Performance Measurement
Blending of Financial & Non-financial information
Performance Measurement System(PMS) The goal of PMS is strategy implementation Presentation of critical success factor measures for current and future Success depends on the soundness of the strategy designed for implementation Strategy defines the critical success factors; if those factors are measured and rewarded, people are motivated to achieve them.
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Framework for Designing PMS
What counts, gets measured
What gets rewarded, really counts
Strategy Strategy
What gets measured, gets done
What gets done, gets rewarded
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Limitations of Financial Control Systems
Optimizing short term profitability does not necessarily ensure optimum shareholder returns since shareholder value represents the NPV of expected future earnings. At the same time, there is a need for ongoing feedback and management control in companies to measure and evaluate business unit performance at least once in a year. Relying solely on financial measures is inadequate and can, in fact, by dysfunctional for several reasons.
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Limitations of Financial Control Systems
First, relying solely on Financial Control Systems may encourage short-term actions that are not in the companys long term interests. Second, business unit managers may not undertake useful longterm actions to obtain short-term profits. Third, using short-term profit as the sole objective can distort communication between a business unit manager and senior management. Fourth, tight financial control may motivate managers to manipulate data. In sum, relying on financial measures alone is insufficient to ensure strategy will be executed successfully. Companies use financial measures at higher organizational levels for management control and non-financial measures at lower levels in the organization for task control.
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General Considerations
Comparing PMS and instrument panel on Dashboard provides insights about the mix of financial and nonfinancila measures needed in a MCS Single measure cannot control a complex system; and too many critical measures make the system uncontrollably complex. A PMS like a dashboard- has a series of measures that provide information about the operation of many different processes. Some of these measures tell the driver (or the manager) what has happened- the odometer that registers the passage of 40,000 miles (or a report that shareholder equity is currently $1 billion), for instance. Other measures tell the driver (or the manager) what is happening, such as the tachometer at 6000 RPM (or an on-time-delivery %age of 70). All these measures have implicit interactions, and changes in one often reflect changes in another: reducing RPMs will increase miles per gallon (or improving ontime-delivery will increase customer satisfaction). Usually there are multiple ways to change one measure, let us say RPM, that may or may not improve the other measure, in this case miles per gallon. Just as the driver does the trade off between various controls he has, a manager too can choose between behaviour that benefits the short or long term success of the organization.
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The Balanced Scorecard
Balanced Scorecard to recognize both financial and nonfinancial measures of performance A balanced scorecard is a performance measurement and reporting system that strikes a balance between financial and operating measures It links performance to rewards. It gives explicit recognition to the diversity of organizational goals.
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The Balanced Scorecard
What are key performance indicators? They are measures that drive the organizations to achieve their goals. The scorecard measures an organizations performance from four key perspectives:
1. Financial (e.g., profit margins, return on assets, cash flow); 2. Customer (e.g., market share, customer satisfaction index) 3. Internal Business (e.g., employee retention, cycle time reduction) 4. Innovation and Learning (e.g., Percentage of sales from new products)
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The Balanced Scorecard
Balanced Scorecard fosters a balance among different strategic measures in an effort to achieve goal congruence, thus encouraging employees to act in the organizations best interest. It is a tool that helps the companys focus, improves communication, sets organizational objectives, and provides feedback on strategy. Every measure on Balanced Scorecard addresses an aspect of a cos strategy. In creating the balanced scorecard, executives must choose a mix of measurements that : (1) accurately reflect the critical factors that will determine the success of the cos strategy (2) show the relationships among the individual measures in a cause-and-effect manner, indicating how nonfinancial measures affect long-term financial results; and (3) provide a broad based view of the current status of the company.
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PMS: Additional Considerations PMS attempts to address the needs of the different stakeholders of the organization by creating a blend of strategic measures: outcome and driver measures, financial and nonfinancial measures, and internal and external measures.
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PMS: Additional Considerations
Outcome and Driver Measures:- Indicate the result of a strategy. These measures are typically are lagging indicators; they tell management what has happened. By contrast, driver measures are leading indicators, they show the progress of key areas in implementing a strategy. Cycle time is an example of a driver. Whereas outcome measures indicate only the final result, driver measures can be used at a lower level and indicate incremental changes that will ultimately affect the outcome.
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PMS: Additional Considerations Outcome and Driver Measures are inextricably linked. If outcome measures indicate there is a problem but the driver measures indicate the strategy is being implemented well, there is a high chance that the strategy needs to be changed.
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PMS: Additional Considerations
Financial and Nonfinancial Measures Internal and external measures Measurements Drive Change Cause-Effect Relationships among Measures:
Perspective Measures
Innovation and Learning Perspective
Internal Business Perspective Customer Perspective Financial Perspective
Manufacturing Skills
First-pass yields Order cycle time Customer Satisfaction Survey Sales Revenue growth
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Key Success Factors (KSFs)
KSFs are nonfinancial measures Customer Focused Key Variables the following are key variables with focus on customer: 1. Bookings, 2. Backorders, [Link] Share 4. Key Account orders, [Link] Satisfaction, [Link] Retention, 7. Customer Loyalty
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Key Success Factors (KSFs)
Key variables related to Internal Business Processes: 1. Capacity Utilization 2. On-time delivery [Link] turnover 4. Quality, 5. Cycle time (= Processing time + Storage time + Movement time + Inspection time), Just in time ( Process time/Cycle time) etc.,
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Implementing PMS
Involves 4 general steps
1. Define the strategy 2. Define measures of strategy 3. Integrate measures into the management system 4. Review measures and results frequently
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Difficulties in Implementing PMS
Poor correlation between Nonfinancial Measures and Results Fixation on Financial Results Uncertain payback of the nonfinancial results Non updated measures, measurement overload Difficulty in establishing trade-offs
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Measurement Practices
Perceived quality measures Types of measures Quality of Measures Relationship of Measures to Compensation Interactive Control (Todays MCS Tomorrows strategy) Control System as a Strategy Implementation Tool. (Chosen Strategy Critical Success factors Design and operation of management control system Control system as a Strategy Formation Tool (Strategic Uncertainties Use of a sub-sect of Mgmt. Control Information Interactively New Strategies
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