Business Performance Measurement - slides MCF lecture at Copenhagen Business School

1. Balanced Scorecard and it’s relation to organisational design, strategy implementation and criteria for selection of performance measures Business performance measurement

2. Before we start… Lacking congruence (alignment of interest) in incentive systems btw leader and shareholder can lead to financial crisis 3 Organisational Architecture Decision making authority, performance evaluation and compensation stucture must be aligned for the three-legged stool not to tilt 10 Performance Measurement There three general types of measures: Market based, accounting based and the combination of the two – BSC is an example 19 Subjectivity in Incentives Subjectivity in Incentives refers to how the performance is evaluated but also to the incentive itself. Is used if targets are stretched 30 Balanced Scorecard BSC takes a balanced approach to value creation, BPM and linkages to strategy by focusing on finance, customers, process and learning 36 Summary What gets measured gets done – so think carefully about what you measure and how you measure it 44

3. Before We Start…

4. Before We Start... Anyone brought a laptop for taking notes?

5. and do you have a twitter account? Before We Start…

6. .. I need three volunteers? Before We Start…

7. Tweet key learnings… Before We Start… MCF10 Control10 Password:

8. What we can learn from a financial crisis and Youtube Incentives and not measuring what is important can be devastating on world economics Before We Start… http://www.youtube.com/watch?v=UC31Oudc5Bg

9. Tweet key learning…. Lacking congruence (alignment of interest) in incentive systems btw leader and shareholder can lead to financial crisis #MCF10 Before We Start… @MCF10

10. Organisational Architecture

11. Organisational Architecture Zimmerman et. al ch. 4

12. To guide internal transactions the three legged stool must balance Organisational Architecture Zimmerman et. al ch. 4 In markets this is self-regulating – in companies this is done by expansive administration

13. All organisations must construct A system that assigns decision rights A system that measures performance A system that rewards and punishes performance

14. Decision control Decision making authority (hiearchies) – Seperatedesision management and control Organisational Architecture Zimmerman et al ch. 4 Agent Principal Decision management 1. Initiation 2. Ratification Formulating and choosing between decisions Approval of selected decision with possible modifications 3. Implementation 4. Monitoring Executing the selected decisions Evaluating the outcome and rewarding decision makers

16. An unbalanced use of objective and subjective measures can lead to over-focus of employees on either the objective or subjetive

17. Greater reliance on incentive compensation requires a higher quality of the measures for evaluationOrganisational Architecture

19. Verifiable measure

20. Quantifiable

21. Examples

22. Sales

24. Hard-to-measure

25. Qualitative

26. It is used because many jobs have multiple dimensions

27. Examples

28. Team spiritOrganisational Architecture Zimmerman et al. CH. 4

30. Must be realistic to obtain and ambitious to ensure performance pressure

31. Employees often need a ”sufficient” base salary – the bonus is uncertain and is not 100% influenced by the individuals actions

32. Often there is lower boundary and upper-bound

33. Must align with strategyOrganisational Architecture

35. When the legs don’t balance (kassetækning)… Organisational Architecture Zimmerman et al ch. 4

36. Performance Measurement

37. Criteria for evaluating performance measures Performance Mearsurement Merchant, 2006

38. Three general measurement alternatives… Performance Measurement Merchant, 2006

40. Measures are based on changes in Market Value or returns to the shareholders

42. Available on a daily basis (timely)

43. Precise and objective (Accurate)

44. Easy to understand

46. Limited influence for ordinary employees (controlable)

47. Causility: 98% of stock price changes can in some markets be explained by macroeconomic factors

48. Short term problems with congruence – Risk of management MyopiaPerformance Measurement Merchant, 2006

50. Ratio Measures: Return on Investement (ROI) etc.

51. Are better at explaining value creation over a longer time period (e.g. 10 years)

53. Measurement system already in place by law (Cost effective)

54. Relatively precise and objective as it is audited (Accurate)

55. Can be tailored to match authority limits of manager (Controllable)

57. Transaction oriented

58. Dependant on measuring method(accurate, congruence)

59. Ignore cost of equity capital risk (congruence), risk and capital structure affects the future value

60. Ignores changes in risk, but when the risk of future cashflow is decreased – economic value is created

61. Conservative, disregard hard to value intangible assets (accurate)Performance Measurement Merchant, 2006

63. Balanced Scorecard etc

64. ”KISS” example (Jeff Immelt, GE)

