CHAPTER 12

EVALUATION AND CONTROL

MEASURING PERFORMANCE

PERFORMANCE IS THE END RESULT OF

ACTIVITY. SELECT MEASURES TO ASSESS PERFORMANCE
BASED ON THE ORGANIZATIONAL UNIT TO BE
APPRAISED AND THE OBJECTIVES TO BE ACHIEVED.
APPROPRIATE MEASURES
• STEERING CONTROLS- MEASURE VARIABLES THAT INFLUENCE FUTURE PROFITABILITY.
O INVENTORY TURNOVER RATIO- RETAILER’S COST OF GOODS SOLD IS DIVIDED BY THE AVERAGE VALUE
OF
ITS INVENTORIES. THIS MEASURE SHOWS HOW HARD AN INVESTMENT IN INVENTORY IS WORKING; THE
HIGHER THE RATIO, THE BETTER.
O CUSTOMER SATISFACTION- COMPANIES THAT SCORE HIGH ON THE AMERICAN CUSTOMER
SATISFACTION
INDEX (ACSI) HAVE HIGHER STOCK RETURNS AND BETTER CASH FLOWS THAN THOSE COMPANIES THAT
SCORE LOW ON THE ACSI.
• DASHBOARD- TO HELP EXECUTIVES KEEP TRACK OF IMPORTANT STEERING CONTROLS. IT IS A
SOFTWARE
THAT DISPLAYS CRITICAL INFORMATION IN EASY-TO-READ COMPUTER GRAPHICS ASSEMBLED FROM
DATA
PULLED FROM OTHER CORPORATE SOFTWARE PROGRAMS.
TYPES OF CONTROLS
OUTPUT CONTROLS SPECIFY WHAT IS TO BE ACCOMPLISHED BY
FOCUSING ON THE END RESULT OF THE BEHAVIORS THROUGH THE
USE OF OBJECTIVES AND PERFORMANCE TARGETS OR MILESTONES.
• BEHAVIOR CONTROLS SPECIFY HOW SOMETHING IS TO BE DONE
THROUGH POLICIES, RULES, STANDARD OPERATING PROCEDURES,
AND ORDERS FROM A SUPERIOR. EX. ISO 9000 STANDARDS SERIES,
ISO 14000 STANDARDS SERIES
• INPUT CONTROLS EMPHASIZE RESOURCES, SUCH AS KNOWLEDGE,
SKILLS, ABILITIES, VALUES, AND MOTIVES OF EMPLOYEES.
ACTIVITY-BASED COSTING (ABC)
• AN ACCOUNTING METHOD FOR ALLOCATING INDIRECT AND FIXED COSTS TO
INDIVIDUAL PRODUCTS OR PRODUCT LINES BASED ON THE VALUE-ADDED
ACTIVITIES GOING INTO THAT PRODUCT.
• VERY USEFUL IN CONSTRUCTING A VALUE-CHAIN ANALYSIS OF A FIRM’S
ACTIVITIES FOR MAKING OUTSOURCING DECISIONS.
TRADITIONAL COST ACCOUNTING
• FOCUSES ON VALUING A COMPANY’S INVENTORY FOR FINANCIAL
REPORTING PURPOSES.
• USEFUL WHEN DIRECT LABOR ACCOUNTS FOR MOST OF TOTAL COSTS AND A
COMPANY PRODUCES JUST A FEW PRODUCTS REQUIRING THE SAME
PROCESSES
ENTERPRISE RISK MANAGEMENT (ERM)
• A CORPORATEWIDE, INTEGRATED PROCESS FOR MANAGING THE
UNCERTAINTIES THAT COULD NEGATIVELY OR POSITIVELY
INFLUENCE THE ACHIEVEMENT OF THE CORPORATION’S
OBJECTIVES.
THE PROCESS OF RATING RISKS INVOLVES THREE STEPS:
1. IDENTIFY THE RISKS USING SCENARIO ANALYSIS,
BRAINSTORMING, OR BY PERFORMING RISK SELF-ASSESSMENTS.
2. RANK THE RISKS, USING SOME SCALE OF IMPACT AND
LIKELIHOOD.
3. MEASURE THE RISKS, USING SOME AGREED-UPON STANDARD
PRIMARY MEASURES OF CORPORATE
PERFORMANCE

