Performace Measurement
Performace Measurement
Taylor’s and Ford’s theories laid the foundation for the development of concepts of
how to organize large-scale machine production, which in turn determined frameworks
for a
model of coordination of modern enterprises.
Between 1920 and 1950, a rational approach in management focusing on the production
cycle was slowly replaced by a ‘classical’ approach, or what is well-known today as
administrative
management, relating to the issues of improved governance and administration at the
level of the organization as a whole and gives priority to the concept of
‘efficiency’ in relation to the
function of the organization as a whole unit.
3. The Human Relations Movement: Mary Parker Follett and George Elton Mayo
They first called attention to the fact that instead of considering the production
process and people involved in it to be components to be controlled, it is vital to
focus on the
interpersonal relationships within the organization.
The theory of the human relations movement studied human behavior from the
production point of view i.e. what benifits worker performance. This approach
focuses on the
relationships between performance and social and psychological conditions as
critical management elements.
Chris Argyris and Douglas M. McGregor argued that the bureaucratic form of
management is largely incompatible with the individual needs of the employees, &
that rigid hierarchy might cause
inefficient relations within an organization when representatives of a higher level
of an association (management level) consider subordinates (the lower level staff)
to be irresponsible.
These relations create structures which promote an unhealthy one-sided dependence
and lead to the basic needs of the workforce being unmet.
This can in turn lead to conditions that foster reduced interest of employees in
their work and the development of anti-organizational activities such as strikes.
The theories of the human relations movement and behavioral management then became
the theoretical basis for the development of a new concept of ‘Informal
Organization’
Chester Barnard, James G. March, and Herbert A. Simon laid the foundations of the
‘informal organization’ concept which focused on understanding how decisions come
to pass among individuals
groups, organizations, companies, and society.
The pivotal idea at that time was that the organization is constantly adapting to
the external environment and changing its internal structures at the same time.
However, the causes for internal changes in the organization should be considered
with regard to the external environment.
The theory of management in the decade was mainly focused on studying the
relationships between external environments,types of organizational structures, and
forms of governance.
Management concepts of the 1990s advocated for the following three principles:
1. Alteration of the role and the value of manufacturing (i.e. material,
production, andservice provision) due to the increasing influence of science and
technology, including the growing
role of quality for competitive advantage
2. More attention given to organizational culture and democratic corporative
governance with focus on behavioral and social aspects of management
3. Usage of the ‘product-market’ model for measuring the organizational performance
The beginning of the 21st century revealed different concepts within the framework
of strategic management. Those are total quality management and the idea of
customer relationship management.
We will discuss the concept of total quality management in the context of
performance measurement in more detail, but, in short, its basic principles
include:
• Continuous improvement of productivity and performance
• A fact-based approach towards and involvement of employees in the decision making
process
• A customer-oriented focus
• Leadership and a mutually beneficial relationship with suppliers, which goes hand
in hand with the creation of strategic targets for effective organizational
development and establishing
a competitive advantage over time.
The concept of CRM is a process approach which can be divided into two parts:
‘front-office’ (client-facing part of the organization) and ‘back-office’
(part of the organization dedicated to tasks that support the business itself).
In this model, the front-office tends to sub#divide performance activity into
marketing management and customer services, while the back-office divides
performance activity into optimizing
effectiveness of sales and processing, logistics, monitoring financial flows, and
other types of business performance.
Performance Management:
Performance management can be described as the management of the performance of an
organization or an individual.
While this definition is not precise, it does acknowledge the breadth of
performance management and points to some of the difficulties in defining its
scope, activities, and practices.
It shows that performance management is concerned with managing the performance
capacity of a whole organization and is often a multidisciplinary approach in its
application.
The theories describing the evolution of performance management most clearly are
performance measurement (since it has the most identifiable body of literature) and
the ‘balanced scorecard’
(which in the eyes of many people is synonymous with performance measurement).
Performance management includes a variety of activities, including the planning and
execution of actions required to ensure that performance objectives are achieved.
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For Business, the running score are data such as profits, gains and losses, or the
market share. However, analyzing costs or other specific measures alone means
little.
The context and position in relation to competitors#the ‘national league’ to draw
on the football example-is equally important for the organization’s strategy
The extent to which financial information must be disclosed is dependent upon the
public or private character of the company, its size, and whether the company is
listed on a stock exchange
or not. Performance measures focusing on financial aspects can be divided into two
main types:
1. Measures based on Accounting Data
2. Market-based Measures derived from Stock or Other Financial Market Values
The various user groups have different interests in the business and consequently
apply a series of accounting ratios to interpret and appraise financial performance
based on their
information needs. From a high-level perspective such performance comparisons and
analysis may include:
1. Comparison of current year’s results with the previous year to identify trends
and performance drivers within the organization.
2. The current year’s results in comparison with the results of companies in the
same line of business, in order to establish whether the organization is performing
better or worse than its
competitors.
3. Current performance against a standard or benchmark of performance.
4. Comparisons of one segment or division of a business with others, so as to
establish Which parts of the business are achieving their goals.
Financial performance indicators included in the financial statement can be
presented in the form of ratios and cover a number of concepts.
• Return on Investment (ROI): Represents the after-tax return which owners are
receiving on their investment and should be compared with alternative forms of
investment.
ROI = Gain from investment−Cost of investment/ Cost of investment
• Earning per Share (EPS): The portion of a company’s profit allocated to weighted
outstanding shares. EPS serves as an indicator of a company’s profitability.
