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Performance 

Evaluation

Shiella Mariz Lapuz

MBA – Human Capital and Employee


Relations
LO1 Describe the types of measures used for decision
making.
LO2 Explain how to calculate and use productivity
measures.
LO3 Explain how internal and external measures are
related.
LO4 Explain how to design a good performance
measurement system.
LO5 Describe four models of organizational
performance.
i magine entering the cockpit of a modern jet airplane and seeing only
Passenger: I’m surprised
a single instrument there. How would to seefeel
you youabout
operating the plane
boarding with only a single
the
instrument. What does it measure?
plane after the following conversation with the pilot?
Pilot: Airspeed. I’m really working on airspeed this flight.
Passenger: That’s good. Airspeed certainly seems important. But what about
altitude? Wouldn’t an altimeter be helpful?
Pilot: I worked on altitude for the last few flights and I’ve gotten pretty good on it.
Now I have to concentrate on proper airspeed.
Passenger: But I notice you don’t even have a fuel gauge. Wouldn’t that be
useful?
Pilot: You’re right; fuel is significant, but I can’t concentrate on doing too many
things well at the same time. So on this flight I’m focusing on airspeed. Once I get
to be excellent at airspeed, as well as altitude, I intend to concentrate on fuel
consumption on the next set of flights.
What do you think?
What measures do you
use to evaluate a
company’s goods or
services? Provide
some examples.
Measurement is the act of quantifying the
performance criteria (metrics) of organizational
units, goods and services, processes, people, and
other business activities.

Good measures provide a “scorecard” of


performance, help identify performance gaps, and
make accomplishments visible to the workforce,
the stock market, and other stakeholders.
Types of Performance Measures
Important categories of organizational
performance measures:

• Financial • Time
• Customer and Market • Flexibility
• Quality • Innovation and Learning
• Sustainability
Exhibit 3.1 The Scope of Business and Operations Performance Measurement
Financial Measures
• Often take top priority in for-profit organizations.

• Traditional financial measures include revenue,


return on investment, operating profit, pretax
profit margin, asset utilization, growth, revenue
from new goods and services, earnings per
share, and other liquidity measures.
Customer and Market Measures
• Customer measures: Customer satisfaction, customer
retention, gains and losses of customers and customer
accounts, customer complaints, warranty claims,
measures of perceived value, loyalty, positive referral,
and customer relationship building.
− A customer-satisfaction measurement system
provides a company with customer ratings of specific goods
and service features, and indicates the relationship between
those ratings and the customer’s likely future buying
behavior.
• Market measures: Market share, business growth, new
product and geographic markets entered, percentage of
new product sales.
Quality
• Quality measures the degree to which the
output of a process meets customer
requirements.
• Goods quality relates to the physical
performance and characteristics of a good.
• Service quality is consistently meeting or
exceeding customer expectations (external
focus) and service delivery system performance
(internal focus) for all service encounters.
Service Quality Dimensions

1. Tangibles—physical facilities, uniforms, equipment,


vehicles, and appearance of employees (i.e., the physical
evidence).
2. Reliability—ability to perform the promised service
dependably and accurately.
3. Responsiveness—willingness to help customers and
provide prompt recovery to service upsets.
4. Assurance—knowledge and courtesy of the service-
providers, and their ability to inspire trust and confidence
in customers.
5. Empathy—caring attitude and individualized attention
provided to its customers.
Service Quality

– Every service encounter provides an


opportunity for error.

– Errors in service creation and delivery are


sometimes called service upsets or service
failures.
Time
• Time relates to two types of performance
measures:
1. the speed of doing something
2. the variability of the process

• Processing time is the time it takes to perform


some task.

