Enterprise Performance Management

Enterprise Performance ManagementByPravin TungarePravin Tungare - Indira Institute of Management PUNE2UNIT 1: OVERVIEW OF PERFORMANCE MANAGEMENT

1.1 Performance ManagementConcept of EPM Process of : - Communicating company goals to everyone - Evaluating their performance w.r.t. goals - Rewarding them fairlyEPM covers - Strategy formulation - Planning & forecasting - Financial management - Supply chain effectivenessEPM helps to focus on value driversEPM ensures that day-to-day work translates into strategic value Pravin Tungare - Indira Institute of Management PUNE3Steps for implementing EPM - Develop enterprise strategy - Organization mapping - Identify improvement opportunities & KPIs - Develop objective & relevant scoreboard - Implement outcome based change management - Measure results & continue to refine methodologyEffective EPM implementation - Integrated approach - Involvement of all decision makers - Training & development - Create enterprise data model - Identify business drivers - Data modeling - User friendly EPM Pravin Tungare - Indira Institute of Management PUNE4(b) EPM & Strategic Planning (SP) (i) Features of SP - SP to business is what GPS to car - SP involves defining strategy & resource allocation - SP decides desired business destination - SP follows mission & vision - SP is driven from top to bottom - SP requires environmental analysis (ii) Linkage of EPM & SP - Current situation analysis - Market segmentation analysis - SWOT analysis - Assessment of core competencies - Focus on KSFs - Integration of strategies - Financial & non financial parameters Pravin Tungare - Indira Institute of Management PUNE5(c) EPM & Management Control (MC) - Organization performance & MC are linked - Traditional & modern approach to MC - MC necessary to tackle one/all following situations: (i) Managers/employees not clear on expectations from them (ii) No impetus for them to perform (iii) Even if clear they cannot perform - W.r.t. EPM, MC is a process of influencing behavior & actions of people to implement strategies - In context of EPM, MC is a process of establishing & revising standards in response to market dynamics - Control ensures that there is no performance deviation & involves: Plan/Coordinate/ Measure/ Evaluate/ Influence - 4 elements of MC process: Detector/Sensor/Assessor/Effecter - 2 types of control: Feedback /Feed forward Pravin Tungare - Indira Institute of Management PUNE6(d) EPM & Operational Control (i) Operation is a set of activities carried out to achieve specific purpose (ii) Two types: Internal & External (iii) Operational control systems ensure that day-to-day actions are consistent with plans & objectives (iv) Actions are taken when performance is not as per standards set (v) Techniques used by EPM to establish OC: - Value chain analysis - Quantitative performance reports - Benchmarking - Key factor rating - Ratio analysis Pravin Tungare - Indira Institute of Management PUNE7(e) Framework for management performance & controlPerformance measurement system aims to implement strategies effectively & efficiently Management influence people to do the work efficiently, effectively & at desired cost level Activities involved in Management Control - Select right employees - Train employees - Proper work allocation - Empower employees - Give advice & suggestion - Solve problems - Provide right work environment - Impose discipline - Resolve disputes - Interaction & approve actions of employeesPravin Tungare - Indira Institute of Management PUNE8 Information required to carry out above activities - Formal information - Informal information - Non financial information - Budget reports Types of targets set - Model targets - Historical targets - Negotiated targets - Externally derived targets - Internally derived targets - Fixed & variable targets Pravin Tungare - Indira Institute of Management PUNE91.2 Performance Evaluation Parameters (Financial) (1) Responsibility Centers (i) Meaning of Responsibility Center - Unit in organization headed by manager responsible for its activities - Company is collection of responsibility centers - Part of organization structure - Hierarchy of responsibility centers: Lowest level - Sections/ Shifts/ Small units Higher level - Departments/ Business units Top most level - Entire company - Inputs are resources used & outputs are final products - Output related to input for optimum output - Performance of center judged on the basis of: Expense/ Revenue/ Profit/ ROI