EPS = Profit/ Weighted Average Common Share
• Cash Flow: There are different definitions for cash flows and different types of
cash flows (e.g. free cash flow, operational cash flows, etc.).
For practical purposes earnings plus depreciations can be used as a simple
approximation.
Cash Flows = Earnings + Depreciation
ROA:
These issues with ROE led some companies to pick a different bottom-line metric for
corporate financial performance.
This is return on assets (ROA) which receives far less attention from executives
and investors alike when seeking to analyze long-term profitability trends across
all public organizations.
Return on Assets avoids the potential distortions created by financial strategies
such as those mentioned above.
At the same time, ROA is a better metric of financial performance than income
statement profitability measures such as return on sales. ROA explicitly considers
the assets used to
support business activities. It determines whether the organization is able to
generate an adequate return on these assets, rather than simply showing robust
return on sales.
Asset#heavy business organizations need a higher level of net income to support the
business, whereas asset-light organizations can generate a very healthy return on
assets on thin margins.
• Receivables Turnover Ratio: Reflect average length of time from sale to cash
collection.
The lower the ratio, the quicker an account is paid. From a cash flow
perspective, it is important to keep the time lag to a minimum.
Accounts Receivable Turnover = Net Credit Sales/ Average Accounts Receivable
The average days to collect receivables can be calculated as: Average Collection
Period = 365/ Accounts Receivable Turnover
• Debt/Equity Ratio: This is a way to measure the extent to which a business relies
on external borrowings to fund its ongoing operations.
The higher the ratio, the more heavily debt financing is used. In order to
provide a reliable measure, assets should be valued at market value.
Debt/Equity Ratio = Total Liabilities/ Shareholders Equity
• Interest Coverage Ratio: Provides a way to measure the ability of the business to
meet its interest commitments through profits and is linked to the debt/equity
ratio.
Therough rule of thumb used by banks is a ratio of 3:1. That is earnings before
interest and taxes (EBIT) exceeding interest expense threefold.
Interest Coverage Ratio = EBIT/ Interest Expense
• Breakeven Sales: Reflects the sales which need to be generated in order to cover
expenses. In other words, this is the level of activity at which neither profit nor
losses are
incurred, or where total costs equate with total revenue. This is a very
important ratio which every business should monitor on a monthly basis.
In addition to these metrics which are mainly based on historical annual totals,
one of the key financial performance indicators an organization should prepare on a
monthly basis is
a profit and loss budget for at least a 12-month period. It is vitally important to
assess the impact that these projections have on the future cash flow of the
business.
Budgets should be compared to actual results and variances acted upon on a timely
basis. The following table shows an example of a profit and loss budget
Excepting this budget, all of the different accounting-based financial measures are
retro#spective and depict the company’s performance over the past year or several
previous years.
This is one of the most criticized aspects of accounting-based performance
meas#ures: they only reflect a company’s former achievements which are not always
indicative of future developments.
These measures show the results of the business after eventshave occurred and as
such are ‘lagging’ indicators. In addition, accounting-based meas#ures have further
weakness.
Since some accounting rules are not static and leave room for interpretation,
accounting measures can be misleading, if they have been ‘massaged’ or ‘window
dressed’ in such a way that they
do not provide a true reflection of the company’s results. Especially when it comes
to the comparison of performance figures between com#panies from different
countries,
accounting-based measures reveal another weakness. Accounting principles (e.g. US-
GAAP and IFRS) can differ significantly from country to country with respect to
goodwill, taxation,
valuation of inventories, and capitalization of losses. This inevitably leads to
different performance figures. As a result, it could be possi#ble that the same
company reports a loss based
on one country’s accounting principles and a gain based on another set of
accounting principles.
• Price-to-book ratio (P/B ratio): This ratio is used to compare a stock’s market
value with its book value.
It is calculated by dividing the current market capitalization by the latest
quarter‘s book value of the shareholders’ equity.
P/B Ratio = Market Capitalization/ Total Assets−Liabilities
• Dividend yield: This figure shows how much a company pays out in dividends each
year relative to its share price.
In the absence of any capital gains, the dividend yield is the return on
investment for a stock.
Dividend Yield = Annual Dividends Per Share/ Price Per Share
• Net present value (NPV): This metric calculates the difference between the
present value of cash inflows and cash outflows (Ct) over a period of time (t). It
is primarily used
in capital budgeting to analyze the profitability of a specific investment or
project and is sensitive to the reliability of future cash inflows that an
investment or project will yield
and the expected rate of return (r).
NPV = r ∑ t − 1 Ct/ (1 + r) t − CO
• Internal rate of return (IRR): The internal rate of return is often used in
capital budgeting. It is the exact interest rate (r) which makes the net present
value (NPV) of all
cash flows from a particular project equal to zero. Generally speaking, the higher
a project’s or an investment’s internal rate of return, the more desirable it is to
undertake the
project or investment. In this context, the IRR can be used to prioritize several
potential projects a company is considering. Assuming all other factors are equal
among the various project
The project with the highest internal rate of return would probably be considered
the best and undertaken first. Seen from a different angle, IRR can be viewed as
the rate of growth
a project is expected to generate. Although, in many cases, the actual rate of
return that a given project or investment ends up generating, will often differ
from its estimated IRR.
