1 Purpose of Performance Measurement SystemsFrom the beginning, it is important to understand why measuring an organization’s performance is both necessary and vital. The purpose of measuring performance is not only to know how a business is performing but also to enable it to perform better so that it may effectively serve its customers, employees, owners, and stakeholders. A performance measurement system enables an enterprise to plan, measure, and control its performance according to a pre-defined strategy.
2 The major performance measurement systems in use today are profiled below (in order of global adoption) and include: The Balanced Scorecard Activity-based Costing and Management Economic Value Added (EVA) Quality Management Customer Value Analysis/Customer Relationship Management Performance Prism
3 THE BALANCED SCORECARDThe balanced scorecard (BSC) is the most widely applied performance management system today. The BSC was originally developed as a performance measurement system in 1992 by Dr. Robert Kaplan and Dr. David Norton at the Harvard Business School. Unlike earlier performance measurement systems, the BSC measures performance across a number of different perspectives—a financial perspective, a customer perspective, an internal business process perspective, and an innovation and learning perspective.
4 Example of a Balanced Scorecard% Revenue from New Services Rate of Improvement Index Staff Attitude Survey # of Employee Suggestions Revenue per Employee Hours with Customers on New Work Tender Success Rate Rework Safety Incident Index Project Performance Index Project Closeout Cycle Return on Capital Employed Cash Flow Project Profitability Profit Forecast Reliability Sales Backlog Pricing Index Tier II Customers Customers Ranking Survey Customer Satisfaction Index Market Share Business Segment Tier I Customers Key Accounts Financial Perspective Customer Perspective Internal Business Perspective Innovation and Learning Perspective Source: Kaplan and Norton. Putting the Balanced Scorecard to Work. Harvard Business Review. September-October 1993
5 Learning and Innovation Internal Processes 9 34 % 24 measures 100 %Financial Internal Processes Customer Learning and Growth 22 % 34 % Example of an “Ideal” Balanced Scorecard Perspective # of Metrics Weight Financial 5 22 % Customer Learning and Innovation Internal Processes 9 34 % 24 measures 100 % Source: Norton, David Beware: The Unbalanced Scorecard The brief article explained the need for balancing the number of measures in all four perspectives, with greater emphasis on process measures, because the process perspective is the primary domain through which organizational strategy is implemented.
6 In fact, the benefits a firm can obtain from properly implementing the BSC includeTranslating strategy into more easily understood operational metrics and goals; Aligning organizations around a single, coherent strategy; Making strategy everyone’s everyday job, from CEO to the entry-level employee; Making strategic improvement a continual process; and Mobilizing change through strong, effective leadership. A “Strategy Map” enables organizations to clarify their strategy and assist organizations with creating their BSC framework and measures.
7 Example of a “Generic” Strategy MapBroaden Revenue Mix Improve Returns Improve Financial Increase Customer confidence in our advice Increase Customer Satisfaction Through Superior Execution Customer Internal Process Understand Segments Cross-Sell Products Develop New Products Minimize Problems Provide Rapid Response Governance Increase Employee Productivity Develop Strategic Skills Provide Access To Strategic Info Align Personal Goals Learning and Growth (Employees) Operating Efficiency
8 ACTIVITY-BASED MANAGEMENT (ABM)Traditional cost accounting permeates most organizations and is characterized by arbitrary allocations of overhead costs to items being produced. Typically, the company’s total overhead is allocated to goods produced based on volume-based measures (labor hours, machine hours, etc.). The underlying assumption is that there is a relationship between overhead and the volume-based measure.
9 Advantages of Activity-Based Costing (ABC)Provide better insight into how overhead costs should be allocated to individual products or customers. Through the use of ABC, expenses are allocated from resources to activities and then to products, services, and customers; Get insights into profitable and profitless activities based on a customer or a product viewpoint; Focuses on the management of activities to maximize the profit from each activity and to improve the value received by the customer.
10 The figure below provides a window into the value of ABC vsThe figure below provides a window into the value of ABC vs. traditional accounting. Comparison of Traditional and ABC Accounting Traditional View ABC View Salaries $375,000 Select Suppliers $82,000 Benefits $92,000 Procure Materials $175,000 Supplies $47,000 Certify Vendors Phone $8,500 Resolve Problems $103,500 Travel $13,000 Expedite Shortage $83,000 Total $535,500
11 Firms that implement an ABC methodology are able toIdentify the most and least profitable customers, products, and channels; Determine the true contributors to (and detractors from) financial performance; More accurately predict costs, profits, and resource requirements associated with changes in production volumes, organizational structure, and resource costs; More easily identify the root causes of poor financial performance; Better track costs of activities and work processes; and Provide front-line managers with cost intelligence to drive improvements.
12 The ABC system is mainly an accounting and cost-based method of viewing and analyzing an organization and its activities. Succesful firms use ABC in combinatioin with the Balanced Scorecard to drive the achievement of a firm’s strategy and competitive advantage.