Pravin Tungare - Indira Institute of Management PUNE10(ii) Significance of Responsibility Center It exists to accomplish objectives useful to implement strategies to achieve organizational goalFocus of control: Right quantity, Right quality, Right specifications with minimum inputFor management control inputs are translated in monetary termsMeasuring output for certain areas is difficultManagement control parameters for R & D, Advt., Training must have long term perspectivePerformance is measured by: - Efficiency - Output per unit of input - Effectiveness - Output w.r.t. objectivesWhen responsibility centers are efficient & effective organization can achieve objectives with optimum utilization of resourcesProfit is difference between revenue (output) & expense (input). Hence profit measures both efficiency & effectiveness

Pravin Tungare - Indira Institute of Management PUNE11(iii) Types of Responsibility Centers [A] Revenue Center - Output measured in monetary terms - Inputs not related to output - Marketing division - Target is budgeted sales - No responsibility for profit - No responsibility for trade off between cost & revenue - Each revenue center is also expense center - Manager in charge is accountable for expenses incurred by him

Pravin Tungare - Indira Institute of Management PUNE12[B] Expense Center - Inputs (expenses) are measured in monetary terms - Outputs are not measured in monetary terms - Expense center is different from cost center Expense center is responsibility center i.e. it has manager Cost center has no identifiable manager - Two types of expense centers: (a) Engineered Expense Center i Relates to engineered costs ii Engineered cost can be reliable & accurately estimated iii Center manager is responsible for: Quantity/quality/cost iv Manufacturing & warehosing

Pravin Tungare - Indira Institute of Management PUNE13 (b) Discretionary Expense Center - Costs incurred on the discretion of management - Discretion of the management depends on (i) Strategies to be implemented (ii) Competitive advantage required (iii) Customer satisfaction levels expected - Costs not estimated on the basis of engineering calculations - Output cannot be measured in monetary terms - Efficiency of Center = [Budgeted input cost] - [Actual input cost] - Important centers 1. Administrative & support centers which provide service to other responsibility centers They have following control problems (i) Intangible output i.e. service & advice (ii) Not possible to set cost standards & measure financial performance

Pravin Tungare - Indira Institute of Management PUNE142 R & D Center - R & D expense depends on : expected innovation/ Technology leadership/ Tax benefits Controlling R & D centers is difficult due to following reasons: - Quantifying results is difficult - Relationship between input & output cannot be established - Efficiency evaluation difficult - Goals of R& D and company may not match - R & D cost cannot be controlled on annual basis - R & D activities continue over large no. of years3 Marketing & sales promotion - Expense depends on market share expected - Efficiency can be calculated but not effectiveness - Expenses less significant, sales target relevant

Pravin Tungare - Indira Institute of Management PUNE15[C] Profit Center Concept of profit centers - Responsibility centers whose performance is measured in terms of profit - Single performance measure is profit - Input & output measured in Rs. - Input related to output - Motivates manager to (i) Increase revenue (ii) Reduce cost (iii) Use resources employed effectively (iv) Achieve trade- offs between costs & profits -Business unit or functional unit can be a profit center

Pravin Tungare - Indira Institute of Management PUNE16Decisions taken by profit center manager Sales priceSales volumeSales mixMarketing strategiesControlling expensesCost managementConditions to introduce profit center conceptBusiness unit must be headed by competent managerTransfer pricing in placePerformance appraisal is based on profitabilityFunction or activity has highest influence on bottom line

Pravin Tungare - Indira Institute of Management PUNE17 Advantages of profit centerSpeedy operating decisionsQuality of decision improvesH.O. management can concentrate on entire organization issuesProfit consciousness of managers increasePerformance measurement broadenedExcellent training ground for general managementManagers potential for higher positions can be evaluated Useful for diversification strategyPressure to improve competitive performance of center

