An investigation into the optimal

performance measurement for investment

centers in logistic industry
(Management Accounting)

Name: Yuqi Chen

Student Number: 369307

Professor: Ted Welten

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Table of Contents
CHAPTER 1: INTRODUCTION 3

CHAPTER 2: RESPONSIBILITY CENTERS AND INVESTMENT CENTERS 5

INTRODUCTION 5
RESULTS 5
CONCLUSION 7

CHAPTER3: THE PERFORMANCE MEASURES IN INVESTMENT CENTERS 7

INTRODUCTION 7
RESULTS 8
CONCLUSION 14

CHAPTER 4 : RELEVANCE OF PERFORMANCE MEASURES TO LOGISTIC INDUSTRY 15

INTRODUCTION 15
RESULT 15
CONCLUSION 17

CHAPTER 5 : CRITERIA TO EVALUATE EACH PERFORMANCE MEASUREMENT 17

INTRODUCTION 17
RESULTS 17
CONCLUSION 20

CHAPTER 6 COMPARISONS AMONG PERFORMANCE MEASUREMENTS 22

INTRODUCTION 22
RESULTS 23
CONCLUSION 26

CHAPTER 7: CONCLUSION 28

BIBLIOGRAPHY 29

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Chapter 1: Introduction
In today’s work place, performance improvement and the role of performance
management is an increasingly popular topic (Success factors, n.d). In a decentralized
company, organizational unit managers are normally responsible for the profits
generated. Additionally, they have the power to influence the assets employed (Anthony
et al, 2014), making the investment center a responsibility center (definitions of
responsibility center and investment center will be clarified later). In these investment
centers, performance measurement systems were developed as a means of monitoring
and maintaining organizational control, which is the process of ensuring that an unit aims
at strategies that lead to the achievement of its overall goals and objectives (Maditinos,
Sevic, & Theriou, 2006). Performance measures, the components of performance
measurement systems, play a significant role because they are regarded as forward-
looking indicators which help management to predict an investment center’s economic
performance and reveal the necessity of improving operational decisions (Otley, 1999)
(Simons, 1999) (Nanni, Dixon, & Vollmann, 1990).

However, the choice of performance measures is one of the most critical challenges
facing organizations (Knight, 1998). Wrong signal might be produced due to poorly
chosen performance measures, and this would lead to poor decisions and bad results
(Maditinos, Sevic, & Theriou, 2006). For instance, many financial analysts tend to use
return on equity as the best company performance measurement. Nevertheless,
management can always maintain a healthy ROE for a while by growing debt leverage
and share buybacks event though operational profitability is eroding (Hagel, Brown, &
Davison, 2010).

The fact mentioned above leaves a room to investigate what is the optimal performance
measurement for investment centers. In order to narrow down the investigation range,
only one industry that is logistics industry will be focused on. Logistics is a backbone for
the global supply chains. It plays a significant role in both micro and macro perspective.
From micro perspective, logistics industry offers services that could fulfill customer’s
needs. From macro perspective, it keeps contributing to a country’s economic
development (Baker et al, N.D). For example, it was reported that the Malaysia logistics
3
industry made great contribution to the gross domestic product (GDP), i.e. 13%(Malaysia
Logistics Council, 2013). In a global supply chain context, moving goods across borders
has been one of its significant role recently and the international expansion of logistics
industry requires better performance measurements. Yet many companies do not use an
optimal performance measurement although they admit the fact that logistic industry is
developing. Hence, this paper is aiming at giving a specific answer to what is the optimal
performance measurement for investment centers in logistics industry. By these given
answers, companies in logistics industry are able to choose a suitable performance
measurement so that they could obtain a more accurate result, conducting a more
effective compensation plan, identifying opportunities for improvements and comparing
performance against internal or external standards (Department of Trade and Industry,
N.D).

Therefore, the central research problem of this paper is:

What is the optimal performance measurement for investment centers in logistics

industry?

The research will be carried out as follows: in the next section a literature review shall be
conducted which will be used to answer several sub-questions in support of the main
question.

The first sub-question is:

S1: what are responsibility centers and what is investment center?

The following question then is:

S2: What are the performance measures used in investment centers?

After answering the second question, a comparison among these performance

measurements will be made in order to choose an optimal performance indicator in
logistics industry. However, before making this comparison, the relevance of performance
measures to logistic industry and several criteria need to be chosen for the purpose of
comparisons first. Hence, the following three sub-questions are:
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S3: How are performance measures relevant to logistic industry?

S4: What criteria should be chosen to evaluate each performance measurement?

S5: How are these performance measurements compared to each other in

investment centers in logistics industry?

In the third section, the conclusion will be drawn based on the results of the literature
review to close the whole discussion.

Chapter 2: Responsibility centers and investment centers

Introduction
This chapter is aiming at clarifying theoretical definitions of responsibility centers and
investment centers. Sub-question that needs to be answered is as follows:

S1: what are responsibility centers and what is investment center?

