It may seem intuitive that no single measure will be perfect for all occasions. But what about more than one measure? If EBITDA is deficient in accounting for capital efficiency, and ROC is deficient in accounting for scale, then why not use both measures, each making up what the other lacks?
That logic must sound reasonable to many managers because the growth of metrics as a way of evaluating overall corporate performance is one of the most pronounced trends in corporate America. It is also one of the most destructive to value creation.
What's wrong with multiple metrics
Let's say we are using both EBITDA and ROC as our main metrics. How much additional EBITDA should we be willing to accept for a one percentage point drop in overall return on capital? Or, if we can bump up our ROC by two percentage points at the expense of 10 percent EBITDA growth, would that be a good trade off? In other words, to what extent are we willing to sacrifice returns for scale, or vice versa?
These questions can be easily answered using an EP or NPV analysis. In fact, we can always find a single measure that can do the work of two or more, enabling us to make trade offs between the other metrics when the answer regarding value maximization would otherwise be ambiguous.
Management is all about trade-offs: Where do we spend our time? How do we allocate our capital? And if your business goal is to make money, and you are or should be profitable, you can create a well-defined version of profit that can best approximate the overall result of value creation. Such a metric will focus your management on what matters most, accounting for all factors of production and the income they generate, in the best balance for shareholders.
Such a metric can be safely maximized over time. Thus, it can provide for an enduring, common language between management and the board, and a powerful basis for rewarding management in their variable compensation plans.
The only thing that a single metric will not enable is trade-offs between short-term vs. long-term profits. A focus on profits may encourage a little more now at the expense of a lot more later. Such a compromise would be invisible to the board or investors. But multiple metrics do not make up for that potential problem. What overcomes short-termism is an incentive plan structure that rewards management for optimally balancing the short- and long-term.
So, the short answer to what's wrong with multiple metrics is: Why use more than one when one metric will do?
When it works, and why it doesn't
Mulitple measures may be useful in the planning stages as leading indicators for particular strategic or tactical objectives, or below the level of the whole company in assessing the effectiveness or efficiency of certain projects, functions, or teams.
But they never work as a substitute for a single, governing measure of overall company performance that can serve as a reasonable proxy for value creation, especially for the purposes of executive rewards. In fact, there is good evidence that companies that base variable compensation on multiple measures significantly underperform companies that pay for a single measure of profitability or returns, even if that measure is less than perfect at tracking value.