Pravin Tungare - Indira Institute of Management PUNE18 Disadvantages of profit centerTop management loses controlCenter manager may not be effective Problems of cooperation & coordinationToo much emphasis on short run profitabilityOptimizing profits of center may not optimize co. profitsCost increase due to duplication of functions Conflicts between centers on following issues: - Sharing of resources & costs - Credit for revenue earned - Setting transfer priceUnwanted competition amongst centersOverall cost control & cost management not possible

Pravin Tungare - Indira Institute of Management PUNE19Types of Profit Centers (i) Business Units - Unit manager controls all functions - Unit manager influence costs & revenues - Unit managers authority has following constraints 1 Relating to strategic considerations 2 Relating to uniformity of business processes 3 Relating to economies of centralization

Pravin Tungare - Indira Institute of Management PUNE20(ii) Functional Units - Each functional unit considered as profit center - Particular function can be treated as responsibility center if center manager has enough influence over activities that affect bottom line - Following functional units can be treated as profit centers Production Service & supply units Marketing

Pravin Tungare - Indira Institute of Management PUNE21 methods of measuring profitability of profit centersThere are two types of profitability measurement (I) Measure of management performance : Focus is on performance of manager It is used for: - Planning, coordinating & controlling day-to-day activities of profit centre -Motivational force for managers. (II) Economic performance Focus is on how well profit centre is doing as an economic activity.

Pravin Tungare - Indira Institute of Management PUNE22Various methods to measure profitability (a) Contribution Margin (b) Direct Profit

(c) Controllable profit

(d) Income Before Tax (EBT)

(e) Net Income (EAT)

Pravin Tungare - Indira Institute of Management PUNE23[D] Investment CenterProfit earned by center is compared with assets employedInvestment base is sum of assets employed by centerEVA & ROI are performance indicatorsPurpose of measuring assets employed by center: - To generate adequate profits from assets & resources within policy framework of company - Incremental revenues Vs. Incremental investments - Comparison of centers on basis of using allocated resourcesProblems faced while implementing investment center - Selection of appropriate base - Tangible or Tangible & Intangible assets - Controllable assets & Uncontrollable assets - Allocation of assets used by more than one center - Total assets or Total assets less liabilities - Valuation of assets

Pravin Tungare - Indira Institute of Management PUNE24Measuring assets employed by investment center Current Assets (i) Cash - If cash control is at H.O. cash balance at business unit very small - Some companies use formula base - Some companies omit cash from investment base as cash equals current liabilities - Average cash balance can be used (ii) Receivables - If unit managers can control receivables then they are shown at Book Value less provision for bad debts - Formula base if they have no control on receivables

Pravin Tungare - Indira Institute of Management PUNE25(iii) Inventories - Closing balance value is considered - Methods to be used: FIFO/WACO/STD. COST - WIP value to be reduced by advance received from customer - Some companies reduce accounts payable from inventory(iv) Working Capital - Include only current assets if unit has no control on current liabilities - [C.A.] [ C.L.] if business unit has control on C.L.

Pravin Tungare - Indira Institute of Management PUNE26Fixed Assets - Purchase of new machine - Depreciation method & rates - Valuation of assets - Replacement of old machine - Disposition of assets - Leased assets - Idle assets - Intangible assets - Use of non accounting methodsCapital charge to be used: - Set by corporate office - Higher than debt financing due to debt-equity mix - Different rates can be used for different units - Lower rate for working capital, higher rate for fixed assets

Pravin Tungare - Indira Institute of Management PUNE272 Return On Investment (ROI) (i) ROI = EBIT(1-t) x100 (operating ROI) Capital employed = [EAT/ Cap. employed] (owners ROI) = [ EAT/sales] x [sales/cap. employed] = [N/P Ratio] x [ Capital Turnover]

(ii) ROI is affected by: -Sales -Costs -Capital Employed (iii) ROI can be increased by: Sales Costs Capital employed

