1. 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: MK01-KA

2. 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: MK01-KA

3. 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: MK01-KA

4. 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: MK01-KA

5. 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: MK01-KA

6. 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: MK01-KA

7. 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: MK01-KA

8. 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: MK01-KA

9. Balanced Scorecard (BSC)
Developing Next Generation Leaders through Applied Know-How project number: MK01-KA

10. 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: MK01-KA

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

12. 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: MK01-KA

13. 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: MK01-KA

14. 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: MK01-KA

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

16. 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: MK01-KA

17. 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: MK01-KA

18. 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: MK01-KA

19. Strategy (Miles & Snow, 1978)

20. What happens to PMS when strategy changes?
Developing Next Generation Leaders through Applied Know-How project number: MK01-KA

21. 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: MK01-KA

22. 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: MK01-KA