Description
Performance measurement is the process of collecting, analyzing and/or reporting information regarding the performance of an individual, group, organization, system or component. It can involve studying processes/strategies within organizations, or studying engineering processes/parameters/phenomena, to see whether output are in line with what was intended or should have been achieved.
Performance Measurement for a Logistics Services Provider to The Polymer Industry
by
Tok King Lai 2007
A Management project presented in part consideration for the degree of Master of Business Administration
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Summary
This management project discusses the form of performance measurement system suitable for a logistics services provider who focuses on providing its services to large multinational petrochemical companies in the polymer industry. The project starts with a brief introduction of the importance of performance measurement driving the efforts put in by the employees of an organization. It is followed by a brief introduction of the nature of the business undertaken by the companies in polymer industry and their need to used logistics services providers. This leads to a brief discussion on the type of services provided by a typical logistics services provider in the polymer industry and the linkage of their performance to the key performance indexes included in a services contract. To find out what type of performance measurements are available, I have carried out literature reviews of a few articles on: traditional financial data based performance measurement; and performance measurement systems that emphasise the inclusion of non-financial factors such as customer expectation, employees’ learning and skill level, innovations, suppliers, shareholders and other stakeholders. The main focus of my literature review is on three non-financial based performance measurements: The Performance Pyramid, The Balanced Scorecard, and The Performance Prism. The second half of the project covers my recommendation of a suitable performance measurement system for a logistics services provider: a scorecard based system with five perspectives on performances. The implementation targets within a logistics services company are segregated into: the Management of the company, the Middle Managers, and the Line Operators. Three measuring scorecards with suggested goals and measures are produced for adoption. The management project ends with discussions on implementation issues, linkage of the performance scorecard to remuneration system, and the problems associated with the measurement. 2
TABLE OF CONTENTS
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Introduction on Performance Measurement ...................................................................... 4 1.1 Brief introduction of the Polymer Industry ................................................................ 5
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Specialization required from Logistics Services Provider to Polymer Industry............. 7 Literature Reviews ................................................................................................................ 9 3.1 3.2 3.2.1 3.2.2 3.2.3 Literature review of Traditional Financial Performance Measurement:................ 9 Literature review of Non-financial factors ............................................................... 14 The Performance Pyramid by Lynch and Cross (1991) .................................. 14 The Balanced Scorecard by Kaplan and Norton (1992) .................................. 17 The Performance Prism by Neely (2002) .......................................................... 22
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Suggested performance measurement covering the financial & non-financial aspects 27 4.1 4.2 4.2.1 4.2.2 4.2.3 Developing a Performance Strategy Map:................................................................ 28 Developing a Scorecard Based Performance Measurement ................................... 32 Proposed Scorecard for the Management......................................................... 34 Proposed Scorecard for Managers .................................................................... 41 Proposed Scorecard for individual operators .................................................. 44
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Implementation of the Scorecard Performance Measures.............................................. 46 Linkage of the performance scorecard to remuneration system .................................... 50 Performance Measures problems ...................................................................................... 53 How to address Performance Measures problems........................................................... 56 Key references ..................................................................................................................... 58
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Introduction on Performance Measurement
In the manufacturing and services sectors, performance measurements have played a vital part in driving corporate performance and results. As profits and results oriented entities, such organizations have goals or objectives which include gaining the required return on investment, protecting or increasing their market share. A suitable set of performance measurements which takes into account the returns and market share achieved by management teams on an ongoing basis would help the organizations to reach their intended goals or objectives. Johnson (2005) feels it is becoming important for organizations to develop systems of performance measurement as the present day business has become more complex and also the need to monitor their strategic response to this complexity. He lists the following main issues which management should consider: ? Linking performance to strategy ? Setting performance standards and targets ? Linking rewards to performance ? Considering the potential benefits and problems of performance measures The important of performance measure was appropriately demonstrated in a non-business environment by Starbuck (2005) where he compared the crime rates of New York City in 1985 and that in 2003. Starbuck noted that New York City was widely perceived as a dangerous place in 1985. But in December 2003, it was mentioned in the press as the 6th city with the lowest crime rates among 193 American cities with populations more than 100,000. The city has achieved this result after various performance measure initiatives were introduced by the city police force. The main driver of this improved crime rates was through the use of effective performance measures adopted by the New York City police force. Prior to that, the performance reports for the police force were limited to annual reports on the number of patrolmen and police cars on the streets, the number of raids occurred, the number of arrests made, and so on. The old practice only required statistics and reports to be compiled once a year. The crime rates reduced after the police force started to compile daily summaries of crimes committed after it deployed more computers and IT savvy offices in its departments. The police commanders began to receive frequent, up-to-date measures of the events that police activity is supposed to affect. The
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commanders were made to appear periodically before a review board to discuss crime statistics and made to present improvement plans. Poor performers were subjected to peers reviews in public or dismissal in the case of ineffective commanders. These illustrations are similar to the call by Johnson for the setting of performance standards, targets and rewards in a business environment. This paper seeks to look into the performance measurements, both financial and non-financial, which may contribute to the achievement of the desired goals of a logistics services provider to the polymer industry.
1.1
Brief introduction of the Polymer Industry
The polymer industry is involved in the polymerization of by-products from crude oil refining processes into various types of plastics products. The finished product from the polymerization process is usually in the form of dried pellets. Key players in the polymer industry are large multi-national petroleum companies. These multi-national companies have usually collected a large quantity of raw material from their crude oil refining activities worldwide. They will further invest in downstream polymer processing facilities and use the material as feed stock to produce other materials of high economic value. Also, they have strong financial resources to set up the polymerization plants. The vast investment in these plants and the accompanying financial returns plus employment opportunities has attracted the interest of many countries in trying to host such processing plants. Appreciating the importance of petrochemicals as a driver of the economy, the Singapore government aggressively embarked on building up a Petrochemical industry in the 1990s. The government invested heavily in this industry and embarked on an ambitious plan to successfully combine a group of 5 small islands at the south-western part of the country through land fills in order to form a big island which serves as petrochemical hub. The government also used aggressive marketing and incentives to attract large multi-national petroleum companies to set up their petroleum chemical refining activities.
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For strategic reason, most of the multi-national petroleum companies have chosen to focus on their core competency in oil refining and polymer manufacturing, thus leaving the less important activities such as the packaging and logistics functions to third party specialist services providers.
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Specialization required from Logistics Services Provider to Polymer Industry
To gain a better understanding of the activities of a Logistics Services provider, here are some typical examples of services it offers: ? ? ? ? ? ? Packaging of finished products Technical services related to packaging and logistics equipments belonging to customers Physical management of inventory in warehouses and computerized inventory management system Pre-delivery preparation of cargo, loading and land transportation Vessel/air freight arrangement Processing of sales documentations for fund collections
Some characteristics of the services provided by a logistics services provider to the polymer industry are: ? A major proportion of service providers’ business is likely to be derived from a couple of large customers, as players in the polymer industry are large MNCs. ? Services providers usually obtain businesses on contractual terms which are subject to renewals every few years. Therefore it is vital that a service provider should maintain high customers’ satisfaction. ? Revenue growth of a service provider is closely linked to the manufacturing capacities of its customers. Hence there is a need for extension of service contracts, failing which the going concern will be in doubt. ? Profitability of a service provider is highly dependent on the competencies, processes and productivity of its labour force. ? Logistics services are often integrated with the sales functions of customers. Specialized skill is required and processes often have to be tailored to suit the marketing requirements of customers. ? In most cases there are specific key performance indexes specified in the contract of services. The focus of performance measurement would be on customers’
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perspectives and their concerns on time, quality, performance and service, and cost. ? Customers have certain degree of intimate knowledge of performance of logistics providers.
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Literature Reviews
My literature reviews will cover: ? Traditional Financial Performance Measurement ? Non-financial factors such as customer acceptance, productivity, efficiency The literature review undertaken here will look into the arguments put forward by proponents of both forms of performance measurements.
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Literature review of Traditional Financial Performance Measurement: ? I will first look into the traditional financial measurement normally used by a company. The owners or shareholders of a business organization are likely to use the financial data from its Profit and Loss Account and Balance Sheet to measure performance of its management. Simon (1999) looked into a number of company performance measures based upon accounting information easily available from the Financial Statements of a company. Some of the measures mentioned by him and popularly adopted by companies using internal accounting based models are : a.) Profit After Tax – This is the measurement companies have been looking at for decades. But the suitability of using just profit after tax as performance measurement has been questioned. Analysts do use company profit to compute earning per share. Brown pointed out that profit is often a better predictor of a company’s future performance as closing stock is available for future sales and depreciation instead of full assets cost is deducted from revenue. However it is common knowledge that profit is also easily manipulated to meet the desired performance level of management. With the various methods available to apply the accounting standards, profits in different periods may be adjusted in order to show different performance levels. Also, there are numerous creative accounting methods
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adopted by many company directors and managers to distort the performance of companies. b.) Net Assets Value – It is computed using data from the balance sheet and Simon stated that it appears to some investor as to be designed to measure the value of a company. Also it is audited and has been generally regarded as containing reliable information. But he noted that the Balance Sheet does contain a number of problems which makes performance measurement difficult. These are due to the fact that most companies have prepared their balance sheets on a historical cost basis with a limited degree of capturing the current value of its assets or liabilities. Problems cited in his article include: ? Some key assets such as a well-trained and highly motivated work force are omitted. His view seems to imply that a productive work force would lead to better performance. But the accounting of the exact value of work force is likely to be a contested item in performance measurement. ? Assets are often recorded at historical value. But the introduction of current value would likely result in the manipulation of assets value in the hands of managements who aim to inflate their performance standard. ? Problem of manipulation of assets and liabilities. These would include the depreciation and amortization of assets, omissions or inclusion of certain types of intangible assets and contingent liabilities, off balance sheets transactions, etc. Performance measurement purely on assets valuation would likely tempt the management to adopt certain favourable accounting practices in order to inflate the value of the company. c.) Cash Flow Measures – uses a company’s Cash Flow Statement to see how much cash it has generated from its operations. Also connected to this 10
measurement is the “free cash flow”(FCF) which is derived by subtracting capital expenditure from operational cash flow. This measure is considered a useful measurement of a company’s present value when forecast of FCF is made over the foreseeable planning horizon. As most financial persons are aware, an appropriate discount rate has to be chosen in the present value computation. Academia has devoted a lot of time in discussing how to arrive at the required rate of return for equity shareholders and the weighted average cost of capital (WACC) as the discount rate for the valuation. In spite of the above difficulty in getting the right discount rate, Simon has considered cash flow a useful measure of company performance due to: ? Cash flow has been considered to be less easily manipulated than profit. However, cash flow may be subject to manipulation through delaying ? and advancing of payments or receipt to/from creditors/debtors. Cash flow is considered a more sensitive measure of liquidity problems because a company in financial difficulties normally moves into a cash flow deficit first before encountering profit decline. d.) Residual Income – This measurement is arrived at by using the operating profit and makes a deduction for the cost of using the capital employed. The cost of capital employed would be the WACC and thus would face the same problem discussed in cash flow measure. The logic behind the deduction of capital cost is that profit would not have been earned without capital. The management should rightfully be measured on the residual profit from the operations. The problems with this method of measurement are similar to those discussed in the profit after tax measurement such as distortion created by creative accounting, difference in accounting methods used, historical convention that understates profit. e.) Economic Value Added® - A trade mark of Stern Stuart, Simon referred to it as a sophisticated version of residual income as it refines the operating profit and capital employed figures with over a hundred adjustments to 11
profit and capital employed. However, even with the comprehensive lists of adjustments to derive the value supposedly generated by a company, this measure is still subject to arbitrary adoption of many accounting methods available. Also, the implementation of this measurement has been considered costly and thus restricted to a limited number of large organizations.
Other measures considered by Simon include Accounting Rate of Return obtained by dividing operating profit by capital employed, Shareholder Value Added which uses present value principles to derive a value for company shares. Another form of measurement discussed by Simon is the Price Earning Ratio. He considered it as a mix of market based model and internal accounting based model as it is simply the company’s share price divided by its earning per share derived from its financial statement. It is favored by analysts worldwide as it encapsulates current thinking about the company performance and its worth.
? In his article, Brown (1998) cited the agency theory which considers the relationship between a principal and an agent as an example of accountability for the management (agent) of an organization. Brown mentioned that the problem in agency theory is how the agent can be motivated and monitored. In financial aspect, the motivation may be by monetary reward and the monitoring may be through submission of income and expenditure reports. Brown went on to discuss the role played by the accountancy profession in the development of regimes of accountability. The control system involves using quantitative and qualitative methods and principles such as budgeting and standard costing and variance analysis. Other management control tools have also included activity based costing (ABC) and total quality management. He thought that there are 2 aspects of accounting and accountability perspective as the basis of management
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control: Hard accountability via financial and qualitative results, and Soft accountability derived from human input. Hard accountability will require: 1.) Counting – converting activities and outcomes into numbers 2.) Accounted for – reporting on activities and outcomes and providing a discussion of how and why they occurred. 3.) Held accountable for – group or team responsible for accounting and the events and circumstances leading to the records. Soft accountability looks into: 1.) The construction of the accountable person and aims at selfaccountability. Brown pointed out that the accountability is likely to be affected by the financial and non-financial rewards. 2.) Focus on transferable skills through comprehensive training and development programme. He also mentioned that traditionally, organization have focused on a range of financial measures such as capital structure, market ratios, liquidity and overall ROI. There are also analysis of costs and profit by product, cost centre and geographical area. These measures may be argued as being unduly inward looking, with major focus on monetary targets and with detailed focus on an analysis of deviations from the planned or targeted figures. Brown went on to examine the alternative views of performance measurement and proposed that there should be different measures for business units with a focus on profitability and for those with a focus on growth and market position.
? Finally I will review the financial measurement mentioned in Horngren’s book, with special focus on his budgetary approach to performance measurement. Horngren (2005) considers the roles of budgets as a major feature of management control systems. He believes budgets can be used as tools to compel strategic 13
planning, provide performance criteria, promote communication within organizations and affect motivational and wider organizational processes. To be useful, budgets must be done as an integral part of an organization’s strategic analysis. Strategic analysis would generally require both long-run and short-run planning. The planning in turn calls for the formulation of budgets which would cover long-run and short-run budgets. Horngren points out that budgets can act as a framework for judging performance. He reasons it by listing two key limitations of using past performance as a basis for judging actual results which budgets are able to overcome. One limitation is that past results may incorporate past substandard performance or the output of a different workforce. Using past results as benchmarks for current workforce would set the performance bar too low. A second limitation of using past performance to compare current actual performance may not fully reflect the different market conditions existing in two periods. Market conditions may have improved since the previous year, thus performance standard would need to reflect the general market predictions. With budgets that incorporate the likely outcomes in future, the performance bar can be set at an appropriate level.
3.2
Literature review of Non-financial factors
I will carry out in depth literature review of alternative views of performance measurement proposed in the Performance Pyramid by Lynch and Cross (1991), in the Balanced Scorecard by Kaplan and Norton (1992), and in the Performance Prism by Neely (2002): 3.2.1 The Performance Pyramid by Lynch and Cross (1991)
The performance pyramid was put forward by Lynch and Cross (1991) as a measurement suitable for a company with business operating systems. They proposed that a company should first form its corporate vision which encompasses both the market and financial aspects. The corporate vision would then steer the company towards formulating its objectives. The objectives are further guided by driving forces from customer satisfaction,
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flexibility and productivity in its core business processes. These forces are further driven by various focuses to be made by groups and work teams within departments in the 4 indicators quality, delivery, cycle time and waste. These indicators should be monitored and the performance of each department group measured on a continuous basis. The performance pyramid also segregates the above mentioned driving forces and indicators into those that focus on the external effectiveness and those that focus on internal efficiency. Figure 1 below provides a mapping and relationship of the various elements covered in the performance pyramid.
Figure 1 : The Performance Pyramid of Lynch and Cross (1991)
Corporate Vision Objectives Business Market Financial Measures
Customer Satisfaction
Flexibility
Productivity
Business Operating Systems
Quality
Delivery
Cycle time
Waste
Departments and work centres
Operations
External effectiveness (Unshaded areas)
Internal efficiency (Shaded areas)
Source: Lynch and Cross, 1991
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According to Johnson, corporate vision is articulated by those responsible for the strategic direction of the organization. The corporate vision leads to a range of objectives which strives for both external effectiveness and internal efficiency. He mentioned that the objectives can be achieved through measures at various levels as shown in the pyramid and the measures would need to interact with each other horizontally and vertically. Lynch and Cross used the term “getting it done in the middle” to refer the need of an organization to focus its business operating systems on customer satisfaction, flexibility and productivity. Such focus would involve crossing departmental and functional boundaries. As an example, if a logistics services provider wishes to achieve an objective of marketing a new method of moving products in bulk at the least cost, there should be close interaction between its products handling, warehousing and marketing departments. Performance focus will be on: ? ? ? all departments to focus on ensuring customer satisfaction products handling department and warehousing department to focus on flexibility in works method or customer requirements all operations departments will need to focus on productivity, such as the most cost effective and the efficient ways to fulfill the customer requirements To measure how well a company’s business operating system has attained the objectives stated in the middle level of the pyramid, Lynch and Cross listed 4 non-financial indicators at the bottom level of the pyramid which they refer to as “measuring in the trenches”. These indicators monitor the quality, delivery, cycle time and waste as the operations are being carried out by businesses. For a logistics services provider, customer satisfaction can be met with services which produce minimal errors from high quality works and shorter delivery time to customers’ buyers. Internally, improved cycle time would result in higher productivity from the work force and also better facility utilization. Reduction in waste such as less time spent on product handling would also improve labour productivity which leads to financial gains ultimately. The Performance pyramid sets out the principle on the need to look into financial and nonfinancial indicators of performance measurement. But it does not provide a more detailed 16
suggestion on what should be done by businesses in order to realize its vision. Also, other factors affecting performance need to be included as indicators, such as staff development, resource utilization, suitable facilities, etc.