Pravin Tungare - Indira Institute of Management PUNE28ROI analysis is useful for : - Optimum utilization of resources - Better asset management - Selecting long term investment proposals (v) ROI is useful in assessing management performance in following ways : - Measuring profitability of business units & entire Co. - Actual ROI can be compared with target ROI - Indicates effective utilization of operating assets - Divisional performance can be easily measured - Useful in inter-divisional & inter-firm comparison - It shows financial power of company (vi) ROI suffers from following operational limitations : - Poor understanding & interpretation of ROI - Divisional investment base & earnings calculations - Use of General accounting principles to business units - Use of ROI may distort allocation of resources

Pravin Tungare - Indira Institute of Management PUNE293 Return on Assets (ROA) ROA = [ EAT x100]/[ Net Fixed Assets + Current Assets] Features of ROA: -Assets of company are allocated to different investment centres as per their needs and objectives Efficiency of using these assets can be judged by ROA -When ROA goes down, means fund providers to buy these assets are not satisfied - ROA can be improved by : (i) Selecting right kind of assets (ii) Maximum capacity utilization (iii) Proper maintenance of assets (iv) Effective asset accounting & control system (v) Replacing old assets by new technology

Pravin Tungare - Indira Institute of Management PUNE304 Economic Value Added (EVA) - Surplus left after making appropriate charge for capital employed in business - EVA = [EBIT (1-t)] - [WACC x TCE] = [ NOPAT ] - [WACC x TCE] = [EAT+IAT ] [WACC x TCE] = TCE[ROI WACC] = EAT [Ke x Equity] - Three components of EVA (i) NOPAT (ii) WACC (iii Capital Employed

Pravin Tungare - Indira Institute of Management PUNE31(i) NOPAT = EBIT (1- Tax Rate) EBIT shows management efficiency of investing & utilizing resources of company(ii)WACC must have following features: 1. It should represent weighted cost of all sources used 2. It must be calculated in post-tax terms 3. It reflects risk taken by fund providers 4. For debt use average cost of all the debts 5. To find cost of equity use CAPM(iii)Total Capital employed (TCE) TCE = [Net Fixed Assets] + [Working Capital] or = [Equity+ Reserves+ Pref.+ Debentures + Loans] Use opening balance of book values as this capital is available to management

Pravin Tungare - Indira Institute of Management PUNE32Difference between EVA & R I ( Residual Income ) Residual income is calculated as:[EBIT WACC x TCE] EVA is calculated as: [EBIT (1-t) WACC x TCE] For calculating RI book values of profits & capital are considered. For calculating EVA many adjustments are done. Actions to improve EVA Improvement in operating performanceInvesting capital in projects which earn rate of return more than cost of capital.Capital is withdrawn from activities which earn inadequate returns.Alter financing strategy to reduce WACC

Pravin Tungare - Indira Institute of Management PUNE33Aadvantages of EVAEVA combines profit centre & investment centre concept With EVA management establishes target for profit or rate of return for business segment. Any income in excess of target level is EVA.e.g. Target ROA for ABC Ltd. = 25% Total Assets = Rs. 200 Cr. Actual Net Income = Rs. 55 Cr. Target Net Income = 50 Cr. [ 200 x 25% ] EVA = 5 Cr.In case of EVA, different interest rates may be used for different type of assets e.g. low rates can be used for inventories while high rates can be used for fixed assets. Again different rates may be used for different fixed assets to take into account different degrees of risk.

Pravin Tungare - Indira Institute of Management PUNE34With EVA all business units have same profit objective for comparable investments.EVA has a stronger positive correlation with changes in companys market share.EVA is most directly linked to the creation of shareholders wealth over time. Maximising value in the EVA context means maximising wealth of shareholder Mechanism of EVA forces management to consider its WACC in all its decisions. This results in goal congruence of managers and ownersEVA framework provides clear perception of underlying economies of business and enables managers to take better decisions

Pravin Tungare - Indira Institute of Management PUNE35Regular monitoring of EVA emphasises on problem areas of company & helps managers to take corrective actionsIt is used to assess likely impact of competing strategies on shareholders wealth & thus helps managers to select those strategies which will best serve shareholders.EVA compensation system ties interests of management and shareholders.It fits well in corporate governance. EVA bonus system involves awarding ownership stake to managers in improving EVA of their divisions or activities. Thus management becomes more accountable to shareholders

