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CHAPTER

11

Chapter 11 – Performance Evaluations Revisited: A Balanced Approach

Performance Evaluation Revisited: A Balanced Approach

Learning Objectives

1. Identify the desirable characteristics of performance measures. (Unit 11.1)2. Explain how to use a balanced scorecard to improve an organization’s performance. (Unit 11.2)3. Explain how to use benchmarking to improve an organization’s performance. (Unit 11.3)4. Calculate delivery cycle time, manufacturing cycle time, and manufacturing cycle efficiency.

(Appendix)

Summary of End of Chapter Material

Difficulty: E = Easy, M = Moderate, D = DifficultBloom: K = Knowledge, C = Comprehension, AP = Application, AN = Analysis, S = Synthesis, E = EvaluationAACSB: A = Analytic, C = Communication, E = EthicsAICPA FN: DM = Decision modeling, RA = Risk Analysis, M = Measurement, R = Reporting, RS = Research, T = TechnologyAICPA PC: C = Communication, I = Interaction, L = Leadership, P = Professional demeanor, PM = Project Management,

PS = Problem Solving and Decision Making, T = TechnologyIMA: BA = Business applications, BP = Budget Preparation, CM = Cost Management, DA = Decision Analysis,

PM = Performance Measurement, R = Reporting, SP = Strategic Planning

Item L. O. Difficulty Level

Minutes to Complete

Bloom’s Taxonomy

AACSB AICPA FN

AICPA PC

IMA EthicsCoverage

GUIDED UNIT PREPARATIONUnit 11.1

1 1 M 10 K, C A M PS PM2 1 M 3 C A M PS PM3 1 E 6 K, C A M PS PM4 1 E 2 K A M PS PM5 1 M 4 K A M PS PM

Unit 11.21 2 M 3 C A M PS PM2 2 E 2 K A M PS PM3 2 D 3 C A M PS PM4 2 M 3 C A M PS PM5 2 E 2 K A M PS PM6 2 D 6 C A M PS PM

Unit 11.31 3 E 3 K A M PS SP, PM2 3 M 3 C A M PS SP, PM3 3 E 2 K A M PS SP, PM4 3 D 6 C A M PS SP, PM

Appendix1 4 E 2 K A M PS PM

11-1

photo: © jsnyderdesign / iStockphoto

Solutions for Davis & Davis, Managerial Accounting, 2nd ed.

2 4 M 3 C A M PS PM3 4 E 2 K A M PS PM4 4 M 4 C A M PS PM5 4 M 2 K A M PS PM6 4 M 3 C A M PS PM

Item L. O. Difficulty Level

Minutes to Complete

Bloom’s Taxonomy

AACSB AICPA FN

AICPA PC

IMA EthicsCoverage

EXERCISES11-1 1 M 5-7 AP A DM PS PM11-2 1 M 10-12 C A DM PS PM11-3 1 M 10 AP, AN A DM PS PM11-4 1 D 8-10 AP, AN A DM PS PM11-5 2 E 8-10 C A DM PS PM11-6 2 M 10-12 C A DM PS PM11-7 2 D 10-12 C A DM PS PM11-8 2 M 10-12 C A DM PS PM11-9 1, 2 E 5 C A DM PS PM11-10 3 E 8-10 AP, E A DM PS PM, SP11-11 4 M 10 AP A DM PS PM, SP11-12 4 M 4 AP A DM PS PM, SP11-13 4 D 15 AP A DM PS PMPROBLEMS11-14 1 D 10-15 C, AN A DM PS PM11-15 2 D 20-25 AN A DM PS PM11-16 1, 2 M 15-20 C A DM PS PM11-17 1, 2 D 25-30 AP, AN A DM PS PM11-18 4 D 25-30 AP, AN, E A DM PS PMC&C CONTINUING CASE11-19 2 D 10-15 C, AN A DM PS PMCASES11-20 1, 2 D 45-50 AP, AN, E A DM PS PM

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SOLUTIONS TO QUESTIONS

Unit 11.1

1. Lagging indicators are measures of outcomes that answer the questions “How did (fill in the blank) do?” and “What did (fill in the blank) achieve?” Their calculation “lags” the performance that is being measured, indicating whether a particular objective has or has not been met. Some examples of lagging indicators include net income, EVA, and market share.

Leading indicators are measures of inputs and help to predict a future result. Some examples include investment in employee training, percent of on-time deliveries, and number of new patents.

Depending on what is being examined, a measure can be both a leading and lagging indicator. For example, defect rate is a lagging indicator of production quality. However, it is a leading indicator of customer satisfaction.

