umhs-ldp 1 friday, november 14, 2003 measurement and control of organizational performance “do the...

UMHS-LDP1

Friday, November 14, 2003

Measurement and Control of Organizational Performance

“Do the Right Things & Do it Right”

Raffi Indjejikian

(In-jay-jik-yan)

UMHS – LDP ProgramNovember 14, 2003

UMHS-LDP2


Agenda

Measurement and Control – a framework

Theme: Performance Measurement and Rewards• Theory• Practice• “Academic” evidence• Performance evaluation exercise – Citibank case

Theme: Cost measurement for decision-making• Evolution of measurement and control systems; corporate, health care• Understanding “relevant” costs• Cost measurement exercise - Cambridge Hospital PCU case

Concluding Remarks

UMHS-LDP3


Measurement and Control – a framework

Control & performance evaluation: Designing measures and mechanisms to align managerial and organizational goals for value creation, such as:• Assigning decision rights • Budgeting processes and responsibility

reporting (e.g., variance reports)• Performance evaluation and incentive

compensation• ...

Actions & decisions: Conducting Cost and Profitability analysis for• Pricing of services / procedures• Negotiating with insurers• Service / Product rationalization• Process reengineering, Outsourcing• …

EnvironmentRegulations, Technology, Markets, etc.

Corporate (UMHS) Strategy

Organizational Architecture

Value Creation

Measurement Systems& Information

Decision Makers - you?

Control & Performance Evaluation

Actions & Decisions

UMHS-LDP4


Performance Measurement and Rewards

“Well, then, says I, what’s the use you learning to do right

when it’s troublesome to do right and ain’t no trouble to

do wrong, and the wages is just the same?”

Huckleberry Finn, Mark Twain (1884)

UMHS-LDP5


Doing the Right Thing and Doing it RightTheory

Key Premise

• Different organizations have different strategies and different success factors

• Face different coordination and motivation problems

• Need different performance evaluation and reward systems

UMHS-LDP6


The “Coordination” problemWho does what? How? When? With what resources?

• Make sure knowledge and decision authority are at the same location:- Move information and knowledge to decision maker, or- Move decision authority down to individual with knowledge and information

• Which decisions are to be centralized and which are to be decentralized - left to individuals and operating units? Who should make these decisions?

• How will information flow in the organization: What information will be transmitted upwards to support the centralized decision and back down to guide those who will implement them.

• Tools: Organizational structure, governance mechanisms, responsibility reporting (e.g., cost centers), budgeting systems and processes, other methods of communication and information flow.

key concept: Assignment of Decision Rights

UMHS-LDP7


The “Motivation” Problem

Incentives (interests) of all individuals that have decision rights

are not necessarily aligned with each other or with the goals of

the organization – even for those who are highly intrinsically

motivated.

key solution: Performance measurement, evaluation, and rewards

UMHS-LDP8


Performance Evaluation and Rewards

UMHS-LDP9


Performance Evaluation and RewardsThe good, the bad, and the ugly

The Enron Corporation paid its executives huge one-time bonuses (under a program known as the Performance Unit Plan) for hitting a series of stock-price targets ending in 2000.

… Almost every corporate decision that led to Enron’s collapse - including the establishment of a series of partnerships - was made during the time frame of the Performance Unit Plan.

Source: NY Times, March 1 2002

Apple Polishing: Kentucky's Teachers Get Bonuses, but Some Are Caught Cheating

--- If Their Schools Score Well, State Ponies Up Cash;

--- Lots of Grade Inflation

Front page: Wall Street Journal September 2, 1997

UMHS-LDP10


Performance Evaluation and RewardsThe good, the bad, and the ugly

SEARS AUTO CENTERS• In 1992, the State of California filed charges alleging that Sears Auto Centers were

overcharging customers an average of $230 for unneeded or undone repairs. Similar allegations were made by the State of New Jersey. Sears admitted that “some mistakes did occur” and agreed to a settlement of approximately $20 million.

• Problem? Auto Center managers were rewarded almost exclusively based on sales revenue / volume.

Buell Motorcycle Co., Milwaukee, discontinues a program in which it gave under-performing workers the day off with pay to write an “action plan” on how they would do better. “We’re going back to more traditional methods,” says Bruce Champion, head of finance and human resources. “Most of us didn’t favor that touchy-feely stuff. Now, you just get fired.”

Source: WSJ, May 27 1997

UMHS-LDP11


Solving Coordination and Motivation Problems

Entrepreneurs versus Individuals in firms

• Entrepreneurs have the property rights (decision rights) to their assets. Entrepreneurs already have the knowledge or have an incentive to acquire the knowledge required to put the assets to their best use. Entrepreneurs bear the entire consequences and reap all the rewards for their actions and decisions. - No motivation problem.

• Within firms, individuals do not have automatic decision rights and do not reap all the rewards or bear all the consequences of their actions.

