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Value Measurement

Using a Measure Network to understand and deliver value.

Introduction

For many people, the expression “performance measurement” probably evokes more negative than positive responses. The words are associated with ideas like discipline, control, and accountability. They rekindle thoughts of pocket-protected technicians with clipboards gathering data to support time and motion studies. They suggest a lack of freedom, a stifling of creativity, an environment of work without fun. Interestingly, when things are going well, performance measurement may be welcome because it reinforces positive feelings, informs others of our positive accomplishments, and forms the basis for performance-based rewards. It may only be unwelcome when the expected outcomes are negative. The dieter is happy to get on the scale to confirm an expected weight loss, but reluctant to do so following an especially big meal. The investor logs on to a broker's website hourly when market prices are rising, and not at all when the market is in decline. The “A” students can't wait for grades to be posted, while those expecting a “C” are happy to avoid recognizing their average performance. Properly formulated and implemented, performance measurement can be encouraging, motivating, and rewarding. The challenge is to have everyone recognize that even when things are going badly, a well-designed performance measurement system can be seen as a positive force for change and improvement. This can best be accomplished with a measurement system that is considered by its users to be complete, systematic, and easy to use. For business firms, the Measure Network offers these characteristics.

Business Performance Measurement – Roles and Limitations

The primary purpose of a business performance measurement system is to provide periodic monitoring of the activities and outcomes leading to stakeholder value creation. Measures help managers to understand current performance relative to plans, relative to our own past, and relative to others who may be role models, competitors, or both. They thereby offer a basis for judging whether current performance is good or bad. Measures help managers deal with great size and complexity of business activity by focusing attention on the aspects of business that are seen as critical to success. Absent the ability to focus on critical success factors or key performance indicators, managers would soon be overwhelmed by the torrent of detailed data generated all too easily by computer-based information systems. Measures also help managers to understand the root causes of today's performance and offer guidance as to how future performance might be improved. Such analytical support enables a more rational approach to both problem solving and opportunity identification. Finally, measures offer a basis for the evaluation and reward of the performance of people in the organization. They provide objectivity in a world of subjectivity, and thereby bring a greater sense of fairness and control than would otherwise be present.

Performance measurement systems, however, are not without important limitations. The first limitation has to do with the time character of measurement and its incompatibility with managers' information needs. Ideally, managers want to know about what is most likely to happen to their business in both the near and distant future. Armed with this information, managers could best adjust tactics and strategies to maximize stakeholder value creation and achieve success. The time character of measurement stands in conflict with this managerial objective because, simply put, it is only possible to measure what has already happened. It is not possible to measure what will happen. We can measure past profitability but future profits can only be estimated. We can measure the errors that have been made by a fulfillment process but there is no way to know for certain how many errors will result from that process in the future. The challenge is to discover and utilize current measures that provide managerial insight into future business success.

A second limitation of performance measurement is that the measures are often imperfect expressions of the underlying ideas they try to capture. Sales/Number of Employees, for example, is a common measure of productivity, but sales may not be an adequate expression of output (profit might be better) and the number of employees is not the only input creating that output. In using such a measure, managers might be tempted to improve productivity by driving up sales even if they are unprofitable, and/or driving down the number of employees even if their contribution is value creating. Such actions may improve the measure while hurting the firm, and can be counterproductive. The challenge is to develop measures that both capture the underlying business idea and lead to managerial actions consistent with corporate value creation.

A third limitation of performance measurement lies not with the individual measures, but in how they relate to each other. For the most part, measurements are not fully systematic, and it can therefore be difficult to understand how changes in one measure affect another, and dangerous to assume a complete understanding of how measures in combination impact the overall corporate objective of value creation. While accounting measures are an exception (it is possible to relate one accounting-based measure to another through the system of equations connecting Income Statements, Balance Sheets and Cash Flow Statements), accounting-based measures offer an incomplete view of the firm, are based on the often misleading principles of historical cost, not market prices, and do not relate clearly to measures derived from outside the accounting system. The challenge here is to identify and manage relationships among all types of measures, even when mathematical expressions of the relationships may not be possible.

