To Which Performance Measures Is Kaplan Referring - Assignment Example

a) To which performance measures is Kaplan referring and what are the problems associated with their use? “One might reasonably ask: Why did these problems with profit centre measures not emerge earlier?” (Kaplan, 1984, p.411) In his 1984 quote, Kaplan primarily refers to the use of return on investment (ROI) as the primary measure of performance of profit centers and their managers. The profit center concept was first developed by DuPont and General Motors in the United States in the 1920’s. This has meant that each division within the organization was treated as if it was a separate “mini-company” (Kaplan, 1984).The two organizations have used ROI, formal budgeting and incentive plans in their management accounting practices across these profit centers which meant that profit was the key motivator for the companies and performance was also appraised based on purely financial terms where tangible assets and short-term profit targets were central. As Johnson (1980, p.97) put it, “the primary responsibility of top management was to insure that the company earned the required market return on invested capital”, not the overall economic value of the organization. While these profit center measures seemed to work well at the time, their flaws became increasingly apparent by the 1980’s. Perhaps, the biggest problem of these measures was the focus on short-term economic performance (Kaplan, 1984, What’s Wrong With Management, 1982). This emphasis brought about two separate difficulties. On the one hand, there was the issue with short-termism. Managers attempted to measure performance over brief periods, which many times led to adverse consequences: while short-range goals were met, they often undermined future operations and financial health of the business. The importance of short-term profit also led to profit center managers reducing investment and expenditure on intangibles, such as product development or promotions – especially in weaker sales periods – in order to maximize departmental profits (Kaplan, 1984, p.411). On the other hand, the centrality of finances as performance evaluators was also problematic. As performance measures were monetary in nature, both senior and profit center managers were incentivized to boost company earnings through financial transactions, such as mergers and acquisitions. While the trades increased earnings on the short-run, they typically did not add long-term value to the firm. (Ittner, & Larcker, 2001 p.401) Accounting conventions were chosen in alignment with external financial reporting standards, rather than focusing on which internal reporting method is in fact beneficial for the given organization. This meant that profit center measures led to each division to be seen as a “mini-organization” (Kaplan, 1984, p.410) with own allocated percentages of corporate expenses, which were not always realistic or directly measurable. Lastly, while ROI seemed to be an adequate measure to assess past performance, the management could not use it to set the company objectives (Dearden, 1987). b) Consider the balanced scorecard. Assess whether this performance measure provides a solution for the problems identified in part a. As these problems of profit center measures became clearer, new management accounting methods started to appear in order to resolve these shortcomings. The balanced scorecard (BSC), which has been presented by Kaplan and Norton in their 1992 seminal article, attempted to keep the benefits of past practices while introducing new performance measures. Its purpose is to give managers a balanced and informative view of the state of the organization (Kaplan and Norton, 1992). While past practices only favored shareholders through their financial focus, the BSC aims to benefit the management through not only financial, but also non-financial measures, whereby it aims to access the performance of the organization as a whole. Based on its stakeholder view, it gives information on how various stakeholders of the organization are affected through the new set of performance metrics. (Meyer, & Gupta, 1993, Christensen, & Demski,2003) Operational issues compliment the familiar financial measures, including customer satisfaction, internal processes and learning and development (Kaplan and Norton, 1992). While financial measures can only be based on past, historical numbers, the newly introduced performance measures are mainly focused towards the future of the company: they provide help in identifying areas of improvement as well as giving positive feedback in each identified area (Knapp, 2001). The BSC is also effective in highlighting the cause-and-effect relationship of business drivers and financial outcome measures (Knapp, 2001, p.6). Employees are therefore motivated as they see how their work contributes to the overall strategy. Hence, the BSC aids in the formulation of long term strategy and planning to maximize economic health of the organization. Even though the BSC addressed many of the problems of performance measurement of the 1900’s, it has not been left without criticism. Criticisms of the Balance scorecard One of the criticism is that no guidance on “how to tie the performance measurement system to managerial incentives and rewards”. Critiques believe that the BSC cannot be used to connect individual performance and how they can be rewarded. The second criticism is that there is no “balance” in the scorecard as long as the weight of the different measures in accessing measures is not specified. The final critique is the BSC is not straightforward to distinguish winners from loosers – if following the basics of the BSC, bonuses are not paid if BSC is “unbalanced”, hence even if a manager is over-performing in one measurement, bonus is not rewarded as long as all the other measurements are not at a satisfactory level. The functionality of the balanced scorecard was questioned, as the environment is getting dynamic and whether the presented model allowed for the existing changes. Despite the fact that the model proposed empowering of the employees, it is still anchored on the up-bottom approach of management. Balance scorecard is also questioned with regards to innovation and changing organization paradigm. It is also criticized when incentives and evaluation are related. (Voelpel, Leibold, Eckhoff, Davenport, & al, 2006 p.57) c) Draw on your answer in part b to explain the timing of the widespread adoption by firms of the balanced scorecard.  