Fundamentals of management control

Zarlowski P., Saulpic O., Giraud F., Dambrin C.

Fundamentals of management control
Zarlowski P., Saulpic O., Giraud F., Dambrin C.
V2021

Table of contents
General introduction ......................................................................................................... 6
Subject of the book ........................................................................................................... 6
Several elements of knowledge about the instruments ...................................................... 7
The rational perspective and contingency ........................................................................................ 7
Sociological perspectives: ................................................................................................................. 7
Our approach to management control and its instruments ............................................................. 8
Our principles concerning management knowledge and managerial practices .................. 10
Abandoning an overly strict opposition between theory and practice ........................................... 10
Taking account of the wide range of opinions about what constitutes an improvement .............. 11
Considering management knowledge as a repository that can be used to ask the right questions11
Adopting a scientific approach to the knowledge disseminated .................................................... 12
Principles limiting the risk of reification .......................................................................................... 13
Summary and book outline .............................................................................................. 14
Bibliography .................................................................................................................... 15
Chapter 1 - Management control: an overview ................................................................ 16
Introduction ........................................................................................................................... 16
Section 1. The basic elements of the process .................................................................... 16
The control cycle ............................................................................................................................. 16
Performance measurement systems .............................................................................................. 20
The role of controllers in the performance management system .................................................. 25
Section 2. Management control within groups: a double level .......................................... 26
Autonomous control by entities...................................................................................................... 26
Control by the hierarchy ................................................................................................................. 27
The links between autonomous control and control by hierarchy ................................................. 30
Conclusion ...................................................................................................................... 32
Bibliography .................................................................................................................... 33
Part 1 - Performance measurement systems .................................................................... 34
Chapter 2 - Clarifying and modelling the organisation’s performance .............................. 35
Introduction ........................................................................................................................... 35
Section 1. What is organisational performance? ............................................................... 35
Section 2. Organisational performance and stakeholder expectations............................... 36
Managing the balance between stakeholders ................................................................................ 37
Managing multi-dimensional organisational performance ............................................................. 38
Section 3. Issues involved in performance modelling ........................................................ 40
The organisation's performance model .......................................................................................... 40
The contributions of performance modelling ................................................................................. 42
Limitations of performance modelling ............................................................................................ 42
Conclusion ...................................................................................................................... 43
Bibliography .................................................................................................................... 44
Chapter 3 - Measuring an organisation’s performance: financial indicators ..................... 45
Introduction ........................................................................................................................... 45
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Section 1. The main financial indicators ........................................................................... 45

Profitability indicators ..................................................................................................................... 45
Return on investment indicators ..................................................................................................... 47
Value creation indicators ................................................................................................................ 50
Cash flows ....................................................................................................................................... 56
Section 2. Advantages and limitations of financial indicators ............................................ 58
Advantages of financial indicators .................................................................................................. 58
Limitations of financial indicators ................................................................................................... 59
Conclusion ...................................................................................................................... 61
Bibliography .................................................................................................................... 61
Chapter 4 - Breaking down the organizational performance by business segment ............ 62
Chapter 5 - Measuring business segment performance through cost accounting .............. 63
Chapter 6 - Breaking down the overall performance of an organization by responsibility
centres............................................................................................................................ 64
Introduction ........................................................................................................................... 64
Definition of a responsibility centre ................................................................................. 64
A subdivision of the organizational structure ................................................................................ 64
Clear authority................................................................................................................................. 65
Resources ........................................................................................................................................ 67
Objectives ........................................................................................................................................ 67
Designing the performance measure of a responsibility centre: aims and principles .......... 67
The aims of the measure ................................................................................................................. 68
The principles .................................................................................................................................. 70
Bibliography .................................................................................................................... 73
Chapter 7 - Measuring responsibility centre performance through Responsibility
Accounting ..................................................................................................................... 74
Introduction ........................................................................................................................... 74
Different types of responsibility centres ........................................................................... 74
RC typology and principles guiding RC evaluation .......................................................................... 74
The four types of responsibility centres .......................................................................................... 75
Concepts that may be poorly applied ............................................................................................. 80
A more complex reality ................................................................................................... 81
A need to adjust to the specificities of the organization................................................................. 81
Shared responsibilities .................................................................................................................... 81
Overlapping responsibilities ............................................................................................................ 83
Hybrid responsibility centres........................................................................................................... 83
Differences between responsibility accounting and cost accounting ................................. 84
The limits of Responsibility Accounting ............................................................................ 84
Limits of a financial measure of RC contributions. .......................................................................... 84
Limits of the cost centre and revenue centre concepts .................................................................. 85
Limits of the profit centre and investment centre concepts ........................................................... 85
Conclusion ...................................................................................................................... 86
Bibliography .................................................................................................................... 86
Chapter 8 - Constructing organisational performance models .......................................... 87
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Introduction ........................................................................................................................... 87
Section 1. Clarifying the meaning of the concept of strategy ............................................. 87
Section 2: The strategy map in the BSC method ................................................................ 88
Guidelines for constructing the strategic map ................................................................................ 88
Discussion: The underlying generic model and its possible adaptations ........................................ 92
Section 3: The Objectives/ critical performance variables grid in the OVAR method .......... 94
Linking Critical Performance Variables / Objectives ....................................................................... 94
Objectives ........................................................................................................................................ 95
Critical performance variables ........................................................................................................ 96
Overall balance of the O/CPV grid................................................................................................... 96
Conclusion: Comparison of the strategy map and the O/CPV grid ....................................100
Bibliography ...................................................................................................................100
Chapter 9 - Dashboards: indicators for performance management and reporting ...........102
Introduction ..........................................................................................................................102
Section 1. Some commonly accepted ideas about dashboards .........................................102
Properties of “good” dashboards .................................................................................................. 102
Recommendations for "good practices" ....................................................................................... 103
Indicators covering the entire set of organisational goals and objectives .................................... 104
Indicators focusing both on desired outcomes and on performance levers ................................. 104
Using indicators that are not exclusively financial ........................................................................ 104
Indicators that are consistent with organisational strategy.......................................................... 105
A limited number of indicators ..................................................................................................... 105
Quick access to results .................................................................................................................. 106
Presenting indicators in a vivid and legible way ............................................................................ 106
Synthesis........................................................................................................................................ 106
Section 2: Recommendations that are not unambiguous .................................................107
Conflicting recommendations on the number of indicators ......................................................... 107
How to use performance indicators? ............................................................................................ 107
Two main uses for performance indicators: performance management and performance
reporting..................................................................................................................................................... 108
Section 3: Two uses of indicators for performance management: Energising and monitoring
108
Indicators used to energize ........................................................................................................... 109
Indicators used to monitor ............................................................................................................ 109
Synthesis........................................................................................................................................ 110
Section 4. Two management reporting uses: Evaluation and information ........................112
Evaluation ...................................................................................................................................... 112
Information ................................................................................................................................... 113
Multiple uses for a same indicator; different uses for indicators used at the same entity level .. 113
Deployment of objectives and uniqueness of performance indicators ........................................ 114
Section 5: Constructing indicators for performance monitoring .......................................115
Bibliography ...................................................................................................................117
Part 2 - The control cycle ................................................................................................119
Chapter 10 - Business planning.......................................................................................120
Introduction ..........................................................................................................................120

