Strategic Performance Measurement

CHAPTER
12
 NON - FINANCIAL PERFORMANCE
• MEASURES
Traditional Performance measurement system tracks only
financial performance of the organization relating the to profit
earned from selling to the capital required. They focus solely on
financial measures based on internal accounting reports such as
profitability, revenue, cash flows, earnings per share (EPS), return
on assets (ROA), economic value added, etc.

• These measures are known as lag indicators as they only

the past data and represent historical performance (Kaplan and
reflect
Norton 1992, 1996).

• Even-though such quantitative performance metrics can control

and improve the internal performance of the organization, they
can result in incorrect decision-making in the long-term
 NON - FINANCIAL PERFORMANCE
• MEASURES
Relying solely on financial metrics can motivate managers to
make decisions that sacrifice long-term value creation for the
benefit of short term performance (Anthony & Govindarajan,
2007; Porter, 1996).

• For example: cost reduction can increase profit in the short-run,

but only at the expense of loss of quality, loss of expertise and/or
loss of customer base which all have long-term impacts.

• Traditional performance measures which predominately focusses

on financial performance measures are not appropriate in this
dynamic and changing environment.
 NON - FINANCIAL PERFORMANCE
• MEASURES
Traditional/financial measures possesses the significant amount
of shortcomings such as short-term orientation, historical in
nature, internally focused only (not comprises entire picture),
and window dressing, which make them unfit for an effective
performance management system, especially in isolation.

• Since profitability is important vis-à-vis stability, hence a

balance need to be maintained between both the financial as
well as nonfinancial measures (so that financial performance
can be measured, but in the context of long -term viability).

• Tools like balanced scorecard, performance pyramid, building

block model, and performance prism is capable to serve the
purpose because these encompass non-financial performance
measures apart from financial performance measures.
 BALANCED
SCORECARD
• The Scorecard (BSC) is a performance
Balanced
measurement system that addresses the weaknesses of the
traditional performance measurement systems.

• It has added strategic non-financial performance metrics

traditional
to financial metrics, thus, providing a ‘balanced’ view of
an organizational performance.

• BSC reflects changes in the modern

environment by taking into account the intangible assets
competitive
that have became a major source of competitive advantage
(Kaplan and Norton, 1996).
 BALANCED
•
SCORECARD
BSC is an integrated strategic management system that aligns business
activities to the strategy of the organization by linking
performance measurement with the company’s strategic objectives.

• It provides a framework to translate the organization's strategy into

specific quantifiable performance objectives that can be measured
(Kaplan & Norton,1996). The performance objectives are measured using the
four inter-connected perspectives (Kaplan and Norton, 1996)., i.e.,
1. the financial perspective,
2. customer perspective,
3. learning and growth perspective and
4. internal business processes perspective
 The Balanced Scorecard – From
12-2

Strategy to Performance Measures

Performance Measures
Financial
Has our financial
What are our
financial goals?
performance improved?

Customer What customers do we Vision

want to serve and how
Do customers recognize that we are we going to win and
are delivering more value? and retain them? Strategy

Internal Business Processes What internal busi-

Have we improved key business ness processes are
processes so that we can deliver critical to providing
more value to customers? value to customers?

Learning and Growth

Are we maintaining our ability
to change and improve?
 12-3

Learning Objective
1
Identify examples of performance
measures that are appropriate for
each of the four balanced
scorecard categories
 12-4

The Balanced
Scorecard
Management translates its strategy into
performance measures that employees
understand and influence.

Financial Customer

Performance
measures
Internal Learning
business and growth
processes
Financial Perspective: “How Do We Look to
Shareholders?”
The financial perspective focuses primarily on the
financial objectives of the organization.
It deals with the tracking and monitoring of financial
success and how the company look to the
shareholders (Kaplan and Norton, 1996).
The typical financial measures are:
 Sales,
 Profits,
 Profitability ratios,
 Trend performance,
 Cash flows, and
 Market performance.
Financial
Measures
 Customer Perspective: “How Do Customer
• View
In this, Us?”
companies identify customers and market segments in which they
compete and also the means by which they provide value to these customers
and markets.
• Managers identify the lead indicators which make a particular business
unit or product different from that of others.
• Lead indicator may vary from customer to customer or market segment. If for
example, a customer values on-time delivery then on-time delivery becomes a
lead indicator.
• Examples of lead indicators may include any number of customer
considerations, including:
 On-time delivery
 On-site service
 After sales support
 Defects per order
 Cost of the product
 Free shipments etc.
By delivering quality as per the customer demand and need, business units can
improve outcome measures such as customer satisfaction, retention, acquisition
and loyalty
Customer
12-7

Measures
Internal Business Perspective: “At What Must We
Excel?”
• In this stage companies identify processes and activities which are
necessary to achieve the objectives as identified at financial perspectives
and customer perspective stage.

• These objectives may be achieved by reassessing the value chain and

making necessary changes to the existing operating activities.

