Chapter 8

Performance Measurement & Control

Concept of Balance Score Card Implementation of Balance Score Card Superiority of Balance Score Card over Other Methods Pitfalls of Balance Score Card Interactive Controls FCFF

Balance Score Card

David Chaudron defines BSC as: A way of measuring organizational, business unit or departmental viewpoints. A way of Balancing long term and short term actions. A way of Balancing different measures of success such as: Financial, Customer, Internal operations and Human Resources systems & Development. A way of tying strategy to measures to action. In short, BSC is a business management concept that transforms both financial and non-financial data into a detailed roadmap that help an enterprise measure performance and meet both short and long term objectives.

Implementation of Balance Score Card

(1) Definition of Strategy: This is the initial step in the implementation of a BSC. Since the BSC establishes a linkage between strategy and operational action, the definition of an organizations strategy should necessary be the starting point in defining the BSC. The goals of the organization should be in writing at this stage and target should have been prepared.

While steps should be taken to develop the scorecard at the corporate level for single industry firms, in respect of multibusiness firms, the development should start at the business unit stage. However, in respect of the single industry firm, and each business unit scorecards should thereafter be prepared for functional levels and below. (2) Definition of measures of strategy:
This is the second stage involved in the implementation of a balance score card. While developing measures for supporting the define strategy, it is important to focuse attention on a few measures which are considered critical for the organization. The reason underlying this is to ensure that management is not burdened with a large number of measures which could prove dysfunctional. There must be an efforts to establish cause and effect linkage between the individual measures

Perspective
Innovation and learning perspective

Measures
Manufacturing skills

Internal business perspective

First pass yield order cycle time

Customer perspective

Customer satisfaction survey. Sales revenue growth

Financial perspective

(3) Integration of measures into the management system:

This is the 3rd step in the implementation of the BSC. At this stage, efforts must be made to integrate the BSC with the culture, HR Practices in formal and formal structures of the organization. However, other system in the organization can create imbalance among the measures.

(4) Frequent Review of measures and results:

This is the last stage in the implementation of BSC. The senior management of the firm must review the BSC constant basis. These review show the seriousness of management regarding the utility of these measures, indicates whether the strategy is being implemented in a correct manner and the degree of success with which it is functioning, serve to align measures to changing strategies, and help in improving measurement.

Superiority of Balance Score Card Over Other Methods

There are several benefits from implementing a Balanced Scorecard. Originally the Balanced Scorecard was seen as a useful tool for performance measurement. In this role, the Balanced Scorecard was seen as integrating financial/non-financial, internal/external and leading /lagging information on firm performance in a coherent fashion. Later it was realised that the Balanced Scorecard could play a pivotal role in the strategic management process. Because the Balanced Scorecard requires management to clarify and obtain consensus on the strategic objectives of the firm, it can assist in the communication of the chosen strategy, consequently aligning the efforts both of individuals and of departments. In this role, there is a clear link between the Balanced Scorecard and management by objectives (MBO). Effective implementation of a Balanced Scorecard project will generally involve the development of a series of hierarchical (cascaded) scorecards. Given the overall corporate scorecard, supporting scorecards can be developed for each department within the firm. Within each department, a scorecard can be developed for each manager (or perhaps even for each individual member of staff) which links the objectives on each perspective for that manager back to the objectives for each perspective outlined in the scorecard for the department and finally, back to the objectives listed in the firms overall scorecard.

The Balanced Scorecard could be used to assist in corporate restructuring. In recent years, many firms have migrated away from a traditional hierarchical structure to a flatter, team-based organisational structure. The Balanced Scorecard can support such changes, as it can help clarify the objectives and the critical success factors for the newly formed teams. Apart from the communication and co-ordination roles of the Balanced Scorecard in strategic implementation, the Balanced Scorecard can be used to link strategy to specific critical success factors in the customer, internal business process and growth/learning perspectives. By setting both short and longterm targets for driver and outcome measures and by comparing actual attainment against target, feedback is obtained on how well the strategy is being implemented and on whether the strategy is working. Building on the Balanced Scorecards use as a strategic management tool, it has been suggested that the Balanced Scorecard can play a role in the investment appraisal process(5). Traditional methods of investment appraisal such as discounted cash flow do not cope well with investments which generate indirect rather than direct financial returns. Examples of these include investments which enhance the future flexibility of a firm or investments in the firms infrastructure, such as an enhanced management information system. The Balanced Scorecard can assist managements investment appraisal decisions as it provides managers with a mechanism to incorporate the strategic aspects of the investment into the appraisal process. This could be achieved by using a weighting system developed from a firms Balanced Scorecard measures to evaluate new projects. An index score would be calculated for each investment opportunity and projects would then be ranked and selected based on this score

Balance Score Card of Rockwater

BSC shown below is of Rockwater, a wholly owned subsidiary of Brown & Root, a global engineering and construction company, which is a worldwide leader in underwater engineering and construction. The measures have been divided into four broad category. This enable the company to be viewed from four different perspective. You will find that all the measures given in the companys BSC are specifically related to strategy. Rockwater strategy is to be the preferred provider in the underwater engineering and construction industry. They select the measures like External (eg. Market share, customer ranking survey) and internal measures (Eg. Project Performance Index, Safety Incident Index). There are also derived measures namely staff attitude survey, time spent with customer on new work and outcome measures such as ROCE.

