USEFULNESS OF TRADITIONAL AND NEW PERFORMANCE

MEASURES: SOME EVIDENCE FROM NIGERIAN COMPANIES

BY

DR. (MRS.) S. L. ADEYEMI

DEPARTMENT OF BUSINESS ADMINISTRATION

UNIVERSITY OF ILORIN

ABSTRACT

This paper reports the findings of a survey on the usefulness of selected traditional and new

performance measures used in some Nigeria companies that have adopted a flexible

manufacturing strategy. The results indicate that majority of these companies considered the new

performance measures useful particularly among the larger companies and among those with 5

years or less of business experience. Traditional measures are still useful, though to a much

lesser extent. These results suggest that a combination of both traditional and new measures

would be needed especially when Nigeria companies are going through the transition of

implementing changes to their strategies from cost leadership to flexible manufacturing.

INTRODUCTION

The combination of slower economic growth and increased competition has forced firms in

every industry to concentrate on efficient and effective deployment of resources. One result of

these efforts has been the emergence of a new corporate position devoted to controllership. The

controller is concerned with continuous measurement of a firm’s performance. In order to carry

out the measurement process, controllership focuses on the assessment of resources deployment

and goal attainment

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Numerous research initiatives have identified the high correlation between superior

performances and the development and use of sophisticated assessment or measurement

capabilities. As early as 1985, A. T. Kuarney Consultants noticed that firm engaging in

comprehensive performance realized improvements in overall productivity in the range of 14 to

22 percent.

Effort has been expended by establishments to improve the quality of information that their

managers have at their disposal to measure, compare and guide performance. In most firms in

Nigeria the traditional formats and travel reports are still in used.

TRADITIONAL AND MODERN MEASURES OF PERFORMANCE: AN OVERVIEW

OF A REVIEW

The traditional performance measurement system has been designed to report labour

productivity, machine and capacity utilization, and standard cost variances. These are cost-

efficiency-based measures derived from a strategy to minimize production costs, described as a

cost leadership strategy, which is characterized by mass production of a new standard products

musing stable technology (hall, 1980; Kaplan. 1986).

The modern manufacturing environment has undergone dramatic changes since the past decades

mainly because of intensive global competition, shifts in customer’s buying behaviour, and rapid

innovation in manufacturing and information technology product. A cost-minimization and mass

production strategy is no longer compatible with this new manufacturing scenario. Instead, issues

such as responsiveness to customer needs, improving quality, reducing lead times, technological

innovation and enhancing production flexibility have emerged as strategically more important to

maintain competitiveness. Direct attention to these issues is the essence of a flexible

manufacturing strategy. (Nemetz and Fry, 1988).

Despite this strategic re-orientation among the more progressive companies, performance

measurement systems have not kept pace with the change. The theory of organizational lag has

been involved to explain this lag in making changes. The theory of organizational lag has been

involved to explain this lag in making changes to management accounting systems of which

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performance system forms a part. According to this theory, administrative innovations in

management accounting (and performance) systems tend to lag behind the technical innovations

of manufacturing. This is because the potential benefits of administrative innovations are less

certain and are likely to take more time to have any recognizable impact (Dunk, 1989). Failure to

make complementary changes in the performance measurement system to fit with the company’s

new flexible manufacturing strategy may lead to dysfunctional consequences. As pointed out by

Howell and Soucy, (1987).

“The manufacturing transformation in many companies has

been slowed, if not set back, as antiquated sets of operating

performance yardsticks promote inaccurate analysis, poor

operating decisions, and inappropriate resource allocations”.

This paper reviews traditional financial measures of performance and discussed the potential

benefits of incorporating new performance measures into the performance measurement system.

The usefulness of these measures was empirically tested using a sample of Nigerian Companies

that have adopted flexible manufacturing strategy.

The bulk of responding companies came from the electronic and other high technology product

industries (60%) Business experience was categorized into groups, as follows: 5 years and below

(7.5%( > 5-10 years (22.5%) and > 10 years (50%).

