PERFORMANCE MEASUREMENT SYSTEMS

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PERFORMANCE MEASUREMENT SYSTEMS

• Responsibility Budgeting Accounting

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The Rise of Bureaucracy

• Perfected by Prussians during 19th Century
• detailed centralized materials requirements and
  logistical planning (input budgets),
• control by rules, standard operating procedures,
  and the merit principle,
• functional administrative design, distinction
  between staff and line
• decomposition of tasks to their simplest
  components,
• Sequential processing.

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Bureaucracy

• made large, complex organizations possible also
  made them inevitable
• POSDCORB functions were all treated as separate
  concerns, performed by staff specialists and
  coordinated by top mgmt.
• substantial staff resources needed to gather and
  process data for top mgmt. to coordinate
  activities and allocate resources

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The MarketingInformation System
Marketing managers Analysis Planning Implemen-
tation Control
Marketing environment Test markets Marketing cha
nnels Competitors Publics Macro- environment fo
rces
Marketing Information System
Developing information
Assessing information needs
Internal records
Marketing intelligence
Marketing research
Marketing decision support analysis
Distributing information
Marketing decisions and communication
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Managing at Arms Length

• Multi-product, or M-form, organizational
  structure
• each major operating division serves a distinct
  product market
• Decentralized control
• by the numbers, using the DuPont system of
  financial controls, return-on-assets target
• Coordination
• short run via transfer prices
• Long run via modern capital budgeting system

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Responsibility Budgeting

• The most common decentralized control system used
  by large-scale organizations
• (a) units and managers are evaluated relative to
  the targets they accept,
• (b) only financial measures are used to measure
  and reward accomplishment or punish failure, and
• (c) financial success or failure is attributed
  entirely to managerial decisions and/or employee
  performance.

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Types of Responsibility Centers

• Discretionary Engineered expense centers
• Revenue centers
• Cost centers
• Standard cost centers
• Quasi-profit centers
• Profit centers
• Investment Centers

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EXPENSE CENTERS

• OE Program Budgets are Discretionary Expense
  Budgets
• (given recipe
• Performance Budgets are Engineered Expense
  Budgets
• recipe varies with volume

• Managers are responsible for executing the
  budget
• (Spending as planned)
• Little discretion to acquire assets no
  discretion to exceed authorized spending levels

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Revenue centers

• In some cases, expense center managers are
  evaluated in terms of the number and type of
  activities performed by their center.
• Revenue centers are expense centers that earn
  revenue or are assigned notational revenue
  (transfer price) by the organization's controller
  as a direct result of the activities they
  perform.

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Cost centers

• Cost center managers are responsible for
  producing a stated quantity and/or quality of
  output at the lowest feasible cost. Someone else
  within the organization usually determines the
  output of a cost center.
• Cost center managers are usually free to acquire
  short-term assets (those that are wholly consumed
  within a performance measurement cycle), to hire
  temporary or contract personnel, and to manage
  inventories.

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Standard cost centers

• In a standard cost center, output levels are
  determined by requests from other responsibility
  centers
• The manager's budget for each performance
  measurement cycle is determined by multiplying
  actual output by standard cost per unit.
• Performance is measured against this figure --
  the difference between actual costs and standard
  costs.

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Quasi-profit centers

• In a quasi-profit center, performance is measured
  by the difference between the notational revenue
  earned and costs
• For example,
• a VA hospital radiology department performs
• 500 chest X-rays and 200 skull X-rays.
• The notational revenue earned is 25 per chest
• X-ray (500) 12,500 and 50 per skull X-ray
• (200) 10,000, or 22,500 total.
• If the departments costs are 18,000, it earns a
  
• quasi-profit of 4,500 (22,500 - 18,000).

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Profit centers

• In profit centers, managers are responsible for
  both revenues and costs. Profit is the difference
  between revenue and cost (or expense).
• In addition to the authority to acquire
  short-term assets, to hire temporary or contract
  personnel, and to manage inventories, profit
  center managers are usually given the authority
  to make long-term hires, set salary and promotion
  schedules (subject to organization wide
  standards), organize their units, and acquire
  long-lived assets costing less than some
  specified amount.

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Investment Centers

• In investment centers, managers are responsible
  for both profit and the assets used in generating
  the profit.
• Investment center managers are typically
  evaluated in terms of return on assets (ROA) --
  the ratio of profit to assets employed.
• In recent years many have turned to economic
  value added (EVA), net operating "profit" less an
  appropriate capital charge.

