ACCA - P5 Study text - Emile Woolf INT - 2010
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Chapter 17: Alternative views of performance measurement
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Perspective The key question
Innovation
and learning
perspective
How can the organisation continue to improve and create value?
The focus here is on the ability of the organisation to maintain its
competitive position, through the skills and knowledge of its
work force and through developing new products and services.
Financial
perspective
How does the organisation create value for its owners? Financial
measures of performance in a balanced scorecard system might
include share price growth, profitability and return on
investment.
Financial performance is likely to be the main perspective that
shareholders will use to assess how well the business has
performed.
1.2 Using the balanced scorecard
The focus is on strategic objectives and the critical success factors necessary for
achieving them. In a balanced scorecard approach, targets are set for a range of
critical financial and non-financial areas covering these four perspectives. The main
performance report for management each month is a balanced scorecard report, not
budgetary control reports and variance reports.
Examples of measures of performance for each of the four perspectives are as
follows:
Perspective Outcome measures
Critical financial
measures
Return on investment
Profitability
Economic value added (EVA)
Revenue growth
Productivity and cost control
Cash flow
Critical customer
measures
Market share
Customer profitability
Attracting new customers
Retaining existing customers
Customer satisfaction
On-time delivery
Critical internal measures
Success rate in winning contract orders
Production cycle time/throughput time
Amount of re-working of defective units
Capacity utilisation of a key resource
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Perspective Outcome measures
Critical innovation and
learning measures
Revenue per employee
Employee productivity
Employee satisfaction
Employee retention
Percentage of total revenue earned from sales of new
products
Time to develop new products
Number of new products developed to market
launch stage
Example: balanced scorecard
Kaplan and Norton described the example of Mobil in the early 1990s, in their book
The Strategy-focussed Organisation. Mobil, a major supplier of petrol, was competing
with other suppliers on the basis of price and the location of petrol stations. Its
strategic focus was on cost reduction and productivity, but its return on capital was
low.
The company’s management re-assessed their strategy, with the aim of increasing
market share and obtaining stronger brand recognition of the Mobil brand name.
They decided that the company needed to attract high-spending customers who
would buy other goods from the petrol station stores, in addition to petrol.
As its high-level financial objective, the company set a target of increasing return on
capital employed from its current level of about 6% to 12% within three years.
From a financial perspective, it identified key success factors as productivity
and sales growth. Targets were set for productivity (reducing operating costs per
gallon of petrol sold) and ‘asset intensity’ (ratio of operational cash flow to assets
employed).
From a customer perspective, Mobil carried out market research into who its
customers were and what factors influenced their buying decisions. Targets
were set for providing petrol to customers in a way that would satisfy the
customer and differentiate Mobil’s products from rival petrol suppliers. Key
issues were found to be having petrol stations that were clean and safe, and
offering a good quality branded product and a trusted brand. Targets were set
for cleanliness and safety, speedy service at petrol stations, helpful customer
service and rewarding customer loyalty.
From an internal perspective, Mobil set targets for improving the delivery of its
products and services to customers, and making sure that customers could
always buy the petrol and other products that they wanted, whenever they
visited a Mobil station.
1.3 Conflicting targets for the four perspectives
A criticism that has been made against the balanced scorecard approach is that the
targets for each of the four perspectives might often conflict with each other. When
this happens, there might be disagreement about what the priorities should be.
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This problem should not be serious, however, if it is remembered that the financial
is the most important of the four perspectives for a commercial business entity.
A useful sporting analogy was provided in an article in Financial Management
magazine (Gering and Mntambo, November 2001). They compared the balanced
scorecard to the judgements of a football team manager during a football match. The
objective is to win the match and the key performance measure is the score.
However, as the match progresses, the manager will look at other important aspects
of performance, such as the number of shots at the goal by each side, the number of
corner kicks, the number of tackles and the percentage of possession of the ball
enjoyed by the team.
Shots on goal corner kicks, tackles and possession of the ball are all necessary factors
in scoring goals, not conceding goals, and winning the match. The manager will
therefore use them as indicators of how well or badly the match is progressing.
However, the score is ultimately the only thing that matters.
In the same way, targets for four perspectives are useful in helping management to
judge progress towards the company’s objectives, but ultimately, success in
achieving those objectives is measured in financial terms. The financial objective is
the most important.