Pravin Tungare - Indira Institute of Management PUNE36Limitations of EVA (i) EVA analysis does not necessarily eliminate problem of comparing the performance of large & small Units generating larger rupee profits (ii) Many adjustments are required to NOPAT and for divisions what should be divisional investment is a matter of debate & ambiguity (iii) Selecting fair and equitable WACC may not be possible & risky. (iv) EVA can be readily transformed into ROI & many firms tend to convert EVA into ROI. I[ROI K] = EVA Where I = Investment K = Cost of Capital

Pravin Tungare - Indira Institute of Management PUNE37Steps in implementation of EVA Step I : Developing commitment of top management Step II : Customise definitions of EVA

Step III : Identify EVA centres

Step IV : Analyse drivers of EVA

Step V : Design EVA based incentive system

Step VI : Provide EVA based management system

Step VII: Motivation & mindset

Pravin Tungare - Indira Institute of Management PUNE38EVA Vs MVATerm closely related to EVA is Market Value Added (MVA) It is defined as :MV=[Market Value of Capital employed by firm]-[Book Value of Capital employed]MVA is a cumulative measure of corporate performance. It measures how much companys stock has added to or taken out of investors pocket over its lifeContinuous improvement in EVA year after year leads to increase in MVAThus if market value of companys equity & debt is Rs. 500 Cr. and book value of equity & debt is Rs. 300 Cr. Then MVA =( 500 300 ) = Rs. 200 Cr.MVA is the present value of all future EVAsMVA = ( EVA )1 + (EVA)2 + (EVA)3 + - - (I + WACC )1 ( I + WACC )2 ( I + WACC )3

Pravin Tungare - Indira Institute of Management PUNE39 EVA Vs ROI EVA represents absolute amount business or its unit has earned over & above its cost of capital i.e. WACC ROI states returns in percentage with reference to capital employed by business or its unit.More of the companies employing investment centres evaluate business units on ROI rather than on EVA due to following three benefits. (i) It is a comprehensive measure. Anything that affects financial statements is reflected in this ratio. (ii) ROI is easy to calculate, easy to understand & meaningful in absolute sense e.g. ROI less than 5% is considered low and above 25% is considered high. (iii) It is a common denominator that may be applied to any organizational unit responsible for profitability irrespective its business & its size.

Pravin Tungare - Indira Institute of Management PUNE40Three compelling reasons to use EVA over ROIDecisions taken by business units may not be in the interest of organization. In such situation EVA is better measure for decision makingDecision which increases ROI of centre may decrease its overall profits. This may not happen if EVA is performance indictor While for ROI same interest rate is to be applied, for EVA different interest rates may be used for different type of assets

Pravin Tungare - Indira Institute of Management PUNE415 Limitations of Financial Measures - Accounting profit do not exactly & usually indicate firms value creation -Financial measures alone are insufficient to ensure that strategy will be executed successfully - Financial measures pose following problems (i) Encourage short term actions at the cost of long term strategy (ii) Managers may not take up new projects to maintain his performance (iii) Setting low targets or not communicating non- achievement of targets (iv) Motivates manipulations - Many non financial activities in organization have financial impact Pravin Tungare - Indira Institute of Management PUNE421.3 Performance Evaluation Parameters ( Non-financial) [A] Balanced Score Card (BSC) Concept - Developed by Robert Kaplan & David Norton at H.B.S. - It provides management system which can deal better in competitive & complex environment - B.S.C. creates balance between unbalanced strategic measures to achieve goal congruence - Integrated performance system which combines financial & non financial measures - Encourages employees to act in the best interest of organization. -Measures performance of organization on following FOUR perspectives: 1. Financial 2. Internal Business Processes 3. Customer 4. Learning & Growth

Pravin Tungare - Indira Institute of Management PUNE43In creating balanced scorecard set of measurements must be selected that:Accurately reflect CSFs of companys strategyShow relationships among individual measures in cause- effect manner indicating how non financial measures affect long term financial resultsProvide a broad based view of current status of company

- Balanced scorecard tries to create a proper blend of: Outcome & driver measuresFinancial & non financial measuresInternal & external measures.