• Queue time is a fancy word for wait time—the


time spent waiting.
In contrast to traditional/absorption costing system, ABC system
first accumulates overheads costs for each organizational
activity, and then assigns the costs of the activities to the
products, services, or customers (cost objects) causing that
activity.
Activity­Based Costing System 1
4
During 1980’s, the limitations of absorption costing
system were felt with severity. Companies were looking
for a system that could reflect true product cost in order
to fight competition. The absorption costing system was
designed decades ago, when most companies produced
narrow range of products. Further, overhead costs were
small enough to make a big difference in the identification
of cost of a product. This criticism of absorption costing
led to generation of the idea of ABC system. David
Cooper and Robert Kaplan wrote articles on the idea of
ABC system in 1990 and 1992. The new system was
accepted widely and became reality of the day. Now ABC
system has become part of every management
accounting text book and being implemented the world
over.
1
5
ABC is a cost attribution to cost units on the basis of benefit received
from indirect activities.
-- Cima Official Terminology
An activity is an event that incurs costs.
A cost object is defined as anything for which a
separate measure of cost is desired/required.
An activity cost pool: The overheads cost
allocated to a distinct type of activity or related activities.
A cost driver is any factor or activity that has a
direct cause and effect
relationship with the resources consumed.
Cost Unit: An item of production or a service for
which it is useful to have cost information.
Cost accounting: The process of identifying,
analyzing, summarizing, recording and reporting costs associated
with business operations.
Direct costs: Those costs that are directly
associated with the
manufacturing process.
Activity­Based Costing System
Indirect/overheads costs: Those costs 1
6
An overheads cost allocation
system that:
allocates overheads cost to
multiple activity cost pools and
assigns the activity cost pools
to products or services by
means of cost drivers that
represent the activities used.
Ste Identify Cost Objects i.e. Product A,B,C

p 12
Step Identify direct costs i.e. Direct Materials, Direct Labor,
Direct expense

Step 3 Select the cost allocation bases to be used for


overheads cost i.e. # of set-ups, # of units,
etc.
Step 4
Identify the overheads cost associated with the bases
selected
Step 5
Compute the rate per unit
Step 6
Compute overheads cost for allocation to products

Step 7 Compute costs of products


Departments

Activity Design Setup Shipping


Overheads Cost
Pool

Cost No. of No. of No. of


Allocation employees Shipments
Base Setup
Hours

Cost
Objects
Product A Product B Product C
Activity Cost
Activity Cost Drivers
Pools
a) Number of units
 Production b) Number of set-ups
c) Number electricity units consumed
a) Number of sales personnel
 Marketing b) Number of sales orders
 a) Number of research projects
Research & b) Personnel hours spend on projects
c) Technical complexities of the projects
Development
a) Number of service calls
 Customer Service b) Number of products serviced
c) Hours spend on servicing products
 Purchasing a) Number of purchase orders
 Material Handling a) Number of material requisitions
I. Unit-level
activities
The costs of direct materials, direct labor, and machine maintenance
are examples of unit-level activities.

II. Batch-level activities


are costs incurred every time a group (batch) of units is produced .
Purchase orders, machine setup, and quality tests are examples of
batch-level activities.

III. Product-line activities


Examples of product-line activities are engineering changes made in
the assembly line, product design changes, and warehousing and
storage costs for each product line.

IV. Facility support activities


The costs relating to the activities are administrative in nature and
include building depreciation, property taxes, plant security, insurance,
accounting, outside landscape and maintenance, and plant
management's and support staff's salaries.
Alpha Ltd. is manufacturing two products A and B. Both products
are manufactured on the same machines and undergo the same
processes. Here is the detail of budgeted data obtained for the
two products for the financial year ending on December 31, 20x1:

Description A B

Budgeted production quantity (units) 25,000 2,500


Number of purchase orders 400 200
Number of set-ups 150 100

Resources required/unit:
Direct material (AED.) 25 62.5
Direct labor (Hours) 10 10
Machine time (Hours) 5 5
1. ABC system provides accurate costing of products/services.
2. Management has better understanding overheads cost.
3. The system utilizes unit cost rather than total cost unlike
absorption costing system.
4. ABC system integrates well with Six Sigma and other
continuous improvement programs.
5. The in-depth study of overheads cost under ABC system
makes all wastages visible to management and all non-
value added activities known to them. Thus, better controls
can be exercised on them.
6. It supports performance management and scorecards.
7. The system enables costing of processes, supply chains,
and value streams.
8. ABC system helps in benchmarking other products.
1. Implementing ABC system requires a big budget initially.
2. After implementation, the maintenance of the system is costly. Data
concerning numerous activity measures must be collected , checked, and
entered into the system on regular basis.
3. ABC system produces numbers such as product margins that are different
from the profits produced by traditional costing system. Management may
be double minded as they are used to work with traditional costing system,
as a requirement for external reporting.
4. ABC system generated data can be misinterpreted and must be used
with care when used in making decisions. Costs assigned to products,
customers and other cost objects are only potentially relevant.
5. Reports generated by ABC system do not conform to Generally
Accepted Accounting Principles (GAAP). Consequently, an organization
involved in ABC should have two cost systems - one for internal use and
one for preparing external reports.
The initiative to implement ABC system must be
strongly supported by the management. The workings
involve a tremendous job of making inquiries from
employees.

The design and implementation of ABC system should be


the responsibility of a cross functional team of
technicians. Normally, the team would include
representatives from accounting, finance, IT, marketing,
production and engineering departments.

Services of an ABC system consultant must be hired in


order to prevent the wastage of resources and time.

Selection of ABC software that could implement and


automate the processing of the system should be made
upon expert advice. We have given a list of ABC system
softwares as Appendix A.
SUPPLY CHAIN OPERATIONS REFERENCE

Is a framework for measuring and evaluating the performance of


supply chain processes. Measurement are made of five key
processes that are undertaken along the supply chain by all
participating organizations.

Activity­Based Costing System 2
7
Flexibility
• Flexibility is the ability to adapt quickly and effectively to
changing requirements.

• Goods and service design flexibility is the ability to


develop a wide range of customized goods and services to
meet different or changing customer needs.
− Measures include the rate of new product development or percent
of product mix developed over the past three years.

• Volume flexibility is the ability to respond quickly to


changes in the volume and type of demand.
− Measures include the time to change machine setups or time
required to “ramp up” to an increased production volume.
Innovation and Learning
• Innovation refers to the ability to create new and
unique goods and services that delight customers and
create competitive advantage.
• Learning refers to creating, acquiring, and transferring
knowledge, and modifying the behavior of employees in
response to internal and external change.
• Measures of innovation and learning include intellectual
asset growth, patent applications, best practices
implemented, new product development, employee
training and skills development, satisfaction, work
system performance and effectiveness.
Sustainability
• The Triple bottom line (TBL or 3BL) refers to the
measurement of environmental, social, and economic
sustainability.

− Environmental sustainability measures include


energy consumption, recycling, air emissions, solid and
hazardous waste rates.
− Social sustainability measures include consumer and
workplace safety, community relations, corporate ethics
and governance, and ethical violations.
− Economic sustainability measures include financial
audit results, regulatory compliance, sanctions and fines,
and accomplishment of strategic initiatives.
Productivity
Productivity is the ratio of output of a process to
the input

Quantity of Output
Productivity = [3.1]
Quantity of Input
Productivity measures include units produced/labor hour,
airline revenue per passenger mile, meals served/labor
dollar.
Linking Internal and External Performance
Measures
• Managers must understand the cause and
effect linkages between key measures of
performance. These relationships often explain
the impact of operational performance on
external results.

• The quantitative modeling of cause and effect


relationships between external and internal
performance criteria is called interlinking.
Exhibit 3.2 Interlinking Internal and External Performance Measures
Linking Internal and External Performance
Measures
• The value of a loyal customer (VLC)
quantifies the total revenue or profit each
target market customer generates over the
buyer’s life cycle.

• By multiplying the VLC times the absolute


number of customers gained or lost, the total
market value can be found.
Solved Problem – Value of Loyal Customer
What is the value of a loyal customer (VLC) in the small
contractor target market segment who buys an electric drill
on average every 4 years or 0.25 years for $100, when the
gross margin on the drill averages 50 percent, and the
customer retention rate is 60 percent? What if the
customer retention rate increases to 80 percent?