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Section 1. The principles .................................................................................................120

The main purpose of business planning ........................................................................................ 120
Basic functions .............................................................................................................................. 123
Functions linked to company organisation ................................................................................... 129
Strategic alignment ....................................................................................................................... 130
Horizontal coordination ................................................................................................................ 132
Motivation and incentives ............................................................................................................. 134
Theoretical difficulty: incompatibility between functions ............................................................ 136
Section 2. Operational implementation...........................................................................137
Business planning over time ......................................................................................................... 137
The budgeting process .................................................................................................................. 141
Practical difficulties ....................................................................................................................... 150
Conclusion .....................................................................................................................153
Bibliography ...................................................................................................................154
Chapter 11 - Analysing results ........................................................................................155
Introduction ..........................................................................................................................155
Section 1. Principles and tools ........................................................................................155
Objectives and principles of results analysis ................................................................................. 155
Results monitoring using a cost accounting approach .................................................................. 157
Monitoring results with dashboards ............................................................................................. 168
Other methods .............................................................................................................................. 171
Summary ....................................................................................................................................... 173
Section 2. Coordination of results monitoring between different levels ...........................174
Coordination between reporting/autonomous local control........................................................ 174
Coordination of management processes ...................................................................................... 176
The link with evaluating managers ................................................................................................ 177
Conclusion .....................................................................................................................178
Bibliography ...................................................................................................................178
Part 3 – The management control actors ........................................................................179

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General introduction

Subject of the book

This book addresses the subject of management control, or performance management. This subject is
examined by studying the management instruments (or tools) used to carry out this function, and
adopting a comprehensive approach to clarify their outcomes, their concrete methods of construction,
their uses and their effects.
It has been designed to act as an educational resource for students and managers, covering management
control in a limited period of time, which required choices to be made in order to determine the
"fundamentals".
This was a more complex issue than it may seem. Many introductory works approach the "basics" by
describing the elementary techniques inherent to management instruments; others get round the
difficulty of choosing by proposing a very wide range of topics, but without clarifying the links between
them. In this book, we have adopted a different stance which we shall describe in this introduction, and
whose broad principles are set out below:
- A managerial approach: management control is presented in this work as a managerial approach,
and not, as it is considered all too often, as a matter for technical experts. As it includes the choice
of an organisation's orientations and their implementation at the level of daily operational decisions,
this process is, above all, the responsibility of the directors and managers of firms. Management
control tools are dedicated to this approach and are intended to help with decision-making. That is
why this book has, first and foremost, been designed for a readership of managers (or of students
aspiring to managerial positions) in their role as the main players in performance management, and
in this way, it differs from works presenting an excessively technical vision of these issues, which
would be inappropriate for this readership.
- Putting technical choices into perspective: while this book does present the main families of
management instruments and their operational structures, it primarily reveals the outcomes and
principles on which these practical choices are based. Consequently, it may also inform the thinking
of managers who have already acquired a degree of experience with management control tools, by
allowing them to take a more objective look at their practices.
- Instruments designed from a socio-technical perspective: management control instruments are
examined by considering both their technical dimension and the way in which they interact with the
social environment in which they are situated.
- Links to research: this book aims to make knowledge derived from research available in an
accessible form. We believe this is essential to allow the readers to assimilate the content of the
book with a view to improving their practices. But to this end, it is necessary to agree on the nature
and origins of this knowledge. However, as research in the management field is in its infancy, there
are still many ambiguities concerning these issues. This is one of the justifications for this relatively
long introduction, which sets out to explain our intellectual positioning and situate our ideas within
the corpus of existing knowledge.
In the following section (2), we shall provide certain details about the current state of research on
management instruments, and then we shall describe the specificities of our approach to management
control and its instruments (section 3). In section 4, we shall describe our intellectual positioning by
stating our principles in relation to management practices and knowledge. Lastly, we shall outline the
structure of the book.

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Several elements of knowledge about the instruments

Our aim is not to present a summary of the literature on management instruments, but rather to allow
readers to improve their understanding of the book's positioning so that they can make the best use of
its contents.

The rational perspective and contingency

From the "rational" perspective, management instruments are neutral techniques allowing for the
resolution of the problems encountered by an organisation with a view to improving its performance. It
is therefore a question of finding the right technique in response to the problem posed.
A research movement known as the "school of contingency" has criticised the idea of there being a
universal solution (a standard instrument) to each problem. It identifies numerous contingency factors:
technology, size, type of strategy, etc. For example, certain authors consider that a "strict" budgetary
procedure, i.e. with strict objectives and little margin for manoeuvre, could be better suited to cost
domination strategies than differentiation strategies. For all that, this movement is consistent with the
rational approach since it postulates that it is possible to create instruments which are adapted to different
situations.
This approach to management instruments predominates in organisations and is supported by the
majority of consultants. However, it has also been strongly criticised, as we shall see in in the following
paragraph.

Sociological perspectives:1
A series of studies have cast doubt on this mechanistic representation of management instruments,
considering that the tools also make a significant contribution to the social processes inherent to
organisations. For example, they are the subject and object of struggles for power and legitimacy2.
Therefore, the tools "act" in the same way as the members of an organisation. They have multiple effects
which are more complex once the social processes in which they operate are taken into account.
Some of these studies also support the idea that the management tools and their products (performance
measurements, forecasts, deviations, etc.) are not rigid and predetermined, but develop gradually as their
interactions with the different parties involved (regulators, managers, researchers, consultants, etc.)
progress.
More precisely, but without seeking to be exhaustive:
- It has been shown that the appropriation of the instruments is a key issue that is often overlooked.
In this way, empirical studies have revealed many situations in which an instrument had been
formally implemented (e.g. a performance dashboard disseminated on a regular basis), but not used
(Collier, 2001).
- Research has underlined that management instruments do not always produce the expected effects
and that this is all the more problematical when managers neglect the effects that deviate from the
desired outcome (Berry, 1983; Miller, date). The effects are therefore invisible, which has led to the
design of management tools based on what is described as "invisible technology".3 In particular,
these effects are influenced by power relationships. Consequently, a system of indicators associated
with management by objectives could lead managers to conceal information, whereas the intention
is to increase transparency. However, the interactions between tools and power issues are difficult
to predict and analyse.