Pravin Tungare - Indira Institute of Management PUNE44Significance of BSC a) Performance measurement system useful to set & achieve strategic goals of organization b) It gives focus on: - Setting organizational objectives - Improving communication - Providing feedback on strategy c) Dividing measures into various categories provide balance balance between needs of different stakeholders d) BSC has ability to measure outcomes & drivers in such a way that organization is prepared to act as per its strategy e) Measures are linked from top to bottom & tied to specific targets throughout the organization f) It shows how non-financial measures drive financial measures g) Four perspectives are linked together in cause & effect way to act as a tool to translate strategy into action h) It covers all aspects of MCS

Pravin Tungare - Indira Institute of Management PUNE45Implementing B.S.C. Step 1: Define strategy Balanced scorecard builds a link between strategy & operational action; hence it is necessary to define strategy of the organization Step 2: Define measures of strategy To decide critical measures on which organization should focus. Individual measures be linked with each other in a cause - effect manner e.g. Perspective Measures -Financial ROI improvement -Customer Customer satisfaction level -Internal business processes Order cycle time -Growth & learning Manufacturing skills

Pravin Tungare - Indira Institute of Management PUNE46Step 3: Integrate measures into management systemBalanced scorecard must be integrated with organizations formal & informal structure, its culture & its H.R. practices.Step 4: Review measures & results frequentlyOnce balanced scorecard is in operation, it must be consistently reviewed by senior management. Management should look for:How organization is doing as per outcome measuresHow organization is doing as per driver measuresHow organizations strategy has changed since last reviewHow scorecard measures have changed This review gives idea about:Whether strategy is being implemented & working successfullyWhether management is serious on these measuresWhether management aligns measures to changing strategiesWhether measures improve measurement.

Pravin Tungare - Indira Institute of Management PUNE47Pitfalls of B.S.C. - Poor correlation between non financial measures & financial results - Managers are always compensated for financial measures - For achieving many of the goals shift in business processes culture & attitude of employees is necessary which may not be possible many times - Many cos. do not up grade measures to match strategy - Focusing all measures may not be possible for managers as they are loaded with many critical measures - Achieving trade offs between financial & non financial measures is many times difficult

Pravin Tungare - Indira Institute of Management PUNE48[B] Malcolm Baldrige Model Originated in USA for excellence in quality of doing businessCriteria for performance excellence widely acceptedProvides framework to improve overall performance of companyCriteria result in : - Delivering improved value to customers - Improve organizational effectiveness & capabilities - Organizational & personal improvementCore concepts of criteria are: Visionary leadership/ Customer driven excellence Organization & personal learning/ Valuing employees & partners Agility/Focus on future/ Managing for innovation Management by fact/ Social responsibility Focus on results & creating value/ Systems perspective Pravin Tungare - Indira Institute of Management PUNE49 Seven criteria to judge organization: 1 Leadership 2 Strategic planning 3 Customer focus 4 Measurement analysis & knowledge management 5 Workforce focus 6 Process management 7 Organizational results Pravin Tungare - Indira Institute of Management PUNE501.4 Measuring SBU level performance [A] Concept of SBU - Part of organization having distinct external market for goods or services different from another SBU - Fully functional & distinct unit of the business - Develops own strategic vision & direction - Introduced in companies having diversified businesses - Examples: GE, TATA group, LG, AP Moller - Each one is having different business & competitive market - Classified in terms of profit, sales growth, cash flows - Four types: Cash cows: High market share & Low market growth, Large net cash flow generator Cash flows used to develop other units Dogs : Low market share & Low market growth Declining sales, cash flows & profits

