Performance evaluation Developing Next Generation Leaders through Applied Know-How Introduction to Business Performance evaluation Metka Tekavčič, PhD Developing Next Generation Leaders through Applied Know-How project number: 2015-1-MK01-KA202-002851

Introduction Performance measurement systems (PMS) are an essential part of planning and control process. Sometimes they are called management control systems (MCS). Important: with PMS/MCS we broaden our discussion of performance measurement beyond the financial performance measures that you‘ve already covered in previous lectures. We will present PMS that include non-financial performance measures, e.g. measures of customer satisfaction and on-time delivery. Developing Next Generation Leaders through Applied Know-How project number: 2015-1-MK01-KA202-002851

Defining SPMS Strategic performance measurement system (SPMS) is a system that translates strategy into an integrated set of financial and non-financial measures across a range of performance perspectives (e.g. learning and growth, internal processes, customer, and financial). Example of SPMS: Balanced Scorecard (BSC) Developing Next Generation Leaders through Applied Know-How project number: 2015-1-MK01-KA202-002851

Problems with traditional financial performance measures in isolation Focus on profit and its components (revenues and costs); Limitations: 1. Financial performance measures emphasise only one perspective of performance: Strategy  we need to manage the determinants of future financial performance to achieve long-term goals; Managers need PMS with more perspectives, e.g. quality, delivery. 2. Financial performance measures focus on the consequence, not the causes: They describe what has happened, not why it has happened; Too aggregated, not timely. Developing Next Generation Leaders through Applied Know-How project number: 2015-1-MK01-KA202-002851

Problems with traditional financial performance measures in isolation 3. Financial performance measures provide limited guidance for future actions (focused on the past): They report on the financial outcomes of past decisions and actions. 4. Financial performance measures may encourage actions that decrease both shareholder and customer value: They encourage managers to achieve short-term fin. performance at the expense of long-term performance. Developing Next Generation Leaders through Applied Know-How project number: 2015-1-MK01-KA202-002851

Example Managers can improve short-term performance by reducing expenditures on: new product development, quality initiatives, HR development (including training), information systems, and customer and market developments. Spending cuts  immediate increase in profits BUT: they can seriously erode future profits and growth potential, and thus decrease shareholder value (in the long-run) WHY? Developing Next Generation Leaders through Applied Know-How project number: 2015-1-MK01-KA202-002851

Advantages of non-financial measures NOTE: They are used in combination with financial measures, not instead of them! They emphasise strategy: if a company‘s strategy is based on providing superior customer service, it makes sense to measure ... They are drivers of future financial performance: … They are more timely: … They are more understandable and easier to relate to, particularly at the operational level. Developing Next Generation Leaders through Applied Know-How project number: 2015-1-MK01-KA202-002851

Limitations of non-financial measures There is a wide choice of non-financial measures available. E.g. how can we measure quality? Difficult to compare. They may lack integrity: Data may be gathered in a variety of ways (manually, computerised, by an external party). Accuracy of the data? Developing Next Generation Leaders through Applied Know-How project number: 2015-1-MK01-KA202-002851

Balanced Scorecard (BSC) Developing Next Generation Leaders through Applied Know-How project number: 2015-1-MK01-KA202-002851

Example Objective Measure Target Initiative To increase production No. of units produced per shift Produce 15 units per shift … To improve quality No. of rejects No more than 10 rejects per day To deliver on time % of sales delivered on time 90% of sales delivered on time To meet the budgeted expenses % of deviation from budget Do not exceed budgeted expenses by more than 5% during year Langfield-Smith, Thorne, Smith, Hilton (2015) Developing Next Generation Leaders through Applied Know-How project number: 2015-1-MK01-KA202-002851

Strategy map - example Langfield-Smith, Thorne, Smith, Hilton (2015)

Lag and lead indicators (measures) Lag indicators = key performance indicators (KPIs); outcome measures Help managers monitor progress towards objectives; Disadvantage: provide limited information to help managers to directly manage performance. Lead indicators = key performance drivers (KPDs); drivers of measures Provide information that is actionable; Relate to organisational processes and activities; Improvements in lead indicators should flow through to improvements in lag indicators over time; Cost drivers are lead indicators of costs (a lag indicator). Developing Next Generation Leaders through Applied Know-How project number: 2015-1-MK01-KA202-002851

Lag and lead indicators (measures) Some of the measures that are lag indicators of one perspective may be lead indicators of another perspective Example: Customer perspective – objective: Expand the customer base Outcome measure (lag): market share Financial perspective – objective: Increase profitability Outcome measure (lag): ROA Lead indicator: market share Developing Next Generation Leaders through Applied Know-How project number: 2015-1-MK01-KA202-002851

Lag and lead indicators (example) Perspective Lag/KPI Lead/KPD Financial ROA Costs Customer Customer satisfaction measure No. of customer complaints Internal business processes % of good units completed % of product defects Learning and growth Employee satisfaction measure Improvements in working conditions Langfield-Smith, Thorne, Smith, Hilton (2015) Developing Next Generation Leaders through Applied Know-How project number: 2015-1-MK01-KA202-002851

BSC: reinforces the learning by providing the possibility to test cause-and-effect relationships. Langfield-Smith, Thorne, Smith, Hilton (2015)

Setting a target and measuring performance – be SMART S: STATE EXACTLY WHAT YOU WANT TO ACCOMPLISH M: ABLE TO DEMONSTRATE AND EVALUATE THE EXTENT TO WHICH GOALS HAVE BEEN MET A: ACHIEVABLE WITH THE AVAILABLE RESOURCES Developing Next Generation Leaders through Applied Know-How project number: 2015-1-MK01-KA202-002851

Setting a target and measuring performance – be SMART R: RESULTS-ORIENTED, STRATEGY-ORIENTED T: TARGET DATE FOR COMPLETION, MILESTONES FOR IMPORTANT ACTION STEPS Developing Next Generation Leaders through Applied Know-How project number: 2015-1-MK01-KA202-002851

PMS and strategy MCS should be closely aligned to the firm’s strategies and goals. This is why they are called strategic performance measurement systems (SPMS). There has to be a clear link between a company’s strategy and its performance measures. What gets measured gets done and… What gets measured becomes important! But: If We Measure the Wrong Things The Wrong Things Will be Done! Developing Next Generation Leaders through Applied Know-How project number: 2015-1-MK01-KA202-002851

Strategy (Miles & Snow, 1978)

What happens to PMS when strategy changes? Developing Next Generation Leaders through Applied Know-How project number: 2015-1-MK01-KA202-002851

Exercise 1 Classify each of the following statements as true or false. In each case give reasons for your answer. Non-financial performance measures provide essential information in order to assist managers at the operational level to take actions to correct problems. Financial measures assist managers to manage the drivers of future financial performance. Non-financial measures provide an indication of how well the organisation has performed across a range of strategically important areas. Developing Next Generation Leaders through Applied Know-How project number: 2015-1-MK01-KA202-002851

Exercise 2 True or false: Both financial and non-financial measures can assist in communicating strategy of the business and in encouraging goal congruence. Jones & George, McGraw-Hill, 2008 Developing Next Generation Leaders through Applied Know-How project number: 2015-1-MK01-KA202-002851