Performance Measurement

What are Performance Measurement Systems and what do they have to do with Practical Turnaround Management?

Performance Measurement, "PM," is a variable or metric used to quantify the efficiency and effectiveness of an action. (Neely et al, 1995) It includes a “complex web of relationships. Understanding the relationships . . . is not an exact science. (Thakkar et al, 2007)”

Current research finds that PM systems are most effective as when used to align everything -- people, systems and processes -- with the firm's strategy, vision, and mission statement.  Very often, management and employees are paid with compensation plans that include a performance-based bonus.  The bonuses are most often based on financial measurements, but there may also be a non-financial component to it.  There is a lot of research confirming that PM systems, in general, improve performance, although there is little agreement on which aspects of financial and balanced performance systems reliably deliver improved performance.  There is also no consensus on exactly how the PM process causes improved performance.   

Adjusting the employees’ pay packages to the current conditions is one of the early steps that turnaround managers must face with underperforming or distressed companies. In turnaround situations, the future cash flows are in question.  Being able to adjust compensation so that employees are motivated to do what's necessary for the turnaround to succeed is a matter of survival.

In designing PM systems, mid- and upper-level managers determine which activities contribute to the company's desired outcome.  Then they find reliable financial and non-financial measures that indicate to what levelthe activities have been performed.  These metrics / indicators are often referred to as performance “drivers.”  Others call them "control levers."  When they happen to be an indicator of corporate decline and they cross into the red zone, turnaround managers call them Early Warning Signs and immediately start looking for the cause of the shortfall.

Some of the early warning signs for corporate decline, such as Operating Profit as a % of Sales, can be put to use as performance measures. There are many other operational and non-financial measures that decision-makers can select.  The key is to measure as little as possible.  Just be sure to measure what matters. 

Here’s the practical turnaround thinking:  do not wait for decline to occur before instituting this tool.  Management teams who want to improve performance must 1) put critical drivers and metrics on a dashboard or scorecard, and 2) align compensation with value-creating behavior and results.

Here’s an example of a PM framework: link bonuses to 3 – 5 year increases in important cash flow and/or earnings measurements. Once the targets are established, do not modify or cap them. Rather, provide substantial reward for positive performance and penalize negative performance. Put as many managers as possible on the program to focus the entire organization on attaining the desired improvements.

EVA and Balanced Scorecard:  Two popular PM techniques
The two predominant PM systems are:

• the traditional financial measurements, and
• the contemporary, so-called balanced measurement systems made up of non-financial and financial measurements.

In the past 15 years, the most popular type of each has been Economic Value Added, “EVA," for the financial measurement systems, and Balanced Scorecard, "BSC," for the balanced measurement systems.  EVA is strictly financial measures and is referred to as “value-based management" (VBM).  Balanced Scorecard evaluates an organization on financial and non-financial measures.  

EVA practitioners measure success as increased shareholder value that comes from excess economic profits.  For BSC practitioners, success means strategy implementation that leads to improved performance.  It is worth noting that, as a performance measure, Earnings per share, "EPS," a financial measure, has never gone out of fashion and is readily available from the accounting system.  Current research suggests that it may be a stronger predictor of management's performance over the period than EVA is.  

On the success of Performance Measurement Systems
The research suggests that many attempts to implement performance measurement systems fail, whether EVA, BSC or any of the many other systems. Some researchers contend that the failure results from the cultural opposition to change that afflicts all organizations. Others contend that none of the formal systems delivers results, and recommend that individual management teams select whatever combination of indicators prove to drive firm value – not quarterly, but over the long term. 

On the other hand, those successful implementers of PM systems have concluded that the entire effort has to be more about changing the culture than it is about installing new accounting systems or other short-term or technology-based solutions. While the is no agreement on which system to use, all agree that 21st century management teams must be looking at timely data, in context, all the time – and constantly perfecting their selection of drivers and metrics.

Contact Melissa Craig to have an informal conversation about how your organization addresses early warning signs and performance measures. See the Services and Solutions in the sidebar. 

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*Eric O. Olsen and Honggeng Zhou et al.  “Performance measurement system and relationships with performance results.”  International Journal of Productivity and Performance Management.  Page 563.

• Balanced Scorecard
  - Vision and strategy statements
  - Strategy maps

• EVA
  - WACC analysis
  - ROIC analysis

• Executive Dashboard
  - Early warning signs
  - Performance drivers