Attachment H: Growing Importance of Non-financial Performance Measures

Studies of price changes showed that in a well managed competitive economy, sustained cost reduction was achieved by firms over a long period as experience was accumulated. Thus those who have high market share should achieve the greatest returns, because this allowed them to accumulate experience. If true, this created a significant tension for management, because profit - as conventionally measured under normal accounting rules - could always be increased in the short term by selling off market share. Unless constraints were placed on management to require maintaining market share, and only profitability was emphasised, the long term health of the company could be sacrificed (Davis J. 'Conceptual Issues in Strategic Management', in New Developments in Public Sector Management: Strategic Planning and Review of Government Operations, ANU 1982)

Today's management accounting information is inappropriate for manager's planning and control. Many short term measures are appropriate for motivating and evaluating performance, but profitability based on requirements for external observers is not one of them. Bookkeeping has a long history, but was not expected to provide a form of management information until the 19^th century. Many simple management accounting measures served the needs of both managers and owners. Others evolved to measure process performance, but not profit - though when firms had only one function - efficient performance of that task usually meant profitability. The development of conglomerate enterprises in the early 20^th century required means for assessing performance of different divisions. Return on investment was developed. This has remained standard, though after the 1960s the competitive environment changed and this measure ceased to be the most relevant guide to future performance. US firms lost competitiveness because their actions were guided by ROI considerations which were inappropriate ways of assessing performance in the new environment (Johnson T. And Kaplan R., Relevance Lost: The Rise and Fall of Management Accounting, Harvard Business School Press, 1987)

There is a shift from treating financial measures as the foundation for performance measures, to being only one of several measures. Firms found that financial measures undercut strategy - and devised new measures where financial considerations were less significant. Need to know what measures truly predict long term success. It is now being shown that accrual accounting systems are obsolete - and often harmful. This relates to concern about short term focus of firms, which affects their competitiveness. Long term strategies were not done because of short term financial effects. Also staff play games to maximize financial measures so making them meaningless. Financial figures assess results of past decisions, but do not cover crucial factors for future performance (eg quality / customer satisfaction - which have different criteria). Benchmarking also makes people aware of large scope for improvement which may exist. Many companies described strategy in terms of customer service, innovation etc - but did not measure it. A coherent organization wide grammar is vital to measurements which are viable in rapidly changing structures. Such change is vital to competitive performance. Methods for measuring financial data are most sophisticated. Putting non-financial measures on an equal footing will be a major task. Incentives need to be aligned with performance measurements, but not through a formula - which is either too simple or too complex - judgment must be used (Eccles R. 'The Performance Measurement Manifesto', Harvard Business Review, Jan-Feb 1991)

Companies worldwide are transforming themselves for a world where competition is based more on information, and on ability to exploit intangible assets, than on their ability to invest in, and manage, tangible assets. Concept of balanced scorecard was introduced to complement financial measures with those related to: customers; internal business processes; and learning. Some have used this as cornerstone of a new strategic management system. Most organizations' operational and management control systems are built around financial measures and targets which have nothing to do with strategy - but balanced scorecard allows processes which create link. Most organizations separate strategy formulation and financial budgeting, with most emphasis on the latter. Balanced scorecard allows these processes to be integrated - identifies strategic objectives, and critical drivers, and allows organizations various change programs to be managed. In turbulent environment, strategy must be constantly redeveloped. Budget and financial measures do not allow this - but strategic learning is possible. (Kaplan R. and Norton D., 'Using the Balanced Scorecard as a Strategic Management System', Harvard Business Review, Jan-Feb 1996)

Performance review can shed light on the real drivers of organisational value, and everyone must now redesign their approach to performance measurement. A balanced family of performance measures is required - which provide comprehensive view of whole organisation, and are individually meaningful. Key is to discover how human, organisational and intellectual assets combine to create value. Measurement is more useful in defining goals than assessing performance - because measurement only refers to a model, not to the real situation. Measures should be closely aligned with current organisational strategies and objectives. Performance measures are used to: measure progress towards goals; calibrate conformance to policies; appraise individual performance; and assess performance of systems and procedures. Measures should be robust, simple, reliable; arise naturally from operations; be limited to controllable factors; hierarchical; and cover an appropriate period. For good results need: balanced set of measures, and ability to influence behaviour. Performance framework could address: competitors; technology; markets; organisation; and performance (in terms of indicators of success of chosen strategy (market share, and financial returns), and in terms of general indicators of success (quality, flexibility, efficiency, creativity and innovation); (Stainer A. and Heap J., 'Performance Measurement - A Management Services Perspective', Management Services, July 1996)