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Unformatted text preview: 9. Combination of Measures/Uncontrollable Factors
1. 2. 3. 4. Outline Overcoming Myopia Problems The Balanced Scorecard Evaluating BSC Financial Result Controls and Uncontrollable Factors Bus 424 ninth lecture presentation 1 Overcoming myopia Measure changes in “shareholder value” directly Measurement precision and objectivity of future cash flows? Control investments with preaction reviews Operating expenses — Today businesses — Financial results controls Developmental expenses Tomorrow businesses Combination of nonfinancial performance indicators and action controls Bus 424 ninth lecture presentation 2 Overcoming myopia (Continued) Improve accounting profit measures Adjust depreciable lives of fixed assets, adopt current value depreciation, charge depreciation for older assets Capitalize expenditures related to long term investments Recognize profits more quickly Impute a cost of equity on income statement Put leases on the balance sheet, etc. Cost of developing performance reports for control purposes? Bus 424 ninth lecture presentation 3 Overcoming myopia (Continued) Extend the measurement horizon Measurement congruence
– The longer the period of measurement, the higher the correlation between accounting income and economic income. Use longterm incentive plans? Bus 424 ninth lecture presentation 4 Overcoming myopia (Continued) Reduce pressure for shortterm profit – Reduce the weighting placed on the annual profit target and emphasize other, longerterm performance indicators, such as market share and technical breakthrough. Use subjective performance evaluations? – Make the shortterm profit targets easier to achieve Some slack is created to fund longerterm projects But, motivational effects of easy targets?
Bus 424 ninth lecture presentation 5 Overcoming myopia (Continued) Measure a set of drivers of future financial performance – Use nonfinancial performance measures – Balanced scorecard The BSC includes financial measures that tell the results of actions already taken. It complements the financial measures with operational measures on customer satisfaction, internal processes, and the firm’s innovation and improvement activities. Bus 424 ninth lecture presentation 6 The 4 perspectives of BSC Bus 424 ninth lecture presentation 7 H ow t o Build t he BSC Bus 424 ninth lecture presentation 8 Step 1: Corporate vision statement Helps to answer: – – – Why do we exist? What do we want to be? What is important to us? Clarifying the Vision – Express vision as Integrated objectives; And measures Gaining Consensus – Managers in one accord
Bus 424 ninth lecture presentation 9 Step 2 : The strategy map Bus 424 ninth lecture presentation 10 Communicating and linking Communicating and Educating – 2 way Communication Setting Goals Top down – to divisions, depts, individuals Bottom up – to corporate HQ Linking Rewards to Performance – Translate high level objectives to department & individual level Measures – Aligns strategy and Employee performance Bus 424 ninth lecture presentation 11 Developing the strategy map Bus 424 ninth lecture presentation 12 Setting Targets Step 3. Determine the strategic objectives Aligning Strategic Initiatives Allocating Resources – All users of the scorecard – Determining actions that drive targets – E.g. ensuring budgets support strategies – Improving most critical processes – Eliminate non strategic investments – Charting progress of targets
Bus 424 ninth lecture presentation 13 Establishing Milestones Step 4 : Deriving the KPIs
STEP 2 STEP 4 Vision M ission Values
STEP 1 Str ategy M ap Str ategic Objectives F inancial Customer
STEP 3 KEY PERF ORM AN CE I N D I CAT ORS = M easur ement that p r ovides infor mation on h ow far w e have succeeded in achieving t he str ategic objectives I nter nal pr ocess L ear ning and gr ow th Bus 424 ninth lecture presentation 14 Step 4 : Deriving the KPIs Bus 424 ninth lecture presentation 15 Corporate Strategy
VISION: To provide society with superior products and services by developing innovations and solutions that improve the quality of life and satisfy customer needs Maximize wealth for Shareholders Provide high quality products at good price Provide open & stimulating environment to employees Missions
