Wk 2: Non-financial performance measures

• Feedback: provides employees feedback on how well they're performing. Can adjust behaviour accordingly
• Rewards: for those who perform well to motivate
• Communication tool; alignment of goals: tells employees what we think is important. What the organisation thinks is important.

May help managers to assess the value added by the various operations and activities in which they engage.

• Emphasise only one perspective of performance: Businesses need to manage the determinants of future financial performance. Senior management determines the strategies that will be implemented to enable the business to achieve long-term goals. Managers need a performance measurement system that assesses how well they perform across the full range of strategically important areas, such as quality and delivery, as well as cost.
• Traditional financial performance measures focus on the consequences, not the causes: Measures of profit, and its components, costs and revenues, describe the financial consequences of decisions and activities, not causes. They describe what has happened, not why it has happened. They are too aggregated and they do not tell managers what needs fixing. Also, summary financial measures are often reported at the end of each month, so they are not timely.
• Provide limited guidance for future actions: Financial measures do not allow managers to assess areas that need to be developed for the organisation to be successful in the long term. For example, to
• ensure future growth, managers need to determine how effectively they have invested in areas such as new product development, development of staff, and actions to ensure customer loyalty. Financial measures report on the financial outcomes of past decisions and actions.
• May encourage short-term actions: Financial measures may encourage managers to achieve short-term financial performance at the expense of long-term performance. This happens particularly when there is excessive pressure on managers to achieve short-term profit improvements, and where remuneration systems are closely tied to short-term profit achievement.

• Mainly only relevant to higher level employees
• Not timely
• They are not actionable

• May emphasise strategy: For example, if a company’s  business strategy is based on providing superior customer service, it makes sense to measure the level of customer satisfaction.
• Can be drivers of future financial performance: For example, managers may measure product quality and customer satisfaction as they believe that high performance in these areas will flow through to improved financial performance. 
• More actionable: For example, it is easier for operational managers to investigate the sources of product defects and customer complaints than it is to investigate cost variances, as defects and customer complaints relate directly to activities and operations that they control.
• May be more timely: Some measures can be reported very quickly after a performance period and lead to immediate correction of problem areas.
• More understandable and easier to relate to: particularly at the operational level. Shopfloor employees may find it easier to understand the meaning of rejects per 100 units or number of delivery days, compared with monthly variable overhead cost variances.

• Generally non-financial measures generates profits in long term
• –↑ non-financials → ↑ financials

Customer satisfaction: May be measured using a survey containing a series of questions designed to gauge aspects of the product/service that contribute to customer satisfaction or dissatisfaction. This measure is important in assessing whether customer value is increasing and to understand the specific aspects of the product that customers value.

Number of defects from this plant at final line: A defect is a fault in a product that occurs during the manufacturing process. It is better that defects are detected early in the production process rather than later (at the final production line), so that minimal resources are expended on a defective product. A low defect rate is critical in supporting a high quality strategy. Defect measures are often expressed as a number of defects per day, week or month, or the number of defects may be expressed relative to total output, for example 3 defects per 1 000 units.

Internal quality audits: The quality of a product may be determined by periodic inspections or testing of products during production processing. High quality products support the competitive strategy of quality.

• Productivity: the ratio of outputs produced per unit of input. It is a measure of efficiency. eg. units of product per direct labour hour. Or units of output per dollar of input costs. Productivity measures support a cost leadership strategy, as productivity is a driver of costs.

Stock status: the balance of inventory on hand.

Accident report: This measure is often called a safety report, and may be measured as the number of accidents that employees experience per day or per week in the production plant.

Multiskilling: measures the number of employees who have completed training and acquired skills that allow them to undertake their own task as well as the tasks of other workers in the production area. Multiskilling is an important driver of production flexibility and efficiency.

Machine downtime: This is measured as the number of hours that machines are unable to operate or the percentage of total production hours lost in a given period. This may be due to many factors, including the machine breaking down, employees refusing to work, electricity outages or setup time. Setup time is the time that it takes to get the machine and materials ready to start producing a product.

