Evaluation and Control - Lessons 13-14 PDF

LESSON 13 Evaluation and Control OBJECTIVES: 1. Understand the basic control process; 2. Discuss the basis of measuring performance; and 3. Choose among traditional measures, such as ROI, and shareholder value measures, such as economic value added, to properly assess performance....

LESSON 13 Evaluation and Control OBJECTIVES: 1. Understand the basic control process; 2. Discuss the basis of measuring performance; and 3. Choose among traditional measures, such as ROI, and shareholder value measures, such as economic value added, to properly assess performance.  T 0 Evaluation and Control in Strategic Management Evaluation and control information consists of performance data and activity reports (gathered in Step 3 in Figure 11–1). Evaluation and control information must be relevant to what is being monitored. One of the obstacles to effective control is the difficulty in developing appropriate measures of important activities and outputs. An application of the control process to strategic management is depicted in Figure 11–2. It provides strategic managers with a series of questions to use in evaluating an implemented strategy. Such a strategy review is usually initiated when a gap appears between a company’s financial objectives and the expected results of current activities. After answering the proposed set of questions, a manager should have a good idea of where the problem originated and what must be done to correct the situation. Evaluation and Control in Strategic Management Measuring Performance Performance is the end result of activity. Select measures to assess performance based on the organizational unit to be appraised and the objectives to be achieved. The objectives that were established earlier in the strategy formulation part of the strategic management process should certainly be used to measure corporate performance once the strategies have been implemented. TYPES OF CONTROLS Controls can be established to focus on actual performance results (output), the activities that generate the performance (behavior), or on resources that are used in performance (input). Output controls specify what is to be accomplished by focusing on the end result of the behaviors through the use of objectives and performance targets or milestones. Behavior controls specify how something is to be done through policies, rules, standard operating procedures, and orders from a superior. Input controls emphasize resources, such as knowledge, skills, abilities, values, and motives of employees.  TYPES OF CONTROLS Output, behavior, and input controls are not interchangeable. Output controls (such as sales quotas, specific cost-reduction or profit objectives, and surveys of customer satisfaction) are most appropriate when specific output measures have been agreed on but the cause–effect connection between activities and results is not clear. Behavior controls (such as following company procedures, making sales calls to potential customers, and getting to work on time) are most appropriate when performance results are hard to measure, but the cause– effect connection between activities and results is clear. Input controls (such as number of years of education and experience) are most appropriate when output is difficult to measure and there is no clear cause–effect relationship between behavior and performance (such as in college teaching). Corporations following the strategy of conglomerate diversification tend to emphasize output controls with their divisions and subsidiaries (presumably be cause they are managed independently of each other), whereas, corporations following concentric diversification use all three types of controls (presumably because synergy is desired).  PRIMARY MEASURES OF CORPORATE PERFORMANCE Traditional Financial Measures The most commonly used measure of corporate performance (in terms of profits) is Return On Investment (ROI). It is simply the result of dividing net income before taxes by the total amount invested in the company (typically measured by total assets). Earnings Per Share (EPS), which involves dividing net earnings by the amount of common stock. Return On Equity (ROE), which involves dividing net income by total equity. Operating cash flow, the amount of money generated by a company before the cost of financing and taxes, is a broad measure of a company’s funds.  PRIMARY MEASURES OF CORPORATE PERFORMANCE Stakeholder Measures Each stakeholder has its own set of criteria to determine how well the corporation is performing. These criteria typically deal with the direct and indirect impacts of corporate activities on stakeholder interests. Top management should establish one or more stakeholder measures for each stakeholder category so that it can keep track of stakeholder concerns. Shareholder Value can be defined as the present value of the anticipated future stream of cash flows from the business plus the value of the company if liquidated. Arguing that the purpose of a company is to increase shareholder wealth, shareholder value analysis concentrates on cash flow as the key measure of performance. Economic Value Added (EVA) has become an extremely popular shareholder value method of measuring corporate and divisional performance and may be on its way to replacing ROI as the standard performance measure. EVA measures the difference between the pre strategy and post-strategy values for the business. EVA = after tax operating income - (investment in assets x weighted average cost of capital)  LESSON 14 Evaluation and Control OBJECTIVES: 1. Explain the use the balanced scorecard approach; 2. Discuss the primary measures of divisional and functional performance; and 3. Apply the benchmarking process to a function or an activity.  