ACCA - P5 Study text - Emile Woolf INT - 2010
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Chapter 13: Measuring performance
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3.8 Qualitative performance
Qualitative performance is performance that is not measured and expressed in
quantitative terms. Qualitative performance targets may be expressed in general
terms, such as:
being the ‘best’ or ‘better than competitors’
‘meeting customer needs’
‘high quality’.
Where possible, performance targets should be quantified. A quantified target
provides a specific objective for achievement, and actual performance can be
measured against it. With qualitative targets, assessing performance may be a
matter of judgement and subjective opinion.
In many cases, it is possible to convert qualitative targets into quantitative targets.
For example, an objective of achieving high quality can be expressed in quantitative
quality targets. Similarly, ‘being better than the competition’ can be converted into
quantitative targets, by identifying the ways in which the company wants to ‘beat’
the opposition. Even ‘meeting customer needs’ can be quantified, by identifying
what customer needs are, or by measuring customer views in an attitude survey.
In some cases, however, it may be difficult to quantify critical performance targets.
In particular, it may be difficult to set quantitative targets for:
brand recognition, or
reputation.
These can, however, be critical success factors.
The commercial success of many companies is reinforced by a strong brand that
the company reinforces through advertising and maintains through quality.
The commercial success of a company may be put at risk by a ‘bad’ reputation.
For example, a well-known footwear company suffered a decline in sales some
years ago following media reports that its suppliers used child labour. Some oil
companies promote an image of being environmentally-conscious, perhaps in
the expectation that it will obtain longer-term benefits from a socially and
environmentally-friendly image.
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Performance measurement in not-for-profit organisations
The special characteristics of not-for-profit organisations
Identifying performance targets for not-for-profit organisations
Value for money (VFM)
Problems with performance measurement in not-for-profit entities
4 Performance measurement in not-for-profit
organisations
4.1 The special characteristics of not-for-profit organisations
Not-for-profit organisations, such as government departments and charitable
organisations, differ from commercial businesses because their main objective is not
financial. The main objective of any such organisation depends on the purpose for
which it exists: to administer the country (government departments), to provide
education (schools and universities), provide medical care (hospitals), do charitable
work, and so on.
A not-for-profit organisation will nevertheless have some financial objectives:
State-owned organisations must operate within their spending budget.
Charitable organisations may have an objective of keeping running costs within
a certain limit, and of raising as much funding as possible for their charity work.
Because of this difference, a different approach is needed to setting performance
targets and measuring performance in a not-for-profit organisation.
4.2 Identifying performance targets for not-for-profit organisations
You may be required in your examination to suggest quantitative targets for a not-
for-profit organisation. The selection of appropriate targets will vary according to
the nature and purpose of the organisation. The broad principle, however, is that
any not-for-profit organisation should have:
strategic targets, mainly non-financial in nature
operational targets, which may be either financial (often related to costs and
keeping costs under control) or non-financial (related to the nature of
operations)
A useful approach to setting performance targets and performance measures in a
not-for-profit entity is to group performance indicators into three groups:
financial measurements, which indicate the efficiency in using available
financial resources and economy in spending
non-financial measurements, which indicate whether the entity has achieved its
strategic objectives (measurements of effectiveness)
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qualitative indicators, which also indicate effectiveness in achieving objectives,
but which cannot be measured in quantifiable terms.
Example
The performance targets and performance measurements for a hospital might
include the following items:
Financial
measures
Budgeted annual expenditure. Comparison of actual spending
with the budget.
(efficiency,
economy)
Costs per selected units of activity, such as average costs per
treatment, average costs per operation, average annual cost per
hospital bed.
Benchmarking costs against costs in other hospitals.
Major items of cost as a percentage of total costs: for example,
administration and management costs as a percentage of total
running costs.
Non-financial
measures
Units of service delivered, such as the number of patients
treated each year, and the number of operations performed.
(effectiveness)
The speed of delivery of services, such as the speed of an
ambulance service, average waiting time for treatment, average
time between start and completion of treatment.
Quality of service, measured in terms of successful treatments,
number of serious errors in treatment.
Utilisation of resources, such as ‘bed occupancy rates’
(percentage of beds occupied on average by patients each day).
Qualitative
Public confidence and satisfaction with the services provided.