Schedule adherence, or delivery on time: a measure of whether the required products or services are provided to the customers by a targeted time. May be expressed as percentage

• There is a wide choice of non-financial measures available: Are all of these measures necessary? How do managers select appropriate quality measures?
• The inclusion of non-financial measures can be ad hoc and undirected: proliferation of measures can occur over time, as new measures are adopted in response to a particular problem. However, old measures may not be discontinued.
• Managers must necessarily make trade-offs: indicates that there are
• many measures to focus on at each level of management. Which measures are the most important? What should a manager do if certain actions improve some measures but not others? For example, improving the quality measure ‘number of defects’ may result in an increase in the cost driver measure ‘labour hours per unit’.
• Some non-financial measures may lack integrity: Data used to calculate nonfinancial performance measures may be gathered in a variety of ways—manually, using a computer, by an external party—and because the accuracy of the data may be difficult to verify (compared with financial data recorded in the accounting system), there is potential for measures to be incomplete, inaccurate and manipulated.
• Some non-financial measures may not easily translate into financial outcomes:

• Developed by Kaplan and Norton
• A tool that translates an organisation’s mission, objectives and strategies into performance measures. Used to implement strategy
• and to monitor and manage performance
• A performance measurement system that identifies and reports on performance measures for each key strategic area of the business.
• Also identifies cause and effect relationships between these measures

• 1. Articulate the mission, the overall goals or objectives and the strategic priorities of the organisation
• 2. Specific objectives are developed for each of the perspectives that will be used within the BSC.
• 3. As part of this process, a strategy map may be formulated to articulate the causal linkages between the different objectives and the overall goals and strategies of the organisation
• 4. For each perspective, performance measures are then chosen that will allow progress towards each of the objectives to be monitored.
• 5. Targets are developed for each of the performance measures which will be used to evaluate actual performance.
• 6. Initiatives and activities are planned and undertaken across the organisation to implement the chosen strategies and to support the achievement of the objectives.
• 7. Reports are generated at regular intervals, such as monthly or quarterly, to monitor and manage actual performance against targets for each unit of the organisation and for the organisation as a whole.

The practice of assigning unit and personal BSCs to specific managers may enhance accountability and improve overall performance.

• Strategy specifies how an organisation matches its own capabilities with the opportunities in the marketplace to accomplish its objectives
• How an organisation competes in the marketplace.
• A thorough understanding of the industry is critical to implementing a successful strategy

• Product differentiation: an organisation’s ability to offer products or services perceived by its customers to be superior and unique relative to the products or services of its competitors eg. Apple
• Leads to brand loyalty and the willingness of customers to pay higher prices

• Cost leadership: an organisation’s ability to achieve lower costs relative to competitors through productivity and efficiency improvements, elimination of waste, and tight cost control
• Target customers that are more sensitive to price
• –Leads to lower selling prices eg. Aldi, Bunnings

• The original balance scorecard identified four key strategic areas for a standard for profit business
• The balanced scorecard translates an organisation’s mission and strategy into a set of performance measures that provides the framework for implementing its strategy
• It is called the balanced scorecard because it balances the use of financial and non-financial performance measures to evaluate performance

• Financial objectives reflect the view of the shareholders or
• other stakeholders of the organisation.
• The performance measures chosen to support the financial objectives will summarise the financial outcomes of decisions and
• activities
• Measures may include cost and product measures, ROI, cash flow measures, shareholder value measures

• Measures the company’s success in achieving customer value
• Outcome (lag) measures include customer profitability, market share, number of new customers (results/outcome, effect)
• Lead indicators include on-time delivery, number of defects (drivers/ cause)

• Objectives are formulated for specific and critical processes that contribute to customer and financial objectives
• The internal business processes may be those in the areas of product design, operations, marketing, sales, customer service processes
• Performance measures are those designed to monitor the internal processes that are critical to delivering products or services to customers and achieving financial objectives.
• They can include measures of cost, product quality, time-based measures, new product development
• Long-term measures may be created to monitor new product development or determine the changing needs of customers.
• Changes depending on what kind of business it is and their strategy (eg. cost leader? competing on quality?)

• Focus is on the capabilities of the organisation that must be developed to achieve superior internal processes that create both customer and shareholder value.
• This perspective concentrates on the infrastructure that firms put into place to deliver long-term growth and improvement.
• Performance measures may focus on employee capabilities (measures of employee satisfaction, training, absenteeism and skills); information system capabilities (measures such as the percentage of customer service employees having real-time access to customer information); and on the organisational climate for employee motivation and initiative (measures such as the number of employee
• suggestions made and implemented, and the number of employees whose goals are aligned with those of the organisation).

Learning and growth is about building those skills, which will then help us to improve the business processes, manage relationships with customers better and ultimately improve the profitability of the organisation.

• The goals of many not-for-profit enterprises and public sector organisations focus on community outcomes, such as the level of education attained (for a government education department) or standard of medical care (for a hospital), rather than on profit, and their performance measurement systems tend to monitor effectiveness in these areas.
• However, even in these organisations financial management is important, and financial measures, such as costs, will be monitored.
• Balanced scorecard approaches are just as relevant in not-for-profit organisations as in profit-seeking organisations, but a dominant focus on achieving financial outcomes may be inappropriate. Thus, in a balanced scorecard the financial perspective may have a reduced focus and a client, community or stakeholder perspective may be
• considered of greater importance.