TRADITIONAL PERFORMANCE MEASURES

Traditional performance measures have been developed to meet the needs of manufacturing

characterized by the production of standard products with high direct labour contest. Set ups are

minimized to assure uninterrupted production runs. In this way, labour and machine capacities

can be fully utilized and the greatest possible output produced with a consequent reduction in the

overhead cost per unit of output. The competitive strategy is cost minimization, so variance

reporting, overhead absorption and capacity utilization measures appropriately reflect this

strategy.

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Variance Reporting: The use of variance accounting for managerial performance evaluation has

been criticized as counter-effective in the modern global environment (Howell & Soucy, 1987).

This is because traditional variance analysis encourages dysfunctional behaviours such as

allowing inventory to build up so as to show a favourable volume variance, and delaying

machine maintenance, padding the budget or shifting expenses between accounts so as to show a

favourable expenses variance.

Purchasing managers, for example, may act dysfunctionally by purchasing materials based on

lowest price considerations at the expense of quality so as to show a favourable materials price

variance. The consequences of inferior quality materials purchased are manifested in increased

reworks, scraps, inspections and storage of defective parts leading to higher production costs and

loss of competitiveness.

The volume variance as a manufacturing indicator has been criticized since traditional absorption

costing encourages excessive production in order to absorb the fixed overheads into inventory

costs. Maximizing capacity utilization is necessary to achieve cost minimization. However, such

a policy is short-sighted because any production in excess of market demand must be consigned

to inventory and this runs counter to the just-in-time philosophy of maintaining a zero inventory

with all its attendant benefits (Sadhwani, et al, 1985).

Variance reports at the manager’s level are also too aggregated for meaningful interpretation.

Moreover, the standard cost itself may be perceived the norm eliminating any incentive for

product innovation. In this case an unintended signal has been put out which impede efforts to

infuse a culture of continuous improvement.

Capacity utilization measures productivity improvement, automation and robotics have shrank

direct labour cost to only a small fraction of the total manufacturing cost, whereas overheads

have increased significantly. Despite these developments and the consequent impact on cost

structures, reports from surveys in various countries indicated that companies have not

responded in tandem with the technological changes (Schoch, et al., 1994; Teoh, 1991). This has

serious implications for production costing and performance evaluation as the continued focus on

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direct labour means labour is still considered a major driver of costs when it is no longer

relevant. The result is the development of burden rates that are volume-driven, based on a

diminished direct labour element. Such a computed burden rate is artificially inflated due to the

small direct labour base. Hen applied to an increasing pool of overheads, the incurrence of which

may not be totally volume-driven, the labour generated burden rate can lead to serious distortions

of the overheads absorbed into production cost. This is because of the unrealistic burden rate

used which does not reflect the actual consumption of overheads by different products or

processes (Kaplan, 1986).

The overhead absorption measure gives rise to a distorted product cost analysis, so “good’

performance is associated with products apparently showing profitable margins but are actually

incurring loses (Beckett & Dang, 1992). Thus an incorrect signal about profitability is received

Earned hours, as a measure of labour efficiency, is also deficient since it provides an erroneous

signal to supervisors to maximize earned hours by keeping employees “gainfully” occupied

regardless of market conditions. It would have been more beneficial in the long term to use the

time for training or cross training of operators so as to upgrade their skills.

The machine utilization rate, as a measure of supervisory performance, also suffers from a

number of deficiencies. It encourages the excessive use of machines for large-scale production,

resulting in an unwidely accumulation of inventory. Worse still, maximizing the utilization rate

encourages continuous machine usage at the expense of regular maintenance. Moreover, the

focus on utilization may lead to inadequate emphasis on quality.

Short-term Financial Measures: Although achieving profit and an acceptable return on

investment are the raison d’etre for a company to stay in business, the traditional focus on these

performance measures however encourages managers to take a myopic view that emphasizes

short-term results to the detriment of long-term profitability (Banks & Wheelwright, 1979). This

is the “gaming” effect where management manipulates accounting figures to show favourable

results or alternatively, builds in slack to ensure that budget targets (Merchant, 1985) are met.

