Here is a brief excerpt from an article co-authored by Aaron De Smet, Bill Schaninger, and Matthew Smith for the McKinsey Quarterly, published by McKinsey & Company. They cite new research suggesting that the performance payoff from organizational health is unexpectedly large and that companies have four distinct “recipes” for achieving it. To read the complete article, check out other resources, learn more about the firm, obtain subscription information, and register to receive email alerts, please click here.

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For the past decade, we’ve been conducting research, writing, and working with companies on the topic of organizational health. Our work indicates that the health of an organization is based on the ability to align around a clear vision, strategy, and culture; to execute with excellence; and to renew the organization’s focus over time by responding to market trends. Health also has a hard edge: indeed, we’ve come to define it as the capacity to deliver—over the long term—superior financial and operating performance.

In previous articles and books, such as Beyond Performance :How Great Organizations Build Ultimate Competitive Advantage, we (and others) have shown that when companies manage with an equal eye to performance and health, they more than double the probability of outperforming their competitors. Our latest research, at more than 800 organizations around the world, revealed several new twists:

o We found that the linkage between health and performance, at both the corporate and subunit level, is much clearer and much larger than we had previously thought. With the benefit of more data and a finer lens, we discovered that from 2003 (when we began collecting data on health) to 2011, healthy companies generated total returns to shareholders (TRS) three times higher than those of unhealthy ones.

o We further discovered that companies consistently outperforming their peers generally followed one of four distinct organizational “recipes.” We had already recognized these patterns but hadn’t understood their strong correlation with health, operational success, and financial performance.

o We also uncovered a practical alternative to the common (but too often disappointing) approach of seeking to improve corporate health by closing every benchmark and best-practice gap. More tailored initiatives that combine efforts to stamp out “broken” practices while building signature strengths not only are more realistic but also increase the probability of building a healthy organization by a factor of five to ten.

In short, we’re more convinced than ever that sustained organizational health is one of the most powerful assets a company can build. We’re also clearer on how to achieve it, including the pitfalls to avoid on the road. We hope this is welcome news to leaders worried about the long term, who frequently complain to us that the benefits of their one-off reorganization initiatives are ephemeral.2

How we track health

For the past ten years, we have measured and tracked organizational health in hundreds of companies, business units, and factories around the world. We ask employees (more than 1.5 million and counting) about their perceptions of the health of their organizations and what management practices they do or don’t see in them. We then produce a single health score, or index, reflecting the extent to which employees say that their organizations are “great” in each of nine dimensions (or outcomes) of organizational health. To establish more precisely what each organization looks like, as well as its strengths and weaknesses, we also ask employees how frequently they observe3 four to five specific management practices—how managers run the place—that drive those nine outcomes. Exhibit 1 provides some flavor of how the management practices, 37 in all, line up against the outcomes.

The organizational-health index tracks nine dimensions of organizational health, along with their related management practices.

When we have done this with similar units—such as factories, processing units, and regions—in a given company, we have frequently found a strong correlation between organizational health (as measured by our survey) and the unit’s financial or operating performance.

For example, when we established health scores at 16 refineries in the same energy group, we noted a sharp linear relationship between those scores and each refinery’s performance as defined by gross profit per unit of output. Health explained 54 percent of the variation in the units’ profits.

In the insurance industry, we found similar results when we compared 11 claims-processing sites. In this case, we found a strong correlation between health (as defined by the site-specific summary score) and performance (defined as a carrier’s specific proprietary amalgamated metric across indemnity, expense, and customer-satisfaction metrics). Health differences explained about one-third of the variation in performance.4This is a significant number, since the remaining two-thirds includes known determinants of performance, such as competition, macroeconomic forces, and local-market dynamics (we did not evaluate the relative importance of these forces, which, unlike organizational health, leaders cannot control).

After replicating these findings across many clients and industries, we began to wonder about the strength of the health effect. Could health possibly explain performance variations across companies, industries, and geographies?

When we compared the health metrics of more than 270 publicly traded companies5 with their financial-performance metrics, we found that the healthiest generated total returns to shareholders that were three times higher than those of companies in the bottom quartile and over 60 percent higher than those of companies with “middle of the road” health profiles. We have not yet isolated the specific health effect for the sample as a whole, but judged by the energy and insurance-company examples, it is likely to be substantial.

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Here is a direct link to the complete article.

Aaron De Smet is a principal in McKinsey’s Houston office, Bill Schaninger is a principal in the Philadelphia office, and Matthew Smith is a principal in the Washington, DC, office.

The authors would like to thank Michael Bazigos, Scott Blackburn, Lili Duan, Chris Gagnon, Scott Rutherford, and Ellen Viruleg for their contributions to the research presented in this article.