Measurement System Principles

A useful starting point for the development of a new measurement system is to develop a wish list of desirable system and measure characteristics. Even though the list might not be fully attainable, it can serve as a standard for judging both the existing measurement system and any new alternatives that may be proposed. The results provided below were obtained from questionnaires administered to and personal interviews with hundreds of corporate executives during the past three years.

  1. Measurement supports value creation for stakeholders
  2. Measurement should be systematic
  3. Measurement should support the accomplishment of strategy
  4. The logic of every measure should be clear
  5. Each organizational unit should have a small set of customized measures
  6. Performance standards should be based on external benchmarks whenever possible
  7. The system should encourage the growth of a measurement culture among users
  8. Performance results should be openly communicated
  9. A measurement system should be easy to use

Existing Performance Measurement Systems

Prior to the mid-Eighties, financial performance measurement was the only systematic measurement process used by businesses. Although many non-financial measures were employed, they were not seen as part of a measurement system, rather, they were usually referred to as “operating” measures and used in support of operating activities. There were no documented efforts to link the operating measures to the financial results. When the quality movement arrived, it raised the profile of many operating measures as critical for senior management attention. However, no general performance measurement systems evolved from the quality effort until the emergence of the “Balanced Scorecard”.

Early versions of the balanced scorecard approach highlighted several advantages. First, it recognized that measurement was best seen from several “perspectives”. Typical perspectives included financial, customer, internal business and innovation/learning. The firm was asked to develop statements of goals for each perspective and then create one or more measures in support of the goal attainment. Little emphasis was placed on linkages among measures. Balance was a key characteristic. Companies were urged to balance measures along a number of dimensions including financial and non-financial, leading indicators and lagging indicators, short-term and long-term, drivers and outcomes, strategic and operational. Over time, the balanced scorecard approach seems to be evolving into more of a “strategy scorecard”. The advantages cited for this change include a stronger focus on the business strategy, a logic for measure development called the “strategy map approach”, and a fit for each measure in a cause/effect sequence that drives high-level strategy outcomes.

The balanced scorecard meets some of the requirements of an ideal system as described above. It encourages the use of both financial and non-financial measures, and perspectives other than just that of the investor. It highlights the current business position through a relative few measures for each organizational unit and for the firm as a whole. It focuses management attention on the factors considered crucial to the accomplishment of the business strategy. And, it offers a similar measurement structure for use at all levels of the organization, while encouraging linked measures from one scorecard to the next.

But there are many problems with the balanced scorecard approach. The design around business strategy does not necessarily ensure that the organization is focused on creating and sharing value among stakeholders to provide the ultimate goal of maximizing stockholder wealth. Balance among measures is encouraged, but an appropriate balance is undefined. Selection of measures based on linkages to key success factors fails to ensure completeness, and is likely to result in a scorecard that rearranges the firm's existing measures without encouraging thoughtful consideration of useful revisions. Finally, the linkages among measures, especially those associated with different perspectives, is not explicit. Users are not encouraged to examine the relative power of measures in helping to achieve the firms desired results.

In all, the balanced scorecard approach represented an improvement of the state of the art of performance measurement. But further improvement to the current state of the art requires a fresh, new and more rigorous approach. The Measure Network offers just such a possibility.

The Measure Network

The underlying structure of the Measure Network is shown schematically in the following figure.

At the top is the structure of stakeholder value propositions that describe the character of the goods, services and money expected by the various stakeholders now and in the future. At the bottom is the structure of primary and support business processes that describe the character of the business activities that enable fulfillment of the stakeholder requirements. On the right side is a view of the management processes that give direction, incentive and assurance to the business processes and the relationships between the firm and the stakeholders. Management processes include strategy formulation and implementation, reward systems, budgeting, and the like. In the center of the diagram are the measures of the attributes of the various facets of corporate success. The measures derive logically from the structure and serve as the linkages among the parts to ensure a coordinated and disciplined approach to business activities and outcomes.

Measuring Stakeholder Deliverable Attributes

A distinguishing feature of the Measure Network is a strong focus on measuring the extent to which a firm delivers on its ultimate objectives – value creation for stakeholders. The stakeholders of a business firm are parties that receive benefits from the firm in exchange for benefits delivered to the firm. They may include customers, employees, investors, consumers, suppliers, communities, governments, distributors and enablers, among others. Each stakeholder chooses to be associated with the firm in the hope that they will thereby be better off than would otherwise be the case. We call this idea of “better off” value creation, and recognize that it is a complex and different relationship for each stakeholder.

