Lektion 10 - Performance management system Flashcards
(!) Describe the different selection criterions when it comes to performance
The representational criterion:
- Capture goal-congurent behavior
- Capture strategically important dimensions
- Same impact on different departments
- ‘’Good to have’’ versus ‘’need to have measure’’
- ‘’Do we measure the behavior we think we do?’’
- RI = High
- ROI = Low
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The measurement criterion:
- Quality of capture, transformation and use of data
- Easier due to digitalization and big data
- ‘’Reasonable degree of certainty for verifying data?’’
- Require no personal bias when collected
- Should be comparable between units
- Should be same collection of data?
- Should be same measurement at different units
- Financial measures = High (Standards)
- Non-financial measures = Low (No standards)
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The user criterion:
- Adapted to attributes & prerequisites of those measured
- Employees & LLM perceives influence on measure
- Employees & LLM accept performance responsibility
- Employees and LLM understand the measure
- Difficult to facilitate nuanced discussion on performance
- Relates to enabling role: Helps maintain or get skill set, motivation and commitment. Supportive. Help identifying problems, prioritize issues and develop innovative ideas
- Non-financial measures = High
- Financial measures = Low
- ROI = High
Give some examples on financial and non-financial measures
Financial measures:
- Revenue
- Expenses
- Earning before interest expenses and taxes
- Return on investments / ROI
- Residual income / RI
- Economic value added / EVA
- Return on capital employed / ROCE
Non-financial measures:
- Customer satisfaction
- Employee satisfaction
- Quality measures
- Lead time
- Delivery precision
- Market share
- Number of started product developments
Describe the different ways to hit targets
Focus on design and measurement:
- Financial & non-financial measures comparable with valid target, which is continuously examined for validity
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Continuous improvement:
General:
- Idea to continuously become better
- Target set by adding additional difficulty compared to previous years performance
Advantages:
- No negotiation, tactical behavior & political discussion
- Less time put into the target-setting process
- Often push people to always strive to become better
Disadvantages:
- Inefficiency in original target is carried forward
- Difficult if changes in macro trends between the years
- May create performance stress over time
- Poor performance in previous year = Easy to hit target
- Good performance previous year = Hard to reach target
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Benchmarking:
General:
- No pre-set target
- Comparing results with internal or external peers
Advantages:
- Avoids political discussions & negotiations
- Less time put into the target-setting process
- If changing macro trends everyone affected the same
- External shocks & uncertainty also affect peers
- Can avoid lost motivation at year-end if target is met
Disadvantages:
- Can be hard to find comparison data, unit or company
- Often leads to focus on easiest measures
- Often problems with internal competition: Difficult to achieve a cooperative climate where knowledge is shared among the ‘competing’ units.
(!) Describe the advantages and disadvantages of financial measures
Advantages:
- Timeliness, precision & objectivity
- Based on accounting standards
- Congruent with goal of profit-maximization
- Largely controllable by managers
- Understandable
- External reporting requirements is a cheap measure
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Disadvantages:
- Commission error risk: Short time focus & low quality
- No errors of omission risk: Longterm actions for short term profit & safe investments rather than high return
- Risk of decreased employee motivation-User criterion
- Risk of focus on the past
- Often perceived as to abstract
- Often no congruence between accounting earnings and economic firm value
- Value-enhancing events without transactions are not reflected in accounting measures. E.g. Patent
- Accounting numbers depend on measure choice
- Conservatively biased accounting rules
- Ignores cost of equity capital & changes in risk
Describe the different measures in a profit center
Contribution margin / DB:
- Spread between revenue and variable expenses
- Used when fixed expenses are beyond control
- No attention on discretionary expenses
- Harder to compare than contribution margin ratio
________________
Contribution margin ratio:
- Easier to compare than contribution margin
Equation:
- CM ratio = Contribution margin/Revenue
________________
Direct profit:
- Contribution to companys general overhead & profit
- Include all expenses incurred by or traceable to PC
- Includes expenses outside managers control
- Excludes expenses incurred at headquarter
- Missed motivational benefit of charging headquarters costs
________________
Controllable profit:
- Controllable headquarter expenses included: Direct profit + Controllable corporate charges