3.2.2
The Balanced Scorecard by Kaplan and Norton (1992)
The Balanced Scorecard was developed by Kaplan and Norton. In their document The Balanced Scorecard: Measures That Drive Performance (1992), they mentioned that many managers and academics have focused on making financial measures more relevant while others have advocated focusing on improving operational measures. But they have found that senior executives do not rely on one set of measures to the exclusion of the other. Instead they believe that managers want a balanced presentation of both financial and operational measures. Based on their research project with 12 companies at the leading edge of performance measurement, they devised a “balanced scorecard” which they believe would give executives a fast but comprehensive view of the business. The main focus of the balanced scorecard developed by Kaplan and Norton is an attempt to measure performances which are grouped into financial and operational measures. They tabulated those performance measures into four groups which they termed as “perspectives”. Their reason for limiting the number of measures is to minimize information overload on senior managers and that the scorecard would force managers to focus on those measures which they think are most critical. Figure 2 on the next page shows the balanced scorecard’s 4 perspectives and the links between them.
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Figure 2 : The Balanced Scorecard
How do we look to shareholders? Financial Perspective GOALS MEASURES
How do customers see us? Customer Perspective GOALS MEASURES
What must we excel at? Internal Business Perspective GOALS MEASURES
Can we continue to improve and create value? Innovation and Learning Perspective GOALS MEASURES
Source : Kaplan and Norton, 1992
Financial Perspective The performance measures based on financial information is termed financial perspective in the balanced scorecard. Kaplan and Norton considered financial measure a must have because they believe it indicates whether the company’s strategy implementation and execution are contributing to bottom-line improvement and it shows whether the financial goals of profitability, growth and shareholder value have been achieved. They pointed out that many have criticized the inadequacy of financial measures due to the backward-looking focus used in the traditional
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financial accounting. While other critics think that even if various more forwardlooking financial analysis which uses forecasted future cash flow and discounting were adopted, the performance measures solely based on financial information are considered inadequate due to the exclusion of the activities and processes that drive cash flow. Also, some critics argue that traditional financial measures do not improve customer satisfaction, quality cycle time, and employee motivation and instead, they view the financial performance as the automatic end result of good operational actions. To support their assertions that financial measures are necessary and rightfully should be included in the balanced scorecard, Kaplan and Norton have quoted the following 2 reasons: ? ? A well-designed financial control system can actually enhance rather than inhibit an organization’s total quality management program. The alleged linkage between improved operational performance and financial success is questionable and uncertain. Periodic financial statements remind executives that improved operational performance need to be translated into improved financial performance or else executives should reexamine the basic assumptions of their strategy and mission.
The rest of the measures specified by Kaplan and Norton as the important components of the balanced scorecard concerns the operational performance in customer perspective, internal business perspective and innovation and learning perspective. They consider these operational measures to be the drivers of future financial performance. Customer Perspective The balanced scorecard takes into account the observation that many companies have made it a priority to focus on the customer in order to ensure growth and improve market share. The inclusion of this measure attempts to show how the company is performing from its customers’ perspective. The balanced scorecard thus demands
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that managers translate the general mission statement on customer service into specific measures that reflect the factors that really matter to customers. Kaplan and Norton think customers’ concerns can be grouped into four categories: ? ? ? ? Time Quality Performance and service Cost
They proposed that the above concerns of the customers should be incorporated in designing a balanced scorecard. Lead time enables a company to measure the time required for the company to meet its customers’ needs. It is essential for a company to focus on the lead time for both existing and new products. Quality measurement compels a company to track the defect level of its products received by customers. The measure of performance and service aims to let the company know how its products or services contribute to creating value for its customers. The last measure of customers’ perspective is on the cost of products or services incurred by them. The cost to be measured should include not only the products’ selling price but also other supplier-driven costs such as ordering, delivering, receiving, handling, storing, obsolescence, schedule disruptions from incorrect deliveries, etc. These are costs which would affect the competitiveness of the customers as a result of being at the receiving end of a poor level of performance of the company.
Internal Business Perspective In this perspective, Kaplan and Norton called for companies to decide what processes and competencies they must excel at and to specify measures for each. In their opinion, to meet customers’ expectation and to produce excellent customer performance as explained in the previous section, managers should focus on critical internal operations that enable the company to satisfy customers’ needs. In this respect, the measures to be included in the balanced scorecard have to cover business
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processes that have the greatest impact on customer satisfaction. They have identified cycle time, quality, employee skills and productivity as the internal business processes affecting customers’ expectation. Another internal business perspective that they recommended to identify and measure is the company’s core competencies which is critical to the company in maintaining market leadership. In order to have an effective measurement of internal business, Kaplan and Norton suggested that managers devise measures on the processes that are influenced by employees’ actions. This requires the managers to breakdown the overall measures on internal business into sub-measurement relating to cycle time, quality and productivity and to use these measures for the employees at local levels so that they have clear targets for actions. Innovation and Learning Perspective This perspective focuses on the measurement of how well the companies have made continual improvements to their existing products, processes and the ability to introduce new products with expanded capabilities. The inclusion of this perspective in the balanced scorecard is to enable companies to look into their strategies to create long term growth. In the present competitive markets, companies which are able to launch new products and create more value for customers would be able to penetrate new markets and thus result in increased revenue and margins. In their paper, Kaplan and Norton quoted a few measures of innovation found in a number of companies. One of them is the innovation measure which focuses on the ability to develop and introduce standard products rapidly. Another is the manufacturing improvement measure that focuses on the stability in the manufacturing of new products. Other types of measurement are measures on the specific improvement goals of existing processes such as the requirement to improve process performance continuously or the specific time period in which the managers are required to make improvements.
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Based on their experience in the implementation of the balanced scorecard, Kaplan and Norton mentioned that the scorecard has brought about a fundamental change in the underlying assumptions about performance measurement by most companies. They observed that usually the financial experts are the ones who have designed and overseen most nonscorecard based performance measurement systems whereas there is no heavy involvement by senior managers who have the full picture of the company’s vision and priorities. But with the inclusion of the 3 non-financial perspectives in the balanced scorecard, there becomes a need for the involvement of non financial senior managers. Also, Kaplan and Norton think that traditional measurement systems have sprung from the finance function and sought to control behaviour. This is because these systems specify the particular actions the employees need to take and then be measured to see if those actions have been taken. In contrast, their ideal implementation of a balanced scorecard system of measurement is for companies to establish goals but let the employees themselves adopt whatever behaviours and take whatever actions necessary to arrive at those goals. In this way the scorecard puts strategy and vision, instead of control, at the center. Through the balanced scorecard, the authors believed that the managers in companies would understand the interrelationships between financial, customer, internal process and innovation and learning perspectives. They said this approach is consistent with what many companies have been seeking: cross-functional integration, customer-supplier partnerships, continuous improvement and team accountability.
3.2.3
The Performance Prism by Neely (2002)
Neely and Adams in their article on the Performance Prism started by arguing that the various performance measurement frameworks and methodologies developed by the various proponents so far only highlight the differences in performance perspectives among each other. They argued that The Balance Scorecard, even with its 4 perspectives, has not covered the importance of other stakeholders such as customers and employees. They viewed all forms of performance measurements proposed by various other parties as being only capable of providing their own set of unique perspective on performance which in turn causes managers to adopt performance measurements with different sets of lenses. This results in 22
difficulties in comparisons of performances across different divisions within the same organizations, or across different organizations within the same industries. The authors of the Performance Prism argued that business performance is itself a multifaceted concept and so far they have not come across a single best way that is able to provide a comprehensive view of business performance. They believe that a suitable performance measurement demanded by most people would be a new multi-faceted yet highly adaptable framework. Therefore their solution is a three dimensional model which they call the Performance Prism. This model has 5 facets arranged in a prism form – Stakeholders Satisfaction, Stakeholder Contribution. Strategies, Process and Capabilities as shown in the diagram below: Figure 3 : The Performance Prism
Process
Stakeholder Satisfaction
Strategies
Capabilities
Stakeholder Contribution
Source : Neely and Adams, 2002
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Neely and Adams think one of the great fallacies of performance measurement developed by others is that measures should be derived from strategy. They think that performance measures are designed to help people track whether they are moving in their intended direction. Whereas strategy is about the route they choose to reach the desired destination. They think that modern day organizations have strategies that are dominated by a list of improvement activities and management initiatives. These organizations normally believe that the initiatives and activities will enable them to better deliver value to their multiple stakeholders – investors, customers, employees, suppliers, regulators and communities. Therefore, the Performance Prism has included the stakeholder perspective as the first and fundamental perspective on performance. The various perspectives advocated in the Performance Prism are described below: Stakeholder Satisfaction Perspective The authors shared the same argument as in the Balance Scorecard by putting shareholders as the most important stakeholders. They also agreed with the proposal in the Balance Scorecard that customers and employees are important stakeholders. They brought in suppliers as an essential stakeholder for manufacturing and service business. They pointed out that as companies have recently outsourced an increasing amount of non-core activity, they become more dependent upon their suppliers. Also companies will have to pay close attention to the requirements of regulators and communities, especially the organizations engaged in activities that have an impact on the environment, food, healthcare, etc. Therefore the Performance Prism calls for performance measures to be established to measure the stakeholder satisfaction. The managers must, through the performance measurement system, ascertain who the most influential stakeholders are, and what they want and need. Strategies Perspective Neely and Adams noted that organizations must first address stakeholders satisfaction before they are able to turn to this second perspective on performance. The key question for the managers is what strategies to adopt to ensure that
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stakeholders are satisfied. The authors think that most organizations will devise strategies to try to improve their performance. But there is a need to develop a measure that will track whether strategy is being implemented. The right measures will also offer a means of communicating strategy and encouraging implementation. They think the measurement of strategies previously taken by managers can enhance the making of judgements and decisions. Process Perspective The next performance measurement covers the organization’s processes. Neely and Adams think the reason for strategic failure is partly due to misalignment of processes with an organization’s strategies. The measurement in this respect allows managers to track whether the right processes are in place, to communicate which processes matter and serves to encourage maintaining and nurturing of the right processes. With the measuring of processes, it is hoped that owners of the processes can be identified, who in turn need to make judgements after the data is analyzed. Capabilities Perspective The argument for capabilities is that processes cannot function on their own but require people with certain skills. The organization also needs to have policies and procedures on the ways things are done, physical infrastructure and technology to enable the processes to be carried out. Therefore the capabilities perspective calls for measurements to be made on whether the organization’s people, practices, technology and infrastructure are in place to create value for its stakeholders. Stakeholder Contribution Perspective This perspective looks into what contributions a company needs from its stakeholders if it is to maintain and develop its capabilities. This perspective is the opposite of stakeholder satisfaction. Contribution from stakeholders includes feedback on services received by them, their continued loyalty and information on customer profitability. The author mentioned that in the olden days, most companies used customers’ complaints data as a form of contribution from customers to help in
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improving their capabilities. In recent times, this is considered not a good contribution as many unhappy customers never complain but just moved elsewhere. Realising this, many companies started to reach out to their customers by including survey forms and feedback requests after services had been provided. The contribution arising from the act of loyalty by customers provides a strong indication of the right strategy and processes adopted by a company. This in turn enables the company to maintain its business strategy. On customer profitability, the author thinks that profitability data of customer helps a supplier company to better understand its customers. These profitability performance data are an indication to suppliers as to whether they need to improve/reduce their prices in order to provide customers with cheaper products or services, so that customers in turn can improve their bottom lines.
The Performance Prism seems to be the duplicate image of the Balanced Scorecard in that its 5 perspectives overlap the 4 perspectives in the scorecard. The prism expanded the measurement coverage to include some of the stakeholders not mentioned in the scorecard as well as including the contribution measurement of stakeholders. The idea in the performance Prism was developed much later than the scorecard. The influence of suppliers and regulators during the development period of the scorecard may not as strong as at the present time. Thus the inclusion of suppliers and regulators as stakeholders can be seen as the authors’ attempt to reflect the changing business environment that current day organizations are facing. The outsourcing of services to suppliers and the concerns of the communities and regulators play an important part in the growth and survival of many companies. However, the Performance Prism lacks a proper framework for users to adopt their various perspectives in the real word situation. It covers a broad general area of concern but without further elaboration on how and what should be the critical issues of performance that an organization should concentrate on. Companies intending to adopt the Performance Prism should therefore follow the argument in the scorecard in which companies are advised to restrict the measurement to a few critical areas.
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Suggested performance measurement covering the financial & non-financial aspects
After reviewing several models of performance measurement, it is apparent that a logistics services provider will need to develop a performance measurement system which encompasses both financial information and those of other achievements not reflected in its annual financial statements. It is also important for the management of a logistics services provider to decide on the areas of performance that best meet its strategy. Most of the practitioner and academia of performance measurement share the opinion that the management of an organization should ensure that performance measures target areas within the business where success is a critical factor. They are advocating that the management should focus on a selected few measures that are most critical to the organization. Following the argument put forward by Johnson, the performance measures chosen by a logistics services provider should be able to provide insight to: ? the effectiveness of all internal processes, especially those that affect services that reach the customer ? the efficiency in which the company utilizes its resources ? enable the company to focus on both the long-term and short-term goals ? enable the company to be flexible and adaptable to changing business environment In this respect the balanced scorecard seems to be a suitable model for a logistics services provider to adopt in developing its performance measurement. The scorecard provides a framework which management can utilize to develop a multi-dimensional set of performance measures to enable it to measure its own achievements as well as the performance of its various divisions and personnel responsible for the daily works of the divisions. The incorporation of financial information helps to indicate how well the management of the company has met the accountability function called for by the agency theory. More specifically, it is always the demand of shareholders as principals to expect the management as agent, to ensure that the investment and resources committed to the business have generated the required rate of return.
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Other than the financial perspective measurement, the scorecard inclusion of non-financial measures enables the company to see how the critical factors that contribute to increasing shareholder value have been handled by its employees. In additional to the four perspectives introduced by the balanced scorecard, the measurement for a logistics services provider should be expanded to include suppliers’ perspective. For a services provider intending to expand its business worldwide, there is high possibility that it has to rely on a few major local suppliers to complement its own services. Such services are likely to require local specializations or where disproportionate resources are need for a logistics provider to set up on its own. Examples of such suppliers include local trucking company, port authority, local utilities suppliers and others.
4.1
Developing a Performance Strategy Map:
According to Kaplan and Norton, the suggested approach to start a balanced scorecard based performance measure is for a company to develop a strategy map. This strategy map serves as a communication to employees on what the strategy of the company is. It provides a visual representation of a company’s critical objectives and the crucial relationships among them that drive the organizational performance. As the map also links the critical factors that employees need to overcome in order to achieve the four perspectives in the balanced scorecard, the employees would certainly strive to work in a coordinated and collaborative manner. To develop a strategy map, a logistics services provider should start from top down with the determination of the destination and then charting the route that will lead there. The following steps are suggested: 1st Step : Its corporate executives should review the mission statement and the core value. The executives include the chief executive officer, operations and financial senior managers directly accountable for the performance of the perspectives. The mission statement and core value provide the reasons for the existence of the company and what the company believes in.
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2nd Step : The directors and managers start to develop a strategic vision based on the information above. The strategic vision enables the company to know what they want to become as they proceed with their business operations. 3rd Step : Create the goals for the company to achieve. 4th Step : Define the logic of how to arrive at the destination – the goals developed from step 3.
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Table 4 : The proposed Scorecard Strategy Map for a Logistics Services Provider
Increase Return on Capital Employee & Shareholder Value
Revenue Growth Strategy
Understand industry & customers needs and differentiate accordingly
Financial Perspective
Productivity Growth Strategy
Maximize output from resources; adopt latest innovation in logistics methods
Introduce new services, expand service types
Sell higher margin services
Improve on labour / machine output
Seek innovation in service delivery methods
Customer Perspective
Strategy adopted: Product Leadership
Service Attributes
Delivery Time Quality Safety first Quick response
Relationship Share philosophy – Safety Helpful staff
Image Trusted service, Best in class
Collaboration Help customer to improve Share resource & best practice
Company excel at creating unique service
Internal Process Perspective
Create efficient new services, reduce new service introduction time
Improve inventory management, deliver services on spec & on time
Improve hardware and operating method to reduce downtime & OT
Improve environmental health & safety
Learning and Growth Perspective
Employees improve their service skill & develop leadership skill
Strive for innovation and adopting new technology
Create opportunities for staff advancement
differentiator General requirement
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In the proposed strategy map in the previous page, a logistics services provider has set out its corporate mission to increase the shareholder value. It can use two approaches to attain its financial strategy: revenue growth and productivity growth. In revenue growth strategy, it needs to introduce new services to widen its revenue base; and concentrate on services that provide higher margin. With productivity growth strategy, the company has to improve the output from machineries and labour force; and introduce innovative service methods which increase output per unit of resource. With these growth strategies linked to the financial perspective laid out at the top of the map, the operational divisions within the company are now provided with clear operational targets as they set out to carry out their responsibilities. After the strategies for financial perspective have been selected by the management, the next attention will be on the customer perspective. This requires the company to decide what customer value proposition its wishes to pursue in order to satisfy its customers. Value proposition describes the service mix and service attributes, customer relations, and corporate image that a company wants to offer to its customers. There are three types of value proposition available for adoption by a company to differentiate its services from competition: operational excellence, customer intimacy and product leadership. The main value proposition to be adopted by a logistics services provider who only services multinational petrochemical companies is likely to be one on product leadership, while maintaining adequate standards in the other two. By adopting a product leadership value proposition strategy, the company must concentrate on the functionality, quality, and overall performance standard of its services. In the above proposed strategy map, the company seeks to differentiate its service attributes with improved service delivery time and quality. It needs to create an image of a trusted service provider with the best of class services. Another important differentiation is the collaboration efforts with customers the company has actively undertaken to create value for its customers. The next step in the design of a strategy map is to determine the means by which the company will achieve the differentiated value proposition to its customers and its growth
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strategy that leads to its financial objectives. In this respect, the company has to focus on its internal process perspective. For a logistics services provider, the ability to create service methods that are effective and efficient will help in its pursuit on being a product leader. To meet this target, the company will need to improve its processes in inventory management and products handling. These are measures that focus on the innovation and operational aspect of internal processes, considered a better strategy than one that focuses on processes that reduce costs of the company. By undertaking processes that focus only on cost reduction, the company may end up not building adequate facilities to take on new businesses. To final section of a strategy map is the establishment of strategy to improve the learning and growth of a company’s workforce. In this perspective, the company has to make efforts to upgrade the core competencies and skills of its workforce, the development of technical knowledge within the organization, and to establish the right corporate culture. This calls for improvement in the company’s human resources functions such as the provision of adequate training and clear career path. Senior managers should be exposed to different activities within the company in order to gain a working knowledge of the whole service chain. Steps should also be taken to let its senior managers have a broader understanding of its business and operational environment .