2. Managers need to use leading indicators to help predict future performance and lagging indicators to provide evidence on the success of prior decisions or actions.

3. A financial measure of performance is one denominated in dollars. Some examples are net income, sales revenue from new customers, and cost per unit. Nonfinancial performance measures are denominated in a unit other than dollars. Some examples include defect rates, employee turnover, and customer satisfaction.

4. SMART measures are those that are specific, measurable, actionable, relevant, and timely.

5. Key performance indicators (KPIs) reflect critical success factors and measure successful progression toward the organization’s goals. Managers must understand the organization’s strategy and the cause-and-effect relationships that exist between measures before selecting KPIs.

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Unit 11.2

1. The balanced scorecard integrates measures across four distinct perspectives to guide operations toward achieving a corporate strategy. The measures are selected based on an understanding of cause-and-effect relationships between the measures and the strategy.

2. The four areas of the balanced scorecard are learning and growth, internal business processes, customer, and financial.

3. Financial data are lagging indicators of performance, and leading indicators of performance are necessary to successfully guide the organization. Also, many important leading measures, such as customer satisfaction, are not measured in financial terms.

4. An organization’s strategy is at the heart of the balanced scorecard. Since each organization’s strategy differs, the balanced scorecard that monitors progress toward that strategy will differ.

5. A strategy map is a pictorial representation of an organization’s strategy and the cause-and-effect relationships embedded in that strategy.

6. An organization can spend significant financial resources attempting to improve customer satisfaction and market share. However, the additional contribution margin generated by the additional sales may not be adequate to cover the cost of the additional expenses. Therefore, the overall financial health of the organization will decrease, even though customer satisfaction and market share have increased.

Unit 11.3

1. Benchmarking is the practice of using data from other organizations to identify the processes and practices associated with world-class performance. Benchmarking is not about trying to achieve another company’s metrics, but about replicating the successful practices that led to their outstanding metrics.

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2. Companies have many of the same processes, such as processing accounts payable invoices. The processing in these areas is not industry-specific, so benchmarking with a company in another industry still yields helpful benchmarks.

3. Best practices are processes and practices associated with world-class performance.

4. Companies should follow common-sense practices when benchmarking. Participants should adhere to the Benchmarking Code of Conduct, which provides general principles to follow during the benchmarking process. Benchmarking does not require an organization to share trade secrets or proprietary information. What is shared is information about processes and process metrics. Another option for collecting benchmarking data is to participate in collaborative efforts such as the APQC’s Open Standards Benchmarking CollaborativeSM.

Appendix

1. Delivery cycle time is the time between when a customer’s order is received and when that order is shipped to the customer.

2. Managers must make a trade-off between the reduced delivery cycle time and the cost to implement process changes needed to achieve that reduction.

3. Manufacturing cycle time, or throughput time, is the time from the start of production of a customer’s order to the shipment of the product to the customer.

4. Value-added activities: conversion of raw materials into finished products, i.e., the actual making of the product units.

Non-value-added activities: inspection, moving, waiting

5.

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6. Perfect manufacturing efficiency is 1.0. That number is not attainable since there is no way to remove all non-value-added activities from the production process.

SOLUTIONS TO EXERCISES

Exercise 11-1

Hardware growth is a leading indicator of future sales of supplies because as sales of hardware increase or decrease, so do anticipated sales of supplies. The revenue from hardware sales is a lagging indicator of performance.

Exercise 11-2

Leading

Lagging Qualitative Quantitative

a. Customer satisfaction score x x

b. Guest room cleanliness score x x

c. Annual investment in linens x x

d. Employee retention x xe. Return visits per year x xf. Time to respond to

reservation requests x x

g. Percentage of guest rooms ready at check-in x x

h. Employee satisfaction x xi. Customer referrals per

year x x

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Exercise 11-3

Possible measures include: Average wait in teller line Average wait in drive-through line Average wait to meet with customer service representatives Number of customer complaints per month Average time to resolve customer complaints Number of new accounts opened Number of accounts closed for reasons other than relocation Employee satisfaction Number of accounts/services per customer

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Exercise 11-4

a. Inexpensive/low quality packing materials could be used to reduce costs with the result being higher returns of damaged merchandise or claims against the company. The same is true for a low quality method of delivery. Low cost delivery may also lead to missed delivery dates. Each of these actions would lead to lower customer satisfaction.

b. Leaving the gate before passengers are secure could affect safety; leaving the gate before all bags are loaded will decrease customer satisfaction. Pilots could be tempted to leave on time without reporting minor mechanical problems.

c. Machines could be left running without being productive, increasing electricity and maintenance costs. Overproduction to keep machines running will increase inventory and the costs associated with holding and insuring inventory. Workers may choose to forego preventive maintenance in the short run which may result in significant machine downtime in the future.

d. Accounts could be opened for customers who have no legitimate business purpose with the organization—friends, relatives of the salesperson. Salespeople may open accounts for people with poor credit, resulting in higher levels of uncollectible accounts. Processing the account information will consume resources in other parts of the organization.