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The performance pyramid
The pyramid structure: linking performance targets throughout an
organisation
Interpreting the pyramid
2 The performance pyramid
Another approach to structuring the performance evaluation system is the
performance pyramid. The concept of a performance pyramid is based on the idea
that an organisation operates at different levels. Each level has different concerns,
but these should support each other in achieving the overall business objectives.
Performance can therefore be seen as a pyramid structure, with a large number of
operational performance targets supporting higher-level targets, leading to targets
for the achievement of overall corporate objectives at the top.
2.1 The pyramid structure: linking performance targets throughout an
organisation
The performance pyramid was developed by Lynch and Cross (1991). They argued
that traditional performance measurement systems were not as effective as they
should be, because they had a narrow financial focus – concentrating on measures
such as return on capital employed, profitability, cash flow and so on. They argued
that in a dynamic business environment, achieving strategic business objectives
depends on good performance with regard to:
Customer satisfaction (a ‘marketing’ objective: here, the focus is on
external/market effectiveness)
Flexibility (the flexibility objective relates to both external effectiveness and
internal efficiency within the organisation)
Productivity (resource utilisation: here, the focus is on internal efficiency, much
of which can be measured by financial performance)
These key ‘driving forces’ can be monitored at the operational level with
performance measures relating to quality, delivery, cycle time and waste.
Lynch and Cross argued that within an organisation, there are different levels of
management and each has its own focus. However, there must be consistency
between performance measurement at each management level, so that performance
measures at the operational level support the corporate strategy.
They presented these ideas in the form of a pyramid of targets and performance that
links operations to corporate strategy.
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A performance pyramid can be presented as follows:
Performance pyramid
2.2 Interpreting the pyramid
The performance pyramid links strategic objectives with operational targets, and
internally-focused with externally-focused objectives.
Objectives and targets are set from the top level (corporate vision) down to the
operational level. Performance is measured from an operational level upwards.
If performance targets are achieved at the operational level, targets should be
achieved at the operating systems level. Achieving targets for operating systems
should help to ensure the achievement of marketing and financial strategy
objectives, which in turn should enable the organisation to achieve its corporate
objectives.
A key level of performance measurement is at the operating systems level –
achieving targets for customer satisfaction, flexibility and productivity. To
achieve performance targets at this level, operational targets must be achieved -
for quality, delivery, cycle time and waste.
With the exception of flexibility, which has both an internal and an external
aspect, performance measures within the pyramid (and below the corporate
vision level) can be divided between:
- market measures, or measures of external effectiveness, and
- financial measures, or measures of internal efficiency.
The measures of performance are inter-related, both at the same level within the
pyramid and vertically, between different levels in the pyramid. For example:
- New product development in a business operating system. When a new
product is introduced to the market, success depends on meeting customer
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needs (customer satisfaction), adapting customer attitudes and production
systems in order to make the changes (flexibility) and delivering the product
to the customer at the lowest cost for the required quality (productivity).
- Achieving improvements in productivity depends on reducing the cycle time
(from order to delivery) or reducing waste.
Lynch and Cross argued that the performance measures that are chosen should link
operations to strategic goals.
All operational departments need to be aware of how they are contributing to
the achievement of strategic goals.
Performance measures should be a combination of financial and non-financial
measures that are of practical value to managers. Reliable information about
performance should be readily available to managers whenever it is needed.
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Performance measurement in service industries
The characteristics of services and service industries
Controllable performance in service industries: Fitzgerald and Moon
Fitzgerald and Moon: Performance measurement in service industries
Applying the Fitzgerald and Moon framework
3 Performance measurement in service industries
3.1 The characteristics of services and service industries
Many organisations provide services rather than products. There are many
examples of service industries: hotels, entertainment, the holiday and travel
industries, professional services, banking, recruitment services, cleaning services,
and so on.
Performance measurement for services may differ from performance measurement
in manufacturing in several ways:
Simultaneity. With a service, providing the service (‘production’) and receiving
the service (‘consumption’ by the customer) happen at the same time. With
production, the product is sold to the customer after it has been manufactured.
Perishability. It is impossible to store a service for future consumption: unlike
manufacturing and retailing, there is no stock or inventory of unused services.
The service must be provided when the customer wants it.
Heterogeneity. A product can be made to a standard specification. With a
service provided by humans, there is variability in the standard of performance.
Each provision of the service is different. For example, even if they perform the
same songs at several concerts, the performance of a rock band at a series of
concerts will be different each time. Similarly, a call centre operator answering
telephone calls from customers will be unable to deal with each call in exactly
the same way.