4.2
Developing a Scorecard Based Performance Measurement
A logistics services provider should not just apply an all encompassing balanced scorecard based performance measures to every level of it employees. To do so will cause a misalignment of the goals or targets to the responsibilities of employees. This occurs because employees will be assigned with responsibilities of different magnitudes and not all employees are tasked to perform similar duties but rather they are placed in the various divisions within the company based on their level of expertise. To apply the various measurement categories of a balanced scorecard, the company should segregate its personnel who are involved in making management decisions which have an impact on the company’s strategy from those who merely take instructions and perform the daily tasks assigned to them. The organizational structure of a
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logistics services provider would usual consist of 3 levels: Management level, Middle Managers level and Line Operators. The reasons for such segregation are: o The Management – The management headed by a Chief Executive Officer or a Board of Directors, is normally entrusted to set the strategy of a company and is in a position to manage the direction of a company. The CEO and directors, collectively termed as management, should therefore be held accountable for the overall growth of the business and the shareholders value generated. They are in a position to influence the actions of all those individuals who undertake the operations where the results are measured by the different perspectives in the scorecard. Therefore the performance measures applicable to the management should encompass a broad based measure which covers all the four perspectives in the balanced scorecard. o Managers in charge of divisions – Due to the segregated nature of logistics services, a number of managers are usually engaged to take charge of different operational divisions within the services chain. They are tasked to manage a specific group of employees assigned to carry out specialized tasks within their divisions. The managers play an important supporting role to the CEO but they should be fairly measured based only on their performance in managing their divisions. Another argument for only measuring manager on selective measures is that managers are usually not in a position to set the service rates or the service scopes of a contract. What has been described in Section D shows there is a need to have a robust costing system for a services provider to price its service rates and service scopes. Managers might be at the receiving end of a bad business venture which was the result of an overly ambitious contract-wining attempt executed by the management or commercial director. An ideal costing system should have a register to record the reasons for the submission of aggressive service rates, as a result of which the company or the managers manning its divisions might have to work within tight business targets or criteria. Therefore the performance measures system for these managers should take into account
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such factors outside their control, and to restrict the measures to the relevant perspectives in the balanced scorecard. o Individual operators who execute the operations – They are tasked with executing the instructions from their divisional managers. Their performance is confined to the handling of the ground works of the business. It is unlikely that they will have influence on the capital or infrastructures deployed in the business. Instead they are likely to work within the resources provided by the company. In term of the financial impact of the company, their performance would only form a small integral part of the company’s full year financial results. Thus it is inappropriate that they are measured on the financial perspective of the balanced scorecard. It is in the area of customer satisfaction that individual employees are likely to have a significant role to play. For a services provider, the performance of its front line employees would be instantly assessed by its customers and very often the continuity of a service contract has been terminated because of poor service standards received by the customers. For strategic reasons, measures developed for individual employees should aim to encourage the improvement of service level, and should be at an attainable level and clearly related to their work scopes. Also, the measurement system applied to a line worker should be simple and easily understood. Therefore a simplified balanced scorecard is an appropriate tool to achieve the measurement of such workers’ performance.
4.2.1
Proposed Scorecard for the Management
The following table lists the suggested goals and measures considered appropriate for performance measurement of the management team of a logistics services provider. The management of a logistics services provider is the prime mover of the growth of the company. Their performance is therefore linked to that of the company. Thus the reasons to include the various goals and measures in the table are explained in greater detail in the paragraphs after the table.
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Proposed Scorecard for the Management A. Customer Perspective Goals: Measures: ? Preferred suppliers Ö Meeting KPI specified in contract Ö Adoption of suggested services ? Service Ö Adoption of company’s entrenchment proprietary systems & solutions ? Responsive supply Ö Meeting on-time delivery Ö Lead time on services ? Shared philosophy Ö Ability to implement the work philosophy of customers ? Partnerships Ö Number of cooperative efforts B. Internal Business Perspective Goals: Measures: ? Service Ö Logistics service efficiency Productivity Ö Handling of down time & overtime ? Service Excellence Ö Response time Ö Unit service cost Ö Yield from optimum resource ? New service Ö Success rate in new service introduction introduction Ö Actual introduction schedule versus plan C. Innovation and Learning Perspective Goals: Measures: ? Service skill Ö Time to develop new staff Ö Increase in level of skill of existing staffs ? Service innovation Ö Degree of innovation in services ? Uniqueness of Ö Development of alternative services services D. Supplier Perspective Goals: Measures: ? Service Quality Ö Error rate vs volume handled Ö Downtime of operations due to suppliers ? ? ? Service lead time Innovation and change Degree of cooperations
Quarterly Scores Target Actual
Quarterly Scores Target Actual
Quarterly Scores Target Actual
Quarterly Scores Target Actual
Ö Time to respond to requirement Ö On-time delivery Ö Time taken to change internal process to meet new requirements Ö Numbers of co-operation developed Table continues on next page
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E.
Financial Perspective Goals: ? Survival ? ? ? Growth Profitability Shareholder value
Measures: Ö Cash flow generated Ö Gearing level Ö Growth in revenue Ö Operating income Ö Gross Margin Ö Net profit from operations Ö Return on capital employed
Quarterly Scores Target Actual
Customer perspective should be regarded as the most important measure that a logistics services provider needs to focus on when it undertakes a contract with an international petrochemical manufacturer. In normal circumstances, the logistics services contract awarded by the customer will be on a single-source provider basis and the awarding of such a contract will be the result of a thorough selection process. It is always an achievement in itself to win a new contract or obtain an extension of the contract from a multinational petrochemical manufacturer. The customer value built up by a logistics company should therefore be maintained and enhanced as one of the core business strategies. This core strategy involves building up customer relations as the contract is being served out with the aim to differentiate itself from competitors in order to retain and deepen relationships. A services provider has the option of choosing 3 differentiators to meet the demands of customer perspective: operational excellence, customer intimacy and product leadership. Working with a multinational company, operational excellence is likely to be the best practice to adopt. The continuous excellent performance of a services provider in meeting the key performance indexes (KPI) set out in the contract would reflect the operational competency of the company. Therefore achieving KPI should remain the main ongoing focus of management and quantifiable measures should be taken to determine if the company has achieved the KPI. Another indicator of good customer relationship is the willingness to adopt suggested services. To be able to gain customer acceptance, a services provider will need to be the product leader. The next measure to determine how
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well the management has improved on customer’s acceptance is to assess how entrenched a customer’s operations is on the services provided by the logistics provider. The areas reflecting such entrenchment includes the adoption of unique information technology developed by the logistics provider, integration of the operations with the customer and execution of decisions such as the procurement of raw material. The meeting of on-time delivery and services deliverance lead time will be another form of operational excellence that will ensure the achievement of the measures under customer perspective. One of the features of services is the perishable nature of service where it is unlikely for a company to store the “services” to meet an increase in demand. Therefore the ability of a services provider in ramping up it resources to meet all on-time delivery becomes a crucial factor when its customers are operating in a seasonal business environment. Yet another measure used to determine customer perspective is the number or degree of cooperative efforts undertaken by a services provider. Internal business perspective requires a logistics services provider to find means to improve its supply chain management, the cost and quality of internal processes, assets and capacity management to achieve the level of performance required by its customers. The financial benefits from improved internal business processes would come in both short-term and long-term stages. Improved processes should immediately result in cost savings in the short term due to better operational efficiencies. In the intermediate term, the improved processes would lead to revenue growth due to customer’s trust. On a long term basis, it is normal to expect that increased innovation leads to sustained revenue growth and margin improvement. In the logistics services industry, service productivity is a crucial driver of profitability under the financial perspective performance. The service productivity performance of each operating division within the company shows how the planned manpower and infrastructure have been adequately deployed. Measures in productivity performance should not just quantify the volume output from manpower and equipment deployed but should also include how down time and overtime are being managed and controlled. Another measure of internal business processes at the management level covers service excellence in terms of response time by the company to provide services demanded by its customers and the yield from the resources used. To
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avoid stagnation in business growth which would certainly affect the financial perspective performance, management needs to explore and introduce new logistics services to stay ahead of competition. The directors and/or senior managers will need to acquire or develop new business processes and to sell the new services to its customers. The success rate of such new introduction and its comparison with the planned schedule is an appropriate measure in the internal business perspective. Innovation and Learning perspective measures how well the logistics services provider has improved the competency level and skills of its employees, the technology innovations and the corporate culture. These are factors needed to support the company’s strategy, the requirements from internal processes and high expectation of customers. The management of a company should take the lead in creating an innovation and learning environment within which the skills and experiences of its employees are developed, or are brought-in from external sources. Thus the first measure to be made on the management in this respect is the length of time invested by the company to develop new staff to the necessary skill level. The upgrading of the skill level of existing staff should also be the focus of management. To enable these measurements to be taken, the scorecard needs to have a standard length of time to develop new staff and the skill scores in various service skills of its existing staff. When measuring service innovations, the company should set the target for the number of innovative attempts required by the company and the percentage of successful and marketable innovations implemented during the measurement period. Obviously the high success rate reflects a corresponding improvement in the internal processes performance. Development of alternative services would be considered as an improvement when it leads to better processes, cost savings and customer satisfaction. Suppliers Perspective measurement allows a logistics services provider to develop a structured assessment of its business relationship with its suppliers. A sustainable and reliable third party services provider enables a logistics company to develop a longer business plan when it markets its services. The uppermost concern of the company is to ensure that its suppliers provide it with good quality service. Therefore measurement will
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be made on the error rate in relation to the volume handled by the suppliers. Downtime by suppliers will lead to idle time incurred in the logistics company’s internal processes and operations. This in turn leads to inefficiency and poor profitability. Another possible significant failure of services by a logistics services provider is linked to a let down in the on-time delivery by its suppliers. Measurement made on the on-time delivery from its suppliers helps a logistics services provider to make alternative arrangements to ensure that it meets its customers’ expectations. Equally important is the innovation and capability shown by the suppliers to assist the company in realizing its strategy. Sometime there is a requirement for the company to enter into a co-operation pact with its suppliers. However, a logistics services provider will need to watch closely the strategy and ambition of its suppliers to prevent them from becoming competitors. Financial Perspective measures the performance of management in achieving the financial goals of the company after having implemented the strategy covering the three measuring perspectives mentioned above. It is tempting for management to just use the high level financial indicators such as rate of returns and shareholder value as the measurement of their performance. Other lower level financial indicators should be included in the scorecard to enable them to investigate the contributing factors if they perform poorly in the high level financial indicators. Therefore the proposal is for the management to be measured on the cash flow generated and the gearing ratio. Cash flow provides the lifeline of a company. Hence it is fundamental that the business generates enough cash flow to meet its operational needs at all time. The cash flow to be measured should be that generated from the company’s ongoing operations as it reflects the health of the logistics business. Sufficient cash flow would ensure that manpower costs, suppliers’ services and infrastructure commitments are paid on time to avoid or reduce disruption in the company’s own service provisions. The gearing level is one of the indicators of the chances of survival of the company’s business in time of a poor economy or a temporary business downturn. The gearing measurement tracks the improvement by the management in repaying its debts as a result of improved business.
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For the measurement of sales growth, the monthly financial reports of a company would be the source of information. Indicators to be used are likely to be the revenue growth comparison between that of the current month and the previous month or that of the current year-to-date with the corresponding period in the previous year. The tracking of the historical revenue growth rate would also provide a good indicator of the effectiveness of the company’s strategies implemented in the past and those at present. Sales growth is an indication of the market share of the company. But the growth in operating income of a logistics services provider is in fact an indicator of the company’s financial performance. Operating income growth indicates the ability of the company in generating sales as well as the control of its costs. The improvement in cost control is likely due to the effective internal business processes implemented by the company and the innovation and improved technical or operational knowledge of its workforce. These factors are measured in the other perspectives of the scorecard. The measurement for profitability involves comparison of gross margin and net profit margin between different periods and by comparing the market margin. The profitability determines the rate of returns to the shareholders. The company might have achieved high growth in revenue but may produce poor profit as a result of the management’s aggressive pricing strategy to grow its business or capture market share. Therefore there is a need to measure the profitability growth to ensure that improvements in revenue actually result in a growth in profit. The profitability measures also give a clear indication of whether the considerable improvements in the company’s services capability have been translated into profitability. If the measurement in customer perspective and internal business processes perspective show that the management had made significant improvements but the financial perspective measurement had not improved, the management team should reexamine the basic assumptions of their strategy and mission. Finally for the financial perspective, management will be measured on the rate of return on the capital employed to show to the shareholders that they have produced a rate of
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return that exceeded the market rate of return. Therefore a suitable market rate of return for the logistics business in the place of operations would be determined as the benchmark for comparison. If the performance indicators in the rest of the perspectives show high achievement, there should be a corresponding high level of financial performance in terms of shareholder value created. If the good performance in the other perspectives does not translate to shareholder value gain, the balanced scorecard measurement system implemented by the company will be put in doubt. Having devised the measurement indicators in order to track the performance of management, it is important that actual readings be taken on a regular basis to ensure that problems in the business are addressed immediately. It is proposed that a logistics services provider should review the performance indicators shown in its performance scorecard on a quarterly basis during its financial year. This quarterly review enables all implemented processes, decisions or innovations to have sufficient length of time to influence the operations and business. Shorter review periods for the scorecard might cause the company to discontinue beneficial processes or decisions prematurely whereas a longer review interval might result in problem areas or damages to business not being rectified early enough.
4.2.2
Proposed Scorecard for Managers
The following table lists the suggested goals and measures considered appropriate for the performance measurement of managers who have responsibility for the daily running of the business divisions within the company. By measuring the performance of the managers of all the divisions within a company, the scorecard also provides information on how well the divisions have performed in achieving the company’s strategy. The scorecard for managers only covers those of the perspectives with their respective goals and measures. The reasons for managers to be measured by the listed perspectives are explained briefly in the subsequent paragraphs as a detailed explanation on the use of all perspectives has already been discussed in the measurements for the management.
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Proposed Scorecard for Middle Managers A. Customer Perspective Goals: Measures: ? Service quality Ö Meeting KPI on services performed by the division ? Responsive supply Ö Meeting on-time delivery Ö Lead time on services ? Partnership Ö Co-operative efforts initiated by initiative the division B. Internal Business Perspective Goals: Measures: ? Service Ö Service efficiency of the division Productivity Ö Percentage of down time & overtime ? Service Excellence Ö Divisional Unit service cost Ö Yield from the resources deployed ? New service Ö Service improvement initiative initiative Ö Success rate in new service introduction in the division C. Innovation and Learning Perspective Goals: Measures: ? Service skill Ö Time to develop new staff Ö Increase in level of skill of existing staff ? Service Ö Initiative on service innovation innovations Ö Realization rate of innovation D. Financial Perspective Goals: Measures: ? Growth Ö Growth in divisional revenue ? Cost control Ö Reduction of operating costs Ö Reduction of wastage & idle time ? Profitability Ö Divisional Gross Margin Ö Divisional Net profit ? Value added Ö Divisional Return on resources
Quarterly Scores Target Actual
Quarterly Scores Target Actual
Quarterly Scores Target Actual
Quarterly Scores Target Actual
This measurement caters to the middle level managers of a logistics services provider. Therefore it is sensible to fine tune the management’s scorecard in order to eliminate those performance indicators not within the control of these mid-level managers. A logistics services company would likely breakdown the whole spectrum of the logistics
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operations into workable divisions so as to achieve efficiency and greater service specialization. Individual managers will be appointed to oversee the divisions. The measurement concerning customer perspective remains important as many operational divisions will be in direct contact with the company’s customers. Therefore, meeting customers’ expectation is one of their important functions. Also, the contractual KPI in the service contracts would likely be operations specific. Such KPI were put in place to determine the quality and availability of services of the various components of the logistics operations. Therefore, meeting KPI, improving service quality and enhancing customers’ relationship become the main focus of measurement. To enable the operations division to meet the customer’s expectation, each division must first establish effective internal business processes. These processes would have been laid down before the start of the logistics contract. But as time progresses, they will be asked to improve on the efficiency of their operations in order to meet the financial targets or increasing customer expectations. Thus the measures on the division’s performance in internal business processes will include the yield factors, down time reduction, better new processes, etc. Without the innovation and learning efforts from the division managers, it is unlikely the customer’s expectations or the requirement to improve on internal processes can be met. Therefore, measurement would need to be made on the efforts taken by the managers on the training of its staff or acquisition of innovative ideas. With the efforts made by managers in the customer perspective, internal processes and innovative perspectives, the company should be able to expect healthy financial performance from the divisions. In the measures to be made on performance on financial perspective, the goals to be met would cover growth, cost controls, profitability and value added. Through the segregation of these financial information for each division, the management can easily focus on the divisions which have failed to contribute to the company’s financial targets.