Opening more accounts than the salesperson can manage may lead to poor service, decreasing customer satisfaction.

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Exercise 11-5

Many measures can be proposed for each measure. Therefore, the following are offered as a possible solution.

Financial: Operating profit growth – Management needs to know that the strategy of “no-frills service” is paying off financially in terms of the revenues generated and costs incurred.

Customer: Number of repeat customers per month – This measure will indicate whether the airline is meeting the needs of people who use the airline for repeat/commuter service.

Internal business processes: On-time departure % – Businesspeople who travel just for the day need to arrive at their destinations for a specific purpose at a specific time. They need the airline to be reliable on this measure.

Learning and growth: Employee efficiency – For the airline to maintain a high percentage of on-time departures, the employees are going to have to be able to complete their tasks well and with limited delays.

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Exercise 11-6

Student answers will vary; however, here are some measures they may provide.

Dollar investment in research and development: Innovation will require a high investment in developing new technologies.

New product designs per month: To stay on the cutting edge, new ideas and products have to be generated continually.

Average time from product concept to market: New products have to be designed, tested and brought to market quickly to keep customers satisfied and to maintain market share.

Number of products in development: A steady pipeline of products under development must be maintained to continue to meet the demand for new technologies.

Number of patents held: New technological innovations are needed to support product development.

Number of patents in development: New technological innovations are needed to support product development.

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Exercise 11-7

Student answers will vary; however, here are some measures they may provide.

Number of employees with professional certification: Most certifications require continuing education to maintain knowledge and skills necessary for continued improvement.

Employee satisfaction: Higher satisfaction should lead to lower turnover and increased productivity.

Employee turnover: Design teams that have successfully created innovative designs establish rapport that facilitates success on subsequent projects.

Average training hours per employee: Creative teams must develop skills in new methods and technologies to maintain their effectiveness in a changing market.

Number of design awards: Professional organizations recognize leaders with industry awards.

Budgeted training dollars: Creative teams must develop skills in new methods and technologies to maintain their effectiveness in a changing market.

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Exercise 11-8

Perspectivea. Number of customer complaints Customerb. Employee turnover Learning & growthc. Net profit per house constructed Financiald. Turnaround time on customer

design changesInternal business processes

e. Hours of training per employee Learning & growthf. Average labor cost per house Financialg. Dollars invested in new equipment Learning & growthh. Grade (quality) of brass fixtures Internal business processesi. Variances between budgeted and

actual costs of building a houseFinancial

Exercise 11-9

On-time arrival rate is a leading indicator of customer satisfaction. It is a lagging indicator of employee efficiency.

Exercise 11-10

World-class manufacturing is not about the perceived quality or reputation of a product such as a watch or an automobile. Rather, it is about implementing the best processes that produce the product. World-class manufacturing is achieved by implementing best practices not only on the actual production line, but also in all supporting functions. These best practices may be found in organizations whose products are not readily identified as “quality” or “image” products.

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Exercise 11-11

Activity Minutes

Minutes

Processing order 15 -Waiting for copying to begin 25 -Copying 20 20Waiting for binding 30 30Binding 10 10Packing for customer 4 4 a. Delivery cycle time 104 b. Manufacturing cycle time 64

Exercise 11-12

Manufacturing Cycle Efficiency= 90-3690

=60%

Exercise 11-13

Activity ManufacturingTime (in minutes)

Value-addedTime (in minutes)

Pull calling cards from inventory

15 -

Set up machine for font style and color

2 -

Process calling cards 40 40Inspect cards 5 -Wait for packaging 16 -Package cards for

shipping2

Wait for pick up by FedEx 120 - Total 200 40

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Process order and wait for production to begin occur before the production begins and are therefore excluded from the calculation of manufacturing cycle time. They would be included as part of delivery cycle time.

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SOLUTIONS TO PROBLEMS

Problem 11-14

Customer satisfaction scores dipped dramatically in March but repeat sales did not dip until May. This would suggest that customer satisfaction scores are a leading indicator of repeat sales. Supporting this relationship is the recovery of customer satisfaction scores followed by an increase in repeat sales.