• If maintaining net earnings is the financial objective of a company and

after sales service can increase customer retention, then internal business
perspective needs to improve after sales services to satisfy customer
requirements to maintain net earnings.

• This objective may be achieved by providing for example toll free

customer help lines, setting up service centres in all major cities.
 12-6

Internal Business Process

Measures

Each company’s internal business process measures will vary depending on its
strategy. A company focused on product leadership may choose business process
measures related to innovation and product quality. A company that differentiates
itself from competitors based on operational excellence may select process measures
related to cost and time. Finally, a company with a customer intimacy strategy may
focus on service quality and agility measures.
Learning & Growth “How Do We Continue
Perspective: to Improve and Create
Value?”
• Learning and Growth Perspective focuses primarily on intangible
drivers of future growth such as human capital.

• This perspective deals with objectives such as the capability of the

company to continue to grow, improve and create value (Kaplan
and Norton, 1992).

• In the modern dynamic and intensely competitive business

environment, the organization must constantly change, adapt,
learn, improve and innovate to create future value and survival.

• Measures selected for this perspective include Job satisfaction,

employee turnover, employee training, and development, the
rate of innovation, etc.
Learning and Growth Performance
12-5

Measures
 The Balanced Scorecard – 12-9

Financial v. Nonfinancial Measures

The balanced scorecard framework rejects the notion that improving
process-oriented measures automatically leads to financial success

Including a financial perspective serves the purpose of holding

organizations accountable for translating improvements in nonfinancial
performance to “bottom-line” results

If favorable trends in a company's learning and growth, internal business

processes, and customer measures do no translate to financial results, the
balanced scorecard is designed to force the

organization to re-examine its strategy for differentiating itself from

competitors.
 12--10

Learning Objective
2
Identify the four types of quality
costs and use them to create a
quality cost report.
 Quality of
Conformance
Costs incurred to prevent defects or that result
from defects in products are known as quality
costs. Many companies are working hard to reduce
their quality costs.

When the overwhelming majority of products

produced conform to design specifications and are
free from defects, it is said to have high quality of
conformance.
 Four Types of Quality
Costs
Prevention Support activities whose purpose is
Costs to reduce the number of defects

Incurred to identify defective products

Appraisal
before the products are shipped to
Costs
customers

Internal Incurred as a result of identifying defects

before they are shipped
Failure
Costs
External Incurred as a result of defective products
Failure being delivered to customers
Costs
 Examples of Quality
Costs
Appraisal Costs
Prevention Costs • Testing and
• Quality training
inspecting incoming
• Quality circles
materials
• Statistical process
• Final product testing
control activities
• Depreciation of testing
equipment

External Failure Costs

Internal Failure Costs • Cost of field servicing
• Scrap
and handling complaints
• Spoilage
• Warranty repairs
• Rework
• Lost sales
 Quality Cost
consequences ofReports
Quality cost reports provide an estimate of the financial
the company’s current defect rate.
 12-16

Uses of Quality Cost

Information
Help managers see the financial
significance of defects.

Help managers identify the relative

importance of the quality
problems.
Help managers see whether their
quality costs are poorly distributed.
 12-18

Limitations of Quality Cost

Information
Simply measuring and reporting quality
cost problems does not solve quality
problems.

Results usually lag behind quality

improvement programs.

The most important quality cost, lost sales,

is often omitted from quality cost reports.
 12-18

Learning Objective
3
Understand how to calculate
throughput (manufacturing cycle)
time, delivery cycle time,
manufacturing cycle efficiency
(MCE), and overall equipment
effectiveness (OEE)
 12-19

Operating Performance Measures – Part 1

Order Production Goods
Received Started Shipped

Process Time + Inspection Time

Wait Time + Move Time + Queue Time

Throughput Time

Delivery Cycle Time

Process time is the only value-added time.

 12-20

Operating Performance Measures – Part

2Order Production Goods
Received Started Shipped

Process Time + Inspection Time

Wait Time + Move Time + Queue Time

Throughput Time

Delivery Cycle Time

Manufacturing Value-added time
Cycle =
Efficiency Manufacturing cycle time
 12-21

Operating Performance Measures – Part

3
Overall Equipment Effectiveness (OEE)

Measures the productivity of a piece of equipment in

terms of three dimensions—utilization, efficiency, and
quality.
 12-22

Quick Check
6
A TQM team at Narton Corp has recorded the following average
times for production:
Wait 3.0 days Move 0.5 days
Inspection 0.4 days Queue 9.3 days
Process 0.2 days

What is the throughput time?

a. 10.4 days.
b. 0.2 days.
c. 4.1 days.
d. 13.4 days.
 12-23

Quick Check
6a team at Narton Corp has recorded the following average
A TQM
times for production:
Wait 3.0 days Move 0.5 days
Inspection 0.4 days Queue 9.3 days
Process 0.2 days

What is the throughput time?