• Organizations have to:

—Delegate decision rights to individuals (implicitly or explicitly).

—Design performance evaluation systems and reward schemes measures to complement the delegation of decision rights.

UMHS-LDP12


Performance Measurement and EvaluationSome Questions

How do (should?) organizations select performance measures for evaluating executives, business unit managers, department heads, other employees?

What are the comparative advantages or disadvantages of:• Financial versus non-financial measures

• Corporate or institution-wide versus localized measures

• Objective versus subjective measures

• Absolute versus relative measures

How do (should?) organizations set performance targets and benchmarks?

“Academic” research evidence: Does any of this matter?

UMHS-LDP13


Components of Business Unit manager Compensation in Corporate America – circa 1995 ( Source: Hewitt Associates, LLP)

Mean 1st Quart Median 3rd Quart

Group VP manager

Base Salary (000s) 316 243 300 367

Target bonus as % of salary 49% 40% 49% 55%

Long-term as % of salary 90% 45% 76% 106%

Division manager

Base Salary (000s) 203 150 192 232



Plant manager

Base Salary (000s) 110 90 104 122



UMHS-LDP14


Annual Incentives

• Incentive plans that provide rewards for performance results measured over a twelve month period.

• Typically explicit plans (may be “formulaic” ) - depend on:• performance measures• performance standards (budgets, prior year, discretionary, external peer groups)

• pay-for performance relation (thresholds, caps, linear, convex/concave incentive zones)

• Common stated objectives for having annual incentive plans:•Support the achievement of the organization’s business and strategic objectives•Attract, motivate and retain qualified employees•Recognize/reward individual contributions•Provide the opportunity to earn competitive annual incentive awards (total cash compensation)

UMHS-LDP15


Independent Tiers

Dependent Tiers

Tier I

Tier 2

Tier 3

Measure A 50%

Measure B 30%

Measure C 20%

100%

Measure A 50%

Measure B 30%

Measure C 20%

100%

Scorecard

Tier I

Tier 2

Tier 3

Spot Awards

Typical Annual Incentive Plan Designs

UMHS-LDP16


Key Components of a “Typical” Annual Incentive Plan

AnnualBonus

The “Incentive Zone”

PerformanceMeasure

Pay/PerformanceRelation

Bonus“Cap”

TargetBonus

PerformanceThreshold

PerformanceStandard

UMHS-LDP17


Performance evaluation and rewards : Citibank Why has Citibank introduced a Performance Scorecard? What is the business model underlying the

performance scorecard?

Underlying Strategy

• To build a profitable franchise by providing relationship banking combined with a high level of service to its customers.

Top Management’s Needs

• Every employee in the division should have a broader view of the business and focus their attention on those dimensions.

Such a focus translates into long term success.

• The California Division developed a Performance Scorecard to reflect the importance of non-financial measures as leading indicators of strategy implementation.

• Performance Scorecard is made from financial measures and new measures reflecting important competitive dimensions in the bank’s strategy.

–Financial measures : Revenue,expense,margin, operating losses,fraud losses,etc…

–New measures(non-financial) : Customer satisfaction,Team work,Training/Development,Leadership,etc…

What they did

UMHS-LDP18


Control and Performance evaluation : Citibank Case(Cont’d)The Details of New Performance Scorecard

Components

• FINANCIAL– Revenue– Expense– Margin

• STRATEGY IMPLEMENTATION– Total Households– New to bank households– Lost to bank households– Cross-sell,splits,mergers households– Retail asset balances– Market share

• CUSTOMER SATISFACTION

• CONTROL– Audit, Legal/Regulatory

PEOPLE– Performance Management– Teamwork– Training/Development– Employee Satisfaction

• STANDARDS– Leadership– Business Ethics/Integrity– Customer Interaction/Focus– Community Involvement– Contribution to Overall Business

Qualitative/Quantitative

Quantitative

Quantitative

Quantitative

Quantitative

Qualitative

Qualitative

• Obtained from regular accounting system

• Focused on measurement of retail customers because of their strategy

• Measured through telephone interviews with approximately twenty-five branch customers who had visited the branch during the past month. Customer satisfaction scores were derived from questions that focused on branch service as well as other Citibank services(e.g. telephone banking,ATM)

• Evaluation by internal auditors on the branch’s internal control processes.

• Ratings are determined subjectively by the branch manager’s boss.• Assessment of a manager’s involvement in community groups,trade

associations,and business ethics

• Ratings are determined subjectively by the branch manager’s boss.• Focused on the proactive efforts of the manager to develop and communicate

with subordinates.

Details

UMHS-LDP19


Control and Performance evaluation : Citibank Case(Cont’d)The Details of New Performance Scorecard(Cont’d)

Evaluation Process

• Lisa evaluates James using Performance Scorecard once per quarter. Rated as Below Par / Par / Above Par

• At yearend,through discussion with Frite,Lisa gives James a global rating for each of six components of the Scorecard and an overall rating.