1
See Chiapello and Gilbert (2013)
2
That is why these studies can be categorised as belonging to a "sociological perspective".
3
Berry (1983)
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- It has also been shown that instruments may have positive effects other than those expected from a
rational perspective. In this way, performance dashboards may not only provide information that is
useful for decision-making, they may also facilitate cooperation between two communities (e.g. the
management and medical professionals in a hospital).
- Certain studies have sought to understand why an organisation adopts a given instrument, such as a
new performance dashboard, for example. It has been shown that certain tools are adopted not for
their expected effects in terms of improving performance, as is postulated by the rational approach,
but out of concern for legitimacy, which implies a high level of imitation (Di Maggio et Powell,
1983 ; Siti-Nabiha et Scapens, 2005).
- Another research finding reveals that management instruments offer new opportunities for action,
e.g. by providing new analytical data for decision-making, but that they impose constraints at the
same time, e.g. by obliging managers to conduct the analysis according to a predetermined
framework, which may not be adapted to the question posed. They are said to be both enabling and
constraining (Adler et Borys, 1996 ; Mundy, 2010). But in practice, only their enabling effects tend
to be considered.
- Many studies have revealed the potentially damaging impacts of the instruments on individuals.
These works show that management tools contribute to practising forms of violence and establishing
or maintaining states of domination. For example, non-controllability, i.e. the fact of setting
objectives for managers based on aspects of performance in which they cannot intervene, could be
reflected by greater anxiety and feelings of powerlessness (Seligman, 1967).
- Finally, certain authors have mentioned a growing and highly damaging tendency towards the
"reification" of management instruments, i.e. the fact of considering them to be objective realities
and, as a consequence, unquestionable (Bourguignon, 2010). In doing so, there is a risk of losing
sight of the origin of these instruments and, in particular, of the social context in which they have
developed: a context that is rarely neutral and always strongly characterised by subjectivity. For
example, putting management control in the same category as several major financial ratios – and
certain debates in the press over recent years suggest that this vision may not be too far removed
from certain actual practices – definitely has an impact on the conception of the outcomes of the
discipline and, more generally, of the underlying economic and social realities. However, as we
shall discover in this book, performance can be defined in a broader manner and the context is not,
therefore, unique. Using these instruments "blindly", by ignoring the specific context in which they
are created, leads to the strengthening of these social contexts by making them part of the practices,
and extends their effects, including when they are damaging, which poses a problem of an ethical
nature.4

Despite these very useful insights, certain researchers criticise the sociological perspectives for studying
the instruments in a somewhat remote manner, without addressing their technical characteristics (see
Hopwood, 2009; Baldvinsdottir et al., 2010, for example). Studies that do address these characteristics
(Bourguignon, 2005; Boussard, 2001) – still too rarely – are carried out from the very worthwhile
perspective of deconstruction, but their non-normative approach may seem insufficient to help
practitioners improve their practices in the field.

Our approach to management control and its instruments

The above-mentioned considerations have led us to develop our positioning vis-à-vis management
control and its instruments.

4
For this reason, A. Bourguignon (2009) considers that the teaching of management, and a fortiori, all of the
resources that contribute to this activity, bear significant responsibility for this situation.
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We consider that management control has multiple outcomes which can in no way be limited to the
desire to align the employees' motivations with those of the directors of an organisation, as could be
envisaged by the agency theory, for example. Indeed, certain approaches to management control
consider that it originally emerged as a response to the need to exert control at distance, due to the
growth of enterprises and the accompanying delegation of management powers, or in other words, to
the need to align the interests of the owners of an enterprise with those of the managers (non-owners).
Implicitly underlying this approach is an idea suggesting that the raison d’être of management control
may be the need to control the managers' goals, which are inevitably different from the directors' goals.
We consider this to be a very narrow view. Although these management issues generated by delegation
will be addressed in this book (see chapter 4 (not included in this book), and chapter 6, in particular),
we will also be defending the idea that management control originated primarily in response to the
difficulty of attaining performance objectives, irrespective of any context of delegation (see chapters 2,
3, and 5 (chapter 5 is not included in this book), in particular). Management control aims to help
managers in their management of operations. Its roles far exceed the monitoring and alignment of
interests at different levels of the hierarchical structure. They certainly encompass coordination and
incentive functions, but also and without doubt primarily include regulation and training.
In the same spirit, management control serves several modes of governance and not just a form focusing
on the shareholders' dominance. Control systems are definitely used to manage the financial
performance expected by shareholders, but they also help managers to manage the performance expected
by other stakeholders such as customers, employees, the State and civil society, etc.
We have decided to examine control instruments by taking account of their technical nature, because
the purpose of our book is to help managers design, diagnose and develop their management control
instrument, and by also considering the fact that they are integrated into social processes. In doing so,
we deviate from the rational perspective, because we do not think it possible for research to lead to
ready-to-use solutions due to the complex nature of the organisational dynamics at the micro-level of
the practices (Cyert & March, 1953).
We are therefore operating from a sociological perspective of management instruments and management
control. However, in contrast to certain sociological and critical studies, in this book, we are seeking to
do more than provide a simple diagnosis of control systems. We examine the technical structures of
these systems, and we focus on ways to work with these tools, to understand them in order to improve
our proficiency with them, and to anticipate their effects and any biases. We have therefore adopted a
comprehensive approach.
Recognising that control instruments can be difficult to appropriate, that they may be used in unexpected
ways, and have both enabling and constraining effects, will allow us to question the context of their
emergence in a given organisation, as well as their design and their uses. We believe that the key issue,
for practitioners as well as students aspiring to become managers, is to abandon an approach that tends
to consider control tools to be "natural", which means that managers often view the control tools
available to them as sacrosanct and believe that they "have no choice" regarding these systems. This
tendency is strengthened by the ever-increasing standardisation of the range of control systems. In this
book, we propose ways to move on from this perception of instruments as ineluctable. We also establish
a certain number of theoretical principles capable of opening up the black box that constitutes a control
system. This means that we have adopted a denaturalising approach.
Establishing theoretical principles to question the "nature" of a control instrument may seem to be
normative and quite opposed to an approach that sets out to be comprehensive and denaturalising.
However, the principles that we establish throughout this book are not normative in the sense that they
do not dictate the "right way" to develop or use a control instrument. Instead, the principles relate to
definitions of concepts that are often vague in practice (the word performance, for example), and the
characteristics of elements that are often confused (e.g. the structure of a control instrument, such as a
performance dashboard, and its implementation, in particular via the management process). These
principles, therefore, invite us to clarify "what we are talking about"; they provide methodological
reference points for investigating a given control instrument, and in this way they are consistent with a
comprehensive and denaturalising approach.
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Here are several examples of the theoretical principles governing control instruments, which we shall
develop throughout this book:
- The fact of considering that management control relates to training, incentive and coordination
outcomes leads us to distinguish between the global (corporate) level and the local (entity) level in
the architecture of a control system.
- We believe that the measurement of performance does not automatically follow on from the strategy.
The measurement is constructed. This means that for any evaluation of a performance measurement
system, it is a prerequisite to ask oneself the following question: "What does it mean to be an
effective performer in the context of this system?" We therefore consider that performance has
many possible meanings and that its definition may be required to change for a given organisation.
- We distinguish between the structure of the measurement (e.g. the choice and ranking of the
indicators for a performance dashboard) and its implementation, in particular via the management
process (e.g. the definition of responsibilities in relation to the indicators for a performance
dashboard, the planning of objectives for these indicators via the budgetary process, the reporting
of results for these indicators, and any updating of the objectives that might result).
- We distinguish between the ability to measure a performance and the managerial ability to manage
the means of producing this performance. This leads us to stress that just because a profit can be
measured at the level of a given business unit does not mean that this business unit should be
considered a profit centre, for example.

