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Performance Management System

PERFORMANCE MANAGEMENT SYSTEM

IN DEPTH ANALYSIS USING BALANCE SCORE CARD MODEL

Mohiuddin Asad
B.Com, MBA(UK), ACCA, CMA, CIA, CFE, FFA, CCSA

Mohiuddin Asad

Performance Management System

Introduction
In this piece of work, author has selected his old company named Aer Rianta International (ARI) Pak where he had worked for six years and has evaluated its Performance management system. Starting with a brief overview of the said organisation, he has first explained various definitions and concepts about performance management system and then tried to evaluate selected organisations performance management system, highlighting limitations of the existing system and recommending possible improvements.

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Performance Management System

Overview of the organisation


Name of the selected organisation is Aer Rianta International. It is a medium sized limited liability company which was incorporated in Pakistan during 1992. Regional Head office of the group is in Dubai which has subsidiary companies in all major cities of the region, including the selected company. The company is a partnership venture between an Irish and a local company which represents a family owned business. ARI is a duty free trading company which sells electronics, perfumes, confectionaries and other items, imported from Europe and United states. The annual turnover is around 200 million USD with net assets of over 60 million and total staff strength of over 200 members. The organizational structure is broken into four main departments, namely sales, finance, procurement and warehousing. Each department is headed by a manager. All department heads report to Director General who in turn reports to the Board.

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Performance Management System

Performance management system Definitions & Concepts


Performance management system has been defined by researchers in different ways. Armstrong and baron (1998) defined it as A strategic and integrated approach to increasing the effectiveness of organizations by improving the performance of the people who work in them and by developing the capabilities of teams and individual contributors. Other researchers describe Performance management as a technology for managing both behaviour and results. There is no single definition agreed by all, however, considering different approaches, one may sum up Corporate Performance management system as part of the planning and control cycle of an organization where expected levels of achievement are set for an organization based on its corporate objectives. These expected targets are expressed both in financial and non-financial terms and are compared to actual achievement with a view to improve future performance. Each system begins with defining the vision or goals of the company. Next, there is a meshing of key performance indicators within a strategic evaluation format where managers rate the significant factors which pertain to achieving each strategic objective. Finally, managers co-ordinate the measures to develop, track, and relate those measures back to the overall strategic vision on a continuous basis. (Page 22, PMQA). The purpose of performance management is not only to know how a business is performing but to enable it to perform better. Thus the ultimate aim of

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Performance Management System implementing a performance management system is to improve the performance of the organization.

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Performance Management System

Performance management system of ARI Company


In order to facilitate evaluation of Performance management system (PMS) of ARI Company, the author has divided his analysis into two sections. In the first section, he has discussed how ARI sets targets, measure performance and takes corrective actions, whereas in second section, he has discussed ARIs performance reward system. In both sections, he has also highlighted limitations in the existing PMS of ARI as well as provided recommendations for improvement. The use of a framework or model usually aids in a controlled and balanced evaluation. There are several models and frameworks for PMS, the business excellence, balanced scorecard, performance prism, Otley, (1999) framework to name few only. The author has chosen Balanced scorecard model which is widely accepted as a method for strategic performance measurement and control and seems more relevant and suitable for evaluation of ARIs PMS. The balanced scorecard (BSC) concept was introduced by Bob Kaplan and David Norton. It is an approach to the strategic management of the whole organization and a framework which provides leverage of the strategic vision of the organization by aligning people and processes behind those activities which drive value creation. In addition, the BSC encourages: feedback; learning; and information transfer throughout the organization. A well-designed BSC will demonstrate the path (intended and actual) that an organization takes to create value over the long term. Its distinctiveness from other frameworks and strategic measurement systems is that it contains outcome Mohiuddin Asad 6

Performance Management System measures which are linked to performance drivers through a set of assumed cause/effect relationships. (Page 245, PMQA) BSC helps in translating the organizations vision and strategy into objectives and measures performance in four different dimensions: 1) Financial perspective 2) Customer perspective 3) Internal business process perspective and 4) Learning and innovation perspective. The distinctive feature is that BSC links these four dimensions in a systematic way. According to Kaplan and Norton (1996), Many managers believe they are using a Balanced Scorecard when they supplement financial measures with generic, nonfinancial measures about customers, processes and employees. But the best Balanced Scorecards are more than ad hoc collections of financial and non-financial measures [...] a scorecard should contain outcome measures and the performance drivers of those outcomes, linked together in cause and effect relationships. (Kaplan and Norton, 1996)

