Session 4B: Performance Measurement Model Design

Dr Frank Selto

CURISES

Cost and Managerial Accounting

Overview

• Sources of Market Value

• Types of Financial Performance Measurement

• Managing Intangible Assets

• Overview of Balanced Scorecard– New Term, Old Concept

Intangible Assets: Mkt to Bookhttp://finance.yahoo.com/ 10 Aug 09

  MicrosoftHewlett Packard

 Symbol MSFT HPQ

Market value per share $ 23.35 $ 43.50

Book value per share $ 4.41 $ 17.02

MV/BV 5.29 2.56

Why are these ratios not equal to 1.00?

What do these ratios say about intangible assets?

Growing Importance of Intangible Assets

The Source of Value Has Shifted From Tangible to Intangible Assets

Intangible Assets

Tangible Assets

1982 19921 20002

percentage of market value related to…

1. Brookings Institute2. Baruch Lev analysis of S&P500 companies

Adapted from a slide by The Balanced Scorecard Collaborative, Inc © 20003. SWAG by Selto

38%

62%

62%85%

38%15%

30%

70%

20093

MV/BV

1.6 2.6 6.7 3.3

Contributions to Market Value

Market Value

Financial Capital Intellectual Capital

Focus of Traditional Accounting Systems

Social Capital

Focus of Most New Performance Models

Focus of EthicalInvestors and Some

Performance Models

Contributions to Market Value

Market Value

Financial Capital Intellectual Capital

Human Capital Structural Capital

Customer CapitalOrganizational

Capital

Social Capital

Contributions to Market Value

Market Value

Financial Capital Intellectual Capital Social Capital

Environmental Capital

Community Capital

Prevention Remediation Employees Neighbors

Example: CMP Media Company founded by Leeds family

From website: “CMP Media's success has been built on a set of principles that has served its employees, customers, readers and suppliers well for more than 30 years.”

1. Be a great company to do business with for customers and suppliers.

2. Be an excellent company to work for – able to hire, motivate and develop outstanding, diverse people who work together harmoniously toward a common objective.

3. Provide only superior products and services. 4. Contribute actively to a better social and physical

environment. 5. Be profitable to provide the resources for future growth,

quality and financial stability.

Leeds’ Approach at CMP Media

• No formal overall measurement program for social responsibility performance

• All board level strategic discussions included human resource and employee involvement programs

• Discussed and approved the proposed donations of the CMP Community Action Fund

• Top executives had major options grants that accelerated if certain diversity goals were met

• Results included: – Top rating as one of the best companies to work

for– Low employee turnover– High productivity and innovation– Superior profitability and market value

Financial Success Depends on Intangible Assets• Most Common Intangible Assets Include

– Knowledge, Skills, Training, Motivation – Knowledge-Based Processes– Customer Knowledge and Relations– Environmental and Social Relations

• Where Do These Show Up in Financial Reports? – Goodwill– Financial Statements Poorly Equipped to Manage

Intangible Assets– May Show up in Mgt Letter, Footnotes and Proxy

Statements

Managing Intangible Assets

• Cannot use most traditional financial management tools– Using ROI, EVA, Cost variances, etc., too late to affect

current financial performance– These are OUTCOMES that occur after good or bad

management has happened

• Many companies have set of Key Performance Indicators (KPI)

• Need valid set of Leading KPIs of financial performance– Performance Measurement Models (PMMs)

Many Competing Performance Measurement Models (PMM)

• “Balanced Scorecard”• “Value-Based Management”• “Value Creation Model”• “Shareholder Value”• “Economic Value Added”• All major consulting firms have own versions• PMMs being widely adopted by many firms world-wide• PMMs commonly model leading and lagging indicators

of performance

An Actual PMM

Popular PMM: Balanced Scorecard

• Linking leading activities and indicators = Balanced Scorecard

• Communication Device and so-called “Causal” Model

• Good Communication Device =– Accurate, Clear, Credible, Interactive

• Causal Model =– Reflection of Cause-and-Effect relations among key

performance indicators (KPI)– No reliable evidence for this yet

Generic Balanced Scorecard

OrganizationalCapabilities

Financial Performance

Customer Value

Social Value

Business and Production

ProcessQuality

Measures of Performance

• Must use “Proxy” measures• Improvements in valid proxies signal

improvements in the “True” measures • Organizational capability examples:

– Training Hours Offered and Completed– Employee Education Levels– Employee Morale and Satisfaction– Employee Turnover

• Do these measure organizational capability?

What do We Know About Measures Actually Used?

• Linked to incentives• Affected by actions• Measurable

– Accurate and timely– Economical– Limited in number

• Auditable• Achieve intended effects• Belief in entire performance “story”

Linked Measures of Performance

• Explain these relations:

• Is this causality or finality?

Higher QualityProcess

Fewer Defects

Shorter CycleTime

IncreasedSales

IncreasedProfit

Higher EmployeeEducation

Combine Leading KPIs to Cover Strategic Decision Making

• BSC tells story of business success– “Value Propositions”– Reflected in Kaplan’s “Strategy Map”

• Gaps in measurement coverage lead to gaps in management decision making– This is the BSC story anyway

• This is not a causal story, however

Sample Strategy Map

EmployeeSatisfaction

EmployeeSkill andTraining

EmployeeTurnover

ProcessInnovation

On-timeDelivery

CustomerSatisfaction

CustomerLoyalty

MarketShare

RevenueGrowth

EVA Financial

Customer &Social

Process

People

EnvironmentalPrevention

Environ.Rating

Research, Education & Teaching

Admissions Discharge

Duke Children’s Hospital Balanced Scorecard

Internal Processes

Mission

To provide patients, families and primary care physicians with the best, most compassionate care possible and to excel at communications

Wait Time Quality Productivity Readmission Rate Infection Rates Blood Culture

Contamination Rate

Use of Clinical Pathways (Top 10)

Length of Stay Daily Staffing vs.

Occupancy

Communication Staff retention Staff approval ratings Productivity through

work redesign

Strategic Database– Availability– Use

% Satisfied % Would Recommend % Parents Could

Articulate Care Plan Discharge Timeliness

Customer

Patient Primary Care Physician

% Satisfied with Communication

% Parents Could Identify DCH Physician

Cost per Case Match flexible

budget

Financial

Revenue from Neonatal Care

Operating Margin

© 2000. The Balanced Scorecard Collaborative, Inc. Robert Kaplan and David Norton. All rights reserved

How to Evaluate BSC Effectiveness?• Internal validity

• Cause and effect relations

• Logic of accounting relations

• Credible story

• External validity• Financial verification of finality relations

• Acceptance and belief in the “story of success”

BSC Opportunities & Questions

Balanced ScorecardOpportunities

Balanced ScorecardQuestions

Strategy Formulation - Recipe for success - Model comparative advantages

Strategy Communication - Story of success - Model impacts of actions

Performance Measurement - Leading indicators - Operational planning

Performance Evaluation - Motivation - Comprehensive performance

Is BSC strategy formulationprocess more effective andefficient?

Is BSC strategy communicationmore effective and efficient?

How good is quality of BSC dataand measures ?

Is BSC a causal model? Is BSC statistically reliable?

Does BSC improve motivation? Is BSC effective basis for

evaluation?