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4.2.3
Proposed Scorecard for individual operators
In most cases, companies will use an annual appraisal system which is linked to their remuneration system to assess the operators’ performance. However, such a human resource focused appraisal system would likely consider only the attendance records, work performance, skills and experience, etc of the employees. The appraisal system does not clearly align the assessment of the performance of its operators with the company’s growth strategy and mission which focuses on customers, internal processes, learning & innovation and financial perspectives. The following table lists the suggested goals and measures considered appropriate to align the company’s strategy with the performance measures for operators. Proposed Scorecard for Individual Operators A. Customer Perspective Goals: Measures: ? Service quality Ö Meeting KPI on services performed Ö Error rates of individual worker ? Responsive supply Ö Meeting on-time delivery B. Internal Business Perspective Goals: Measures: ? Service Ö Service efficiency Productivity Ö Percentage of down time ? Service Excellence Ö Yield from the working hours C. Innovation and Learning Perspective Goals: Measures: ? Service skill Ö Increase in individual skill level ? Service Ö Identification of problems in innovations service D. Financial Perspective Goals: Measures: ? Growth Ö Increase revenue per headcount ? Cost control Ö Reduction of wastage in resources Ö Reduction of idle time
Quarterly Scores Target Actual
Quarterly Scores Target Actual
Quarterly Scores Target Actual
Quarterly Scores Target Actual
The above measures for individual workers concentrate on the contributions under the control of workers themselves. The KPI target for the division should be applied onto the workers as they are the ones who need to perform the services that should meet the KPI targets. The scorecard therefore acts as a clear notice to the individual workers of the 44
required customer services standard expected from them. In logistics services, customers are likely to lose confidence if there are repeated missed or wrong deliveries due to errors made by the company’s workers. The impact could include additional shipment costs to be borne by the logistics services provider or compensation in lost sales in a worse case scenario. Therefore measurement on the error rates of individual workers and the on-time delivery of the services performed by them allow the company to identify poor performers who had failed in meeting the company’s strategy on customer perspective. The other three perspectives included in the measures are aimed to encourage an increase in the productivity of individuals. Yields from the packaging plant may drop due to workers who intentionally slow down their work if there is no measurement on individual yields. Wastage of materials used in the logistics services may increase if workers are not measured on the costs related to their wasteful behavior. Equally important will be the upgrading of the skills level of individual workers. This is particularly important in the technical and maintenance divisions. Workers who have continuously upgraded their knowledge with the latest technologies will be able to make proposals for improved alternative services practices.
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5
Implementation of the Scorecard Performance Measures
In the literature review of the balanced scorecard of Kaplan and Norton in Section C above, I mentioned that they had observed that usually the financial experts are the ones who design and oversee most non-scorecard based performance measurement systems. Their opinion is that a company intending to implement a scorecard based measurement system should also include its senior operational managers who have the full picture of the company’s vision and priorities. Also the adoption of the above scorecard measures involves an overhaul of a company existing control system. Changing from a control system previously based on financial results to one that emphasizes both financial and non-financial issues requires a change of mindset and the company’s internal culture. To make a smooth switch, a logistics services provider might have to consider the following implementation issues: ? Ensure that the implementation process has been properly communicated within the company. The process should be started with the objectives being clearly laid down by the management and the linkage to the strategy of the company should be explained. ? The involvement of the decision makers in the company should be obtained right from the formation stage of the performance scorecard. It is important that the Chief Executive Officer has to be the first one to buy in to the idea of the change to the new performance system. Once the leader has made his/her intention clear within the company, it should be easier to obtain the participation of other division managers within the company. ? The company should not underestimate the time, effort and cost required to implement the scorecard measurement system. A scorecard based measurement system requires focus to be placed on both financial and non-financial factors affecting the company’s strategy. Therefore management will need to consider a suitable set of goals and their related measures that are acceptable. For example when considering the goals for customer perspective, a logistics services provider has to consolidate the KPI and the diverse expectation of all its customers in order to find 46
the appropriate measures concerning the customer perspective. Due to the different influence in the execution of operational decisions, suitable financial measures are to be considered before they are applied to the divisions or employees. There may be a need to consider obtaining external help in the event that there is a lack of internal experienced personnel who can implement the performance measurement system. ? The implementation of a scorecard based measurement requires the company as whole to take steps to improve on its level of performance toward external and internal parties. When one division has to depend on the services from another division, conflicts may occur. The company should set up a framework to resolve the conflicts arising as a result of the implementation of the scorecard. This framework should be equipped with a clear line of authority and steps which the affected employees can take to resolve the conflicts. ? The management should recognize that the scorecard measurement system is dynamic and will change over time to meet the change in the business strategy. For example an addition of a major customer may require a logistics services provider to rethink its measures to ensure that its employees keep up to the expectations of its new customer. In recent year, safety and environmental issues have become the main focus of many petrochemical producers. Therefore the goals and measures have to be adjusted in the customer perspective in the scorecard in order to reflect the concerns of the customers. In the financial perspective, the stage of the service life-cycle may require the company to adjust its financial goal. Apart from implementation issues, another area of likely concern to the managers of a logistics services provider is the financial results used in performance evaluation under the financial perspective. The ultimate aim of a scorecard is to measure whether the activities undertaken result in an increase in shareholder value of the company. This shareholder value is derived from financial figures when the company nets off its operating revenues against its operating expenditures. For a manufacturing or a trading company, their operating revenues are likely to be the product costs plus certain margin which are both fairly simple to determine through their
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manufacturing or trading processes. However, logistics services providers in the polymer industry are likely to price their services on a piece rate basis. The rates are derived by dividing the total projected operating cost of manpower and equipment with the output quantity from the operations. The output quantity is usually based on a best guess of the projected output volume provided by their customers. Smart customers might provide a high estimate of projected volume in an attempt to reduce the piece rates. Eager commercial personnel from the logistics services provider might purposely disregard working out a reasonable output and instead consciously use customer provided volume to price the services at below costs. The effect of this aggressive pricing strategy is a low margin or a loss from the project. Also excess resources might be committed in the project which leads to a low productivity in the divisions undertaking the project. The end result is a group of resentful division managers who are being measured on factors beyond their control. Therefore it is essential for a logistics services provider to use an appropriate costing system to price their services when they tender for projects. This costing system not only helps to reduce error in pricing its service rates but also to eliminate fraudulent pricing by the commercial personnel. The service rates derived from such a costing system would be readily accepted by the operational divisions in measuring their performance. To meet this demand, an ActivityBased Costing (ABC) system would be a right pricing platform for the commercial managers of a logistics services provider. Horngren has suggested this costing system as being able to provide a better measurement of the non-uniformity in the use of an organization’s overhead resources. ABC system focuses on individual activities as the fundamental cost objects; it also focuses on the allocation of direct and indirect costs to the activities. It makes a distinction between the 2 costs with emphasis on spreading indirect costs; direct costs can be traced to products or services relatively easily. It enables users to assign all direct costs to the individual activities (cost objects) and to allocate the indirect costs on the basis of the actions undertaken to perform the activities. A logistics services provider should be able to adopt ABC fairly easy as the individual activities to be used in an ABC system can usually be identified easily with the type of activities that a logistics services provider wishes to contract with its customers. The costing process also will
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lead to the creation of a budget of the whole project in which the outcomes from the project can be studied by the company before tenders are sent out. This budget can subsequently be used as targets on which performance can be measured. If we adopt the recommendation of Horngren for the services sector to implement ABC, a logistics services provider would follow a seven-steps approach to determine the unit costs of the various activities as stated in the above table. A desired profit margin would be added to the derived unit costs in order to price the services rates to be quoted to customers. The seven-steps approach is as follows: Step 1: Identify the chosen cost objects Step 2: Identify the direct costs of the services Step 3: Select the cost-allocation bases to use for allocating indirect costs to the services Step 4: Identify the indirect costs associated with each cost-allocation base Step 5: Compute the rate per unit of each cost-allocation base Step 6: Compute the indirect costs allocated to the services Step 7: Compute the total costs of the services by adding all direct and indirect costs
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Linkage of the performance scorecard to remuneration system
It is probably the choice of most companies which have implemented a performance measurement system to link the employees’ performance scores with their remuneration system. The linkage of the performance scorecard to remuneration should be carefully considered by a logistics services provider. For an ambitious employee, the performance scorecard offers him the best barometer to measure his efforts in helping the company to achieve its strategy. He will be able to make adjustment or improvements in the areas in which shortcomings have occurred. The linkage to the remuneration system enables such an employee to have a clear understanding and acceptance of his rewards. On the other hand, an uninitiated employee may find the various goals and measures in the performance scorecard a source of unhappiness and dissent. Linkage of the scores to the remuneration will further compound the dissatisfaction if the goals and measures have been set at the high end of the spectrum. The following suggestions are recommended: ? The linkage of the remuneration system at the initial implementation of the performance scorecard should be managed properly to avoid leading the employees to focus on rewards rather than the goals and measures in their scorecards. Employees would instead neglect the linkage of the various perspectives to the company’s strategy. A trial run of the scorecard without linkage to remuneration at the initial stage would allow employees to understand the purpose of the scorecard and help in getting to focus their attention away from remuneration. ? Only a portion of the remuneration should be linked to the performance score. The proportion of linked remuneration should be smaller at the initial period of the implementation of the scorecard. This will enable employees to adapt to the change and to adjust their performance to be in line with the measured criteria. New employees should be given sufficient time for adequate adaptation before their remuneration is linked with all the perspectives in the scorecard. ? Segregate the degree of linkage in accordance with the seniority of the employees. Senior management’s remuneration should be linked to all the perspectives in the scorecard with emphasis on selected areas depending on their responsibility.
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Financial goals are likely to be the main driver on their remuneration as improvements in other non-financial goals should result in better financial results for the company. For the junior managers and operational workers, it is more appropriate to link their remunerations to operational measures in customer and internal business process perspectives. ? The scorecard aims to measure the performance of managers across several perspectives. The remuneration system used should be able to deal with the trade-offs between the perspectives in the scorecard. Appropriate remuneration rules should be in place to resolve cases of employees who have exceeded some targets but missed out on the others. Suitable remuneration rules on the distribution of rewards would have an encouraging and motivating effect on the employees. ? Even out the reward for good performance over the measurement period rather than a lump sum pay out at the end of that period. As the recommended performance measurement system calls for quarterly reviews of the performance, a flexible remuneration payout structure can be implemented in which a small proportion of the reward may be paid out before the year end. Such a system should lead to employees’ satisfaction on their ongoing efforts or would encourage improvements when the targets are not met. A remuneration system in which a lump sum bonus is paid out only at the end of the measuring period might cause reduced interest in pursuing goals set out in the scorecard. ? To use a mixture of monetary and non-monetary reward system. Such a remuneration system is likely to be welcomed by the senior managers in the company. The nonmonetary reward may come in the form of career progress, equity participation, involvement in executive decision making, etc which all serve as a recognition of status for the employees. However, there are problems in linking remuneration with the performance scorecard when a company is faced with changing market conditions. For a logistics services provider which concentrates on the petrochemical industry, the fast changing petroleum market and the influence 51
of the state owned petroleum companies in oil producing or user countries is likely to affect its market share in logistics services. As a result the company would need to redefine its strategy frequently and this will lead to the refocusing of the performance goals and measures in the perspectives of its scorecard. As these goals and measures are changed, the remuneration linkage will have to be modified. The frequent changes in the remuneration system could lead to confusion on the part of managers as they will find it difficult to establish the alignment of their efforts to the goals in their scorecards.
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7
Performance Measures problems
In this section, I will discuss the problems associated with the use of performance measures adopted by a logistics services provider. The problems arising as a result of the implementation of a performance measurement system is very often due to a mismatch of organizational and individual goals. As discussed in the earlier section on the need for a logistics services provider to focus on financial and non-financial areas, individual employees too would focus on the financial and non-financial aspects of their employment. The concerns of employees would include monthly remuneration, future benefits, long-term career development, job security and satisfaction, the industry in which the company operates in, etc. These personal goals might be in conflict with the company’s goals and may result in employees not striving to ensure the achievement of the company strategy. Problems are: ? Tunnel vision – this occurs when undue focus is placed on the performance measures to the detriment of other areas. For example an over emphasis on maximizing the yield from working hours could lead to overlooking workers’ need for adequate rest, which inadvertently leads to errors, to the detriment of the quality of service rendered, thus affecting customer’s satisfaction. ? Sub-optimisation – the employees may focus on some selected targets considered favourable to them and leave others not achieved. For example technical personnel might proceed to procure a liquid filling machine with added features in order to improve their process perspective measure. But this may result in excess capacity not needed in the liquid filling operations division and thereby cause a poor performance in the yield factors overall. ? Myopia – refers to the undue focus being made on short-term objectives and neglecting the longer term objectives. An example would be setting of high service rates in the hope of recovering the initial capital investment in order to provide a better shareholder’s value creation. But the longer term objective under the customer perspective may be adversely affected as the customers may move out the region due to their uncompetitive cost 53
structure. Other forms of myopia in the logistics services include failure to invest in staff training or grooming in the shorter term which may result in the failure of the company to improve on its processes in the longer term. ? Measure fixation – Sometimes the managers may select options in order to achieve specific performance indicators which may not be effective. For example, managers may select a less reliable forklift truck with lower leasing cost in order to improve the unit cost measure. But the action may result in frequent break-down of the machine which causes the unsatisfactory performance in productive yield indicator. ? Misrepresentation – this may be resorted to in order to mask a less than favourable performance measurement result. As an example, the petrochemical customer imposes a KPI for an acceptable safety level, which is a maximum number of down days due to industrial accidents. Where this level has been exceeded, the division manager might be inclined to misrepresent days off resulting from accidents as due to general ill health just so that the performance measure result is acceptable.
?
Gaming – this problem is encountered where managers try to gain some strategic advantage by deliberately falsifying or distorting the performance measure. For example, there may be an intentional under performance in one period so that targets set in subsequent periods would not be too high. Where the performance measure is set on the financial perspective of controlling the cost of wastage of resources, workers may deliberately incur more wastage when, in reality, they could easily achieve a higher rate of waste reduction. This is so that the targeted waste reduction set for the next period would be easily achievable for the workers.
?
Ossification – refers to the reluctance to change the performance measure scheme once it has been set up. As mentioned earlier, the scorecard measurement system is dynamic and should be adapted over time to meet changing business strategies or priorities. As an example, acquisition of a major new customer who pays serious attention to
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environmental issues may force a logistics services provider to adjust its goals and measures to incorporate the demands and expectations of this new customer. ? Misinterpretation – here, there is a failure to appreciate the complexities of the environment in which the company operates. In the logistics services industry, this might be a failure to recognize a need to diversify its customer base, resulting in an overreliance on a single large customer. Staff and management might be reluctant to source for other customers, as they have fallen into a comfortable cushy relationship with the existing customer. Having new customers may very well mean having to adopt different ways of operations, meet different customer specifications, expectations, etc. However, the complexities of the business environment may very well mean that the customer may not renew its contract for logistics services with the same company, having obtained a more attractive quote from a competitor.
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How to address Performance Measures problems
Imperfections are bound to exist in any proposal or schemes – this must be acknowledged firstly before we can deal with the problems. The following are some suggestions to minimize the impact of such shortcomings: ? Staff involvement at all levels – they must be involved at the very beginning, i.e. at the development and implementation stages. This will go some way towards solving the problems of gaming and tunnel vision, as when staff is fully engaged and consulted, they are more willing and inclined to work towards the performance measures meant to monitor their work performance; this is because their own input have helped to form and shape the performance measurement eventually adopted by management. ? Flexibility in the use of performance measures – To solve the problems of fixation and misrepresentation, performance measures cannot be relied on exclusively for control purposes. Sometimes, actions or activities which result in long-term gains may not reflect positively when performance measures are applied towards short-term objectives. ? Focus on customer satisfaction – with this very clear and utmost objective in mind at all times, the problems of tunnel vision and sub-optimisation can be reduced to a great extent. Workers, managers and management must always bear in mind that the overriding consideration must always be a continuous and improved levels of customer satisfaction, otherwise the organization is underachieving on all counts of performance measures. ? Quantification of all objectives – this is to counter the problem of sub-optimisation. Quantification may prove to be elusive with some of the non-financial objectives, for example, on environmental impact. However, the idea here is that the organization should try its best to put into numerical figures all its objectives – this is to promote a greater understanding of its goals, hence people will know what action to take to achieve the intended objective, instead of working towards some vague or ambiguous or imprecise goal.
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?
Guarantee integrity of the data used by having an audit – such an audit will ensure that data used in the performance measurement is carefully analysed and interpreted, hence minimizing the problems of misinterpretation, gaming and measure fixation.
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9 1.) 2.) 3.) 4.) 5.) 6.) 7.) 8.) 9.)
Key references Starbuck, W.H. (2005), ‘Performance Measures : Prevalent and Important but Methodologically Challenging’ Journal of Management Inquiry, September 2005. Brown, G (1998), ‘Accountability and Performance Measurement’ ACCA Students’ Newsletter, August 1998. Horngren C T, Bhimani A, Datar S M, & Foster G (2005), Management and Cost Accounting, 3rd Edition, FT Prentice Hall. Johnson, S (2005), ‘The Pyramids and Pitfalls of Performance Measurement’ ACCA Students’ Newsletter, September 2005. Kaplan, R S and Norton, D P (1992), ‘The Balanced Scorecard: Measures That Drive Performance’ Harvard Business Review, January/February 1992. Martin J (2005), Organizational Behaviour and Management, 3rd Edition, Thomson Learning. Lynch R L, and Cross K F, (1991), Measure up!: Yardsticks for Continuous Improvement 1st Edition, Blackwell (USA). Neely A and Adams C (2002), The Performance Prism, Cranfield School of Management, March 2002. Simon J (1999), ‘Company Valuation and Performance Measurement’ ACCA Students’ Newsletter, April 1999.
10.) Kaplan, R S and Norton, D P (2000), ‘Having Trouble with Your Strategy? Then Map It’ Harvard Business Review, September/October 2000.