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Performance Management System

Performance Targets, measurement & Action


Like many other companies in South Asia, ARI does not have any sophisticated performance management system in place. The company follows old traditional style of performance management which largely depends on financial targets and achievements. There is no formal strategy declaration or mission statement for the company. The only known objective is to increase the wealth of the shareholders by increasing sales and profit. Target setting process is simple. A guideline is received from board before start of the year. This guideline is exclusively based on financial targets, including a certain percentage increase in the sales & profit from the last year actual figures. There is no back up to justify or explain how such percentages were arrived at. The other targets include trade receivables and Inventory to remain within given limits. Upon receiving the guideline, Director General of ARI reviews these percentages and limits and negotiates with board for required adjustments. As a result of this, a final target is agreed which is generally only slightly lesser than the original one. Once the overall sales & profitability targets are finalised, the Director General distributes this equally to the Sales Managers. All the branches & support departments are then informed to prepare a formal budget based on the mentioned targets. The branches prepare detailed month-wise budgets in Income statement format and send these to Director General who reviews and adjusts them, if required. The budget is then consolidated and sent to board for formal approval. Once approved, individual budget is forwarded to relevant branch/department with following targets: Mohiuddin Asad 8

Performance Management System 1) To achieve or exceed the budgeted sales 2) To keep the expenses below the approved limits 3) To exceed or maintain the budgeted bottom-line. 4) To keep the Total trade receivable within 100 million 5) To keep the Total Inventory within 100 million A monthly management report is prepared by the Finance department, comparing for the month and year to date targets with actual for the month and year to date results. In addition to above, both Receivable and Inventory figures are compared with the target amounts and included in the monthly management report. The said management report package is circulated to all branch managers and Director General on 5th of the following month. The Director General then prepares a commentary on these results, highlighting important features and justifying shortfalls, if any. The management report along with commentary is then sent to the board on 7th of following month. As evident from the above discussion, ARI lacks badly in both objective setting and measurement areas. The first problem is that there is no long term vision of the company. There is no formal strategy or direction except to make more profit. To make more profit should be one of the prime objectives but not the only one. Occasionally, organisations have to pay heavy costs for such narrow profitability vision. This is because management usually pursues a more risky strategy to meet the short term profitability goals imposed on them which can sometimes cause threat even for the very existence of the company. ARI Company should, therefore, re-design its objective Mohiuddin Asad 9

Performance Management System setting process. The first thing is to decide a strategic direction i.e. where the shareholders want to see the company after 5 or 10 years. Once the strategic objective is decided, the company should set up tactical and operational goals which should be supporting the main strategic objective of the company. At present, Company is emphasizing only on the financial objectives which should be changed to a more broaden and balanced approach. As discussed above, balanced scorecard (BSC) provides guidance in both setting objectives and measuring performance towards those objectives and links outcome measures to performance drivers through a set of assumed cause/effect relationships using a four dimensional approach. Thus ARI can make use of this model as below:

Financial dimension
Although, ARI is exclusively focusing on financial targets, yet it has not been using them intelligently. The only targets are sales and profitability to be increased by a certain percentage, expenses to be below budget and receivables and inventory to be within given limits. Below table represents a sample extracted from the monthly report:

Sales targets are set up in ARI based on historical patterns without giving due importance to current and expected trends. Though it may appear to be practical, yet Mohiuddin Asad 10