• Monitor progress towards the organisation's objectives
• (What is our objective? How would we measure whether we have achieved that successfully or not?)
• Lag indicators can be seen as the outcome or the effects
• While these measures provide important information about the outcomes of decisions and operations, they provide limited information to help managers directly manage performance
• Summary of financial measures, market share, customer satisfaction

• Drivers of outcomes and provide information that is actionable and manageable
• (What is going to drive those outcomes? Predictors or causes of outcomes)
• Lead indicators often relate to the processes and activities of the business and improvements in these measures should, over time, flow through to improvements in lag indicators
• Lead indicators are often used as the focus for process improvement or cost management activities

• Financial Perspective
• Income measures: Operating profit, gross margin percentage
• Revenue and cost measures: revenue growth, revenues from new products, cost reductions in key areas
• Income and investment measures: EVA, ROI

• Customer perspective
• Market share, customer satisfaction, customer-retention percentage, time taken to fulfil customers' requests, number of customer complaints

• Internal-business-process perspective
• Innovation process: operating capabilities, number of new products or services, new-product development times and number of new patents
• Operations process: yield, defect rates, time taken to deliver product to customer, percentage of on-time deliveries, average time taken to respond to orders, set-up time, manufacturing downtime
• Post-sales service process: time taken to replace or repair defective products, hours of customer training for using the product

• Learning-and-growth perspective
• Employee measures: employee education and skill levels, employee-satisfaction rating, employee turnover rates, percentage of employee suggestions implemented, percentage of compensation based on individual and team incentives
• Technology measures: information system availability, percentage of processes with advanced controls

• Financial
• Objectives: improve returns to shareholders, increase profits
• Lag indicators: return on equity, EVA, product profitability
• Lead: sales mix, cost per product

• Customer
• Objectives: increase customer satisfaction, expand customer base
• Lag indicators: customer satisfaction, market share, number of new customers, number of customers retained
• Lead: number of product returns, on-time delivery, number of product variations available, number of customer complaints, number of good units completed

• Internal business process
• Objectives: improve the quality of products, create new innovative products, improve production process
• Lag: number of good units completed, number of products under development
• Lead indicators: product defects, number of product returns, product development time, production cycle time, number of machine breakdowns

• Learning and growth
• Objectives: improve employee satisfaction, develop employee's technical skills
• Lag: employee satisfaction survey, number of employees participating in training programs
• Lead: improvements made to employee facilities, time spent developing employee programs

• There isn't a standard way of producing balanced score cards
• Not all organisations use lag and lead indicators or clearly articulate causal links between all measures.
• A range of alternative terms are used in companies to describe lag and lead indicators. Eg. Lag indicators may be called outcome measures or key performance indicators (KPIs)
• Lead indicators may be called driver measures or key performance drivers (KPDs)
• Some organisations identify critical success factors (CSFs) . These are  the factors that derive from the competitive strategy that management considers critical to the survival of the business, such as quality, cost or innovativeness. The performance measurement system will focus on these factors because if they are not achieved, the company would fail.
• The number of perspectives on which the scorecard is based may differ, or the names of the perspectives may be different.
• Strategy maps are not always used and when they are used, rather than mapping causal linkages between objectives, some maps focus on linkages between performance measures.
• Some companies combine the strategy map and BSC into a single document.

• Perspective of a for-profit business:
• *The above is a typical flow. Variation possible where one perspective directly influences the other rather than going through this chain reaction (e.g., IBP->Financial because of higher productivity)

• L&G: higher skilled employees, more knowledge will help us to improve our IBP
• IBP: good IBP eg. fast response time, high quality products -> keep customers happy
• Customers: high customer satisfaction -> profits
• Financial: profits -> can reinvest in learning and growth

• We don't want BSC to be too complicated

• If introducing BSC for the first time or even just changing, it is a major change and must be carefully implemented.
• Key for successful implementation:
• Must have commitment and leadership from top management (I look at what my boss thinks is important)
• Must be communicated to all employees so that it is understood
• (Not all employees have studied business and may not know what a BCS is, why it's important, and how it's relevant) 
• May involve running workshops and meetings, involving employees in designing BSC.