For the investor, value is created when the business is able to provide market-based return on investment that beats alternative investment opportunities in the same risk class. For the customer, a business creates value when it provides products and services that offer more net benefit over time than competing providers. For the employee, a business creates value when it provides employment that offers greater net benefit than competing opportunities for the employee's time, expertise, and energy. For these and all the other firm stakeholders, association with the company is all about being better off than would be possible with partners other than the firm.

The ultimate objective of the firm is value creation for the investors. They are the owners of the firm and hold the residual claim on its activities. When managers deal with customers, they are expected to take a long-term view of the products, services, prices, and other elements of the relationship required to remain the supplier of choice. But they only give enough to keep the customer buying, not more. As they deal with employees, managers are expected to offer terms of employment sufficient to keep the employees working in the interest of investors, not more. Similar arguments hold for all other stakeholders, but the investor is different. The manager's job is to maximize the long-term net benefit stream to investors. Since the price of a share of common stock is in theory the present value of the expected net benefits to owners, the manager can simply focus on doing the things that increase the stock price. This does not imply an inappropriate focus on short-term profit. Expenses today that lower current profit but offer sufficiently higher future profits are consistent with the value maximization idea. A useful performance measurement system provides managers with indications of whether the firm is making proper tradeoffs among the potentially conflicting interests of the stakeholders to ensure value maximization for investors.

Value creation is complex. It happens over time in the interaction of the various transactions between the firm and its stakeholders. The deliverables may include money, goods and services, time, knowledge, reputation, sense of self-worth, and other benefits and costs flowing to and from the firm and its stakeholders. Employees provide the firm with time, knowledge and skill. The firm gives them money, training, and future growth opportunities. Customers pay money for the goods and services provided by the firm. Communities offer land, infrastructure improvements, current tax breaks, and access to skilled workers in return for employment opportunities and a future stream of tax payments. In the Measure Network structure, deliverables to stakeholders are viewed as the objectives of the firm, while deliverables from stakeholders are part of the business processes helping to accomplish the objectives.

Stakeholder deliverable attributes are the characteristics that define and give dimension to stakeholder deliverables. A bakery customer wants to buy bread, but the bread must be fresh, have a chewy crust, and be available in time for use at dinner. A supplier wants to receive an order from the firm, but would find the order far more desirable if it generated a high level of profitability, offered an opportunity to learn how to make a new product, and fit comfortably into the existing production schedule. Examples of a variety of stakeholder deliverable attributes include:

  • The completeness of a delivery received by a retailer
  • The consistency of payments received by a supplier
  • The breadth of a product line offered to a distributor
  • The reliability of the dividend paid to an investor
  • The amount of compensation offered to an employee

A focus on stakeholder deliverable attributes allows managers to identify the key elements of the firm's competitiveness for stakeholders and provides a compelling logic for the selection of performance measures.

The selection of stakeholder deliverable attribute measures combines the experience and judgment of managers with the logical structure of the Measure Network. The first task is to develop potential measures for a specific stakeholder deliverable attribute. This step requires an understanding of potential data sources, an appreciation for the types of data that can be captured by information systems, and a recognition of the managerial insight offered by different combinations of data into ratios. Step two is the refinement of potential measures to consider possibilities for segmentation, and/or to build in comparisons to the measure itself at another time or to standards such as the budget. The final step is to select the best measure for each stakeholder deliverable attribute from the set of candidates. Selection criteria will include an assessment of the relationship between changes in the attribute and changes in the measure, the ease and cost of measurement, the familiarity of the measure to the organization, the ability to communicate the significance of the measure, and the connectivity of the measure with other, related measures in the system.