Results
In a company with a decentralized structure, daily operations and decision-making
responsibilities are delegated by top management to middle and low-level managers
within the organization, allowing top managers to focus more on major decisions and
overall strategic planning. Since unit managers have accepted authority and
accountability and each manager is responsible for assets and activities which are
defined by responsibility centers, making these independent business units responsibility
centers (Holtzman, 2013). A responsibility center exits to achieve objectives. The
company as a whole has its goal, and senior management decides on a set of strategies
to achieve these goals. Responsibility centers are there to help implement these sets of
strategies. This decentralized structure with responsibility centers has several
advantages. First, employees are given more autonomy. They can make better use of
their knowledge and experience they have gained and implement some of their own
ideas. Second, managers can make decisions more efficiently. Managers can react to

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situations more fast instead of waiting for top managers’ command. And third, it is easy
to measure the performance of units’ managers when there is less influence coming from
top management and make adjustments based on these measurements.

There are roughly four types of responsibility centers: Revenue center, Cost center, Profit
center and Investment center (Anthony et al, 2014). These four main responsibilities are
assigned to business units based on the analysis of their core operations. The core
operations are analyzed through the relationship between inputs and outputs. In revenue
centers, output is measured in monetary terms and managers are responsible for revenue
only. Here, input is not directly related to output because these outputs are partially
dependent on the company’s marketing function. Expense center can be divided into two
categories: engineer expense center and discretionary expense center. The former
means that outputs are measured in physical terms, and an optimal relationship can be
established between inputs and outputs. Output is purely dependent on a company’s
manufacturing function. In the latter case, an optimal relationship between inputs and
outputs cannot be established since these expenses are resulted from research and
development activities, thus hard to be controlled. In profit centers, both revenues and
expenses are measured and managers are responsible for profits. Here, outputs are
measured in monetary terms and inputs are directly related to outputs because the cost
of inputs decides how much outputs you can get.

The last one is investment center and this paper will only focus on this one. Investment
center is an organizational unit that responsible to top management for its profitability in
relation to the unit’s own investment base. In investment centers, revenues, expenses
and assets employed are measured (James & Cool, 1978). Outputs, which are measured
in monetary terms, are related to the capital employed and inputs. The purposes of
measuring assets employed are analogous to the purpose of profit centers in two ways:

1.To provide information that is useful in making sound decisions about assets employed
and to motivate managers to make decisions in the best interest of the company.

2. To measure the performance of the business unit as an economic entity.

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Management evaluates an investment center based on its return on those assets invested
(Accounting Tools, 2012). An example of investment center in logistic industry is Amazon
logistic department. Amazon is the largest internet-based retailer in the United States. It
is selling electronic products, books and nowadays, even food and clothes online. In order
to make sure that its delivery is efficient and on time, Amazon keeps improving its logistic
chain. Today, Amazon logistics is not only just logistics department for delivering products
of Amazon, it is also a more independent business unit in logistic industry, which offers
delivery services for other companies as well. Managers in logistics divisions are
responsible for their own performances.

Conclusion
This section clarifies theoretical definitions of responsibility centers and investment
centers. Findings are summarized as follows: 1) responsibility centers are decentralized
divisions, where managers are responsible for assets and activities, which are defined by
responsibility centers. There are four types of responsibility centers: revenue centers,
expense centers, profit centers and investment centers. The criteria, which are used for
assigning responsibilities, are the core operations of the unit and the measurement
possibilities of input and output 2) Investment centers are one type of responsibility
centers, where managers can relate its profitability to its investment base. Methods,
which measure these investment centers’ performance, will be discussed in next section.

Chapter3: The performance measures in investment centers

Introduction
This chapter mainly focuses on answering the sub-question: what are the performance
measurements in investment centers. There are roughly two types of performance
measurements: non-financial measures and financial measures. In this paper, non-
financial measures are referred to market measures and financial measures are referred
to accounting measures. Accounting measures can be divided into two categories: ratio
measures such as return on investment and residual income. Other than traditional

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residual income measures, an important extension form of residual income method is
economic value added method. (Merchant & Van der Stede, Management Control
Systems, 2011). In this paper, all measurements mentioned above will be described in
detail. The sub-question to be answered is as follows

S2: What are the performance measurements used in investment centers?

Results
According to Merchant and Van der Stede, market measures are any measures for which
the value created can be measured directly for any period as the sum of the dividends
paid to shareholders in the measurement period plus, or minus the change in the market
value of the stock (Merchant & Sandino, Four Options for Measuring Value Creation,
2009). He believes that market measure can be used in a financial. However, other
researchers believe that market measurements cannot be expressed in a financial term
since they are brought up for compensating the drawbacks of traditional financial
measures. Hoque and Mia argue that in today’s environment of global competition, other
than traditional financial measures, market measures should be focused on non-financial
aspects, in order to make the whole performance measurement system more
multidimensional. It is supposed to provide executives with continuous signals as to what
is most important in their day-to-day activities and where efforts must be directed (Hoque
& Mia, 2001). Kaplan & Norton possess the same idea. They believe that non-financial
dimensions including customer, internal business processes and learning and growth
should be taken into considerations (Kaplan & Norton, 1996). In addition, according to
David M. Raab, he argues that there should be some non-value market measures that
marketers need to build into their reporting systems (Raab, 2012). For instance,
benchmarks, strategy goals and projections. Benchmarks is helping to place the
numbers, which can be this year’s revenue or next year’s market plan, in the context in
order to have a sense of whether these numbers are good or bad. Strategy goals, on the
other hand, help the managers have an insight of the cumulative impact of deviations
from the original plans. This market measure can provide them with direct indicators of
strategic objectives. In this way, long-term goals would not fade away because managers
start making choices based on day-to-day result. Besides, projections make the mangers
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understand the factors that determine the future results. Changes in these factors provide
an insight of development opportunities or competitive risks.