Sales to new customers were flat for several months and started to fall four months after customer satisfaction scores fell. It could be that it took time for the reputation effect of the low quality materials to reach potential new customers. By the end of the year, new customer sales were increasing, though again this measure lags the other two by several months.

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Problem 11-15

There is no single correct strategy map for these companies. The following strategy maps are offered as suggestions.

Kohl’s Strategy Map

Neiman Marcus’s Strategy Map

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Problem 11-16

a.Objective Perspective Maintain and improve the quality of

clinical servicesInternal business processes

Improve patient service CustomerEnhance employee recruitment and

retentionLearning & growth

b.Metric Perspective Patient satisfaction score CustomerNumber of medication errors Internal business processesNursing turnover rate Learning & growthReadmission rate Internal business processesNumber of new hires Learning & growthEmergency room wait time before

treatmentCustomer

Nurse-to-patient ratio Internal business processesLikelihood of patient recommending

the hospitalCustomer

Number of patient complaints CustomerEmployee satisfaction with incentive

systemsLearning & growth

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Problem 11-17

a.

Adapted from Peter Vlant, “What Does Strategy Mapping Have to Do With HR?” June 2007 Human Capital Magazine, http://www.hcamag.com/hca_aus/detail_article.cfm?articleID=940

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Problem 11-17, continued

b.

Perspective Objectives MeasuresFinancial Reduce cost to hire a

candidate Average cost to hire candidate Percent reduction in annual average

cost to hire candidateContain organizational recruitment cost

Average cost to recruit candidate Total recruitment cost

Achieve EBIT target Annual EBIT Quarterly EBIT

Customer Reduce time needed to hire a new candidate

Average time to hire candidate Average time between application

receipt and initial interviewImprove employee engagement

Employee satisfaction score Annual employee review rating by

supervisorReduce employee-initiated turnover

Percent reduction in annual turnover rate

Internal business processes

Implement recruitment management system

Percent of applicants processed in system

Average time to identify appropriate recruits for openings

Implement performance management program

Percent of employees participating in program

Average time to complete performance reviews

Learning and growth

Educate managers on new hiring process

Percent of managers completing training

Train HR staff on links between engagement and performance management

Percent of HR staff completing training

Train managers in performance management

Percent of managers completing training

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Problem 11-18

Activity

a.Manufacturing time

b.Value-added time

Materials moved to production floor 25 -Production in station 1 35 35Materials moved to station 2 5 -Wait to begin at station 2 8 -Production in station 2 45 45Inspection 3 -Materials moved to finished goods

inventory 6 -

Total 127 80

c.Manufacturing Cycle Efficiency= 80

127=63%

d. Moving materials to Station 1 takes a long time. In fact, 36 minutes (28%) of the total manufacturing cycle time is needed for moving. The first step that managers should take is to evaluate why so much time is needed to move work-in-process. It is possible that rearranging workstations could eliminate considerable non-value-added time.

The next area for managers to review is the wait between stations 1 and 2. Getting the materials to station 2 faster will not improve overall production time if there is a bottleneck at station 2.

The final area to review is inspection. The number of defective items that reach the inspection area should be monitored, and the reason for the defects should be identified. If possible, employees at each station should be given the responsibility to inspect with the goal of eliminating defective products before they reach the finished goods warehouse.

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SOLUTIONS TO C&C CONTINUING CASE

Case 11-19

C&C Sports adopted a seasonal production schedule to meet seasonal sales demand and to reduce the amount of inventory it had to maintain throughout the year. The managers also believed that the lower inventory levels would increase cash flow throughout the year.

Based on the balanced scorecard results, it appears that providing more full-time employment rather than seasonal employment should improve the learning and growth measures. The tradeoff for providing full-time employment will be a build-up of inventory throughout the year, increasing the inventory carrying costs. This increased cost, along with the increased time between payments for raw materials inventory purchases and eventual cash collection from customers will further strain C&C’s cash position.

Over the long run, it is likely in C&C Sports’ best interest to rely more on full-time employment rather than highly seasonal employment practices. Workers can be cross-trained to produce all three products. Full-time employees would more likely be satisfied with their jobs than seasonal employees, and would be less likely to leave the company.

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SOLUTIONS TO CASE

Case 11-20

a.