However, it can be expected that a project with a substantially higher IRR value
than other available options would still provide a much better chance of strong
growth.
The concept of Economic Value Added (EVA) expands this approach and additionally
builds on the residual income concept.
Residual income measures how much profit reamains for investment in the business or
distribution to the owners after subtracting expected returns on investment.
It is generally defined as the accounting profit minus a charge for capital used to
generate returns: Residual Income = Profit − Capital Charge
It is expected that a positive residual income should help to increase the total
market value of an organization because a positive residual income indicates that a
company is
accumulating profits at a greater rate then it needs to accummulate in order to
satisty the providers of capital.
Consequently, the residual income concept has shifted focus from a total profit
perspective to a ‘net’ profit view that takes into account expected capital
returns.
The EVA model expands the residual income concept further and tries to measure the
difference between the revenue made during a period and the costs of all resources
valued in
economic terms consumed in the same period. Discounting the stream of all the
expected future improvements in EVA helps to explain the difference between the
total market value
of an organization and its debt plus equity capital. In other words, the market
value added (MVA) is the present value of all future EVA.
The main idea of EVA and how it differs from traditional approaches. The two main
differences are:
• Inclusion of capital costs: One of the key features of the EVA model is that it
brings balance sheets and therefore cash flow variables into the profit and loss
account by charging the
organization’s cost of capital as a percentage of the assets employed in the
business before the bottom-line profit is calculated.
• Post-tax profits: Another main feature of EVA is its focus on post-tax profits
rather than operational profit. This incentivizes management to actively take this
part into consideration
when managing the profit and loss account. Althoug this sounds like a simple
modification, for the practical implemention the tax issues add a significant layer
of complexity to the EVA
model. The resulting number is usually called net profit after tax (NOPAT).
• Interest is not deducted: In order to avoid double accounting interest, paid for
capital is not deducted from the revenues but it is included in the capital charge
for both equity
and debt (net working capital).
Cash value added (CVA) is another well-known performance measure and serves as an
alternative to economic value added. Cash value added is considered to be another
form
of residual income. This measure calculates the difference between an
organizations’ operating cash flow and a capital charge based on the gross amount
of invested capital.
One of the major differences between CVA and EVA is that depreciations and accruals
are added when calculating the operating cash flow values in CVA. Furthermore,
accumulated
depreciation is included in the invested capital amount when the gross invested
capital is determined. The calculation of CVA is less complex than the calculation
of EVA since no
accounting adjustments are required. Since depreciation is added back during the
calculation of the CVA, the measure is not influenced by an organization’s
depreciation policy.
This characteristic of CVA can be seen as an advantage over EVA where different
depreciation policies can result in large variations in the value of the measure.
Cash flow return on investment (CFROI): has been presented by its proponents as an
improvement over some of the other traditional and value-based measures.
It is calculated by considering the inflation-adjusted investment in assets, the
inflation-adjusted cash flow generated by employing these assets in the
organization, and determines
the yield generated over the estimated lifetime of the assets.
The calculation of CFROI is based on basic discounted cash flow principles. The
four inputs required to calculate the measure are as follows:
• The Average life of the depreciating assets.
• The Total amount of assets (includes both depreciating as well as non-
depreciating assets) adjusted for inflation.
• The Inflation-adjusted cash flows generated by the assets over their lifetime.
• The Final Inflation-adjusted residual value of the non-depreciating assets at the
end of the asset lifetime.
The company’s cash flow return on investment (CFROI) value is calculated as the
discount rate which would ensure that the present value of all the future cash
flows (i.e. the equal
annual inflation-adjusted gross cash flows, as well as the terminal non-
depreciating assets amount), is equal to the initial investment (i.e. total non-
depreciating and depreciating
assets). As such, the CFROI may be viewed as a return on investment (ROI). However,
it is not calculated for individual projects, but rather for the firm as a whole.
After an initial analysis, phase actions must be untertaken to create and preserve
share#holder value and allign the company with its overall goal. This is clearly
the management
component of the value-based management process. For the practical implementation
of this process, several techniques such as portfolio management and competitive
advantage frameworks are
used. In many cases, specific reward and compensation plans are also developed to
back this process.
A traditional managerial bonus plan awards a target bonus for meeting expectations.
These expectations can be linked to share price or any other metric. The size of
the bonus to be earned
by exceeding expectations is capped. The cap controls costs, but it provides no
incentive to improve performance above a certain level. Sub-par performance is
punished by reducing the bonus
with no further disincentive once the bonus bottoms out at zero. A value-based
bonus plan can also include a target bonus plus a fixed percentage of excess value
added improvement
(since value-based metrics are measured in currency and can be positive or
negative). The fixed percentage component results in an uncapped bonus level on the
upside or the downside.
Although such a bonus model has advantages over traditional measures, it still has
three major limitations:
• The bonus plan can backfire if the corporate or national culture spurns strong
wealth incentives. Older managers near retirement may see strong wealth leverage as
too risky.
• In highly cyclical industries, it is difficult to create strong wealth leverage
while avoiding large negative bonus bank balances in downtimes. This can only be
achieved by setting
compensation above market levels which results in a high cost to shareholders.
• In start-up companies or emerging markets, EVA is not the best performance
metric.