A second measure of performance is accounting measures. Accounting measures of

performance have been the traditional mainstay of quantitative approaches to
organizational performance measurement (Neely, 2007). They are also referred to
financial measures. Andy Neely outlines three functions of financial measures. They are:

1) The use of financial measures of performance as a tool of financial management.

2) The role of financial performance as a major objective of a business organization

3) The function of financial performance measure as a mechanism for motivation and

control within the organization. (Neely, 2007)

Although the functions of financial measures are widely admitted in the past decades,
and they definitely contribute to business control and motivation within organizations,
nowadays people have doubts regarding to these financial measures functions, especially
the third one. After all, a financial number just reveals result from a financial perspective.
But, how about other perspectives that are equally important to financial perspectives?
Do accounting measures motivate and control managers in those aspects too?

Mostaque Hussain finds that non-financial measures can play a significant role in
motivating and controlling managers’ decision making too. Non-financial measures
contain more specific information. Also he finds that there is a trend of using non-financial
performance measures (Hussain, 2005). This finding is remarkable because it focuses
on the functions of non-financial measures and these functions can partially replace those
of financial measures. Although Mostaque Hossain only focuses on financing service
industry, but his findings are very useful for this paper.

However, there are still researchers who believe that some functions of financial
measures cannot be replaced. This section will only focus on important representatives
of accounting measures: ROI, RI and EVA as well as their functions.

ROI
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After discussing accounting measures in general, the focus will be on one specific ratio
measure, namely return on investment (ROI). The formula for ROI is :

It can also be written as:

ROI method is a ratio measure and easy for managers and outsiders to understand and
make comparisons (Way, 2012). Also ROI method is the most widely used performance
measures (James & Cool, 1978). ROI can capture controllable aspects of performances
by not only offer accounting information, but rather, represents the underlying activities
that are being managed. Every item on balance sheet can affect ROI, which make
managers more careful of the decision they take. Besides, in an organization, there is a
need to be able to represent a variety of different activities in terms of a common language
or unit of measurement (Neely, 2007). ROI makes it possible that denominator can be
applied to any organizational unit, regardless of size or type of business. In addition,
based on the formula mention above, ROI also equals net profit margin times asset
turnover. A low capital turnover implies that the business unit needs more invested capital
to produce revenues and profits. Through this formula, ROI can graphically be shown as
different curves in a diagram, which many managers find very useful for internal
communication. Here, it can be seen that a business unit can produce 20% ROI by

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maintaining 10% profit margin and 2 asset turnover. Another business unit with 20% profit
margin onle need 1 asset turnover to reach 20% ROI.

Figure1:

Residual income

According to Solomons, residual income is a measure of managerial success (Solomons,

1983). It is money that is earned on a continual basis, but is often based from one original
activity (Schofield, N.D). He defines residual income as:

The excess of net earnings over the cost of capital

The formula for Residual Income is :

The main rationale advanced for the use of residual income in divisional performance
measurement is its consistency with the net present value for decision-making. (Egginton,
1995). An advocate of residual income is Preinreich who first demonstrates that the
present value of the stream of residual income for a project equals the net present value
of the project (Preinreich, 1938). In 1938, Preinreich showed that residual income could
be easily derived from an expression for the capital value of a machine that is, its present
value. He predicted that the ability to reconcile accounting figures with capital values is
the dominating foundation of both the residual income debate and of value management
approach. He argued that the accounting book value of a machine plus discounted excess
profits it generated equals to the capital value of the machine. Excess profits are defined
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as the differences between profit per unit of capital investment less interest per unit of
capital investment. He also used this concept to discover the relationship between
accounting figures and stock market values. In addition to Preinreich, Hicks further
described the concept of residual income but he used a different name, which is called
“economist’s income”(equal to economic income) (Hicks, 1946). He used several
formulas. First, economist’s income can be defined as :

Y(t)= K * V(t-1) = C(t) – D (t) = V(t) + C(t) – V(t-1) (1)

Where y is economic income, k is the interest rate and V(t-1) and V(t) are the present
value of future net cash flows at the beginning and end of period t. C(t) represents the net
cash flow of the period and D(t) is the depreciation in the period where D(t)= V(t-1) V(t).
This approach reveals the importance of the clean surplus concept where all gains and
losses are passed through income statement. Also, the economic income formula offers
guidelines for what adjustments can be done to RI without reducing its congruence with
capital market. One difference between economic income and residual income is that RI
attempts to provide a performance measurement for elements of the organization, that is
divisions. Edwards and Bell contributes to the RI definition through substituting
accounting figures into the economic income definition, which shows RI’s reliance on the
ideas underlying economic income (Edwards & Bell, 1961). O’hanlon and Peasnell gave
a formal formula of this issue:

(2)

Where X is residual income for period t, D(t) is depreciation expressed as the difference
between opening and closing book values A(t-1) and A(t) respectively. K*A(t-1) is the cost
of capital charged on the periodic opening book value of the firm (O'hanlon & Peasnell,
1998). Summing the discounted residual income over a project lifetime gives:

(3)
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The left hand element of the third formula is the sum of discounted residual income over
a project lifetime, which is the present value of RI. The right hand element is NPV. Hence,
it can be concluded that the essence of RI is NPV.

