Lecture 9 Chapter 14, LS, T

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Lecture 9Chapter 14, L-S, T H

• Contemporary approaches to measuring and managing
  performance

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Outline

• Understand the various purposes of performance
  measurement systems and the role of these systems
  in enhancing customer value and shareholder
  value.
• Understand why conventional financial measures
  are not sufficient for managing an organisation.
• Describe the characteristics of contemporary
  approaches to performance measurement.

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Outline continued

• Explain the advantages and disadvantages of
  non-financial performance measures compared to
  financial measures.
• Describe the four perspectives of the Kaplan and
  Norton (1996) balanced scorecard.
• Understand the causal linkages within the
  balanced scorecard.

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Outline continued

• Understand the relationship between lead and lag
  indicators.
• Formulate a balanced scorecard for an
  organisation, selecting objectives, and lead and
  lag measures for each of the four perspectives.
• Understand the du Pont chart, linking
  non-financial measures to financial measures and
  performance.

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Outline continued

• Describe the basis steps of benchmarking and
  understand how benchmarking can improve
  competitiveness.
• Outline the major warning signs of an inadequate
  performance measurement system.
• Outline the issues that are relevant to selecting
  performance measures in service organisations.

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The purposes of performance measurement

• Communicate the strategy and plans of the
  business and align employees goals
• Track performance against targets
• Identify problem areas
• Evaluate subordinates performance and as a basis
  of rewards
• Guide senior managers in developing future
  strategies and operations

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• Maximising shareholder value
• performance measurement systems aim to measure
  the aspects of the organisation which are
  critical to the organisations success.

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Problems with conventional performance measures

• Conventional performance measures
• are not actionable
• emphasise only one perspective
• Financial performance measures
• provide limited guidance for future actions
• can encourage actions which limit future
  competitiveness

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Assessment of Strategy?

• How does an organisation develop a performance
  measurement system that focuses on strategic
  issues - the drivers of long-run performance?
• Balanced Scorecard?

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Contemporary performance measurement systems

• Include non-financial and financial measures
• Have a strategic orientation - directly measure
  areas that provide competitive advantage
• Use external benchmarks
• Emphasis continuous improvement

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Non-financial measures for operational control

• Non-financial measures reflect the drivers of
  future financial performance
• More actionable
• More understandable and easier to relate to

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Non-financial measures

• Customer satisfaction
• Measured by survey administered to customers
• Defect measures
• Measurement of faults in a product that occur
  during manufacturing process
• Support a high quality strategy
• Quality
• Periodic inspections or testing of products

continued
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Non-financial measures

• Productivity
• The ratio of outputs produced per unit of input

continued
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Non-financial measures

• Stock status
• Accident report/safety reports
• Multiskilling
• Machine down time
• Number of hours, or percentage of total
  production hours that machines are unable to
  operate
• Delivery on time

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Problems with non-financial performance measures

• Wide choice of non-financial measures available
• Their development can be ad-hoc and undirected
• Managers must necessarily make trade-offs
• Some measures lack integrity
• Some measures not easily translated into
  financial outcomes

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Measuring performance with a balanced scorecard

• A performance measurement system that identifies
  and reports on performance measures for each key
  strategic area of the business
• The Kaplan and Norton model translates an
  organisations mission and strategies into
  objectives and performance measures
• Four perspectives

continued
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Measuring performance with a balanced scorecard

• financial perspective
• customer perspective
• internal business processes
• learning and growth

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Balanced Scorecard
A cause-and-effect model of lead and lag
indicators of performance that demonstrates how
changes in one operation cause or are balanced by
changes in others.
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The Balanced Scorecard
Financial Perspective How do we lookto the
firms owners?
Internal OperationsPerspective In which
activities must we excel?
Customer Perspective How do our customers see us?
Innovation andLearning PerspectiveHow can we
continuallyimprove and create value?
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Four Basic Balanced Scorecard Perspectives
The balanced scorecard translates an
organizations mission and strategy into
performance measures from four perspectives
Financial perspective
How should we appear to our shareholders?
Customer perspective
Business and production process perspective
Vision and strategy
How should we appear to our customers?
At what business practices must we excel?
Learning and growth perspective
How should we sustain our ability to change and
improve?
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Measuring performance with a balanced scorecard

• Measures in the balanced scorecard provide
  balance between
• short-term and long-term objectives
• financial and customer measures, and measures of
  business processes and learning and growth
• outcome measures and measures of the drivers of
  those outcomes
• hard, objective and easily quantified measures
  and soft, subjective performance measures