FINANCIAL CUSTOMER INTERNAL PROCESS LEARNING AND GROWTH Business strategy Bus 424 ninth lecture presentation 16 K PI -Financial Per spect ive
Mission Perspective Strategic Goals Indicators Targets Actual Performance Trend Maximise shareholde r value Financial Increase revenue growth Increase in new customers Increase in new products Sales volume Gross margin X% Y% ↑ X X Z X ↓ = Improve productivity Total asset turnover Inventory turnover Debtors turnover ROCE Bus 424 ninth lecture presentation 17 KPICustomer Perspective
Perspe ctivec Strategic Goals Indicators Targets (month/y ear) X% Actual Perform ance Y% Trend Custo mer Increase Response time to customers CPV of Customer complaints (per 100,000 end consumer calls) users Product return per 10,000 units Number of product safety brochures distributed ↑ X%
X% X/month Increase Order lead time X hrs/m CPV of X% distributo Number of distributors in “high sales capacity – high Norwalk sales portion” rs zone Number of training activities for distributors on product safety and usage X times Number of printed advertising X copies Bus 424 ninth lecture presentation materials such as company brochures 18 KPIInternal Process Perspective
Per spect i ve Str ategi c Goals I ndicator s I nt er nal I ncr ease N ew pr oduct s launched per year d New applicat ions of cur r ent i nnovat io pr oduct s n N umber of st aff suggest ions submit t ed and i mplement ed Number of pat ent s filed and gr ant ed Regulat o Number of safet y incident s fr om r y and n ew pr oduct s social Number of envir onment al incident s pr ocesses f r om new pr ocesses Bus 424 ninth lecture presentation T ar get Actual T r en s P er for ma d nce X Y ↑ X X = 19 KPIInternal Process Perspective
Per spect Str ategic ive G oals I nt er nal I ndicator s
Actual T ar get T r en P er for ma s d nce Oper at ion M anufact ur ing cost s of new al pr oduct s excellence X X Y Z ↑ ↓ Time fr om st ar t of pilot pr oduct ion unt il full volume capabi li t y achieved Number of new pr oduct s l aunched or commer cialized Gr oss/net pr ofit abilit y I nvent or y levels Cycle t ime Number of per fect or der s (deliver ed in full and on t ime Bus 424 ninth lecture presentation D .I .F.O.T.) 20 KPIInternal Process Perspective
Per specti ve I nt er nal Str ategic G oals Enhance Cust omer Relat ionshi p M anageme nt I ndicator s
Actual T ar ge P er for ma ts nce Tre nd ↑ ↓ Six mont hs r evenues fr om new X pr oduct s St ockout s or backor der s fr om n ew pr oduct s Sur veys and feedbacks about pr oduct sat isfact ion and usage Consumer sat isfact ion/complaint s Dist r ibut or s' t ur nover Dist r ibut or at t r it ion r at es No. of cust omer r el at ionship building exer cises X Y Z L evel of r eal-t ime cust omer Bus 424 ninth lecture presentation i nvolvement in R& D 21 KPI Learning & Growth Perspective
Perspective Strategic Goals Indicators Targets Actual Performance Trend Learning & Enhance No. of training Organizational hours/employee Growth
Competence X% X X Y% Z X ↑ ↓ = Training effectiveness index Employee turnover rate Employee satisfaction index Absenteeism rate Participation rate in firm organised nonwork activities Increase Employee Satisfaction Promotion rate Bus 424 ninth lecture presentation 22 St r at egy M ap
M aximize Shar eholder Value F inancial
I ncr ease Pr oductivity I ncr ease Revenue Gr ow th a nd pr ofitability Customer I ncr ease C ustomer Satisfaction I ncr ease D istr ibutor Satisfaction Enhance Customer Achieve I nter nal O Pr ocess R elationship M anagement per ational Excellence I ncr ease I nnovation L ear ning & Enhance or ganizational Gr ow th competence T r aining and k now ledge shar ing I mpr ove E mployee Satisfaction
23 Bus 424 ninth lecture presentation A Good Balanced Scorecard “Tells the Story of Your Strategy” Every measure is part of a chain of causeand effect linkages. All measures eventually link to organizational outcomes. A balance exists between outcome measures (financial, customer) and performance drivers (customer value, internal processes, learning and growth).