EVA

One extension of residual income method is named of Economic Value Added (EVA),
which nowadays is a representative measure of modern value-based performance
measurement. As Anthony et al say, economic value added focuses, among other things,
on the measurement problems of intangible non-current assets (Anthony et al, 2014).
EVA proponents suggest that a set of adjustments need to be performed to get better
measurement of profit and asset employed than only book value of asset. Thus, EVA is
calculated as :

EVA=adjusted net operating profits after taxes – (cost of capital * adjusted assets

emploed)

Most of the adjustments are related to intangible assets such as the capitalization of
research and development expenses. Some firms tend to be R&D intensive. The
capitalization of intangible assets of R&D and then amortizing them over a selected life
would change how the business unit manager views these expenditures. By viewing
these assets as long-term investments, managers will gain less short-run benefit from
reducing outlays on such items. For example, if R&D expenditures are expensed right
now, each euro of research and development cut will be a euro more in pre-tax profits.
On the other hand, if R&D costs are capitalized, each euro will reduce the asset employed
by a euro, the capital charge is then reduced only by one euro times the cost of capital,
which has a smaller impact on EVA. So when the company possesses lots of intangible
assets, EVA can reflect a more accurate performance. In addition, many articles support
this new concept by stressing that EVA gives to value creation. However, there are still
many critics of EVA for not being very different from traditional financial measures. Some
academics argue that in fact EVA is only a variation of residual income and internal rate
of return (eg. Chen and Dogg,1997; Ittner and Larcker,1998).

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Conclusion
In conclusion, there are roughly two types of performance measures: market measures
and accounting measures. It is believed in this paper that market measures are not
referred to the change of market value of stocks plus dividends. In order to differ from
traditional financial measures, market measures should focus more on market
perspective and reflect facts regarding to market elements such as customer retention
rate, strategic goals and learning and growth rate. Accounting measures are also named
as financial measures. Accounting measures are often criticized for not being able to offer
multidimensional information of investment centers and their functions are tending to be
replaced by market measures. However, based on the discussion above, there are still
some financial measures that cannot be replaced. Return on investment is the most
popular performance measures among investment centers. ROI makes it possible to
represent a variety of different activities in terms of a common language or unit of
measurement, which market measures cannot achieve. Also, because profit margin alone
is not enough for comparisons if business differ in capital turnover, managers need to
consider the effect of their decisions on balance sheet(capital turnover) as well as on
income statement( profit margin), and also consider the tradeoffs between these two.
Residual income is another branch of accounting measures. It is consistent with the net
present value for decision-making, while market measures are not. Also, it reconciles
accounting measures with capital value, yet market measures cannot relate the capital
value to its accounting measure in a simple way. Last, Economic Value Added is an
extension form of residual income. It is made some adjustments that related to intangible
assets. When it comes to measure the performance of a company which possesses lots
of intangible assets, EVA can reveal a more accurate result.

All of these performances have their own functions and they are all found being used in
investment centers in logistic industry. Like other industries, ROI is the most popular
among business units in logistic industry. However, there is a clear trend that many
logistic companies are seeking for performance measurements which not only increase
its financial figures, but also improve non-financial performance such as customer

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satisfaction rate and quality. Next section will be focused on the relevance of these
performance measures to logistic industry.

Chapter 4 : Relevance of performance measures to logistic industry

Introduction
Logistics is a backbone for the global supply chains. In a global supply chain context,
moving goods across borders has been one of its significant role recently. It plays a
significant role in both micro and macro perspective. From micro perspective, logistics
industry offers services that could fulfill customer’s needs. Logistics have influences on
customer retention rate, product delivery, and many other core business processes.
From macro perspective, it keeps contributing to a country’s economic development
(Baker et al, N.D). Unfortunately, the performance measures that many logistics
companies are using are not keeping up with the increasing position and scope of logistics
industry yet the international expansion of logistics industry requires better performance
measurements.

In this chapter, the definition of logistics industry will be clarified. Also the relevant aspects
of logistics industry to performance measures will be listed and the reasons why they are
relevant will be discussed. The sub-question will be answered by the conclusion of the
discussion is :

S3: How are the performance measures relevant to logistic industry?

Result
Logistics is the management of the flow of things between the point of origin and the point
of consumption in order to meet requirements of customers or corporations. The
resources involved in logistics process include food, materials and abstract items such as
time, energy and information. Normally, the motivation of logistics industry to import and
export is to minimize the use of resources. According to the Council of Logistics
Management, logistics includes planning, control, realization and motitoring of all
materials, and products. Other researchers believe that logistics is the process of
planning, implementing, and controlling the effective and efficient flow of goods and
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services from the point of origin to the point of consumption. This process is also referred
to the value chain of logistic companies. In a research conducted by Zhou, he contstructed
a model of logistics value chain of express enterprises through analyzing the value of the
activities in the process of express delivery. The value chain that involved in logistics
business process is: delivery of raw materials and finished goods, and production and
selling. He found that the key competitiveness of logistics industry are four aspects:
strategic location, networking optimization, value added services and performance
measures (Zhou, 2013). Performance measures play a significant role in enhancing
value-added activities in logistics process. In addition, Popova and Schut find that
performance measures play a significant role in planning process, which is a stage of
assigning individual tasks to resources at a certain point in time in logistics industry.
Lohman et al. (2004) also perceive performance measurements as elements for process
control system within logistics companies. They are used to evaluate the operational level
and adjust its goals.

