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Is there a way to prevent these issues associated with using accounting measures as performance measures?
The use of nonaccounting measures in conjunction with accounting-based measures can help mitigate the
problems of using accounting-based measures alone. Therefore, most performance measurement systems
today use a combination of accounting-based measures and non-accounting-based measures, short-term or
long-term indicators, or quantitative and qualitative components. Let’s first look at the use of accounting-
based measures, and then we’ll consider a methodology that also incorporates non-accounting-based
measures.
12.2 Identify the Characteristics of an Effective Performance Measure
It is important to identify the characteristics that make a performance measure a good assessment of goal
congruence. A good performance measurement system will align the goals of management with the goals of
the corporation, and both parties will benefit. A lack of goal congruence in a performance measurement
system can be detrimental to a business in many ways. Without proper performance measures, goal
congruence is almost impossible to achieve and will likely lead to lost profits and dissatisfied employees,
A good performance measurement system should have the following characteristics:
• It should be based on activities over which managers have control or influence.
• It should be measurable.
• It should be timely.
• It should be consistent in its application.
• When appropriate, the actual results should be compared with the budgeted results, standards, or past
T H I N K I T T H R O U G H
Balancing Customer Needs with Company Needs
Noah Barnes just graduated from college and took a position as production supervisor for Morgensen
Machines, who manufactures sewing machine and vacuum cleaner parts. On his first day at work, one of
Morgensen’s sales managers asked Noah if it would be OK to rearrange his manufacturing job schedule
so that a special order from a new customer could be pushed to the front of the line. This new customer
requires fast turnarounds; unfortunately, this also means running the production equipment for all three
shifts at maximum output for at least one week, possibly more. This would completely prohibit the
schedule that management told Noah to implement. Noah does not want to make the sales manager
angry at him, but he also does not want to lose his job in the first month out of college. He knows that
the manager is focused on landing this new customer, who could reward the company with a needed
increase in overall sales and plant output. The problems, as Noah sees them, are that (1) current jobs will
be delayed; (2) there will be greater demand on the machines during all three shifts, increasing the
possibility that they will fail; (3) there will not be time for needed maintenance; and (4) eventually all of
these factors will snowball into significant delays for the new customer, as well as extensive delays for
the previously scheduled orders.
How should Noah handle this problem? What managerial principles would you advise him to use from
his college studies to help him develop better policies for future events like this?
626 Chapter 12 Balanced Scorecard and Other Performance Measures
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performance.
• The measurements must not favor the manager over the goals of the entire organization. Often,
managers have the ability to make decisions that favor their individual units but that may be detrimental
to the overall performance of the organization.
As you’ve learned, it is important that the activities on which managers are evaluated are within that
manager’s control. In addition, it is very important for the information that is used in the performance
measurement system be gathered, evaluated, and presented in a timely manner. Performance measurement
systems provide an indication of how well the evaluated managers are doing their jobs. Remember, the
organization wants managers to make decisions that are in the best interest of the organization as a whole,
and hence the need for the performance management system. If managers do not receive appropriate
feedback in a timely manner, they will not know which decisions they should continue to make in the same
manner and which are less effective. The same is true from the corporation’s perspective. Timely information
allows the evaluation team to determine the effects of individual management decisions on the corporation as
a whole.
In addition to being timely, performance measures need to be applied or measured consistently. The
accounting variables or other measures that are used to evaluate a manager should be measured the same
way from period to period. For example, if a performance measure includes some form of income, such as
operating income, then that measure should be used each time and not replaced with another income
measure for the current measurement cycle (usually one year). If, upon further analysis, it seems that net
income is a better measure to use in the evaluation of a manager, then the new measure can be implemented
during the next measurement cycle. When measures are changed, it is imperative that the manager being
evaluated is aware of the measurement change, as this may affect his or her decision-making. The idea is to
keep the targets stable for a period. Otherwise, the measurements might be inconsistent, and thus
misleading. A good performance measurement plan would include the manager’s input in the design
discussion. Not only does this help to ensure that the plan is clear to all parties involved in the process, it also
helps to motivate managers. Rather than being told what goals are to be met, managers will be more
motivated to achieve the goals if they have input into the process, the goals to be reached, and the
measurements or metrics being used.
