Third-generation strategies can't thrive in second-generation organizations with first-generation management. Sumantra Ghoshal, who was a professor of strategic management at the London Business School, made this point years ago — yet the lag he saw in the evolution of management is still institutionalized in most businesses' performance management practices. In fact, the gap between the modern business model and the way we try to manage it grows every day.

In many industries, customers can directly access systems within the companies they do business with. Think of Internet banking or online check-in for air travel. Processes like these save the organization money, while ensuring high data quality. They also strengthen the value proposition for many customers. Some companies combine this model of customer self-service with mass customization so that every transaction is tailored to the buyer's specific needs. New car orders include seemingly endless choices on options. Most PCs are built to order. Amazon.com produces personalized home pages, and Build-A-Bear Workshop allows children to make their own teddy bear.

The classical value chain, as depicted in section A of exhibit 1 has reversed directions. Section B of the exhibit shows the reality of many businesses' relationships with their customers today. Customers are effectively running the organization's processes. They choose which contact channel is used, and they take advantage of that channel at whatever moment is most convenient for them. There is no longer any difference between the front office and the back office; systems are integrated and transparent to the customer. Doing business is a process of continuous interaction and collaboration.

At the same time, many organizations are outsourcing activities such as accounting, IT, logistics, manufacturing, call centers, and even R&D. Some do so to save costs, but increasingly companies are outsourcing to gain access to new markets, faster time to market, or specialized skills. A modern organization's true value chain usually looks like section C of exhibit 1. Many physical products never even touch the organization. For example, most Nike shoes never see the inside of a Nike facility, and most Philips TV sets are not even touched by a Philips employee. The flow of information is what connects all the elements.

For some businesses, even innovation is no longer a core competency. There are countless examples of organizations collaborating with external stakeholders to create competitive differentiation. Consider a marketing department that asks customers to submit homemade commercials to YouTube or an organization that includes, as part of the product it sells, technology that it has licensed from an external business partner. Frequently new products or services are created through the collaboration of multiple distinct companies. Collaboration between Nike and Apple resulted in Nike+ shoes; Douwe Egberts and Philips jointly developed the Senseo coffee maker; and Adidas and Goodyear worked together on sports shoes with special soles. Sometimes even competing companies come together to offer a joint service; airline loyalty programs oneworld, SkyTeam, and Star Alliance are examples.

Despite the high level of interconnectivity among businesses today, our business intelligence (BI) and performance management processes remain hierarchical in nature. We “roll up” financials and “drill down” budgets. We “cascade” scorecards throughout the organization. Budgeting, Economic Value Added (EVA), and the Balanced Scorecard — to name just a few performance management methodologies — focus primarily on meeting the needs of shareholders, even though optimizing results for a single category of stakeholders doesn't necessarily optimize the company's results for everyone involved in the value-creation process. Nor does that approach take into account how a range of stakeholders contribute to the organization's performance.

Many decisions that significantly impact business performance are made outside the organization's walls. Insurance policies are often sold via associated banks or intermediaries; these organizations drive the insurer's sales. Likewise, customer service is often outsourced to contractors, who have a large impact on customer satisfaction. And the challenge of improving process efficiency to drive margins spans the complete value chain. Performance management initiatives that concentrate on performance within the corporate entity, based on an old-fashioned notion of the organization, usually come up short.