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Analyzing Economic Performance Indicators in a Steel Industry: A Case Study

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 Analyzing Economic Performance Indicators in a Steel Industry: A
Case Study

Taha Vafaeenezhad*, Hamed Ganji, Masoud Rabbani, Hamed Farrokhi-Asl

School of Industrial Engineering, College of Engineering, University of Tehran, Tehran, Iran

Abstract

Economic performance indicators are some indicators that analyze the performance of an
economic investment. In these situations, we need to create indicators to inform us about the
performance of an enterprise. These indicators are so urgent for improving management and
decision making for controlling economic performance of enterprises. It seems that there are few
searches on this context and it is hard to find such indicators. Because of variety of economic
indicators, choosing the correct type of them for analyzing the economic performance of an
enterprise is such a difficult step. In this paper we want to use the indicators like return on sales,
customer satisfaction, economic profit, recency, etc. to analyze the economic performance of a
steel industry, as a case study. Unlike the other types of performance measures, we demonstrate
how this type of indicators measures such performance exactly and appropriately.

1. Introduction

An indicator is a measuring system that quantifies a trend, dynamic or characteristic. In virtually

all disciplines, practitioners use indicators to explain phenomena, diagnose causes, share findings
and project the results of future events. Throughout the worlds of science, business and
government, indicators encourage rigor and objectivity. They make it possible to compare
observations across regions and time periods. They facilitate understanding and collaboration.
Today, numerical fluency is a crucial skill for every business leader. Managers must quantify
market opportunities and competitive threats. They must justify the financial risks and benefits of
their decisions. They must evaluate plans, explain variances, judge performance and identify
leverage points for improvement – all in numeric terms. These responsibilities require a strong
command of measurements and of the systems and formulas that generate them. In short, they
require metrics.

*
Corresponding author
Email address: tahavafainejhad@alumni.ut.ac.ir
Tel: +9821-88021067/ Fax: +9821-88013102
 Managers must select, calculate and explain key business metrics. They must understand how
each is constructed and how to use it in decision-making.

2. Types of Performance Measures

Many companies are working with the wrong measures, many of which are incorrectly termed key
performance indicators (KPIs). Very few organizations really monitor their true KPIs. The reason
is that very few organizations, business leaders, writers, accountants, and consultants have
explored what a KPI actually is. There are four types of performance measures:
1. Key result indicators (KRIs) tell you how you have done in a perspective or critical success
factor.
2. Result indicators (RIs) tell you what you have done.
3. Performance indicators (PIs) tell you what to do.
4. KPIs tell you what to do to increase performance dramatically.
Many performance measures used by organizations are thus an inappropriate mix of these four
types.

2.1. Key Result Indicators

KRI’s are measures that often have been mistaken for KPIs. They include:

 Customer satisfaction
 Net profit before tax
 Profitability of customers
 Employee satisfaction
 Return on capital employed

The common characteristic of these measures is that they are the result of many actions. They
give a clear picture of whether you are traveling in the right direction. They do not, however, tell
you what you need to do to improve these results. Thus, KRIs provide information that is ideal for
the board.

2.2. Performance and Result Indicators

The 80 or so performance measures that lie between the KRIs and the KPIs are the performance
and result indicators (PIs and RIs). The performance indicators, while important, are not key to the
business. The PIs help teams to align themselves with their organization’s strategy. PIs are
nonfinancial and complement the KPIs; they are shown with KPIs on the scorecard for each
organization, division, department, and team.
Performance indicators could include:

 Percentage increase in sales with top 10% of customers

 Number of employees’ suggestions implemented in last 30 days
  Customer complaints from key customers
 Sales calls organized for the next week, two weeks
 Late deliveries to key customers

The RIs summarize activity, and all financial performance measures are RIs (Daily or weekly
sales analysis is a very useful summary, but it is a result of the efforts of many teams). To fully
understand what to increase or decrease, we need to look at the activities that created the sales (the
result).
Result indicators could include:

 Net profit on key product lines

 Sales made yesterday
 Customer complaints from key customers

2.3. Key Performance Indicators

KPIs represent a set of measures focusing on those aspects of organizational performance that are
the most critical for the current and future success of the organization. We could define seven
characteristics of KPIs:
1. Are nonfinancial measures (e.g., not expressed in dollars, yen, pounds, euros, etc.)
2. Are measured frequently (e.g., 24/7, daily, or weekly)
3. Are acted on by the chief executive officer (CEO) and senior management team (e.g.,
CEO calls relevant staff to enquire what is going on)
4. Clearly indicate what action is required by staff (e.g., staff can understand the measures and
know what to fix)
5. Are measures that tie responsibility down to a team (e.g., CEO can call a team leader who
can take the necessary action)
6. Have a significant impact (e.g., affect one or more of the critical success factors [CSFs] and
more than one balanced scorecard (BSC) perspective)
7. They encourage appropriate action (e.g., have been tested to ensure they have a positive
impact on performance, whereas poorly thought-through measures can lead to dysfunctional
behavior).