Morale of the work force.
Standards of cleanliness in the hospital.
Example
Similarly, the performance measurements for a school might be as follows:
Financial
measures
Budgeted annual expenditure. Comparison of actual spending
with the budget.
(efficiency,
economy)
Costs per selected units of activity, such as average costs per
student per year.
Benchmarking costs against costs in other schools.
Major items of cost as a percentage of total costs: for example,
cost of spending on books or IT systems as a percentage of total
running costs.
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Non-financial
measures
Examination results (compared with a government target or
benchmarked against other schools).
(effectiveness)
Number of students going on to university.
Annual intake of new students.
Utilisation of resources, such as the ratio of teachers to students.
Qualitative
Reputation of the school.
Behaviour of students.
4.3 Value for money (VFM)
The performance of not-for-profit organisations may be assessed on the basis of
value for money or VFM. Value for money is often referred to as the ‘3Es’:
economy
efficiency
effectiveness.
Economy
Economy means keeping spending within limits, and avoiding wasteful spending. It
also means achieving the same purpose at a lower expense. A simple example of
economy is found in the purchase of supplies. Suppose that an administrative
department buys items of stationery from a supplier, and pays $2 each for pens. It
might be possible to buy pens of the same quality to fulfil exactly the same purpose
for $1.50 each. Economy would be achieved by switching to buying the $1.50 pens,
saving $0.50 per pen with no loss of operating efficiency or effectiveness.
Efficiency
Efficiency means getting more output from available resources. Applied to
employees, efficiency is often called ‘productivity’. Suppose that a sales order clerk
processes 50 customer orders each day. Efficiency would be improved if a sales
order clerk increases the rate of output, and processes 60 orders each day, without
any loss of effectiveness.
Effectiveness
Effectiveness refers to success in achieving end results or success in achieving
objectives. Whereas efficiency is concerned with getting more outputs from
available resources, effectiveness is concerned with achieving outputs that meet the
required aims and objectives. For example, the efficiency of sales representatives
will be improved if they increase their calls to customers from eight to ten each day,
but their effectiveness will not be increased if they do not achieve any more sales
from the extra calls.
Management accounting systems and reporting systems may provide information
to management about value for money. Has VFM been achieved, and if so, how
much and in what ways?
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Value for money audits may be carried out to establish how much value is being
achieved within a particular department and whether there have been
improvements to value for money. Internal audit departments may carry out
occasional VFM audits, and report to senior management and the manager of the
department they have audited.
VFM budgeting can be particularly useful in not-for-profit organisations, whose
purpose is to achieve a stated objective as closely as possible, with the resources
available.
Example
State-owned schools may be given a target that their pupils (of a specified age) must
achieve a certain level of examination grades or ‘passes’ in a particular examination.
A VFM audit could be used to establish spending efficiency within a school.
Economy. Was there any unnecessary spending? Could the same value have
been obtained for lower spending?
Efficiency. Have the school’s resources been used efficiently? Could more
output have been obtained from the available resources? Could the same results
have been achieved with fewer resources? A study of efficiency might focus on
matters such as teaching time per teacher per week, and the utilisation of
resources such as science equipment and computer-based training materials.
Effectiveness. The most obvious measurements of effectiveness are the number
or percentage of pupils achieving the required examination ‘passes’, or the
grades of pass mark that they have achieved. Effectiveness is improved by
increasing the pass rate.
4.4 Problems with performance measurement in not-for profit entities
There are several problems commonly found with performance measurement in
not-for-profit entities, particularly in entities that are controlled by the government.
The entity might have several different strategic targets, which may sometimes
conflict with each other. For example, the strategic targets for a state-owned school
might be to:
raise the general standard of education, as measured by pass rates in
examinations
provide a broad education
raise the standards of the most able students.
These targets conflict because it may be impossible to focus on examination results
and also provide a broad education. Similarly, it might not be possible to raise
education standards for all students but at the same time try to develop the most
gifted students.
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Multiple strategic targets might not be achievable within the limits of the available
resources and expenditure budgets. For example, the strategic targets of a police
force might be to:
prevent crime and
increase the detection rate for crimes that have been committed.
Given the limited resources available, a police force might be unable to prevent
crime and also increase detection rates.