Reliance on short-term financial measures can lead to dysfunctional decisions since these

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indications fail to signal the erosion of a firm’s value if discretionary expenditures have to be

reduced for short-term gains. Such spending is fact essential for new products development

production process improvement, worker skills training and upgrading distribution networks and

promoting customer awareness (Kaplan, 1986). Furthermore, profit measures represent outcomes

that may not fully reflect management’s effort (Drucker, 1964). Stated differently, total

performance cannot be completely captured by Naira profits.

NEW PERFORMANCE MEASUREMENT OBJECTIVES

In the new technological environment, a flexible manufacturing strategy must be implemented

that focuses on customer responsiveness, quality, time, innovation and human resources

practices. A performance measurement system designed to achieve the traditional objective of

cost efficiency will be incongruent with this new strategy. It is necessary to redesign the system

so as to reflect this change in strategic objectives.

Customer Responsiveness: increasingly, customers demand not only a better service but also a

wider variety of products with improved quality and shorter delivery times (Northey, 1991).

Customer responsiveness examines a firm’s relative ability to satisfy customers. Therefore, high

customer responsiveness translates into greater customer retention, leading to longer-term.

Profitability as the costs of acquiring and serving customers come down. Customers’

responsiveness measures therefore must be designed into the performance measure system.

These include reporting on the number of customer complaints, warranty claims, and on-time

deliveries, among others. As Eccles (1991) put it bluntly “what you measure is what you get and

what you measure gets attention”, indicating that performance measures must be relevant to send

the right signals for employees to achieve desired company objectives. For example, a system

that evaluates how well customer demands have been satisfied can better support efforts in

achieving sustainable competitive advantage than one that emphasizes labour or machinery

efficiency in internal operations (Beckette & Dang, 19910, Goldhar & Lei 1991).

Quality: Quality measures, which are the most process-oriented evaluations are designed to

determine the effectiveness of a series of activities rather than the individual activity. Quality

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refers to the degree to which a product’s specific features in terms of workmanship; durability

and so on satisfy the requirements of a particular customer. Poor quality can contribute to a

significant increase in the manufacturing costs in various ways. As Howell and Soucy (1997)

stated:

“The absence of good materials, highly-trained labour, and well-maintained equipment will

dramatically increase the costs of non quality such as scrap, rework, excess inventories, process

and equipment: breakdowns, field serves, and warranty claims.

However, quality is usually difficult to measure because of the broad scope. A contemporary

measurement concept that is increasing in interest is “the perfect order”. Delivery of the perfect

order is the ultimate measure of quality operations. The perfect order represents ideal

performance from an operational perspective, a multi-industry consortium defines the perfect

order as one that meets the complete delivery of all items requested, delivery customer’s request

date with one-day tolerance, complete and accurate documentation supporting the order and

perfect condition, that is, faultlessly installed, correct configuration, customer-ready with no

damage.

Operational and financial measurers to monitor quality include the manufacturing quality index

(i.e. defect rates), inventory levels, warranty claims, vendor quality, cost of quality and scrap

cost. All these provide valuable feedback for identifying existing problems and assessing

whether the quality objective is adequately meet.

Time: Reducing level times is also of the new manufacturing strategy through out,

(manufacturing cycle) time measures the amount of time required to convert raw materials into

completed products. Cycle time is the total value from the issue of materials into production to

the delivery of the final products to customers. The theory is that the cost of a product is related

to the time required to produce it. Cycle time variance therefore provides useful information

about non-value-adding activities such as moving, inspecting, reworking, storing and waiting,

that added to production costs as overhead charges but no value to customers (Alexander et al,

1991). Using throughput and cycle times as performance measures help managers to eliminate

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these non-value adding activities, considered as waste time, and achieve substantial cost savings.

Thus, according to Lippa (1990);

Shorter cycle times can result in less finished goods inventory,

less forecast reliance, strategic capability when a firm reacts

to customer demands faster than the competition and the ability

to exploit opportunities).