Pravin Tungare - Indira Institute of Management PUNE51 Stars: High market share & High market growth Successful business unit Rapidly growing sales & profitability Question marks: Low market share & High market growth Serious doubts of exploiting potential - management, capital expenditure, balance between sales growth & ROI & developing strategy depends on category of SBU - Relation between SBU & EPM Financial performance of each SBU separately highlighted Each SBU is treated as profit center & its efficiency is highlighted in terms of ROI or EVA Contribution of each SBU to overall profitability of business can be highlighted Reports are generated on how resources available with SBU have been utilizedTransfer price mechanism is applied for any transactions between two or more SBUs

Pravin Tungare - Indira Institute of Management PUNE52Effectiveness of HR & marketing strategies by different SBUs can be assessedAs each unit formulates its own strategies top management can assess whether business unit strategies are in line with corporate strategies & whether these strategies are bringing results as desired by top managementWhether SBU is giving due weightage to financial & non financial parameters Performance of the organization depends on performance of the SBUsAssessment whether SBUs are achieving goal congruence or not

Pravin Tungare - Indira Institute of Management PUNE53[B] Goal Congruence - Goal Conflict & congruence [A] Goal conflict - It is due to divergence of individual, functional & organizational goals - Reasons for goal conflict (i) Individual strive hard for monetary gains (ii) Different functions different goals (iii) Different goals for different hierarchy levels (iv) Thrust on organizational goals & neglecting personal goals (v) Companys mission is broken into functional, hierarchical & individual activities

Pravin Tungare - Indira Institute of Management PUNE54[B] Goal Congruence - Act of encouraging consistency among the goals of organization & its people - Ensures that organization & its people march towards a common goal - Ties performance of two or more entities to a common path - MCS ensures that actions of individuals are in the best interest of the organization - MCS ensures that actions of individuals are in the best interest of the organization - MCS induces individuals to pursue his personal goals in a way that it automatically takes care of organizational goals - MCS aims at bringing maximum possible consistency among the goals followed by managers

Pravin Tungare - Indira Institute of Management PUNE55 - Factors which influence goal congruence [a] Informal factors: External Internal - Attitude of society - Organization culture - Work ethics of society - Management style - Customs in particular area - Informal communication - Cultural values of society - Informal relationships - Social honesty & discipline - Perception of goal - Social discipline - Communication of goal [b] Formal factors - Defined framework for doing particular task - Rules/ regulations for employee behavior in the form of: (i) Physical controls (ii) Manuals (iii) System safeguards (iv) Task control systems Pravin Tungare - Indira Institute of Management PUNE56Pravin Tungare - Indira Institute of Management PUNE(c) Transfer PricingConcept Price at which goods & services are transferred between business units Necessity - To manage business growth - To maintain status of each business unit as profit center - To transfer goods/services at appropriate prices - To measure profitability of each business unit - To ensure win-win situation to both business units - To make planning & budgeting more realistic

57Pravin Tungare - Indira Institute of Management PUNEObjectives of transfer pricing - To provide each unit information for achieving trade off between overall company costs & revenue

- To achieve goal congruence

- To measure economic performance of each profit center

- To establish simple & easy transfer price system

- To improve profit performance of selling unit

- To provide autonomy to unit managers

58Pravin Tungare - Indira Institute of Management PUNEBenefits of transfer pricing - Divisional performance evaluation is made easier. - Develops healthy inter- divisional competitive spirit - To implement profit centre concept across the company - Helps in coordination of divisional objectives in achieving organizational goals. - Provides useful information to the top management in making policy decisions like expansion, sub contracting, closing down of division, make or buy etc. - Acts a check on suppliers prices - Improves productivity of organization & prepares managers to meet competitive economy. - Optimises allocation of companys financial resources.

59Pravin Tungare - Indira Institute of Management PUNEMethods of Transfer Pricing(TP) Based on: (I) Cost (a) Production Cost

(b) Standard Cost

(c) Full Cost

(d) Full Cost + Mark-Up (e) Standard variable cost (II) Market price

(III) Negotiations

60