Long-Range Planning and Organizational Performance: A Cross-Valuation Study DAVID M. HEROLD The Bernard M. Baruch College This study is an attempt to validate and extend a study by Thune & House on the performance of formal planners vs informal planners. A new independent variable, profits, was used to cross-validate the planning questionnaire of the original study. In addition, it was hypothesized that R & D expenditures would be higher for the formal planners than for the informal planners. This, if confirmed, would provide a second source of construct validity for the original questionnaire due to the future orientation of both forma! planning and R & D, which would lead one to be theoretically predicted by the other. Using a sample of five pairs of formal and informal planners, comparison over a 7-year period showed formal planners to outperform informal planners on sales and profits and to significantly out-spend informal planners on R & D expenditures. Theoretical limitations and implications are discussed. BACKGROUND S. Thune and R. House reported the findings of a study designed to investigate the effects of long-range planning on firms' performance [2]. They sent questionnaires to 145 companies having sales of $75 million, or more, for the year 1965. The purpose of the questionnaire was to identify those companies actively engaged in formal long-range planning. To be considered formal long-range planners, they would have had to answer that they determined corporate strategy and goats for at least 3 years in advance and that they established specific action programs, projects, and procedures for achieving the goals. All other respondents were considered informal planners. Of the 145 companies contacted, 92 responded, of which 36 were roughly matched for size and industry so as to represent six industrial groupings. 91
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The sample companies were then compared on the basis of the following economic measures: (1) sales, (2) stock prices, (3) earnings per share, (4) return on common equity, and (5) return on total capital employed. When comparing the performance of the formal planners vs the informal planners, as a group, the investigators found that; Formal planners, from the time they initiated long-range planning through 1965, significantly outperformed informal planners with respect to earnings per share, earnings on common equity, and earnings on total capital employed. Furthermore, the companies outperformed their own records based on an equal period cf time before they began formal planning. Finally, Informal planners did not surpass format planners on any of the measures ot economic performance after long-range planning was introduced.
Industry-by-industry analysis showed long-range planners in the drug, chemical, and machinery industries, consistently outperforming the informal planners on all five measures. However, in the food, oil, and steel industries, it was found that the formal planners outperformed the informal planners even before they initiated formal planning. Thus, slightly superior performance could not be attributed to formal planning exclusively; in addition, these three industries are characterized by a lower rate of technological innovation and new product introduction. This, along with the fact that oils and steels are highly dependent on government policies, led the researchers to conclude that the advantages associated with formal longrange planning are primarily concentrated in the more rapidly changing industries. THE PRESENT INVESTIGATION The Problem The present investigation is an attempt to cross-validate and broaden the findings of the Thune and House study. Because respondents were classified as informal or formal planners on the basis of their questionnaire answers only, there remains a question as to the validity of the questionnaire. Two means of scale validity have been given credence in the social science literature.^ One is the multimethod approach that determines the degree to which the properties which a scale proportedly measures vary in the same direction and magnitude as other measures of the same properties. For example, questionnaire scales can be validated against observation, interview data, or experimental variations. A second, and somewhat weaker, approach is one of construct validation [1, pp. 281-302]. This approach is based on the argument that measures of variables in a theoretical framework would relate to each other in systematic and predictable ways; i.e., the magnitude and pattern of relationships should meet a set of test requirements that a valid questionnaire would be expected to meet. Like reliability, construct validity is usually regarded as a necessary, but not sufficient, condition to claim ^Discussed in R. House and J. Rizzo, "Toward the Measurement of Organizational Practices: A Scale Development and Validation" (unpublished).
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scale validity; whereas, tests of multimethod validity are usually considered sufficient to claim scale validity. However, under conditions where multimethod tests of validity cannot be conducted, tests of construct validity are informative and, in the absence of other validity data, are indeed very useful. The original questionnaire can only claim face validity, i.e., it appeared to be measuring the degree and kind of planning used. A correlation with a new dependent variable measuring the same entity as the five criteria in the original study; namely, the success of a firm, would offer a construct validation or a demonstration that the questionnaire responses co-vary with variables as would theoretically be predicted. Therefore, it could be considered a predictor of company policy and success. The new criterion selected for this validation attempt was the pretax profit of the firm, the hypothesis being that profits will be greater for the formal long-range planners than for the informal. It was further hypothesized that research and development (R & D) expenditures would be higher for the formal planners than for the informal. This is based on the belief, as expressed in the original study, that formal long-range planning is a characteristic of the well-managed firm, rather than the single cause of success. Since R & D expenditures are made with respect to future outcomes, they would theoretically be expected to be greater among formal planners than informal planners. Thus, tests of relationships between formal planning and level of R & D expenditures provide a second basis for construct validation of the questionnaire used in the original study. Further, investigation of the relationship between planning and R & D expenditures will help to develop one dimension of a profile of the effective practices, which, in conjunction with long-range planning, would represent the successful firm. The Somple Originally, the same sample of 36 firms in the original study was going to be used in order to interpret the new findings as an extension of the original, without accounting for differences in samples used. However, mergers, acquisitions, and, above all, the secrecy with which R & D figures are treated by most companies, have made this impossible. What remained to be analyzed were the three original pairs which comprised the drug industry group, and two pairs in the chemical industry group. Table 1 describes these companies by industry and by sales as of the base line date, as explained later. As in the original study, the pairs are only roughly matched due to limitations of available published data. Findings The performance of all formal and informal planners was compared for the 7 years from 1962 to 1969. The base-line date was 1962 because
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TABLE 1 Sample Composition* Sales As of Base Line Date Industry Drug
Format Planners A B C
Average Chemical Average
217 246 311
Informal Planners A' 177 B' 186 C 387
258 A B
326 663 495
250 A' B'
245 459 352
'A&A', B&B' and C&C represent matched pairs.