Innovation in today’s competitive environment companies must continuously engage in product

improvement be designing new and improved products with unique characteristics valued by

customers. Only in this way are companies able to enlarge their market share and maintain a

competitive edge. Introducing technological innovation and advanced design features into new

products is costly initially and requires operational flexibility; unlike cycle have unique

characteristics (Ainikal & Teo, 1992) that will require performance measures tailored for this

purpose such as turnover by products and product cost improvement.

Human Resources: The benefit of adopting a long-term employment policy is a loyal and

committed workforce, resulting in productivity increases, reduced training costs, and improved

customer services since this is provided by long-serving, presumably more experienced and

better-informed employees. A performance measure such as employee turnover is needed to help

management assess an enterprise’s human resource availability and capabilities.

It is against this background that the present study has been conducted. In Nigeria, the trend

toward high technology manufacturing is a recent event, partly motivated by rising costs and

partly encouraged by the Government as a strategy to maintain a sustainable competitive edge.

As companies automate or adopt advanced manufacturing technology, complementary changes

in performance measurement systems must be implemented to reflect the new manufacturing

environment. The following sections presented the results of a recent empirical study

CASE STUDY METHOD

A questionnaire survey design was employed as an exploratory case study. The sample was

drawn from a cross-section of companies in Nigeria that have implemented or are implementing

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changes in their production processes. Respondents were asked to consider the usefulness of

selected performance measures. Usefulness has been operationalized as the frequency of use of

each measure. Based on a total of 200 questionnaires distributed, 36 useable replies were

received, given a response rate of 18 percent. Response rates of this level were consistent with

previous other studies of Ghosen el al, 1992 Petzall el. Al, 1991. Responding companies were

classified by size musing sales turnover as the proxy measure, as follows: N20million and below

(7.5%), > N20 million – N100 million (17.5%) > N100 million (75%). It was not surprising to

find a higher percentage of response from the larger companies, because previous studies have

found size as important determinant for a company to adopt a flexible manufacturing strategy

(Schoch, el.al, 1994).

EMPIRICAL FINDINGS AND DISCUSSION

Table 1 shows that at least 63 percent of respondents indicated their dissatisfaction with the

existing performance measure system. As more and more companies turn to automation or other

advanced technology for their manufacturing processes, it is not unexpected that performance

measures originally designed for a labour intensive environment will no longer be appropriate.

What is noteworthy is that 37 percent of respondents reported that they were either satisfied with

the existing system (26%) or not sure see any need for significant changes to the system (11%).

Many of such companies are currently going through the different stages of implementing

changes to their manufacturing processes. So it may not be surprising that 37 percent continue to

rely on the traditional measures.

TABLE 1

OVERALL RESPONSE TO TRADITIONAL PERFORMANCE MEASURE

FREQUENCY (EXPRESSED AS %)

Satisfied 26

Did not see any significant change needed 11

Dissatisfied 63

Total 100

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Table 2 presents findings on the usefulness of selected traditional performance measures. These

results are consistent with the overall findings above. For example, for five of the eight

measures, the percentage of respondents indicating “useful” is also lower, ranging from 61.3

percent for standard cost overhead to 41.4 percent for earned hours, and these correspond to the

overall 63 percent who expressed dissatisfaction with traditional measures. As earlier indicated,

not all companies have fully automated, so some traditional measures have been regarded as still

useful, such as purchase price variance reported by 86.7 percent.

TABLE 2

USEFULNESS OF TRADITIONAL PERFORMANCE MEASURES

Useful Not or Less Useful

Materials price variance 86.7% 13.3%

Standard cost overhead 61.3% 38.7%

Scrap factor built into standard overhead 51.6% 48.4%

Labour Reporting 58.6% 41.4%

Earned Hours 41.4% 58.6%

Machine Utilization 78.8% 21.2%

Net Income 85.7% 14.3%

Return on Investment (total assets) 50.0% 50.0%

Average 64.1% 35.9%

The new performance measures presented in Table 3 relate to customer responsiveness, quality,

time, innovation and human resources factors, reflecting the strategic objectives of the new

manufacturing environment. There is overwhelming evidence that these measurers were found to

be “useful” by most respondents. The overall average of 83.7 percent compares favourably

against the 64.1 percent for the traditional measures.