Fidlerova says that the objective of logistics is to meet customer’s requirements on

products with minimum costs, but customers insist not only on delivering product on right
time on right place but they wish to fulfill their special requirements on quality and
environmental friendly products (HRDINOVA, Sakal, & Fidlerova, 2012). Hence,
performance measures are crucial in monitoring what customers really need and want. In
addition, Weber(2002) finds that performance measures which can be used to control the
business process should pay attention to performance of delivery to customers,
processing time and customs clearance time. Besides, Knemeyer et al. (2003) also
studies the perspective of a customer and he finds customer reflection of the services
that a logistic company offers significant. And performance measures can strengthen the
relationship between the companies and customers.

On the other hand, in order to achieve a balance, the management should also take the
needs and desires of other parties into account. For instance, decreasing the price of
logistics services will benefit the consumers, however, they may hurt the benefits of other
parties. Hence, performance measures can also control the management to balance the
desires of all parties. In addition to the function of offering better services to various
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parities, performance measurements also play a significant role in influencing the market
share of logistic companies. For instance, Daugherty,Stank and Ellinger(1998) find that
performance measures will influence market share indirectly through consumer
satisfaction.

Conclusion
To be concluded, performance measurements are relevant to logistic industry in many
aspects. They can enhance the value chain of the company from the process of
production to the end of delivery of the products by identifying value-added activities.
Also, they help monitor the planning process, which help to improve the efficiency and
effectiveness of usage of resources. In addition, they are influencing process control
system within logistics companies by adjusting operational goals. Lastly, they motivate
the logistics services to focus on consumers’ requirements but at the same time, fulfill the
needs of other parties. And then indirectly, they have an impact on market shares.

Chapter 5 : Criteria to evaluate each performance measurement

Introduction
Before finally start investigating what is the optimal performance measurement for
investment centers in logistics industry, some criteria which are used to do the evaluations
need to be presented. Four criteria in total are chosen and the reasons why these criteria
are selected are going to be discussed. Sub-question, which will be answered in this
section, is as follows:

S4: What criteria should be chosen to evaluate each performance measurement?

Results
According to Anthony et al, managers in investment centers receive authority and they
are responsible for the profits and the assets employed in generating profits. However, in
the meanwhile, top management still needs to monitor and control the performance of
these divisions. It might happen that these divisional managers have less incentive to
behave in the best interest of the company and this would lead to severe agency
problems. In order to avoid agency problems, they argue that performance
17
measurements should meet these two criteria, which are also the purposes of measuring
performances:

1) To provide information that is useful in making sound decisions about assets

employed and to motivate managers to make these sound decisions that are in the
best interest of the company.

2) To measure the performance of the business unit as an economic entity.

Scapens also argues that the corporate management should remain responsible for the
entire operations of the business and must exercise some control over delegated
activities (Scapens, 1979). This control function could be implemented by setting
divisional objectives, which are the criteria that define the required or desirable
performance for the division, reinforced by periodic reports of actual divisional
performance. These reports provide data for top management to monitor divisional
activities and act as a motivating tool for divisional managers. It is essential that the
performance reports be expressed in terms of the criteria that are used by the corporate
management to define the performance required of the division (Scapens, 1979). For
instance, its actual performance should be measured in terms of NPV if a division’s
objective is expressed in terms of maximizing the NPV of its projects. Otherwise, these
periodic reports might not be useful if divisional performance is measured in different
terms, such as accounting profits because managers could just focus on maximizing
performance measures instead of realizing divisional goal. Hence, it is crucial that before
choosing a performance measurement, management assigns clear objectives to each
division.

In addition, Solomon also mentions that some performance measurements do not actually
control economic profits; instead they pay more attention to managerial behavior.
However, Solomon believes that there is a distinction between the success of a division
and the success of the men responsible for managing it (Solomons, 1983). Thus, there
should be different standards of success for judging both the division and the manager.
And when it comes to measure the performance of the division, it is significant that these
performance indicators are measuring the division as an economic entity. Otherwise, unit
18
managers are not going to focus on achieving its economic goal, which will lead the unit
to develop in the wrong track. Also, since business units are results of company’s
decentralized structure, whether each unit can achieve its objective has an impact on the
whole company. Hence, it might happen that the development of the whole company is
slow down due to the mistake of one business unit.

On the other hand, some researchers disagree that choosing performance

measurements should be based on objectives of divisions. Instead, they focus more on
subjective perspective. For instance, Neely, Gregory & Platts argue that performance
measures should be derived from strategy; that is they should be used to reinforce the
importance of certain strategic variables (Neely, Gregory, & Platts, 2005). A strategy
consists of decisions that are made and actions that are taken. For example, if a business
unit’s strategy is to “produce profitably high quality cars sold in Europe”, however, one
manufacturing department manager decides to buy low-quality components, and then the
result might be that the strategy cannot be followed. Strategic visions can be difficult to
communicate, but by dividing the top goal into smaller concrete targets managers are
able to make it easier to deliver them. In this way, strategy and day-to-day operations
have a special link. Hence, performance measurements also play a significant role in
monitoring the actions that are taken and decisions that are made within the business
unit. A good performance measurement should be helpful to some subjective aspects
such as how much they follow the strategy, do the managers take right actions. These
subjective aspects will lead to reinforcement of its strategy within its company.

