managers should be judged based on their decision. And not on the outcomes realized. Many of us would say that a good manager will take good decisions that lead to good outcomes. Fair enough. But how do you judge if a manager is ‘good’. Most likely because he produces good outcomes. But let me explain why good outcomes are not always the result of good decisions, or even any decision, taken.

Professor Horngren first gave the following case. Someone offers you to flip the coin. When you win the toss, you get $10 and when you lose you pay $1. Would you accept the offer? Any rational thinking person would say yes. The chance of winning $10 is the same as losing $1. This is a no brainer as statistically the projected outcome is 0.5*$10 – 0.5*$1 = +$4.5. Accepting the offer is a good decision. Now lets flip the coin. And oooohhh no you lose the toss. You lose $1 instead of winning $10. Bad outcome.

The above shows that ‘Good Decisions do not always lead to Good Outcomes’. The reverse is also true, ‘Good outcomes are not always the result of good decisions’. The person who offered you this toss should never have offered it but the outcome is good for him. He walks away with $1 more.

The point here is that if you judge people solely on outcomes we could incentivize the wrong behavior and punish the good behavior. Enterprise Performance Management should be about supporting good decisions. And in the end that will generate good outcomes.

In the above example do not be fooled by the outcome of just one toss. If there would be a second toss and you win the $10 then your overall gain, outcome, is $10-$1 = +$9. In the long run good decisions will lead to good outcomes. Even if you lose the second toss again but win the third toss you still gain $8.

Next post more real live examples. And how not taking decisions will impact your outcome, for better or for worse.

Post Author: Frank van Vliet

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