Investigating Performance Evaluation - Assignment Example

Strengths At a simplistic or theoretic level, pure profitability measurement provides a single financial metric to judge Niessen Peru's operations.Incentivising Valencia (the profit centre manager) gives him the motivational spur to keep operations profitable. It also eliminates any subjective bias. Translating the Profit/Loss statement to US dollars enables Niessen to value the return on it's investment in a comparable and familiar currency; it also provides company management with a view of the foreign currency exchange rate gain/loss enabling it to measure the success in protecting the investment from erosion due to currency devaluation, "provided that the 'objectives' of the translation process are fully understood"; and it enables the measurement of financial and managerial performance in a "common numeraire". (McIness et al cited by Demirag, 1988, p. 258). The use of a single accounting standard - for both performance measurement and tax reporting removes the risk of a more favourable internal valuation becoming damaging evidence in the event of disputes with tax authorities (Baldenius et al, 2003, p. 592). Also, there is no additional administrative overhead and associated costs that may have resulted if the performance reporting was decoupled from tax reporting. Weaknesses Using only profits as the measurement gauge may work if all other factors are equal. However, the business enterprise is a dynamic environment and all factors rarely, if ever, remain equal and a simple reliance on profitability numbers may not prove an adequate measure of performance, even though it would (and should) provide guidance on the financial health of the organization. Watty and Terzioglue (1999, p. 5) cite Kaplan as saying non-financial measures are just as essential and too much emphasis on just financial measures may decrease an organization's long-term viability. Also, Kren (1994, p. 68) assumes that excessive or inappropriate reliance on accounting performance measures would prompt managers to manipulate accounting data. That this pressure exists within the Niessen culture can be inferred from the US marketing manager's manipulation of the transfer pricing. A profit centre model implies that managerial control is decentralized with ultimate responsibility for centre performance residing the business unit manager. However, Niessen Peru is a captive subsidiary company with only one customer: Niessen Apparels, USA, its parent. The present policy excludes any scope for attracting or soliciting orders from other apparel companies who may or may not be competing in the same market space. This would mean that Valencia's responsibilities are limited to operations: production efficiency and cost control. Being a captive subsidiary, Niessen Peru is totally dependant on the parent company to keep its production capacity fully utilized. Any slackening in the order flow will impact the bottom line. Sales are outside Valencia's control and responsibility. Any performance measure that does not compensate for this factor will present a skewed result that can be easily misinterpreted. The subsequent events bear this out as seen by the increase in idling due to the slow down in US sales and the misinterpretation of the Peru operations statement by management members not aware of the behind the scenes price fixing. Another factor that hasn't been taken into account, as it may effect Niessen's satisfaction with subsidiary performance, is cultural distance. In the context of multi-national companies, cultural distance is the difference in the way business is conducted between companies of different cultural backgrounds. Dikova and Witteloostuijn's (2005, p. 24-25) research suggests that there is a significant positive correlation between cultural similarity and the performance of the subsidiary. Also, they cite Anderson, et al (p. 24) arguing against foreign investments for the sole purpose of increasing short-run financial performance although they do qualify the target market as "young" and "high-risk". In this context, some thought needed to be given by Nissen to alleviate any expectation bias that might creep in due to 'cultural distance'. Discussion Some clarity on the purpose of performance evaluation would be helpful. Watty and Terigolu (1999, p. 11) cite Choi and Chechowicz finding that the goal of evaluation procedures in MNCs is to: 1. Ensure adequate profitability 2. Have an early warning system if something is going wrong 3. Have a basis for the allocation of resources 4. Evaluate individual managers Clearly, while sustainable profitability is the driver in performance evaluation at MNC, the current method for Niessen Peru has sufficient drawbacks to consider a change. That they are not following the original evaluation plan is also sufficient reason to consider a change. Additionally, the original decision to use arm's length pricing as a means to prevent inflating profits was soon forgotten under performance pressures of the parent. In considering a change in the evaluation methodology a framework needs to be developed that would be acceptable both to Niessen and Valencia. As Kren (1997, p. 92) discovers line managers (agents1) "self select compensation contracts based on privately (self) known skill level and risk preference". Once the contract is known and "in the absence of risk highly skilled agents will select performance-contingent contracts and exert maximum effort". This corresponds to Valencia's situation: a highly skilled worker (as inferred from Charles Niessen's reluctance to let him go) who believed (implied) that he was taking on a risk-free high performance contract. Given the slow down in US sales and the increased volatility of the Peruvian currency, Niessen's risks in the venture have increased an order of magnitude. Bloom and Milkovich (n.d.) find that high risk firms that de-emphasise incentive pay perform better than those who do. This suggests that, for Nissen's Peru operations, incentive pay is not the way to go. Strengthening Valencia's accountability by implementing a direct sales strategy (from the Peru unit) could be another area for consideration. The sales strategy would be to establish alternate markets and customers. Niessen Apparel would remain Peru's captive customer for the US market while they would