CHAPTER 14 STRATEGIC PERFORMANCE MEASUREMENT SYSTEMS ANSWERS TO REVIEW QUESTIONS 14.1 The major limitations of traditionalfinancial performance measures: • Traditionalperformance measures are not actionable; they describe consequences, not causes. They are too aggregated and they do not tell operational managers what needs fixing. Also, financial measures tend to be reported at the end of each month, so they are not timely. • Traditionalperformance measures emphasise only one perspective as they only focus on costs. 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 performance, as well as cost. • Financial performance measures provide limited guidance for future actions, emphasising only immediate financial outcomes of actions and decisions. • Financial performance measures can encourage actions which limit future competitiveness. This is particularly the case when there is excessive pressure to achieve short-term financial results. 14.2 Non-financial measures have several advantages over financial measures for managing resources and creating value: • Non-financial measures may emphasise strategy. • Non-financial measures are the drivers of future financial performance, whereas financial measures indicate outcomes of past decisions. • Non-financial measures are more actionable, whereas financial measures provide limited guidance for future actions. • Non-financial measures are more understandable and easier to relate to than financial measures, particularly at the operational level. Financial measures are too aggregated and they do not tell operational managers what needs fixing. • Non-financial measures may be more timely than financial measures so may be used to achieve immediate performance improvements. 14.3 Examples of non-financial performance measures for World Vision or Oxfam may include: Percentage of phone calls per day unanswered, average time spent on hold. Number of phone calls received in response to advertising campaign. Number of children and/or communities being supported through the sponsorship commitments of supporters. 14.4 Customer satisfaction surveys Number of customer complaints Staff satisfaction, as measured by surveys Staff turnover Hours of staff training Percentage of phone calls answered within four rings Number of customers transacting • online • on the telephone • face to face over the counter • Using ATMs. 14.5 The production cycle time is a measure of the time between receiving the order for a product and when that product is ready for delivery. The set-up time records the time it takes to get the machine and materials ready to start producing a product. Machine downtimemeasures the amount of time that the machines are unable to work, for whatever reason. It can be presented as a percentage of the total production hours lost in a given period. All of these measures relate to strategies that address superior customer service as they affect the time it takes to fill an order. 14.6 The over-reliance on non-financial performance measures can be problematic for the following reasons: • There is a very wide range of possible measures so: —managers need to be selective to keep the number in use to a reasonable level —if new measures are added there should be a review of existing measures to try to discard some —selection should be chosen to support the organisation’s strategy. • There is potential for data to be incomplete, inaccurate and manipulated. Students should be aware of why this is the case (nature of data collection, lack of verifiability and so on). • The non-financial measures used may not translate into financial outcomes—again students must understand why this is the case. 14.7 The Kaplan and Norton (1996) balanced scorecard exhibits the characteristicsof a strategic performance measurement system and is probably the most well-known example of an SPMS. Other examples include the performance pyramid (Lynch and Cross, 1991), the performance prism (Neely and Adams, 2000), and the intangible asset scorecard (Svieby, 1997). The balanced scorecard translates the organisation’s mission and strategies into objectives and performance measures for (usually) four key strategic perspectives for profit orientated entities: financial, customer, business process and learning and growth. The Kaplan and Norton (2004) strategy map provides visual representation to further explain the cause and effect relationships that link the objectives of the four perspectives of the BSC and the organisation’s objectives. Not-for-profit organisations may design a balanced scorecard to include perspectives such as stakeholder, community and people. 14.8 The Kaplan and Norton balanced scorecard translates the organisation’s mission and strategies into objectives and performance measures that reflect four different perspectives: the financial perspective, the customer perspective, internal business processes, and learning and growth. Measures can be identified for managers at each level in the organisation. 14.9 One tool that is discussed in the context of strategic performance management systems is the balanced scorecard (BSC). One aspect of the BSC is the ability to design related BSCs for every level in the organisation, such that the measures at one level explain and feed into the measures at the next higher level (for example cost centre BSC measures explain and feed into the measures at profit centre level). Each BSC should be designed to be consistent with the objectives, performance measures and targets of (a) the organisation and (b) the next higher level in the organisation. To be most useful they must also reflect the responsibilities of the individual managers. As well as a strategic feedback and feed-forward mechanism, their use to designate responsibility and monitor and evaluate the performance of managers promotes their use for control purposes. 14.10 Balanced scorecards translate an organisation’s mission, objectives and strategies into performance measures. The mission, objectives and strategies of a not-for-profit organisation are likely to be very different from those of a profit-oriented organisation. Hence the balanced scorecard for each will reflect those differences. A profit-oriented organisation will devise strategies for competitive advantage and will measure the success with which the strategic plans are carried out. The objectives can include high market share, market leadership, high ROI, high sales levels and so on. Depending on the strategic approach chosen there may be a focus on cost containment, quality control and/or innovation. These will be measured and reported in the balanced scorecard. 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. Even in these organisations financial management is important, and financial measures such as costs will be monitored. The financial imperative is usually to keep costs within a spending allowance or to sell services such that costs are just covered, or slightly exceeded to allow for rising costs in the next period. These organisations do not usually compete with others in the provision of products, whether goods or services. 14.11 The purpose of a strategy map is to visually represent an explanation of the cause and effect relationships that link the objectives of the four perspectives of the BSC and the organisation’s objectives. It allows managers to specifically identify and verify the linkages. It also can be used by senior managers to communicate, to managers across the organisation, the components of the organisation’s strategies, and the processes and systems that will help the organisation achieve the strategy. The role of a strategy map in a BSC is that it links strategies, objectives and measures, which is characteristic of and fundamental to all types of SPMS. 14.12Lag indicators are measures of progress towards the organisation’s objectives (e.g. profit, ROI, market share). They are measures of the outcome of past decisions and may therefore be difficult to manage directly. In practice, lag indicators may sometimes be referred to as key performance indicators (KPIs). Lead indicators are measures of the factors that drive outcome measures and provide information, which is both manageable and actionable (for example, scrap measures, number of products under development, throughput times, efficiency and usage variances). In practice, lead indicators may sometimes be referred to as key performance drivers (KPDs). 14.13 Some reasons why the implementation of aBSC may not be successful: • The translation of complex operations into the simplified representation we get from a BSC may cause managers to overlook vital elements or misrepresent relationships between items. • The assumed cause and effect relationships may be too simplistic. • Managers may depend too much on the BSC and attempt armchair management, withdrawing from valuable hands on involvement. • The time between lead and lag indicators varies, and decisions based on the lead indicators can take a long time to affect the lag indicators. • Imposition of the BSC on lower level managers by top level managers can lead to lack of buy-in (i.e. low commitment). • There may be little opportunity for lower level managers (who ‘work at the coal face’) to have input. • The design of the BSC can be poor, perhaps due to misunderstandings and insufficient research—often an outcome of disjointed development where each stage is managed separately and without a full understanding of the whole process (e.g. people reporting measures and devising targets at the development stage without knowing the use to which they are to be put and/or without knowing the measures to be used for other perspectives). • Borrowing features of the design of the BSC from a different organisation due to lack of experience—they must be designed for the particular organisation. • Implementation problems—new processes, performance measures, software, training and so on are likely to be required and short-cuts can lead to poor outcomes. • Resistance to change or impatience with a new system that takes a long time to show results can lead to a drop in support for the new system. • There can be impacts on bonus award payments due to the changed performance evaluation basis, and this can stimulate withdrawal of commitment and goodwill. 