3. Economic Performance Indicators

3.1. Customer Satisfaction and Willingness to Recommend

Purpose: customer satisfaction provides a leading indicator of consumer purchase intentions and
loyalty
Customer satisfaction: The number of customers, or percentage of total customers, whose
reported experience with a firm, its products or its services (ratings) exceeds specified satisfaction
goals.
Willingness to recommend: The percentage of surveyed customers who indicate that they would
recommend a brand to friends.
 Customer satisfaction is generally based on survey data and expressed as a rating.
For example, see Table 1.

Table 1. Customers’ satisfaction rating

Somewhat Neither satisfied Somewhat Very
Very dissatisfied
dissatisfied nor dissatisfied satisfied satisfied
1 2 3 4 5

Within organizations, customer satisfaction ratings can have powerful effects. They focus
employees on the importance of fulfilling customers’ expectations. Furthermore, when these
ratings dip, they warn of problems that can affect sales and profitability.
A second important metric related to satisfaction is willingness to recommend. When a
customer is satisfied with a product, he or she might recommend it to friends, relatives and
colleagues. This can be a powerful marketing advantage.
These metrics quantify an important dynamic. When a brand has loyal customers, it gains
positive word-of-mouth marketing, which is both free and highly effective. Customer satisfaction
is measured at the individual level, but it is almost always reported at an aggregate level. It can be,
and often is, measured along various dimensions. A hotel, for example, might ask customers to
rate their experience with its reception and check-in service, with the room, with the amenities in
the room, with the restaurants, and so on. Additionally, in a holistic sense, the hotel might ask
about overall satisfaction “with your stay”. Customer satisfaction is generally measured on a five-
point scale (as the above figure).
Customer satisfaction data are among the most frequently collected indicators of market
perceptions. Their principal use is twofold:
1) Within organizations, the collection, analysis and dissemination of these data send a message
about the importance of tending to customers and ensuring that they have a positive experience
with the company’s goods and services.
2) Although sales or market share can indicate how well a firm is performing currently,
satisfaction is perhaps the best indicator of how likely it is that the firm’s customers will make
further purchases in the future. Much research has focused on the relationship between customer
satisfaction and retention. Studies indicate that the ramifications of satisfaction are most strongly
realized at the extremes. On the scale in Figure above, individuals who rate their satisfaction level
as “5” are likely to become return customers and might even evangelize for the firm. Individuals
who rate their satisfaction level as “1”, by contrast, are unlikely to return. Further, they can hurt
the firm by making negative comments about it to prospective customers. Willingness to
recommend is a key metric relating to customer satisfaction.

3.2. Customers, Recency and Retention

Purpose: to monitor firm performance in attracting and retaining customers

Customer counts: These are the number of customers of a firm for a specified time period.
Recency: This refers to the length of time since a customer’s last purchase. A six-month
customer is someone who purchased from the firm at least once within the last six months.
Retention rate: This is the ratio of the number of retained customers to the number at risk.
 These three metrics are used to count customers and track customer activity irrespective of the
number of transactions (or monetary value of those transactions) made by each customer.
A customer is a person or business that buys from the firm.
In contractual situations, it makes sense to talk about the number of customers currently under
contract and the percentage retained when the contract period runs out.
In non-contractual situations (such as catalogue sales), it makes less sense to talk about the
current number of customers, but instead to count the number of customers of a specified recency.
Only recently have most producers worried about developing metrics that focus on individual
customers. In order to begin to think about managing individual customer relationships, the firm
must first be able to count its customers. Although consistency in counting customers is probably
more important than formulating a precise definition, a definition is needed nonetheless. In
particular, we think the definition of and the counting of customers will be different in contractual
versus non-contractual situations.