• TRADITIONAL FINANCIAL MEASURES

• RETURN ON INVESTMENT (ROI)
O MOST COMMONLY USED MEASURE OF CORPORATE PERFORMANCE (IN TERMS OF PROFITS).
O RESULT OF DIVIDING NET INCOME BEFORE TAXES BY THE TOTAL AMOUNT INVESTED IN
THE COMPANY (TYPICALLY MEASURED BY TOTAL ASSETS).
O GIVES THE IMPRESSION OF OBJECTIVITY AND PRECISION, HOWEVER, IT CAN BE EASILY
MANIPULATED.
• EARNINGS PER SHARE (EPS)
O DIVIDING NET EARNINGS BY THE AMOUNT OF COMMON STOCK.
O HAS SEVERAL DEFICIENCIES AS AN EVALUATION OF PAST AND FUTURE PERFORMANCE.
• RETURN ON EQUITY (ROE)
O DIVIDING NET INCOME BY TOTAL EQUITY.
O ALSO HAS LIMITATIONS BECAUSE IT IS ALSO DERIVED FROM ACCOUNTING-BASED DATA.
O EPS AND ROE ARE OFTEN UNRELATED TO A COMPANY’S STOCK PRICE.
• OPERATING CASH FLOW
O THE AMOUNT OF MONEY GENERATED BY A COMPANY BEFORE THE COST OF FINANCING
AND TAXES.
O IS A BROAD MEASURE OF A COMPANY’S FUNDS. O NET INCOME PLUS DEPRECIATION,
DEPLETION, AMORTIZATION, INTEREST EXPENSE, AND INCOME TAX EXPENSE.
• FREE CASH FLOW
O THE AMOUNT OF MONEY A NEW OWNER CAN TAKE OUT OF THE FIRM WITHOUT HARMING
THE BUSINESS.
O NET INCOME PLUS DEPRECIATION, DEPLETION, AND AMORTIZATION LESS CAPITAL
EXPENDITURES AND DIVIDENDS.
O VERY USEFUL IN EVALUATING THE STABILITY OF AN ENTREPRENEURIAL VENTURE
 PRIMARY MEASURES OF CORPORATE
PERFORMANCE
• SHAREHOLDER VALUE - THE PRESENT VALUE OF THE ANTICIPATED FUTURE STREAM OF CASH
FLOWS FROM THE BUSINESS PLUS THE VALUE OF THE COMPANY IF LIQUIDATED.
• • ECONOMIC VALUE ADDED (EVA)
• O HAS BECOME AN EXTREMELY POPULAR SHAREHOLDER VALUE METHOD OF MEASURING
CORPORATE AND DIVISIONAL PERFORMANCE.
• O MEASURES THE DIFFERENCE BETWEEN THE PRE-STRATEGY AND POST-STRATEGY VALUES
FOR THE BUSINESS. O AFTER-TAX OPERATING INCOME MINUS THE TOTAL ANNUAL COST OF
CAPITAL.
• O COST OF CAPITAL COMBINES THE COST OF DEBT AND EQUITY. O ANNUAL COST OF
BORROWED CAPITAL IS THE INTEREST CHARGED BY THE FIRM’S BANKS AND BONDHOLDERS.
• O INVESTMENT IN ASSETS IS THE TOTAL AMOUNT OF CAPITAL INVESTED IN THE BUSINESS,
INCLUDING BUILDINGS, MACHINES, COMPUTERS, AND INVESTMENTS IN R&D AND TRAINING
(ALLOCATING COSTS ANNUALLY OVER THEIR USEFUL LIFE).
USING BENCHMARKING TO EVALUATE
PERFORMANCE

• ACCORDING TO XEROX CORPORATION, THE COMPANY THAT

PIONEERED THIS CONCEPT IN THE UNITED STATES, BENCHMARKING IS “THE
CONTINUAL PROCESS OF MEASURING PRODUCTS, SERVICES, AND PRACTICES
AGAINST THE TOUGHEST COMPETITORS OR THOSE COMPANIES RECOGNIZED
AS INDUSTRY LEADERS.
THE BENCHMARKING PROCESS USUALLY INVOLVES THE FOLLOWING STEPS:
1. IDENTIFY THE AREA OR PROCESS TO BE EXAMINED. IT SHOULD BE AN ACTIVITY
THAT HAS THE POTENTIAL TO DETERMINE A BUSINESS UNIT’S COMPETITIVE
ADVANTAGE.
2. FIND BEHAVIORAL AND OUTPUT MEASURES OF THE AREA OR PROCESS AND OBTAIN
MEASUREMENTS.
3. SELECT AN ACCESSIBLE SET OF COMPETITORS AND BEST-IN-CLASS COMPANIES
AGAINST WHICH TO BENCHMARK.
4. CALCULATE THE DIFFERENCES AMONG THE COMPANY’S PERFORMANCE
MEASUREMENTS AND THOSE OF THE BEST-IN-CLASS AND DETERMINE WHY THE
DIFFERENCES EXIST.
5. DEVELOP TACTICAL PROGRAMS FOR CLOSING PERFORMANCE GAPS.
6. IMPLEMENT THE PROGRAMS AND THEN COMPARE THE RESULTING NEW
MEASUREMENTS WITH THOSE OF THE BEST-IN-CLASS COMPANIES
ENTERPRISE RESOURCE PLANNING