14.14 Barriers to not-for-profit organisations adopting SPMS include: • a resistant organisation or industry culture, especially when the SPMS is seen as a function of bean-counters that necessarily ‘draws the heart out of’and diverts attention from charitable activity • a lack of expertise due to the scarcity of business professionals in charitable organisations • a lack of resources, since donors expect the majority of the donated funds to go to the charitable purpose, and keep an eye on what percentage of donations is diverted to administration costs. 14.15 Effective management of non-financial measures may not flow through to improved financial performance for several reasons: • The measures may focus on the wrong critical success factors. • Management may fail to utilise freed up resources that result from improvements in areas such as productivity and quality for other profitable activities. • There may be a lag between improvements in non-financial measures and subsequent flow through to improvements in financial performance. • The performance measures selected may not be well designed. They may encourage dysfunctional actions which maximise performance in those particular non-financial areas at the expense of other important areas, or encourage manipulation or falsification of performance. 14.16 Improved product quality and improved time-to-market may not necessarily be accompanied by higher profits for reasons such as: • Improving product quality and time-to-market may not be the right strategic priority for the organisation, the product and/or the targeted market. For example, the home handy person may not seek the same durability in DIY tools as a tradesman who will use them daily and receives a tax deduction for their purchase. However, the home handy person is likely to look for high quality in the materials they use as the materials bought are probably for work in their own home, whereas the tradesman may be prepared to use lower quality materials in jobs he is doing for others. • There could be a long time lag between the improvement in quality of products and improved profits, especially if customers who have been disappointed in the product quality in the past need to be encouraged to buy the improved product. • It is possible that the measures of quality have been manipulated/falsified. Hence, the ‘real’ performance is best reflected in the profit measures. • These improvements may have been achieved at significant financial costs. (If bonuses depended on achieving favourable outcomes for product quality and time-to-market but ignored costs and profits, the system would encourage dysfunctional behaviour!) • If these improvements have resulted in freed up capacity, it is important that those resources are put to use. Sometimes resources accumulate more costs after they have achieved their object, such as equipment lying idle, labour not being redeployed, and so on. 14.17 A Du Pont chart shows the linkages between key performance drivers, non-financial measures and financial measures. A Du Pont chart can help a firm manage performance, as it illustrates the linkages between the various non-financial and financial measures within the firm. 14.18 Continuous improvement can be built into a performance measurement system by: • selecting relevant performance measures • defining and redefining the measure • making the target more challenging. An example would be the repeated reduction in the target set up time and the increase in the target percentage of telephone pickups within three rings. Note that on a customer survey form, a question that asks whether the customers’ expectations were exceeded will automatically measure continuous improvement as regular customers will increase their expectations each time they have been exceeded! 14.19 Management accountants can play a variety of roles in benchmarking activities. They may become involved in determining the appropriate functions to benchmark, be a part of a multidisciplinary benchmarking team and manage data collection and analysis. 14.20 The four types of benchmarking and some of their advantages and limitations: 1 Internal benchmarking involves benchmarking between units of the same company.This is the simplest form of benchmarking to use, as it is relatively easy to gain access to other areas of the one organisation. However, internal benchmarking partners may not provide the best benchmarks as they may not be the best performers in certain areas. Also, they may be operating in dissimilar markets and industries, so processes and measures may not be directly comparable. 2 Competitive benchmarking involves a company identifying the strengths and weaknesses of competitors to assist them to prioritise areas for improvement so it has the advantage of evaluating the organisations’ competitive achievements. However, while the objective may be to equal or exceed the competitors’ performance, formal benchmarking processes may be difficult to arrange with direct competitors. 3 Industry benchmarking is broader than competitive benchmarking as it involves comparing a business against all other businesses that have similar interests and technologies, to identify performance and trends within an industry. Where these are relatively common to all firms in the industry, this can be a very valuable form of benchmarking, but as industries become more globalised and directly compete in the same markets, opportunities for benchmarking of this nature are likely to diminish. 4 Best-in-class or process benchmarking. This involves benchmarking against the best practices, which may occur in any industry. It has the advantage of easier access, as it does not depend on access to the data from a direct competitor. The difficulty with this approach is that many characteristics of best practice businesses may not be common to other industries. SOLUTIONS TO EXERCISES EXERCISE 14.21 (20 minutes) Financial and non-financial measures 1 True. It is often difficult to use financial measures to take actions to correct problems at the operational level as they tend to describe consequences (what has happened) not causes of the problem (why it has happened). Also, financial performance measures are often not timely enough to be used to correct problems. However, non-financial measures are more timely and actionable. 2 False.It is non-financial measures that tend to focus on the drivers of future financial performance, so can be used to uncover the causes of problems. 3 True. A combination of financial and non-financial measures can assist in communicating strategy and encouraging goal congruence if the measures are selected or designed in a way that is consistent with the strategy of the firm. 4 True.Unlike financial measures, non-financial measurescan indicate whether strategies encompassing quality, delivery or customer satisfaction have been achieved. EXERCISE 14.22 (20 minutes) Financial and non-financial performance measures: service firm 1 Favourable revenue variances can indicate that more parties were catered for than in the budget and/or that the fee charged for parties was higher than planned. Unfavourable cost variances indicate that it cost more to cater for those parties than would have been expected, which is totally unrelated to how many parties there were or how much was charged for each party. 2 Monthly performance reporting at The Corporate Caterers would be improved by breaking the variances down into cause and effect components. The revenue variances should show the variance due to the increased volume of sales separate from the variance due to a change in the pricing policy (one of which might be negative!). The cost variances should show separately the variances due to materials usage; material cost; labour efficiency; labour rate changes; overhead efficiency and price changes. While this will not in itself provide answers to Heidi, it will indicate problem areas, suggest questions that need to be asked to investigate poor profitability and guide decisionmaking directed at improving profitability. 3 A further improvement in the performance report would be to include non-financial measures. Customer satisfaction measures; enquiries from guests for future bookings;and complaints about facilities, food, drink, waiters, table dressing and so on should be regarded as helpful information to guide improvements and future profitability. Other information that might help includes the timeliness of deliveries and the suitability of new fancy lighting. EXERCISE 14.23 (20 minutes) Non-financial performance measures 1 Accounting firm: Length of time between client interview for tax return and its completion; percentage of late lodgements of tax returns; number of audit queries not responded to within 14 days; number of late lodgement penalties for a period; amount of late lodgement penalties for a period; number of client queries about completion time; and number of returning clients. 2 A company that manufactures electric garden equipment: number of product returns and number of customer complaints. 3 A firm that designs advertising campaigns for sporting events: number of late campaign starts and number of returning customers. 4 A company that sells children’s toys: number of returns and market share. 5 A taxi company: passenger order receipt time; waiting time;and number of passenger queries about non-arrival of taxi. EXERCISE 14.24 (20 minutes) Non-financial performance measures: manufacturer 1 Strategic priorities Performance measures (a) On-time delivery Customer response time Production lead time. Number of customer queries about delayed meals. (b) Product quality Results of customer surveys regarding satisfaction with quality. Number of customer complaints about quality. Number of returning customers. 