ACCTG 533, Section 1: Module 2: Strategic Performance Measurement

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1 ACCTG 533, Section 1: Module 2: Strategic Performance Measurement Strategic Performance Measurement Strategic performance measurement. Failure to Integrate Failure to integrate performance measurement with strategic plan Why? o Despite what gets measured gets done o Hard to identify good measures o Instead use easy or controllable measures We turn now to consider further what a good performance measurement system would look like. We mentioned common weaknesses of performance measurement systems earlier. One of the most critical weaknesses is the failure to integrate performance measurement with the organization s strategic plan and objectives. Even when it is recognized that what gets measured gets done, it is hard to identify measurements that really link to strategic objectives. Because it is hard, we often use things that are easy to measure like hours worked (an input measure) or we use things that are easy to control like the amount of chicken pieces thrown away (an output measure). Strategic Plan Vision and mission Long-term objectives o 3-5 year o 5-10 objectives Long-term approaches/strategies For each objective o Short-term performance targets Annual plan The first step is, of course, to have a clearly defined strategic plan. Ideally, this would include: A vision and a mission that set out the organization s target level of excellence meaning how good it wants to be in its business and as an organization. Long-term (3 to 5 year) objectives that together spell out how the organization plans to achieve its vision (no more than 5 to 10 1

2 objectives). Long-term approaches or strategies defining how the objectives will be accomplished. For each objective, short-term performance targets, then an overall annual plan implementing the strategies. Strategic Performance Measurement System Alignment of business activities to strategy Monitoring of progress toward strategic goals Once you have a good plan, then you need to be able to tell how well, or how poorly, you are doing in comparison to your plan. A strategic performance measurement system enables the following: the alignment of business activities to an organization s strategy and the monitoring of progress toward strategic goals over time. Key Performance Indicators Measures progress against goals Most common and often only measures Financial measures The organization can now determine its progress by utilizing key performance indicators to measure progress against its strategic goals. In the past, the most common and often only performance indicators were financial measures. Financial measures, to be sure, are important but they are not enough to ensure that a strategic plan is accomplished. They are too onedimensional. Nonfinancial Performance Measures: Information about input, output, performance Evaluation and comparison Communication of Strategic Objectives Provide incentives [Table Shown] That leads us to the incorporation of nonfinancial performance measures. As with financial measures, the goals of nonfinancial measures are to collect information about input, output, and 2

3 performance. This information enables us to evaluate and compare the results and then go on to operate and improve the organization. In particular, nonfinancial measures provide a means of communicating strategic objectives to managers and to provide incentives for them to accomplish those objectives. What kinds of measures are we talking about? Things like service quality or innovation, flexibility, and competitiveness. 1. Closer linkage to long-term strategies Financial measure ST oriented NFM address issues important to LT Nonfinancial measures provide the following advantages over purely financial measures: Closer linkage to long-term strategies: Financial measures tend to be very short-term oriented as they are measures of quarterly or annual performance. Nonfinancial measures address issues such as customer needs or competitor challenges that are important to the organization s longterm performance and goals. For example, implementing new customer relationship tracking and monitoring capabilities may reduce profits in the near-term but enhance customer satisfaction in the long-term. 2. Facilitates emphasis on intangible assets Significant to stock market value Missing from financial statements Decisions based on financial measure may hurt, not help Number two: Facilitates emphasis on intangible assets. Studies in recent years have found that intangible assets including management ability, employee satisfaction, innovation, and quality represented a significant portion of a company s stock market value. As these assets typically do not appear on the financial statements, decisions based on an organization s financial measures would fail to take intangible assets into consideration. As a result, the decisions may actually hurt instead of help. 3. Better indicators of futures financial performance 3

4 Financial measures of ST No capture of LT benefits Better indicators of future financial performance: Because financial measures tend to be shortterm oriented, they do not adequately capture long-term benefits arising from current decisions. For example, funds spent on R&D must be expensed. Yet R&D is critical to a company s future success. Nonfinancial measures may better indicate an organization s long-term performance prospects. 4. Less noisy measures Financial measures sensitive to external factors Need to know if actions successful Need for less noisy measures Number four: Less noisy measures. Financial measures, for example, stock price, are sensitive to external factors that are not under the control of the organization or its managers. Managers, however, need to know if their actions are successful. So they need measures that are not as noisy, measures that will better reflect how well they are doing. Nonfinancial measures are less subject to external noise and, as a result, may provide manager with the information that they really need. Stakeholder Approach [Web Diagram Shown] In order to achieve long-term objectives, an organization must identify and meet the needs of all stakeholders involved in its operations. Stakeholders are those parties that have an interest in or can affect an entity s performance. Primary stakeholder groups are customers, employees, suppliers (and by suppliers we re talking about suppliers of goods, services, and debt), owners, and the community. Atkinson et al Performance measurement system Evaluate contributions 4

5 Evaluate provisions Provide information Enable evaluation Because of this need to satisfy stakeholders, the performance measurement system must be able to identify whether or not the needs of stakeholders are being met. In a Sloan Management article in 1997, Atkinson et al. proposed that the performance measurement system must: evaluate whether anticipated contributions from employees, suppliers and customers were being received by the entity; evaluate whether the entity was providing stakeholders with what they needed; provide the information needed to design and implement needed processes, and enable evaluation of planning and stakeholder management. Beware! What measures should we use? o Unique to organization Yes, a lot of work Dynamic environment Change is constant! Nonfinancial measures better enable an organization to accomplish its strategic objectives. In recent years, they have become commonplace and are increasingly used for decision-making and evaluation purposes. What you need to be careful about is, as always, deciding what measures to use. Simply copying measures used by other organizations is not going to work. The measures that you select have to be linked to your own strategy, value drivers, objectives, and the competitive environment that you face. Yes, it takes an incredible amount of work to select the right nonfinancial measures. Even after doing all that work, you won t be able to rest on your laurels indefinitely. Organizations operate in a dynamic environment. As a result, performance measures, so painfully and carefully selected and implemented, may become out of date or ineffective. The performance measurement system must be continually monitored and reassessed because things are always changing! 5