Performance measures are only useful if there is a baseline against which to compare the measured results.
For example, students often evaluate how well they performed on a test by comparing their grade to the
average for the test. If a student scored 65 out of 100 on a test, the initial response may be that this is a less
than stellar grade unless that score is compared to the average. Suppose the average on that particular test
was a 50. Obviously, in this example, the student performed above average on this test, but this could not be
interpreted correctly until the score was compared to a baseline. In evaluating performance measures, a
standard, baseline, or threshold is typically used as a basis against which to compare the actual results of the
manager.
A company has both short- and long-term goals. Short-term goals include reducing costs of production by a
certain percentage for the current year or increasing year-over-year sales by a certain percentage. Long-term
goals may include expanding into new territories or adding new products. Employees also have short- and
long-term goals. Short-term goals can include a beach vacation, and long-term goals can include saving for
retirement or college. A good performance measurement system will include both short- and long-term
measures in order to motivate managers to make decisions that will fulfill both the corporations and their own
short- and long-term goals.
You’ve learned about the human factor that causes managers to make what is typically the best decision for
themselves rather than the best decision for the overall good of the corporation, especially if the decision that
Chapter 12 Balanced Scorecard and Other Performance Measures 627
benefits the corporation is not beneficial to the manager. Again, this means the performance measurement
system must attempt to prevent the manager from benefitting without the corporation also benefitting. This is
one of the trickiest parts of performance measurement system design.
For example, suppose the manager of the used car department at an automobile dealership is responsiblefor
the profit he makes selling used cars that were taken as trade-ins on new car sales. Some of these used cars
need a few repairs to prepare them for sale. The manager has the option of getting the cars fixed using the
service department at the dealership or outsourcing the repairs to another company. If the manager can get
the repairs completed at a lower cost at another repair shop, and if he is evaluated and receives a bonus based
on his profit, then he is likely to use the outside repair shop. Is this a good thing to do? Obviously, it is good for
the manager of the used car department who will have fewer costs getting the used car ready to sell and
therefore will make more of a profit from the sale of that car. Higher profits for the used car department mean
a higher bonus for the manager. But what about for the dealership? Was outsourcing the repairs the right
decision?
It depends on several factors, but here are points to ponder. What if the dealership’s service department is
more expensive because it provides higher-quality parts and the mechanics are certified? Does the reputation
of the quality of the used cars sold by the dealership affect more than just the used car department? What if
the service department could have completed the work at cost? As you can tell by these questions, without
further information, we do not know whether or not the used car manager should outsource the repairs. But
we do know that his decision was based on his bonus being tied to his profitability and not linked to other
factors such as dealership profitability or dealership reputation (customer satisfaction). Therefore, it is
important that the performance management system not promote decisions that only benefit the manager to
the detriment of the corporation.
C O N C E P T S I N P R A C T I C E
Performance Measures at NASA[1]
Nearly twenty years ago, the National Aeronautics and Space Administration (NASA) along with five NASA
contractors undertook a project to derive performance measures. As a result, they developed a series of
five models for measures. These measures included effectiveness, quantity, quality, value, and change,
and are as follows:
• Effectiveness was measured as projected/actual. An example was number of tests completed/
number of tests planned.
• Quantity was measured as process or product unit/sources of cost. An example was total number of
wind tunnel tests run/facilities management cost.
• Quality was measured as indicators of error or loss/process or product unit. An example of quality
measures is mistakes in work packages issued/work packages issued in total.
• Value was measured as desirability/source of cost. An example of value measures is savings from
suggestion program/man hours to review suggestions.