What is a 1 percent change in market share worth to the


manufacturer if it represents 100,000 customers? What do
you conclude?
Solution
If customer retention rate is 60 percent, the average customer
defection rate = (1 – customer retention rate). Thus, the customer
defection rate is 40 percent, or 0.4. The average buyer’s life cycle
is 1/0.4 = 2.5 years. The repurchase frequency is every four
years, or 0.25 (1.4).

Therefore:
VLC (P)(RF)(CM)(BLC) =
($100)(0.25)(0.50)(1/0.4) = $31.25 over the buyer’s life cycle

The value of a 1 percent change in market share =


(100,000 customers)($31.25/customer) = $3,125,000
Solution (continued):

If customer retention rate is 80 percent, the average customer


defection rate is 0.2, and the average buyer’s life cycle is 1/0.2 =
5 years.

Then:
VLC (P)(RF)(CM)(BLC) =
($100)(0.25)(0.50)(1/.2) = $62.50

Thus, the value of a 1 percent change in market share


(100,000 customers)($62.50/customer/year) = $6,250,000

The economics are clear. If customer retention can be increased


from 60 to 80 percent through better value chain performance, the
economic payoff is doubled.
Designing Measurement Systems in Operations
Key Questions:
• Does the measurement support our mission?
• Will the measurement be used to manage change?
• Is it important to our customers?
• Is it effective in measuring performance?
• Is it effective in forecasting results?
• Is it easy to understand/simple?
• Is the data easy/cost-efficient to collect?
• Does the measurement have validity, integrity, and
timeliness?
• Does the measurement have an owner?
Designing Measurement Systems in Operations
Good performance measures are actionable.
Actionable measures provide the basis for
decisions at the level at which they are applied—the
value chain, organization, process, department,
workstation, job, and service encounter.
Models of Organizational Performance
“Big picture” models of organizational performance:

• Baldrige Performance Excellence Framework


• Balanced Scorecard

More detailed frameworks for operations managers:

• Value Chain Model


• Service-Profit Chain Model
Baldrige Performance Excellence Framework
• Primary purpose of the program is to provide a
framework for performance excellence through
self-assessment to understand an organization’s
strengths and weaknesses, thereby setting
priorities for improvement. www.nist.gov/baldrige

• Organizations in manufacturing, small business,


service, education, health care and non-profit
sectors may receive the Malcolm Baldrige Award.
Exhibit 3.3 Baldrige Performance Model of Organizational Performance

Source: 2011-12 Baldrige Criteria for Performance Excellence, U.S. Depart. of Commerce
The Balanced Scorecard Model
Purpose is to translate strategy into measures that
uniquely communicate an organization’s vision.

Four perspectives:

1. Financial—value to shareholders
2. Customer—customer satisfaction and market
growth
3. Innovation and Learning—people and
infrastructure
4. Internal—processes that drive the business
Exhibit 3.4 The Balanced Scorecard Performance Categories and Linkages

Source: Kaplan R. S., and Norton, D. P., “The Balanced Scorecard—Measures That Drive Performance,” Harvard Business Review, January–February 1992, p. 72.
The Value Chain Model
• Evaluates performance throughout the value
chain by identifying measures associated
with suppliers, inputs, value creation
processes, goods and service outputs and
outcomes, customers and market segments,
and supporting management processes.
Exhibit 3.5 Examples of Value Chain Performance Measurements
Service-Profit Chain Model
• Most applicable to service environments.

• Based on a set of cause and effect linkages


between internal and external performance, and
defines the key performance measurements on
which service-based firms should focus.
Service-Profit Chain Model
• The theory of the Service-Profit Chain is that
employees, through the service delivery system,
create customer value and drive profitability.

• As J.W. Marriott, the founder of Marriott Hotels


said long ago, “Happy employees create happy
customers.”
Cost & Management Accounting by Colin Drury, 5/e
Cost Accounting by Horngren /Datar /Foster, 11/e
Managerial Accounting by Hilton and Platt
Managerial Accounting by Weygandt / Kieso / Kimmel,
2/e
Cima Official Terminology