3.3. Customer Profit

Purpose: to identify the profitability of individual customers

Customer profitability: The difference between the revenues earned from and the costs
associated with the customer relationship during a specified period.
Customer profit (CP) is the profit the firm makes from serving a customer or customer group
over a specified period of time.
Calculating customer profitability is an important step in understanding which customer
relationships are better than others. Often, the firm will find that some customer relationships are
unprofitable. The firm may be better off (more profitable) without these customers. At the other
end, the firm will identify its most profitable customers and be in a position to take steps to ensure
the continuation of these most profitable relationships.
A database that can analyze the profitability of customers at an individual level can be a
competitive advantage. If you can figure out profitability by customer, you have a chance to defend
your best customers and maybe even poach the most profitable consumers from your competitors.
In theory, this is a trouble-free calculation. Find out the cost to serve each customer and the
revenues associated with each customer for a given period. Do the subtraction to get profit for the
customer and sort the customers based on profit. Although painless in theory, large companies
with a multitude of customers will find this a major challenge even with the most sophisticated of
databases.
To do the analysis with large databases, it may be necessary to abandon the notion of calculating
profit for each individual customer and work with meaningful groups of customers instead.
After you have the sorted list of customer profits (or customer-group profits), the custom is to
plot cumulative percentage of total profits versus cumulative percentage of total customers. Given
that the customers are sorted from highest to lowest profit, the resulting graph usually looks
something like the head of a whale.
Profitability will increase sharply and tail off from the very beginning. (Remember, our
customers have been sorted from most to least profitable.) Whenever there are some negative profit
customers, the graph reaches a peak – above 100% – as profit per customer moves from positive
to negative. As we continue through the negative-profit customers, cumulative profits decrease at
an ever-increasing rate. The graph always ends at 100% of the customers accounting for 100% of
the total profit.

3.4. Net Profit and Return on Sales

Purpose: to measure levels and rates of profitability

Net profit measures the profitability of ventures after accounting for all costs. Return on sales
(ROS) is net profit as a percentage of sales revenue.

Net profit = Sales revenue - Total costs

Net profit
Return on sales (ROS) (%) = Sales revenue

ROS is an indicator of profitability and is often used to compare the profitability of companies
and industries of differing sizes. Significantly, ROS does not account for the capital (investment)
used to generate the profit.
How does a company decide whether it is successful or not? Probably the most common way
is to look at the net profits of the business. Given that companies are collections of projects and
markets, individual areas can be judged on how successful they are at adding to the corporate net
profit. Not all projects are of equal size, however, and one way to adjust for size is to divide the
profit by sales revenue. The resulting ratio is return on sales (ROS), the percentage of sales revenue
that gets “returned” to the company as net profits after all the related costs of the activity are
deducted.
Net profit measures the fundamental profitability of the business. It is the revenues of the
activity less the costs of the activity. The main complication is in more complex businesses when
overhead needs to be allocated across divisions of the company. Almost by definition, overheads
are costs that cannot be directly tied to any specific product or division. The classic example would
be the cost of headquarters staff.

3.5. Return on Investment

Purpose: to measure per-period rates of return on money invested in an economic entity

Return on investment is one way of considering profits in relation to capital invested.

Net profit
Return on investment (ROI) (%) = Investment

Return on assets (ROA), return on net assets (RONA), return on capital (ROC) and return on
invested capital (ROIC) are similar measures with variations on how “investment” is defined. New
plants and equipment, inventories, and accounts receivable are three of the main categories of
investments that can be affected by marketing decisions.
ROI and related metrics (ROA, ROC, RONA and ROIC) provide a snapshot of profitability
adjusted for the size of the investment assets tied up in the enterprise.
3.6. Economic Profit (EVA)

Purpose: to measure economic profits while accounting for required returns on capital invested
Economic profit = Net operating profit after tax (NOPAT) - Cost of capital
Cost of capital = Capital employed * WACC (%)
If your profits are less than the cost of capital, you have lost value for the firm. Where economic
profit is positive, value has been generated.
Economic profit has many names, some of them trademarked as “brands”.
Economic value added (EVA) is Stern-Stewart’s trademark. They deserve credit for
popularizing this measure of net operating profit after tax adjusted for the cost of capital.
Unlike percentage measures of return (for example, ROS or ROI), economic profit is a
monetary metric. As such, it reflects not only the “rate” of profitability, but also the size of the
business (sales and assets).
Economic profit, sometimes called residual income, or EVA, is different from “accounting”
profit – in that economic profit also considers the cost of invested capital – the opportunity cost.
Like the discount rate for NPV calculations, this charge should also account for the risk associated
with the investment. A popular (and proprietary) way of looking at economic profit is economic
value added.
Increasingly, producers are being made aware of how some of their decisions influence the
amount of capital invested or assets employed. First, sales growth almost always requires
additional investment in fixed assets, receivables or inventories. Economic profit and EVA help
determine whether these investments are justified by the profit earned. Second, the marketing
improvements in supply chain management and channel coordination often show up in reduced
investments in inventories and receivables. In some cases, even if sales and profit fall, the
investment reduction can be worthwhile. Economic profit is a metric that will help assess whether
these trade-offs are being made correctly.
Economic profit/economic value added can be calculated in three stages. First, determine
NOPAT (net operating profit after tax). Second, calculate the cost of capital by multiplying capital
employed by the weighted average cost of capital. The third stage is to subtract the cost of capital
from NOPAT.