• The implementation of the BSC may take considerable time and involve major change to organisational processes, performance reporting and employee incentives.
• This can include the design of new performance measures, the creation of new processes and databases to enable those measures to be calculated and reported, the implementation of new software, and the orientation and training of managers and employees to enable them to understand and commit to the BSC as a new performance management
• tool.
• The design of the right performance measures can be difficult; it may take several attempts and testing of measures before management can have confidence that they do measure what they are intended to measure and have integrity, so that they do not encourage dysfunctional behaviour.
• This issue must be considered if the achievement of new performance targets in the BSC is linked to employee rewards.
• Resistance to the implementation of the new BSC may occur if it adversely affects managers’ and employees’ pay or if they are held responsible for achieving performance targets they consider unfair or unachievable
• Some managers and employees may have high expectations that performance improvements will emerge very soon after the implementation of the BSC. However, they may become impatient, withdraw their support for the project and the implementation may lose momentum. While there may be improvements in some areas of non-financial performance in the short term, the impact on financial
• performance may take more than one reporting period.

• 1. Tells the story of a firm’s strategy, articulating a sequence of cause-and-effect relationships
• – the links among the various perspectives that describe how strategy will be implemented

2. Helps communicate the strategy to all members of the organisation by translating the strategy into a coherent and linked set of understandable and measurable operational targets

• (Helps employees see how we measure performance and the things they can do in their role that are aligned with the business strategy. Particularly for employees that are lower in the org, can be helpful tool to understand how they are contributing to the org strategy. 
• A tool to help them make decisions, which are in alignment with strategy implemented by business)

3. Must motivate managers to take actions that eventually result in improvements in financial performance (predominately applies to for-profit entities, but has application to not-for-profit entities)

4. Limits the number of measures, identifying only the most critical ones1

• A visual representation that explains the cause and effect relationships linking the objectives of the four perspectives of the BSC and the organisation’s objectives
• (Tool to see whether our strategies and measures really do fit together, and the relationships between them)
• May also identify linkages between lag and lead measures
• A tool to communicate to mangers the components of the strategy and the processes that will help achieve it

• Base of arrow: cause
• End of arrow: effect
• Strategy map shows how objectives are all linked in some way (none of them are by themselves)
• Understand cause and effect relationships and how measures fit together

• This is for profit business
• This will vary depending on purpose of organisation
• Some of the measures that are lag indicators of one perspective may be lead indicators of another perspective.
• For example, market share is an outcome measure of the customer perspective, and this helps managers assess whether they will achieve their customer objective of expanding the customer base, but it could also be a lead indicator of the financial perspective, as increases in market share drive profitability.
• To improve financial performance, the BSC relies on cause and effect linkages between measures in different perspectives.

• BSCs are a simplification of the complex workings of an organisation and its business environment. The cause and effect assumptions may also be too simplistic. For example, does higher customer satisfaction always lead to improved financial outcomes?
• The BSC may also encourage managers to ‘manage from the cockpit’ rather than observing operations directly, which can lead to the simplistic BSC model being viewed as reality.
• Also, the timing between the lead indicators and lag performance outcomes may differ for different perspectives—designing new product innovations may take a year to improve sales, while more satisfied customers may lead to improved sales in a few weeks.
• The BSC may be designed and implemented in a top-down fashion by senior management so there is limited input or buy-in from lower levels of management within the organisation.
• Also, the strategy maps that should drive the BSC may not have been sufficiently developed or understood by those involved in the design of the BSC. The links between strategy and performance measures may not have been rigorously tested and validated, and there may be a limited understanding of the nonfinancial performance areas that drive future financial performance.
• The BSC needs to be designed or tailored to meet the particular circumstances of the particular business, its market and its stakeholders.

• 1. Managers should not assume the cause-and-effect linkages are precise-Typically, they are merely hypotheses.  (too simplistic?)
• (effects may take time, effects not guaranteed)

• 2. Managers should not seek improvements across all of the measures all of the time
• (As manager, need to be conscious that initiatives uses up resources. May need to make trade offs and only focus on some measures)
• Managers must include both costs and benefits of initiatives placed in the balanced scorecard- costs are often overlooked

• 3. Managers should not use only objective measures
• –subjective measures are important as well
• –They should not ignore non-financial measures when evaluating employees
• (we may miss key important things that we cannot objectively measure)

• 4. Managers should not use too many measures. 
• Don't want to make it complicated, overwhelm, have to pick and choose

5. The links between strategy and performance measures may not have been rigorously tested and validated. The BSC needs to be designed or tailored to meet the particular circumstances of the particular business,\