There are other problems with assessing performance of not-for-profit entities.
There might be political interference that prevents strategic targets from being
achieved. For example, the government might decide to change the strategic
targets for the hospitals service, or introduce additional targets.
It might be difficult to measure the output of a not-for-profit entity. For example,
how might the output of a fire service be measured?
The service may be organised on a regional basis. For example, there may be a
regional fire service, a regional police force or a regional schools network. It is
usual in these circumstances to compare the performance of each region or area.
This is often unfair, since conditions and circumstances very widely between
different areas of the country. (An extreme example in the UK in 2006 was the
criticism by a government audit agency of the police force on Lundy Island: the
agency criticised the police for failing to improve its road accident statistics,
whereas many other police forces had succeeded in reducing road accidents in
their area. There had not been any road accidents on Lundy Island since the car
was invented, which made the criticism somewhat unfair!)
There may be a tendency to measure performance by the amount of resources
and money put into the entity, rather than measuring performance on the basis
of outputs achieved. For example, it might be tempting to judge the health
service on the basis of extra staff employed or extra money spent on hospitals,
equipment and medicines.
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Behavioural aspects of performance reporting: reward systems
Unintended consequences of performance measurement systems
Performance rewards
Designing reward schemes: factors to consider
Behavioural problems with reward systems
5 Behavioural aspects of performance reporting:
reward systems
5.1 Unintended consequences of performance measurement systems
An aim of performance reporting systems should be to improve performance. In
order to achieve this objective, it is often necessary to consider the behavioural
implications of performance reports.
Performance reports should be used in the way intended. In practice, however,
there may be unintended consequences, particularly when managers receive
rewards for good performance.
Performance measurement systems can suffer from several problems that reduce
their effectiveness. Berry, Broadbent and Otley (1996) suggested that the use of
performance measures may cause the following problems.
Tunnel vision. Tunnel vision means focusing on performance measurement to
the exclusion of other aspects of management.
Sub-optimisation. Sub-optimisation occurs when managers focus on achieving
good performance in one area, but in doing so overlook other aspects of
performance. As a result, overall performance is not as good as it should be. For
example, management may be given performance targets for the sales of new
products: they may focus on sales growth for new products, and in doing so
overlook the need to maintain sales of established products. As a result total
sales and profits might fall.
Myopia. Myopia is short-sightedness. In the context of performance
measurement, it means concentrating on short-term performance measures to
the exclusion of longer-term considerations.
Measure fixation. Measure fixation means taking action to ensure that specific
performance targets are reached without considering the possible consequences.
For example, a department might have a target for labour costs as a maximum
proportion of its total operating costs. In order to meet this target, management
might recruit and employ inexperienced and untrained staff who are paid less
money than experienced employees. The labour cost target might be met, but the
quality of work might deteriorate.
Misrepresentation. Misrepresentation describes the tendency to give a false but
flattering picture of performance, by disguising actual results. For example, a
sales manager might represent the sales performance for a period in a flattering
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light – with some growth in sales volume. However, this could be misleading:
sales volume growth might have been achieved only as a result of heavy price
discounting and a big reduction in gross profit margins.
Misinterpretation. Misinterpretation occurs when performance measures are
interpreted in an incorrect or over-simplified way. Management might read
something good or something bad in a set of performance figures, when the
actual situation is more complex and the results are not so easy to interpret.
Gaming. Gaming occurs when there is a deliberate distortion of a performance
measure or a performance target, in order to make actual results subsequently
appear much better than they really are. For example, a departmental manager
might argue that productivity in the department has been poor, so that a low
performance target is set for productivity in the department. If the target is set at
a low level, it is relatively easy to achieve, and the department’s performance
will therefore appear better than it really is.
Ossification. Performance measurement systems should be flexible, and new
performance measures should be introduced as appropriate to replace measures
that are no longer appropriate. Ossification refers to an unwillingness that may
exist to change any parts of the measurement system, after it has been
introduced.
Lack of consistency. Within an organisation, the performance targets set for
individuals or groups may be inconsistent with each other. For example, a
production manager may be given performance targets relating to keeping costs
under control, and a quality control manager may have performance targets for
ensuring the quality of completed output. The targets of the production manager
and the quality control manager may be inconsistent, if lower costs are
achievable by reducing quality.
