OBJECTIVES, CRITICAL SUCCESS FACTORS AND PERFORMANCE METRICS

By the end of this lesson students should be able to;

a) Explain the significance of considering critical success factors in performance
management.
b) Understand the relationship that exists between objectives, Critical Success Factors
(CSFs) and Key Performance Indicators (KPIs).
c) Discuss strategic performance measures in the private sector
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Critical success factors are those aspects of a product or service particularly valued by
customers and therefore those which the business must excel at to outperform competitors.

- When the business develops its measures of performance it needs to set them using the
particular critical success factors relevant to its performance. For instance, customers
may consider technical quality, and reliability as particularly important when buying a
laptop.

- Performance measures are the means by which management can see whether the
objectives are being met. When the business draws up performance measures from its
objectives it must make sure these include measures of the aspects of performance it has
identified as crucial to success (ie its CSFs).

So, for example, the laptop manufacturer would develop performance measures to
include technical quality and reliability. These could be measured through quality
inspections before the laptops leave the plant, remedial works on faulty machines sent
back or customer surveys.

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Objectives, critical success factors and key performance indicators

- It is important to understand how objectives, critical success factors (CSFs) and key
performance indicators (KPIs) relate to each other.

Once an organisation has established its objectives, it needs to identify the key factors and
process that will enable it to achieve those objectives. These key factors are the CSFs. In effect,
the CSFs are the building blocks which will enable an organisation to implement its mission and
thereby achieve future success.

However, once an organisation has identified its CSFs, it also needs to know whether it is
delivering on them. This is done by using KPIs, which measure how well the organisation is
performing against its CSFs. The KPIs are the hard data which tells the organisation how well it
is performing. KPIs must be measurable.

CSFs and KPIs are crucial for enabling an organisation to achieve its mission:
- Vision and mission: The organisation’s vision is a statement of its aspirations or what
it wants to be in the future. The organisation’s mission expresses its fundamental
objectives; what it wants to achieve.
- CSFs The CSFs are the building blocks which will enable an organisation to implement
its mission and thereby achieve future success.
- KPIs KPIs are the measures which indicate whether or not the CSFs are being achieved.

Example
We can look at the relationship between objectives, CSFs and KPIs by looking at an example of
a
supermarket.

Let us assume it has defined two of its objectives as follows:

- To ensure the loyalty of its customers ('to generate lifetime loyalty')

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 - To ensure its prices are at least 2% cheaper than the average of rival supermarkets' ('to
create value for customers')

The supermarket then needs to identify the critical success factors which will help it achieve
those
objectives. These CSFs could be:
- Stocking the goods that customers most want to buy
- Making the shopping experience as pleasant as possible
- Refining internal processes to operate the business on a cost effective basis
- Using economies of scale to source appropriate goods as cheaply as possible

Then in order to measure how well it is performing against these CSFs, the supermarket needs
to set KPIs. Example KPIs could be:
- The proportion of goods taking more than a week to sell.
- Results of customer feedback surveys
- Percentage of customers who are repeat customers
- Market share
- Cost measures and progress against savings targets
- Cost savings in procurement; results of benchmarking prices or costs against rivals

To be SMART (Specific, Measurable, Attainable, Relevant, and Time-bounded), the KPIs

should include numerical targets and deadlines, ideally aiming at continuous improvement.

STRATEGIC PERFOMANCE MEASURES IN THE PRIVATE SECTOR

Whereas the public sector tends to use non-financial indicators, the profit-making private sector
tend to favour financial performance measures. There are four main groups of such measures.
1. Those covering growth
2. Those covering gearing
3. Those covering liquidity
4. Those covering profitability

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Significance of long-term owner focus
a) As maximising shareholder wealth is a long-term goal for a business, inevitably
managers must decide between what funds they want to disburse now and what funds
need to be maintained in the business to ensure the prospects of long-term profitability.
b) Shareholders own the business and so the directors of the company have a duty to
safeguard their interests.
c) What the shareholders require as a return is used to judge the validity of investment
projects.
d) Shareholders assess the quality of management by how well the business performs
financially.
e) Shareholders are the principal source of capital investment in a business. They provide
funds on share issues or permit managers to retain profits for investment.

What are shareholders interested in?