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Case 11-20, continued

b.Perspective Measures Lead/Lag Fin/Nonfin.Financial Number of new products

developed Percentage of sales by product

category Time to double sales revenue

Leading

Lagging

Lagging

Nonfinancial

Nonfinancial

Nonfinancial Return on equity Earnings per share Stock price that exceeds $30

LaggingLaggingLagging

FinancialFinancialFinancial

Customer Number of new accounts Number of retained accounts Increased domestic and foreign

sales

LeadingLaggingLagging

NonfinancialNonfinancial

Financial

Number of brands that are marketplace leaders

Number of new “icon brands” acquired

Fair pricing (price relative to competitors’ prices)

Leading

Leading

Leading

Nonfinancial

Nonfinancial

Nonfinancial

Internal business processes

Defect rate Sales growth

LeadingLagging

NonfinancialNonfinancial

Establish inventory turnover measures

Number of new products under development

Number of continuous improvement projects

Capital budget maintained at 4.7% of sales

Lagging

Leading

Leading

Lagging

Nonfinancial

Nonfinancial

Nonfinancial

Financial

Learning and growth

Number of appropriate hires Employee turnover rate Absenteeism rate Training and development cost

LeadingLagging LaggingLeading

NonfinancialNonfinancialNonfinancial

Financial

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MetroMed’s managers have developed a balanced scorecard using a combination of leading and lagging measures and financial and nonfinancial measures. Overall, there are 12 lagging measures and 10 leading measures. While this is balanced between the two types of measures, a greater emphasis is needed on leading measures that can drive performance rather than the current focus on lagging measures which only report outcomes.

The scorecard contains 16 nonfinancial measures and only 6 financial measures. This may not represent an optimal balance between these two types of measures.

c. Learning and growth: According to the objectives, the company wants to continue to be a values-driven company. That is a vague objective—how will they know when such an objective is achieved? Nevertheless, training in the corporate culture should help achieve the objective. The metric, “training and development costs,” is not specific enough. Training dollars could be spent on computer training, for example, and while important, it doesn’t help achieve the objective. A more specific measure is “dollars spent on company mission and values training.”

“Number of appropriate hires” is not specific, measurable, actionable, relevant or timely. What is an “appropriate” hire? Does the company keep hiring employees, or is there a maximum number of employees that the company needs?

“Employee turnover rate,” while desirably low, is not as specific as “voluntary employee turnover rate for reasons other than relocation.” Retaining employees who are productive and believe in the company mission should be an objective of the company.

“Absenteeism rate,” like “appropriate hires” doesn’t get at the objective of being a values-driven company.

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Internal business processes: The two objectives of product quality and innovation are fairly typical for a company that creates products with short life cycles. “Defect rate” will capture the trend of internal costs of ensuring quality. As investment is made to improve processes, defects should be reduced. A measure of external costs of quality is “warranty claims.”

“Sales growth” has little to do with internal business processes. While it may ultimately be an outcome of improved products and services leading to customer satisfaction, it is not specific to the objective of product quality.

Innovation is best measured by introducing new products to the market. “Number of new products under development” is SMART. Developing products isn’t sufficient, though. “Time to market” is a complementary measure that will encourage managers to focus on completion of the project rather than development only.

With the combination of quality and innovation, managers should be motivated to design quality products that get to market quickly.

The other measures, “establish inventory turnover measures,” “number of continuous improvement projects,” and “capital budget maintained at 4.7% of sales” are not as relevant to the internal business process perspective as the other two mentioned above.

Customer: The objective “maintain high-quality, ‘market leader’ brand image” should appeal to customers who are looking for these kinds of products. The measures “number of brands that are marketplace leaders,” and “number of new ‘icon brands’ acquired” aren’t different enough. One of those measures should be replaced with “customer perceptions of brand image.”

“Fair pricing,” while important, is not specific or relevant to the company’s brand image objective.

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To achieve the objective of “grow market share of existing brands,” the company needs to measure “market share.” “Number of new accounts” and “number of retained accounts” aren’t specific to market share. If the market expands faster than the growth in new accounts, then market share could decrease.

Financial: The objective “achieve strong, balanced growth” tends to refer to growth in sales. “Sales growth by product” is a more specific measure for this objective than the others suggested in the balanced scorecard. “Percentage of sales by product category” is a good measure to capture the balanced growth aspect of the objective. “Time to double sales revenue” and “number of new products developed” are not relevant to the objective.

Shareholders will consider a return “fair” based on the market value of the stock they hold. A measure “stock price that exceeds $30” is not actionable by corporate managers. Too many other factors affect stock price. However, a measure such as “gap between growth in the Dow Jones Industrial Average and market price” would better capture the value created by the company apart from changes in the economy. “Earnings per share” is a measure that is more actionable by managers and ultimately influences the market return to shareholders.

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