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Performance Measures: Critical Review
Human Resources » Performance Management


Chrm Message From: jaswinder Total Posts: 51 Join Date: 06/11/2006
Rank: Manager Post Date: 18/03/2007 04:00:59 Points: 255 Location: United States

Dear Members,

I was reading a book on performance measures. Rethinking Performance Measurement by Meyers. It is a very nice book with lots of new concepts. I cant assess them because i have no practical experience in thsi field. However I would like to share what i learnt from there. I have prepared a summary of all the concepts i read so far and tried to arrange it in the form of an article. I request all of you to give feedbacks on it so taht i can learn about the practical implicantiosn of these concepts and arguments.

In this article we will try to understand what Performance actually is?
Is there a differnce between dictionary and economic meanings of performance?
Is so how does it affect performance measurement?
Which major types of measures are being used at present?
Where are they located in the organisation?
What si their function(s)?
Does their nature create a paradox for large organisations?
How have the organisations attempted to solve thsi paradox so far?
What else they need to do?

I am still reading the book, so i will share more concepts eventually . Please share your experience so that thsi does not remain only a bookish knowledge.

We know that business is like a game. And games are no fun without scores! Right? Similarly organizations also need to keep track of their performance in order to assess how well it is doing, vis a vis the set targets as well as in comparison to other players in the field. Measurement is also necessary to bring about the necessary improvements in the way business is being conducted. However these improvements can be brought about only with the full involvement and cooperation of the company’s employees.

In order to motivate the employees to give their best, we need to reward their performance. This reward strategy needs to be fair and equitable. For ensuring this we again require Performance Measures!

So this article tries to look into the characteristics of the Performance Measures prevalent at present and also assess their shortcomings .

First let us understand what we mean by Performance . Dictionary meaning of this term is the achievement attained in the act of performing/ functioning ( present) or in the form of accomplishment ( past). These can be directly observed and measured.

But the economic meaning meaning of Performance involves an element of anticipation. According to Franklin Fisher,organizational performance refers to “the magnitude of cash flow still to come”, discounted to the present values. Measures would be shareholder value /share price or long term efficiency or viability of the firm. But these will be revealed only as we move ahead in time so they can only be inferred from the measures based on past or present performance. So here lies the conflict between what we can measure and what we would like to measure. This leads to the conclusion that all measures of performance are only Second Best Measures ( since economic performance is infered )

Therefore Performance Measurement consists of measuring past accomplishments, present functions and inferring how these will subsequently affect the economic performance of the organization. The amount of uncertainty in the inference depends on the lag between measures and their impacts and the volatility of the business environment.

But we also know that Performance Measurement is necessary to run a business. Therefore the challenge before an HR Manager is to choose right measures. Right measures will be unique to each business.

The four common types of Performance Measures used at present Market Valuation, financial measures, non-financial measures and cost measures. We will describe them in terms of where they are located(whole firm, SBU, or still lower level) in the organization and which purposes(look ahead, look back, compensate, motivate, roll up, cascade down) each of them fulfills.

Market Valuation : It gauges the performance of the firm as a whole. It looks ahead in the sense that financial markets are efficient and capture information about future cash flows. It is used to compensate and motivate top executives. It facilitates external performance comparison only.

Financial Measures : They measures performance of the firma s a whole and also of business units, whichever unit has a balance sheet. They look back ( capture results of past performance) and also look ahead ( effect firm’s cost of capital and reputation). They are widely used to compensate and motivate. They can roll up from the SBU to the firm as a whole and also cascade down . They are also used to compare performance of various SBUs.

Non Financial Measures : These are complex, myriad and ubiquitous. They compare performances of functional units, cannot be rolled up or cascaded down, may/may not look ahead and are used to compensate and motivate especially when they are a must do like safety adherence. They may be used for internal comparisons if same functions are carried out at different points in the organization and also external comparison if benchmark data is available.

Cost Measures : These are usually incomplete or limited in their nature. They can be cascaded and rolled as well as well compared laterally.As such they penetrate deeply. They are usually not used to compensate and motivate except when cost control is critical. Cost measures usually look back at what we have soent and their trajectory helps us to look ahead, ie., which costs to cut.

Conclusion: From the above description it becomes quite clear that measures that actually/ potentially look ahead and hence influence economic performance of the organization do not necessarily cascade down or roll up . Thsu it is difficult to find measures that can be applied to different levels of the organization and from which inferences about economic performance can be made.

Paradox of Large Organisations

Managers need measures that look ahead for inferences and which roll up and cascade down for alignmement. But we saw that measures that look ahead ( shareholder valuation + non-financial measures) cannot roll up and cascade down. And the measures that can roll up and cascade down ( financial and cost measures) do not look ahead.

Moreover as the company grows, it gets more specailised so that aligning functional measures with financial measures becomes all the more difficult because place where functioning takes place gets more separated from palce where financial results accrue.

Thus managers today are afcing the dual challenge of simplicity of Performance Measures vs Complexity in organizations. Both are required. So how have fiorms sought to solve this problem?

Firms have failed to understand the changing requirements of the firms and consider it solely a problem of measurement. Therefore most have adopted the solution of finding better solutions. However we fail to realize that even these better measures are only second best measures and hence uncertainty is endemic to them.

Moreover this solution of finding new and better measures led to a spurt of performance measures being used by the organizations. When Balanced Scorecard emerged about 10 years ago, it made us aware of the growing complexity of Performance Measurement. It was introduced mainly as a tool to communicate the strategic decisions to all in the organization i.e., as a framework of action. However nowadays it is also being used as a template for compensation. We know that Balanced Scorecard attempts to arrange all the performance measures being used by an organization by calssifying them into four compartments i.e., innovation, internal process, customer satisfaction and financial performance. However the problem still remains unsolved because most of the organizations use around 50-60 financial and non-financial measures. These can be aligned from top to the lower most organizational level . However problem comes when these multiple dimensions need to be compressed into a single dimension ( of better or worse) in order to compensate/ reward/ promote an employee.

This problem has been termed as ‘Compression Principle of Measurement’

According to this principle, measurement does not aim at measuring more rather it tries to compress/condense information by ordering what would otherwise be unordered bits of data so as to focus on critical properties of the object at hand.

Example: when we measure the length of a line, we consider only the end points of the line and not the location of each point on it.

To put it in a different way, we partition universe into an area of interest and an environment to which we can banish excess information. So we can make rough predictions and use the system. IGUSES ( information gathering and utilizing systems) exists by virtue of this myopia, the inherent inability to keep track of every detail……if you know everything, you know nothing.

Applying this principle to our present problem of Performance Measures, we realize that most measures of 1990s make sense BUT together they do not make sense. This shows that our capacity to produce performance measures has outpaced our capacity to distinguish between measures that contain information about economic performance and those that do not.

So how can we be sure that the new measures are the right measures?

The problem can be minimized if we ensure that each of the new measures has the following characteristics:

Parsimony: The organization must adopt at the most 3 financial and 3 non financial measures or else the information may get lost.

Predictive Ability: non financial measures predict the financial measures , ie., the former are leading measures and the latter the lagging one. Ex: customer satisfaction predicts sales revenue. Therefore such non-financial measures that do not have predictive ability should be discarded unless they are related to regulation, ethics and security.

Pervasiveness : the measure should be applicable to the whole firm ie., it can be summed bottom up(this will allow people to see connections between their results and firm’s results.) , rolled down ( to enable managers to drill down capacity) and can be compared horizontally for improvement and performance appraisal.

Stability : the measure should change gradually to maintain people’s awareness of long term goals and to ensure consistency in their behaviour.

Regards

Jaswinder

 
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