Module VII

Performance Measurement

Objectives
To understand the Performance Measurement System. To study the limitations of Financial Control Systems. Balance Scorecard as a tool of performance measurement. Implementation of Performance Measurement System. Difficulties in Implementing Performance Measurement System.

Performance Measurement System

The goal of performance measurement system is to implement strategies. A performance measurement system is simply a mechanism that improves the likelihood the organization will implement its strategy successfully. Any performance measurement system blends the financial information and non-financial information with each other. In setting up such systems, the senior management selects measures that best represent the companys strategy and these measures can be seen as current and future critical success factors.

Limitation of Financial Control Systems

The short-term actions taken by managers to earn profits may be wrong in the long term. Business unit managers may not take long term actions in terms of investment, in order to generate short term profits. Using short-term profit as the sole objective can distort communication between unit manager and senior management. If business unit managers are evaluated based on their profit budget, they may try to set profit targets they can easily achieve. Tight financial control may motivate managers to manipulate data. Thus, relying only on financial data is insufficient to ensure that strategy will be executed successfully.

The Balance Scorecard

The BSC was developed to communicate the multiple, linked objectives of the companies must achieve to compete on the basis of its capabilities and innovation. The BSC is a tool for performance measurement systems. The BSC is organized into four perspectives: Financial, Customer, Internal Business Process and Learning and Growth. In each of the above perspective the main components are objectives, measures, targets and initiatives.

BSC View
Financial

Customer

Vision And Mission

Internal Business Process

Learning and Growth

Four Perspectives
1. Financial Perspective: The BSC retains the financial perspective since financial measures are valuable in summarizing the readily economic results of actions taken. Financial performance measures the strategies implemented and targets achieved. Financial objectives are basically related to profitability measures like operating income, return on capital employed, economic value added, profitability ratios etc. The other objectives can be rapid sales growth or generation of cash flow.

Contd.
2. Customer Perspective: - in this perspective, managers identify the customer and market segments in which the unit is competing. - The customer perspective generally include the measures like customer satisfaction, customer retention, customer profitability, new customer acquisition, market share etc. 3. Internal Business Process Perspective: - in this perspective, executives identify the critical internal processes in which the organization must excel. - The internal business process measures are focused on the internal processes that will have greatest impact on customer satisfaction and achieving financial perspectives.

Contd.
the generic value chain of business encompasses three principal business processes. i) Innovation ii) Operation iii) Post-sales services 4. Learning and Growth Perspective: This perspective identifies the infrastructure that the organization must build for the long term growth and improvement. Organizational learning and growth comes from three principle sources: people, systems and organizational procedures.

Implementing a Performance Measurement Systems

Implementation of a performance measurement system involves four general steps: 1. Define Strategy: the BSC builds a link between strategy and operational action. Therefore, it begins with the strategy first, to achieve the goals and objectives. 2. Define Measures of Strategy: the next step is to develop the measures to support the formulated strategy. The organization must focus on a few critical measures and should not overload with the measures. And importantly, the measures should be linked with each other in a cause and effect manner.

Contd.
3. Integrate measures into the management system: - the scorecard must be integrated with the organization's formal and informal structures, culture and human resource practices. 4. Review measures and results frequently: once the scorecard is implemented and running, the senior management should review is constantly. The organization should look for the following: - how is the organization is doing according to the outcome measures? - how is the organization is doing according to the driver measures? - How has the organizations strategy changed since the last review? - How have the scorecard measures changed?

Difficulties in implementation
1. 2. 3. 4. 5. Poor correlation between non-financial measures and results Fixation on financial results Measures are not updated Measures are overloaded Difficulty in establishing trade-offs