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doc_145465254.pdf
Performance measurement is the process of collecting, analyzing and/or reporting information regarding the performance of an individual, group, organization, system or component. It can involve studying processes/strategies within organizations, or studying engineering processes/parameters/phenomena, to see whether output are in line with what was intended or should have been achieved.
Performance Measurement for a Logistics Services Provider to The Polymer Industry
by
Tok King Lai 2007
A Management project presented in part consideration for the degree of Master of Business Administration
1
Summary
This management project discusses the form of performance measurement system suitable for a logistics services provider who focuses on providing its services to large multinational petrochemical companies in the polymer industry. The project starts with a brief introduction of the importance of performance measurement driving the efforts put in by the employees of an organization. It is followed by a brief introduction of the nature of the business undertaken by the companies in polymer industry and their need to used logistics services providers. This leads to a brief discussion on the type of services provided by a typical logistics services provider in the polymer industry and the linkage of their performance to the key performance indexes included in a services contract. To find out what type of performance measurements are available, I have carried out literature reviews of a few articles on: traditional financial data based performance measurement; and performance measurement systems that emphasise the inclusion of non-financial factors such as customer expectation, employees’ learning and skill level, innovations, suppliers, shareholders and other stakeholders. The main focus of my literature review is on three non-financial based performance measurements: The Performance Pyramid, The Balanced Scorecard, and The Performance Prism. The second half of the project covers my recommendation of a suitable performance measurement system for a logistics services provider: a scorecard based system with five perspectives on performances. The implementation targets within a logistics services company are segregated into: the Management of the company, the Middle Managers, and the Line Operators. Three measuring scorecards with suggested goals and measures are produced for adoption. The management project ends with discussions on implementation issues, linkage of the performance scorecard to remuneration system, and the problems associated with the measurement. 2
TABLE OF CONTENTS
1
Introduction on Performance Measurement ...................................................................... 4 1.1 Brief introduction of the Polymer Industry ................................................................ 5
2 3
Specialization required from Logistics Services Provider to Polymer Industry............. 7 Literature Reviews ................................................................................................................ 9 3.1 3.2 3.2.1 3.2.2 3.2.3 Literature review of Traditional Financial Performance Measurement:................ 9 Literature review of Non-financial factors ............................................................... 14 The Performance Pyramid by Lynch and Cross (1991) .................................. 14 The Balanced Scorecard by Kaplan and Norton (1992) .................................. 17 The Performance Prism by Neely (2002) .......................................................... 22
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Suggested performance measurement covering the financial & non-financial aspects 27 4.1 4.2 4.2.1 4.2.2 4.2.3 Developing a Performance Strategy Map:................................................................ 28 Developing a Scorecard Based Performance Measurement ................................... 32 Proposed Scorecard for the Management......................................................... 34 Proposed Scorecard for Managers .................................................................... 41 Proposed Scorecard for individual operators .................................................. 44
5 6 7 8 9
Implementation of the Scorecard Performance Measures.............................................. 46 Linkage of the performance scorecard to remuneration system .................................... 50 Performance Measures problems ...................................................................................... 53 How to address Performance Measures problems........................................................... 56 Key references ..................................................................................................................... 58
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1
Introduction on Performance Measurement
In the manufacturing and services sectors, performance measurements have played a vital part in driving corporate performance and results. As profits and results oriented entities, such organizations have goals or objectives which include gaining the required return on investment, protecting or increasing their market share. A suitable set of performance measurements which takes into account the returns and market share achieved by management teams on an ongoing basis would help the organizations to reach their intended goals or objectives. Johnson (2005) feels it is becoming important for organizations to develop systems of performance measurement as the present day business has become more complex and also the need to monitor their strategic response to this complexity. He lists the following main issues which management should consider: ? Linking performance to strategy ? Setting performance standards and targets ? Linking rewards to performance ? Considering the potential benefits and problems of performance measures The important of performance measure was appropriately demonstrated in a non-business environment by Starbuck (2005) where he compared the crime rates of New York City in 1985 and that in 2003. Starbuck noted that New York City was widely perceived as a dangerous place in 1985. But in December 2003, it was mentioned in the press as the 6th city with the lowest crime rates among 193 American cities with populations more than 100,000. The city has achieved this result after various performance measure initiatives were introduced by the city police force. The main driver of this improved crime rates was through the use of effective performance measures adopted by the New York City police force. Prior to that, the performance reports for the police force were limited to annual reports on the number of patrolmen and police cars on the streets, the number of raids occurred, the number of arrests made, and so on. The old practice only required statistics and reports to be compiled once a year. The crime rates reduced after the police force started to compile daily summaries of crimes committed after it deployed more computers and IT savvy offices in its departments. The police commanders began to receive frequent, up-to-date measures of the events that police activity is supposed to affect. The
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commanders were made to appear periodically before a review board to discuss crime statistics and made to present improvement plans. Poor performers were subjected to peers reviews in public or dismissal in the case of ineffective commanders. These illustrations are similar to the call by Johnson for the setting of performance standards, targets and rewards in a business environment. This paper seeks to look into the performance measurements, both financial and non-financial, which may contribute to the achievement of the desired goals of a logistics services provider to the polymer industry.
1.1
Brief introduction of the Polymer Industry
The polymer industry is involved in the polymerization of by-products from crude oil refining processes into various types of plastics products. The finished product from the polymerization process is usually in the form of dried pellets. Key players in the polymer industry are large multi-national petroleum companies. These multi-national companies have usually collected a large quantity of raw material from their crude oil refining activities worldwide. They will further invest in downstream polymer processing facilities and use the material as feed stock to produce other materials of high economic value. Also, they have strong financial resources to set up the polymerization plants. The vast investment in these plants and the accompanying financial returns plus employment opportunities has attracted the interest of many countries in trying to host such processing plants. Appreciating the importance of petrochemicals as a driver of the economy, the Singapore government aggressively embarked on building up a Petrochemical industry in the 1990s. The government invested heavily in this industry and embarked on an ambitious plan to successfully combine a group of 5 small islands at the south-western part of the country through land fills in order to form a big island which serves as petrochemical hub. The government also used aggressive marketing and incentives to attract large multi-national petroleum companies to set up their petroleum chemical refining activities.
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For strategic reason, most of the multi-national petroleum companies have chosen to focus on their core competency in oil refining and polymer manufacturing, thus leaving the less important activities such as the packaging and logistics functions to third party specialist services providers.
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2
Specialization required from Logistics Services Provider to Polymer Industry
To gain a better understanding of the activities of a Logistics Services provider, here are some typical examples of services it offers: ? ? ? ? ? ? Packaging of finished products Technical services related to packaging and logistics equipments belonging to customers Physical management of inventory in warehouses and computerized inventory management system Pre-delivery preparation of cargo, loading and land transportation Vessel/air freight arrangement Processing of sales documentations for fund collections
Some characteristics of the services provided by a logistics services provider to the polymer industry are: ? A major proportion of service providers’ business is likely to be derived from a couple of large customers, as players in the polymer industry are large MNCs. ? Services providers usually obtain businesses on contractual terms which are subject to renewals every few years. Therefore it is vital that a service provider should maintain high customers’ satisfaction. ? Revenue growth of a service provider is closely linked to the manufacturing capacities of its customers. Hence there is a need for extension of service contracts, failing which the going concern will be in doubt. ? Profitability of a service provider is highly dependent on the competencies, processes and productivity of its labour force. ? Logistics services are often integrated with the sales functions of customers. Specialized skill is required and processes often have to be tailored to suit the marketing requirements of customers. ? In most cases there are specific key performance indexes specified in the contract of services. The focus of performance measurement would be on customers’
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perspectives and their concerns on time, quality, performance and service, and cost. ? Customers have certain degree of intimate knowledge of performance of logistics providers.
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3
Literature Reviews
My literature reviews will cover: ? Traditional Financial Performance Measurement ? Non-financial factors such as customer acceptance, productivity, efficiency The literature review undertaken here will look into the arguments put forward by proponents of both forms of performance measurements.
3.1
Literature review of Traditional Financial Performance Measurement: ? I will first look into the traditional financial measurement normally used by a company. The owners or shareholders of a business organization are likely to use the financial data from its Profit and Loss Account and Balance Sheet to measure performance of its management. Simon (1999) looked into a number of company performance measures based upon accounting information easily available from the Financial Statements of a company. Some of the measures mentioned by him and popularly adopted by companies using internal accounting based models are : a.) Profit After Tax – This is the measurement companies have been looking at for decades. But the suitability of using just profit after tax as performance measurement has been questioned. Analysts do use company profit to compute earning per share. Brown pointed out that profit is often a better predictor of a company’s future performance as closing stock is available for future sales and depreciation instead of full assets cost is deducted from revenue. However it is common knowledge that profit is also easily manipulated to meet the desired performance level of management. With the various methods available to apply the accounting standards, profits in different periods may be adjusted in order to show different performance levels. Also, there are numerous creative accounting methods
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adopted by many company directors and managers to distort the performance of companies. b.) Net Assets Value – It is computed using data from the balance sheet and Simon stated that it appears to some investor as to be designed to measure the value of a company. Also it is audited and has been generally regarded as containing reliable information. But he noted that the Balance Sheet does contain a number of problems which makes performance measurement difficult. These are due to the fact that most companies have prepared their balance sheets on a historical cost basis with a limited degree of capturing the current value of its assets or liabilities. Problems cited in his article include: ? Some key assets such as a well-trained and highly motivated work force are omitted. His view seems to imply that a productive work force would lead to better performance. But the accounting of the exact value of work force is likely to be a contested item in performance measurement. ? Assets are often recorded at historical value. But the introduction of current value would likely result in the manipulation of assets value in the hands of managements who aim to inflate their performance standard. ? Problem of manipulation of assets and liabilities. These would include the depreciation and amortization of assets, omissions or inclusion of certain types of intangible assets and contingent liabilities, off balance sheets transactions, etc. Performance measurement purely on assets valuation would likely tempt the management to adopt certain favourable accounting practices in order to inflate the value of the company. c.) Cash Flow Measures – uses a company’s Cash Flow Statement to see how much cash it has generated from its operations. Also connected to this 10
measurement is the “free cash flow”(FCF) which is derived by subtracting capital expenditure from operational cash flow. This measure is considered a useful measurement of a company’s present value when forecast of FCF is made over the foreseeable planning horizon. As most financial persons are aware, an appropriate discount rate has to be chosen in the present value computation. Academia has devoted a lot of time in discussing how to arrive at the required rate of return for equity shareholders and the weighted average cost of capital (WACC) as the discount rate for the valuation. In spite of the above difficulty in getting the right discount rate, Simon has considered cash flow a useful measure of company performance due to: ? Cash flow has been considered to be less easily manipulated than profit. However, cash flow may be subject to manipulation through delaying ? and advancing of payments or receipt to/from creditors/debtors. Cash flow is considered a more sensitive measure of liquidity problems because a company in financial difficulties normally moves into a cash flow deficit first before encountering profit decline. d.) Residual Income – This measurement is arrived at by using the operating profit and makes a deduction for the cost of using the capital employed. The cost of capital employed would be the WACC and thus would face the same problem discussed in cash flow measure. The logic behind the deduction of capital cost is that profit would not have been earned without capital. The management should rightfully be measured on the residual profit from the operations. The problems with this method of measurement are similar to those discussed in the profit after tax measurement such as distortion created by creative accounting, difference in accounting methods used, historical convention that understates profit. e.) Economic Value Added® - A trade mark of Stern Stuart, Simon referred to it as a sophisticated version of residual income as it refines the operating profit and capital employed figures with over a hundred adjustments to 11
profit and capital employed. However, even with the comprehensive lists of adjustments to derive the value supposedly generated by a company, this measure is still subject to arbitrary adoption of many accounting methods available. Also, the implementation of this measurement has been considered costly and thus restricted to a limited number of large organizations.
Other measures considered by Simon include Accounting Rate of Return obtained by dividing operating profit by capital employed, Shareholder Value Added which uses present value principles to derive a value for company shares. Another form of measurement discussed by Simon is the Price Earning Ratio. He considered it as a mix of market based model and internal accounting based model as it is simply the company’s share price divided by its earning per share derived from its financial statement. It is favored by analysts worldwide as it encapsulates current thinking about the company performance and its worth.
? In his article, Brown (1998) cited the agency theory which considers the relationship between a principal and an agent as an example of accountability for the management (agent) of an organization. Brown mentioned that the problem in agency theory is how the agent can be motivated and monitored. In financial aspect, the motivation may be by monetary reward and the monitoring may be through submission of income and expenditure reports. Brown went on to discuss the role played by the accountancy profession in the development of regimes of accountability. The control system involves using quantitative and qualitative methods and principles such as budgeting and standard costing and variance analysis. Other management control tools have also included activity based costing (ABC) and total quality management. He thought that there are 2 aspects of accounting and accountability perspective as the basis of management
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control: Hard accountability via financial and qualitative results, and Soft accountability derived from human input. Hard accountability will require: 1.) Counting – converting activities and outcomes into numbers 2.) Accounted for – reporting on activities and outcomes and providing a discussion of how and why they occurred. 3.) Held accountable for – group or team responsible for accounting and the events and circumstances leading to the records. Soft accountability looks into: 1.) The construction of the accountable person and aims at selfaccountability. Brown pointed out that the accountability is likely to be affected by the financial and non-financial rewards. 2.) Focus on transferable skills through comprehensive training and development programme. He also mentioned that traditionally, organization have focused on a range of financial measures such as capital structure, market ratios, liquidity and overall ROI. There are also analysis of costs and profit by product, cost centre and geographical area. These measures may be argued as being unduly inward looking, with major focus on monetary targets and with detailed focus on an analysis of deviations from the planned or targeted figures. Brown went on to examine the alternative views of performance measurement and proposed that there should be different measures for business units with a focus on profitability and for those with a focus on growth and market position.
? Finally I will review the financial measurement mentioned in Horngren’s book, with special focus on his budgetary approach to performance measurement. Horngren (2005) considers the roles of budgets as a major feature of management control systems. He believes budgets can be used as tools to compel strategic 13
planning, provide performance criteria, promote communication within organizations and affect motivational and wider organizational processes. To be useful, budgets must be done as an integral part of an organization’s strategic analysis. Strategic analysis would generally require both long-run and short-run planning. The planning in turn calls for the formulation of budgets which would cover long-run and short-run budgets. Horngren points out that budgets can act as a framework for judging performance. He reasons it by listing two key limitations of using past performance as a basis for judging actual results which budgets are able to overcome. One limitation is that past results may incorporate past substandard performance or the output of a different workforce. Using past results as benchmarks for current workforce would set the performance bar too low. A second limitation of using past performance to compare current actual performance may not fully reflect the different market conditions existing in two periods. Market conditions may have improved since the previous year, thus performance standard would need to reflect the general market predictions. With budgets that incorporate the likely outcomes in future, the performance bar can be set at an appropriate level.
3.2
Literature review of Non-financial factors
I will carry out in depth literature review of alternative views of performance measurement proposed in the Performance Pyramid by Lynch and Cross (1991), in the Balanced Scorecard by Kaplan and Norton (1992), and in the Performance Prism by Neely (2002): 3.2.1 The Performance Pyramid by Lynch and Cross (1991)
The performance pyramid was put forward by Lynch and Cross (1991) as a measurement suitable for a company with business operating systems. They proposed that a company should first form its corporate vision which encompasses both the market and financial aspects. The corporate vision would then steer the company towards formulating its objectives. The objectives are further guided by driving forces from customer satisfaction,
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flexibility and productivity in its core business processes. These forces are further driven by various focuses to be made by groups and work teams within departments in the 4 indicators quality, delivery, cycle time and waste. These indicators should be monitored and the performance of each department group measured on a continuous basis. The performance pyramid also segregates the above mentioned driving forces and indicators into those that focus on the external effectiveness and those that focus on internal efficiency. Figure 1 below provides a mapping and relationship of the various elements covered in the performance pyramid.
Figure 1 : The Performance Pyramid of Lynch and Cross (1991)
Corporate Vision Objectives Business Market Financial Measures
Customer Satisfaction
Flexibility
Productivity
Business Operating Systems
Quality
Delivery
Cycle time
Waste
Departments and work centres
Operations
External effectiveness (Unshaded areas)
Internal efficiency (Shaded areas)
Source: Lynch and Cross, 1991
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According to Johnson, corporate vision is articulated by those responsible for the strategic direction of the organization. The corporate vision leads to a range of objectives which strives for both external effectiveness and internal efficiency. He mentioned that the objectives can be achieved through measures at various levels as shown in the pyramid and the measures would need to interact with each other horizontally and vertically. Lynch and Cross used the term “getting it done in the middle” to refer the need of an organization to focus its business operating systems on customer satisfaction, flexibility and productivity. Such focus would involve crossing departmental and functional boundaries. As an example, if a logistics services provider wishes to achieve an objective of marketing a new method of moving products in bulk at the least cost, there should be close interaction between its products handling, warehousing and marketing departments. Performance focus will be on: ? ? ? all departments to focus on ensuring customer satisfaction products handling department and warehousing department to focus on flexibility in works method or customer requirements all operations departments will need to focus on productivity, such as the most cost effective and the efficient ways to fulfill the customer requirements To measure how well a company’s business operating system has attained the objectives stated in the middle level of the pyramid, Lynch and Cross listed 4 non-financial indicators at the bottom level of the pyramid which they refer to as “measuring in the trenches”. These indicators monitor the quality, delivery, cycle time and waste as the operations are being carried out by businesses. For a logistics services provider, customer satisfaction can be met with services which produce minimal errors from high quality works and shorter delivery time to customers’ buyers. Internally, improved cycle time would result in higher productivity from the work force and also better facility utilization. Reduction in waste such as less time spent on product handling would also improve labour productivity which leads to financial gains ultimately. The Performance pyramid sets out the principle on the need to look into financial and nonfinancial indicators of performance measurement. But it does not provide a more detailed 16
suggestion on what should be done by businesses in order to realize its vision. Also, other factors affecting performance need to be included as indicators, such as staff development, resource utilization, suitable facilities, etc.