2 Achieving challenging targets for these non-financial measures may not necessarily result in higher profitability because: • the wrong strategic priorities may have been selected • freed-up resources may not have been utilised or not utilised effectively • an improvement in a non-financial measure may not translate into increased profits until a subsequent period • the design of the performance measurement system may provide incentives to maximise performance in some areas at the expense of others • non-financial measures may be subject to manipulation so that performance is not as high as measures indicate. EXERCISE 14.25 (20 minutes) Balanced Scorecard: internet search Each student may have a different example here. It is important that students can see the link between the perspectives selected by the organisation, how the perspectives cover all aspects of operations, and the interaction between them.Examples of sources students may find: htpp://scm.ncsu.edu/scm-articles/article/philips-electronics-balanced-scorecard, accessed on 3 July 2011. This is the website for North Carolina State University. Philips Electronics has implemented a scorecard system to align company views, to focus employees on how they fit into the big picture, and to educate employees on what drives the business. Philips management uses the scorecard as a guide at quarterly business reviews worldwide to promote organizational learning and continuous improvement (3). Philips created its balanced scorecard with the belief that understanding what drives present performance is the basis to determine future results. Philips uses the scorecard as a basis for employees to understand management’s strategic policies and vision for the future. Philips created four critical success factors (CSFs) to align indicators that measure markets, operations and laboratories with business success (3). At the business unit level, six key indicators are also included under each CSF. These CSFs and key indicators are: Competence (knowledge, technology, leadership, and teamwork) Indicators: Organizational development and IT support Processes (drivers for performance) Indicator: Operational excellence Customers (value propositions) Indicators: Customer delight and employee satisfaction Financial (value, growth, and productivity) Indicator: Profitable revenue growth Aurora Energy provides a convenient statement called ‘our balanced scorecard’: www.auroraenergy.com.au/pdf/about_aurora/annual_report_2009/segments/7_our_balanced_scorecard.pdf, accessed 3 July 2011. Perspectives, each with one objective: Our Shareholders Commercial returns for our shareholders Our Customers Loyal highly satisfied customers Our Community Model corporate citizen Our Business Realise the full potential of our business Our People High performing motivated team and leaders who deliver with zero injuries For examples such as this, in addition to discussing why these perspectives would be selected, it would be useful to consider how helpful the objectives are in the selection of lag and lead indicators. EXERCISE 14.26 (30 minutes) Lag and lead indicators: service organisations 1 & 2 There is no right answer to this question. Possible answers include the following examples of lead and lag indicators: Quality lead indicators A sporting goods firm An airline A law firm Range of products stocked with regard to quality and cost Hours or cost of training of sales staff in the products offered Number of staff with relevant sport or fitness experience Number of aircraft operating Number of flightscancelled Percentage of on-time departures and arrivals Number of law qualified professionals on staff Amount spent on training support staff Number of lawspecialists available on staff Quality lag indicators A sporting goods firm An airline A law firm Number of regular customers Number of returned goods Number of passengercomplaints Number of frequent flyer members Number of loyalty club (e.g. Qantas Club) memberships not renewed Number of complaints relating to the outcomes of legal cases Number of cases won in court Number of new clients resulting from referrals Innovation lead indicators A sporting goods firm An airline A law firm Range of goods offered Number of new customers Customer complaints Number of different menus that rotate through different flights. Passengersurveys about their views of new aircraft, loungefacilities, and experience collecting baggage Survey of new clients as to why they approached the firm Range of services offered Number of specialist lawyers on staff Innovation lag indicators A sporting goods firm An airline A law firm Number of returning customers Customer satisfaction survey Number of new loyalty club members Percentage of seats filled per flight Customer satisfaction survey Length of customer relationships Number of new customers EXERCISE 14.27 (20 minutes) Strategy map; cause and effect linkages 1 Economic Customer Workforce Community Environment 2 Perspective Measures Economic Customer Workforce Community Environment Low staff turnover and high employee engagement can mean there are satisfied staff who will provide good customer care. The resultant high customer satisfaction would mean high customer retention and possibly more policies with the same customers (for example, customers happy with car insurance may take out home insurance as well). We might also expect the good publicity from environmental controls and community investment to boost the number of new customers. Hence the measures for the environment, community and workforce perspectives are likely to be consistent with the measures for the customer perspective. Increased business volumes would lead to an increase in the measure of gross written premiums and claims. EXERCISE 14.28 (20 minutes) Balanced scorecard; strategy map: manufacturer 1 & 2 The objectives are in the strategy map. The increase in sales revenue can be achieved by increasing the volume of sales, improving the marketability of the product and by improving the quality of accessories such that a higher price can be put on the product. The firm needs to make strategic decisions with regard to whether they wish to sell more products at low prices or have high quality-high sales price products, or what balance to strike between two extremes. We will assume a balance between top quality and price on one hand and low quality and price on the other. We do not know whether there is to be an improved ROI but we can expect the objective does not allow for a decrease in profitability! This will suggest a modest increase in quality with improved margins and volumes of sales. FINANCIAL Improve profitability Improve customer satisfaction CUSTOMER Offer innovative products INTERNAL BUSINESS PROCESS Improve productivity Improve time to market Improve quality of products LEARNING AND GROWTH Increase products in development Improve employee satisfaction Train staff in product development and customer service Develop innovative products 3 Perspective Lag Indicator Lead Indicator (for continuous monitoring) Financial 15% ROI Sales revenue (target of 20% increase p.a.) Customer 20% market share Number of customer complaints (target of 20% reduction p.a.) Internal business processes Launch 100% of new products on the same day as the mobile phone is launched Number of products in design (target of 10% increase p.a.) Learning and growth Improve score on staff satisfaction by 20% Employee turnover (target of 50% reduction p.a.) EXERCISE 14.29 (30 minutes) Du Pont chart; continuous improvement: service firm 1 2 Continuous improvement may be built into the KPDs in several ways. (a) Selecting relevant performance measures. As the bank makes changes in its strategies or operations, some KPDs may be dropped and new ones added. Also, when certain problem areas have been corrected, measures may be developed to address other areas. For example, once the average length of queues has come down to an acceptable level of five people the bank may focus on another KPD—say, average time to solve a customer inquiry. (b) Defining and redefining the measure. As the ‘percentage of customers using ATMs for the majority of their transactions’, increases to an acceptable level, this measure may be redefined as the ‘percentage of customers using ATMs for all transactions’. Each time the measure is redefined the apparent performance level will drop, as each version of the performance measure is more difficult to achieve. (c) Making the target more challenging. Employees may initially be set a target of seven as the average queue length, and once this is achieved the target may be raised to four. EXERCISE 14.30 (15 minutes) Benchmarking: manufacturer 1 The Doveton plant is planning to undertake internal benchmarking. 2 The advantages of this form of benchmarking is that access is more likely to be granted to the Doveton plant, compared to the difficulties faced if the plant attempts to gain access to firms that are external to the Zippy Cola Group. The main disadvantage is that the best performing plant within the company group may not be the best performing plant by global standards. Therefore, the benchmarking targets may not be sufficiently challenging or appropriate. 3 Multidisciplinary benchmarking teams contain people with many different skills, often working at different levels in the organisational hierarchy. The team may have broader insights, compared with a team consisting of employees with the same skills. A range of perspectives is brought to bear on the project. Also, members of the team undertaking benchmarking visits may often be involved in implementing the new practices or systems across several areas of the business, that result from the benchmarking exercise. SOLUTIONS TO PROBLEMS PROBLEM 14.31 (35 minutes) Performance measures in manufacturing 1 There are three main problems with standard costing variances as measures of performance. (a) They are untimely and too aggregated, particularly the overhead variances, which combine the effects of many different costs. The real problem is that the standard costing variances are not actionable as they report the consequences not the causes of problems. (b) The manufacturing overhead variances are based on budgeted variable overhead costs, which are assumed to be driven by the volume of production, and budgeted fixed overhead costs, which are assumed to be fixed regardless of the volume of production. In the modern business environment, it is likely that manufacturing overheads are a major cost, and a large part of manufacturing overhead is not driven by the volume of production but by other cost drivers. (c) The system focuses on costs and cost variances. To be competitive in domestic and export markets, the company’s strategic plan is likely to be based on quality and delivery, as well as cost competitiveness. Standard costing can erode performance and cost in these other areas by encouraging the purchase of poor quality inputs, and the purchase and production of excessive inventories. 