Our principles concerning management knowledge and

managerial practices
Our approach is based on four principles concerning management knowledge and practices:
- Abandoning an overly strict opposition between theory and practice
- Taking account of the diversity of opinions about what constitutes an improvement of practices.
- Considering management knowledge to be a repository that does not directly give managers
solutions, but allows them to ask themselves the right questions in order to find solutions that are
adapted to their particular context.
- Adopting a scientific approach to the knowledge disseminated
We present these principles before showing how they contribute to limiting the risk of reification.

Abandoning an overly strict opposition between theory and practice

It is common to oppose theory and practice and denounce the lack of links between these two
approaches. Considering a management tool from the perspective of practices, i.e. the way in which it
is implemented in a particular manner in different organisations, has the advantage of being a concrete
approach. Certain students, who are legitimately impatient to enter "real" business world, may attach
excessive importance to the knowledge of practices, and conversely, may reject any approach that
appears too "theoretical".
We consider that theory and practice are very closely related, or even inseparable. Indeed, it is not
possible to form an objective view of a practice without analytical frameworks that allow for the
examination of this practice. Without an analytical framework, it is impossible to understand a practice
and establish a diagnosis. It is equally impossible to envisage the transferability of this practice to a
different context, which is often the implicit concern of many managers.
In this book, "theory" is not considered to be an end in itself but, first and foremost, as an aid to
improving practices. However, this perspective raises two additional questions for clarification: what is
an improvement of practices? How could more theoretical knowledge be useful in this respect?
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Taking account of the wide range of opinions about what constitutes an

improvement
An "improvement" is gauged in light of an expected type of performance, and we consider this to be
neither one-dimensional nor exogenous. It covers several potential dimensions and is the result of a
constructive process in which the managers participate.
This is particularly apparent when the organisation concerned has multiple outcomes, as applies to a
public hospital, for example, because the economic and/or health issues are not commensurate. What
might be considered an improvement according to economic criteria could therefore appear to be a
regression in light of health criteria. This multi-dimensional nature of performance also concerns
shareholder enterprises, because the shareholders may choose broader outcomes than profitability alone,
such as sustainable development outcomes. From this perspective, the instruments can be assessed with
regard to their effects (positive and negative) on people and the environment and not only in light of an
economic performance. Identifying the outcomes of an organisation assumes the integration of certain
exogenous considerations, such as the specificities of a business sector, for example. Ultimately,
however, it is always a question of managerial choice and policy positioning.
Similarly, we shall see that performance does not just come down to the outcomes of the organisation,
whatever they may be, but that it also covers the means of attaining these outcomes. These means are
varied, and must be discussed and determined by the managers, which reinforces the idea that the type
of performance that allows for the qualification of the value of a practice is neither one-dimensional nor
exogenous.
In terms of the practical consequences, in chapter 1, we propose an analytical framework in which the
definition of performance constitutes a component of performance management in its own right (and
which may be the first aspect to be re-examined when seeking to perform a diagnosis of a management
control system).

Considering management knowledge as a repository that can be used to

ask the right questions
We believe that the purpose of the management knowledge derived from research5 is to allow people in
managerial positions to analyse the problems confronting them properly so that they can devise solutions
to them, rather than to propose "ready-to-use" solutions (Saulpic & Zarlowski 2015). This approach to
management knowledge is consistent with the concept of inquiry (Dewey 1938, Lorino 2014), in which
a problematic situation is progressively transformed into an intelligible problem and then into a solution
via a dialogic and collective process situated in the organisational context. In this process, the problem
and the solution are jointly constructed, which precludes the existence of an external solution, and the
construction of the problem is placed at the heart of the search for a solution. This approach is also
consistent with the limitations of a rational approach to instruments (cf. 3.).
In practice, in this book we shall be proposing conceptual frameworks, ideal approaches and principles,
rather than solutions.
More specifically, this leads us to present the instruments not only according to their technical
characteristics, but also by clarifying their outcomes and the construction principles that make it possible
to attain them.6 We consider this to be important for several reasons:

5
We are aware of the existence of other sources of knowledge, including experience. But this knowledge is hard
to mobilise in the framework of a book such as ours. That is why we shall be concentrating on the knowledge
generated by research.
6
In accordance with the management instruments of the French school (Hatchuel & Weil, 1992; Moisdon, 1997).
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- When seeking to examine the practices objectively, it is possible to confine oneself too closely to a
single methodological position. The instrument is then not examined in its specific configuration
within an organisation, but rather according to the operating rules that have allowed for its creation.
In this way, rather than focusing on a performance dashboard for the average group, different
methodologies for the development of this management instrument can be presented, such as the
Balanced Scorecard proposed by Kaplan and Norton. But stumbling blocks become apparent: as
soon as a methodology gains a reasonable reputation, it starts to be disseminated on a large scale,
but rarely in its original form; it is subject to interpretations, adjustments, extensions, or even
deformations, including by its originators, who often make changes. In reality, what is presented as
a "single" methodology actually has several variants, so which version should be adopted? In
addition, methodologies, by definition, focus on the "hows": how do you choose the relevant
performance indicators in a dashboard? How do you calculate adequate margins for divisions? How
do you analyse results in a relevant manner for decision-making? In this way, for example, to
calculate the margin of a division, the full cost method states that it is firstly a question of
apportioning the direct costs, and then the indirect costs, and provides elements that allow for the
satisfactory allocation of these costs (choice of allocation criteria, order of allocation, etc.).
Sometimes, however, focusing on the "hows" may cause the "whys" of the matter, which are
essential, to be forgotten. Should costs be allocated from the headquarters to the divisions? What is
the justification for this rule? Answering these questions requires the clarification of the outcomes
pursued, on the one hand, and the principles adopted, on the other, with both aspects being closely
related. Returning to our example, the allocation of costs from headquarters to divisions may allow
for an evaluation of the profitability of the division (outcome), and the justification for this would
therefore be the principle of causality (see chapter 4 – not included in this book)
- Clearly explaining the outcomes and principles is all the more important since a single management
instrument, of which we shall see numerous examples in this book, often has several outcomes,
which may be reflected by divergent operational consequences for the creation of the tool. For
example, if a budget is considered to be a motivational instrument for managers (outcome 1), it is
important, except in specific cases, for the target to remain unchanged until the results have been
measured, in order to maintain its incentive nature. If, on the other hand, it is viewed as a regulatory
tool (outcome 2), it is essential for changes in the environment to lead to rapid adjustments in the
initial target, in order to allow for the mobilisation of the necessary resources, for example.
Moreover, for a given outcome, there may be multiple and conflicting principles, requiring trade-
offs or compromises. For example, we shall see that from the perspective of assessing managers,
the performance management system is torn between the matching and controllability principles.
- Identifying the outcomes and principles governing the development of tools, such as the choices and
compromises they may induce, also allows us to situate management instruments within a
managerial intent, which we believe to be essential, as we have explained above.
Our approach could be considered conceptual and consequently, not very "practical". But we consider
it to be quite the opposite. Indeed, the literature has clearly revealed the limitations of a solution-based
approach, due to the difficulty of appropriation as well as conceptual limitations. It is therefore futile
and counter-productive to attempt to present "ready-to-use" solutions that subsequently turn out to be ill
adapted and fail to produce the desired effects. Furthermore, with regard to existing practices, the
principles and ideal approaches allow for the diagnosis of problems and the proposal of improvements
that correspond to the socio-organisational environment.

Adopting a scientific approach to the knowledge disseminated

In this book, this principle is conveyed in concrete terms by:
- The method used to produce this work (and the fact of presenting it). This is based on a process in
which the key messages in each chapter are presented and then collectively validated, followed by
the drafting of the content of these chapters, which are subsequently proofread by two co-authors.

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Therefore, the validity of the content stems primarily from the collective discussion of the key
messages and the authors' knowledge of control practices.
- The particular attention paid to the definition of the terms and concepts used. The managerial
literature is brimming with all kinds of controversies, a number of which, in our eyes, prove to be
nebulous through ignorance of exactly what is being talked about, or may even be false debates, as
the parties disagree on heterogeneous concepts. For example, the recurrent question of the
limitations of the budgetary tool, about which much has been written, is rarely based on a clear and
detailed explanation of what "budget" really means. And yet the analysis differs according to
whether the criticism is directed at a tool defined as an "an allocation of costs that cannot be
exceeded", "a financial estimation of managerial action plans", or a "short-term planning tool", to
mention just some of the common (and problematical!) definitions.
- A detailed explanation of the outcomes and principles on which the practices and methodologies are
at least implicitly based (as we have already mentioned above). From the perspective of the validity
of knowledge, this choice requires a presentation of the validity of these practices or methodologies,
and the identification of the arguments that support them or otherwise cast doubt upon them.
Presenting these arguments does not necessarily make them any more valid or neutral, but it
contributes to doing so in an indirect manner: on the one hand, it requires a rationalisation effort,
and on the other hand, it also allows the reader to assimilate them, to appropriate them or, on the
contrary, to contribute a different viewpoint which will ultimately enrich the corpus of principles.
- The quest to strike a balance between the operational and critical perspectives (in the positive sense
of the term), but above all, to establish links between these two dimensions. To this end, after
identifying the outcomes and fundamental principles for the development of tools, as well as the
concepts on which they are based, and then covering the development methodologies, we discuss
the validity of these principles and the limitations of the tools. Since it is an introductory work,
however, the amount of discussion will remain limited.
- The presentation of our intellectual stance in this introduction.
- The fact that we endeavour to specify the sources of our assertions. In particular, what relates to our
own thinking.

Principles limiting the risk of reification

We believe that the following principles limit the risk of reifying management instruments in several
ways:
- Defining the tools and concepts allows for the clarification of what we are talking about and
therefore makes it possible to discuss the assertions relating to these tools.
- Putting managerial tools in the context of their managerial use shows that tools do not exist outside
their use in a specific context. This allows important questions to be broached, such as the need to
transform these tools, in order to allow for their appropriation by the parties concerned, and to adapt
them to a given context (sectoral, cultural, historic context, etc.).
- Explaining the outcomes and principles on which the practices and methodologies are based, at least
implicitly, shows that there is no "single" correct way to proceed, but "several" ways that are more
or less consistent with the stated intention. Furthermore, any principle is characterised by a degree
of subjectivity, and usually represents a "point of view". The "enterprise" itself corresponds to no
"reality" other than the set of policies and strategies developed by its senior managers. Explaining
the outcomes and principles therefore requires a presentation of their validity and the identification
of arguments that support them or otherwise cast doubt upon them. This will allow each party to
accept his or her share of responsibility for the use to which the instruments are put.
- Mentioning the sources shows the foundations of the knowledge and statements, and facilitates their
discussion.

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Summary and book outline

In summary, our positioning is based on the following choices:
- Management control will be examined not from the perspective of the management controller's
profession, but as a managerial approach in which different parties participate: first and foremost,
the managers themselves.
- We examine the instruments from a technical perspective while also considering that they form part
of social processes.
- We attach particular importance to clarifying the outcomes of these tools and presenting the
principles on which their development is based. This will allow us to present their development
methodologies and their operational characteristics in a more substantiated manner.
- We make every effort to discuss the rationality of these principles, for which we shall propose a
short and precise summary in the form of "key messages" at the end of each chapter.
- We endeavour to adopt a scientific approach to the knowledge that we are disseminating.
These choices have been made in order to allow managers to ask themselves the right questions so that
they can develop their own responses which are adapted to their personal situations.
Moreover, we have sought to strike a balance and foster mutual enrichment between the practical and
operational standpoint on the one hand, and the theoretical perspective on the other:
- The practical and operational standpoint will be revealed by the different methodologies,
frameworks and concrete examples presented throughout the book;
- The theoretical perspective will provide a foundation for these operational aspects by identifying
the outcomes, principles and concepts used, in order to provide a basis for the rationale while also
revealing the limitations of these tools.
The book is structured in the following manner:
- Chapter 1 will provide an overview of the issues associated with the approach by presenting our
proposed framework of analysis, in order to allow the reader to situate the different topics addressed
in the book and, if he or she so wishes, to cover them in a different order to the one we have chosen.
- Part 1 “Performance measurement systems” (chapters 2 to 9) will develop the initial issue of how
to provide a clear explanation of the desired performance and its operational manifestation in
relevant measurement systems. It reveals what the notion of performance covers at the qualitative
level, and distinguishes between measurement systems operating at the global level of organisations
(financial indicators, global performance dashboards), and management systems used at the local
level of their entities (responsibility accounting, management accounting and local performance
dashboards).
- Part 2 “The control cycle” (chapters 10 and 11) will present the components of the management
process based on this structure of indicators. It sets out the aims and principles of management
planning on which the basic tools such as budgets and operational and strategic plans are based. It
explains the result analysis procedures and success factors.
- Lastly, part 3 “The management control actors” (not included in this book) will revisit the issue of
key players in the management process (complementarity between the roles of managers and
management controllers) and will propose two cross-functional case studies to illustrate the issues
covered in the book from the perspective of situations actually encountered by two firms: an
automotive equipment manager and a waste processing group.
Consequently, rather than presenting the different management tools sequentially, this book sets out to
present the fundamental issues associated with the approach. Management tools, which are considered
to be operational responses to these issues, may therefore be addressed in several different places.
Performance dashboards, for example, will be examined in part 1, which is devoted to the design of
performance indicators, but also in part 2 (the management process), in which we shall analyse its role
in the result analysis process, for example.