Classifying Processes in an Organization

To facilitate the building of a Measure Network, we describe all business activities as being part of one of three main types of processes which are illustrated in the following figure:

  1. primary business processes
  2. support business processes
  3. management processes

Primary business processes are the series of activities that enable delivery of goods and services to customers. One primary business super-process is demand generation, which includes development, marketing, sales and other activities closely related to understanding the customers' needs, developing and communicating the capability of the firm to respond to those needs, and closing the sale. The other super-process is demand fulfillment which includes procurement, production, delivery and other activities related to the creation and delivery of products and services. Each of these high-level primary processes will typically break down into hundreds of integrated processes, sub-processes and activities.

Support business processes are specialized activities done by functional professionals which are in support of, but are not central to, the completion of primary business and management processes. Support processes typically provide a similar service to many parts of the business, such as an information systems development process providing technology solutions to improve both sales and manufacturing capabilities. The research, finance and human resource processes also play the role of providing tools and solutions which support the effective execution of other processes.

Management processes are the set of activities, common to people in all parts of the business, that managers do to understand, guide, integrate, coordinate and control the business processes that ultimately create value for customers and investors. Management processes focus on the cycle of design, execution and assessment of managerial activities related to setting strategy, managing business processes, measuring performance and managing people.

The following table highlights activities that would be done within each of the process categories at an office equipment maintenance and repair company.

PROCESS DESCRIPTION OF ACTIVITY

Primary Business Processes

  • Demand Generation Call customers in target companies to offer services
  • Demand Fulfillment Maintain office equipment

Support Business Processes

  • Manage Information Technology Set up a customer tracking system
  • Manage Financial Resources Deposit customer checks into company account
  • Manage Human Resources Advertise a job opening

Management Processes

  • Manage Strategy Identify markets to be served and services to be offered
  • Manage Business Processes Implement a quality process around tracking potential customers
  • Manage Performance Measurement Measure the average time to repair each type of equipment breakdown
  • Manage People Assess capabilities of employees and organize work teams to maximize effectiveness

Different types of processes are interlinked. The manager of maintenance operations completes a management process when she identifies the need and outlines the requirements for an improved scheduling process. The information systems manager executes a support process by creating and implementing a new computer system for scheduling. In using the new system to schedule work teams, the operations manager completes a primary business process that directly affects the company's ability to serve customers.

The benefits of process recognition and management are many.
  • Improvement of value creation for customers by helping managers identify and improve all links in the customer value chain as an integrated system
  • Facilitation of a total value focus for support processes by highlighting their specific connections and deliverables to primary business processes
  • Encouragement of people to plan, coordinate and control their managerial activities in a more systematic, complete and effective manner.

Measuring the Elements of Processes

Because measurement for a business or management process must highlight the most important aspects of the process, the Measure Network identifies measurable “elements” that include the process itself or any subset of the process, an input to the process, an output from the process, or a person working in the process. For example, elements of the purchasing process might include, the supplier payment process, the production forecast, the order for materials, and the purchasing agent. Proper identification of these elements and an assessment of their relative importance is an important input to the development of process-related measurements.

Process element attributes are the characteristics that define and give dimension to process elements. They may include inherent characteristics of the process, behaviors of the process or of the people who work in it, the process environment, perceptions of users of the process, actual outcomes of the process, and impacts of the process on the users. Examples of business process element attributes might include:

  • The professionalism of a sales representative
  • The completeness of an order shipped to a customer
  • The satisfaction of an employee with the job
  • The cost of the order-taking process
  • The productivity of the shipping department
The process of defining attributes focuses attention on the aspects of business and management processes that are critical to creating value for stakeholders and enables a clear understanding of what must be measured.

Finally, measures of the process element attributes must be developed. The three steps mirror those used to determine stakeholder deliverable attribute measures. Candidate measures are developed and refined, and the selection process yields a best measure for each attribute. The result of the effort for management processes might be measures such as:
  • The number of months to complete the strategic plan
  • The number of new ideas generated by the strategic process
  • The cost of annual budgeting
  • The hours of management training during a year

Employing the Measure Network

Feedback from business managers regarding the usefulness of measurement systems inevitably mentions three dimensions of difficulty. First, there is the difficulty of striking an appropriate balance between getting enough information and having too many measures that result in information overload and confusion. Second, measures must simultaneously meet the needs of local and corporate management. Third, “the line of sight” between the activities of a lower level person or department and the objectives of the firm should be as clear as possible. The Measure Network addresses these issues through the use of two tools, the measure set, and the value path.