3.2.2
The Balanced Scorecard by Kaplan and Norton (1992)
The Balanced Scorecard was developed by Kaplan and Norton. In their document The Balanced Scorecard: Measures That Drive Performance (1992), they mentioned that many managers and academics have focused on making financial measures more relevant while others have advocated focusing on improving operational measures. But they have found that senior executives do not rely on one set of measures to the exclusion of the other. Instead they believe that managers want a balanced presentation of both financial and operational measures. Based on their research project with 12 companies at the leading edge of performance measurement, they devised a “balanced scorecard” which they believe would give executives a fast but comprehensive view of the business. The main focus of the balanced scorecard developed by Kaplan and Norton is an attempt to measure performances which are grouped into financial and operational measures. They tabulated those performance measures into four groups which they termed as “perspectives”. Their reason for limiting the number of measures is to minimize information overload on senior managers and that the scorecard would force managers to focus on those measures which they think are most critical. Figure 2 on the next page shows the balanced scorecard’s 4 perspectives and the links between them.
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Figure 2 : The Balanced Scorecard
How do we look to shareholders? Financial Perspective GOALS MEASURES
How do customers see us? Customer Perspective GOALS MEASURES
What must we excel at? Internal Business Perspective GOALS MEASURES
Can we continue to improve and create value? Innovation and Learning Perspective GOALS MEASURES
Source : Kaplan and Norton, 1992
Financial Perspective The performance measures based on financial information is termed financial perspective in the balanced scorecard. Kaplan and Norton considered financial measure a must have because they believe it indicates whether the company’s strategy implementation and execution are contributing to bottom-line improvement and it shows whether the financial goals of profitability, growth and shareholder value have been achieved. They pointed out that many have criticized the inadequacy of financial measures due to the backward-looking focus used in the traditional
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financial accounting. While other critics think that even if various more forwardlooking financial analysis which uses forecasted future cash flow and discounting were adopted, the performance measures solely based on financial information are considered inadequate due to the exclusion of the activities and processes that drive cash flow. Also, some critics argue that traditional financial measures do not improve customer satisfaction, quality cycle time, and employee motivation and instead, they view the financial performance as the automatic end result of good operational actions. To support their assertions that financial measures are necessary and rightfully should be included in the balanced scorecard, Kaplan and Norton have quoted the following 2 reasons: ? ? A well-designed financial control system can actually enhance rather than inhibit an organization’s total quality management program. The alleged linkage between improved operational performance and financial success is questionable and uncertain. Periodic financial statements remind executives that improved operational performance need to be translated into improved financial performance or else executives should reexamine the basic assumptions of their strategy and mission.
The rest of the measures specified by Kaplan and Norton as the important components of the balanced scorecard concerns the operational performance in customer perspective, internal business perspective and innovation and learning perspective. They consider these operational measures to be the drivers of future financial performance. Customer Perspective The balanced scorecard takes into account the observation that many companies have made it a priority to focus on the customer in order to ensure growth and improve market share. The inclusion of this measure attempts to show how the company is performing from its customers’ perspective. The balanced scorecard thus demands
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that managers translate the general mission statement on customer service into specific measures that reflect the factors that really matter to customers. Kaplan and Norton think customers’ concerns can be grouped into four categories: ? ? ? ? Time Quality Performance and service Cost
They proposed that the above concerns of the customers should be incorporated in designing a balanced scorecard. Lead time enables a company to measure the time required for the company to meet its customers’ needs. It is essential for a company to focus on the lead time for both existing and new products. Quality measurement compels a company to track the defect level of its products received by customers. The measure of performance and service aims to let the company know how its products or services contribute to creating value for its customers. The last measure of customers’ perspective is on the cost of products or services incurred by them. The cost to be measured should include not only the products’ selling price but also other supplier-driven costs such as ordering, delivering, receiving, handling, storing, obsolescence, schedule disruptions from incorrect deliveries, etc. These are costs which would affect the competitiveness of the customers as a result of being at the receiving end of a poor level of performance of the company.
Internal Business Perspective In this perspective, Kaplan and Norton called for companies to decide what processes and competencies they must excel at and to specify measures for each. In their opinion, to meet customers’ expectation and to produce excellent customer performance as explained in the previous section, managers should focus on critical internal operations that enable the company to satisfy customers’ needs. In this respect, the measures to be included in the balanced scorecard have to cover business
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processes that have the greatest impact on customer satisfaction. They have identified cycle time, quality, employee skills and productivity as the internal business processes affecting customers’ expectation. Another internal business perspective that they recommended to identify and measure is the company’s core competencies which is critical to the company in maintaining market leadership. In order to have an effective measurement of internal business, Kaplan and Norton suggested that managers devise measures on the processes that are influenced by employees’ actions. This requires the managers to breakdown the overall measures on internal business into sub-measurement relating to cycle time, quality and productivity and to use these measures for the employees at local levels so that they have clear targets for actions. Innovation and Learning Perspective This perspective focuses on the measurement of how well the companies have made continual improvements to their existing products, processes and the ability to introduce new products with expanded capabilities. The inclusion of this perspective in the balanced scorecard is to enable companies to look into their strategies to create long term growth. In the present competitive markets, companies which are able to launch new products and create more value for customers would be able to penetrate new markets and thus result in increased revenue and margins. In their paper, Kaplan and Norton quoted a few measures of innovation found in a number of companies. One of them is the innovation measure which focuses on the ability to develop and introduce standard products rapidly. Another is the manufacturing improvement measure that focuses on the stability in the manufacturing of new products. Other types of measurement are measures on the specific improvement goals of existing processes such as the requirement to improve process performance continuously or the specific time period in which the managers are required to make improvements.
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Based on their experience in the implementation of the balanced scorecard, Kaplan and Norton mentioned that the scorecard has brought about a fundamental change in the underlying assumptions about performance measurement by most companies. They observed that usually the financial experts are the ones who have designed and overseen most nonscorecard based performance measurement systems whereas there is no heavy involvement by senior managers who have the full picture of the company’s vision and priorities. But with the inclusion of the 3 non-financial perspectives in the balanced scorecard, there becomes a need for the involvement of non financial senior managers. Also, Kaplan and Norton think that traditional measurement systems have sprung from the finance function and sought to control behaviour. This is because these systems specify the particular actions the employees need to take and then be measured to see if those actions have been taken. In contrast, their ideal implementation of a balanced scorecard system of measurement is for companies to establish goals but let the employees themselves adopt whatever behaviours and take whatever actions necessary to arrive at those goals. In this way the scorecard puts strategy and vision, instead of control, at the center. Through the balanced scorecard, the authors believed that the managers in companies would understand the interrelationships between financial, customer, internal process and innovation and learning perspectives. They said this approach is consistent with what many companies have been seeking: cross-functional integration, customer-supplier partnerships, continuous improvement and team accountability.
3.2.3
The Performance Prism by Neely (2002)
Neely and Adams in their article on the Performance Prism started by arguing that the various performance measurement frameworks and methodologies developed by the various proponents so far only highlight the differences in performance perspectives among each other. They argued that The Balance Scorecard, even with its 4 perspectives, has not covered the importance of other stakeholders such as customers and employees. They viewed all forms of performance measurements proposed by various other parties as being only capable of providing their own set of unique perspective on performance which in turn causes managers to adopt performance measurements with different sets of lenses. This results in 22
difficulties in comparisons of performances across different divisions within the same organizations, or across different organizations within the same industries. The authors of the Performance Prism argued that business performance is itself a multifaceted concept and so far they have not come across a single best way that is able to provide a comprehensive view of business performance. They believe that a suitable performance measurement demanded by most people would be a new multi-faceted yet highly adaptable framework. Therefore their solution is a three dimensional model which they call the Performance Prism. This model has 5 facets arranged in a prism form – Stakeholders Satisfaction, Stakeholder Contribution. Strategies, Process and Capabilities as shown in the diagram below: Figure 3 : The Performance Prism
Process
Stakeholder Satisfaction
Strategies
Capabilities
Stakeholder Contribution
Source : Neely and Adams, 2002
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Neely and Adams think one of the great fallacies of performance measurement developed by others is that measures should be derived from strategy. They think that performance measures are designed to help people track whether they are moving in their intended direction. Whereas strategy is about the route they choose to reach the desired destination. They think that modern day organizations have strategies that are dominated by a list of improvement activities and management initiatives. These organizations normally believe that the initiatives and activities will enable them to better deliver value to their multiple stakeholders – investors, customers, employees, suppliers, regulators and communities. Therefore, the Performance Prism has included the stakeholder perspective as the first and fundamental perspective on performance. The various perspectives advocated in the Performance Prism are described below: Stakeholder Satisfaction Perspective The authors shared the same argument as in the Balance Scorecard by putting shareholders as the most important stakeholders. They also agreed with the proposal in the Balance Scorecard that customers and employees are important stakeholders. They brought in suppliers as an essential stakeholder for manufacturing and service business. They pointed out that as companies have recently outsourced an increasing amount of non-core activity, they become more dependent upon their suppliers. Also companies will have to pay close attention to the requirements of regulators and communities, especially the organizations engaged in activities that have an impact on the environment, food, healthcare, etc. Therefore the Performance Prism calls for performance measures to be established to measure the stakeholder satisfaction. The managers must, through the performance measurement system, ascertain who the most influential stakeholders are, and what they want and need. Strategies Perspective Neely and Adams noted that organizations must first address stakeholders satisfaction before they are able to turn to this second perspective on performance. The key question for the managers is what strategies to adopt to ensure that
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stakeholders are satisfied. The authors think that most organizations will devise strategies to try to improve their performance. But there is a need to develop a measure that will track whether strategy is being implemented. The right measures will also offer a means of communicating strategy and encouraging implementation. They think the measurement of strategies previously taken by managers can enhance the making of judgements and decisions. Process Perspective The next performance measurement covers the organization’s processes. Neely and Adams think the reason for strategic failure is partly due to misalignment of processes with an organization’s strategies. The measurement in this respect allows managers to track whether the right processes are in place, to communicate which processes matter and serves to encourage maintaining and nurturing of the right processes. With the measuring of processes, it is hoped that owners of the processes can be identified, who in turn need to make judgements after the data is analyzed. Capabilities Perspective The argument for capabilities is that processes cannot function on their own but require people with certain skills. The organization also needs to have policies and procedures on the ways things are done, physical infrastructure and technology to enable the processes to be carried out. Therefore the capabilities perspective calls for measurements to be made on whether the organization’s people, practices, technology and infrastructure are in place to create value for its stakeholders. Stakeholder Contribution Perspective This perspective looks into what contributions a company needs from its stakeholders if it is to maintain and develop its capabilities. This perspective is the opposite of stakeholder satisfaction. Contribution from stakeholders includes feedback on services received by them, their continued loyalty and information on customer profitability. The author mentioned that in the olden days, most companies used customers’ complaints data as a form of contribution from customers to help in
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improving their capabilities. In recent times, this is considered not a good contribution as many unhappy customers never complain but just moved elsewhere. Realising this, many companies started to reach out to their customers by including survey forms and feedback requests after services had been provided. The contribution arising from the act of loyalty by customers provides a strong indication of the right strategy and processes adopted by a company. This in turn enables the company to maintain its business strategy. On customer profitability, the author thinks that profitability data of customer helps a supplier company to better understand its customers. These profitability performance data are an indication to suppliers as to whether they need to improve/reduce their prices in order to provide customers with cheaper products or services, so that customers in turn can improve their bottom lines.
The Performance Prism seems to be the duplicate image of the Balanced Scorecard in that its 5 perspectives overlap the 4 perspectives in the scorecard. The prism expanded the measurement coverage to include some of the stakeholders not mentioned in the scorecard as well as including the contribution measurement of stakeholders. The idea in the performance Prism was developed much later than the scorecard. The influence of suppliers and regulators during the development period of the scorecard may not as strong as at the present time. Thus the inclusion of suppliers and regulators as stakeholders can be seen as the authors’ attempt to reflect the changing business environment that current day organizations are facing. The outsourcing of services to suppliers and the concerns of the communities and regulators play an important part in the growth and survival of many companies. However, the Performance Prism lacks a proper framework for users to adopt their various perspectives in the real word situation. It covers a broad general area of concern but without further elaboration on how and what should be the critical issues of performance that an organization should concentrate on. Companies intending to adopt the Performance Prism should therefore follow the argument in the scorecard in which companies are advised to restrict the measurement to a few critical areas.
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4
Suggested performance measurement covering the financial & non-financial aspects
After reviewing several models of performance measurement, it is apparent that a logistics services provider will need to develop a performance measurement system which encompasses both financial information and those of other achievements not reflected in its annual financial statements. It is also important for the management of a logistics services provider to decide on the areas of performance that best meet its strategy. Most of the practitioner and academia of performance measurement share the opinion that the management of an organization should ensure that performance measures target areas within the business where success is a critical factor. They are advocating that the management should focus on a selected few measures that are most critical to the organization. Following the argument put forward by Johnson, the performance measures chosen by a logistics services provider should be able to provide insight to: ? the effectiveness of all internal processes, especially those that affect services that reach the customer ? the efficiency in which the company utilizes its resources ? enable the company to focus on both the long-term and short-term goals ? enable the company to be flexible and adaptable to changing business environment In this respect the balanced scorecard seems to be a suitable model for a logistics services provider to adopt in developing its performance measurement. The scorecard provides a framework which management can utilize to develop a multi-dimensional set of performance measures to enable it to measure its own achievements as well as the performance of its various divisions and personnel responsible for the daily works of the divisions. The incorporation of financial information helps to indicate how well the management of the company has met the accountability function called for by the agency theory. More specifically, it is always the demand of shareholders as principals to expect the management as agent, to ensure that the investment and resources committed to the business have generated the required rate of return.
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Other than the financial perspective measurement, the scorecard inclusion of non-financial measures enables the company to see how the critical factors that contribute to increasing shareholder value have been handled by its employees. In additional to the four perspectives introduced by the balanced scorecard, the measurement for a logistics services provider should be expanded to include suppliers’ perspective. For a services provider intending to expand its business worldwide, there is high possibility that it has to rely on a few major local suppliers to complement its own services. Such services are likely to require local specializations or where disproportionate resources are need for a logistics provider to set up on its own. Examples of such suppliers include local trucking company, port authority, local utilities suppliers and others.
4.1
Developing a Performance Strategy Map:
According to Kaplan and Norton, the suggested approach to start a balanced scorecard based performance measure is for a company to develop a strategy map. This strategy map serves as a communication to employees on what the strategy of the company is. It provides a visual representation of a company’s critical objectives and the crucial relationships among them that drive the organizational performance. As the map also links the critical factors that employees need to overcome in order to achieve the four perspectives in the balanced scorecard, the employees would certainly strive to work in a coordinated and collaborative manner. To develop a strategy map, a logistics services provider should start from top down with the determination of the destination and then charting the route that will lead there. The following steps are suggested: 1st Step : Its corporate executives should review the mission statement and the core value. The executives include the chief executive officer, operations and financial senior managers directly accountable for the performance of the perspectives. The mission statement and core value provide the reasons for the existence of the company and what the company believes in.
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2nd Step : The directors and managers start to develop a strategic vision based on the information above. The strategic vision enables the company to know what they want to become as they proceed with their business operations. 3rd Step : Create the goals for the company to achieve. 4th Step : Define the logic of how to arrive at the destination – the goals developed from step 3.
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Table 4 : The proposed Scorecard Strategy Map for a Logistics Services Provider
Increase Return on Capital Employee & Shareholder Value
Revenue Growth Strategy
Understand industry & customers needs and differentiate accordingly
Financial Perspective
Productivity Growth Strategy
Maximize output from resources; adopt latest innovation in logistics methods
Introduce new services, expand service types
Sell higher margin services
Improve on labour / machine output
Seek innovation in service delivery methods
Customer Perspective
Strategy adopted: Product Leadership
Service Attributes
Delivery Time Quality Safety first Quick response
Relationship Share philosophy – Safety Helpful staff
Image Trusted service, Best in class
Collaboration Help customer to improve Share resource & best practice
Company excel at creating unique service
Internal Process Perspective
Create efficient new services, reduce new service introduction time
Improve inventory management, deliver services on spec & on time
Improve hardware and operating method to reduce downtime & OT
Improve environmental health & safety
Learning and Growth Perspective
Employees improve their service skill & develop leadership skill
Strive for innovation and adopting new technology
Create opportunities for staff advancement
differentiator General requirement
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In the proposed strategy map in the previous page, a logistics services provider has set out its corporate mission to increase the shareholder value. It can use two approaches to attain its financial strategy: revenue growth and productivity growth. In revenue growth strategy, it needs to introduce new services to widen its revenue base; and concentrate on services that provide higher margin. With productivity growth strategy, the company has to improve the output from machineries and labour force; and introduce innovative service methods which increase output per unit of resource. With these growth strategies linked to the financial perspective laid out at the top of the map, the operational divisions within the company are now provided with clear operational targets as they set out to carry out their responsibilities. After the strategies for financial perspective have been selected by the management, the next attention will be on the customer perspective. This requires the company to decide what customer value proposition its wishes to pursue in order to satisfy its customers. Value proposition describes the service mix and service attributes, customer relations, and corporate image that a company wants to offer to its customers. There are three types of value proposition available for adoption by a company to differentiate its services from competition: operational excellence, customer intimacy and product leadership. The main value proposition to be adopted by a logistics services provider who only services multinational petrochemical companies is likely to be one on product leadership, while maintaining adequate standards in the other two. By adopting a product leadership value proposition strategy, the company must concentrate on the functionality, quality, and overall performance standard of its services. In the above proposed strategy map, the company seeks to differentiate its service attributes with improved service delivery time and quality. It needs to create an image of a trusted service provider with the best of class services. Another important differentiation is the collaboration efforts with customers the company has actively undertaken to create value for its customers. The next step in the design of a strategy map is to determine the means by which the company will achieve the differentiated value proposition to its customers and its growth
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strategy that leads to its financial objectives. In this respect, the company has to focus on its internal process perspective. For a logistics services provider, the ability to create service methods that are effective and efficient will help in its pursuit on being a product leader. To meet this target, the company will need to improve its processes in inventory management and products handling. These are measures that focus on the innovation and operational aspect of internal processes, considered a better strategy than one that focuses on processes that reduce costs of the company. By undertaking processes that focus only on cost reduction, the company may end up not building adequate facilities to take on new businesses. To final section of a strategy map is the establishment of strategy to improve the learning and growth of a company’s workforce. In this perspective, the company has to make efforts to upgrade the core competencies and skills of its workforce, the development of technical knowledge within the organization, and to establish the right corporate culture. This calls for improvement in the company’s human resources functions such as the provision of adequate training and clear career path. Senior managers should be exposed to different activities within the company in order to gain a working knowledge of the whole service chain. Steps should also be taken to let its senior managers have a broader understanding of its business and operational environment .