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Bibliography
Baldvinsdottir G., Mitchell F., Nørreklit H. (2010), Issues in the relationship between theory and practice
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Berry M. (1983), Une technologie invisible - L’impact des instruments de gestion sur l’évolution des
systems humains, hal-00263141.
Bourguignon A. (2005), “Management accounting and value creation: the profit and loss of reification”,
Critical Perspectives on Accounting, 16: 353–389.
Bourguignon A. (2009), "Enseigner le contrôle de gestion : un piège éthique ?" , La place de la
dimension européenne dans la comptabilité, le contrôle et l’audit, Proceedings of the 30th Conference
of the Association Francophone de Comptabilité (AFC), Strasbourg, May, http://www.iae.univ-
poitiers.fr/afc09/PDF/p188.pdf
Bourguignon A. (2010), "Les instruments de gestion sont-ils éthiques? Les enjeux de la réification", in
Palpacuer F., Leroy M. and Naro G. (dir.), Management, mondialisation, écologie: regards critiques en
sciences de gestion, Paris, Hermès, p. 163-183
Boussard V. (2001), "Quand les règles s'incarnent: L'exemple des indicateurs prégnants", Sociologie du
Travail, Vol. 43, No. 4, pp. 533-551
Chiapello E., Gilbert P. (2013), Sociologie des outils de gestion, Paris, La Découverte.
Dewey, J. (1938), Logic: The Theory of Inquiry. New York: Holt; reprinted, 1980, New York: Irvington
Publishers.
Giraud F., Saulpic O. (2016), How to teach management control systems with a sociological perspective
and what consequence for research?, Conference of the Association Francophone de Comptabilité,
Clermont-Ferrand, 19-20 May.
Hatchuel, A., & Weil, B. (1992). L’expert et le système. Paris: Economica.
Hopwood A. G. (2009), The economic crisis and accounting: Implications for the research community,
Accounting, Organizations and Society, vol. 34, pp. 797-802
Lorino, P. (2014), From Speech Acts to Act Speeches. Collective Activity, a Discursive Process
Speaking the Language of Habits. In F. Cooren, E. Vaara, A. Langley & H. Tsoukas (Eds) Language
and Communication at Work: Discourse, Narrativity and Organizing. Oxford: Oxford University Press
Moisdon, J.-C. (Ed.). (1997). Du mode d’existence des outils de gestion. Paris: Seli-Arslan.
Saulpic O., Zarlowski P., (2014), "Management Control Research and the Management of Uncertainty:
Rethinking Knowledge in Management", in Otley D., Soin K. (Eds.), Management Control and
Uncertainty, Palgrave Macmillan, pp 207-223

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Chapter 1 - Management control: an overview

Introduction
This first chapter introduces management control by providing an overview of its objectives,
components, concepts and fundamental tools. The aim is to outline the general structure of management
control so that the reader will be able to understand the links between the various topics that are dealt
with in subsequent chapters of the book.
Management control will be defined in a progressive manner. In the first section, we will deliberately
place ourselves within a simplified context, that of an autonomous entity- a small company, for example.
This will allow us to explore the basic elements of the approach. In the second section, we will take a
look at the more complex context of an "organisation", made up of several "entities" (operational
divisions, and functional or other departments), and will explore the new dimensions induced by this
broader configuration.
This general presentation will allow us to situate management control vis-à-vis related fields such as
financial accounting and cost accounting.

Section 1. The basic elements of the process

What does management control comprise and what are its purposes? In order to grasp this notion, we
need to draw on a broad definition of "control", such as found in dictionaries:
Control: "ability to direct a phenomenon or a process, and to intervene in its development. E.g. to control
one's breathing, control the situation" (Larousse, trad.)
The notion of control must therefore be likened to the notions of "mastery" and "regulation".
- It refers to the proactive intervention on the part of an agent and thus contrasts with chance.
- It is purpose-oriented, aiming at producing desired effects.
- It implies actions to achieve these effects and contain the impact of disruptive external factors.
- It postulates that the progression toward results can be regulated.
To return to the example in the Larousse dictionary: saying that someone controls his or her breathing
means that he or she is the agent (absence of an artificial breathing appliance), but also that he or she is
seeking to attain a given result (calm and regular breathing) by resisting disruptive internal or external
factors (violent emotions or a lack of oxygen) and by acting to regulate the rate of his or her breathing
(e.g. by practising a relaxation exercise, or, in the longer term, by practising a regular physical training).
By analogy, management control is a process by which agents (a company and its managers) produce
desired results (generally expressed in terms of "performance"), by taking action to achieve these results
and by managing the risks generated by difficulties either external (linked to factors such as the market,
the competitors and to the economic and political context) or internal (disorganization, lack of
motivation) to them. In other terms, management control can be defined as setting an organization’s
performance targets and guiding their progressive achievement (Reeves and Woodward, 1970). It means
managing an organization’s performance.

The control cycle

This process takes place over time: it is situated successively before the action – this is the planning
phase, and after the action – this is the monitoring and analysis of results phase. This makes it dynamic
and progressive, which is why we refer to it as a control cycle.

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Figure 1.1 The two main phases of the management control process

PLANNING ACTION MONITORING AND

ANALYSIS OF
RESULTS

Consequently, controlling cannot be reduced to a simple exercise of "verification", because then we

would be acting "after the event" – once the decision has been made or the action has been undertaken.
In such a case, the scope of control would be confined to reactions rather than fully effective action. In
seeking to attain the desired results, it is essential to prepare the action, to organise it, to perform
simulations and to anticipate its consequences. Planning is therefore an essential phase.