- Non-controllable headquarter expenses excluded: No direct compare to other companies profit
________________
Earnings before interest and taxes / EBIT:
- All corporate overhead cost allocated to PC based on relative amount of expense each PC incurs
- Incorporate portion of corporate overhead cost into profit centre performance reports
Arguments against allocation:
- Manager can’t control corporate staff department cost
- Difficult allocating corporate staff services to each PC
- Difficult to find fair and adequate allocation basis
Arguments favoring allocation:
- More realistic and comparable
- More goal-congruent from overall firm perspective
- Corporate service units have tendency to increase power base and enhance own excellence without regard to their effect on company as a whole
- Manager cost focus keep headquarters spending low
- More realistic performance of each profit centre comparable to competitors with similar service
- Motivation of optimum long-term marketing-decisions
- Indirect cost control of service units through unit managers
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Earnings before interest, taxes, depreciation and amortization / EBITDA:
- Reference to EBIT
- Related to financial accounting
- More ‘’cash flow like’’
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Net income:
- Performance according to bottom line
Arguments against use:
- Decided at headquarter, no control from managers
- No advantage of incorporating income taxes since after-tax income often constant percentage of pre-tax income
(!) Describe the measure of ROI for an investment centre
General:
- Percentage
- Ratio
- Most used despite its flaws
- Benefits reduce investment in current & fixed assets
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Equations:
- ROI = EBIT/Assets employed
- Assets employed = Total assets - Current liabilities
DuPont formula:
- ROI = Profit margin · Capital turnover
- Profit margin = EBIT / Sales
- Profit margin has reference to income statement
- Capital turnover = Sales / Assets employed
- Need of lots of invested capital if low
- Reference to balance sheet
________________
Conclusions:
ROI < 5% = Low
ROI > 25% = High
________________
Advantages regarding measurement system criterion:
- Anything affecting financial statements is reflected
- Common denominator
- Easy to compare
Advantages in relation to user criterion:
- Simple calculation
- Easy to understand
- Meaningful in absolute sense
- Easy to communicate internally
- Can be shows graphical through DuPont formula:
- (X-axis = Capital turnover, Y-axis = Profit margin %)
- (Underlines solely profit margin alone is inadequate basis for comparison and trade-off between income statement and balance sheet is required)
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Disadvantages:
- Different incentives for investment across centre
- (High ROI = Little or no incentive to expansion)
- (Low ROI = Makes the inferior investments
- Risk of underinvesting
- Problems with goal-congruence
- Cost on capital not included
- Old or depreciated assets show higher ROI
- Low score on the representational criterion: Same investment may create different ROI in different IC
- Some decisions increasing ROI decrease overall profit
(!) Describe the measure of RI for an investment centre
General:
- Euro amount
- Not a ratio
- Advise of using this
- Same as EVA, but without adjustments
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Equation:
RI = EBIT - capital charge
Capital charge = Cost of capital · Assets employed
Assets employed = Total assets - Current liabilities
- Cost of capital % and interest rate set by headquarter
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Conclusions:
- RI > 0 = True profit, value created, cover all cost of capital
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Advantages in general:
- Same investment is accepted or declined in all IC
- Possible incorporation of same decisions rules used in the planning process in the measurement system
- Goal congruence due to inclusion of cost of capital
- Easy to calculate
- Same profit objective for IC´s for comparable investment
Advantages in relation to representational criterion:
- Increase in RI can’t decrease overall profit as ROI
- Different interest rate for different assets account for risk
Advantages in relation to user criterion:
- Solves problem of differing profit objectives for same asset in different investment center
- Solves problem of same profit objectives for different asset in same investment center
- Relatively easy to communicate
________________
Disadvantages in general:
- Represent single time period: Risk of short-time focus
Disadvantages in relation to user criterion:
- Monetary basis makes a difficult comparison between departments of different sizes
Disadvantages in relation to representational criterion:
- No adjustment of financial figures
(!) Describe the measure of EVA for an investment centre
General:
- Advanced version of RI
- Superior measure of IC performance
- Extra useful if many non-tangible non-current assets
- If different from RI, double check the adjustments
- Adjustment due to often pessimistic numbers
- Looks on intangible non-current asset measure problem
Equation:
EVA = Adjusted net operating profit after taxes - (Cost of capital · Adjusted asset employed)
Suggest accounting adjustments:
- 160 potential adjustments
- 20-25 necessary adjustments
- 5-10 adjustments actually used in practice
Key accounting adjustments:
- Adjust profit & asset measure: Instead of book value
- Treatment of intangible assets: Capitalization of R&D, expenses, capitalization of market-building expenses,
adding back of goodwill amortization. Eg. R&D treated as asses investment
Advantages:
- Goal-congruence due to included cost of control
- Adjustments correct assets & income numbers
Disadvantages:
- Difficult calculation
- Difficult to understand & communicate: User criterion
- Comparison of different size departments difficult
(!) Describe the types of non-financial measures including examples and non-financial measurement i general
General:
- Indicates if financial performance is sustainable
- Even good as stand alone for non-profit organizations
- Needed at all levels in organization
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Customer-oriented measures:
- Bookings: Better than sales revenue since earlier data
- Market share: Take overall market growth into account
- Key accounts orders: Early indicate marketing strategy success
- Customer satisfaction: Surveys or complaint letters
- Customer retention: Length of relationship
- Customer loyalty: Repeat purchases, customer referral
________________
Business process-oriented measures:
- Capacity utilization: Extra important if high fixed costs
- On-time delivery: Still increased importance
- Quality: Defect units, late delivery, unique parts in product, scrap, rework, machine breakdowns, warranty claims, number and frequency of product returns
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Employee-oriented measures:
- Number of training hours completed per employee
- Employee retention index
- Employee satisfaction: Survey
- Employee health: Total number of sick days
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Innovation and environmental-oriented measures:
- Number of development projects started
- The environment
- Number of new products/services launched/ or percentage of sales from new products or services
(!) Describe the pitfalls for non-financial measures
Not validating the causal links:
- Reference to representational criterion
- Cause-and-effect behind lagging & leading measures
- Prove that non-financial performance affects result
- Managers often rely on preconceptions for importance
- Risk of spending money on initiatives giving no result
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Not considering system support when choosing measure:
- Contradict with measurement system criterion
- Required for effective collecting required information
- Often different methods of measuring same thing
- Need for reliable data without too much resource use
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Not setting the right performance targets:
- Important continuously examining of target validity
(!) Describe the balanced scorecard in general and its advantages and potential issues at implementation.
General:
- An enabling performance measurement system
- Supports lower-level managers and employees in identifying problems, prioritizing issues and develop innovative ideas
- Measures linked together in an ‘’cause-and-effect’’
- Tool to implement or refine mission, goals & strategy
- Assign goals and critical success factors to responsibility centre measured from perspectives
- Environment, sustainability & climate change should often added-on instead of another perspective
- Emphasizes link between mission, goal, strategies and performance measurement
- Not a generic model: Specific targets for organization
- Both a performance measurement system and aid to strategic refinement
- Process, designing, development & implementing of BSC is valuable in itself due to thoughts
- Developed at corporate level or business unit level
- Possible weighted measures resulting in reward
- Both financial & non-financial performance measures
- Both long term and short term
- Communicate strategic objectives
- Highlight possible trade-offs
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Advantages:
- Meets the user criterion
- Meets the representational criterion
- Systemizing various measures into perspectives
- Balance strategic measures to achieve goal- congruence
- Encourages employees to work in best interest
- Force managers to focus on critical business areas
- Equal consideration to measures in each perspective
- Fast but comprehensive business view
- Help managers choose appropriate measure-mix
- Safeguard against suboptimization
- Ensure no conflicts between measures
- Reduces measurement overload
- Improves communication
- Forces managers and employees to think about mission, goals and strategies and specify timescales in which they hope to achieve strategic objectives clearly
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Issues relating to implementation
General:
- Time-dimension not included
- Interdependent instead of unidirectional relationships
- Not always a valid cause-and-effect
- Iterative use of BSC against its control method