13 ECONOMIC VALUE ADDED (EVA) Stern Stewart Corporation developed in 1982 the Economic Value Added (or, more simply EVA) as an overall measure of organizational performance. EVA is both a specific performance measure and the basis for a larger performance measurement framework. The definition of EVA is net operating profit less an appropriate charge for the opportunity cost of all capital invested in an enterprise. Mathematically it is EVA = Net Operating Profit After Taxes - ( Capital x Cost of Capital )
14 EVA is designed to give managers better information and motivation to make decisions that will create the greatest shareholder wealth. Since EVA is a single metric (although it can cascade down and across an enterprise to evaluate the performance of specific investments) it is complementary to the BSC and can be included in a BSC framework (for example, as a financial perspective measure).
15 Consider a simplified calculation of EVA for an organization called “Firm A.” Suppose Firm A generated net profit after taxes of yuan (CNY)100 in 2006, and suppose that Firm A had capital (plant, equipment, cash, etc.) of CNY100,000, if one determines the prevailing cost of capital (both debt and equity) average 10% during 2006 in the areas where Firm A raises capital, we can calculate its “cost of capital” as being equal to 10% x CNY100,000 = CNY10,000. The Firm’s EVA would then equal – CNY 9,900.00 EVA = (Net Operating Profit After Taxes ) – ( Capital X Cost of Capital) = CNY100 – (CNY100,000 * 10%) = CNY100 – CNY10,000 = CNY9,900 In other words, the firm lost value for its shareholders because the firm’s capital was not effectively invested and used.
16 Example of a Framework for EVA Impact AnalysisSource: Demystifying EVA and EVA Implementation. Finegan and Company, LLC. Presentation at Icelandic Management Association. EVA Conference, November 16, 1999. Raw Materials Labor Other Plant and Equipment Property Inventory Receivables Payables Good Will Intangibles Capital Employed Revenue Tax Operating Expenses Cost of Capital Capital Charge NOPAT EVA Legend: High Impact Medium Impact Low Impact Price Volume Cost of Goods Sold SG&A Cost of Debt Cost of Equity Fixed Capital Working Capital
17 QUALITY MANAGEMENT Over the past few decades, many firms have adopted various quality programs, such as Total Quality Management (TQM), Six Sigma, European Foundation Quality Management (EFQM), and The Baldridge National Quality Program. Such Quality Programs aim to assist organizations to improve the quality of the manufacturing and service offerings. A central tenet for all of these programs is business performance measurement. For example, The Baldrige National Quality Program measures businesses in seven categories and the EFQM in nine.
18 Baldrige Categories EFQM CriteriaFramework Comparison of Baldridge and EFQM Criteria Baldrige Categories EFQM Criteria Leadership Human Resource Focus People Strategic Planning Policy and Strategy Process Management Processes Customer and Market Focus Customer Results Information and Analytics Key Performance Indicators Business Results People Results, Society Results Partnerships and Resources
19 CUSTOMER VALUE ANALYSIS AND CRMCustomer Value Analysis (CVA) and Customer Relationship Management (CRM) techniques are enabling businesses to improve performance, to measure that improvement, and to focus a firm on the value of its customers. Moreover, CVA and CRM technologies are providing firms with better data integration and, hence, better measurement regarding customers.
20 Several CVA/CRM frameworks have evolved over the yearsSeveral CVA/CRM frameworks have evolved over the years. One illustrative framework decomposes the customer problem down to three top-level areas: Value equity refers to the customers’ perceptions of value Brand equity refers to the customers’ subjective appraisal of the brand Retention equity refers to the firm building relationships with customers and encouraging repeat-purchasing These three areas correspond to three distinct disciplines in the CVA/CRM and marketing literature (brand management, customer value analysis, and customer loyalty analysis)—each with its own detailed measurement approaches. The implications for organizational performance measurement systems are clear: measuring business activities and outcomes regarding customers is becoming increasingly complex and increasingly important to the successful execution of a firm’s strategy.
21 PERFORMANCE PRISM Many alternative and “customized” frameworks continue to be developed based on the breakthrough BSC framework developed by Kaplan and Norton in The “Performance Prism” is an example of one such “customized” BSC framework. The “Performance Prism” is an example of a “customized” balanced scorecard framework
22 In the “Performance Prism,” companies view their organizations from five perspectives, rather than the four traditional perspectives of the BSC. These five perspectives are Stakeholder Satisfaction – Who are the key stakeholders and What do they want and need? Strategies – What strategies do we have to put in place to satisfy the wants and needs of these key stakeholders? Processes – What critical processes do we require if we are to execute these strategies? Capabilities – What capabilities do we need to operate and enhance these processes? Stakeholder Contribution – What contributions do we require from our stakeholders if we are to maintain and develop these capabilities?
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