2 The direct material usage variance is favourable; this indicates that the Finishing Department is using fewer materials than expected for the number of units produced. The direct material price variance is unfavourable, suggesting that the Finishing Department is paying more than expected for the materials used. The direct labour efficiency variance is favourable, but the direct labour rate variance is unfavourable. These variances suggest that the Finishing Department is completing more units than expected per hour, but is spending more on labour per hour than anticipated. Overall, the direct material and direct labour variances are both favourable. The variable and fixed overhead efficiency variances are favourable, suggesting that more units are completed in the given time than the standard expects. The variable and fixed spending/budget variances are unfavourable, indicating that more is being spent per hour in these areas than expected. The overall result of these variances suggests that units are being completed more quickly than expected but hourly costs are greater than expected, which is making the price-based variances unfavourable and the efficiency-based variances favourable. 3 Suggested performance measures: Cost: • paint thickness • labour hours worked • overtime hours worked • paint quality • energy consumption. Quality: • paint quality • number of defects • number of good units first time • warranty claims • customer surveys. Delivery: • number of orders delivered on time • percentage of problem free orders on time • percentage of problem free delivered orders on time compared to rush orders • time through finishing department • machine downtime. (Some students may attempt to develop a hierarchy of measures for the different levels of management (for example, plant, department, line foreman). In this case the measures at the upper level should be more aggregated, and the measures at the lower levels should be more detailed and actionable. There should be some causal link between the measures at one level and those at the level above. Also, students may develop measures for other key strategic areas such as innovation and flexibility.) PROBLEM 14.32 (65 minutes) Problems with traditionalperformance measures; strategy and performance measures: manufacturer 1 Standard costing performance measures: The monthly standard costing reports would record detailed direct material and direct labour variances (possibly for each major type of material and labour) for each production department. The variances would be broken into price and quantity variances for materials and rate, and efficiency variances for labour. The overhead variances would depend on whether there was a plantwide or departmental overhead rate and whether fixed and variable or total overhead rates were used. There would be some form of overhead spending and possibly efficiency variances. These may be plantwide or for each department. 2 Usefulness of the standard costing information: For each level of management, the reports will be relevant only for controlling costs, not other important sources of value such as quality and delivery performance. As far as the cost information is concerned, the overhead variances provide little useful information because they are related to many different costs all bundled together. Also, the overhead variances are likely to be based on inappropriate cost drivers. The usefulness of the other cost information is likely to depend on the level of management. (a) Managing director: The monthly reports will provide an overview of the costs incurred, compared to standard costs, for each department for the month. This information is likely to be presented to the managing director in a summarised form. (b) Manufacturing plant manager: The monthly reports will provide an overview of the costs incurred, compared to standard costs, for each department for the month. (c) Production department managers: The monthly reports will provide an overview of the results for the department for the last month. The variances will indicate areas where performance differs from the budget (based on the standard costs), but will not indicate the causes of these variances. There may be a considerable lag between problems occurring and their effects showing up as monthly variances. (d) Production line foremen and supervisors: The variance reports will be too late and too aggregated to be of any use to these managers, who need to know about problems and their causes quickly. 3 The company will probably want to manage its performance in the areas such as quality and delivery performance, as in most businesses these are important determinants of success. Other strategically important areas may include flexibility to adapt to customer demands and innovation. 4 Students’ answers here will depend on the strategic areas of importance chosen in requirement 3. The important point is that the measures provided to upper-level managers should provide an overview of performance in the area, whereas the measures at thelower levels of management should be detailed and actionable and, therefore, available frequently. The managers at the middle level need measures with less detail than the lower level, but more detail than the upper level. Also, the measures should be available less frequently than measures at the lower level, but more frequently than measures at the upper level. Selecting quality as a strategic measure, the performance measures for each level of management may be as follows: Managing director Quarterly surveys on quality as perceived by customers and/or distributors Quarterly reports on relative quality by trade associations or consumer choice groups Manufacturing plant manager Weekly reports for each product group on: Number of final inspection failures Number of customer complaints or distributor warranty claims Production department manager Daily report on number of rejects identified for each production process Daily report on number of components requiring rework Production line foremen or supervisors Daily record of machine stoppages, time lost and reason Daily number of components rejected and source of supply. PROBLEM 14.33 (30 minutes) Performance measures for operational control: manufacturer To: President, Australian Plastics Ltd From: I M Student Subject: Performance of Whyalla Plant 1 The Whyalla Plant’s performance for the period January to June is summarised as follows: (a) Production processing and productivity: The plant’s cycle time (or throughput time) has improved over the period from 20 hours to 17 hours (average of 18.8 hours). This indicates that the efficiency of the actual processing of products has improved. Consistent with this observation is the reduction in setup time from 70 to 62 hours (average of 65.5 hours). Overtime hours have increased due to higher demand late in the period. Power consumption has remained stable. (b) Product quality and customer satisfaction: The plant’s quality control program appears to be paying off. The number of defective units in finished goods declined dramatically, and no products were returned. This is the result of the plant’s inspectors more effectively identifying defective units while still in process. Effort should be devoted in the future to the reduction of the in-process defect rate. (c) Delivery performance: Delivery performance could be improved. Not all orders were filled, with an average of 92.8 per cent of orders filled on time between January and June, and only 90 per cent for May and June. On-time deliveries averaged only 81.2 per cent between January and June, and only 80 per cent for most months. This probably reflects the increased demand, as evidenced by the increase in overtime hours and bottleneck machine downtime. It may be possible to improve throughput and delivery performance by investigating capacity constraints, in particular the bottlenecks in the manufacturing process. (d) Raw material, scrap and inventory: The rate of defective raw materials has declined to zero. The purchasing team is doing a good job by ensuring delivery of high-quality raw materials. Inventory value has been steady through the period with an average of 4.8 per cent of sales. This is probably as low as can reasonably be expected in this industry. (e) Machine maintenance: Machine downtime improved during the period from 30 hours to 10 hours (average of 21.7 hours), but bottleneck machine downtime was too high, particularly in March, May and June. Also, unscheduled machine maintenance calls were up in May and June. 2 Recommended actions: (a) Maintain inspections in process. Try to reduce the in-process defect rate by emphasising the importance of quality to the work force. (b) Investigate causes of bottleneck machine downtime and correct the situation. (c) Investigate whether the plant needs to increase production capacity. PROBLEM 14.34 (45 minutes) Performance measures for operational control: manufacturer 1 Categories of measures: Area of manufacturing performance Cycle time (days) a Number of defective finished products b Customer complaints c Unresolved complaints c Products returned b, c Warranty claims b, c In-process products rejected d Average number of units produced per day, per employee a, e Percentage of on-time deliveries f Percentage of orders filled f Inventory value/sales revenue g, h Machine downtime (minutes) i Bottleneck machine downtime (minutes) i Overtime (minutes) per employee a, e Average setup time (minutes) a 2 To: Management, Medical Systems Corporation From: I M Student Subject: Performance of Elizabeth plant during first quarter Performance of the Elizabeth plant is evaluated in nine key areas: (a) Production processing: Cycle time and the average number of units produced per employee per day point to consistency and high-level performance throughout the measurement period. Both exhibit slight, favourable trends. Average setup time has reduced from 120 to 101 minutes, a reduction of about 16 per cent. (b) Product quality: The number of defective finished products, number of products returned, and warranty claims all show improvement over the period. All three measures suggest excellent performance in quality control. (c) Customer satisfaction: Customer complaints range between five and eight over the six periods, but the number of unresolved complaints improved during the period from two to zero. Products returned and warranty claims are very low. There is scope for reducing the number of customer complaints. (d) In-process quality control: The number of products rejected in process has increased. This speaks well for the in-process inspection effort. The cause