1. Current earnings
2. Future earnings
3. Dividend policy
4. The relative risk of the investments compared to other investments and the return
available

Difficulties of incorporating shareholder concerns in performance measurement for

managers

1. Accounting. Shareholders are interested in future returns whereas accounts generally

provide historic information. Accounting measures such as ROCE do not measure
shareholder wealth.
2. Shareholders have a different assessment of risk to managers. Managers, typically,
worry about their careers, which don't concern shareholders at all. Shareholders are
concerned about the security of the investment and the likelihood of making a return.

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 3. At operating level, it is not easy to identify exactly how well a business is doing in
relation to other businesses.
4. Any other yardstick than shareholders' objectives effectively means that managers may
run an organisation in their own interests.

Why should managers bother to know who their shareholders are?

A company's senior management should remain aware of whom its major shareholders are, and it
will often help to retain shareholders' support if the chairman or the managing director meets
occasionally with the major shareholders, to exchange views.
1. The company's management might learn about shareholders' preferences for either high
dividends or high retained earnings for profit growth and capital gain.
2. For public companies, changes in shareholdings might help to explain recent share price
movements.
3. The company's management should be able to learn about shareholders' attitudes to
both risk and gearing. If a company is planning a new investment, its management
might have to consider the relative merits of seeking equity finance or debt finance and
shareholders' attitudes would be worth knowing about before the decision is taken.
4. Management might need to know its shareholders in the event of an unwelcome takeover
bid from another company, to identify key shareholders whose views on the takeover bid
might be crucial to the final outcome.

Aligning shareholder and manangerial goals

One way of rewarding managers is share options:
a) This is regarded as a good thing as it means that managers have a direct financial interest
in increasing owner wealth, ensuring goal congruence.
b) Drawbacks are more subtle.
i. Managers are rewarded for past performance and the rewards are often immediate.
They may be incentivised to take short-term measures and ignore the long term.
ii. There may be a general rise in share prices which is not performance related.

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SURVIVAL AND GROWTH
Successful businesses might report expanding sales volumes, manufacture prestigious brands,
receive awards and recognition and be a good company to work for. These may be desirable
achievements and objectives but they are not enough to guarantee the survival and growth of an
organisation.

The clearest measure of success for a business is continued existence and expansion. It is widely
accepted that growth requires profits and that growth produces profits; growth without profits
can mean a company is taken over or goes into liquidation, that it does not survive.

So whatever else it aims to do, a business must make profits and make them in perpetuity.

The potential conflict between survival and growth

There can be a conflict between the survival and growth of a business.

Survival often entails lower risk choices such as deciding to stay in an existing profitable
market where returns are stable and predictable. However, in the future the market may contract
and profits start to decline.

Survival may be a choice reflecting limited options, especially in a recession where all
companies
in a market are struggling.

If companies are focused on survival, this can often lead to management’s attention being
concentrated on cost-cutting. This may either be through spending cuts – for example, reducing
marketing spend, renegotiating purchasing contracts – or through laying off staff (redundancies).

Growth can require a business to seek new opportunities, for example expanding internationally
or developing new products. However, in order to do pursue growth, an organisation may have to
sacrifice its current security against the prospect of future returns.

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Funding and cash flow may play a vital part in any growth decision. Does the company have
sufficient funding in place to support the growth, or will it need to secure additional funding?
Can it do so?
This identifies that shareholders and banks could be key stakeholders, and they will have a keen
interest in the business’ performance to date.

Investors will use ratio analysis to assess the potential levels of risk and return relating to
their
investment. They will be concerned with dividends, market prices, level of debt versus equity,
and so on.

Banks who have given loans are interested in receiving the payments due to them, so will want
to know how liquid the business is.

Equally, suppliers will be concerned with the business’ liquidity, with a view to being paid, on
time, for goods and services they have supplied.

Managers are interested in ratios that indicate how well the business is being run, and also how
the business is doing in relation to its competitors.

Measures of growth
Despite the overriding importance of profits, growth can be measured in a number of ways.

1. Revenue: In the long term, growth in revenue is only really valuable to investors if it
means growth in profits

2. Profitability: Growing profitability is more useful if it is related to the level of

investment

3. Return on investment; A growing return on investment suggests that capital is being

used more Productively

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 4. Market share Growth in market share is generally regarded as a good thing, as it can
generate economies of scale

5. Number of employees Shareholders are interested in productivity and profit per

employee. An increasing head count is a measure of success if people are needed to
deliver a service but people need to be employed productively.