Communication is the third and last step in value-based management. While specific
to various aspects of internal and external communication, good, clear
communication is sort of a holistic
approach which especially stresses the question of how everybody in the company can
contribute to the overall goal of the organization. Comminication efforts outside
the company need to be
very well coordinated and are part of the value realiza#tion process. Good and
clear communication to the financial markets is crucial. In addition to these
practical and more operational
steps, value-based management is generally embedded in an ethical framework for
achievement in business. As such, this management system balances individual values
with economic values.
The key management areas affected by the value based management transforma#tion
process include:
• Corporate Values and vision • Leadership Style and skills • Corporate Governance
• ‘Open Book’ Management • Operations (policies and procedures) • Communications
and information sharing
• Training and Education • Payment and Rewards • Grievances and Adjudication •
Collective Bargaining with labor unions • Employee Shareholder education and
participation • Future planning
Experiences from a growing number of organizations indicate that the more people’s
self interests are unified within a management system which is reflecting the
principles of
value-based management, the greater customer and employee satisfaction will be.
This can lead to a flow of increased cost savings, increased sales, and increased
profits.
The success of value-based management comes when each person, from top manage#ment
down to lowest staffing levels, feels that they own and benefit from the process
and
can share the results as members of one team.
Pros:
Considered alongside similar value-based measures metrics, the EVA metric can
overcome some significant shortcomings of other approaches such as:
• Traditional income measures, including net income and earnings per share, can be
easily manipulated and they do not account for the cost of equity.
• Market-based measures, including market value added (MVA), excess return, and
future growth value (FGV) can only be calculated for publicly-traded entities.
• Cash flow measures, including cash flow from operations (CFO) and cash flow
return on investment (CFROI) include neither the cost of equity nor the cost of
debt.
Cons:
It can be said that EVA as a single period measure does not address the problem of
the time period over which profits are to be maximized and it does not provide a
strong
enough incentive to avoid ‘short-termism’. An additional critique stems from the
fact that EVA is still tied to accounting derived figures such as the capital
charge being based on the
economic book value and thus strategic and market based aspects are neglected. A
final drawback of EVA is the financial focus of the model. It fails to consider the
industry
and competitive context in which each organization operates and it does not give
clear direction on how businesses can create sustainable value from a strategic
long-term view.
The performance measures, in particular the balanced scorecard, tackles these
issues.
Additionally, it is worth mentioning that implementing EVA is a complex and very
much company-specific process. Its practical application goes beyond pure account
and financial measures.
Companies are more likely to benefit from economic value added (EVA) if they adopt
the following characteristics:
• The corporate structure consists of relatively autonomous business units, rather
than one large unit or a matrix organization with substantially shared resources.
• Strong managerial wealth incentives are tied to business unit performance, rather
than to corporate-wide goals or the discretion of the compensation committee.
• The CEO is an enthusiastic advocate. They go along with something that they fully
understand and support. Economic value added implementation should begin at the
top.
• Business unit heads are personally involved with the well-being of the
organization and are thus motivated by long-term incentives.
What are the Specific BUISNESS PRESSURES that Drive Operational Performance Goals:
• Improve Executive Visibility: to operational drivers: There is no doubt that
organizations can do better than just an entry-level of maturity.
Companies are successful when operational data is applied within a time frame,
since that can affect performance improvement.
Quality: includes a number of other dimensions, such as how well a product performs
additional features next to its primary functions, how reliable and technically
durable it is,
how easy it is to service the product, how the look and feel of the product is
perceived by the cus#tomers, and how the value for money viewpoint is.
Dependability: can mean the adherence to a plan or set schedule, but may also refer
to the delivery performance. The question of whether the products are delivered in
full and always on time). It can also include the general ability to meet promises.
Speed: can refer to the time taken to generate quotes, the time to answer quotes,
the frequency with which deliveries can be made, the time to manufacture a
product, or the time to develop and invent a new product.
Cost: includes manufacturing cost, value added, selling price, running cost,
service cost, profit.
There are two additional points which add to the complexity and multidimensional
nature of operational performance measures. The first point is that the five
operations perform#ance objectives
trade off with one another, but the extent of these trade-offs depends very much on
context-specific characteristics and timing.
Like a big jigsaw puzzle, the "Challenge for Operations Managers" is to decide on
which of the five objectives they wish to focus their main attention to and how
changing this dimension will
affect the other dimensions.
The following graph shows how leading indicators and operational KPIs can be linked
with performance metics:
Performance metrics measure aspects of the business process or value stream which
directly affect results or outcomes.
There are four key performance metrics which are often used to determine excellent
performance:
Organizations:
In addition to having a process for updating the performance management system
related to operational performance, organizational aspects are relevant as well.
This also includes adopting a process in which the Key Performance Indicators
suitable for the respective organization are defined.
Monitoring Key Performance Indicators will look into the following aspects:
Knowledge Management:
Performance Management:
It is not enough to simply define key performance indicators and track them over
time. They also need to be clearly communicated throughout the organization in
order to enable all levels of
staff to understand how the indicators relate to performance goals of the group,
the company, and how this performance compares to that of competitors’.
Technologies:
Technical ability, or the lack of it among users, naturally pushes the job of
report generation to the IT department. This does not only lead to additional costs
in terms of IT resource
utilization, but also drives up the headcount required to meet the increasing
demand for reports and the requests for analytical views.
Automation of data integration, report generation, and alerting can improve the
speed and ease with which information can be collected and delivered to end-users.
At the top list of priorities should be ‘ease of use for end-users’ and
‘integration capabilities with other applications’.