Pitfalls of Balance Score Card

(1) Trade off is difficult:
While some firms prepare a single report by suitably combining financial and non-financial measures and giving weights to each of the measures, no weights are assigned explicitly to the measures in most of the BSC. Consequently, making trade offs between non-financial and financial measures is difficult owing to the lack of weights.

(2)

Correlation between non-financial measures and result is poor: -

The underlying assumption in the BSC is that the achievement of measures is the score card leads to future profitability. This is far from true. There is no certainly that accomplishing targets in any non-financial area would give rise to profitability in the future. Although it is theoretically possible to establish cause and effect relationship among the different measures, there is a poor understanding of the linkage between the non-financial measures and financial performance. Consequently, firms which adopt a BSC should understand this problem.

(3) Failure to update measures:While changes and adoption of different strategies necessitates updation of measures to bring about alignment, it is surprising that many firms lack formal mechanism to update the measures. Consequently, measures based on past strategy are being still developed by firms. Also, as employees become familiar with the use of measures they tend to build up inertia.

(4) Bias towards financial results:Senior management are highly trained conversant with measures used for judging financial performance of a firm. Apart from this, because of the pressure applied by the BOD on behalf of the shareholders, the financial performance of a given priority.

The BSC is of-ten linked up in a poor manner to an incentive scheme. As a result, the compensation of senior management is based on financial performance. Moreover, there is a good deal of bias towards financial performance by senior manager who have made an effort to link rewards to measures in BSC. This could lead to managers being more concerned about financial measures resulting in loss of goal congruence. (5) Managerial overload:How many critical measures can one manager track at one time without losing? Unfortunately there is no right answer to this question except it is more than 1 and less than 50. It too few then the manager is ignoring measures that are critical to creating success. If it too many then the manager may risk losing focus and trying to do too many things at once.

Interactive Control
We know that there are certain industries which are influenced by extremely changes, in the environment. In case of such industries, the idea about new strategies in this field and the same has been refereed to be him as Interactive Control. The figure shows the interactive control.

Survival of firms is a rapidly changing and dynamic environment demands the creation of a learning organization. When we use the term learning organization we means the employees capacity to learn to deal with environmental changes on a continuing basis. The purpose of interactive control is to forewarn management of strategic uncertainties based on which managers adopt to rapid environmental changes, this is done by thinking and formulating new strategies. Interactive controls should not be viewed as a separate system. In fact, they form a part of the management control system. The following are the features of the interactive control: 1. It is subset of management control information 2. This information pertains to the strategic uncertainties confronting the business and becomes the focus of attention. 3. Such information is considered seriously by senior managers. 4. The information generated by the system become the focal point of attention of managers at all levels. 5. Meetings are held among peers, subordinates and superior for the interpretation and discussion of the information. The purpose of this meeting is to formulate strategic initiative for the future. 6. The meetings are held face to face. 7. During such meetings, the underlying assumptions, data and actions are debated and challenged.
The following figure shows the role of Interactive Control as a tool of Strategy Formulation

Free Cash Flow

A measure of financial performance calculated as operating cash flow minus capital expenditures. Free cash flow (FCF) represents the cash that a company is able to generate after laying out the money required to maintain or expand its asset base. Free cash flow is important because it allows a company to pursue opportunities that enhance shareholder value. Without cash, it's tough to develop new products, make acquisitions, pay dividends and reduce debt. FCF is calculated as:

(B) Process of its Computation Step 1: Calculation of contribution by deducting Variable cost from sales. Step 2: Calculate EBDIT by deducting the Fixed Cost from contribution. Step 3: Calculate EBIT by deducting Depreciation from EBDIT. Step 4: Calculate the EBT by deducting interest from EBIT. Step 5: Calculate the EAT by deducting taxes from EBT. Step 6: We add back depreciation (Non cash expenses) and interest (since it is paid to providers of capital) to the EAT to arrive at the NOPLAT. Step 7: The NOPLAT is adjusted to deduct capital expenditure & investment in Net Working Capital to finally arrive at FCF.

Example: Particulars Sales Less: Variable cost Contribution Less: Fixed Cost EBDIT Less: Depreciation EBIT Less: Interest EBT Less: Tax EAT Add: Depreciation Add: Interest NOPLAT Less: Capital Expenditure Less: Increase in NWC Free Cash Flow Amount Lacs 500 (300) 200 (100) 100 (50) 50 (10) 40 (12) 28 50 10 88 (40) (10) 38