Bus 424 ninth lecture presentation 24 Evaluating the BSC-approach Are BSCs balanced?
What is the proper weighting to achieve “balance” » Among the four perspectives? » Among the two dozen measures? Average weights in a study of 60 BSC firms by Towers Perrin (1996):
Financial 56% Customer Internal business Innovation and learning Other 19% 12% 5% 8% Bus 424 ninth lecture presentation 25 Using Financial Results Controls in the Presence of Uncontrollable Factors Bus 424 ninth lecture presentation 26 Controllability principle Employees should be held accountable only for that which they alone can control; or, Employees should be held accountable only for that over which they have significant influence. Bus 424 ninth lecture presentation 27 Rationale Uncontrollable factors distort performance measures and evaluations. Uncontrollable business risks are best borne by shareholders (who are better able to diversify the risks). – If managers bear the risk: They must be compensated for it. They may engage in undesirable actions to protect themselves from the risks (e.g., by engaging in “gameplaying” or by becoming excessively risk averse).
Bus 424 ninth lecture presentation 28 Choices that must be made include Purpose(s) for which adjustments are made? – Salary raises – Incentive pay (shortterm, longterm) – Job retention Bus 424 ninth lecture presentation 29 Choices that must be made include (Continued) Types of uncontrollables for which adjustments are made? – Economic and competitive factors – “Acts of nature” – Interdependencies i.e., uncontrollables due to decisions made by personnel in other parts of the organization, such as higher organizational levels or other organizational entities. Bus 424 ninth lecture presentation 30 Choices that must be made include (Continued) Who makes the adjustments? – Immediate superior – Upper management – (Compensation committee of the) Board of Directors – Done automatically by predetermined formulae/rules Bus 424 ninth lecture presentation 31 Choices that must be made include (Continued) Which method to use to make the adjustments? – Variance analysis – Flexible performance targets (e.g. “flexed budgets”) – Relative performance evaluations – Subjective judgments Bus 424 ninth lecture presentation 32 Other choices Should the adjustments be total or partial? Should the adjustments be for negative uncontrollable factors only (i.e. “bad luck”), or should adjustments be made in either direction, both positive and negative?
Bus 424 ninth lecture presentation 33 How to decide? Costs vs. benefits: – For some types of adjustments, the benefits clearly outweigh the costs: Factor is totally uncontrollable Manager is not expected to respond to the factor The effect of the uncontrollable factor can be calculated objectively Bus 424 ninth lecture presentation 34 How to decide? (Continued) The benefits of making adjustments are: – More accurate performance evaluations – Less manager frustration; better motivation – Better decision making; less noise in the performance measures – Lower compensation costs (in the long run – less risk, less turnover) Bus 424 ninth lecture presentation 35 How to decide? (Continued) What if the company wants the managers to respond to an uncontrollable factor? – Should not buffer them completely from the effects – Consider partial adjustment Bus 424 ninth lecture presentation 36 How to decide? (Continued) What if the effect of the uncontrollable factor can only be estimated?
– Subjectivity enters in – Subjectivity introduces another form of risk (evaluation bias) Bus 424 ninth lecture presentation 37 How to decide? (Continued) What if the factor is only partially uncontrollable? – Consider not making adjustments: Performance measures provide some information about manager’s performance. Consideration of adjustments leads to the creation of an “excuse culture”. – Managers are prone to make excuses instead of addressing their problems. Costly in terms of management time involved to investigate the claims and determine appropriate adjustments. Bus 424 ninth lecture presentation 38 How to decide? (Continued) If adjustments are made where they should not be made: – Bad decisions; managers fail to consider relevant factors in their decision making. – Shareholders lose as managers are given undeserved rewards. Bus 424 ninth lecture presentation 39 Summary Consider costs and benefits of making adjustments – Benefits exceed costs if: Factor is clearly uncontrollable and do not want managers to respond (they have no influence) Subjectivity can be avoided (or is tolerated) – In all other cases, use adjustments sparingly Bus 424 ninth lecture presentation 40 ...
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