of these defective in-process units should be investigated and corrected. (e) Productivity: The number of units produced per day, per employee, exhibited a slight and favourable trend. Overtime minutes per employee range from zero to twenty. It is unclear if this problematic, but could relate to bottleneck downtimes. (f) Delivery performance: Both performance measures (percentages of on-time deliveries and orders filled) were very high through the period, finishing at 100 per cent in period 6. (g) & (h) Raw material and scrap; inventory: Inventory value/sales revenue remained consistently low through the period (average of 1.83 per cent). There is no measure of scrap for the period. (i) Machine maintenance: Machine downtime was low through the period (average of 84 minutes each two-week period). Bottleneck machine downtime was low, except in period 5. The cause of that incident should be investigated. Overall evaluation: The Elizabeth plant has performed at a very high level of efficiency and effectiveness in most areas of its operations during the first quarter. PROBLEM 14.35 (30 minutes) Financial versus non-financial performance measures: manufacturer In this answer students should demonstrate an understanding of the issues relating to the disadvantages of only providing financial data in the monthly report, which includes not gaining potential benefits to be had from including selective non-financial measures. In preparing the following report some assumptions have been made (for example, about corporate strategies) for the sake of illustration. To: Management From: Jason Bell Re: The Monthly Manufacturing Performance Report I have been have been reporting and analysing manufacturing performance data and feel that I can add value to these reports by introducing some explanatory measures that are currently being taught in universities. Some disadvantages in only presenting data on costs and profits are that these measures do not provide managers with explanation about why poor results were not as favourable as anticipated, feedback on which actions led to superior results nor guidance on how to improve the results of operations over coming periods. Since the financial data are not actionable, operations managers are not assisted in decision making by the formal reports and usually prepare their own operating reports. I suggest that, in the monthly manufacturing performance report that I prepare each month, I incorporate relevant non-financial data and link them to the financial data. In this way senior managers will receive the financial data that they expect, operations managers will understand the impact of operating decisions on the financial results and will have data to guide their decisions. We will also save the expense incurred when operating departments need to prepare their own reports on operations. The non-financial measures that I plan to report will be useful for senior management to evaluate their strategies. The measures would be chosen on the basis of their relevance to financial success, their ease of understandingand guidance to managers with regard to what action to take, and their relevance to the strategic direction of the organisation. For example: • A strategy of the organisation is to manufacture high quality innovative products. In addition a large percentage of manufacturing costs are for the high quality materials used in production. I therefore propose that the monthly report includes measures of scrap, material volumes and number of products in design. • We have high staff training costs and part of the mission of the organisation is to be a caring organisation. I propose that the monthly report provides staff turnover measures as this affects training costs and also provides feedback on employee morale. PROBLEM 14.36 (45 minutes) Balanced scorecard; strategy map: service firm 1 Financial Customer Internal business process Learning and growth 2. Performance Measures Objectives Lag Indicators Lead Indicators 1. Financial Increase profit Improve cash flow Profit per tour Average cost for major tours Average value of each booking Number of tours cancelled Quality of tour operators 2. Customer Increase market share Improve customer satisfaction Market share Customer satisfaction survey Number of bookings per week Number of customer complaints Number of bookings cancelled Number of repeat customers 3. Internal Business Increase office cost effectiveness Increase innovative tours Monthly operating costs Number of tours on offer Staff absenteeism Number of tours under development Quality of relationships with tour operators 4. Learning and Growth Increase environmental knowledge of employees Number of employees attending green training courses Number of customer complaints Number of employee suggestions for tours PROBLEM 14.37 (45 minutes) Balanced scorecard; design and implementation issues; internet search: airline 1It can be difficult to find the relevant pages for this activity for a number of airlines when the search engines keep taking you to promotion materials about flights and destinations or pages where you seek or book flights. Once in these pages it is very difficult to get to corporate governance and planning. Source: From http://www.finnairgroup.com/group/group_2.htmlaccessed on 26April2014. 2 With the strategic priority areas defined for us we can see that four suitable perspectives would be customer, internal business processes, employees and financial. Strategy map: FINANCIAL Improve profitability Improve customer satisfaction CUSTOMER Improve the quality of operations Improve comfort INTERNAL BUSINESS PROCESS Reduce costs Develop strategic alliances for aviation support services and European feeder traffic Become more adaptable to changes in the market Upgrade the long haul fleet EMPLOYEES Train managers in leadership Train staff in customer service 3 Lead and lag indicators for each perspective: Performance measures Perspectives/objectives Lag indicators Lead indicators 1 Financial: Improve profitability ROI Earnings per share Number of new passengers Number of new FinnairPlus members Corporate Programmeretention rates Cost measures Profitability of individual routes 2 Customer: Improve the quality of operations Improve comfort Improve customer satisfaction Market share Industry ranking Customer satisfaction survey Industry ranking Client satisfaction survey Growth in market share Number of passengers % of seats occupied Number of new memberships in frequent flyer program Renewals of Finnair Corporate Programme memberships Number of customer complaints Trend of sales volume 3 Internal business processes: Reduce costs Develop strategic alliances for aviation support services and European feeder traffic Become more adaptable to changes in the market Upgrade the long haul fleet Cost variances Measure of absolute cost Quality measures related to strategic alliances Increased business in the oneworld flights Market share Customer satisfaction survey Increase in capacity Trend in fuel efficiency measures Monthly cost variances Trend in monthly costs Number of strategic alliances agreed Passenger numbers on strategic routes Number of passengers Membership numbers in The Corporate Programme Number of deliveries of aircraft Number of on-time deliveries of new aircraft 4 Employees: Train managers in leadership to better manage staff Train staff in customer service Number of managers attending training Employee satisfaction with regard to leadership Number of all staff attending new skills courses Hours available for manager training Hours available for staff training Skills of existing staff Number of passengers 4 Lag indicators are the measures used to evaluate success with regard to the outcome of addressing defined objectives. In the BSC above we can see that the lag indicators used to evaluate the achievement of ‘Improve profitability’ are the ROI and the EPS, and the lag indicators selected to evaluate success with regard to meeting customer needs and having satisfied customers are the market share and a customer satisfaction survey. A feature of lag indicators is that they are often not directly manageable and are the result of many initiatives. The final measure is also likely to be available intermittently, and is thus not timely enough for most decisions (hence the term lag indicator). We therefore need other indicators that can be measured on an ongoing basis. This makes them timely for decision-making but, in addition to being timely, they must also be actionable—they must directly link operations and decisions and provide a suitable representation of what is happening in operations. They are used as feedback on past decisions and feed-forward to present decisions (remember, current decisions are about the future!). These indicators are measures of things that drive outcomes (the lag indicators) and are called lead indicators. We can see above that the lead indicators for the overall profitability measures are the numbers of passengers, seat occupation rates, the number of new members and retention rates of the loyalty programsand the profitability of routes. We could also break these down further to keep a closer eye on costs. It is possible to see how managers can closely monitor passengerretention, new business, product profitability and costs as a way of checking the likely achievement of the financial objectives. Similarly we can see that customer complaints can be categorised into causes and monitored to check whether the final customer satisfaction survey is likely to be favourable, whether processes are too cumbersome to understand and/or time-consuming for staff or customers, and whether the current range of products and quality meets customer needs. An exit survey of passengers or corporate memberswho closeloyalty program memberships,or passenger complaints, would be a check on the waysthat this airline’sproducts fail to meet their needs. A useful discussion with students could focus on the fact that staff training described above is designed to meet certain needs. In this case ‘customer service and leadership’ as mentioned on Finnair’s web page. This focus on meeting training needs makes it easier to identify vital lead indicators. Attention could then go back to the strategy map to relate these measures to the achievement of objectives in other perspectives. 