To achieve excellent quality performance, organizations must prioritize the areas
of the business which will benefit most from operational performance management
initiatives.
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Measuring the Improvements in quality and the Profits from different Customers or
Customer Groups require performance measurement techniques:
Goals of CPA
Forward Looking: Right Decisions about Current and Potential Customers
Backward Looking: Identify what was actually working to increse profitability with
cusromers (Learning)
Operational: Analyze resource allocation
A customer profitability analysis can help to identify factors which could have a
negative impact on the future of the company.
For example, most customer profitability analysis templates allow for determining
what percentage of revenue is generated from a given customer or group of
customers.
There are cases when analysis makes it clear that the company is depending on two
or three large customers to generate half or more of its business volume.
In such a case, steps are taken to diversify and expand the client base, often by
attracting more small- to mid-sized customers.
A proper customer profitability analysis will also look closely at how much of the
compny’s resources are dedicated to producing goods and services for specific
clients.
For many years organizations focused primarily on acquiring new customers, without
taking into consideration how many purchases an individual customer made.
Acquiring a large number of customers who only purchase once is not an optimal
strategy. Instead, businesses should concentrate on identifying how much each
customer contributes to the
overall profit and performance of the organization. The customer lifetime value
tries to provide this information by measuring the worth of a customer to the
company.
With this information businesses can rank order their customers and formulate
different strategies.
Retention Rate:
It refers to the possibility that an individual customer remains loyal to a
particular supplier and keeps yielding expected revenue, as well as costs, within a
fixed period of time.
Revenue:
The second component revenue can be divided into four sub-categories:
• Autonomous revenue • Up-selling revenue • Cross-selling revenue • Referral
activities of existing customers
*The autonomous revenue represents factors which are not directly influenced by the
organization or only affected by standard marketing measures such as TV
advertising.
Costs:
The principle methods for predicting customer costs are those which are commonly
applied in product-related accounting.
The following graph illustrates the main phases of the customer lifetime cycle and
depicts how it relates to the different costs and revenue which occur:
• The first component is the gross contribution margin, defined as the difference
between recurring revenues minus recurring costs.
• Gross contribution margin minus marketing costs results in the net margin.
• If the net margin is constant over time, it can be multiplied by the number of
purchases which are expected within a given time frame resulting in the accumulated
margin.
• The gross profit or accumulated margin needs to be corrected by any acquisition
costs which usually only occur in the first period.
• Finally, the results per period need to be discounted to calculate the net
present value of the profit per period and the cumulative net present value over
all periods.
This results in the customer lifetime value. As mentioned earlier, the discount
rate is usually estimated by the weighted average capital costs (WACC).
However, there may be rea#sons to use a different factor as a discount rate.
To illustrate the customer lifetime value calculation we conclude this unit with a
simple case study.
The company Brand New Limited plans to extend its services to a new cus#tomer
segment based in the following data:
• The planning horizon is three years. It is expected to gain 20,000 new customers
with the service provided.
• The expected retention rate for the first year is 60 %. For the following two
years it is expected that the retention rate will increase to 65 % and then to 70
%.
• Moreover, it is expected that the customers make 1.8 orders on average in the
first year. This is expected to increase to 2.6 in year two and 3.6 in year three.
• The average order size in year one is $2,980. In year two it is expected that
this increase to $5,589 and in year three to $9,106.
• The direct costs are available as a percentage of the average costs. They are 70
% in year one, 65 % in year two and 63 % in year three.
• To win the new customers, the average acquisition costs for marketing and other
activi#ties per customer are $630.
• The weighted average capital costs (WACC) for the first year are 13.0 %. However,
based on a market study it is expected that capital costs will significantly
increase after year one.
In year two, costs are estimated to be 34.5 % and for year three 36.3 %.
The following table shows the calculation of the customer lifetime value based on
the above information and following the steps of customer lifetime value
calculation
Benchmarking:
This is an important tool not only in customer analysis, but also performance
measurement and business improvement in general. Benchmarking has established its
position as a tool to improve an organization’s performance and competitiveness
in the business world. Recently, the process of benchmarking has extended from only
looking at large companies to also include small businesses as well as the public
sector.
Therefore, It is clear that the central essence of benchmarking is learning how to
improve activities, processes, and management.
Benchmarking experts apply Two main types: ‘Informal’ and ‘Formal’ benchmarking.
Informal benchmarking is a type of benchmarking that is unconsciously practiced by
people at work or in their private life. People constantly compare themselves to
others and
learn from their behavior and practices-whether it is how to use a software
program, how to cook a better meal, or improve their performance in a favorite
sport.
As far as Formal types of benchmarking are concerned, there are Two Types:
Performance & Best Practice Benchmarking.
Best Practice Benchmarking: Best practice benchmarking involves the whole process
of identifying, capturing, analyzing, and implementing best practices.
Where organizations search for and study organizations which are high performers in
particular areas of interest. The focus lies on the actual processes within
those businesses rather than just the associated performance levels. This
information is usually gathered through some mutually beneficial agreement which
follows a benchmarking code of
conduct. Knowledge gained through the study is evaluated and where feasible and
appropriate, these processes are adapted and incorporated into the organization.
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One of the most valuable assets companies have today is intellectual capital which
is comprised of the intangible assets of skill, knowledge, and information.
The market value of leading companies is far higher than their value of tangible
assets.
This is especially the case forbig technology companies such as Microsoft, Intel,
Apple, and Samsung or companies with a strong brand name such as Coca-Cola.