Performance Management System the objective setting process should be more involved. The objectives should be SMART i.e. specific, measurable, achievable, realistic and time bound. In ARI case, there is a possibility that market might be growing significantly fast so, say a 5% increase in last year sales could be too small and easily achievable. Similarly, in a fast declining market, a 5% increase could be too high because organisations might be struggling to sustain the existing share. Hence, while setting up sales target, ARI should do a market analysis as well. There are several ways of doing that however, use of Boston consulting group (BCG) matrix can be helpful for ARI. This is a quadrant model which maps relative market share with market growth and provides good basis to plan future strategy. ARI can collect these data from different local trade journals and government departments like customs can provide the total number of electronics imported in the country during a particular year. Having done a thorough market analysis, ARI can set realistic but challenging targets to make optimum use of the market opportunities. Such analysis will make the targets more justifiable and will also help in buying in managements support and staff motivation. A sales achievement percentage will then be meaningful; however, it should still be seen with other relevant financial and non-financial measures. For example, higher sales achievement should be seen with quality of receivables as it should not end up in higher bad debts. Similarly monitoring receivable to remain under X million amounts is not enough. For instance, there is a possibility that receivables remain under limit but a significant part of it becomes un-collectible. So ARI should change their current receivable management approach and adopt a broader vision as follows: Mohiuddin Asad 11

Performance Management System - A receivable aging report should be prepared to monitor, manage and collect debts on due dates. Appropriate action should be taken for over due and over aged balances. - Receivable turnover ratio and Average receivable in days should be benchmarked and compared with actual data on regular basis for necessary actions. Like receivables, keeping Inventory under given limit is also not enough and ARI should thus change its inventory performance measurement to align with overall operational objectives. It is possible that inventory limit is too high to result in un-necessary blocking of funds or it may be too low to enable ARI to achieve targeted sales. Moreover, it may include a large portion of obsolete or slow moving items. Hence, ARI should benchmark its inventory turnover and average days in inventory and regularly measure it against actual figures. Furthermore, it should prepare an inventory aging report to monitor aged, obsolete and slow moving inventory and carry out regular physical counts to check for any shortages. Appropriate actions should then be taken based on the outcomes. There is a long list of financial performance ratios which can be measured, however, considering ARI; following may be relevant and useful: Gross profit (GP) % is one of the important measures. Since GP can only be affected by sales and cost of sales, it provides signals whenever a change occurs in said elements. ARI already has a history of GP trend which can be used as a yardstick to measure and control any deviations. ARI is currently not giving importance to its liquidity position due to the fact that it has enough funds available at present. However, this situation may not remain for long. It is Mohiuddin Asad 12

Performance Management System very important for ARI to measure and monitor its liquidity which can easily be done by calculating Current ratio and quick or Acid test ratio. Another important financial dimension is gearing of the company. ARI is currently financed by a local bank and has gearing of only 30%. However, it must regularly monitor its gearing to be able to take timely decisions for future prospects. A Debt equity ratio will be useful for this purpose. ARI is not a listed company hence P/E or EPS ratios are not relevant. However, board can measure what returns they are generating from ARI on their investments. This can be measured by Return on capital employed ratio (ROCE) which is Net profit /Net Assets. ROCE helps investors to compare their returns with other options available in the market. ROCE can also be broken down into two different ratios, i.e. Assets turnover and Net profit %. Asset turnover is calculated by dividing sales with assets and this helps to know the rate or extent at which assets are being utilized to generate sales. Net profit % is the net profit divided by sales. This tells how much net profit company is making on the achieved sales.

Customer perspective
Companies are now increasingly realizing the importance of customer focus and customer satisfaction in any business. These are key indicators because if customers are not satisfied, they will eventually find other suppliers that will meet their needs. Poor performance from this perspective is thus a leading indicator of future decline, even though the current financial position may appear good. So understanding the basis of the customer perspective is very important, as this element reflects how the customer Mohiuddin Asad 13

Performance Management System might perceive the business. This in particular includes relationships, quality, service and overall performance levels. ARI has so far completely ignored this area and hence need to focus on these matters immediately. ARI should set up targets for customer share, customer satisfaction, customer retention and customer profitability. Customer share can be measured by capturing total sales by value and volume for individual customers. This will tell ARI which customers are most important and should be handled carefully. Customer satisfaction can be measured by regular surveys or by logging customer complaints. These measures will tell ARI which features are more valued by the customers and will guide it where to improve its quality and service. Customer retention can be measured by tracking customers, measuring the rate at which the business retains customers or maintains existing relationships. This is also important because cost of finding a new customer is generally higher and can be saved by retaining existing customers. Similarly, ability to measure profitability at the individual customer level will allow ARI to consider new customer profitability measures such as "percentage of unprofitable customers," or "dollars lost in unprofitable customer relationships." Such customer profitability measures provide a valuable signal that share, satisfaction, retention and relationships are desirable only if these contribute to higher value for the company.