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Responsibility budgets I

• For expense centers the budget is a spending plan
• For discretionary expense centers, fixed spending
  targets
• For engineered expense centers, flexible spending
  targets (i.e., the budget has two components, a
  discretionary component and a component that
  varies directly with volume)

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Responsibility budgets II

• For a cost or profit centers the budget is a
  performance target or goal
• For cost centers, the target is a unit-cost
  standard
• For quasi-profit centers, the target is a
  quasi-profit measure (Standard Cost units
  delivered Actual Unit Cost units delivered).

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Responsibility budgets III

• For profit centers, the budget is a profit
  target revenue cost of goods sold.
• The budget of an investment center is also a
  target or goal usually return on assets ROA or
  ROI or residual income EVA or RI
• The main difference between investment centers
  and all other responsibility centers is that the
  former approve their own capital budgets

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Capital budgeting I

• is concerned with changes that have multi-period
  consequences for the responsibility center in
  question
• e.g. investment in new plant or equipment, a new
  program, a major process enhancement, etc.
• Where cost and profit centers are concerned, some
  higher authority must approve these kinds of
  projects. And, each time a project is approved,
  the targets for the current period should be
  adjusted accordingly, as should future year
  targets.

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Capital budgeting II

• IN CONTRAST, investment center mangers make these
  kinds of decisions without the approval of a
  higher authority.
• Their budgets are expressed in terms that reflect
  their skill in managing assets ROA, EVA.

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Formerly, individual production units were
typically standard cost centers staff units were
typically discretionary expense centers. Mission
centers were investment centers. Mission centers
in private sector organizations produce final
products that are easily priced and that are
expensed following generally accepted accounting
practice. In contrast, support centers produce
intermediate products and these were, until
recently, hard to cost, let alone price, with
accuracy. Attempts to do so were often either
excessively arbitrary or prohibitively costly.
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Modern Control Methods

• New developments in management control technique
• Recognized that firms in Japan and Germany were
  producing higher quality goods and services at a
  lower cost
• JIT, Cycle-time analysis, Cost of Quality
  Analysis, Balanced Scorecards, and the Rules of
  BPR

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The German Critique

• Narrow rather than comprehensive
• Uses wrong cost drivers
• Unwillingness to rely on statistical cost
  measures and estimates
• Poor averaging, especially temporal averaging
• Failure to distinguish between needs of financial
  reporting and management control

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Investment Centers (Charging for Assets Used I

• The charge for invested capital working
  capital fixed capita discount rate
• This approach contains three errors assumed to
  be self-correcting
• HC is used rather than replacement cost
• A nominal rather than a real rate is used (not
  adjusted for inflation), and
• An average rate is used rather than a marginal
  rate.

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Investment Centers (Charging for Assets Used II

• The proper way to measure the use of invested
  capital would the market rent that could be
  earned on each item
• The rental rate per asset interest foregone,
  plus depreciation, minus any price appreciation
  or decline
• Replacement Cost (rd-a)

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The Japanese Critique I

• Importance of inventories and overheads,
  insignificance of labor hours
• Quality
• Solution manage process through product design
  and process value management so as to minimize
  the discrepancy between Process time and Cycle
  time inefficiency 1 (PT/CT)

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Process value analysis (PVA)

• Chart the flow of activities needed to design,
  create, and deliver a service
• For each activity and step within the activity
  determine its associated cost and its cause
• Determine how the step adds value or, if it is
  non-value adding, identify ways to eliminate it
  and its associated cost
• Determine the cycle time of each activity and
  calculate its cycle efficiency (value-added
  time/total time) and
• Seek ways to improve cycle efficiency and reduce
  associated costs due to delays, excesses, and
  unevenness in activities.

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Business Process Reengineering

• Jobs should be designed around an objective or
  outcome instead of a single function
• Functional specialization and sequential
  execution are inherently inimical to expeditious
  processing
• Those who use the output of activity should
  perform the activity and the people who produce
  information should process it, since they have
  the greatest need for information and the
  greatest interest in its accuracy
• Information should be captured once and at the
  source
• Parallel activities should be coordinated during
  their performance, not after they are completed
• The people who do the work should be responsible
  for decision making and control built into job
  designs

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Reflects Assumptions of Flexible Production

• Nobody but the front-line worker adds value,
• Front-line workers can perform most functions
  better than specialists (lean manufacturing),
• Every step of the service delivery process should
  be done perfectly (TQM)
• This reduces the need for buffer stocks (JIT) and
  produces a higher quality end-product.

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Modern IT reduced economies of scale and scope

• Multidisciplinary teams, members work together
  from start of job to completion
• push exercise of judgment down to teams that do
  an organization's work
• more equal distribution of knowledge, authority,
  and responsibility
• average firm size falling for the last twenty
  years

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The Balanced Scorecard

• Four perspectives .
• Financial
• Customer
• Internal Business Processes
• Learning and Growth Perspective

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