Balanced Scorecard Approach: Using Key Performance Measures Rather than evaluate a corporation using a few financial measures, Kaplan and Norton argue for a “balanced scorecard,” that includes non-financial as well as financial measures. This approach is especially useful given that research indicates that non-financial assets ex plain 50% to 80% of a firm’s value. The balanced scorecard combines financial measures that tell the results of actions already taken with operational measures on customer satisfaction, internal processes, and the corporation’s innovation and improvement activities—the drivers of future financial performance. In the balanced scorecard, management develops goals or objectives in each of four areas: 1. Financial: How do we appear to shareholders? 2. Customer: How do customers view us? 3. Internal business perspective: What must we excel at? 4. Innovation and learning: Can we continue to improve and create value? Key performance measures —measures that are essential for achieving a desired strategic option.  Balanced Scorecard Approach: Using Key Performance Measures Strategic Audit is a type of management audit. The strategic audit provides a checklist of questions, by area or issue, that enables a systematic analysis of various corporate functions and activities to be made. It is a type of management audit and is extremely useful as a diagnostic tool to pinpoint corporate wide problem areas and to highlight organizational strengths and weaknesses. A strategic audit can help determine why a certain area is creating problems for a corporation and help generate solutions to the problem. As such, it can be very useful in evaluating the performance of top management.  PRIMARY MEASURES OF DIVISIONAL AND FUNCTIONAL PERFORMANCE Control systems can be established to monitor specific functions, projects, or divisions. Budgets are one type of control system that is typically used to control the financial indicators of performance. Responsibility centers are used to isolate a unit so that it can be evaluated separately from the rest of the corporation. Each responsibility center, therefore, has its own budget and is evaluated on its use of budgeted resources. It is headed by the manager responsible for the center’s performance. The center uses resources (measured in terms of costs or expenses) to produce a service or a product (measured in terms of volume or revenues). Five major types of responsibility centers 1. Standard cost centers: Standard cost centers are primarily used in manufacturing facilities. Standard (or expected) costs are computed for each operation on the basis of historical data. In evaluating the center’s performance, its total standard costs are multiplied by the units produced. The result is the expected cost of production, which is then compared to the actual cost of production.  Responsibility centers Five major types of responsibility centers 2. Revenue centers: With revenue centers, production, usually in terms of unit or dollar sales, is measured without consideration of resource costs (for example, salaries). The center is thus judged in terms of effectiveness rather than efficiency. The effectiveness of a sales region, for example, is determined by comparing its actual sales to its projected or previous year’s sales. 3. Expense centers: Budgets will have been prepared for engineered expenses (costs that can be calculated) and for discretionary expenses (costs that can be only estimated). Typical expense centers are administrative, service, and research departments. They cost a company money, but they only indirectly contribute to revenues. 4. Profit centers: Performance is measured in terms of the difference between revenues (which measure production) and expenditures (which measure resources). A profit center is typically established whenever an organizational unit has control over both its resources and its products or services. By having such centers, a company can be organized into divisions of separate product lines. The manager of each division is given autonomy to the extent that he or she is able to keep profits at a satisfactory (or better) level. 5. Investment centers: An investment center’s performance is measured in terms of the difference between its resources and its services or products.  Using Benchmarking to Evaluate Performance According to Xerox Corporation, the company that pioneered this concept in the United States, benchmarking is “the continual process of measuring products, services, and practices against the toughest competitors or those companies recognized as industry leaders.” Benchmarking, an increasingly popular program, is based on the concept that it makes no sense to reinvent something that someone else is already using. It involves openly learning how others do something better than one’s own company so that the company not only can imitate, but perhaps even improve on its techniques. The benchmarking process usually involves the following steps: 1. Identify the area or process to be examined. It should be an activity that has the potential to determine a business unit’s competitive advantage. 2. Find behavioral and output measures of the area or process and obtain measurements 3. Select an accessible set of competitors and best-in-class companies against which to benchmark. These may very often be companies that are in completely different industries, but perform similar activities. 4. Calculate the differences among the company’s performance measurements and those of the best-in-class and determine why the differences exist. 5. Develop tactical programs for closing performance gaps. 6. Implement the programs and then compare the resulting new measurements with those of the best-in-class companies.