1.1.1. Planning
Planning will be covered in detail in chapter 10. Here, we will identify its main components.
First of all, planning involves the setting of objectives. In common language, an "objective" refers to
two different notions:
- The kind of performance desired. Is the organisation seeking to increase its profitability? To increase
the volume of its activities? To decrease its debt load? To provide a high-quality service for its
customers or users? To increase its social or environmental performance?
- The level of performance desired. If the company defines its performance in terms of profitability,
are they aiming at 10%? 20%? Are they trying to double their volume of business to become the
market leader, and to maintain the current market shares? Are they aiming for a 90% customer-
satisfaction rate?
In this book, the term "objective" will take on this double meaning. However, for greater conceptual
accuracy, whenever possible, we shall reserve the term "objective" for designating the type of
performance intended, and the term "target" for mentioning the desired level of performance. In this
way, it would be more accurate to state that planning aims to set "targeted objectives".
The second role of planning is to anticipate how the company will go about achieving these objectives.
It is important to put a coherent system in place before launching into the action stage. Therefore,
planning also includes a decision about means, i.e. the choice of action plans that will be implemented
and the identification and mobilisation of the resources that will be necessary (financial, human and
material resources, etc.).
Let's take the example of an IT service company that is seeking to expand on the French market and sets
itself an objective of increasing its turnover with a target of +20% over a three-year horizon. To increase
its turnover, it may consider very varied types of action plans: extending its business to new customer
segments, improving the attractiveness of its services on current markets (e.g. by cutting their prices),
or creating new services. The chosen action plans will reveal needs in terms of resources: the number
and type of sites, number of computer experts, spending associated with their training, promotional
actions, and financial resources, which must be anticipated and organised.

Figure 1.2 The fundamental dimensions of planning

Targeted objectives

Action plans Resources

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The further off the time horizon, the more the firm must anticipate and organise its actions. But,
conversely, the risks of error are higher due to the greater uncertainty. The function of the first planning
tool - the strategic plan – is to determine the firm's "long-term" objectives, finding a compromise
between these two considerations (anticipation/risk). Strategic plans are generally established on a 5-
year timeframe, but in reality this greatly depends on the business sector that the firm operates in, as
well as the scope of the action plans being considered.
"Controlling" the objective entails the creation of a path leading to the intended goal(s). It is done by
setting milestones along the space-time corridor which leads from the present situation to the long-term
objective, and in other words, breaking it down into shorter horizons and creating intermediate stages.
To this end, the strategic plan will be supplemented by two other planning tools:
- the operational plan, which translates the objectives to a mid-term horizon, generally on a 3-
year timeframe;
- the budget, which translates them to an even shorter time horizon, usually one year.
As its name suggests, the operational plan "operationalises" the strategic plan by establishing an
intermediate stage in the achievement of the final objectives. The budget continues this process, setting
milestones on an annual time horizon. If a firm's objective is to attain a target market share of 20% in
ten years and its current level stands at 5%, the path towards achieving this ambition may, at first sight,
seem long, arduous or even unrealistic. To give itself a chance of succeeding, the firm may set a target
of 10% over 3 years in the operational plan, and a target of 8% in the budget for the following year. The
long-term action plans and resources will also be translated to shorter terms.

Figure 1.3 The different planning horizons

Long term

STRATEGIC
Mid term PLAN
BUDGET

Short
OPERATIONAL
term PLAN
Targeted
objectives

BUDGET
Action plans
Resources

1.1.2. Monitoring and analysis of results

The aim of planning is to anticipate, as much as possible, any potential difficulties in the achievement
of objectives, by setting realistic targets, by developing coherent action plans and by allocating the
necessary resources. Even so, it may happen that the results are not attained, particularly if the action
plans are improperly implemented or if unexpected complications arise. The results must therefore be
monitored. This is the downstream phase of the control cycle.

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If the planning phase has been properly conducted, it forms a precious benchmark for monitoring results,
which will indeed be assessed in terms of any variance with the objectives. Consequently, if the planning
is carried out in a superficial or incomplete manner, it will be difficult to know whether a variance
indicates poor performance, for which solutions must be found, or if it simply stems from bad planning
and does not require any specific response. On the other hand, diligent planning will provide the manager
with reliable information on the level of performance achieved and enable him or her to focus on
unfavorable variances: this principle is known as management by exception.
The purpose of monitoring is not merely to "observe" whether targets have been attained or not, as
management control is a dynamic rather than static process. In a perspective of "mastery", monitoring
is not carried out at the end of the timeframe, but during the implementation of action plans, which gives
the manager an opportunity to react "mid-stream" if the final result appears to be in jeopardy. Therefore,
strictly speaking, results progress tracking precedes the "monitoring" of results. Navigating the path
toward goal achievement is done progressively through regular progress checks. Thus, if the time
horizon for budgetary objective is annual, the budget monitoring will generally be carried out on a
monthly basis. Therefore, the control cycle (planning, monitoring of results) is not sequential, but rather
a "loop", where the firm regularly intervenes to check on progress. It is called a regulation loop and this
is a first function of management control.
Any deviation between the objectives and the results may also lead the company to review the targets
themselves: certain assumptions held during the target setting process may no longer be valid and new
elements may have appeared. For example, economic growth may prove to be weaker than predicted,
currency exchange rates may have changed significantly, an economic partner may have suffered
irreversible difficulties, or a competitor may have made a major commercial innovation, which will
seriously compromise the probability of attaining the initial targets. Therefore, it is important to know
how to incorporate these changes through the use of reforecasts, i.e. by adjusting the forecasts, in order
to quickly adjust the course of action and resources brought into play.
Similarly, as the budget is the short-term part of the operational plan, annual year-end results will
constitute interim tracking points for the three-year plan. This need for regular adjustment, largely due
to uncertainty in the economic environment, requires a strong link between the different timeframes and
levels of control. As early authors in the management control field have suggested to draw a distinction
between management control, strategic control and operational control (Anthony, 1965), others have
more recently advocated for a comprehensive framework (Otley, 1994).

Figure 1.4 The regulation loop

MONITORING OF RESULTS

Objective

Results
Progress tracking Progress Progress Progress
tracking tracking tracking
Action plan

In chapter 11 we will look at different methods of monitoring results, which provide managers with a
more or less rich and reactive basis for analysing the performance obtained, and therefore unequally
support decision making for corrective actions.

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Management control and financial accounting

Management control is often perceived as a "number-crunching" field, which explains why it is

frequently associated in people's minds with financial accounting (also known as general accounting).
However, there are fundamental differences between these two systems7. Financial accounting is
primarily concerned with external communication and reporting on the overall performance, for legal
and fiscal purposes, as well as for the financial analysis’s requirements of third parties. It conforms to
standardised regulations for the publication of results. The purpose of Management control, on the other
hand, is for company executives to formulate strategic objectives and oversee their achievement.
Therefore, it is principally an internal process; it is less concerned with measuring results than producing
them, which also means defining them upstream. In addition, the tools that it uses are generally adapted
to the specificities of each firm (objectives, strategy, and structure), whereas financial accounting is of
a more standardised nature. Finally, as we shall see, it is not confined to the financial dimensions of
performance.

