Performance measures

Traditionally the measures of business performance have been derived from the financial data alone, but the reliance on financial measures in analysing performance is now under serious challenge. By the 1980s there was a growing realisation that the traditional performance measures were not any more sufficient to manage the organisations competing in the modern markets. Neely et al. (2002, 16) point out that it is generally accepted that the level of financial performance achieved today is a function of decisions made 6 – 18 months earlier or even earlier as that. The choices made by today’s executives will affect the financial performance of tomorrow. The focus on financial measures satisfies the regulatory and accounting reporting requirements, but largely ignores the needs of the operational issues inside the organisation. With the more demanding customers and more competitive markets, a need for greater responsiveness and external focus for the activities has arisen. It has been realised that whilst the traditional financial accounting systems indicate the performance that results from the activities of an organisation, they provide a little indication of how that performance is achieved or how it can be improved (Kennerley & Neely 2003, 214).

Companies are changing their performance measurement to track non-financial measures as well. Quality, customer satisfaction, innovation and market share indicators reflect the company’s economic condition and the future prospects better than its reported earnings do (Eccles 1991, 131). Kaplan and Norton (1996, 3) argue that the ability of the company to mobilise and exploit its tangible or invisible assets has become more decisive than investing and managing the physical, tangible assets. Sveiby (1997, 12) has categorised the company’s tangible and intangible assets. He says that the total market value of the company consists of its visible equity and three kinds of intangible assets (Table 4.1).

Table 4.1 Total market value of the company (Sveiby 1997, 12)

Visible equity

The internal structure includes the patents, concepts, models, administrative systems, etc. These are created by the employees and are generally owned by the organisation. The external structure includes relationships with the customers and suppliers. It also encompasses the brand names, trademarks and the company’s image. The individual competence involves the capacity to act in a wide variety of situations to create both tangible and intangible assets (Sveiby 1997, 10 – 11).

Several authors have divided the performance measures into two categories:

objective measures reflecting the financial performance and subjective measures reflecting the perceptual operational performance (cf. Miller et al. 2003, 216;

Venkatraman & Ramanujam 1986, 803 - 804). Examples of objective measures are the sales growth, profitability, and the earning per share. Examples of subjective measures are the market share, new product introduction and product quality (Venkatraman & Ramanujam 1986, 803 - 804). Miller et al. (2003, 221 - 226) have noticed that the financial performance is positively associated with the business owner’s perceptual performance. Ketokivi and Schroeder (2004, 261) augment that for research purposes the usable measurement instruments are quasi-perceptual

measures, which are operationally defined, but the measurement is done as perceptual.

Dess and Robinson Jr. (1984) explain that performance is a complex and multidimensional phenomenon that is difficult to operationalise without using a combination of objective and subjective measures. Venkatraman and Ramanujam (1986, 804 - 805) continue that a further issue in the operationalisation of business performance is the source of the data, which can be primary or secondary. Primary data is collected directly from organisations, and secondary data is collected from publicly available records. According to Venkatraman and Ramanujam (1986, 807), operationalising the business performance using only financial or operational measures collected exclusively from one data source should be avoided as far as possible.

Performance has to be measured from different dimensions covering all the aspects of business: financial results, operating performance, the way the company is perceived externally, and cultural aspects of the working environment. Hudson et al. (2001, 1102) have found six important dimensions from the literature: quality, time, flexibility, finance, customer satisfaction, and human resources. Table 4.2 illustrates the dimensions more detailed.

Table 4.2 Dimensions of performance (Hudson et al. 2001, 1102)

Quality Time Flexibility Finance Customer

satisfaction Human

To be able to improve performance effectively, it is important to identify those factors of performance that should be particularly addressed, either because they are key to the success or because they identify under-performance (Grünberg 2004, 53). According to Hudson et al. (2001, 1100 – 1102), characteristic for performance measures is that they are derived from the strategy and clearly defined with an explicit purpose. The measures are relevant and easy to maintain.

They are simple to understand and use. The measures provide a fast and accurate feedback and there is a link from the operations to the strategic goals, and finally the measures stimulate continuous improvement.

Gupta and Govindarajan (1984, 34) have validated 12 performance dimensions when conducting a study about the effects of linking the managerial characteristics to small business unit (SBU) strategy. The validated dimensions are: sales growth rate, market share, operating profits, cash flow from operations, return on investments, new product development, market development, R&D-activities, cost reduction programs, personnel development and political/public affairs.

Kaplan and Norton (1996, 149 - 150) emphasise that the strategy is a set of hypotheses about the cause and effect. The cause and effect relationships can be expressed by a sequence of if-then statements by utilising outcome measures and performance drivers. The outcome measures tend to be lag indicators, such as profitability, market share, customer satisfaction and employee skills. The performance drivers, the lead indicators, are ones that tend to be unique for a particular business unit. The outcome measures without performance drivers do not communicate how the outcomes have been achieved. Neely et al. (2002, 79) continue that a good measurement system has a right balance of leading and lagging indicators, but it is not easy to say what is a leading and what a lagging indicator. They provide an example about customer satisfaction, which is said to be a lagging indicator of employee satisfaction. It is commonly said that dissatisfied employees result in a dissatisfied customer. This means that customer satisfaction is both a leading indicator of financial performance and a lagging indicator of employee satisfaction.