it was the year that three of the five formal planners initiated their formal long-range plans, with a fourth company having done so in 1961. The criteria of performance compared were sales and profits, the latter being the new criterion used in the attempt to validate the original scale. As Figures I and II show, formal planners, from the time they initiated long-range planning through 1969, significantly outperformed informai planners with respect to sales and profits. At the end of the time period, formal planners had achieved a 150 percent increase in sales with a 139 percent increase in profits. This contrasts with only 89 percent and 59 percent increases in sales and profits, respectively, for informal planners. Informal planners did not surpass or even approach formal planners on either measure of economic performance. Figures III-VI show the superiority of formal planners over informal planners by industry. In the drug industry, formal planners enjoyed a 162 percent increase in sales accompanied by a 191 percent increase in profits, while informal planners managed only 98 percent and 78 percent increases in sales and profits, respectively (Figures II and IV). In the chemical industry, formal planners achieved a 141 percent growth in sales with an 88 percent increase in profits, while the informal planners achieved only an 81 percent growth in sales with a 37 percent increase in profits (Figures V and VI).- As the figures show, informal planners never surpassed the formal planners on either of these two measures at any time. Informal planners were then compared to formal planners, by industry, for R & D expenditures. Figure VII shows the difference between formal and informal planners in the drug industry. Formal planners spent more ' N o statistical test was applied to these percentage differences because of the small N.
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FIGURE I Increases in Sales for Forma) vs Informal Planners 1200
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for R & D every year of the comparison, and the range was from 7.0 percent (of sales) to 7.6 percent, with a mean of 7.3 percent. Informal planners ranged from 5.7 percent to 6.3 percent, with a mean of 5.9 percent. The FIGURE II Increases in Profits for Formal vs Informal Pianners 200
150
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10
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1964 1965 Year
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Formal Planners Informal Planners
difference is even more dramatic because the lowest yearly expenditure for formal planners is higher than the highest yearly expenditure of informal planners. This zero-overlap distribution is so significant that no statistical test is required; in addition, formal planners significantly and consistently out-spent their industry's average for every year that these industry figures are available (1962-1967).3 ' These figures are: (as a percent of sales) 4.3, 4.7, 5.9, 6.2, and 6.1 for the years 1962 through 1967, respectively. Source: Basic Research, Applied Research and Development in Industry, National Science Foundation.
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FIGURE III Increases in Sales for Formal vs Informal Planners In the Drug Industry
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Z 400 E ^
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Year Formal Planners Informal Planners
For the chemical industry, as Figure VIM shows, the same differences were found. Formal planners out-spent informal planners in R & D expenditures every year of the comparison. For formal planners, the range was from 3.2 percent (of sales) to 4.5 percent, with a mean of 3.8 percent. For
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informal planners, the range was from 2.8 percent to 3.2 percent, with a mean of 2.9 percent. The lowest yearly expenditure of formal planners during that period equaled the highest yearly expenditure of informal planners. As in the drug industry comparison, this distribution does not
FIGURE IV Increases in Profits for Formal vs Informal Planners in the Drug Industry 200
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FIGURE V Increases in Sales for Formal vs Informal Planners in the Chemical Industry 1200
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I nformaI P I anners
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FIGURE VI Increases in Profits for Formal vs Informal Planners in the Chemical Industry
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Z 150
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o (CL X (0
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to 1962
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Year Forma I Planners Informal
Planners
require a statisticai test to demonstrate its significance. No industry averages were used for comparison because figures are compiled in subcategories, such as industriai chemicais, drugs, and allied products. Conclusions it is clear from these findings that companies which are actively engaged in formal long-range planning in the drug and chemical industries significantly outperformed those who are not. Resuits also show that there are other factors which, along with formal long-range planning, correlated with superior performance. The factor identified here, R & D expenditures, was shown to be significantly related to a firm's success. Finaily, the
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FIGURE VII R&D Expenditures for Formal vs Informal Planners in the Drug Industry
6.0
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6.0
5.0
4.0
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Year Forma I PIanners
Informal Planners
results support the findings of Thune and House by correlating another independent variable, profits, with their predictions and findings using the long-range planning questionnaire. One limitation of this study concerns differences in company size of formal and informal planners. It could be argued that the performance differences found here are due to the larger size of the formal planners as of the base line date. However, in the original study, Thune and House controlled for such differences by comparing historic performance of large and small companies {before they engaged in formal planning) with their performance for a comparable time after adopting formal planning and found no differences in performance that could be associated with inertia resulting from differences in company size. Thus, it is unlikely that company size influenced the results of the present study.
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FIGURE Vlll R&D Expenditures for Formal vs Informal Planners in the Chemical Industry
5.0
3.0
2.0
-5
1 .0
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967
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Although these results make a strong case for long-range planning and R & D investments, they must be interpreted as strong indicators rather than as conclusive findings. The original study's sample was small, and further complications left this sample even smaller and less than perfectly matched. However, it is hoped that these two studies can be used to give direction to future studies, which will be able to form a composite of all the characteristics (such as formal-long-range planning and high R & D expenditures) needed for a successful business organization. REFERENCES 1. Cronbach and Meehl, "Construct Validity in Psychological Tests," Psychological Bulletin, 52 (1955). 2. Thune S.. and R. House, "Where Long-Range Planning Pays Off," Business Horizons (August 1970).
