Lecture 7

Evaluation and Control

Evaluation and Control Process

Ensures that the company is achieving what it set out to accomplish y Five step feedback model
y
Determine what to measure Establish predetermined standards Measure Performance Take corrective action

STOP

Does performance match standards

Measuring Performance
y y

Performance is the end result of activity Appropriate Measures

Static measures like ROI which are post-facto metrices Dynamic measures needed called steering controls: ensure changes to the system before they get out of control

Types of Controls
Behavior controls:
x specify how something is to be done through policies, rules, standard operating procedures x Important where cause effect relationship is clear but output is not clearly identifiable

Output controls:
x specify what is to be achieved by focusing on outcomes x Important where output is clearly identifiable

Input controls:
x focus on resources such as knowledge, skills, abilities, values and motives of employees

Primary measures of corporate performance

y

Traditional financial measures

ROI = Net Income before taxes/ Total Assets
x Advantage of being simple and encompassing all underlying business complexities x Dependant on depreciation policy x Mostly a short range parameter

Earnings per share: Net Earnings/ Number of shares of common stock issued Return on Equity: Net Income / Total Equity
y

Stakeholder Measures

Shareholder value
y

Economic value added

Shareholder value method of measuring corporate and divisional performance = after tax operating income (investment in assets * weighted average cost of capital) WACC = weighted average cost of firms debt and equity capital EVA can be increased by earning more with the same capital, investing less in assets or by investing capital in high return projects

Market value added

Difference between the market value of a corporation and the capital contributed by shareholders, bondholders and retained earnings Present value of all EVA as it measures the stock markets estimate of the net present value of the firms past and expected capital investment projects Calculation: first add all capital put into company, reclassify accounting expenses like R&D giving total capital Using current stock price total the value of all outstanding stock, adding to it the companys debt. This is the companys market value

Primary measures of divisional and functional performance

y y

Standard cost centers: primarily for manufacturing facilities, standard costs are arrived at and then multiplied with units produced leading to expected cost of production, compare this with actual cost to look at performance Revenue centers: Production is identified in terms of units without consideration of costs, sales departments for example do not have any control on costs, so only measured on revenue Expense centers: Resources measured in value terms, e.g. for admin, service and research departments which cost money but only indirectly contribute to earnings Profit centers: profit center typically established whenever an organizational unit has control over both its resources and its products or services, use of transfer pricing between different units Investment centers: Factoring in of asset base, typically ROI is a measure of this

Using benchmarking to evaluate performance

y y y y

y y

Identify the process or area to be examined Find behavior and output measures of the area or process and obtain measurements Select an accessible set of competitors and best in class companies against which to benchmark Calculate the differences in the companys performance measurements and those of the best in class and determine why the difference exists Develop tactical programs for closing performance gaps Implement the programs and then compare the resulting new measurements with those of the best-in-class companies

Strategic Information systems

y

Enterprise resource planning

Very important for providing consolidated information across all the critical activities of the organization to the top management Typically quite complicated and not suitable for companies with less standardized processes

Divisional and functional IS support

Depending on every departments objectives particular type of information system would make sense IS can be used to perform various functions like drive efficiencies or it can be used to create differentiation etc.

Problems in measuring performance

y

Short term orientation

Due to short term pressures of shareholders etc. Executives dont believe in it or feel it not as important, many times have a myopic view Most accounting based measures encourage short-term orientation

Goal displacement
confusion of means with ends and occurs when activities originally intended to help managers attain corporate objectives become ends in themselves Behavior substitution: happens when wrong activities are being rewarded, typically quantifiable measures overshadow non-quantifiable measures Sub-optimization: when a unit optimizes its goal accomplishment to the detriment of the overall organizations e.g. marketing agreeing to an early shipment leading to the manufacturing dept doing overtime to fulfill the order

Guidelines for proper control

y

Control should involve only the minimum amount of information (80:20 rule to identify 20% of
activities which impact 80% of the results)

y y y y y

Controls should monitor only meaningful activities and results Controls should be timely Long-term and short-term controls should be used Controls should aim at pinpointing exceptions Emphasize the reward of meeting or exceeding standards

Strategic Incentive Management

To ensure congruence between the needs of the corporation as a whole and the employees as individuals y Incentive plans should be linked to corporate and divisional objectives
y

E.g. companies with a growths strategy emphasizes bonus over salary and benefits SBU managers having long-term performance elements in their compensation favor a long-term perspective Typical CEO package is composed of 21% salary, 27% short term annual incentives 16% long-term incentives and 36% stock options

Weighted factor method y Long term evaluation method y Strategic Funds method
y

Weighted Factor Method

Growth High Parameters Return on Assets Cash Flow Strategic funds programs Market Share Increase Medium Return on Assets Cash Flow Strategic funds programs Market Share Increase Low Return on Assets Cash Flow Strategic funds programs Market Share Increase Weight 10% 0% 45% 45% 25% 25% 25% 25% 50% 50% 0% 0%

Long-term evaluation method

Compensates for achieving multi-year objectives Typically through a stock-option More applicable to the top management

Strategic Funds Method

Developmental expenses segregated from day to day operational expenses Measurement based on both how much has been spent on each item Therefore the manager can be evaluated from both short term and long term perspective

Strategic audit of a corporation

Refer to the book Use this for the assignment

Balanced scorecard approach

Financial y Customer y Internal business perspective y Innovation and learning
y