4.2
Developing a Scorecard Based Performance Measurement
A logistics services provider should not just apply an all encompassing balanced scorecard based performance measures to every level of it employees. To do so will cause a misalignment of the goals or targets to the responsibilities of employees. This occurs because employees will be assigned with responsibilities of different magnitudes and not all employees are tasked to perform similar duties but rather they are placed in the various divisions within the company based on their level of expertise. To apply the various measurement categories of a balanced scorecard, the company should segregate its personnel who are involved in making management decisions which have an impact on the company’s strategy from those who merely take instructions and perform the daily tasks assigned to them. The organizational structure of a
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logistics services provider would usual consist of 3 levels: Management level, Middle Managers level and Line Operators. The reasons for such segregation are: o The Management – The management headed by a Chief Executive Officer or a Board of Directors, is normally entrusted to set the strategy of a company and is in a position to manage the direction of a company. The CEO and directors, collectively termed as management, should therefore be held accountable for the overall growth of the business and the shareholders value generated. They are in a position to influence the actions of all those individuals who undertake the operations where the results are measured by the different perspectives in the scorecard. Therefore the performance measures applicable to the management should encompass a broad based measure which covers all the four perspectives in the balanced scorecard. o Managers in charge of divisions – Due to the segregated nature of logistics services, a number of managers are usually engaged to take charge of different operational divisions within the services chain. They are tasked to manage a specific group of employees assigned to carry out specialized tasks within their divisions. The managers play an important supporting role to the CEO but they should be fairly measured based only on their performance in managing their divisions. Another argument for only measuring manager on selective measures is that managers are usually not in a position to set the service rates or the service scopes of a contract. What has been described in Section D shows there is a need to have a robust costing system for a services provider to price its service rates and service scopes. Managers might be at the receiving end of a bad business venture which was the result of an overly ambitious contract-wining attempt executed by the management or commercial director. An ideal costing system should have a register to record the reasons for the submission of aggressive service rates, as a result of which the company or the managers manning its divisions might have to work within tight business targets or criteria. Therefore the performance measures system for these managers should take into account
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such factors outside their control, and to restrict the measures to the relevant perspectives in the balanced scorecard. o Individual operators who execute the operations – They are tasked with executing the instructions from their divisional managers. Their performance is confined to the handling of the ground works of the business. It is unlikely that they will have influence on the capital or infrastructures deployed in the business. Instead they are likely to work within the resources provided by the company. In term of the financial impact of the company, their performance would only form a small integral part of the company’s full year financial results. Thus it is inappropriate that they are measured on the financial perspective of the balanced scorecard. It is in the area of customer satisfaction that individual employees are likely to have a significant role to play. For a services provider, the performance of its front line employees would be instantly assessed by its customers and very often the continuity of a service contract has been terminated because of poor service standards received by the customers. For strategic reasons, measures developed for individual employees should aim to encourage the improvement of service level, and should be at an attainable level and clearly related to their work scopes. Also, the measurement system applied to a line worker should be simple and easily understood. Therefore a simplified balanced scorecard is an appropriate tool to achieve the measurement of such workers’ performance.
4.2.1
Proposed Scorecard for the Management
The following table lists the suggested goals and measures considered appropriate for performance measurement of the management team of a logistics services provider. The management of a logistics services provider is the prime mover of the growth of the company. Their performance is therefore linked to that of the company. Thus the reasons to include the various goals and measures in the table are explained in greater detail in the paragraphs after the table.
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Proposed Scorecard for the Management A. Customer Perspective Goals: Measures: ? Preferred suppliers Ö Meeting KPI specified in contract Ö Adoption of suggested services ? Service Ö Adoption of company’s entrenchment proprietary systems & solutions ? Responsive supply Ö Meeting on-time delivery Ö Lead time on services ? Shared philosophy Ö Ability to implement the work philosophy of customers ? Partnerships Ö Number of cooperative efforts B. Internal Business Perspective Goals: Measures: ? Service Ö Logistics service efficiency Productivity Ö Handling of down time & overtime ? Service Excellence Ö Response time Ö Unit service cost Ö Yield from optimum resource ? New service Ö Success rate in new service introduction introduction Ö Actual introduction schedule versus plan C. Innovation and Learning Perspective Goals: Measures: ? Service skill Ö Time to develop new staff Ö Increase in level of skill of existing staffs ? Service innovation Ö Degree of innovation in services ? Uniqueness of Ö Development of alternative services services D. Supplier Perspective Goals: Measures: ? Service Quality Ö Error rate vs volume handled Ö Downtime of operations due to suppliers ? ? ? Service lead time Innovation and change Degree of cooperations
Quarterly Scores Target Actual
Quarterly Scores Target Actual
Quarterly Scores Target Actual
Quarterly Scores Target Actual
Ö Time to respond to requirement Ö On-time delivery Ö Time taken to change internal process to meet new requirements Ö Numbers of co-operation developed Table continues on next page
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E.
Financial Perspective Goals: ? Survival ? ? ? Growth Profitability Shareholder value
Measures: Ö Cash flow generated Ö Gearing level Ö Growth in revenue Ö Operating income Ö Gross Margin Ö Net profit from operations Ö Return on capital employed
Quarterly Scores Target Actual
Customer perspective should be regarded as the most important measure that a logistics services provider needs to focus on when it undertakes a contract with an international petrochemical manufacturer. In normal circumstances, the logistics services contract awarded by the customer will be on a single-source provider basis and the awarding of such a contract will be the result of a thorough selection process. It is always an achievement in itself to win a new contract or obtain an extension of the contract from a multinational petrochemical manufacturer. The customer value built up by a logistics company should therefore be maintained and enhanced as one of the core business strategies. This core strategy involves building up customer relations as the contract is being served out with the aim to differentiate itself from competitors in order to retain and deepen relationships. A services provider has the option of choosing 3 differentiators to meet the demands of customer perspective: operational excellence, customer intimacy and product leadership. Working with a multinational company, operational excellence is likely to be the best practice to adopt. The continuous excellent performance of a services provider in meeting the key performance indexes (KPI) set out in the contract would reflect the operational competency of the company. Therefore achieving KPI should remain the main ongoing focus of management and quantifiable measures should be taken to determine if the company has achieved the KPI. Another indicator of good customer relationship is the willingness to adopt suggested services. To be able to gain customer acceptance, a services provider will need to be the product leader. The next measure to determine how
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well the management has improved on customer’s acceptance is to assess how entrenched a customer’s operations is on the services provided by the logistics provider. The areas reflecting such entrenchment includes the adoption of unique information technology developed by the logistics provider, integration of the operations with the customer and execution of decisions such as the procurement of raw material. The meeting of on-time delivery and services deliverance lead time will be another form of operational excellence that will ensure the achievement of the measures under customer perspective. One of the features of services is the perishable nature of service where it is unlikely for a company to store the “services” to meet an increase in demand. Therefore the ability of a services provider in ramping up it resources to meet all on-time delivery becomes a crucial factor when its customers are operating in a seasonal business environment. Yet another measure used to determine customer perspective is the number or degree of cooperative efforts undertaken by a services provider. Internal business perspective requires a logistics services provider to find means to improve its supply chain management, the cost and quality of internal processes, assets and capacity management to achieve the level of performance required by its customers. The financial benefits from improved internal business processes would come in both short-term and long-term stages. Improved processes should immediately result in cost savings in the short term due to better operational efficiencies. In the intermediate term, the improved processes would lead to revenue growth due to customer’s trust. On a long term basis, it is normal to expect that increased innovation leads to sustained revenue growth and margin improvement. In the logistics services industry, service productivity is a crucial driver of profitability under the financial perspective performance. The service productivity performance of each operating division within the company shows how the planned manpower and infrastructure have been adequately deployed. Measures in productivity performance should not just quantify the volume output from manpower and equipment deployed but should also include how down time and overtime are being managed and controlled. Another measure of internal business processes at the management level covers service excellence in terms of response time by the company to provide services demanded by its customers and the yield from the resources used. To
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avoid stagnation in business growth which would certainly affect the financial perspective performance, management needs to explore and introduce new logistics services to stay ahead of competition. The directors and/or senior managers will need to acquire or develop new business processes and to sell the new services to its customers. The success rate of such new introduction and its comparison with the planned schedule is an appropriate measure in the internal business perspective. Innovation and Learning perspective measures how well the logistics services provider has improved the competency level and skills of its employees, the technology innovations and the corporate culture. These are factors needed to support the company’s strategy, the requirements from internal processes and high expectation of customers. The management of a company should take the lead in creating an innovation and learning environment within which the skills and experiences of its employees are developed, or are brought-in from external sources. Thus the first measure to be made on the management in this respect is the length of time invested by the company to develop new staff to the necessary skill level. The upgrading of the skill level of existing staff should also be the focus of management. To enable these measurements to be taken, the scorecard needs to have a standard length of time to develop new staff and the skill scores in various service skills of its existing staff. When measuring service innovations, the company should set the target for the number of innovative attempts required by the company and the percentage of successful and marketable innovations implemented during the measurement period. Obviously the high success rate reflects a corresponding improvement in the internal processes performance. Development of alternative services would be considered as an improvement when it leads to better processes, cost savings and customer satisfaction. Suppliers Perspective measurement allows a logistics services provider to develop a structured assessment of its business relationship with its suppliers. A sustainable and reliable third party services provider enables a logistics company to develop a longer business plan when it markets its services. The uppermost concern of the company is to ensure that its suppliers provide it with good quality service. Therefore measurement will
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be made on the error rate in relation to the volume handled by the suppliers. Downtime by suppliers will lead to idle time incurred in the logistics company’s internal processes and operations. This in turn leads to inefficiency and poor profitability. Another possible significant failure of services by a logistics services provider is linked to a let down in the on-time delivery by its suppliers. Measurement made on the on-time delivery from its suppliers helps a logistics services provider to make alternative arrangements to ensure that it meets its customers’ expectations. Equally important is the innovation and capability shown by the suppliers to assist the company in realizing its strategy. Sometime there is a requirement for the company to enter into a co-operation pact with its suppliers. However, a logistics services provider will need to watch closely the strategy and ambition of its suppliers to prevent them from becoming competitors. Financial Perspective measures the performance of management in achieving the financial goals of the company after having implemented the strategy covering the three measuring perspectives mentioned above. It is tempting for management to just use the high level financial indicators such as rate of returns and shareholder value as the measurement of their performance. Other lower level financial indicators should be included in the scorecard to enable them to investigate the contributing factors if they perform poorly in the high level financial indicators. Therefore the proposal is for the management to be measured on the cash flow generated and the gearing ratio. Cash flow provides the lifeline of a company. Hence it is fundamental that the business generates enough cash flow to meet its operational needs at all time. The cash flow to be measured should be that generated from the company’s ongoing operations as it reflects the health of the logistics business. Sufficient cash flow would ensure that manpower costs, suppliers’ services and infrastructure commitments are paid on time to avoid or reduce disruption in the company’s own service provisions. The gearing level is one of the indicators of the chances of survival of the company’s business in time of a poor economy or a temporary business downturn. The gearing measurement tracks the improvement by the management in repaying its debts as a result of improved business.
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For the measurement of sales growth, the monthly financial reports of a company would be the source of information. Indicators to be used are likely to be the revenue growth comparison between that of the current month and the previous month or that of the current year-to-date with the corresponding period in the previous year. The tracking of the historical revenue growth rate would also provide a good indicator of the effectiveness of the company’s strategies implemented in the past and those at present. Sales growth is an indication of the market share of the company. But the growth in operating income of a logistics services provider is in fact an indicator of the company’s financial performance. Operating income growth indicates the ability of the company in generating sales as well as the control of its costs. The improvement in cost control is likely due to the effective internal business processes implemented by the company and the innovation and improved technical or operational knowledge of its workforce. These factors are measured in the other perspectives of the scorecard. The measurement for profitability involves comparison of gross margin and net profit margin between different periods and by comparing the market margin. The profitability determines the rate of returns to the shareholders. The company might have achieved high growth in revenue but may produce poor profit as a result of the management’s aggressive pricing strategy to grow its business or capture market share. Therefore there is a need to measure the profitability growth to ensure that improvements in revenue actually result in a growth in profit. The profitability measures also give a clear indication of whether the considerable improvements in the company’s services capability have been translated into profitability. If the measurement in customer perspective and internal business processes perspective show that the management had made significant improvements but the financial perspective measurement had not improved, the management team should reexamine the basic assumptions of their strategy and mission. Finally for the financial perspective, management will be measured on the rate of return on the capital employed to show to the shareholders that they have produced a rate of
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return that exceeded the market rate of return. Therefore a suitable market rate of return for the logistics business in the place of operations would be determined as the benchmark for comparison. If the performance indicators in the rest of the perspectives show high achievement, there should be a corresponding high level of financial performance in terms of shareholder value created. If the good performance in the other perspectives does not translate to shareholder value gain, the balanced scorecard measurement system implemented by the company will be put in doubt. Having devised the measurement indicators in order to track the performance of management, it is important that actual readings be taken on a regular basis to ensure that problems in the business are addressed immediately. It is proposed that a logistics services provider should review the performance indicators shown in its performance scorecard on a quarterly basis during its financial year. This quarterly review enables all implemented processes, decisions or innovations to have sufficient length of time to influence the operations and business. Shorter review periods for the scorecard might cause the company to discontinue beneficial processes or decisions prematurely whereas a longer review interval might result in problem areas or damages to business not being rectified early enough.
4.2.2
Proposed Scorecard for Managers
The following table lists the suggested goals and measures considered appropriate for the performance measurement of managers who have responsibility for the daily running of the business divisions within the company. By measuring the performance of the managers of all the divisions within a company, the scorecard also provides information on how well the divisions have performed in achieving the company’s strategy. The scorecard for managers only covers those of the perspectives with their respective goals and measures. The reasons for managers to be measured by the listed perspectives are explained briefly in the subsequent paragraphs as a detailed explanation on the use of all perspectives has already been discussed in the measurements for the management.
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Proposed Scorecard for Middle Managers A. Customer Perspective Goals: Measures: ? Service quality Ö Meeting KPI on services performed by the division ? Responsive supply Ö Meeting on-time delivery Ö Lead time on services ? Partnership Ö Co-operative efforts initiated by initiative the division B. Internal Business Perspective Goals: Measures: ? Service Ö Service efficiency of the division Productivity Ö Percentage of down time & overtime ? Service Excellence Ö Divisional Unit service cost Ö Yield from the resources deployed ? New service Ö Service improvement initiative initiative Ö Success rate in new service introduction in the division C. Innovation and Learning Perspective Goals: Measures: ? Service skill Ö Time to develop new staff Ö Increase in level of skill of existing staff ? Service Ö Initiative on service innovation innovations Ö Realization rate of innovation D. Financial Perspective Goals: Measures: ? Growth Ö Growth in divisional revenue ? Cost control Ö Reduction of operating costs Ö Reduction of wastage & idle time ? Profitability Ö Divisional Gross Margin Ö Divisional Net profit ? Value added Ö Divisional Return on resources
Quarterly Scores Target Actual
Quarterly Scores Target Actual
Quarterly Scores Target Actual
Quarterly Scores Target Actual
This measurement caters to the middle level managers of a logistics services provider. Therefore it is sensible to fine tune the management’s scorecard in order to eliminate those performance indicators not within the control of these mid-level managers. A logistics services company would likely breakdown the whole spectrum of the logistics
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operations into workable divisions so as to achieve efficiency and greater service specialization. Individual managers will be appointed to oversee the divisions. The measurement concerning customer perspective remains important as many operational divisions will be in direct contact with the company’s customers. Therefore, meeting customers’ expectation is one of their important functions. Also, the contractual KPI in the service contracts would likely be operations specific. Such KPI were put in place to determine the quality and availability of services of the various components of the logistics operations. Therefore, meeting KPI, improving service quality and enhancing customers’ relationship become the main focus of measurement. To enable the operations division to meet the customer’s expectation, each division must first establish effective internal business processes. These processes would have been laid down before the start of the logistics contract. But as time progresses, they will be asked to improve on the efficiency of their operations in order to meet the financial targets or increasing customer expectations. Thus the measures on the division’s performance in internal business processes will include the yield factors, down time reduction, better new processes, etc. Without the innovation and learning efforts from the division managers, it is unlikely the customer’s expectations or the requirement to improve on internal processes can be met. Therefore, measurement would need to be made on the efforts taken by the managers on the training of its staff or acquisition of innovative ideas. With the efforts made by managers in the customer perspective, internal processes and innovative perspectives, the company should be able to expect healthy financial performance from the divisions. In the measures to be made on performance on financial perspective, the goals to be met would cover growth, cost controls, profitability and value added. Through the segregation of these financial information for each division, the management can easily focus on the divisions which have failed to contribute to the company’s financial targets.