3.7. Evaluating Multi-period Investments

Purpose: to evaluate investments with financial consequences spanning multiple periods

Multi-period investments are commonly evaluated with three metrics.
Payback (N) = The number of periods required to “pay back” or “return” the initial investment.
Net present value (NPV) = The discounted value of future cash flows minus the initial
investment.
Internal rate of return (IRR) (%) = The discount rate that results in an NPV of zero.
These three metrics are designed to deal with different aspects of the risk and returns of multi-
period projects.
Investment is a word business people like. It has all sorts of positive connotations of future
success and wise stewardship. However, because not all investments can be pursued, those
available must be ranked against each other. Also, some investments are not attractive even if we
have enough cash to fund them. In a single period, the return on any investment is merely the net
profits produced in the time considered divided by the capital invested. Evaluation of investments
that produce returns over multiple periods requires a more complicated analysis – one that
considers both the magnitude and timing of the returns.
Projects with a shorter payback period by this analysis are regarded more favorably because
they allow the resources to be reused quickly. Also, generally speaking, the shorter the payback
period, the less uncertainty is involved in receiving the returns. Of course the main flaw with
payback period analysis is that it ignores all cash flows after the payback period. As a consequence,
projects that are attractive but that do not produce immediate returns will be penalized with this
metric.
Net present value (NPV) is the discounted value of the cash flows associated with the project.
The present value of $1 received in a given number of periods in the future is:

Cash flow
Discounted value = [(1− Discount rate (%))∗ Period (N)]

The internal rate of return is the percentage return made on the investment over a period of time.
The internal rate of return is a feature supplied on most spreadsheets and thus is relatively easy to
calculate.
The IRR is especially useful because it can be compared to a company’s minimum attractive
rate of return (MARR). The MARR is the necessary percentage return to justify a project. Thus a
company might decide only to undertake projects with a return greater than 12%. Projects that
have an IRR greater than 12% get the green light; all others are thrown in the bin.
The internal rate of return is the percentage discount rate at which the net present value of the
operation is zero. Thus companies using a MARR are really saying that they will only accept
projects where the net present value is positive at the discount rate they specify as the MARR.
Another way to say this is that they will accept projects only if the IRR is greater than the MARR.

4. Merat Poolad Company

With 41 years’ experience as one of the biggest suppliers of services and products to steel industry,
Merat Poolad Engineering Co. initiated its business along with foundation of National Esfahan
Steel Co. as general mechanic engineering authority to Esfahan Steel Factory with its mission as
in charge of maintenance and repair of production lines and manufacture of spare parts to the
factory. Following privatizing policies, this ward reformed as an independent and private-run
company since 23 July 1995. By now, Merat Co. is going through its 15th year of activity as private
joint stock company. The company is affiliate and subsidiary to Takado group.

4.1. Market Position

As the main supplier of parts, equipment, maintenance and repair services, Merat Co. took its
first step toward other industries, such cement, oil and petrochemical, machineries, mine in 2001
by codifying a strategic plan. Year in and year out the company manages to take more share in the
markets.
4.2. Customers

Isfahan Steel Company is the largest and main customer comprising 80% of market share to the
company. Other clients are Khouzestan Steel Company, Esfahan's Mobarakeh Steel Company,
Mine industries (Chadormalo and Golgohar mines), oil and petrochemicals (Petropedem
industries), cement (Doroud and Sepahan cement companies), power plant machineries, and cone
farming and processing (Karoun and Haft Tape Agro Industry).

4.3. Products

Relying on hardware and software capabilities of the company, Merat Co. is honor to introduce
variety of mechanisms for steel and casting factories, repairing and renewing mechanisms and
parts for steel and other industries, machine works, repairing big industrial parts and also
manufacturing metal skeleton and equipment for different industries. In addition, the company is
capable to undertake big industrial project from first stages of studies to operation stage.

4.4. Society

Taking into account that majority of the units of the company are located in Isfahan Steel Co.’s
lot, Lenjan of Isfahan Province forms the main portion of the company’s local society. The second
main portion of the society is comprised of Ashtarjen industrial zone civilians. Noticeable is that
social responsibilities of the company encompasses the whole province of Isfahan and the
company has codified plans for better interaction with the community.