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Outcome measures and performance drivers

• Outcomes measures
• indicate whether operational performance
  improvements have led to improved customer
  satisfaction, increased business and improved
  financial performance

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Outcome measures and performance drivers

• Performance drivers
• communicate how outcomes can be achieved
• Allow the firm to see whether the operational
  improvements have been achieved
• provide early indications of problems
• Cause and effect linkages between different types
  of measures

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Financial perspective

• bottom-line financial performance is extremely
  important for the long-term survival of an
  organisation
• properly designed system of financial control
  within the balanced scorecard framework
• must link the other three perspectives

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Financial Perspective

• Financial measures summarise the financial
  outcomes of past decisions
• Cost and profit based
• profit, ROI, cash flow, shareholder value measures

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The Financial Perspective
Financial Performance Measures
Net Income
Return on Investment
Financial measures provide a common language for
analyzing and comparing companies
Nonfinancial measures are not sufficient for
providing the bottom line score.
Financial measures are not sufficient to guide
performance in creating value.
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Customer perspective

• How do customers see us?
• customer driven
• customers expectations
• time - time taken to respond to customer
  requirements
• quality - quality of products and processes
• performance and service - how the organisations
  products are valued by customers

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Customer perspective

• Cost - are the organisations products in the
  eyes of the customer priced competitively?

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Customer Perspective

• Measures of the business units performance in
  targeted customer and market segments
• Core outcome measures customer satisfaction,
  customer retention, customer profitability,
  market share

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Customer Perspective

• Drivers of customer outcomes
• product/service attributes
• customer relationship
• image and reputation
• factors that are critical for customers to
  switch or remain loyal

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The Customer Perspective
Focus on how the organization should look to its
customers if it is to succeed
Key performance measures
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Internal business perspective

• The processes within the organisation which
  provide the means of achieving organisational
  strategic objectives - if you have become
  customer driven then the organisation needs to
  measure its performance in terms of
  customer-oriented measures.
• Business processes which bear directly on
  customers perceptions.

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Internal Business Perspective

• Internal business processes enable the business
  to
• deliver the value that will attract and retain
  customers
• satisfy shareholder expectations of financial
  returns

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Internal Business Perspective

• Measures are those that impact on customer
  satisfaction and financial objectives
• Focus on improving existing processes
  identifying new processes that the company must
  create.

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The Internal Business and Production Perspective
Employees who do the work are the best source of
new ideas for better business processes
Key measures
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Learning and Growth Perspective

• Identifies the infrastructure that the firm must
  build to create long-term growth and improvement
• Three sources
• people
• systems
• organisational procedures

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Learning and Growth Perspective

• Promoting continuous improvement
• Targets need to constantly reassessed and
  improved
• improving production process, eliminating
  non-value added processes, reduce costs,
  realigning product lines, improving product
  lines, identifying new opportunities - new
  markets
• R D and training

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The Learning and Growth Perspective
The learning and growth perspective focuses on
the capabilities of people.
Managers are responsible for developing employee
capabilities
Key measures
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Why do we need a balanced scorecard?

• Financial measures do not assist firms to improve
  their performance
• Allows both financial and non-financial measures
  to be available for employee use
• employees see the consequences of their
  decisions/actions
• managers understand the drivers of long-term
  success

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Why do we need a balanced scorecard?

• Draws attention to what factors are important to
  achieve strategy
• Focus on short-term and long-term performance
  drivers

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Measuring performance with a balanced scorecard

• Measures in the balanced scorecard provide
  balance between
• short-term and long-term objectives
• financial and customer measures, and measures of
  business processes and learning and growth
• outcome measures and measures of the drivers of
  those outcomes
• hard, objective and easily quantified measures
  and soft, subjective performance measures

