Week 10 Flashcards
Benefits of using non-financial performance measures?
- Prediction. Financial measures may not offer forward-looking, actionable information in a timely manner. Non-financial measures can be leading indicators of future financial performance.
- Causal Identification. Financial measures do not generally track the actions that are part of a strategy, and are limited in identifying what is causing the financial performance. Non-financial measures track actions that are part of a strategy, identifying what is causing the financial performance.
Examples of financial measures
- Net Income
- EBITDA
- Gross Margin
- Return on Assets
- Revenues from new products
- Cost reductions from process innovations
Net income equation
Net income = total revenue - total expenses
Other names for net income?
Net profit, earnings or the bottom line
Why look at Net Income?
- Net Income indicates whether, after all is said and done, thecompany is building owner’s equity or not.
- Net Income matters to investors because stocks are usually considered to be a discounted value of future net income.
- Net Income affects the cash position of the firm—which is important for staying liquid; even firms with assets well in excess of their liabilities can run out of liquidity.
- However, a focus on Net Income may not be so relevant especially for early-stage companies because many operate with negative Net Income for several years.
EBITDA equation
EBITDA = Net income + Interest + Taxes + Depreciation + Amortization
Why look at EBITDA? Does it help us in a way that Net Income does not?
- EBITDA focuses on things that managers can influence – sales and the direct and operating costs.
- EBITDA excludes things that the managers cannot influence very much or at all, such as interest payments, depreciation of equipment, and taxes.
- This provides a measure that managers can then take more ownership of.
- However, a focus on EBITDA can be a problem because it ignores issues such as taxes and financing that managers should keep in mind as they try to work within the company’s limitations.
Gross margin equation
Gross margin = (Total revenue - COGS) / Total Revenue
Why look at Gross Margin?
- Gross Margin helps us to identify whether the company is selling products that have a high mark up over the amountof resources they directly consume.
- Gross Margin can therefore indicate whether managers are successfully driving customers toward the higher margin products. This type of “upselling” is important in many industries.
- However, a focus on Gross Margin can be a problem if it causes managers to deviate from a low-cost, high-volume strategy or to raise prices without justification.
Return on assets equation
Return on assets = Net Income / Total Assets
Why look at Return on Assets?
- Return on Assets helps to identify whether a company is using its assets efficiently.
- A low return on assets suggests that a company may want to cut off a product that uses assets less efficiently so that those assets can be shifted to where the return is higher.
- However, a focus on Return on Assets can be a problem if it causes a company to forgo an investment that does not pay off for a while. That investment would temporarily decrease Return on Assets, but could be important for innovation and long-term growth.
Revenues from new products
Revenues from new products are those that are from products that have been introduced recently. The definition of “recent” can be chosen by the company—e.g., six months, one year, two years.
Why look at revenues from new products?
- Revenues from new products help us to identify whether the company has healthy levels of growth.
- This measure can indicate that the company is meeting demand for a new type of product, or is successfully taking market share away from competitors.
- However, a focus on revenues from new products might shift the company away from its brand—what it is known for—and what loyal customers expect from it.
Cost Reduction from prcoess innovations
Cost reductions from process innovations are cost reductions that are due to increasing the efficiency of production rather than scaling it down.
Why look at cost reductions from process innovations?
- Cost reductions from process innovations help us to identify whether the company is identifying systems for operating more efficiently.
- This measure is particularly important with process automation that is possible due to advances in computing and production technology.
- However, a focus on cost reductions from process innovations can create unwanted tradeoffs. For example, what does the process innovation require? Is it putting more pressure on workers, is it requiring investments in technology?
Examples of non-financial measures
- Customer Satisfaction
- New Customer Acquisition
- Customer Profitability
- Safety
- Employee Satisfaction
- Response Time
- Numbers of patents or new products
Three categories for non-financial measures
- Customer
- Internal Business Process
- Learning and Growth
Balanced scorecard categories?
Category 1 – Financial
Category 2 – Customer
Category 3 – Internal Business Process
Category 4 – Learning and Growth
Who designed the balanced scorecard?
HBS Professor Bob Kaplan
Why look at ‘Customer’ Non-financial measures?
- Customer satisfaction is a predictor of future revenue.
- Customer loyalty predicts steady revenue.
- A drop in customer satisfaction can help in quickly identifying a drop in quality that might be hard to gauge based on financial numbers alone.
Why look at ‘Internal Business Process’ Non-financial measures?
-Internal business process measures, like the quality of information systems and the positivity of organizational culture, is a predictor of productivity.
Why look at ‘learning and growth’ non-financial measures?
-Learning and growth measures such as employee training and number of patents filed can predict productivity and future revenue.
Features of providing performance feedback?
Public Visibility – can make the information viewable to the performer and at least some others, potentially even disclosing the information to everyone
Social Comparison – can compare the performer to others
Multitask – can report performance on one task or multiple tasks
Detail – can have just one measure per task or many measures per task
Why is public visibility of performance useful?
- Even when pay is not tied to performance, people perform better when their performance is visible to others.
- People perform better when pay is tied to performance.
- People perform best when their performance is visible to others and pay is tied to performance.
Why is social comparison of performance important?
- Information for social comparison increases average performance, even if one’s own identity is kept private so others can’t see how one is performing.
- High performers ease off if they see how they compare to the median.
- Low performers improve if they see how they compare to the median.
- Low performers perform best when they see the median.
- High performers perform best when they see the top-quartile.
- Benefit of Customization – the best performance effects occur when low performers see the relatively attainable median reference point and high performers see the relatively challenging top-quartile reference point.
Why is ‘multitasking’ review important?
- Performance feedback on a measure can lead to better performance by that measure through a motivation effect.
- Performance feedback on a measure can lead to worse performance by other measures through an effort redirection effect.
Why is it important/not important to give detail in performance reviews?
- In contrast with Bayesian predictions that more information is better, more detailed and more frequent information can lead to worse performance.
- This depends on whether the information works through salience bias to make less useful information more salient, or visible, and thereby causing people to pay too much attention that less useful information
Pros of public visibility
Can increase incentives due to concerns for public image
Cons of public visibility
Can make ratings become stuck near initial values
Pros of social comparison
Can increase incentives due to innate desires to perorm well relative to peers
Cons of social comparison
Can cause high performers to ease off if they feel very high above their peers
Pros of multitask performance feedback feature
Can lead to better performance by the displayed measures
Cons of multitask performance feedback feature
Can lead to worse performance by undisplayed measures that have different inputs
Pros of detail performance feedback feature
Can be helpful if it includes useful information
Cons of detail performance feedback feature
Can lead people to pay attention to information that is not useful
Two core components of motivation
- Belief that effort is necessary (plausibly helped by feedback on weaknesses)
- Confidence in one’s ability (plausibly helped by feedback on strengths)
Economic theory of diminishing returns
- It is common for economic literature to model and find evidence of diminishing returns to effort
- Management control research has posited that diminishing returns may warrant directing effort to areas of weaker performance
Difference between self-reported motivation and effort
- Intentions to improve performance may be fleeting as shown in economic research
- Achievable targets for improvement could help through the “high-performance-cycle” described in goal theory
- Help motivation translate into effort
- Preserve and reinforce confidence after the receipt of negative feedback