5 Discussion could focus on the need to: • incorporate measures that are financial and non-financial, lead and lag indicators, internally focused and externally focused • link strategy to goals; support staff decision making by providing timely, easy to understand controllable measures; emphasise the positive rather than the negative (e.g. 90 per cent good output rather than 10 per cent defects); and be selective and keep numbers of measures low by culling some if others are introduced • achieve staff support by involving many of them in the process of defining objectives, identifying indicators and setting targets • continuallyimprove the BSC itself by reviewing and redefining measures. Experience may show that those selected originally were not quite right or changing strategies or environment could require flexibility to accommodate the changes. The interaction between measures should also be reviewed with a view to making adjustments if necessary • review the reward system to ensure that it is consistent with the measures in the BSC. PROBLEM 14.38 (40 minutes) Strategy map; internet search: not-for profit organisation The following extract is from the web pages of the Brotherhood of St Laurence at www.bsl.org.au/About-the-Brotherhood/What-we-do.aspx, accessed on 4 August 2014. How we work The Brotherhood works not just to alleviate poverty but to prevent it. We focus on people who are at risk at four critical stages (transitions) in their lives: • children and families in the early years, both at home and in school • young people in the years through school to work and further education • adults seeking employment and training • older people facing the challenges of retirement and ageing. Within this broad framework, we pay particular attention to issues relating to refugees and settlement and money matters. We undertake research, service development and delivery, and advocacy, with the objective of addressing unmet needs and translating our learning into new policies, programs and practices for implementation by government and others. Through Brotherhood businesses, we provide employment opportunities and raise funds for our other programs. We aim to have a national voice on poverty and disadvantage. We believe that tackling poverty effectively requires the integration of social and economic policy, so that all Australians have the capacity and the resources to lead rewarding lives. We want to demonstrate how economic efficiency and social fairness can reinforce each other and lay the foundations for a new social safety net based on economic participation and opportunities. Our current areas of policy focus include social inclusion, equity and climate change, a fairer tax system and financial inclusion. An influencing organisation The Brotherhood aspires to be an influencing organisation. We seek to engage with key decision makers in government, business and the community, and to enlist the support of a broader audience in order to achieve social change. 1 The extracts above from the web pages of the Brotherhood of St Laurence indicate that the ultimate goal of the Brotherhood is to prevent poverty. In the long-term the goals are to alleviate poverty and influence government, business and communities in pursuit of social change. The principal clients are recognised as: children and families in the early years, both at home and in school; children and families in the early years, both at home and in school; adults seeking employment and training; and older people facing the challenges of retirement and ageing. 2 Suitable perspectives and their objectives could be: Financial • Operate within budget • Raise resources adequate to needs from grants, donations and volunteers. Client • Assist young people living in poverty to stay at school as long as is required to reach their potential in their chosen profession or trade • Assist needy unemployed adults to obtain training and jobs. Internal processes • Improve research into the nexus between economic efficiency and social equity • Improve communication channels between the Brotherhood on one hand and government, business and communities on the other. Volunteers, donors and employees • Provide monthly newsletters for volunteers and donors to give feedback on the operations and achievements of the organisation • Satisfy volunteers, donors and employees that their funds and efforts are effectively and efficiently utilised. 3 FINANCIAL Operate within budget Assist the young living in poverty to stay on at school CLIENTS Obtain adequate resources Assist needy unemployed to obtain training and jobs INTERNAL BUSINESS PROCESSES Improve research into nexus between economic efficiency and social equity Improve communication with stakeholders VOLUNTEERS, DONORS AND EMPLOYEES Provide monthly newsletter on operations Satisfy resource providers about efficient and effective use of resources PROBLEM 14.39(45 minutes) Balanced scorecard; strategy map; implementation: government department 1 Government and other stakeholders Improve opportunities for communication Clients Improve client satisfaction Provide timely interventions Service delivery Increase flexibility of service delivery Provide effective support to clients in need Employees Improve skills base of employees Improve employee satisfaction Finance Operate within budget 2 FINANCE Operate within budget Improve client satisfaction CLIENTS Provide timely interventions SERVICE DELIVERY Increase flexibility of service delivery Provide effective support to clients Improve opportunities for communication GOVERNMENT AND OTHER STAKEHOLDERS EMPLOYEES Improve skills base of employees Improve employee satisfaction 3 Performance measures Perspective/objectives Lag indicators Lead indicators 1. Financial: Operate within budget Cost variances Service costs Average cost per client in each service Number of clients Number of closed cases Number of new cases 2. Clients: Provide timely interventions Improve client satisfaction Percentage of client problems dealt with within specified time for each service Client satisfaction survey Client problems outstanding Number of homeless in the State Number of unplaced children needing foster care Waiting time on waiting list for each service Number of client complaints Number of appointments not kept Number of grant applications received Percentage of grant applications approved Number of foster parents registered 3. Service delivery: Improve flexibility Provide effective support to clients in need Professional skill base of staff matched to positions Number of multilingual staff Number of stakeholder organisations consulted in the development of services Number of children in care Benchmarking of services against other providers Hours of outsourcing required Hours of professional development and general training for staff Number of services with improved processes Customer complaints about quality or timing of service Reduction of drug overdoses Number of community programs supported 4. Employees: Improve skills base Improve employee satisfaction Number of professional staff attending update (PD) courses Number of staff attending new skills courses Employee satisfaction survey Hours of trauma counselling for staff Percentage of appointments filled by internal applicants Spending on training Hours available for staff training Staff retention Number of professionally qualified staff recruited Skills of existing staff Hours of professional supervision Number of staff involved in community support programs Number of employee complaints Staff turnover 5. Government and other stakeholders: Improve opportunities for communications Number of stakeholders on list of consulting agencies Number of clients attending or supported by the stakeholder agencies Number of hours in meetings with stakeholder agencies Number of services changed as a result of government policies Number of services changed with input from stakeholder agencies 4 The balanced scorecard can be used to monitor performance by regularly reporting the lead indicators. The lag indicators should be reported periodically but it is to be expected that the use of lead indicators to guide decisions will have a favourable impact on lag indicators. That is a principle of their selection. Favourable lead indicator measures will motivate staff. Staff are also motivated by having lead indicators to show them what is expected of them, and by seeing that managers are making informed decisions. Those decisions are made with the feedback from the lead indicators. For example, if the number of clients is down, data is available to indicate whether that is due to closing more case files than anticipated (indicating success in helping the clients) or fewer new cases than anticipated. If there is a decline in new cases investigation should reveal whether: • the available services are not being promoted well enough, hence people are not making application for assistance when they need it • there is difficulty accessing the services • the service has a poor reputation • there is a decline in need due to more favourable economic conditions or other reasons. Continuous improvement can be guided by this kind of analysis. There can also be a tightening of targets. In addition, areas for improvement can be targeted by a few lead indicators and, when that aspect of services has improved, the lead indicators can change to lead indicators of the next target areas that need improvement. PROBLEM 14.40 (40 minutes) Designing a performance measurement system; Du Pont chart: service firm 1 Mark needs to select performance measures that will support the strategies of the on-line delivery service of floral arrangements, boxes of roses and floral wreaths, and that will alert him to any problems that may be occurring. These same measures should be ones that encourage employees to focus their efforts in a way that is going to encourage the ‘right’ performance. However, even once he has selected suitable measures, he needs to consider a range of additional issues: • The measures should be simple enough for employees to understand. • The measures that employees are going to be held responsible for should relate to activities and processes that they can influence or control. • Targets set for measures should be expressed in positive terms—measuring, for example, customer satisfaction not customer dissatisfaction. • Performance measures need to be reported in a timely manner, to allow immediate feedback and timely correction of problems. • Performance measures should be benchmarked to high external standards. • If possible, employees should be involved in the formulation and operation of the measures to encourage employee acceptance of them. • Mark should use only a few performance measures. • Mark could consider linking performance achievement to employee rewards. 