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Chain of cause and effect
Return on capital employed
Financial
Customer
Customer loyalty
On-time delivery
Internal /Business Process
Process Quality
Process cycle time
Employee skills
Learning growth
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Measures of performance
Dimensions of performance
Learning growth
Business production process efficiency
of on-time deliveries
Customer value
Retention of existing customers
Final performance
Return on Sales
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Quantifying the Causal Relationships
A mathematical model that allows managers to
estimate the effects on profitability from
changes in activities.
The basic relationship model is ?Y b(?X)
Weightings (b) are assigned to each relationship
in the causal Balanced Scorecard Model.
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Balanced Scorecard - Example
Bennett Industries realizes that a simple 1
increase in on-time deliveries will lead to a .8
increase in customer satisfaction. A 1 increase
in customer satisfaction will lead to a .3
increase in sales. If on-time delivery improves
by 5, what will be the effect on sales?
of on-time deliveries
.8
Retention of existing customers
.3
Sales Revenues
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Balanced Scorecard - Example
If on-time delivery improves by 5, what will be
the effect on sales? A 5 increase in on-time
delivery results in a 4 increase in customer
retention. This will lead, in turn, to a 1.2
increase in sales revenues!
of on-time deliveries
.8
Retention of existing customers
.3
Sales Revenues
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Key performance indicators and key performance
drivers

• Key performance indicators (KPIs)
• monitor progress towards strategic objectives
  they are also known as lag indicators or key
  performance outcomes
• Key performance drivers (KPDs)
• provide information which is actionable and
  manageable, and often related to the processes
  and activities of the business

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Linking non-financial and financial performance
measures

• Improvements in non-financial measures will not
  result in improved profits if
• management has selected the wrong critical
  success factors
• management fails to utilise freed up resources
• the performance measurement system is incorrectly
  designed

Cont.
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Measuring performance with a balanced scorecard

• Lag indicators
• Monitor progress towards the organisation's
  objectives
• Difficult to monitor directly
• Summary financial measures, market share,
  customer satisfaction

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Measuring performance with a balanced scorecard

• Lead indicators
• Measures that driver the outcomes and provide
  information that is actionable and management
• Relate to the processes and activities of the
  business

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Linking non-financial and financial performance
measures

• Du Pont chart
• shows the linkages between key performance
  drivers, key performance indicators and financial
  performance measures

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Exhibit 14.6 Du Pont Chart, linking financial and
non-financial measures
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Benchmarking

• A continuous and systematic process of evaluating
  the products, services and work practices of an
  organisation against businesses that are
  considered to be best practice
• Best practice companies
• high performers in relation to a particular
  practice or process

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Exhibit 14.7 The Benchmarking Process
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Steps in the benchmarking process

• Identify the functions/activities to be
  benchmarked, and performance measures
• Select benchmarking partners
• Data collection and analysis
• Establish performance goals
• Implement plans

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Forms of benchmarking

• Internal benchmarking
• Benchmarking operations that are internal to the
  larger business group
• Simplest form of benchmarking
• Problem may not provide the worlds best
  benchmarks

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Forms of benchmarking

• Competitive benchmarking
• identifying competitors strengths and weaknesses
  to prioritise areas for improvement.
• Continuous improvement processes are used
• Problem where do you get your benchmarking
  information from?

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Forms of benchmarking

• Industry benchmarking
• broader than competitive benchmarking
• Compares a company against companies that have
  similar interests and technologies, to identify
  performance and trends within an industry

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Forms of benchmarking

• Best in class or process benchmarking
• benchmarking against the best practices that
  occur in any industry

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Benchmarking

• Normalisation
• - the practice of removing the effects of
  factors outside the control of the organisation,
  so that narrowing the performance gap is
  achievable

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Benchmarking

• Cost structures
• requires the understanding of competitors cost
  structures to discover why a competitor is
  performing so well

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Warning signs of an inadequate performance
measurement system

• Performance is acceptable on all dimensions,
  except profit
• Customers do not buy, even when prices are
  competitive
• No one notices when performance reports are not
  supplied

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Warning signs of an inadequate performance
measurement system

• Significant time is spent debating the meanings
  of measures
• Measures have not changed for some time
• The business strategy has changed

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Designing an effective performance measurement
system

• Link to strategy and goals of the organisation
• Be simple
• Recognise controllability
• Emphasise the positive
• Be timely

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Designing an effective performance measurement
system

• Include benchmarking
• Embrace participation and empowerment
• Include only a few performance measures
• Link to rewards

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Designing measures for continuous improvement

• Continuous improvement can be built into
  performance measurement systems by
• selecting relevant performance targets
• defining and re-defining the measure
• making the performance target more challenging

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Behavioural implications of changing performance
measures

• Resistance to change
• individuals consider targets unfair or
  unachievable
• individuals pay is involved
• Changes are most likely to succeed if
• they are supported across the entire organisation
• they are not seen as an add on to an inadequate
  performance measurement system