- Strategic uncertainties not reflected
- important shareholder may be excluded
TM commitment and employee involvement:
- Require participation, commitment, trust and support from TM
- Require involvement of LL-managers & employees
- Own scorecard for department within business unit
- Corporate-wide scorecard should address synergies across different business units
- Must involve people of different departments & levels
- Scorecard must be relevant to the actual activities
- Should help LL- managers and employees maintain or enhance the skill set, job motivation & commitment
- LL- managers must see performance measurement system as supporting, help to identify problems, prioritizing issues & develop innovative ideas
- Need overall coherence between all levels scorecard
Review measures and results frequently:
- Refers to leaning phase in performance management
- Shows seriousness of importance from top managers
- Information from LL- managers & employees to TM
- ‘’Cause-and-effect’’ must be frequently reviewed
- Both review according to financial & non- measures
- Change in mission, goals & strategies since last one
- Changes in scorecard measures
Avoid measurement overload and reflect on the link to incentive systems:
- 4-7 measures, but no right amount
- To many = Risk of loosing focus
- To few = Risk of ignoring critical measures
- TM often too well trained in financial measures
- Shareholders & directors pressure profit organizations
- Non-profit organizations pressured by public scrutiny
- Poor designed incentives program = Added pressure
(!) Describe the balanced scorecard model
General:
- Perspectives are a template: Adapted by company
- Public sector often add a society perspective
- Many companies add employee perspective
- As few measures as possible in each perspective
- Managers has to have control over the measures
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Center:
- Organizations mission, goals and strategies
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Financial perspective:
General:
- Financial goals
- How shareholders look at us
- Lagging measures
Potential performance measures:
- Economic value added / EVA
- Market value added
- Return on investment / ROI
- Growth in sales
- Earnings before interest and taxes / EBIT
- Residual income / RI
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Customer perspective:
General:
- Strategic goals
- How customers see us
- Leading measures
Potential performance measures:
- Customer profitability
- Repeat customers
- Customer surveys
- Number of customer complaints
- On-time delivery
- Service response times
- Market share
- Customer satisfaction
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Internal business perspective:
General:
- Strategic goals
- What to excel at
- Leading measures
Potential performance measures:
- Supplier quality
- Process cost
- Number of units requiring reworking
- Length of operating cycle
- Volumes of goods shipped
- Optimal asset utilization
- Cycle time
- Defect rate
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Innovation & learning perspective / Learning & growth:
General:
- Strategic goals
- Possibility of continue to improve & add value
- Leading measures
- More longterm than customer- & internal perspective
Potential performance measures:
- Employee motivation
- Employee empowerment
- Information systems capabilities
- Employee capabilities
- Number of employee suggestions
- Hours spent on training employees
- % of sale from new product
Describe what is meant by strategic map
General:
- Going from mission, goals & strategies to measure
- Link between measures are made explicit
- Visualize strategy of organization
- Includes strategy formulation
- Highlight cause-and-effect relationship between different perspectives
Advantages:
- Increases engagement in goals
- Map design is important inputs to strategy formulation
- Facilitate clear understanding for managers of how objectives assigned to them
Describe the different types of measures
Market measures:
General:
- Changes in stock price
- Changes in shareholder return: Including dividends
Strengths:
- Goal-congruent
- Precise
- Objective
- Cost effective
Problems:
- Controllability
- Noise
- Only based on publicly available information
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Accounting measure:
General:
- Based on internal generated accounting info
Measures:
- Residual terms: E.g. Profit measures
- Ratios: E.g. ROI
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Combining:
- Inclusion of non-financial measures
- Combine different performance measures: BSC
- Additional aggregated measures: Revenue & expenses
(!) Describe the advantages and disadvantages of non-financial measures
Advantages:
- Drive & indicate future financial performance
- Closer link to long-term organizational goals
- Indirect quantitative info on intangible assets
- More transparent evaluation measure of managerial action
Disadvantages:
- Sometimes no clear link to financial performance
- Better performance might not be economic valuable
- No common measurement unit
- Drivers of success too numerous
- Time consuming
- Costly to measure
- Difficult comparing since different measurements