6. Number of products; Growth in the number of products is only useful if the products
are profitable

7. Cash flow This is one of the most important measures of growth as it ultimately
determines how much a business has to invest

MEASURES OF PERFOMANCE IN PRIVATE SECTOR

Performance measurement aims to establish how well something or somebody is doing in

relation to a plan.

Performance measures may be divided into two types.

i. Financial performance indicators.
- Financial measures are typically measures relating to revenues, costs, profits, return
on capital, asset values or cash flows. Actual performance is often measured against a
financial plan, such as a budget.

ii. Non-financial performance indicators

- Non-financial measures may relate to a number of different aspects of performance, such
as:
 Product or service quality
 Reliability

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  Speed of performance
 Risk
 Flexibility
 Customer attitudes
 Innovation
 Capability
 Pollution
- Non-financial aspects of performance are often a good indicator of future financial
performance.
- Strong financial performance is not achievable over the long term unless nonfinancial
performance is sufficiently strong to sustain the business.
- Some performance measurements combine financial and non-financial aspects of
performance, especially performance that relates to the efficiency of resource utilisation
or capacity utilization

Performance measures
The performance measures that are used will vary between organisations. Different measures are
appropriate for different businesses. Other factors that influence the design of a performance
management system are:
a) Measurement needs resources – people, equipment and time to collect and analyse
information. The costs and benefits of providing resources to produce a performance
indicator must be carefully weighed up.
b) Performance must be measured in relation to something, otherwise measurement is
meaningless.
- Overall performance should be measured against the objectives of the organization and
the plans that result from those objectives.
- If the organisation has no clear objectives, the first step in performance measurement is
to set them.
- The second is to identify the factors that are critical to the success of those objectives.
c) Measures must be relevant. This means finding out what the organisation does and how
it does it so that measures reflect what actually occurs.

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 d) Short and long-term achievement should be measured. Short-term targets can be
valuable, but exclusive use of them may direct the organisation away from opportunities
that will mean success for the business in the long-term.
e) Measures should be fair. They should only include factors which managers can control
by their decisions, and for which they can be held responsible. Measuring controllable
costs, revenues and assets may prove controversial however.
f) A variety of measures should be used. Managers may be able to find ways to distort a
single measure, but should not be able to affect a variety of measures. The balanced
scorecard provides a method of measuring performance from a number of perspectives.

g) Realistic estimates may be required for measures to be employed. These include

estimates of financial items whose value is not certain, such as the cost of capital, and
estimates of the impact of non-financial items.
h) Measurement needs responses, above all managers to make decisions in the best interests
of the organisation.
- Managers will only respond to measures that they find useful.
- The management accountant therefore needs to adopt a modern marketing philosophy to
the provision of performance measures: satisfy customer wants, not pile 'em high and
sell 'em cheap.

Quantitative and qualitative performance measures

i. Quantitative information is information that is expressed in numbers and by
measurements.
- An example of a quantitative performance measure is: 1,000 units were produced in 50
hours at a cost of K15 per unit

ii. Qualitative information is not numerical, and may relate to issues such as customer
loyalty, employee morale and capability.
- Qualitative information can sometimes be converted into quantitative values through
tools such as ranking scales. For example 1 = Good, 2 = Average, 3 = Poor.

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 - An example of a qualitative performance measure is 'Market research indicates very
strong and positive consume response to the new product.'

- Qualitative measures are by nature subjective and judgmental but they can still be
useful. They are especially valuable when they are derived from several different
sources, as the likelihood of an unreliable judgement is reduced.

Financial performance indicators (FPIs)

- Financial performance indicators analyse return on capital, profitability, liquidity and
financial risk, often in relation to a plan or budget, or in relation to performance in
preceding time periods.
- Financial indicators (or monetary measures) include:
i. Profit (both gross profit and net profit)
ii. Revenue
iii. Costs
iv. Cash flows
v. Debt and gearing.

The two most common ways of using financial measures to assess performance are:
i. Comparing actual results with the budget or another financial plan.
ii. Comparing performance in the most recent time period with performance in a
corresponding previous time period (or analysing a trend over time).

- Financial measures may be presented as ratios, such as gross profit margin (gross
profit/sales), and return on capital employed (net profit/capital employed).

- Monetary amounts have meaning only in relation to something else. Financial results
should be compared against a benchmark such as:
 Budgeted sales, costs and profits.
 Standards in a standard costing system.
 The trend over time (last year/this year, say).

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 The results of other parts of the business.
 The results of other businesses.
 Future potential (for example the performance of a new business may be judged in
terms of nearness to breaking even).

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