2 Mark Fisher’s concerns seem to focus around cost overruns and customer loyalty. Therefore, performance measures could be designed to address cost effectiveness and customer satisfaction. Some suggested measures are as follows: Customer satisfaction: • results of customer surveys for each of the three product lines • results of customer surveys on overall satisfaction with service • customer complaints • amount spent on training employees • hours online site is not available • days listed flowers are not available • number of orders that could not be filled with the exact products that customers order • percentage of orders filled on the requested date. Cost effectiveness: • average unit cost per product line • cost per month of each product line • cost of updating web pages for product changes and availability of materials • labour cost per delivery • cost of materials wasted • average delivery cost per order 3 PROBLEM 14.41 (35 minutes) Benchmarking: manufacturer 1 Benchmarking is the continual process of measuring products, services and practices against businesses that are considered the best performers. The focus is wider than just comparing performance measures against a benchmark; it involves examining the processes that those high-performing businesses use to achieve their high levels of performance. In the past, businesses often assessed their progress by comparing their current performance with their own past performance. However, this gave no indication that they were competitive in their markets. Benchmarking provides an external perspective that may help a business assess and improve its own performance relative to other businesses. It also allows a business to consider how the best companies have achieved their high performance. 2 When selecting a benchmarking partner, the business environment, processes and systems should be as comparable as possible. If the benchmark data relates to Speedy Plastics, then comparability to Glamour Plastics will be a problem. Glamour Plastics differs in many ways from Speedy Plastics. Their products are aimed at a different type of customer and their products, scale of production, production methods and manufacturing equipment are different. The similarity is that both businesses are in the broad plastics industry and, therefore, could potentially use similar raw materials and production processes. Because of these differences, it is difficult for Glamour Plastics to interpret the performance gap. The gaps revealed in each measure may be a result of the many differences between the two businesses, which Glamour Plastics cannot change (or may not ever want to change) in the short term. (a) Product cost per kilogram of product: Glamour Plastics’ measure is greater than the benchmark data, but this is understandable given the higher quality of raw materials that Glamour uses in its more prestigious products, and the larger scale of operations of Speedy Plastics. (b) Direct labour per kilogram of product: Glamour Plastics’ rate is much higher than the benchmark data. This may be due to the high level of automation of Speedy Plastics, compared to the more labour-intensive Glamour Plastics. (c) Raw material cost per kilogram of product: Glamour Plastic’s higher rate is probably due to the higher quality of materials used in its products, compared with Speedy. (d) Cycle time per 100 units: Glamour Plastics uses older extrusion machines that are probably slow, whereas Speedy Plastics uses high-speed, computer-controlled machines. Thus, Speedy Plastics’ slower cycle time is predictable. (e) Reject rate: Speedy Plastics has a high reject rate, compared to the benchmark data. This may partially be due to differences in manufacturing technology, the difficulties of producing speciality products versus basic plastics products, or there may be quality control practices at Glamour that could be improved. Pascale should be concerned about the performance gaps. However, it is difficult to interpret the ‘real’ performance gaps, as the benchmark data probably relates to Speedy Plastics, which has very different products, technology, and a larger scale of operations. 3 The benchmarking data do not provide suitable benchmarks for Glamour Plastics. Where the differences in business situations are great some companies attempt to ‘normalise’ the data to make it more comparable, and to reveal areas where improvement can be made. Given the degree of differences between the two companies this would be very difficult to achieve. Alternatively, Glamour should consider finding a more suitable benchmark partner that has more comparable operations and products. Glamour could also consider benchmarking more generic areas of their operation, such as quality practices and control of reject rates, and consider non-related businesses from any industry that have developed superior ways of managing these operations. SOLUTIONS TO CASES CASE 14.42 (90 minutes) Review of Chapters 12, 13 and 14; responsibility accounting, transfer pricing; reward systems: manufacturer Students’ answers to this question will vary. To: Regional Finance Director From: Management Consulting Department Monoclean has adopted a very complex structure with overlapping responsibilities and this makes it difficult to design effective performance and remuneration systems. The incentives that are in place encourage managers to maximise their own performance at the expense of the other managers. This can lead to reduced profits for the company as a whole. Organisational structure and responsibility centres In the past, the company consisted of 12 business units, established along geographical lines. Each business unit had a managing director (MD) who was responsible for manufacturing, marketing and selling of the business units’ products. The MDs were evaluated and remunerated based on business unit profitability and managers within the business units were evaluated and remunerated according to their area of responsibility. Under the new structure, the 12 business units continue to exist, but only five contain manufacturing plants. These plants supply all business units in the region. The MDs of the five business units now have responsibility for marketing and sales for their plant, but not the manufacturing function, which is now the full responsibility of the manufacturing manager within the business unit. A manufacturing director has ultimate responsibility for all manufacturing managers. The MDs are evaluated on marketing profit (actual sales revenues less standard manufacturing cost and actual marketing and sales costs). The manufacturing managers are evaluated on manufacturing profit (sales revenue less manufacturing cost). Products are transferred within a business unit at standard manufacturing cost, and to other business units at standard cost plus 5 per cent. Under the new structure, manufacturing units and marketing units are profit centres. This is to encourage managers to be sensitive to managing costs and generating a profit. This would make sense where managers are being held responsible for revenues and costs that are within their control. However, in Monoclean, this is not always the case. In addition, it is unclear why the manufacturing director, who is outside of the business units, would be initiating capital expenditure requests, when this affects the profits and the production capacity of the business units. This responsibility should be reviewed Transfer pricing Products are transferring within a business unit at standard cost, and this does not allow manufacturing managers to generate a profit on those sales. It is more profitable to transfer product to other business units. Sales staff in their own business unit would clearly prefer to buy from within their business unit, as it is cheaper than buying from another business unit. Where there is limited capacity within a manufacturing plant, this could cause conflict. The transfer pricing policy needs to be reviewed to make sure that an optimal price is being used. It seems that the manufacturing areas bear the cost of inventory, including obsolete inventory. However, this can be the result of marketing decisions. Production planning needs to be based on accurate forecasting of sales. Where there is excess production and costs then this might need to be shared by both the marketing and manufacturing areas. Similarly, where manufacturing incurs additional shipping and transportation costs due to marketing activities, these costs may need to be passed on to the marketing department. While there is an incentive to keep actual manufacturing costs close to standard cost, there is little incentive for manufacturing managers to develop a tight standard cost. Where there are increased raw materials or other costs, these are passed on to the marketing areas within the standard cost-based transfer price. Ultimately, this may lead to an inflated external selling price for the products. Some ‘reasonableness’ test needs to be applied in the development of standard manufacturing costs. This could involve some form of external cost benchmarking. Performance evaluation and management remuneration The overlapping responsibilities outlined above suggest that there is a problem with the new organisational structure and the responsibilities and reporting structures. The profit-based incentives motivate managers to pass on cost to other business units to maximise their own profitability. The basis of managers’ remuneration should extend beyond short-term profits. Remuneration could also be linked to inventory management, forecasting accuracy, product quality, and so on, or to other measures of strategic importance to encourage managers to focus on profit but not at the expense of long-term performance. Summary The company should consider revising the structure and aligning managerial responsibilities with a broad-based performance evaluation system and managerial remuneration package. The business units could be separated into manufacturing business units, and marketing and sales business units. This could be accompanied by changes in the transfer pricing