65. 50% bonus dependant on operating cashflows over a three year period

67. Canbe future oriented

68. Causuallinkages in the BalancedScorecardsstrategymapprovideguidance. A cause and effectrelationship.(controllable)

70. Canbeveryexpensive to implement and measure, due to a high no. of complexmeasure points

71. Method for measuringcanaffectresults (customersatisfaction)

72. Valuable information canbe lost in aggregation due to weighing problems

73. Difficult to determinewhat is optimal (S-curve / Net promoter Score)Performance Measurement

75. Be realistic in order to for people to believe that it is possible to get their bonus

76. In budgetting – people tend to be conservative about own future performancePerformance Measurement

78. Can the measure reflect a strategic intent?

79. Sears example:

80. Compelling place to work

81. Compelling place to shop

83. Goal specificity

84. Goal difficulty

85. Goal CommitmentHad an effect on task performance Performance Measurement

86. Dilemma in performance measurement… Performance Measurement Benchmarking Continous Development

87. Performance Measurement

88. Subjectivty in Incentives

89. Subjective in Incentives Gibbs et. al, 2004 Two meanings of subjectivity in incentives… 1. Meaning: The basis for which the incentive is given is measured subjectively Subjectivity in Incentives.. 2. Meaning: The incentive itself is subjective e.g. Promotion, job assignment or threat of termination

91. The weights on quantitative measures are determined subjectively

92. A subjective performance threshold is used, meaning whether to pay a bonus is determined on measured performance and other factors

93. Subjective bonuses are also refered to as discretionary bonusesSubjectivity in Incentives Gibbs et al, 2004

94. Subjectivity is used when… Subjectivity in Incentives Gibbs et al, 2004 When there has been significant investment in training When there are departemental interdependencies Subjectivity is used.. When objective / quantitative bonuses are difficult to achieve and where there is significant consequence of not achieving them

95. The study failed to prove that following was determinants in usage of subjectivity… Subjectivity in Incentives Gibbs et al, 2004

96. The Effect… Subjectivity in Incentives Gibbs et al., 2004

97. Balanced Scorecard

98. Traditional financial measures are focused on historic performance and tangible assets Balanced Scorecard

99. Strategy understanding and implementation is a challange Balanced Scorecard Gary Hamel Vision Management systems Less than 5% of the employees understands the strategy In more than 60% of companies the budgets are NOT derived from the strategy Compensation Leadership Less than 25% of managers are rewarded based on the strategy More than 85% of managers use LESS than an hour a month to talk about the strategy

100. What is a balanced scorecard… Balanced Scorecard A tool to balance value-creating activities towards shareholder value, as well as ensure strategy implementation and performance measurement

101. Balanced Scorecard Kaplan & Norton, 2001 Financial Perspective If we succeed how will we look to our shareholders Learning and Growth Customer Perspective Vision & Strategy To achieve my vision, how must my organisation learn and Improve To achieve my vision how must look to my customers Process Perspective To satisfy my customers at which processes must I excel

102. Balanced Scorecard

103. The 5 Principles of the Balanced Scorecard Balanced Scorecard

105. Provide transparency - ”Seeing” what is going on in the organisation

106. Provide horizontal integration - Numbers initiate debate across functional borders = verbalisation of local knowledge

108. Assumes that structure follows strategy

109. Top-down communication – interactivity at top-management level

110. These issues are naturally adressed in the continous development of the revision of the Balanced Scorecard – but provides difficulty in making benchmarksBalanced Scorecard

111. Causal Linkages and concrete objectives, measures, targets and initiatives Balanced Scorecard Kaplan & Norton, 2001

112. Summary

114. Controllable

115. Timely

116. Accurate

117. Understandable

118. Cost EffectiveSummary

120. Decision Rights and Systems

121. Knowledge and decision making

122. Markets vs. Firms

123. Influence Cost

124. Cost EffectiveSummary

126. To ensure a long-term focus

127. To counter manipulability of quantitative bonuses

128. To filter out ”noise” from the performance from other departments

129. To recalibrate incentives in situations where ambitious quantitative performance targets are not met

130. Where departments operates in a ”loss” situationSummary

131. Balanced Scorecard A tool to balance value-creating activities towards shareholder value, as well as ensure strategy implementation and performance measurement Summary