Since there is still no acceptable way of measuring intellectual capital. This of
course makes performance measurement difficult as it is a challenge to track
changes in IC over time.
Refer Page No: 78 for : Comparison of Tangible and Intangible Assets Table:
Tangible Assets: Required for Business Operations
• Readily visible • Rigorously quantified • Part of the balance sheet • Investment
produces known returns • Can be easily duplicated
• Depreciates with use • Has finite application • Best managed with ‘scarcity’
mentality • Best leveraged through control • Can be accumulated
# There are several groups of methods of measuring the intellectual capital, which
can be used in order to evaluate intangible assets:
• Direct Intellectual Capital Methods: These methods estimate the dollar value of
intangible assets by identifying its various components.
Once these components are identified, they can be evaluated, either individually
or as an aggregated coefficient.
There are a number of different individual methods which fall into this category.
One example is the total value creation (TVC).
• Scorecard Methods: This is a very broad category which tries to identify various
components of intangible assets or intellectual capital. It uses various
indicators, indices
and generates a scorecard, which usually is a score value not necessarily related
to a dollar value. Probably the most prominent approach which belongs to this
category is
the balanced scorecard concept. It tries to combine different performance
perspectives including intangible aspects.
# Advantages and Disadvantages which are connected with different ways to tackle
the intellectual capital measurement phenomenon:
Perceptual Measures, Process Measures, Financial Measures and Other measures
including Social Measures
However, the analysis of different approaches to measure performance has shown that
numerous factors make performance measurement a complicated process. Sometimes it
is unclear what to measure.
In addition, the intangibility of some measuring parameters, particularly non-
financial ones, is a complicating factor as these measures may be subject to
manipulation.
This can greatly complicate and distort performance measurement. And, finally, once
certain measures have been defined, they need to be combined with a complete view
of the organization.
Three tools will be discussed in this unit: The Balanced Scorecard, The European
Foundation for Quality Management (EFQM) model, and the Performance Prism Approach.
The PMS can be the information system which is the key to the performance
management process. It also integrates all relevant information from all the other
management systems.
There are a number of reasons for managing performance. PMS can be used to:
• Formulate a Strategy in order to determine what the objectives of the
organization are and how the organization plans to achieve them
• Manage the Strategy implementation process by examining whether an intended
strategy is being put into practice as planned
• Challenge Assumptions by focusing not only on the implementation of an intended
strategy but also on making sure that its content is still valid
• Check Progress by looking at whether the expected performance results are being
achieved
• Comply with Non-negotiable parameters by making sure that the organization is
securing its survival by achieving the minimum standards needed (e.g. legal
requirements, environmental parameters, etc.)
• Communicate Direction to the rest of the employees by passing on information
about what the strategic goals are and how individuals are expected to achieve them
• Communicate with External Stakeholders
• Provide Feedback by reporting to employees how they, their group and the
organization as a whole are performing in comparison to the expected goals
• Evaluate and Reward behavior in order to focus employees’ attention on strategic
priorities and motivate them to take action and make decisions that are consistent
with organizational goals
• Benchmark the Performance of different organizations, plants, departments, teams
and individuals
• Inform Managerial decision-making processes
• Encourage Improvement and Learning
The Roles of the performance management system can be defined by three key
categories:
• Strategy: Comprises the roles of managing strategy implementation and challenging
assumptions.
• Communication: Comprises the role of checking progress, complying with the non-
negotiable parameters and the communicating direction as well as providing feedback
and benchmarking.
• Motivation: Comprises the role of evaluating and rewarding behavior and
encouraging improvement and learning.
In the centre of the balanced scorecard is the vision of the organization’s future.
This includes strategy, mission, and goals.
In order to achieve its objectives, the organization needs to satisfy shareholders
and customers and has to manage internal processes as well as innovation and
learning.
The balanced scorecard tries to give all of these four perspectives the required
attention and aims to derive critical success factors and critical measures for
each of these dimensions.
We will see that the balanced scorecard does not introduce new indicators, but
tries to combine and ‘balance’ existing performance measures:
Weaknesses:
• Does not express the interests of all stakeholders
• Lack of long-term commitment and leadership for management
• Too many/few metrics, development of unattainable metrics
• Lack of employee awareness or a failure to communicate information to all
employees
• Constructed as a controlling tool rather than an improvement tool
• No relationship quantification
• Inappropriate for benchmarking
Case Study: IMP Page No: 94
Fly High Airline Inc. Balanced Scorecard and Strategy Management
Performance Prism:
Claimants or stakeholder categories which help to form a holistic view in this
context are:
• Investors (Including shareholders, banks, and other capital providers)
• Customers and Intermediaries
• Employees (Including labor unions)
• Suppliers and Partners
• Regulators
• Pressure groups, Communities, and The Media
Two theoretical schemes which link performance measures with different hierarchical
levels and foster a stakeholder view of the corporation are the performance pyramid
(or the SMART system) proposed by Cross and Lynch and the performance prism
introduced by Neely.
Performance Prism:
The performance prism suggests that measurements of stakeholder satisfaction,
stakeholder contribution, strategies, processes, and capabilities of the
organization are taken
into account when developing the company’s strategy. These new areas of
consideration can give managers a more holistic report of the company’s performance
and can allow
them to plan for wider improvements across the company. No definitive evidence on
there needs to be an equal weighting of importance in these areas of measurement.