4.5. Stockholders

As the largest subsidiary to Takado Co., main portion of the company’s stock is owned by
Takado Co., and the remaining is owned by the employees.

4.6. Suppliers

The Table 2 lists suppliers of the company:

Table 2. Suppliers of company

Supplier Main suppliers

Casting raw materials Radan Co, Roin Pol, Sepahan Zobaray

Steel materials and parts
Equipment, tools, spare parts
Requirement, consumable
materials
Contractors, manufacturers
Hardware and software
Irvan service group, Yarlou, Khavandkar, Sfaraien
Alloy Steel
Almas Saz, Yaz Electrode, Ama, Kale head office,
Omid Tools
Sang Samin, Ama, Bonakdar, Sang Sombade Tous,
Armaghan Kalaie Jordan
Kamal Sepahan, Foulad Akhgar, Azar Felezan,
Sangin Tarash, Tamkar
Asam Argham, Rayanegan Behpou, Farad, Rad
Tarashe Asia

4.7. Organizational Chart

Organizational chart is designed based on strategies, objective and major policies of the company
as follows:
Production, marketing and sale, materials, financial, projects, maintenance, repairs and
engineering services, quality guarantee, management and computer information, human resources.

4.8. Human Resources

The company employs 1700 associates with average work experiences of 15 years in different
sections. Average age of the employees is 40 and classification in education order is as follows:

Graduate and postgraduate: 7.9% Pre graduate: 7.6%

High school diploma: 26% lower degrees: 58.4%
It is noticeable that all workers with lower degrees are well experienced and skillful staff
passing many in service training courses. Cost of capital from NOPAT.

4.9. Business Environment

There are several competitors in this business at different sizes, which some are potential threats.
One of greatest challenges in this business is raw materials supply whether from domestic or
foreign sources. Current number of customers, but instead to count the number of customers of a
specified recency.
5. Results

1) Net Income = 1498970000

2) Operating Costs = 201427000
3) Maintenance Costs = 19546700
4) Customer Satisfaction = 4 (Somewhat Satisfied)
5) Customer Counts (For a year) = 10
6) Recency = {For Esfahan Steel Company (The major customer of Merat)} 18 per week
7) Customer Profit:

Table 3. Type of customers

Customer Type
Esfahan Steel Company 1
Esfahan's Mobarakeh Steel Company and
2
Khouzestan Steel Company
Chadormalo and Golgohar mines 3
Doroud and Sepahan cement companies 4
Karun and Haft Tape Agro Industry 5

The major income is belongs to customer type 1 and the minor for type 5 one.

8) Return on Sales (ROS) = % 7.1(149897/2098808) {In Million Rials}

9) Return on Investment (ROI) = % 4.5 (149897/3292823) {In Million Rials}
10) Economic Profit (EVA) = 3142926 (3292823 – 149897) {In Million Rials}
11) Net Present Value (NPV) = 1632540000
12) Internal Rate of Return (IRR) = % 32.85

6. Conclusion

As the customer satisfaction ratio was calculated 4 (Somewhat Satisfied), Merat Poolad Co.
ensures that they have a positive experience with the company’s goods and services and it has
much more customers that returns for purchase new products or renews contracts. As the matter
of fact, it won’t be so far to gain the rate of 5 (Very Satisfied) for customer satisfaction, so it would
be a new goal for the company by improving its services.
Based on 10 main company’s customers and Esfahan Steel Co. is the major customer of it, it is
obviously realized that Merat Poolad Co. should manage its relationship with Esfahan Steel Co.
as an individual customer. And transactions’ procedures with Esfahan Steel Co. is so important for
the company to retain its major customer.
The customer profitability is illustrated in the table above. The company could manage its
relationships with the customers based on their profits. Esfahan Steel Company is the most
profitable customer of the company and Esfahan's Mobarakeh Steel and Khouzestan Steel
 companies are the next profitable customers of the company. The company should be noticed to
ensure the continuation of these most profitable relationships.
As the ROS rate is calculated % 7.1, it means % 7.1 of sales revenue gets “returned” to the
company as net profits after all the related costs of the activity are deducted. With this information
the company could decide whether it is successful or not.
As the ROI is calculated % 4.5, it means % 4.5 of the investment assets tied up in the company.
As the EVA is calculated positive, it means that the investments are justified by the profit
earned and value has been generated. Based on this rate, we could realized that the company’s
trade-offs are being made correctly.
The NPV is calculated positive and IRR is calculated % 32.85, it shows a satisfied investing
and ofcourse for future economic decisions, it could be used to compare with new projects rate of
return to accept or not.

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