• Improvements in non-financial measures will not result in improved profits if:
• The wrong strategic priorities are emphasised: the performance
• measurement system may be directing employees to focus on areas that will not lead to the achievement of the company’s goals.
• Management has selected the wrong critical success factors/ measures
• Management fails to utilise freed-up resources, following on from improvements in non-financial measures. Improvements will not translate into cost savings and improved profits unless the idle resources are used in some other profitable activities or are disposed of. This means that employees and equipment may be underutilised— there is spare capacity. 
• However, many of the resources that are freed up may be committed costs; for example, it may be difficult to dispose of equipment or rationalise staff levels immediately.
• Also, it may be difficult, in the short term, to increase sales demand, and hence production, to use the idle resources. Thus, improvements in a range of non-financial areas will benefit a firm only if they can be translated into higher capacity utilisation, or cost reductions.
• There is a lag between financial and non-financial performance: (might not see benefits for a while) For example, an improvement in quality in the March quarter may not result in improved sales for six months or more, as it takes time for former customers to learn of that quality improvement and to recommence purchasing product from a company.
• There are incentives to engage in dysfunctional behaviour: The design of the performance measurement system can provide incentives to maximise performance in some areas of the business, at the expense of other areas. In addition, the measures may be easy
• to manipulate and falsify, so that real performance is not as high as the measures indicate. (e.g. call centre- length of call vs customer satisfaction)

• Wide choice of non-financial measures available- can't have too many otherwise it gets too complicated or employees become overwhelmed
• Development can be ad-hoc and undirected- proliferation of measures can occur over time as new measures are adopted in response to a particular problem. However old measures may not be discontinued.
• Managers must necessarily make trade-offs between achieving some measures and not others- which are most important? For example, improving the quality measure ‘number of defects’ may result in an increase in the cost driver measure ‘labour hours per unit’.
• Some measures may lack integrity: because the accuracy of the data may be difficult to verify (compared with financial data recorded in the accounting system), there is potential for measures to be incomplete, inaccurate and manipulated.
• Measures may not easily translate into financial outcomes

How does a firm know when its performance measurement system (PMS) is inadequate?

• –Performance is acceptable on all dimensions, except profit
• –Customers do not buy product, even when prices are competitive
• –Managers are not concerned when performance reports are not supplied
• –Measures have not changed for some time
• –The business strategy has changed

• Link to strategy and goals of the organisation
• –Encourages goal congruence

• Keep it simple
• –Measures should be understandable and easy to communicate with employees

• Recognise controllability
• –Responsibility for achieving measures should relate to activities and processes which employees can control

Emphasise the positive

Be timely (i.e., quick reporting)

• Relate to benchmarking
• –Against external standards

• Embrace participation and empowerment
• –To promote motivation and goal congruence

• Include only a few performance measures
• –Rule of thumb is that no person should be responsible for more than four or five measures

• Link to rewards
• –Motivational

• To become and remain world class, an organisation must strive for continuous improvement , which refers to the ongoing search for improved methods to reduce or eliminate waste and improve performance in areas such as cost, quality and customer
• service.
• In today’s fast-paced environment, customer expectations are increasing and competitors continually improve their performance. This means that organisations have to continually improve their performance to remain competitive.

• Continuous improvement can be built into performance measurement systems by:
• Selecting relevant performance measures: The emphasis on continuous improvement means that, as changes are made throughout the business, some performance measures should be dropped and others added. Some companies focus their improvement efforts on problem areas, and then refocus on other areas when performance has improved.
• Defining and redefining the measure: there are many measures to measure the same thing. When a new performance measure is first introduced it may be defined loosely. As performance improves, stricter measures may be in place.
• Why would a company design the loose measure initially? If the measure is perceived as not too difficult, employees may be motivated to achieve this measure. As their performance improves, there becomes little room for improvement, so the measure is made more challenging to provide a new improvement cycle.
• Making the target more challenging: Employees may be set performance targets that increase in difficulty over time. Continuing our on-time delivery measure example, employees may have been given a series of monthly targets, which, once they were achieved, were increased in difficulty.

• Resistance to change may be more likely when
• –Individuals consider targets unfair or unachievable
• –Individuals’ rewards are affected by changes

• Changes are most likely to succeed if
• –They are supported across the entire organisation
• –Bottom-up approaches are included
• –New measures should not be seen as an ‘add on’ to an inadequate performance measurement system

• Conventional financial-based performance measurement systems have many limitations and can be enhanced by non-financial measures
• Non-financial measures have their own limitations
• Strategic performance measurement systems (e.g. the balanced scorecard) track performance across key strategic areas of the organisation
• Strategy maps assist in the communication of strategy and the articulation of the performance measurement system
• Learned how to design an effective performance measurement system