Weaknesses:
• Offers little about how the performance measures are going to be implemented
• Some measures are not effective in practice
• Short of logic among the measures, no sufficient link between the results and
drivers
• No consideration is given to the existent PMSs that companies may have in place
SMART PYRAMID:
The strategic measurement and reporting technique (SMART) pyramid facilitates the
need for the inclusion of measures which are focused internally and externally.
The purpose of this performance pyramid is to connect an organization’s strategy to
its operation levels by conveing objectives from
the top down (based on customer priorities) and transmitting measures from the
bottom up.
This framework encourages executives to pay more attention to the horizontal flows
of materials and information within the organization, i.e. the business processes.
The SMART system includes four levels of objectives which address the
organization’s
External Effectiveness (At the bottom of the left side of the pyramid) and it's
Internal Efficiency (At the bottom of the right side of the pyramid).
The development of an organiza#tion’s SMART pyramid begins with defining an overall
corporate vision at the first horizon#tal level, which is then translated into
individual business unit
objectives. The second#level business units are set short-term targets of cash flow
and profitability and long-term goals of growth and market position (e.g. market,
financial, etc.).
The third horizontal level, i.e. business operating system, bridges the gap between
top-level and day-to-day operational measures. Here, targets include customer
satisfaction, flexibility
and productivity. Finally, four key performance measures such as Quality,
Delivery, Cycle Time, and Waste are used at Departments and Work Centers on a daily
basis.
Theoretically, the main strength of the SMART pyramid is its attempt to integrate
corporate objectives with operational performance indicators.
However, this approach does not provide any practical mechanisms to identify key
performance indicators, nor does it explicitly inte-grate the concept of continuous
improvement.
Weaknesses:
• Does not provide any mechanism to identify key performance indicators
• Fails to specify the form of the measures
• Does not explicitly integrate the concept of continuous improvement
The ‘European Foundation for Quality Management Excellence Model’ is based upon the
fundamental concepts of excellence described below:
• Adding value for customers: Consistently add value for customers by
understanding, anticipating and fulfilling needs as well as expectations and
opportunities.
• Creating a sustainable future: Creating positive impact on the surrounding
environment by enhancing performance.
• Developing organizational capability: Outstanding organizations enhance their
capa#bilities by effectively managing change within and beyond the organizational
boundaries.
• Harnessing creativity and innovation: Generate increased value and levels of
performance through continual improvement and systematic innovation.
• Leading with vision, inspiration, and integrity: High goals can only be achieved
by leaders who shape the future and make it happen,acting as role models for a
company’s values and ethics.
• Managing with agility: Ability to identify and respond effectively
and efficiently to opportunities and threats.
• Succeeding through the talent of people: Values people and creates a culture of
empowerment for the achievement of both organizational and personal goals.
• Sustaining outstanding results: Sustaining by outstanding results which
meet both the short and long-term needs of all their stakeholders.
The EFQM excellence model is depicted by key nine criteria-five enablers and four
results#which lay ground for a whole view of an organization and,
when used as a diagnostic tool, it allows an organization to assess its strengths
and define areas for improvement in detail across nine key areas.
At the heart of the model lies the RADAR management logic, which is another set of
guiding principles.
At the highest level, RADAR logic states that:
• Results need to be determined and should be achieved as part of an organizational
strategy.
• Approaches have to be planned and developed as an integrated set of directives to
deliver the required results both now and in the future.
• Deploy the approaches in a systematic way to ensure implementation.
• Assess and refine the deployed approaches based on monitoring and analysis of the
• Results achieved and on-going learning activities.
The elements of approach, deployment, assessment, and review are used when
assessing ‘enabler’ criteria and the ‘results’ elements are applied to assess
‘result’ criteria
A key feature of the model is that it can be used as a diagnostic tool for self-
assessment, where organizations grade themselves against a set of detailed criteria
under each of the
nine headings. The overall score acts as a European benchmark and helps
organizations identify areas to be improved.
It is then possible to develop and implement improvement plans which deliver
sustainable growth and enhanced performance for the organization.
EFQM is not to be understood as a ‘standard’. It is a framework or a practical
diagnostic tool.
There are eight generic steps for carrying out a self#assessment. These steps are
shown below:
• Develop Commitment • Plan Sef-Assesment
• Establish Teams to perform self-assesment and educate them • Communicate Self
Assesment Plans
• Conduct Self Assesment • Establish Action Plan • Implement Action Plan • Review
Progress 1-7 Steps
Although they are shown as sequential, some activities may overlap others:
• Educating and training staff to give them the knowledge and skills necessary to
fulfill their role.
• Scheduling self-assessments • Developing action plans resulting from self-
assessments.
• Planning review meetings • Embedding the self-assessment process into the regular
business planning cycle.
• Maintaining commitment to activity plans by supporting improvement activities.
Weaknesses:
• No focus/priorities – no links • Criteria are not specific within the company –
no possibility for differentiation.
• Is not a strategic management tool and therefore is not for the strategy
implementation. • Is not suitable for enterprise communication. • Promotes the
tendency for bureaucracy.
• Does not give guidelines how to design and conduct effective performance
measurement.
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The previous chart shows clearly that both models have much in common, in
particular using measurement approaches for the improvement of performance and
applying similar principles of
management. But despite the fact that these two models come from the same origins,
they take different routes and deliver different outcomes and benefits.