Internal business process perspective


The internal perspective looks very closely at the implementation of the essential internal processes required to meet customer needs and achieve ultimate customer satisfaction (Page 251, PMQA) The strategic focus of the internal business process Mohiuddin Asad 14

Performance Management System perspective is to determine the business processes an organization must excel at, to satisfy its customers. ARI can do a Value chain analysis for its internal processes. This exercise will help ARI to identify which processes add value and which processes do not or add little value. ARI should then monitor, measure and improve those areas which add more value for customers and remove or replace those processes which add no or little value. For example, late delivery is one of the critical problems at ARI. Many customers cancel their orders because of this problem. ARI should critically review the whole delivery process and analyse the root cause of this problem and improve it to meet customers requirements. Likewise, ARI should improve other key internal processes and implement measurement techniques to regularly measure and improve those processes. There are many measurements but installation time per unit, cost per delivery, hours per delivery, warranty claims per model, defects per model hours to respond shall be very useful for ARI .

Learning and innovation perspective


The fourth major indicator of the balanced scorecard is learning and innovation. This includes change, evolution and growth of an organization through the use of learning and innovative features. The key focus is on continuous improvement philosophy. The main areas where ARI should focus are availability of the information, better communication, staff training, staff empowerment, staff motivation and continuous improvement. Again, there are many measurements but hours reserved for training, number of suggestions received from staff, staff turnover, staff attitude survey Mohiuddin Asad 15

Performance Management System results, No. of new locally made product features are some which can be useful for ARI .

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Performance Management System

Performance reward system


ARI has a bonus scheme for its management staff. After the yearend, a report is prepared showing budget achievements for the year. The bonus scheme operates in following manner: On 100% or above achievement: one half of the annual basic salary for Director General and one fourth of the annual basic salary for other managers. Between 90% to 99.9%: one third of the annual basic salary for Director General and one fifth of the annual basic salary for other managers. There is no bonus below 90% achievement.

It is important that performance goals are aligned with overall corporate objective of the company and that the reward system is linked with the success in achieving those performance goals. Howard Rohm (2008), President of the Balanced Scorecard Institute explains that Incentives should be tied to performance to make strategy actionable for people, and help build buy-in for the behaviour changes needed to create a highperformance organization (Howard Rohm, 2008). Though, ARI has tried to link its reward system with performance, yet, it has many weaknesses. First of all, it lacks a real motivational element. There is no reward below 90%. This means that if staffs do not expect to reach 90%, they might loose hopes as there is no benefit to do even 89%. Similarly, the reward is same for 100% and above, hence, staffs will not have any motivation to do better than 100%. ARI should re-adjust its reward system so that even remained challenging, it provides a desire and motivation to do better at all levels.

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Performance Management System ARIs existing reward system is exclusively based on financial performance. As discussed earlier, ARI should adopt a balanced approach wherein along with financial performance; reward system should also be linked with relevant non-financial performances i.e. performance from customer, internal process, Learning and innovation perspectives. For example, reduction in delivery time, improvement in customer satisfaction, better response time for after sales service etc should also be considered while setting up a reward system. Many companies have adopted a formal staff appraisal system. ARI can also explore and implement such a system. Finally, financial reward is unarguably important but people do get encouraged and motivated by recognition also. ARI does not follow any programme of this nature. It is recommended that ARI should implement such recognition award system like announcing Employee of the month, Salesman of the year etc for good performers.

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Performance Management System

References:
Performance Measurement: Quantitative Approaches, Book, School of Management Kaplan, R.S., and Norton, D.P. (1992) The balanced scorecard measures that drive performance, Harvard Business Review, Jan/Feb, pp. 7179 Howard Rohm, (2008) Using the Balanced Scorecard to Align Your Organization The Balanced Scorecard Institute. Otley, D. (1999) Performance management: a framework for management control systems research, Management Accounting Research, 10, pp. 363382 Armstrong and Baron, A. (1998), Out of the tick box, People Management, 23 July, pp.38-41.

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