• MANY CORPORATIONS AROUND THE WORLD HAVE ADOPTED ENTERPRISE

RESOURCE PLANNING (ERP)SOFTWARE. ERP UNITES ALL OF A COMPANY’S
MAJOR BUSINESS ACTIVITIES, FROM ORDER PROCESSING TO PRODUCTION,
WITHIN A SINGLE FAMILY OF SOFTWARE MODULES. THE SYSTEM PROVIDES
INSTANT ACCESS TO CRITICAL INFORMATION TO EVERYONE IN THE
ORGANIZATION, FROM THE CEO TO THE FACTORY FLOOR WORKER.
RADIO FREQUENCY IDENTIFICATION AND NEAR
FIELD COMMUNICATION

• RADIO FREQUENCY IDENTIFICATION (RFID) IS AN ELECTRONIC TAGGING

TECHNOLOGY USED IN A NUMBER OF COMPANIES TO IMPROVE SUPPLY-
CHAIN EFFICIENCY WHILE NEAR FIELD COMMUNICATION (NFC)STANDS FOR
CONTACTLESS COMMUNICATION BETWEEN DEVICES LIKE SMARTPHONES OR
TABLETS. BY TAGGING CONTAINERS AND ITEMS WITH TINY CHIPS,
COMPANIES USE THE TAGS AS WIRELESS BARCODES TO TRACK INVENTORY
MORE EFFICIENTLY.
DIVISIONAL AND FUNCTIONAL IS SUPPORT

• AT THE DIVISIONAL OR SBU LEVEL OF A CORPORATION, THE INFORMATION

SYSTEM SHOULD BE USED TO SUPPORT, REINFORCE, OR ENLARGE THE
BUSINESS-LEVEL STRATEGY THROUGH ITS DECISION SUPPORT SYSTEM. AN
SBU PURSUING A STRATEGY OF OVERALL COST LEADERSHIP COULD USE ITS
INFORMATION SYSTEM TO REDUCE COSTS EITHER BY IMPROVING LABOR
PRODUCTIVITY OR IMPROVING THE USE OF OTHER RESOURCES SUCH AS
INVENTORY OR MACHINERY.
PROBLEMS IN MEASURING PERFORMANCE
PROBLEMS IN MEASURING PERFORMANCE

• THE MEASUREMENT OF PERFORMANCE IS A CRUCIAL PART OF EVALUATION

AND CONTROL. THE LACK OF QUANTIFIABLE OBJECTIVES OR
PERFORMANCE STANDARDS AND THE INABILITY OF THE INFORMATION
SYSTEM TO PROVIDE TIMELY AND VALID INFORMATION ARE TWO OBVIOUS
CONTROL PROBLEMS. WITHOUT OBJECTIVE AND TIMELY MEASUREMENTS, IT
WOULD BE EXTREMELY DIFFICULT TO MAKE OPERATIONAL, LET ALONE
STRATEGIC, DECISIONS
 SHORT-TERM ORIENTATION
MORE OFTEN, TOP EXECUTIVES REPORT ANALYZE NEITHER THE LONG-TERM IMPLICATIONS
OF PRESENT OPERATIONS ON THE STRATEGY THEY HAVE ADOPTED NOR THE OPERATIONAL
IMPACT OF A STRATEGY ON THE CORPORATE MISSION.
REASONS ON WHY LONG-TERM EVALUATIONS MAY NOT BE CONCLUDED
1. DON’T REALIZE THEIR IMPORTANCE.
2. BELIEVE THAT SHORT-TERM CONSIDERATIONS ARE MORE IMPORTANT THAN LONG-
CONSIDERATIONS.
3. AREN’T PERSONALLY EVALUATED ON A LONG-TERM BASIS.
4. DON’T HAVE THE TIME TO MAKE A LONG-TERM ANALYSIS.
GOAL DISPLACEMENT

• IS THE CONFUSION OF MEANS WITH ENDS AND OCCURS WHEN ACTIVITIES

ORIGINALLY INTENDED TO HELP MANAGERS ATTAIN CORPORATE
OBJECTIVES BECOME ENDS IN THEMSELVES OR ARE ADAPTED TO MEET
ENDS OTHER THAN THOSE FOR WHICH THEY WERE INTENDED
 TWO TYPES OF GOAL DISPLACEMENT

