Performance Management System Its Limitations & Recommendation for Improvement

Performance Management System

Mohiuddin Asad

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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

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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 organisation’s performance

management system, highlighting limitations of the existing system and recommending

possible improvements.


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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 – 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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implementing a performance management system is to improve the performance of the

organization.


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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 ARI’s 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 ARI‘s 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


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measures which are linked to performance drivers through a set of assumed

cause/effect relationships”. (Page 245, PMQA)

BSC helps in translating the organization’s 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, non-

financial 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 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:


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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


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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


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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 management’s 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:


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- 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


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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


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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


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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 customer’s 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


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results”, “No. of new locally made product features” are some which can be useful for

ARI .


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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 high-

performance 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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ARI‘s 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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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. 71–79

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. 363–382

Armstrong and Baron, A. (1998), Out of the tick box, People Management, 23 July,

pp.38-41.

Documents

Performance Management System Its Limitations & Recommendation for Improvement