• Overall rating affects James’ bonus as follows.

• Frits Seegers–President of Citibank California

• Lisa Johnson– Area manager of LA

(supervising James McGaran)• James McGaran

–Manager (of the most important of the 31 branches in the LA)

Par

Below Par

Above Par •Bonus is as much as 30% of the basic salary.

•Bonus is zero

•Bonus is up to 15% of the basic salary.

• The performance planning process started in October with a negotiation process between Frits and his area managers(including Lisa).• Performance Scorecard targets for the upcoming year were established for the division and for each area.

UMHS-LDP20


Control and Performance evaluation : Citibank Case(Cont’d) What are the strengths and weaknesses of customer service as a performance measure in this case?

In general?

Strengths

• Customer service as a performance measure can reflect their customer-oriented strategy.

• Prevent sales representatives from selling that is based on supplier logic

–(Customer service performance as a performance measure is sometimes hard to reconcile with demonstrated financial or sales performance.)

• By using some kinds of customer surveys,that can be measured quantitatively and objectively.

Weaknesses

• There is a risk that the adequacy of the surveys can’t be kept.

• It is difficult to consider the special characteristics of the regional market ,customer behavior ,competitor’s situations,etc…

– (In fact,James had a demanding clientele and challenging competition.)

• There is a risk that the customer service as a performance measure is not consistent with financial performance.

So WhatCustomer service as a performance measure ( That means the contents and procedure of customer survey)

should be updated carefully and frequently and to cover those weaknesses.

UMHS-LDP21


Control and Performance evaluation : Citibank Case(Cont’d) Assume that you are Lisa Johnson. Complete exhibit 1 to evaluate James performance. Should James get the

full bonus?

Performance Evaluation of James

• FINANCIAL

• STRATEGY IMPLEMENTATION

• CUSTOMER SATISFACTION

• CONTROL

• PEOPLE

• STANDARDS

• OVERALL EVALUATION

1Q

BelowPar Par Above

Par

2Q

BelowPar Par Above

Par

3Q

BelowPar Par Above

Par

4Q

BelowPar Par Above

Par

Total

BelowPar Par Above

Par

N/A

Rules 1.Evaluation for the year can’t be better than each quarter’s evaluations.

Strict application of the new policies for performance evaluation means that James can get at most a “par” evaluation in the component of customer satisfaction for the year.

2. For evaluation of the year, without “par” ratings in all the components of the Scorecard, a manager could not get an “above par” overall rating.

Rule 2.

Rule 1.

UMHS-LDP22


Control and Performance evaluation : Citibank Case(Cont’d)

The reasons which support James’ evaluation “above par”

• He generated the highest revenue and made the greatest margin contribution to the business of any branch in the system. His financials were outstanding - 20% above target.

• His branch is the largest and toughest branch in the division.

• He had a demanding clientele and challenging competition.

The reasons which support James’ evaluation “ par”

• Strict application of the rules (see P.5)

• If the performance evaluation team gave James an “above par” ,people could think that the division was not serious about its non-financial measures.

• Any rules shouldn’t have any exceptions.

• Customer satisfaction should be the most important to achieve their strategy.

James’ evaluation should be “ par”

What we think as important

UMHS-LDP23


Branch Manager Survey (1997) …

Agree Neutral Disagree

I have a good understanding of the scorecard process 61% 18% 21%

With scorecard, it is easy to see the connection between individual and branch performance 41% 28% 31%

My scorecard goals cover all the important parts of my job 39% 21% 40%

When it comes to scorecard bonuses, I have no idea who gets what and why 55% 20% 25%

Overall, I am satisfied with the scorecard process 32% 23% 45%

UMHS-LDP24


Explicit Statements by Managers (1997) …

“Eliminate the scorecards! Promotions and bonuses are still given to those who kiss-up to their supervisors, with little regard to performance, educational background, and experience”

“I hate this new process. Favoritism comes too much into play”

“Scorecards only reflect certain parts of your job”

“This is a black box process, no one knows anything”

“I would have liked to have known what my evaluation was going to be based on before the quarter began”

UMHS-LDP25


Global Focus Group Study (1997) …

48% of all focus groups cited inequitable rewards (second biggest problem):

• Lack of recognition and rewards

• “One size fits all” scorecard

• Inequitable, subjective performance measures

• Said to produce lower morale, dissatisfaction, stress/burnout, and turnover

UMHS-LDP26


Epilogue …

CEO’s response: “I never said that this should happen. It was never said that the balanced scorecard should be used to compensate people.” Maybe scorecards shouldn’t be pushed down to branch managers

HR’s response: “If not the scorecard, then what?” Proposed new bonus plan that would combine a formula-driven component with an explicit subjective component.

Final outcome: Scorecard-based bonus plan replaced with a commission-style revenue plan in 1999 after change in the business model

umhs-ldp 1 friday, november 14, 2003 measurement and control of organizational performance “do the...

Documents