policies. Alternatively, five business units could be formed along the lines of the old structure. The MDs could have responsibility for the entire operation of the business units, including manufacturing. CASE 14.43 (90 minutes) Review of Chapters 13 and 14; financial performance measures and reward systems; balanced scorecard and strategy maps; behavioural issues: manufacturing and service organisation 1 Calculation of ROI (target): Last year Current year Newspaper 17% 0.59 = 10.0% 20.7%  0.53 = 11.0% (10.0%) (10.0%) Brewing 20%  0.95 = 19.0% 24.4%  0.70 = 17.1% (18.0%) (16.0%) Cable Television 11.1%  0.27 = 3.0% 41.2%  0.12 = 5.0% (2.0%) (3.0%) The Brewing Division has outperformed the two other divisions both last year and in the current year, and in both years has performed better than target. Even though the current year ROI was lower than the previous year, this appears to have been anticipated due to the lower target ROI. Note that this division is the oldest of the three, so old, written-down assets could help explain the high ROI. Compared to the other two divisions, asset turnover is higher as is profit margin (except compared to the Cable Television Division in the current year). The Newspaper Division is the second highest performing division. Its performance is on target for the last year and just above target for the current year. An increase in profit margin seems to be the main source of ROI improvement. The performance of the Cable Television Division is the lowest of the three divisions. However, it is performing above target. Last year its profit margin was the lowest in the group at 11.1 per cent, however, this jumped to a dramatic 41.2 per cent for the current year. The low revenue in current year, compared to the previous year, seems curious in this growing market, and could point to a loss of market share. 2 Calculation of bonuses Last year Current year Target Actual Bonus Target Actual Bonus Newspaper 10 10 $60 000 10 11 $60 000 10 000 options Brewing 18 19 $60 000 10 000 options 16 17 $60 000 10 000 options Cable TV 2 3 $60 000 10 000 options 3 5 $60 000 20 000 options 3 Leonard Smith is the managing director of the Brewing Division, which earned an ROI of 19 per cent last year and 17.1 per cent for the current year. The new brewing equipment is needed for competitive reasons. Without the equipment, the division’s ROI may drop to 14 per cent next year. However, if the new equipment is acquired, it will also decrease the division’s ROI next year. The incremental ROI on the equipment in year one is 10 per cent (see calculations below). This is why Smith is reluctant to invest in the new equipment. The effect on next year’s ROI from investing in the new equipment may be lower than the 14 per cent ROI expected if the equipment is not purchased. Smith should realise that in the longer term it will be important to invest in the new equipment to prevent any loss of competitive position. Incremental ROI in year one: = = 10% If the new equipment is purchased and if we assume that profit and other assets are unchanged, then the ROI for next year could be as low as 12.75 per cent: Next year ROI: = = = 12.75% 4 (a), (b) & (c) A variety of answers are possible, and it is important that the scorecards are tailored specifically to the particular divisions. Newspaper Division Objectives Lag indicators Lead indicators 1 Financial Improve returns to shareholders ROI Sales revenue growth Market share Increase advertisingrevenue Advertising revenue growth Number of regular advertisers 2 Customer Increase customer satisfaction Sales revenue growth Market share Customer complaints Delivery on time Increase circulation Number of new customers Regular newspaper promotions 3 Internal business processes Improve efficiency of production processes Cycle time Printing press downtime Delivery times Number of printing press breakdowns Regular maintenance of equipment Number of delivery complaints Wastage of material Reduce litigation Number of pending cases Number of legal complaints 4 Learning and growth Improve skills levels of journalists Number of ‘exclusives’ Employee days spent in training Improve skills levels of legal department Number of legal complaints New, more highly-skilled employees engaged Strategy map: Financial Customer Process Learning & Growth Brewing Division Objectives Lag indicators Lead indicators 1 Financial Improve returns to shareholders ROI Profit growth Market share Reduce maintenance and operating costs Maintenance and operating costs Maintenance hours Non-value added production costs 2 Customer Increase customer satisfaction Customer satisfaction survey results Number of customer complaints Increase market share Number of new customers Number of new beer types 3 Internal business processes Increase variety of beers Improve efficiency of production processes Number of different beers Cycle time Number of hours of research into beer recipes Hours of machine downtime 4 Learning and growth Improve effectiveness of research and marketing Number of favourable mentions of beer in media New, more highly-skilled employees engaged Improve skills levels of production employees Number of employee suggestions Employee days spent in training Strategy map: Financial Customer Process Learning & Growth Cable Television Division Objectives Lag indicators Lead indicators 1 Financial Improve returns to shareholders ROI Sales and advertising revenue growth Increase advertisingrevenue Advertising revenue growth Number of regular advertisers 2 Customer Increase customer satisfaction Customer satisfaction survey results Number of customer complaints Increase market share Market share Churn rate 3 Internal business processes Increase favoured Australian and news content in packages Improve billing and account keeping processes Percentage of Australian and news content per packages on offer Time spent on accounts receivable control Number of rights to Australian and news shows Number of customer queries 4 Learning and growth Improve skills levels of advertising managers Number of suggestions to promote advertising services Employee days spent in training Improve effectiveness of research and marketing Number of suggestions to promote cable TV subscriptions Employee days spent in training Strategy map: Financial Customer Process Learning & Growth CASE 14.44 (45 minutes) Review of Chapters 13 and 14; performance measures and reward systems; behavioural issues; benchmarking; continuous improvement 1 Long-run emphasis: A long-run emphasis could be added to the performance measurement system in several ways. For example: • linking rewards to average divisional performance over three years • choosing performance measures that focus on long-term performance, such as those relating to new product development, and employee training • implementing a share option plan which may encourage managers to consider future performance. Company-wide and divisional-based performance measures: This can be achieved by tying rewards to both company performance and divisional performance. This can encourage managers to consider the effect of various decisions on both divisional and company-wide performance. A share option plan may also help managers identify with the company as a whole. Targets that specifically consider competitive challenges: (These will be different for each division.) • Brewing: market share, cost per litre, sales volume • Newspaper: market share, share of advertising dollar, delivery on time • Cable television: cash flow, market share, growth in subscribers. 2 There are several difficulties that may arise in implementing these changes: • If managers’ performance is based on average three-year performance, a decision needs to be made as to when the bonus will be paid. Waiting three years for a bonus may be far too long. • There are always unforeseen outcomes associated with bonus schemes, so care must be taken to ensure that the new system does not encourage opportunistic behaviour, or result in inequities between managers. • It is necessary to ensure that the non-financial measures selected flow through to improved financial performance. • The introduction of any change to bonus systems is often resisted, as managers become accustomed to the existing system and may not welcome introducing any uncertainty into their salary packages. • It may take time for managers to learn to change their orientation away from that encouraged by the previous bonus system. For example, managers may now have to consider the longer-term performance as well as short-term performance, and the impact of decisions on the division and broader company performance. 3 Benchmarking will allow the business to set performance targets that are in line with the best performers in the industry, and can help each division to set in place improvement strategies to help minimise performance gaps. For the Newspaper Division this may entail research into how satisfied readers are with other similar tabloid newspapers and why, how quickly best newspaper firms deliver to newsagents and directly to customers and how that delivery performance is achieved and the extent of litigation experienced by other tabloid newspapers and how litigation is avoided. In researching ways to improve processes the division may also learn from the experiences of companies in other industries who have achieved outstanding performances. 4 Continuous improvement could be introduced into the performance measurement system at the Cable Television Division in a variety of ways: • Redefining performance measures. Target measures for ROI, revenue growth, market share, churn rate, customer queries, complaints, and satisfaction, churn rate, rights to shows and so on could be defined more tightly over time, as the business achieves set targets. • Selecting the relevant performance measure. As some problem areas are improved, certain performance measures may be dropped or de-emphasised and new measures defined. For example, once customer satisfaction on the package content of Australian and news shows is under control, this measure may be de-emphasised and more focus could be placed on the number of customer complaints, which may be an ongoing concern. • Making performance targets more challenging. The target for number of customer complaints may initially be set as 1 per cent of subscribers per annum. When this target is achieved the target may be changed to 0.5 per cent.