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Blending of Financial & Non-financial information
• Performance Measurement System(PMS) • The goal of PMS is strategy implementation • Presentation of critical success factor measures for current and future • Success depends on the soundness of the strategy designed for implementation • Strategy defines the critical success factors; if those factors are measured and rewarded, people are motivated to achieve them.
gets done What gets done.Framework for Designing PMS What counts. really counts Strategy Strategy What gets measured. gets measured What gets rewarded. gets rewarded 9/25/2013 3 .
• Relying solely on financial measures is inadequate and can. there is a need for ongoing feedback and management control in companies to measure and evaluate business unit performance at least once in a year. 9/25/2013 4 . in fact.Limitations of Financial Control Systems • Optimizing short term profitability does not necessarily ensure optimum shareholder returns since shareholder value represents the NPV of expected future earnings. • At the same time. by dysfunctional for several reasons.
Limitations of Financial Control Systems • First. • Companies use financial measures at higher organizational levels for management control and non-financial measures at lower levels in the organization for task control. • Fourth. relying on financial measures alone is insufficient to ensure strategy will be executed successfully. tight financial control may motivate managers to manipulate data. • Third. • Second. business unit managers may not undertake useful longterm actions to obtain short-term profits. 9/25/2013 5 . using short-term profit as the sole objective can distort communication between a business unit manager and senior management. • In sum. relying solely on Financial Control Systems may encourage short-term actions that are not in the company’s long term interests.
such as the tachometer at 6000 RPM (or an on-time-delivery %age of 70).000 miles (or a report that shareholder equity is currently $1 billion). in this case miles per gallon. Other measures tell the driver (or the manager) what is happening. All these measures have implicit interactions. A PMS – like a dashboard.the odometer that registers the passage of 40.General Considerations • • • • • • Comparing PMS and instrument panel on Dashboard provides insights about the mix of financial and nonfinancila measures needed in a MCS Single measure cannot control a complex system. Some of these measures tell the driver (or the manager) what has happened. that may or may not improve the other measure. and too many critical measures make the system uncontrollably complex. 9/25/2013 6 . let us say RPM. for instance. Just as the driver does the trade off between various controls he has. Usually there are multiple ways to change one measure. and changes in one often reflect changes in another: reducing RPMs will increase miles per gallon (or improving ontime-delivery will increase customer satisfaction). a manager too can choose between behaviour that benefits the short or long term success of the organization.has a series of measures that provide information about the operation of many different processes.
• It gives explicit recognition to the diversity of organizational goals.The Balanced Scorecard • Balanced Scorecard to recognize both financial and nonfinancial measures of performance • A balanced scorecard is a performance measurement and reporting system that strikes a balance between financial and operating measures • It links performance to rewards. 9/25/2013 7 .
Innovation and Learning (e... employee retention.g. Financial (e. Percentage of sales from new products) 9/25/2013 8 . Customer (e. The scorecard measures an organization’s performance from four key perspectives: – – – – 1.g. Internal Business (e.g.g. 2... return on assets. profit margins. customer satisfaction index) 3. cash flow).The Balanced Scorecard • • • What are key performance indicators? They are measures that drive the organizations to achieve their goals. cycle time reduction) 4. market share.
and provides feedback on strategy. executives must choose a mix of measurements that :– (1) accurately reflect the critical factors that will determine the success of the co’s strategy – (2) show the relationships among the individual measures in a cause-and-effect manner. 9/25/2013 9 . improves communication. It is a tool that helps the company’s focus. indicating how nonfinancial measures affect long-term financial results. sets organizational objectives. thus encouraging employees to act in the organization’s best interest.The Balanced Scorecard • • • • Balanced Scorecard fosters a balance among different strategic measures in an effort to achieve goal congruence. and – (3) provide a broad based view of the current status of the company. Every measure on Balanced Scorecard addresses an aspect of a co’s strategy. In creating the balanced scorecard.
9/25/2013 10 . and internal and external measures.• PMS: Additional Considerations PMS attempts to address the needs of the different stakeholders of the organization by creating a blend of strategic measures: outcome and driver measures. financial and nonfinancial measures.
Whereas outcome measures indicate only the final result. they tell management what has happened. Cycle time is an example of a driver. driver measures can be used at a lower level and indicate incremental changes that will ultimately affect the outcome. By contrast. These measures are typically are “lagging indicators”. they show the progress of key areas in implementing a strategy. 9/25/2013 11 . driver measures are “leading indicators”.Indicate the result of a strategy.PMS: Additional Considerations • • • Outcome and Driver Measures:.
If outcome measures indicate there is a problem but the driver measures indicate the strategy is being implemented well. 9/25/2013 12 . there is a high chance that the strategy needs to be changed.• • PMS: Additional Considerations Outcome and Driver Measures are inextricably linked.
PMS: Additional Considerations • • • • Financial and Nonfinancial Measures Internal and external measures Measurements Drive Change Cause-Effect Relationships among Measures: Perspective Measures Innovation and Learning Perspective Internal Business Perspective Customer Perspective Financial Perspective Manufacturing Skills First-pass yields Order cycle time Customer Satisfaction Survey Sales Revenue growth 9/25/2013 13 .
6.Customer Satisfaction. Customer Loyalty 9/25/2013 14 .Market Share 4. 5. Backorders.Key Success Factors (KSFs) • KSFs are nonfinancial measures • Customer Focused Key Variables – the following are key variables with focus on customer: 1. 2. 3. Bookings. 7. Key Account orders.Customer Retention.
On-time delivery 3. 9/25/2013 15 . Quality.Inventory turnover 4. Capacity Utilization 2. Cycle time (= Processing time + Storage time + Movement time + Inspection time). 5.Key Success Factors (KSFs) • Key variables related to Internal Business Processes: 1.. Just in time ( Process time/Cycle time) etc.
Integrate measures into the management system – 4. Define measures of strategy – 3. Define the strategy – 2. Review measures and results frequently 9/25/2013 16 .Implementing PMS • Involves 4 general steps – 1.
Difficulties in Implementing PMS • Poor correlation between Nonfinancial Measures and Results • Fixation on Financial Results – Uncertain payback of the nonfinancial results • Non updated measures. measurement overload • Difficulty in establishing trade-offs 9/25/2013 17 .
Measurement Practices • • • • • • Perceived quality measures Types of measures Quality of Measures Relationship of Measures to Compensation Interactive Control (Today’s MCS Tomorrow’s strategy) Control System as a Strategy Implementation Tool. (Chosen Strategy Critical Success factors Design and operation of management control system • Control system as a Strategy Formation Tool (Strategic Uncertainties Use of a sub-sect of Mgmt. Control Information Interactively New Strategies 9/25/2013 18 .
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