There is a third view regarding to the criteria that used to choose performance measures.
The researchers who possess the third view argue that “objective” and “subjective” cannot
be the only criteria to select performance measures. For instance, Muckler & Seven
argue that the distinction between “objective” and “ subjective” measurement is neither
meaningful nor useful in human performance studies. All measurement in science and
technology is necessarily filled with subjective elements, whether in selecting measures
or in collecting, analyzing, or interpreting data (Muckler & Seven, 1992). In his research,
he proposes several remarkable criteria for selecting measures. First, it has to possess
relative simplicity. In all but the most trivial cases, human and system performance
19
measurement is enormously complex, with multitudes of measurement dimensions.
Considerations should only be given to the most critical dimensions and activities instead
of all aspects of performances. Also, these measures should be simply understandable
without deep interpretation. Second, performance measures need to possess
generalizability, which means that they can be used across many researches and test
settings, leading to measurement standardization and probably to better development of
all measures. The third criterion is precision. This precision relates to two aspects: (1) the
fineness or grain of the unit measurement and (2) the accuracy or correctness of the
measurement. In the first aspect, the shorter time is always more precise than the longer
one. In the second aspect, it is crucial to guarantee the performance measurements are
accurate. Other criteria that he mentioned including adequate validity, sufficient reliability,
data-processing requirements and resource requirements. Meister (1938) also argues
that selecting performance measures based on objectivity-subjectivity distinction is not a
particularly useful or valid rule. He proposed 14 specific criteria for selecting measures:
directly relevant to the output, directly observable in task performance, not requiring
additional interpretation, reflecting critical task events, precisely definable, objective,
quantitative, unobtrusive, easily collected, without specialized instrumentation
requirements, at appropriate level etc. Among these criteria, achieving objective is just
one rule rather than the only one criterion.

Conclusion
In this paper, all three views are taken into consideration in order to choose a
multidimensional performance measurement, which best suits the fast developing and
global competitive situation of logistics industry. This paper assumes that the overall
objective of each investment center in logistic industry is to maximize its economic profit
because profit is the main responsibility of divisional managers. Hence, it is crucial that
managers strive for realizing overall divisional objectives, which is keeping maximizing
the economic profits of the divisions. Performance measures should be selected to
motivate divisional managers to realize these divisional objectives. The performance
measure should guarantee that managers set the goal of the divisions in the priority and
behave in the best interest of the whole company. Only logistics companies that achieve

20
to realize high economic profits will survive from the severe global competition. Thus, the
first criteria which is used to select the optimal performance measurement in investment
centers in logistic industry is :

 Goal congruence

Also, based on the fact that in a logistics company, sometimes a division can perform well
even though the manager performs poorly, while a good manager can be in a division
which performs badly, the criteria should also focus on a subjective perspective. Also,
logistics companies always have a clear value chain, from the stage of collecting products
to the stages of deliver them. Good performance measurement should control the
performance of each stage and improve the performance of each stage. The most
representative of performance measures from subjective perspective and able to monitor
every stage’s performance is reinforcing the strategy. It does not only control whether the
divisional strategy is inline with the whole logistics company’s strategy, but also it monitors
the actions at each stage that managers take to follow the strategy. In this way, each
manager’s action is under control of the top management and each action can be
evaluated. Therefore, the second criteria is :

 Reinforcing company’s strategy

The last criteria are the discussion results of the third point of view that a performance
measure is not necessarily objective or subjective. It can be a characteristic that a
performance measurement is supposed to possess. For instance, it should be simple in
form and easily understandable. It should be accurate and reliable. The best way to satisfy
first characteristic is to present the performance measurement in a number. Since
logistics companies have various business activities, if the performance measurements
are not conducted in a number, there will be too much variation and inconsistency among
evaluations of these activities. Also if different people carry out the measurements at
different times, it is probable that the results are also different. A number is simple and
easily understandable enough, even the outsiders of the company can evaluate the
performance based on the numbers. Presenting in a number is called quantifiable here.

21
Also, in order to be accurate and reliable, the performance measures should be measure
something controllable by managers. If they are measuring factors that cannot be
controlled, then it is unfair to evaluate the performance of them. For instance, one might
choose interest rate as a determinant of performance for a certain type of business, but
one cannot use the national bank’s base rate as a performance indicator because this
base rate is not something that can be controlled by managers, and it is not something
that a business can change. In the contrary, for example, a business’s cost of capital,
which is its exposure to certain risk, can be controlled and so this might be considered as
a performance measurement. In logistics company, it is also crucial for them to choose a
performance measurement that is controllable. Choosing something that the business
division cannot change will lead to inefficiencies and ineffectiveness. In summary, last
criteria that used to select performance measures are :

 Quantifiable and controllable

To be concluded, there are three views of criteria from researchers used to select
performance measures. First, performance measures should be based on the division’s
objective. Second, performance measures should contain some subjective elements.
Third, a performance measure does not necessarily be objective or subjective. In this
paper, four criteria are chosen and each criterion is based on one view. The four criteria
are : goal congruence, reinforcing strategy and quantifiable and controllability.