• Change was measured as the information provided by the indexes that are developed by tracking
the same performance measures over time. An example would be the improvement measures, like
◦ Reduction by X percent in downtime of facilities/tests accomplished or attempted or
◦ Increase by X percent of documents prepared/procurement clerk
These measures have some distinct advantages but also may be met with some resistance from
628 Chapter 12 Balanced Scorecard and Other Performance Measures
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12.3 Evaluate an Operating Segment or a Project Using Return on Investment,
Residual Income, and Economic Value Added
There are three performance measures commonly used when a manager has control over investments, such
as the buying and selling of inventory and equipment: return on investment, residual income, and economic
value added. These measures use financial accounting data to evaluate how well a manager is meeting certain
goals.
Introduction to Return on Investment, Residual Income, and Economic Value Added as
Evaluative Tools
One of the primary goals of a company is to be profitable. There are many ways a company can use profits. For
example, companies can retain profits for future use, they can distribute them to shareholders in the form of
dividends, or they can use the profits to pay off debts. However, none of these options actually contributes to
the growth of the company. In order to stay profitable, a company must continuously evolve. A fourth option
for the use of company profits is to reinvest the profits into the company in order to help it grow. For example,
a company can buy new assets such as equipment, buildings, or patents; finance research and development;
acquire other companies; or implement a vigorous advertising campaign. There are many options that will
help the company to grow and to continue to be profitable.
One way to measure how effective a company is at using its invested profits to be profitable is by measuring
employees and contractors. Advantages likely included a better understanding of their processes as well
as an understanding of the amount of time wasted and value emulating from these processes.
Development and implementation become an opportunity to discover what may be wrong with
processes, to start a dialogue concerning ongoing change and improvement, and to communicate and
brainstorm about organizational inefficiencies. Networking involved in development of the performance
measures can become an equalizer among processes that break down silos and complexity.
Resistance would likely come from the measurements being too time consuming and the processes too
complex to be charted for these measurement objectives. How can upper management judge the
complex progress on projects if they have little to no involvement? If these measures were so important,
then NASA would have already developed them in an organization that was started around 1960.
Resistance like this develops as one where the prior absence of these measures becomes the primary
resistance toward developing them.
L I N K T O L E A R N I N G
General Electric is changing their performance measurement practices to more closely align with the
goals of millennials. Read the Impraise blog on GE Performance Reviews (https://openstax.org/l/
50GE_perform) for more details.
1 D. Kinlaw. “Developing Performance Measures with Aerospace Managers.” National Productivity Review. December 1, 1986.
Chapter 12 Balanced Scorecard and Other Performance Measures 629
https://openstax.org/l/50GE_perform
https://openstax.org/l/50GE_perform
its return on investment (ROI), which shows the percentage of income generated by profits that were
invested in capital assets. It is calculated using the following formula:
Capital assets are those tangible and intangible assets that have lives longer than one year; they are also
called fixed assets. ROI in its basic form is useful; however, there are really two components of ROI: sales
margin and asset turnover. This is known as the DuPont Model. It originated in the 1920s when the DuPont
company implemented it for internal measurement purposes. The DuPont model can be expressed using this
formula:
Sales margin indicates how much profit is generated by each dollar of sales and is computed as shown:
Asset turnover indicates the number of sales dollars produced by every dollar invested in capital assets—in
other words, how efficiently the company is using its capital assets to generate sales. It is computed as:
Using ROI represented as Sales Margin × Asset Turnover, we can get another formula for ROI. Substituting the
formulas for each of these individual ratios, ROI can be expressed as:
To visualize this ROI formula in another way, we can deconstruct it into its components, as in Figure 12.4.
630 Chapter 12 Balanced Scorecard and Other Performance Measures
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	Chapter 12. Balanced Scorecard and Other Performance Measures
	12.2. Identify the Characteristics of an Effective Performance Measure*
	12.3. Evaluate an Operating Segment or a Project Using Return on Investment, ResidualIncome, and Economic Value Added*