The measure set is a grouping of measures applicable to an organizational unit of the firm. A measure set can be created for the overall firm, a business unit, a functional area or department, a process or sub-process or a group of people. A well-constructed measure set combines measures that facilitate control of local business activities and measures that enable an understanding of the influence of these activities on other organizational units and on the objectives of firm as a whole.

The development of a measure set is a process of selecting measures from the Measure Network that will meet the needs of managers. First, the business processes engaged in by the organizational unit are identified and fully described. Next, the stakeholder deliverable attributes that can be most directly affected by the business processes are identified. Third, managers within the organizational unit select the attributes of management processes that make the greatest contribution to the success of the firm. Finally, appropriate measures from the Measure Network are identified and classified by relative importance. Measures falling into the “most important” group are tested for completeness and redundancy, and the selection of the measure set is determined. Over time, the measures continue to be tested for usefulness, and revisions are made, as necessary.

The value path is a linking of a process activity to a stakeholder deliverable through performance measures. It can be used to recognize key drivers of strategic success, to improve the “line of sight” between local process managers and key stakeholder deliverables, and to emphasize a small number of critical local measures. A value path is extracted from a measure set by identifying the critical process and its key measure, linking it to a measure associated with the related stakeholder deliverable, and tracking the path between them. If multiple stakeholders are affected, multiple value paths may be considered.
Measure sets and value paths are refinements of the Measure Network that help reduce the number of measures of concern to a manger, focus attention on critical aspects of performance, and connect the units of the organization to the key stakeholder deliverables.

Assessing the Measure Network

Does the Measure Network fulfill the requirements of an ideal measurement system? In many ways, it does. The Measure Network is a systematic representation of the relationships between the firm's business and management processes and the goals of the stakeholders. All measures in the system derive from the structure and are linked through it. The relationships among measures are not described by equations, but there is a strong sense of directional influence. The measures support and link to the firm's business strategy because the strategy management process is an integral part of the Measure Network structure. Measures are selected because they represent the best-known way of capturing the attributes of the underlying business processes and stakeholder deliverables. The development process encourages creation of measures that offer strong insight into future performance. The number of measures employed in any measure set is the minimum number required to accomplish the needs of each organizational unit. “Balance” is not an objective of the Measure Network. Instead, value creation for the organization is the goal. Consistent with this goal, the Measure Network recognizes all stakeholders, all processes, short-term and long-term, behaviors and outcomes, local and aggregate results. Measure sets allow customization of measures to meet the specific requirements of each organizational unit. Moreover, a measure set may contain measures that are primarily designed to meet the needs of other units of the firm. The logic and transparency of the Measure Network should help encourage a positive measurement culture in a firm. The openness of measure selection and the requirement that measures be reevaluated for effectiveness ensures that the system will adjust to the changing needs of managers over time.

Conclusion

Performance measurement is an essential component of the management process. It supports fulfillment of the business strategy, aids the analysis of business problems and opportunities, and offers a basis for rewarding desirable behaviors and outcomes. Unfortunately, performance measurement is often unstructured and undisciplined. Firms use too many measures, there is a weak logic underlying the selection of measures, and the measures do not function as a system. As a consequence, the benefits available from a strong performance measurement system are often lost.

The Measure Network addresses these issues. It provides a methodology for the development and use of a performance measurement system that overcomes many of the deficiencies of other methods. While the development of the Measure Network recognizes the complexity and richness of business activity, the resulting measurement system is straightforward and highly intuitive for users. It offers highly customized measures for parts of the business, pays attention to linkages among the measures used in various parts of the firm, and connects the highly summarized measures used at the corporate office to the related measures in the business processes. The Measure Network supports management's efforts to meet the needs of the firm's stakeholders.

Reprinted with permission of Journal of Cost Management, "Using a Measure Network to Understand and Deliver Value," by Gregory P. Reilly and Raymond R. Reilly (November/December 2000): pp.5-14. Copyright C by RIA/WG&L; all rights reserved.



Content date: Wednesday, March 06, 2002
Author: Gregory P. Reilly and Raymond R. Reilly (greilly@measure.net )
Company: Measure.net (http://www.measure.net)


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