Chapter – 11Performance Measurement

Management Control Systems

Presented By:Shweta Khamar (31)

Flow of Presentation

• What are performance measurement systems?

• Limitations of financial control systems• The Balanced Scorecard• Implementing a performance measurement

system• Difficulties in implementing PMS• Interactive Control

Performance measurement systems

• Objective – To implement strategy

• “A performance measurement system is a mechanism that improves the likelihood the organization will implement its strategy successfully”

• Strategy defines the critical success factors, if those factors are measured and rewarded, people are motivated to achieve them

Limitations of Financial control systems

• Relying solely on financial measures is inadequate and in fact, be dysfunctional for several reasons

• It encourages short term actions that are not in the company’s long term interest

• Errors of commission – Eg Baush & lomb – credit terms

• Errors of omission – R & D investments

• Manipulation of data – manipulate budget data

• Falsifying data – Baush & lomb – shipped products not asked

Balanced scorecard• It is a performance measurement system

• In creating balanced scorecard, executives must chose a mix of measurement that

1. Accurately reflect the critical success factors

2. Show the relationship among the individual measures in a cause-and-effect manner

3. Provide a broad based view of current status of the company

Other considerationsOutcome & Driver measures

outcome – indicate result of strategy (eg. Increased revenue)

• Lagging indicators - tell what has happened

• Indicate only the final result

Driver measures

• Leading indicators – they show the progress of key areas in implementing a strategy Eg Cycle time

• Indicate incremental changes that ultimately affect “outcomes”

Financial & Non-financial measures• Organizations have developed many sophisticated systems

to measure financial performance

• But industries are being driven by Non-financial measures as well, such as customer satisfaction, quality, innovation

• Non-financial measures eventually affect the financial performance of the organization

• Eg. In 1970s , IBM, US steel, Xerox – dominated the market financially, but attacked by competitors who achieved quality, customer satisfaction

External & Internal measures• Companies too often sacrifice internal development for

external results or ignore external results altogether, mistakenly believing internal measures are sufficient

• Companies must strike the balance between external measure such as customer satisfaction, and measures of internal business process, such as manufacturing productivity

• All the measures are interlinked i.e. nonfinancial measures (product quality) drive financial measures (increased revenue)

Key success factors

Customer focused key variables

• Bookings• Backorders• Market share• Key account orders• Customer satisfaction• Customer retention• Customer loyalty

Key variables related to internal business processes

• Capacity utilization• On-time delivery• Inventory turnover• Quality• Cycle time = process time + storage time +

movement time + inspection time• Just-in-time – ideal ratio =1

Implementing performance measurement system

Steps

• Define strategy (single industry – multiple business –functional levels)

• Define measures of strategy (focus on few critical measures – cause & effect)

• Integrate measures into the management system (integrate with formal/informal culture, structure)

• Review measures and results frequently

Difficulties in implementing PMS

• Poor correlation between nonfinancial measures and results (cause –effect)

• Fixation of financial results• Measures are not updated (as strategies

change)• Measurement overload (losing focus)• Difficulty in establishing trade off (assign

weights)

Interactive control

• The primary role of management control is to help execute chosen strategies

• In industries that are subject to rapid environmental changes, management control information can provide basis for taking new strategies

• The main objective of interactive control is to facilitate the creation of a “learning organization”

• In changing and dynamic environment, creating a learning organization is essential to corporate survival

• Learning organization refers to the ability of organization’s employees to learn to cope with environmental changes

An effective learning organization is one where employees at all levels continuously

• scan the environment• Identify potential problems• Identify potential opportunities• Exchange information candidly & rapidly• Experiment with alternate business

In order to successfully adapt to emerging environment

Critical success factors & strategic uncertainties

• Critical success factors are derived from chosen strategies• They support the implementation of strategies for current

products & markets

• Strategic uncertainties are fundamental environmental shifts that could potentially disrupt the rules by which organization is playing today

• They are the basis for developing new strategies

• They are the questions such as “what has changed?” “why has it changed?”

• Interactive controls are not a separate system but an integral part of the management control system

• Interactive controls alert management to strategic uncertainties, either troubles or opportunities

• They become the basis for manager to adapt to a rapidly changing environment by thinking about new strategies