Chapter 6 Comparisons among performance measurements

Introduction
It is assumed that the overall goal of the division is to maximize NPV in this paper. Under
this assumption, the advantages and disadvantages will be discussed in this section
under each criterion: goal congruence, reinforcing strategy, quantifiable and controllable.
After that, the sub-question that is going to be answered in this section is :

S6: How are the performance measurements compared to each other in investment
centers in logistic industry?

22
Results
a) Goal Congruence

Since market measures are referred to non-financial measures in this paper, it can
provide information regarding to goal achievements of various perspectives of markets.
For instance, it can be known that whether a division has achieved its target customer
retention rate or whether a division has occupied a bigger market share. In addition, in
today’s competitive environment, businesses cannot rely solely on the narrowly focused
financial goal and internal financial measures for performance evaluations. Performances
should be judged from more aspects and market measures can balance multi aspects.
However, one can also argue that accounting measures can also work in line with the
company’ goal. When measuring the economic success of a division, the division that
generates more profits is judged more successful. However, when the performance
measurement is ROI, managers will change their focus from maximizing NPV into
maximizing ROI. Achieving high ROI can also be resulted from selling assets, destroying
long-term value, both of which are not good for the division’s long-term goal. Besides,
according to the affairs of General, ROI tends to retard incentive to growth and expansion
because it dampens the incentive of the more profitable business to grow (Lewis, 1955).
Managers are likely to dispose projects with 25% return on investment (ROI) with
preference to a 30% ROI project. This will cause profit reduction for the whole company
(Anthony et al, 2014). Besides, given an investment opportunity of which ROI is higher
than the cost of capital but below an investment center’s current ROI, the center’s
manager will forgo this opportunity (James & Cool, 1978).

Residual income has the advantage over other performance measurements in goal
congruence. There are three reasons. First, residual income in essence is NPV.
According to the formula mentioned in chapter 3, when managers accept investment
projects whose residual income is positive, it automatically means managers accept
projects with positive NPV. Since maximizing NPV of a division is overall economic goal
of investment centers, residual income is the best performance measure in controlling
goal congruence. Second, the purpose of maximizing NPV of a division is to increase
shareholder’s wealth. Wealth creation refers to changes in the wealth of shareholders on
23
a periodic basis. These changes are inferred mostly from changes from stock prices,
dividend paid and equity raised (Institute of Management Accountant, 1997). In order to
increase shareholder wealth, it follows naturally that the manager of a division should
make investment decisions based on NPV of projects (Donnelly, 2014). They will
maximize their value and hence shareholder wealth if they accept projects with positive
NPV and reject projects with negative NPV. Third, compared to ROI, residual income will
not forgo investment opportunities. One disadvantage of ROI is that managers dispose
projects of which ROI is higher than cost of capital but lower than current overall ROI,
because managers worry that these projects will lower their current overall ROI level, and
this will affect their performance evaluation. If this is the case, managers missed
opportunities of generating profits and this is not good for the goal. However, when
residual income is used, all projects with positive residual income will be attractive to
managers and managers have no need to worry about lowering its current financing
situation. EVA, as an extension form of residual income, it possesses the advantages of
residual income. Hence, EVA also works well in goal congruence.

In logistics industry, which is facing global competition and fast developing, it is significant
for those investment centers to keep realizing high economic profits and thus, managers
should only invest in projects which generate positive NPV. High economic profits lead to
wealth creation of shareholders and it supports company’s expansion and long-term
growth. Therefore, logistics companies should seriously consider residual income
method. However, it is not enough for top management to only evaluate the overall goal.
Strategic goals such as customer retention rate, market share and satisfaction rate are
also important elements of a company. It is possible that a division does not realize high
profits while it does achieve high customer satisfaction rate. Or it might happen that a
division occupies a big market share in a new market while does not realize high
economic profit. Therefore, market measures also play a significant role in realizing goal
congruence in logistics industry. So it can be concluded that residual income is a better
performance measure for evaluating overall goal but market measures are better
performance measurements for evaluating various strategic goals.

b) Reinforcing company’s strategy

24
Lamber&Larcker find that firms place relatively more weight on market performance
measures for situations in which:(i) the variance of the accounting measure of
performance measure is high relative to the variance of the market measure of
performance, (ii) the firm is experiencing high growth rates in assets and sales, and (iii)
the value of the manager’s personal holding of his firm’s stock is low (Lambert & Larcker,
1987). In these situations, firms can reinforce their strategy through market measures.
For instance, if the firm’s strategy is to increase its sales by 10%, then market measure
that focus on sales can be used. Market measures cannot only control whether the
divisional strategy is inline with the whole company’s strategy, but also it monitors the
actions that managers take to follow the strategy. In this way, each manager’s action is
under control of the top management and each action can be evaluate.

Accounting measures, on the contrary, do not meet this criterion. These internal financial
measures are incomplete and focuses on data largely historical and internal to the firm.
Kaplan & Norton believe that these traditional financial measures report on what
happened last period without indicating how managers can improve performance in the
next period (Kaplan & Norton, 1996). In addition, John Deard argues that traditional
performance measures are not set validly to meet future plans, because the historical
costs of assets- on which it is based-are meaningless in planning future action. In a word,
these accounting measures do not provide forward-looking suggestions of what should
be done to follow company’s strategy.