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TABLE 3

USEFULNESS OF NEW PERFORMANCE MEASURE

Useful Not or Less Useful

Customer Complaints 88.6% 11.4%

Warranty Claims 75.8% 24.2%

On-time Delivery 93.9% 6.1%

Manufacturing Quality Index 82.4% 17.6%

Inventory Levels 88.9% 11.1%

Vendor Quality 84.8% 15.2%

Cost of Quality 84.4% 15.6%

Scrap Naira 85.7% 14.3%

Throughput Time 91.2% 8.8%

Cycle Time 78.1% 21.9%

Waste Time 72.7% 27.3%

Product Cost Improvement 70.0% 30.0%

Inventory Turnover 88.2% 11.8%

Turnover of Products 78.8% 21.2%

Employee Turnover 86.1% 13.9%

Average 83.7% 16.3%

Cross-tabulation analyses were performed by company size and years of experience in business.

Only significant results have been reported in Table 4 and 5. Larger companies found four

specific new performance measures more useful than the smaller companies. On-time deliveries

(X2 = 7.92, df = 2, p < .05); inventory levels (X2 = 5.98, df = 2, p < .05); throughput time (X2 =

9.80, df = 2, p < .01) and inventory turnover to be the forerunners in implementing technological

innovations, and so find new performance measures more appropriate. Smaller companies tend

to lag behind in implementing changes, so adoption of these new measures is not as widespread.

In table 5 significant results were found for vendor quality (X2 = 6.32, df = 2, p < .05) and

throughput time (X2 = 5.00, df = 2, p < .10). Companies with 5 years or less in business reported

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the new measures as useful compared to companies in the other categories, especially in regard

to vendor quality longer established companies have developed special relationship with selected

vendors and, consequently, vendor quality is no longer of major concern. In contrast, more

recently established companies need to identify vendors who can meet the more stringent

demands in high-tech manufacturing, such as just-in-time deliveries and supply of quality

materials.

TABLE 4

CHI-SQUARE TESTS FOR NEW PERFORMANCE MEASURES BY COMPANY SIZE

Company Size On-time

Deliveries

Inventory

Levels

Throughput

Time

Inventory

Turnover

N20m & below

Useful

Not Useful

66.7%

33.3%

66.7%

33.3%

66.7%

33.3%

66.7%

33.3%

>N20m-N100m

Useful

Not Useful

85.7%

14.3%

71.4%

28.6%

71.4%

28.6%

71.4%

28.6%

>N100m

Useful

Not Useful

100.0%

0.0%

96.7%

3.3%

75.0%

25.0%

96.7%

3.3%

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TABLE 5

CHI-SQUARE TESTS FOR NEW PERFORMANCE MEASURES BY YEARS IN

BUSINESS

Years in Business Vendor Quality Throughput Time

5 YEARS

Useful

Not Useful

100.0%

0.0%

100.0%

0.0%

>5 YEARS – 10 YEARS

Useful

Not Useful

88.89%

11.11%

77.8%

22.2%

>10 YEARS

Useful

Not Useful

60.0%

40.0%

100.0%

0.0%

CONCLUSION AND SUMMARY

Effective performance measurement and controllership are necessary to locate and monitor

resources. As competency becomes a more critical factor in creating and maintaining

competitive advantage greater attention must be given to strategic issues concerning customer

responsiveness, quality, time, innovation and human resources factors than a cost-minimization

mass-production strategy, in order that companies can remain competitive.

To this end, a performance measurement system capable of meeting these strategic objectives

also must be in place. This study reported the findings of a survey on the usefulness of selected

traditional and new performance measures used by Nigerian companies that have adopted

flexible manufacturing strategy. The results indicated that the majority of these companies

considered the new performance measures useful particularly among the larger companies and

among those with 5 years or less of business experience. Traditional measures are found to be

still useful, though to a smaller extent, as companies are going through a transition of

implementing changes to their manufacturing strategies.

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