These problems need to be recognised and understood. It may be difficult to
eliminate the problems entirely, but some measures may help to cure the worst of
the difficulties.
Staff at all levels should be involved developing and implementing the
performance measurement scheme. This may make them more willing to accept
the performance measures and work towards the achievement of their targets.
Involvement may reduce the problems of tunnel vision and myopia.
Performance measures should be used with flexibility, and should not be relied
on exclusively for control. Management should accept that sometimes measured
performance is not an accurate portrayal of the true position. For example, short-
term profitability may be reduced in order to invest in the longer term. A fall in
short term profits should not be regarded as ‘failure’ in these circumstances.
Taking a flexible approach to performance measures may reduce the problems
of fixation and misrepresentation.
Management should continually review the performance measurement system
and the appropriateness of the performance targets and performance
measurements that are used. This may help to reduce the problems of
ossification and gaming.
Management should also regularly audit the reliability and accuracy of the data
that is used to measure performance. Performance reporting is only as good as
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the data on which it is based. This should help to reduce the effects of measure
fixation and misinterpretation.
5.2 Performance rewards
Many organisations have systems for linking the achievement of performance
targets with rewards for the successful individual. Rewards may take the form of
higher pay (for example, a cash bonus or a higher salary) or promotion. Individuals
may also feel rewarded by a sense of personal achievement (and possibly also by a
formal recognition of their achievement by senior management). In some cases,
there may be systems of ‘punishment’ for poor performance, such as withholding a
bonus or even dismissal.
Advantages of reward systems
There are several advantages in having a system of rewards linked to performance:
A well-designed reward scheme should link rewards to performance that
supports strategic objectives. This should help the organisation to implement its
strategies and achieve its strategic objectives.
Rewards can motivate individuals to achieve their performance targets. They
can also help to attract and retain talented individuals.
The payment of rewards for achieving key targets helps to inform managers and
employees about what the critical aspects of performance are.
An effective reward system will encourage employees to focus on continuous
improvement.
Where rewards involve granting shares or share options in the company,
employees who benefit from the rewards may be encouraged to think more
about the long-term prospects of their company and its market value.
Reward schemes might help to attract talented employees, and make them want
to work for the entity.
5.3 Designing reward schemes: factors to consider
There are several factors to consider and questions to answer when designing a
reward scheme.
Should the rewards for performance be based on results (outputs) or on the
effort that has been put in? A reward scheme for salesmen, for example, can be
based fairly simply on results achieved (volume of sales). It is often much more
difficult however to reward administrative staff for results achieved, because the
results of their efforts might not be easily quantifiable, or measured against clear
targets.
Should rewards be given in a money form (a bonus or higher salary) or in non-
monetary form (such as share options)?
Should rewards be explicit or implicit? Explicit rewards are rewards that will
definitely be given for meeting performance targets, such as a cash bonus.
Implicit rewards are not specific promises, but there is a general understanding
that the rewards will be available for good performance. For example, there is
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often an expectation of promotion or a higher salary for good performance, but
these are not explicit promises, only an implicit understanding.
How large should rewards be?
Over what time period should performance be measured before rewards are
given?
Should rewards be given for individual performance, or should there be group
rewards for team performance?
Should the rewards involve equity participation – giving shares or share options
to individuals?
What are the tax implications of different reward schemes? Can a reward
scheme be devised that limits the tax liabilities of the employees receiving the
rewards, without breaching the tax laws?
5.4 Behavioural problems with reward systems
When individuals are rewarded for performance, some potential behavioural
problems might occur.
It is often difficult to measure the performance of individuals, and the performance
of groups or teams must be measured instead. When group performance is
measured, there may be a problem in the following situations:
Some members of the group or team believe that they have been responsible for
the successful performance of the group, whereas other team members have not
contributed as much as they should have done. These individuals may be
angered if rewards are paid to all members of the team, including the
undeserving members.
The reward system provides rewards to some members of a group, but not to
others: for example, a departmental manager may be rewarded, but none of the
departmental staff.
When performance is rewarded, the individuals affected will be inclined to focus on
the measures of performance that set the level of their reward – to the exclusion of
all other aspects of performance. This can have unintended consequences.