It is especially crucial for logistics company to follow their strategy because logistics
companies have their own value chain. From the process of receiving products,
distribution, to the time of delivery, each stage has strong autonomy. However, the
performance of each latter stage is highly dependent on the performance of the former
stage. If a manager is not following the strategy, it is likely that the managers in the latter
stage cannot follow the strategy either and the whole value chain is damaged. Hence, it
is significant that every part of this value chain is working according to the strategy to
prevent from working toward a wrong direction. Under this criterion, market measures are
better than accounting measures including ROI, traditional RI and EVA.

25
 c) Quantifiable and controllable

Market measures can be quantifiable. For instance, customer retention rate and market
share can both be expressed in absolute numbers. However, most of market measures
are not quantifiable, especially in some subjective areas such as customers’ satisfaction
rate and how much do they follow the strategy. Non-quantifiable makes the performance
measurements lack consistency among different people and there is no single standard
for top management to judge their performance. Also it makes the comparisons among
different periods impossible. In addition, they are always hard to be controlled. The
advantages of market shares are that they are forward-looking, however, this also
indicates they are not under control of the managers because managers cannot be
responsible for something that has not happened.

Accounting measures are both controllable and quantifiable. The first advantages of these
accounting measures are that they make comparisons of performances between past and
today, actual result and objective result possible. The second advantage is that these
accounting measures enable outsiders of investment centers understand their
performance situations. For outsiders who do not possess internal information, they can
judge different investment centers’ performance based on these accounting measures
and numbers are easily to be compared by these outsiders. For instance, 30% ROI is
definitely better than 20% ROI. Hence, it is straightforward for them to make decisions.

Conclusion
To be concluded, market measures are better at reaching goal congruence when
divisional managers emphasize on strategic perspectives such as objective customer
retention rate and target market share. However, when performances are evaluated
based on the achievements of overall economical goals, residual income is a better
indicator because it is similar to NPV. When you accept a project with a positive residual
income, you automatically accept a project with positive NPV. And this will lead to the

maximization of logistics company’s economic profits. ROI do not guarantee goal

congruence because managers have more incentives to maximize ratio instead of

economic profit. Reaching high ROI can be done through selling assets and reducing
26
investments, which are not beneficial for the company’s long-term development. In a

word, logistics companies should use residual income to support its economic goal and
some market measures to support its strategic goals.

In addition, market measures are best at reinforcing strategy within the company because
market measures can not only control whether the divisional strategy is inline with the
whole company’s strategy, but also it monitors the actions that managers take to follow
the strategy. Besides, market measures offer forward-looking information, which means
they indicate what the company to make improvement should do. On the other hand,
accounting measures do not provide forward-looking information. They only focus on
historical data and can only be used to evaluate past performances. It does not offer
specific suggestion of what to do within the company to reinforce its strategy. In logistics
industry, it is especially important to use a performance measurement that can reinforce
the strategy within the company because each stage of logistic is influencing the
performance of the next stage. Only when all stages of the value chain are behaving
according to the strategy, will the whole company move towards the direction it wants.

Last, market measures are neither quantifiable nor controllable. The evaluations given by
market measures are hard to be expressed as an absolute number, which make the
performance measurements lack consistency among different people. And there is no
single standard for top management to judge their performances and it makes the
comparisons among different periods impossible. In addition, market measures are barely
controllable because they are forward-looking and focus on market perspective.
Managers cannot control something that has not happened and the market elements are
almost impossible to be changed by divisions. Accounting measures are both quantifiable
and controllable, and they make comparisons of performances between past and today,
actual result and objective result possible. Also, they are understandable even for
outsiders of the company. It is very straightforward to make sense. For instance, 20%
ROI is always better than 10% ROI. In addition, nowadays accounting measures tend to
only take items which can be controlled by managers into account. Manages can change
these financial figures from both income statement and balance sheet. They decide how
27
much to be invested and which projects to be accepted. Quantifiable and controllable are
both significant characteristics of performance measurements used in logistics industry.
Obviously when a logistic company wants to survive from the global competition, it has to
realize good financial figures. Accounting measures enable companies in logistics
industry easily to be compared with each other. Also, they offer opportunities to evaluate
the performance of companies on timely basis. Lastly, they give general ideas of how
these business divisions perform as a whole. If the final financial figures are bad, then
maybe the business division should consider about rebuild its value chain.

Conclusion table:

Performance measures Market measures ROI Residual Income

Criteria
(Including EVA)

Goal Congruence Yes No Yes

Reinforcing strategy Yes No No

Quantifiable No Yes Yes

Controllable No Yes Yes

Chapter 7: Conclusion
Based on the discussion above, the research question of this paper, what is the optimal
performance measurement for investment centers in logistics industry, shall be answered.
Market measures and residual income method works best when investment centers in
logistics industry combine them together. They together enable business units to reach
goal congruence, reinforce strategies and they are quantifiable and controllable,
supporting business units to realize good accounting figures and improve constantly in all
aspects. Combining market measures with residual income method leads to a

28
multidimensional performance measurement system, which helps investment centers in
logistics industry to maintain high developing speed and win from global competition.

The limitations of this paper are that first; no logistics companies are selected as samples
so that no empirical data are available for the discussion. The whole paper is based on
theoretical discussion and it lacks data support. Second, only four criteria are chosen
due to the scope of the paper, yet there might be other criteria which are significant for
logistic industry. Hence, the future research should first, focus on the empirical test of
this paper and second, take more criteria into consideration.

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