a. 10.4 days.
b. 0.2 days.
c. 4.1 days.
d. 13.4 days.
Throughput time = Process + Inspection + Move + Queue
= 0.2 days + 0.4 days + 0.5 days + 9.3 days
= 10.4 days
 12-24

Quick Check
7
A TQM team at Narton Corp has recorded the following average
times for production:
Wait 3.0 days Move 0.5 days
Inspection 0.4 days Queue 9.3 days
Process 0.2 days
What is the delivery cycle time (DCT)?
a. 0.5 days.
b. 0.7 days.
c. 13.4 days.
d. 10.4 days.
 12-25

Quick Check
7a
A TQM team at Narton Corp has recorded the following average
times for production:
Wait 3.0 days Move 0.5 days
Inspection 0.4 days Queue 9.3 days
Process 0.2 days
What is the delivery cycle time (DCT)?
a. 0.5 days.
b. 0.7 days.

c. 13.4 days. DCT = Wait time + Throughput time

d. 10.4 days. = 3.0 days + 10.4 days
= 13.4 days
 12-26

Quick Check
8
A TQM team at Narton Corp has recorded the following average
times for production:
Wait 3.0 days Move 0.5 days
Inspection 0.4 days Queue 9.3 days
Process 0.2 days
What is the Manufacturing Cycle Efficiency (MCE)?
a. 50.0%.
b. 1.9%.
c. 52.0%.
d. 5.1%.
 12-27

Quick Check
8a
A TQM team at Narton Corp has recorded the following average
times for production:
Wait 3.0 days Move 0.5 days
Inspection 0.4 days Queue 9.3 days
Process 0.2 days
What is the Manufacturing Cycle Efficiency (MCE)?
a. 50.0%. MCE = Value-added time ÷ Throughput time
b.
1.9%. = Process time ÷ Throughput time
c. 52.0%. = 0.2 days ÷ 10.4 days
d. = 1.9%
5.1%.
 12-28

Quick Check
9
Narton Corp has provided the following information for a machine whose
limited capacity is prohibiting the company from producing and selling
additional units:
Actual run time this week 4,550 minutes
Machine time available/week 6,500 minutes
Actual run time this week 3.8 units per minute
Ideal run rate 4.0 units per minute
Defect-free output this week 16,000 units
Total output this week 17,290 units
(including defects)
What
a. is50.3
the machine’s
OEE?
b. .615
c. .984
d. 1.7
 12-29

Quick Check
9a
Narton Corp has provided the following information for a machine whose
limited capacity is prohibiting the company from producing and selling
additional units:
Actual run time this week 4,550 minutes
Machine time available/week 6,500 minutes
Actual run time this week 3.8 units per minute
Ideal run rate 4.0 units per minute
Defect-free output this week 16,000 units
Total output this week 17,290 units
(including defects)
What is the machine’s OEE?
a. 50.3 Utilization rate: .70 (4,550 minutes ÷ 6,500 minutes) Efficiency
rate: .95 (3.8 units per minute ÷ 4 units per minute) Quality rate:
b. .615 .925 (16,000 units ÷ 17,290 units)
c. .984
d. 1.7 OEE: .615 ( .70 × .95 × .925)
 12-30

Learning Objective
4

Understand how to construct

and use a balanced scorecard.
 12-31

Selecting Balanced Scorecard

Measures
The four categories of a balanced scorecard are interrelated to
one another.

A company’s employees need to continuously learn and

grow in order to improve internal business processes

Improving business processes is necessary to improve

customer satisfaction

Improving customer satisfaction is necessary to

improve financial results.
The Balanced Scorecard –
12-32

Jaguar Example
 The Balanced Scorecard –
12-33

Jaguar Example – Part 2

•In essence, the balanced scorecard lays out a
theory of how the company can take concrete
actions to attain its desired outcomes (financial,
in this case)
• Jaguar’s strategy seems plausible, but it should
be regarded as only a theory.
• One of the advantages of the balanced
scorecard is that it continually tests the theories
underlying management’s strategy
 Tying Compensation to the Balanced
12-34

Scorecard
Incentive compensation should be linked to
balanced scorecard performance measures

Managers must be confident that the performance

measures are reliable, sensible, understood by those who
are being evaluated, and not easily manipulated.
Corporate Social Responsibility
12-35

Performance Measures
Corporate social responsibility (CSR) is a concept
whereby organizations consider the needs of all
stakeholders when making decisions beyond those that
produce financial results to satisfy stockholders

Many of the world’s largest companies prepare corporate

social responsibility performance reports (also called
sustainability reports) that are shared with their external
stakeholders.

The Global Reporting Initiative (GRI) is a leading

organization in the field of social and environmental
performance measurement
Corporate Social Responsibility and the
12-36

Balanced Scorecard

The balanced scorecard provides a useful framework

for organizing and managing the types of social and
environmental performance measures that companies
often include in their sustainability reports.
Corporate Social Responsibility and the
12-37

Balanced Scorecard – Part 2