22421: Management Decisions and Control

Lecture 2: Introduction to performance measurement

Lecture objectivesTheory recap from last week: • Johnson & Kaplan (1987) Relevance Lost

This week: to understand the basic principles of performance measurement: • Why measure performance?• What is ‘performance’ in organisations?• Basics of measurement• Performance measurement systems• Design criteria

Theory Recap Questions

Theory Recap Questions

• Johnson & Kaplan (1987, p.6-12) describe the development of management accounting techniques throughout history, explaining why the needs of types of organisations drive the emergence of innovation in management accounting. Ch 1

Theory Recap Questions

1. Draw a timeline mapping the key phases in the development of management accounting techniques and systems. Try to show the approximate periods in time and the corresponding advances in the types of management accounting information. Ch 1

Theory Recap Questions

2. Explain the benefit of the following ‘innovations’ in management accounting information:a. Basic conversion efficiency measures (e.g. cost/hr,

cost/pound)b. Segment reporting and summary performance measures

of managerial performancec. Standard costing proceduresd. Overhead allocation methodse. Divisional Return on Investmentf. Responsibility accounting

Ch 1

Why measure performance?

Why measure performance?

‘What gets measured gets done’- Robert Kaplan

Why do organisations measure performance?

• Implement and monitor strategy• Support managerial decision making• Motivate managers and employees

(evaluation and/or rewards)• Communicate with stakeholders

Ch 12

Ch 1

Q: But why do most organisations use measurement to do this?

Why not something else?

Why do organisations rely on measurement?

As organisations grow:• Decentralisation• Specialisation• Inter-dependencies

Ch 12

What is ‘performance’ in organisations?

What is performance?• Depends on the level:

– Individual?– Division, department or function?– Whole-organisation?

• Performance of activity (process) or outcome (output)

Organisational performance is…

Organisational unit

Profit and returns to shareholders

Long term growth

Innovation

Safety

Environmental management

Stakeholder management

Reputation and customer satisfaction

Employee satisfaction

Quality products

• Achievement of organisational objectives: – What is the organizational unit trying to achieve?– Specific aims?

Organisational performance

ObjectiveTo have shareholder return in top quartile

(compared to peers) on 5 year rolling basis

PerformanceRelative magnitude of

financial returns (over 5 years)

Task: Take one of the following objectives and translate it into a

relevant definition of performance

Objective1. To offer a wide range of well-

designed, functional home furnishing products at prices so low that as many people as possible will be able to afford them

2. To organize the world’s information and make it universally accessible and useful

3. To inspire and nurture the human spirit – one person, one cup and one neighborhood at a time

Performance?

How do we achieve objectives?

• Organisational strategy:– The long term direction to achieve an

organisation’s mission and objectives– 3 levels:

• Corporate strategy• Competitive strategy• Operational strategy Ch 1

Corporate strategy

• Choices about the types of businesses• How best to structure and finance the

organisation– Single business vs. multi-business units

portfolio vs. leveragePorter (1980)

HQ

Competitive (business) strategy

• The way a business competes within its chosen market

• Distinct business strategies for each business unit– Cost Leadership vs. Differentiation vs. Niche

Operational strategy

• Tactical and operational decisions about how the organisations will deliver competitive strategy:• How does the business function on a daily basis? • What are the core activities or processes?• How do we structure our processes and activities?

Basics of measurement

What is a measure?

• A measure transforms something in reality into a quantified, standardised unit of information

• Can also be referred to as:– Indicator– Metric– Scale– Index

• Measures must have units

Activity

Performance measure

Outcome of activity Measured output

Essay marking guide:

Use of research…Communication….

Performance measures generally focus on the outcome of activity, process or behaviour

Performance measurement systems

Performance measurement systems

…a set of processes that includes the collection, analysis and reporting of actual performance, usually compared to a target

Ch 12

Establish (expected)

standards or targets

Measure actual

performance

Compare actual to standard

(variance)

Evaluate variance

Take corrective

actionCybernetic

loops

How do performance measurement systems work?

Pre-conditions of cybernetic control:1. There are measures that enable the quantification of an

underlying phenomenon activity or system

2. There are standards of performance or targets to be met

3. There is a feedback process

4. There is a comparison of the outcome to the standard

5. There is the ability to modify the phenomenon, activity or system

(Malmi & Brown 2008)

Elements of P.M. system

Information Information system

Measures Measuredoutput

Activity or outcomes

Standard/ target Evaluation

Production report

________________________________________________

Receipts________________________________________________

Inventory Audit

________________________________________________

ERP System

(e.g. SAP)

Chain produced

(metre) per hr

Cost ($) per metre

produced

Material wastage (%) per metre produced

72m/h85m/h

$0.35/m$0.65/m

8%35%

Design criteria

Design criteria

1. Validity: the extent to which a measure captures what is intended

2. Reliability: the extent of accuracy, objectivity and precision of the measurement

3. Clarity: the extent to which the measure (and measured output) is easy to understand, without vagueness in interpretation

From Malmi & Brown (2009) CPA 104 Strategic Management Accounting

Design criteria

4. Cost efficiency: the cost of collecting and measuring performance information does not outweigh the information benefits

5. Timeliness: the extent to which information arrives in time for analysis and action to be taken

6. Access: the extent to which the measurer has the right to access to the required performance information

From Malmi & Brown (2009) CPA 104 Strategic Management Accounting

Design criteria

7. Controllability: the extent to which you can improve or reduce the value of the measured output through action

8. Cannot be gamed: gaming when a measure alters the behavioural patterns of employees

9. Cannot be manipulated: manipulation is when managers or employees influence a measure so that it no longer reflects what was originally intended.

From Malmi & Brown (2009) CPA 104 Strategic Management Accounting

• Q: How ‘good’ is the performance measurement of this Guinness World Record attempt…

Criteria Criteria

Validity Access

Reliability Controllability

Clarity Gaming

Cost efficiency Manipulation

Timeliness

Q: Any questions?

Lecture summary• Why measure performance?

– Need for information in large decentralised organisations

– Performance measurement is more efficient than other mechanisms

• What is ‘performance’ in organisations?– Can be individual, unit or organisational– Relates to achievement of organisational

objectives and strategy

Lecture summary (cont’d)• Basics of measurement

– Translate the real world (activities, outcomes) into numbers (measured output)

– Measures require units• Performance measurement systems

– Based on cybernetic loops– Comprise different elements (e.g. information,

measures, standards etc.)• Design criteria

– There are 9 – Important for evaluating our designs