BEHAVIOR SUBSTITUTION
IT REFERS TO THE PHENOMENON OF PURSUING SUBSTITUTE ACTIVITIES THAT DO
NOT LEAD TO GOAL ACCOMPLISHMENT INSTEAD OF ACTIVITIES THAT DO LEAD TO GOAL
ACCOMPLISHMENT BECAUSE THE WRONG ACTIVITIES ARE BEING REWARDED.
SUBOPTIMIZATION
IT REFERS TO THE PHENOMENON OF A UNIT OPTIMIZING ITS GOAL
ACCOMPLISHMENT TO THE DETRIMENT OF THE ORGANIZATION AS A WHOLE. THE
EMPHASIS IN LARGE CORPORATIONS ON DEVELOPING SEPARATE RESPONSIBILITY
CENTERS CAN CREATE SOME PROBLEMS FOR THE CORPORATION AS A WHOLE
 GUIDELINES FOR PROPER CONTROL
CONTROLS ENSURE THE USE OF THE PROPER STRATEGY TO ACHIEVE OBJECTIVES, THERE IS
A STRONG LIKELIHOOD THAT DYSFUNCTIONAL SIDE EFFECTS WILL COMPLETELY
UNDERMINE THE IMPLEMENTATION OF THE OBJECTIVES. 1. CONTROL SHOULD INVOLVE
ONLY THE MINIMUM AMOUNT OF INFORMATION NEEDED TO GIVE A RELIABLE PICTURE OF
EVENTS
2. CONTROLS SHOULD MONITOR ONLY MEANINGFUL ACTIVITIES AND RESULTS,
REGARDLESS OF MEASUREMENT DIFFICULTY
3. CONTROLS SHOULD BE TIMELY SO THAT CORRECTIVE ACTION CAN BE TAKEN BEFORE IT
IS TOO LATE
4. LONG-TERM AND SHORT-TERM CONTROLS SHOULD BE USED
5. CONTROLS SHOULD AIM AT PINPOINTING EXCEPTIONS
6. EMPHASIZE THE REWARD OF MEETING OR EXCEEDING STANDARDS RATHER THAN
PUNISHMENT FOR FAILING TO MEET STANDARDS
 ALIGNING INCENTIVES

• ENSURES CONGRUENCE BETWEEN THE NEEDS OF A

CORPORATION AS A WHOLE AND THE NEEDS OF THE
EMPLOYEES AS INDIVIDUALS, MANAGEMENT AND THE BOARD
OF DIRECTORS SHOULD DEVELOP AN INCENTIVE PROGRAM
THAT REWARDS DESIRED PERFORMANCE.
THREE TAILORED APPROACHES TO MEASURE
REWARDS WITH EXPLICIT STRATEGIC OBJECTIVES
AND TIME FRAMES

1. WEIGHTED-FACTOR METHOD- PARTICULARLY APPROPRIATE FOR MEASURING AND

REWARDING THE PERFORMANCE OF TOP SBU MANAGERS AND GROUP LEVEL
EXECUTIVES WHEN PERFORMANCE FACTORS AND THEIR IMPORTANCE VARY FROM ONE
SBU TO ANOTHER.
2. LONG-TERM EVALUATION METHOD- COMPENSATES MANAGERS FOR ACHIEVING
OBJECTIVES SET OVER A MULTIYEAR PERIOD. AN EXECUTIVE IS PROMISED SOME
COMPENSATION BASED ON LONG-TERM PERFORMANCE.
3. STRATEGIC-FUNDS METHOD- ENCOURAGES EXECUTIVES TO LOOK AT DEVELOPMENTAL
EXPENSES AS BEING DIFFERENT FROM EXPENSES REQUIRED FOR CURRENT
OPERATIONS
AN EFFECTIVE WAY TO ACHIEVE THE DESIRED STRATEGIC
RESULTS THROUGH A REWARD SYSTEM IS TO COMBINE THE
THREE APPROACHES:
1. SEGREGATE STRATEGIC FUNDS FROM SHORT-TERM
FUNDS, AS IS DONE IN THE STRATEGIC-FUNDS METHOD.
2. DEVELOP A WEIGHTED-FACTOR CHART FOR EACH SBU.
3. MEASURE PERFORMANCE ON THREE BASES: THE
PRETAX PROFIT INDICATED BY THE STRATEGIC FUNDS
APPROACH, THE WEIGHTED FACTORS, AND THE LONG-
TERM EVALUATION OF THE SBUS’ AND THE
CORPORATION’S PERFORMANCE