Performance Measurement,

Balanced Scorecards, and

Performance Rewards
Mission and Values Statements
Underlies organizational goals and objectives

 Missionstatement
Values statement
 Reflects thethe
Expresses organization’s
organization’s
culture
purposes
 Identifies fundamental
how the organization
beliefs about
will meet
whatits
is targeted
importantcustomers’
to the
needs through products or services
organization
 Communicates organizational purpose and intentions to external
parties and to employees
 Provides a basis for setting organizational strategy

Without short-run success,

there will be no long-run success.
Without long-run planning,
short-run success will probably fade
rapidly.
Performance Measures
 Use performance measures to:
 Implement strategies that apply resources to
activities
 Gauge the effective and efficient use of
organizational resources
 Provide proof of a firm’s competitive advantages
 Enhance organizational communication
 Motivate managers
 Implement organizational control over activities
 Evaluate comparative managerial performance
Designing a Performance
Measurement System
 Assess progress toward goals and
objectives
 Awareness of and participation in
developing measures
 Appropriate skills, equipment, resources,
information, and authority to achieve goals
and objectives
 Timely and useful feedback
 Flexible system for new conditions
Assess Progress

 Use multiple performance measures

 Financial performance measures
 Customer satisfaction
 Zero defects
 Minimal lead time to market
 Social responsibility for environment
Awareness and Participation

 Communicate standards to those being

measured
 Workers act specifically in accordance with

how they are measured

 Participation in setting standards forms a
“social contract”
 Workers understand and accept the

standards
Tools for Performance and Feedback

 Tools for performance

 Adequate equipment, resources,
information, and authority
 Performance measures needed in decentralized firms
 Monetary and nonmonetary benchmarks
 Feedback
 Positive and negative feedback
 Given on continuing basis to avoid surprises
 Ultimate feedback provided by short-run financial measures
Short-Term Financial Performance
Measures
 Divisional profits
 Achievement of budget objectives
 Variances from budget or standard
 Cash flow—Statement of Cash Flows shows
 Sources and uses of cash
 Quality of earnings
Evaluating Responsibility Centers
 Cost Center
 Variances from budgeted costs

 Revenue Center
 Compare budget to actual revenue

 Profit and Investment Centers

 Revenue and expense variances

 Net cash flow

 Return on Investment (ROI)

 Residual Income (RI)

 Economic Value Added (EVA)

Return on Investment (ROI)
Return on = Income
Investment Assets Invested

 Income
 Segment or operating
 Before tax or after tax
 Assets
 Total assets utilized, total assets available or net
assets
 Plant assets at original cost, book value, current
value
 Beginning, ending, or average assets
Return on Investment (ROI)
Dupont Formula
Return on = Income Sales
Investment Sales * Assets Invested

Profit Asset
Margin Turnover

Increase ROI
Increase sales price (if it does not impact demand)
Decrease expenses
Decrease dollars invested in assets
Residual Income (RI)
Residual Income =
Income – (Target Rate * Asset Base)

 RI is the profit earned that exceeds an

amount “charged” for funds committed to the
center
 Make additional investments in assets as
long as RI is a positive number
Residual Income (RI) Illustration

 Top management establishes a minimum rate

of return
12%
 Multiply the asset base (P100,000) by the
minimum rate of return
P100,000 * 12% = P12,000 (required return)
 RI is income ($30,000) minus the required
return
P30,000 – P12,000 = P18,000 (RI)
 Economic Value Added (EVA) ®
After-Tax Profits – ( Cost of Capital %*Invested Capital)

 Measure of profit above the cost of capital

 Capital is market value of total equity and
interest-bearing debt
 EVA provides a better measure than ROI if market
value is much greater than book value
 Short-term measure may discourage
investment in long-term projects
 Invested capital increases before profits
ROI, RI, EVA Limitations
 IncomeInvestment Base
Asset

Income
Assets maycanbebeunderstated
manipulated
(R&Donexpensed)
short-run basis

 Current management
To compare, may bemust
all segments judgeduseon the
decisions
sameofaccounting
previous managers
 Assets
methods not restated for changing (rising) price levels (older assets will
 report
Income higher ROI) on accrual accounting; cash flows and time
is based
 ROI, RI,ofEVA
value do not
money are measure performance relative to
not considered
company-wide objectives
 Can lead to suboptimization of resources
Short-Term versus Long-Term
Objectives
 Short-run objectives
Long-term objectives
 Investments
Effective andinefficient
resources
management of
  Operating
Enhance activities position through customer
competitive
satisfaction
 Financing activities