As explained in the above answer, the introduction of business scorecard was a plus to a number of organizations across the globe. Shareholders form part of the organizations main assets and therefore the need to involve them in all the operations. The timing of the balanced score card was perfect for a number of organizations globally. The first reason for the timing of the widespread adoption of the balance scorecard is the financials. The balance scorecard introduced the return of capital, cash flow, sales growth and economic value added. As firms were injecting different investment to the company, it was not easy to analyze the return on the investment, which was being injected. Apart from measuring the return, the scorecard introduced the economic value added when there is an injection in the business. Management can therefore make decision on whether to continue with the process. It is also easy to analyze whether the sales are growing, stagnating or reducing. When a specific department is performing, the management might direct more resources towards its expansion. The introduction of the cash flow enabled the management to analyze the flow of the financials in the organization. Therefore the timing of the widespread introduction of the balance score card was appreciated because managers could easily make decisions on whether to continue with the business. (Desai, & Ferri, 2006) A myriad of organizations have remained in business because of its loyal customers. Before the introduction of the balance scorecard, managers were not aware on how to meet the demands of the customers. The concept resulted into the need to ensure that customers were satisfied and retained. The balanced score card introduced mechanisms of acquiring new markets and increasing their market share that might result into profitability. The widespread introduction of the concept benefited the management on how to retain its customers. (Cobbold, Lawrie, & Issa, 2004 p.629) The internal business process also enhanced the widespread adoption of the scorecard. The concept prompted innovation that enabled the firm on how well the firm identified its future needs. It also enhanced the streamlining of the internal operations to ensure efficiency. The introduction of the concept resulted to the post sale service which helped in measuring, repair and treatment of various returns and defects. (Atkinson, 2006 p.1451) Finally, the concept was introduced at a time when the firms had not appreciated the need to encourage learning and growth amongst staff members. As part of shareholders, employees are the major organizations assets and should always be treated with respect and dignity. Through learning and growth, the organization will be able to retain its main assets. Apart from retention, the growth of the employees is an opportunity to boost their morale. The concept was introduced at a point when most firms required reasonable systems that could help in ensuring that there is efficiency in the operations of the firms. The introduced system could help in the analysis of critical information required for the organizations growth. (Gomes, & Liddle, 2009 p.361) In a nutshell shell, the introduction of the balance scorecard was a blessing in disguise to a myriad of organizations across the world. Most organizations had not appreciated the importance of stakeholder involvement in various operations of the company. The companies appreciated the need to involve employees in various development and innovative agenda. Therefore the appreciation of the balance scorecard was as a result of new concepts that spurred the financial performance of the companies. (Merchant, & Van de Stede, 2007) References Atkinson, H. 2006, "Strategy implementation: a role for the balanced scorecard?", Management Decision, vol. 44, no. 10, pp. 1441-1460. Christensen, J. & Demski, J. (2003) Accounting Theory: An Information Content Perspective, Chapter 11 Cobbold, I., Lawrie, G. & Issa, K. 2004, "Designing a strategic management system using the third-generation balanced scorecard: A case study", International Journal of Productivity and Performance Management, vol. 53, no. 7, pp. 624-633. Desai, M. & Ferri, F. 2006, Understanding Economic Value Added Harvard Business School note (number 9-206-016) Johnson T, 2013 A New Approach to Management Accounting History; Business and Economics Gomes, R.C. & Liddle, J. 2009, "The Balanced Scorecard as a Performance Management Tool for Third Sector Organizations: the Case of the Arthur Bernardes Foundation, Brazil", Brazilian Administration Review, vol. 6, no. 4, pp. 354-366. Kaplan, R. 1984 The evolution of management accounting The Accounting Review Vol. 59, No. 3: 390-418 Ittner, C., & Larcker, D. 2001 Assessing empirical research in managerial accounting: a value-based management perspective Journal of Accounting and Economics Vol. 32: 349 410 Merchant, K. & Van de Stede (2007) Management Control Systems 2nd ed. chapter 11:Combinations of Measures and other remedies to the myopia problem Meyer, M. & Gupta, V. (1993) The Performance Paradox Research in Organizational Behaviour Vol. 16 p. 309 369, especially pages 325 353. Voelpel, S.C., Leibold, M., Eckhoff, R.A., Davenport, T.H. & al, e. 2006, "The tyranny of the Balanced Scorecard in the innovation economy/Commentary: on Voelpel, Leibold, Eckhoff and Davenports "The tyranny of the Balanced Scorecard in the innovation economy"", Journal of Intellectual Capital, vol. 7, no. 1, pp. 43-60. Read More