be given the freedom to pursue other markets with only supervisory control of the parent. This would give a two-fold benefit: firstly, idle capacity can be productively employed and secondly responsibility for meeting profitability numbers can be squarely fixed. However, there would remain two problems for such a strategy to work, assuming of course that investment funds, in terms of staffing and monitoring are available. One: bridging the cultural gap. The Americans would need adequate assurances of air-tight controls that protect their investments, i.e. an element of trust has to be built. Two: normalization of the intra-company transfer price. The cultural problem could probably be addressed by installing an executive interface between Niessen Peru and the parent. Possibly, a native US American of Peruvian descent with experience in the apparel industry who would be able to bridge the cultural gaps between both sides. Normalizing the transfer price would be much more complex. Firstly, the US manager's resistance would have to countered. In 'real' terms price fixing would have gained them only marginal savings on their tax burden (back of the envelope calculations). The fact is the US marketing manager has 'dressed' up his sales numbers to protect himself from criticism. The pricing rationale should be adjusted to present an equitable formula that would fair to the Peruvian operation as well as be at an optimal price point to enjoy the tax benefits. Tackling the issue of exchange rate volatility, there seems to be many divergent thoughts on how to arrive at a 'common numeraire' to evaluate performance. Jacque and Vaaler (2001) argue for an Economic Value Added framework (EVA2) while at the same time they cite Abdallah, et al (p. 826) recommending using a different set of metrics for measuring foreign operations. Along similar lines to Jacque and Vaaler, Troberg (1994) argues for a Global Currency Unit (CU) that would work similar to the European Council Unit. The GCU would be a composite of the major operating currencies of the multinational and provide a neutral currency denomination that would be stable in value. In Niessen's context however, with a single overseas subsidiary, both EVA and GCU based evaluations may be overkill as the cost of developing the reporting system may not be commensurate with the benefits of evaluation. Investigating performance evaluation of multinational managers Kihn (2006) finds that in general three sets of controls are employed in evaluating performance of multi-national companies' subsidiary managers: Financial results Non financial results; and Action accountability Financial measures and accountability have already been discussed above. The non-financial criteria identified by BIC (cited by Watty and Terizoglu) in order of importance are: Market share Not relevant to Niessen Peru currently but would be an important and beneficial part of any new performance metric. Productivity improvement Relevant now and in the future. Drawback: additional overhead in terms of monitoring Relationship with host government Relevant now and in the future However, this would be a subjective measure and will depend to some extent on the perception of management Quality Control Always relevant If a Quality Management System (QMS) is implemented, the benefits are two fold: Monitoring data would be easily available, customer trust would increase with the assurance of standards compliance. Both these benefits should adequately compensate the cost of implementing the QMS Employee development Always relevant A focus on employment will be expensive but there is sufficient anecdotal evidence to strongly recommend an HR development programme within a financially viable framework Safety Relevant Safety regulations in developing countries are much more lax than in industrialized nations. Implementing safety standards are also not cheap. However, for the employee development program to 'make sense' to the employees sufficient coverage should also be given to workplace safety implementations. Also, since this would form part of the QMS requirement that would cover the associated monitoring costs. Bibliography Baldenius, Tim, Melumad, Nahum D., and Riechelstein, Stephan J. 2004, 'Integrating Managerial and Tax Objectives', The Accounting Review, Vol. 79, No. 3, pp 591-615 Retrieved April 04, 2006 from < www2.gsb.columbia.edu/faculty/tbaldenius/integrating.pdf > Bloom, Mathew C., and Milkovich, George T. (n.d.), 'The Relationship Between Risk, Incentive Pay and Organizational Performance', Mendoza College of Business, University of Notre Dame, Retrieved April 05, 2005 from < www.nd.edu/mbloom/amj_risk.pdf > Demirag, Istemi S. 1988, 'Assessing Foreign Subsidiary Performance: The Currency of Choice of UK MNCs", Journal of International Business Studies, Summer Dikova, Desislava, and Witteloostuijn, Aren van 2005, 'Managerial Satisfaction With Subsidiary Performance - The Influence of the Parent MNE's Capabilities and the Subsidiary's Environment", Research Institute of SOM (Systems, Organization and Management), University of Groningen Retrieved April 06, 2006 from < http://ideas.repec.org/p/dgr/rugsom/05g07.html#download > Jacque, Laurent L. and Vaaler, Paul M. 2001, 'The International Control Conundrum with Exchange Risk: An EVA Framework', Journal of International Business Studies, 4th quarter, pp 813 - 832 Kihn, Lili-Anne 2006, 'The Use and Determinants of Controls in Multinational Managerial Performance Evaluations', School of Business, Montclair State University, Working paper Kren, Leslie 1997, 'The Role of Accounting Information in Organizational Control: The State of the Art', in Steve G. Sutton and Vicky Arnold (eds), Behavioral Accounting Research: Foundations and Frontiers, American Accounting Association, Retreived April 05, 2006 from < http://www.uwm.edu/lkren/control.pdf> Watty, Kim and Terzioglu, Bulend 1999, 'Performance Measures Employed by Australian Subsidiaries of US Service Multinational Companies: An Empirical Survey', School of Accounting and Law, RMIT University, Retrieved April 06, 2006 from < http://mams.rmit.edu.au/9dvu6urpwy8.pdf > Troberg, Pontus 1994, 'Global Currency Unit: a balanced approach to performance evaluation in multinational enterprise", Swedish School of Economics and Business Administration, Retreived April 05, 2006 from Read More