Intangibility. With a service, there are many intangible elements of service that
the customer is given, and that individual customers might value. For example,
a high quality of service in a restaurant is often intangible, but noticed and
valued by the customer.
Since services differ to some extent from products, should performance setting and
performance measurement be different in service companies, compared with
manufacturing companies?
3.2 Controllable performance in service industries: Fitzgerald and Moon
A starting point for analysing performance measurement in service industries is that
companies in a service industry should be able to link their competitive strategy to
their operations, to make sure that the services that they are providing will enable
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the company to achieve its strategic objectives. Performance management systems
have an important role, because they can:
show how well or how badly the organisation has performed in achieving its
strategic objectives, and
identify where improvements are needed.
Performance management systems have been developed in many organisations
that:
link performance measures to objectives
include external as well as internal measures of performance, and
include non-financial as well as financial performance measures, and also
recognise that a compromise is often necessary between different performance
targets, such as targets for service quality and targets for the cost or the speed of
providing the service.
The performance measures that are used can vary widely between different service
industries, and there is no standard set of performance measurements that apply to
all services.
There have been various suggestions about how to provide a framework for
performance management linked to strategic objectives. A framework can be used
to analyse the strengths or weaknesses of an existing performance management
system, and can be used to suggest improvements in a performance management
system.
A framework for analysing performance management systems in service industries
has been provided by Fitzgerald and Moon.
3.3 Fitzgerald and Moon: performance measurement in service industries
Fitzgerald and Moon (1996) suggested that a performance management system in a
service organisation can be analysed as a combination of three building blocks:
dimensions
standards, and
rewards.
These are shown in the following diagram.
Building blocks for performance measurement systems
(Fitzgerald and Moon 1996)
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Dimensions of performance
Dimensions of performance are the aspects of performance that are measured. A
critical question is: What are the dimensions of performance that should be
measured in order to assess performance?
Research by Fitzgerald and others (1993) and by Fitzgerald and Moon (1996)
concluded that there are six aspects to performance measurement that link
performance to corporate strategy. These are:
profit (financial performance)
competitiveness
quality
resource utilisation
flexibility
innovation.
Some performance measures that might be used for each dimension are set out in
the following table:
Dimension of
performance
Possible measure of performance
Financial
performance
Profitability
Growth in profits
Profit/sales margins
Note: Return on capital employed is possibly not so relevant
in a service industry, where the company employs fairly
small amounts of capital.
Competitiveness
Growth in sales
Retention rate for customers (or percentage of customers
who buy regularly: ‘repeat sales’)
Success rate in converting enquiries into sales
Possibly market share, although this may be difficult to
measure
Service quality
Number of complaints
Whether the rate of complaints is increasing or decreasing
Customer satisfaction, as revealed by customer opinion
surveys
Number of errors discovered
Flexibility
Possibly the mix of different types of work done by
employees
Possibly the speed in responding to customer requests
Resource
utilisation
Efficiency/productivity measures
Utilisation rates: percentage of available time utilised in
‘productive’ activities
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Dimension of
performance
Possible measure of performance
Innovation
Number of new services offered
Percentage of sales income that comes from services
introduced in the last one or two years
Other measures of performance might be appropriate for each dimension,
depending on the nature of the service industry. However, this framework of six
dimensions provides a structure for considering what measures of performance
might be suitable.
The dimensions of performance should also distinguish between:
‘results’ of actions taken in the past, and
‘determinants’ of future performance.
Performance: results of past actions
Some dimensions of performance measure the results of decisions that were taken
in the past, that have now had an effect. Fitzgerald and Moon suggested that results
of past actions are measured by:
financial performance and
competitiveness.
Determinants of future performance
Other dimensions of performance will not have an immediate effect, and do not
measure the effects of decisions taken in the past. Instead they measure progress
towards achieving strategic objectives in the future. The ‘drivers’ or ‘determinants’
of future performance are:
quality
flexibility
resource utilisation
innovation.
These are dimensions of competitive success now and in the future, and so are
appropriate for measuring the performance of current management. Measuring
performance in these dimensions ‘is an attempt to address the short-termism
criticism frequently levelled at financially-focused reports’ (Fitzgerald). This is
because they recognise that by achieving targets now, future performance will
benefit. Improvements in quality, say, might not affect profitability in the current
financial period, but if these quality improvements are valued by customers, this
will affect profits in the future.