 Investing activities
Nonfinancial Measurements

 Can be clearly articulated and defined

 Are relevant to the objective
 Can trace responsibility
 Rely on valid data
 Have target objectives
 Have established internal and/or
external benchmarks
Advantages of Nonfinancial over
Financial Performance Measures
 Relevant to nonmanagement
Indicate productive activity and employees
future cash flows
 Appropriate
Timely; more measure of teamwork;
apt to identify focusand
problems on potential
processesbenefits
not outputs

 Cross-functional performance
Reflect leading indicators measuresthat create shareholder wealth
of activities

 Comparable for benchmarking
Cause goal-congruent externally
behavior rather than suboptimization

 Aligned withwith
Integrated reward systems; measures
organizational under control
effectiveness; focus onof processes
lower-level
employees
rather than outputs
Selecting Nonfinancial
Performance Measures
 Identify critical success factors
 Direct causes of achievement of organizational
goals and objectives
 Choose some short and long-run attribute
measures of critical success factors
 Use qualitative and quantitative measures
 Limit the number of measures
Throughput
 Number of good units or quantity of services
that are produced and sold within a specified
time
 Increase throughput in time and in quality
 Decrease non-value-added activities
 Increase total unit production and sales
 Decrease per-unit processing time
 Increase the process quality yield
 Throughput Formula Good Units
Total Time

Manufacturing Process
Process
Cycle X X Quality
Productivity
Efficiency Yield

Value-Added Total Units

Processing Time Value-Added Good Units
Total Time Processing Time Total Units
Comparison Bases

 Establish benchmark
 Assign specific responsibility
 Monitor and report at appropriate intervals
Multiple Measures

 Measures
Areas
 Human resources
Internal and external
 Short run and long run
Market
 Qualitative
Costs
 Quantitative
Returns (Profitability)
 Nonfinancial
 Financial
Balanced Scorecard

Internal
Financial Business

Learning and
Customer Growth
Balanced Scorecard Measures
 FinancialBusiness
Internal
 Process quality yield issues
Shareholder-relevant
 Cycle
Profitability
efficiency
 Time
Organizational
to market growth
 On-time
Market price
delivery
of stock
  Cost variances
Customer
 Learning and Growth
 Lead time

 Number
Quality of patents or copyrights
 Percentage
Service of R&D projects that are patentable
 Time
Price of R&D from conception to commercialization
 Percentage of capital invested in “high-tech” projects
Multinational Performance Measures

 Flexible performance measures should:

 Recognize differences in
 Sales volumes
 Accounting standards
 Economic conditions
 Risks
 Use qualitative measures
 Market share
 Quality improvements
 Inventory management improvements
 New product development
Plan Performance Reward Model
Set strategic goals

Identify critical success factors, set

operational targets and compensation strategy

Identify performance measures

Set performance rewards

Employee or employee group performs tasks

Measure/monitor performance

Determine rewards
Traditional Compensation Strategy

 Top managers
 Salary and significant financial incentives
 Middle managers
 Salary and raises based on performance and
bonuses
 Workers
 Wages and small bonuses
Pay-for-Performance Plans

 Correlation with organization targets

 Maximization of shareholder wealth
 Appropriate time horizon
 Long-run perspective
 Reward with stock or stock options
 Subunit mission
 Employee perspective relative to commitment
 Balance of group and individual benefits
Setting Performance Measures
Minimize risk to Incentives Worker Pay and
worker of random Relative to Performance
effects Organization Links
Level
Worker Specific, short-run Weighted toward Rely more on
measures monetary and results-based
short-term evaluations; rely
measures less on direct
supervision
Upper Less specific, Weighted toward
Management longer-time nonmonetary and
horizon, long-term
organization measures
longevity
measures
Profit Sharing

 Contingent on organizational success

 Current and/or deferred incentives in form of
cash or stock
 Allocated among employees based on
 Personal performance measures
 Seniority
 Team performance
 Managerial judgment
 Specified formulas
Employee Stock Ownership Plan
(ESOP) and Nonfinancial Incentives
 ESOP
 Profit-sharing compensation invested in company
stock
 More valuable as company stock price increases
 Employees lose some or all benefits if company
goes bankrupt
 Nonfinancial incentives
 Recognition of efforts
 Participation in decision making
Tax Treatments of
Compensation Elements
 Full and immediate taxation
 Tax deferral—pay tax at a future date
 Tax exempt—pay no tax
Global Compensation

 Expatriate compensation
 Domestic base salary and fringe benefits plus
adjustments for:
 Cost of living—housing, education, security, spouse’s
loss of employment
 Currency fluctuations
 Tax implications
 Retirement benefits in home currency