The principal difference between the two approaches is that the balanced scorecard
communicates and assesses strategic performance, whereas the excellence model
includes its various
applications, such as the self-assessment process, and focuses more on the adoption
of good practice across all management activities.
For example, the self-assessment, which is typically an annual exercise, examines
how well an organization defines and manages the process of its strategic planning.
It does this by determining whether the organization has a formally established and
appropriate process. This process is reviewed regularly and is systematically
deployed at different levels.
On the other hand, the balanced scorecard tests the validity of the strategy and
monitors the organization’s performance against its delivery on a regular and
monthly basis.
The balanced scorecard does not assess the quality of the strategic planning
process itself. The main purpose of the balanced scorecard is to ensure that the
strategy gets
implemented as well as to enable an organization to continuously learn from its
performance and adapt its strategy accordingly.
Additional comparisons of the two approaches can help to understand how they work
and, what is more interesting, how the two choose to address issues on performance
management.
#Table 13: Characteristics of Balanced Scorecard and EFQM's Excellence Model Refer
Page No: 114 Table
The excellence model and its associated self-assessment processes are assessing
best practice at the process level. In order to provide equitable comparison and a
system of benchmarking to
organizations, the assessment must be applied consistently in its structure,
criteria, approach and content. It makes it easier for an organization to situate
itself in a kind of European
top league table. In this case, a market niche or particular competitive
environments are factors that do not have any essential impact on the usefulness &
application of the model.
As for the balanced scorecard and its context specific approach to performance
management, it is obvious that it entirely depends and is based on an
organization’s positioning, challenges,
competitive context, and, of course, its strategy. Thereby the balanced scorecard
model becomes a high-level guiding framework which needs to be tailored to the
organization’s individual
circumstances. (This process needs to be repeated every time it is applied to a
different situation or framework).
Thus the key task of this framework is to lead corporate governance through a path
of logical strategic thinking, which in turn can be flexed and adapted to every
situation.
#The next critical delimitation lies in the fact that each model takes two entirely
different approaches as starting point of comparison:
On the other hand, The Balanced Scorecard distinguish performance objectives which
need to be achieved in order to reach the organization’s vision in two or five
years’ time.
The balanced scorecard is future-oriented. It asks the question: “Where does the
organization need to improve to achieve its three-year financial objectives?”
Attached to those objectives is a set of actions and initiatives which the
organization needs to undertake today to get the objective.
In the scorecard, the priorities for today are derived from the assumption of where
the organization needs to be tomorrow.
It then takes further analysis to determine how much effort it will take to get to
tomorrow, given the current strengths and weaknesses of the organization.
By using the EFQM's excellence model, an organization will have a good and broad
understanding of its own strengths and weaknesses at the process level. As a result
of the
assessment, an organization will have an indication as to where it may need to
improve significantly, where it performs adequately, and where it excels against
the ideal benchmark.
On the other hand, the balanced scorecard can be used to provide knowledge of where
the strategic focus is needed and which action needs to be prioritized as well as
where
resources need to be allocated to
•Information Overload:
Since information gathering and provision are key areas of a performance
measurement system, there are some cases in which a large amount of information
creates negative effects on an
organization. Management teams become overloaded with excessive amounts of
information which leads to ‘paralysis by analysis’.
The conclusion is to reassess measurement systems and metrics which do not
contribute to the achievement of strategic goals.
KPI's can be those measurements. Examples from different sectors indicate how KPIs
can be applied:
* A business may have ‘Percentage of Income’ generated from return customers as one
of its KPI.
* A school may focus its KPI on graduation rates of its students.
* A customer service department may define ‘percentage of customer calls answered
in the first minute’ as one of its KPI and evaluate that in line with overall KPIs.
* A KPI for a social organization might be the number of clients assisted during
the year.
Whatever KPI's are selected, they must reflect the organization’s goals, they must
be critical to the success of the organization, and they must be measurable.
The goals of a particular KPI may change as the organization’s goals change or as
it gets closer to achieving a goal.
•Unreasonable Incentives:
Another obstacle lies in the creation of incentives and their application. The risk
in this case is that incentives which are linked to performance may motivate
employees only
temporarily and thus an incentive scheme will not result in any long-term
commitment to performance. It is important to state that all performance measures
must be thoroughly examined
before defining incentives for their achievement. Consider the following example. A
retail outlet may have a KPI which measures ‘stock outs’, a situation which occurs
when the outlet
cannot satisfy demand because of insufficient stock. In addition, the retail outlet
also has a KPI to keep a lean stock inventory.
If the retail outlet excels at the latter KPI (i.e. keeping a lean inventory), it
may increase the amount of ‘stock outs’ and thus delay or fail to realize the first
KPI.
•Cost of Measurement:
Every measurement activity, the implementation as well as the maintenance, creates
costs. Every additional measure potentially reduces the efficiency of the process.
In addition, all proposed measures must be examined to determine if they are
adequately contribute to the strategic intentions of the organization.
Any measures which do not that should be eliminated as they add unnecessary costs
without providing any value to the organization in return.
•Cultural Resistance:
Using too many performance measurement metrics may generate resistance from
employees who potentially feel that the amount of observation is excessive.
Employees who are instructed via using performance measurement metrics must be
equipped with appropriate information and knowledge to act on these measures
accordingly.
If, however, they are unable to do so, it may lead to employee disappointed and
reduced staff morale.