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4.2.3
Proposed Scorecard for individual operators
In most cases, companies will use an annual appraisal system which is linked to their remuneration system to assess the operators’ performance. However, such a human resource focused appraisal system would likely consider only the attendance records, work performance, skills and experience, etc of the employees. The appraisal system does not clearly align the assessment of the performance of its operators with the company’s growth strategy and mission which focuses on customers, internal processes, learning & innovation and financial perspectives. The following table lists the suggested goals and measures considered appropriate to align the company’s strategy with the performance measures for operators. Proposed Scorecard for Individual Operators A. Customer Perspective Goals: Measures: ? Service quality Ö Meeting KPI on services performed Ö Error rates of individual worker ? Responsive supply Ö Meeting on-time delivery B. Internal Business Perspective Goals: Measures: ? Service Ö Service efficiency Productivity Ö Percentage of down time ? Service Excellence Ö Yield from the working hours C. Innovation and Learning Perspective Goals: Measures: ? Service skill Ö Increase in individual skill level ? Service Ö Identification of problems in innovations service D. Financial Perspective Goals: Measures: ? Growth Ö Increase revenue per headcount ? Cost control Ö Reduction of wastage in resources Ö Reduction of idle time
Quarterly Scores Target Actual
Quarterly Scores Target Actual
Quarterly Scores Target Actual
Quarterly Scores Target Actual
The above measures for individual workers concentrate on the contributions under the control of workers themselves. The KPI target for the division should be applied onto the workers as they are the ones who need to perform the services that should meet the KPI targets. The scorecard therefore acts as a clear notice to the individual workers of the 44
required customer services standard expected from them. In logistics services, customers are likely to lose confidence if there are repeated missed or wrong deliveries due to errors made by the company’s workers. The impact could include additional shipment costs to be borne by the logistics services provider or compensation in lost sales in a worse case scenario. Therefore measurement on the error rates of individual workers and the on-time delivery of the services performed by them allow the company to identify poor performers who had failed in meeting the company’s strategy on customer perspective. The other three perspectives included in the measures are aimed to encourage an increase in the productivity of individuals. Yields from the packaging plant may drop due to workers who intentionally slow down their work if there is no measurement on individual yields. Wastage of materials used in the logistics services may increase if workers are not measured on the costs related to their wasteful behavior. Equally important will be the upgrading of the skills level of individual workers. This is particularly important in the technical and maintenance divisions. Workers who have continuously upgraded their knowledge with the latest technologies will be able to make proposals for improved alternative services practices.
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5
Implementation of the Scorecard Performance Measures
In the literature review of the balanced scorecard of Kaplan and Norton in Section C above, I mentioned that they had observed that usually the financial experts are the ones who design and oversee most non-scorecard based performance measurement systems. Their opinion is that a company intending to implement a scorecard based measurement system should also include its senior operational managers who have the full picture of the company’s vision and priorities. Also the adoption of the above scorecard measures involves an overhaul of a company existing control system. Changing from a control system previously based on financial results to one that emphasizes both financial and non-financial issues requires a change of mindset and the company’s internal culture. To make a smooth switch, a logistics services provider might have to consider the following implementation issues: ? Ensure that the implementation process has been properly communicated within the company. The process should be started with the objectives being clearly laid down by the management and the linkage to the strategy of the company should be explained. ? The involvement of the decision makers in the company should be obtained right from the formation stage of the performance scorecard. It is important that the Chief Executive Officer has to be the first one to buy in to the idea of the change to the new performance system. Once the leader has made his/her intention clear within the company, it should be easier to obtain the participation of other division managers within the company. ? The company should not underestimate the time, effort and cost required to implement the scorecard measurement system. A scorecard based measurement system requires focus to be placed on both financial and non-financial factors affecting the company’s strategy. Therefore management will need to consider a suitable set of goals and their related measures that are acceptable. For example when considering the goals for customer perspective, a logistics services provider has to consolidate the KPI and the diverse expectation of all its customers in order to find 46
the appropriate measures concerning the customer perspective. Due to the different influence in the execution of operational decisions, suitable financial measures are to be considered before they are applied to the divisions or employees. There may be a need to consider obtaining external help in the event that there is a lack of internal experienced personnel who can implement the performance measurement system. ? The implementation of a scorecard based measurement requires the company as whole to take steps to improve on its level of performance toward external and internal parties. When one division has to depend on the services from another division, conflicts may occur. The company should set up a framework to resolve the conflicts arising as a result of the implementation of the scorecard. This framework should be equipped with a clear line of authority and steps which the affected employees can take to resolve the conflicts. ? The management should recognize that the scorecard measurement system is dynamic and will change over time to meet the change in the business strategy. For example an addition of a major customer may require a logistics services provider to rethink its measures to ensure that its employees keep up to the expectations of its new customer. In recent year, safety and environmental issues have become the main focus of many petrochemical producers. Therefore the goals and measures have to be adjusted in the customer perspective in the scorecard in order to reflect the concerns of the customers. In the financial perspective, the stage of the service life-cycle may require the company to adjust its financial goal. Apart from implementation issues, another area of likely concern to the managers of a logistics services provider is the financial results used in performance evaluation under the financial perspective. The ultimate aim of a scorecard is to measure whether the activities undertaken result in an increase in shareholder value of the company. This shareholder value is derived from financial figures when the company nets off its operating revenues against its operating expenditures. For a manufacturing or a trading company, their operating revenues are likely to be the product costs plus certain margin which are both fairly simple to determine through their
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manufacturing or trading processes. However, logistics services providers in the polymer industry are likely to price their services on a piece rate basis. The rates are derived by dividing the total projected operating cost of manpower and equipment with the output quantity from the operations. The output quantity is usually based on a best guess of the projected output volume provided by their customers. Smart customers might provide a high estimate of projected volume in an attempt to reduce the piece rates. Eager commercial personnel from the logistics services provider might purposely disregard working out a reasonable output and instead consciously use customer provided volume to price the services at below costs. The effect of this aggressive pricing strategy is a low margin or a loss from the project. Also excess resources might be committed in the project which leads to a low productivity in the divisions undertaking the project. The end result is a group of resentful division managers who are being measured on factors beyond their control. Therefore it is essential for a logistics services provider to use an appropriate costing system to price their services when they tender for projects. This costing system not only helps to reduce error in pricing its service rates but also to eliminate fraudulent pricing by the commercial personnel. The service rates derived from such a costing system would be readily accepted by the operational divisions in measuring their performance. To meet this demand, an ActivityBased Costing (ABC) system would be a right pricing platform for the commercial managers of a logistics services provider. Horngren has suggested this costing system as being able to provide a better measurement of the non-uniformity in the use of an organization’s overhead resources. ABC system focuses on individual activities as the fundamental cost objects; it also focuses on the allocation of direct and indirect costs to the activities. It makes a distinction between the 2 costs with emphasis on spreading indirect costs; direct costs can be traced to products or services relatively easily. It enables users to assign all direct costs to the individual activities (cost objects) and to allocate the indirect costs on the basis of the actions undertaken to perform the activities. A logistics services provider should be able to adopt ABC fairly easy as the individual activities to be used in an ABC system can usually be identified easily with the type of activities that a logistics services provider wishes to contract with its customers. The costing process also will
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lead to the creation of a budget of the whole project in which the outcomes from the project can be studied by the company before tenders are sent out. This budget can subsequently be used as targets on which performance can be measured. If we adopt the recommendation of Horngren for the services sector to implement ABC, a logistics services provider would follow a seven-steps approach to determine the unit costs of the various activities as stated in the above table. A desired profit margin would be added to the derived unit costs in order to price the services rates to be quoted to customers. The seven-steps approach is as follows: Step 1: Identify the chosen cost objects Step 2: Identify the direct costs of the services Step 3: Select the cost-allocation bases to use for allocating indirect costs to the services Step 4: Identify the indirect costs associated with each cost-allocation base Step 5: Compute the rate per unit of each cost-allocation base Step 6: Compute the indirect costs allocated to the services Step 7: Compute the total costs of the services by adding all direct and indirect costs
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6
Linkage of the performance scorecard to remuneration system
It is probably the choice of most companies which have implemented a performance measurement system to link the employees’ performance scores with their remuneration system. The linkage of the performance scorecard to remuneration should be carefully considered by a logistics services provider. For an ambitious employee, the performance scorecard offers him the best barometer to measure his efforts in helping the company to achieve its strategy. He will be able to make adjustment or improvements in the areas in which shortcomings have occurred. The linkage to the remuneration system enables such an employee to have a clear understanding and acceptance of his rewards. On the other hand, an uninitiated employee may find the various goals and measures in the performance scorecard a source of unhappiness and dissent. Linkage of the scores to the remuneration will further compound the dissatisfaction if the goals and measures have been set at the high end of the spectrum. The following suggestions are recommended: ? The linkage of the remuneration system at the initial implementation of the performance scorecard should be managed properly to avoid leading the employees to focus on rewards rather than the goals and measures in their scorecards. Employees would instead neglect the linkage of the various perspectives to the company’s strategy. A trial run of the scorecard without linkage to remuneration at the initial stage would allow employees to understand the purpose of the scorecard and help in getting to focus their attention away from remuneration. ? Only a portion of the remuneration should be linked to the performance score. The proportion of linked remuneration should be smaller at the initial period of the implementation of the scorecard. This will enable employees to adapt to the change and to adjust their performance to be in line with the measured criteria. New employees should be given sufficient time for adequate adaptation before their remuneration is linked with all the perspectives in the scorecard. ? Segregate the degree of linkage in accordance with the seniority of the employees. Senior management’s remuneration should be linked to all the perspectives in the scorecard with emphasis on selected areas depending on their responsibility.
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Financial goals are likely to be the main driver on their remuneration as improvements in other non-financial goals should result in better financial results for the company. For the junior managers and operational workers, it is more appropriate to link their remunerations to operational measures in customer and internal business process perspectives. ? The scorecard aims to measure the performance of managers across several perspectives. The remuneration system used should be able to deal with the trade-offs between the perspectives in the scorecard. Appropriate remuneration rules should be in place to resolve cases of employees who have exceeded some targets but missed out on the others. Suitable remuneration rules on the distribution of rewards would have an encouraging and motivating effect on the employees. ? Even out the reward for good performance over the measurement period rather than a lump sum pay out at the end of that period. As the recommended performance measurement system calls for quarterly reviews of the performance, a flexible remuneration payout structure can be implemented in which a small proportion of the reward may be paid out before the year end. Such a system should lead to employees’ satisfaction on their ongoing efforts or would encourage improvements when the targets are not met. A remuneration system in which a lump sum bonus is paid out only at the end of the measuring period might cause reduced interest in pursuing goals set out in the scorecard. ? To use a mixture of monetary and non-monetary reward system. Such a remuneration system is likely to be welcomed by the senior managers in the company. The nonmonetary reward may come in the form of career progress, equity participation, involvement in executive decision making, etc which all serve as a recognition of status for the employees. However, there are problems in linking remuneration with the performance scorecard when a company is faced with changing market conditions. For a logistics services provider which concentrates on the petrochemical industry, the fast changing petroleum market and the influence 51
of the state owned petroleum companies in oil producing or user countries is likely to affect its market share in logistics services. As a result the company would need to redefine its strategy frequently and this will lead to the refocusing of the performance goals and measures in the perspectives of its scorecard. As these goals and measures are changed, the remuneration linkage will have to be modified. The frequent changes in the remuneration system could lead to confusion on the part of managers as they will find it difficult to establish the alignment of their efforts to the goals in their scorecards.
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7
Performance Measures problems
In this section, I will discuss the problems associated with the use of performance measures adopted by a logistics services provider. The problems arising as a result of the implementation of a performance measurement system is very often due to a mismatch of organizational and individual goals. As discussed in the earlier section on the need for a logistics services provider to focus on financial and non-financial areas, individual employees too would focus on the financial and non-financial aspects of their employment. The concerns of employees would include monthly remuneration, future benefits, long-term career development, job security and satisfaction, the industry in which the company operates in, etc. These personal goals might be in conflict with the company’s goals and may result in employees not striving to ensure the achievement of the company strategy. Problems are: ? Tunnel vision – this occurs when undue focus is placed on the performance measures to the detriment of other areas. For example an over emphasis on maximizing the yield from working hours could lead to overlooking workers’ need for adequate rest, which inadvertently leads to errors, to the detriment of the quality of service rendered, thus affecting customer’s satisfaction. ? Sub-optimisation – the employees may focus on some selected targets considered favourable to them and leave others not achieved. For example technical personnel might proceed to procure a liquid filling machine with added features in order to improve their process perspective measure. But this may result in excess capacity not needed in the liquid filling operations division and thereby cause a poor performance in the yield factors overall. ? Myopia – refers to the undue focus being made on short-term objectives and neglecting the longer term objectives. An example would be setting of high service rates in the hope of recovering the initial capital investment in order to provide a better shareholder’s value creation. But the longer term objective under the customer perspective may be adversely affected as the customers may move out the region due to their uncompetitive cost 53
structure. Other forms of myopia in the logistics services include failure to invest in staff training or grooming in the shorter term which may result in the failure of the company to improve on its processes in the longer term. ? Measure fixation – Sometimes the managers may select options in order to achieve specific performance indicators which may not be effective. For example, managers may select a less reliable forklift truck with lower leasing cost in order to improve the unit cost measure. But the action may result in frequent break-down of the machine which causes the unsatisfactory performance in productive yield indicator. ? Misrepresentation – this may be resorted to in order to mask a less than favourable performance measurement result. As an example, the petrochemical customer imposes a KPI for an acceptable safety level, which is a maximum number of down days due to industrial accidents. Where this level has been exceeded, the division manager might be inclined to misrepresent days off resulting from accidents as due to general ill health just so that the performance measure result is acceptable.
?
Gaming – this problem is encountered where managers try to gain some strategic advantage by deliberately falsifying or distorting the performance measure. For example, there may be an intentional under performance in one period so that targets set in subsequent periods would not be too high. Where the performance measure is set on the financial perspective of controlling the cost of wastage of resources, workers may deliberately incur more wastage when, in reality, they could easily achieve a higher rate of waste reduction. This is so that the targeted waste reduction set for the next period would be easily achievable for the workers.
?
Ossification – refers to the reluctance to change the performance measure scheme once it has been set up. As mentioned earlier, the scorecard measurement system is dynamic and should be adapted over time to meet changing business strategies or priorities. As an example, acquisition of a major new customer who pays serious attention to
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environmental issues may force a logistics services provider to adjust its goals and measures to incorporate the demands and expectations of this new customer. ? Misinterpretation – here, there is a failure to appreciate the complexities of the environment in which the company operates. In the logistics services industry, this might be a failure to recognize a need to diversify its customer base, resulting in an overreliance on a single large customer. Staff and management might be reluctant to source for other customers, as they have fallen into a comfortable cushy relationship with the existing customer. Having new customers may very well mean having to adopt different ways of operations, meet different customer specifications, expectations, etc. However, the complexities of the business environment may very well mean that the customer may not renew its contract for logistics services with the same company, having obtained a more attractive quote from a competitor.
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8
How to address Performance Measures problems
Imperfections are bound to exist in any proposal or schemes – this must be acknowledged firstly before we can deal with the problems. The following are some suggestions to minimize the impact of such shortcomings: ? Staff involvement at all levels – they must be involved at the very beginning, i.e. at the development and implementation stages. This will go some way towards solving the problems of gaming and tunnel vision, as when staff is fully engaged and consulted, they are more willing and inclined to work towards the performance measures meant to monitor their work performance; this is because their own input have helped to form and shape the performance measurement eventually adopted by management. ? Flexibility in the use of performance measures – To solve the problems of fixation and misrepresentation, performance measures cannot be relied on exclusively for control purposes. Sometimes, actions or activities which result in long-term gains may not reflect positively when performance measures are applied towards short-term objectives. ? Focus on customer satisfaction – with this very clear and utmost objective in mind at all times, the problems of tunnel vision and sub-optimisation can be reduced to a great extent. Workers, managers and management must always bear in mind that the overriding consideration must always be a continuous and improved levels of customer satisfaction, otherwise the organization is underachieving on all counts of performance measures. ? Quantification of all objectives – this is to counter the problem of sub-optimisation. Quantification may prove to be elusive with some of the non-financial objectives, for example, on environmental impact. However, the idea here is that the organization should try its best to put into numerical figures all its objectives – this is to promote a greater understanding of its goals, hence people will know what action to take to achieve the intended objective, instead of working towards some vague or ambiguous or imprecise goal.
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?
Guarantee integrity of the data used by having an audit – such an audit will ensure that data used in the performance measurement is carefully analysed and interpreted, hence minimizing the problems of misinterpretation, gaming and measure fixation.
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9 1.) 2.) 3.) 4.) 5.) 6.) 7.) 8.) 9.)
Key references Starbuck, W.H. (2005), ‘Performance Measures : Prevalent and Important but Methodologically Challenging’ Journal of Management Inquiry, September 2005. Brown, G (1998), ‘Accountability and Performance Measurement’ ACCA Students’ Newsletter, August 1998. Horngren C T, Bhimani A, Datar S M, & Foster G (2005), Management and Cost Accounting, 3rd Edition, FT Prentice Hall. Johnson, S (2005), ‘The Pyramids and Pitfalls of Performance Measurement’ ACCA Students’ Newsletter, September 2005. Kaplan, R S and Norton, D P (1992), ‘The Balanced Scorecard: Measures That Drive Performance’ Harvard Business Review, January/February 1992. Martin J (2005), Organizational Behaviour and Management, 3rd Edition, Thomson Learning. Lynch R L, and Cross K F, (1991), Measure up!: Yardsticks for Continuous Improvement 1st Edition, Blackwell (USA). Neely A and Adams C (2002), The Performance Prism, Cranfield School of Management, March 2002. Simon J (1999), ‘Company Valuation and Performance Measurement’ ACCA Students’ Newsletter, April 1999.
10.) Kaplan, R S and Norton, D P (2000), ‘Having Trouble with Your Strategy? Then Map It’ Harvard Business Review, September/October 2000.
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