Performance measurement systems

1.2.1. What type of performance?
The short, medium and long-term objectives of a firm can be established on the basis of very diverse
conceptions of the kind of performance sought.
Although management control was developed originally on the basis of a representation of performance
expressed in exclusively financial terms (see chapter 3 for the main financial indicators), this is not its
inherent nature. Since then, the conception of performance has been significantly enlarged to incorporate
non-financial aspects. This is necessary when the organisational goals are broader than economic
profitability alone, i.e. when they reflect a public service mission or environmental constraints, etc. (see chapter
2). Therefore, contrary to what is sometimes believed, management control is not confined to profit-making
enterprises. It is also relevant for organizations such as municipalities, hospitals and humanitarian
associations.
Performance management also involves focusing managers' attention on action levers to achieve the
objectives, which are more operational in nature. For example, a firm that is pursuing a profitability-based
performance objective could set an intermediate objective in terms of product quality or brand
communication.

Cost accounting and management control

Cost accounting focuses on measuring the costs generated by an organisation. Costs are one of the levers
for action on the organisation’s overall performance. Costs measure consumptions (of materials, time,
energy, etc.) within this organisation. Several concepts and methods are used for calculating costs (see
chapter 5).
Consuming resources is necessary to run activities that are expected to generate value for customers. In
the luxury industries, for example, the image of a product, its quality and packaging, are very important
performance levers. In rail transport, safety, punctuality and the reliability of service are important
dimensions to integrate into the performance management system.

7
The distinction made in this case is perhaps excessive with respect to the real links that exist between management control and financial
accounting, which prove to be more complex than what is presented in this box. Nevertheless, it is of considerable pedagogical value, as it
clarifies the basic framework of management control by formulating clear definitions and using them to illustrate the purposes of the systems,
including the importance of the practical configuration of measurement and management tools, as we shall see on numerous occasions
throughout this book.
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Management control is therefore wider than cost accounting insofar as it endeavours to manage all
dimensions of the organisation's performance, cost management being only one of its concerns in this
respect.
Management accounting has an analytical focus, it breaks down the overall performance of the
organisation at the level of its business segments, while other management control measurement systems
look at performance at a more global level.

As a consequence, performance is not a universal notion, it is a "construct" that is influenced by different

factors: the type of organisation concerned, its business sector, its strategy, and the configuration of the
stakeholders (see chapter 2). The varied nature of these factors generally makes the definition of
performance specific to each organisation. The implementation of the control cycle (planning, results
monitoring) is therefore impossible without prior work to clarify the dimensions of performance chosen
for the company, which is the aim of performance modelling (see chapter 8). These dimensions will
structure the management process: for each of them, objectives/targets will be set and results monitored.

Figure 1.5 The structuring role of performance dimensions for the control cycle

Performance dimensions

Control cycle (planning, results monitoring)

The performance dimensions are not always very clear. An operational manager or a member of the
group’s executive board may perceive them differently. The latter will have a more strategic vision of
the firm's goals and stakes, but at the same time, a less precise knowledge of the specificities of each
customer segment. Similarly, a sales manager will have a very different perception of the firm
performance to a plant manager or a human resource manager.
To clarify the dimensions of performance, it will therefore be essential to align the different
representations of the various actors. In chapter 8, we shall discover methods that facilitate this
alignment of representations.

1.2.2. The role of measurement systems

Fundamentally, performance dimensions are defined qualitatively: the goals are profit, product quality,
an innovative image, etc. However, in order to set targets and monitor the results, these qualitative
dimensions will need to be translated into measurable units or indicators.
For example, profit can be measured using an indicator like net income, and customer satisfaction
gauged by the number of complaints. It is then possible to decide if the target should be a net income of
100 or 200 or a number of complaints down by 5 or 10%. As many indicators will be used, they form
what is called a measurement system. For every indicator, targets will be set and results monitored.

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Figure 1.6 The structure of the control cycle: measurement systems

Defining and modeling Designing measurement

Precedes and structures
performance systems

Control cycle (planning, results monitoring)

Measurement systems form the backbone of the control process and play a critical role, to the extent
that certain people have unreservedly stated that only what is measured can be managed properly. As a
matter of fact, measurement systems present the advantage of translating performance in concrete,
explicit terms. By doing so, they facilitate its clarification and communication, which is particularly
important in large organisations in which people must coordinate their actions (see section 2).
However, designing relevant measurement systems is not that easy. A given qualitative phenomenon is
not always easy to capture with an indicator. The indicator is often just an approximation, a more or less
faithful reflection, of the phenomenon. It often rests on conventions, whose relevance is not always easy
to demonstrate. For example:
- How can one measure a customer’s satisfaction? Customers do not necessarily show their
displeasure in a direct and immediate fashion. An indicator such as the number of products
physically returned by the customer to the company overlooks cases where customers were
unhappy but did not bother to return the product. The number of telephone complaints is also
imprecise. A satisfaction score coming from surveys carried out by interviewing customers will
depend on how the customer sample was set up.
- How can one measure the profit margin generated by a given product? Does one include the
costs of the entire manufacturing chain from the purchase of components to the sale of the
product? Should product creation costs (design costs, prototype costs, etc.) be included or only
those expenses undertaken when production has reached “cruising speed”? How can one take
into account overhead costs and what is the most appropriate way of allocating them to the
different products?
In general, any measure must have two intrinsic qualities:
- Reliability: the measure should capture the phenomenon to be measured with a satisfactory level
of precision, while limiting “noise”. In a transport company, for example, the working hours of
each driver are measured in the following way: a tachograph automatically measures the time
that the vehicle is in motion. To this driving time we have to add “physical” working time
(loading and unloading trucks) and “standing” time (various kinds of waiting time), as well as
rest time. To do this, the driver manually switches on the tachograph to record the appropriate
kind of time. In practice, the way drivers record the time varies quite a lot. Still, at the end of
the week, before the IT system automatically generates the payroll, the working hours declared
are verified by the owner, (himself a former trucker who knows the ins and outs of the system)
which helps to improve the reliability of the system.

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-
Validity: The measure must be suited to the phenomenon that we are trying to measure. For
example, measuring the total time worked by a driver, even if it is carefully checked by the
owner (as far as possible) is not a very valid measure if we are trying to measure the driver’s
performance. He is of course expected to put in a certain number of hours working, but other
factors are also essential (safety, observance of speed limits, etc.).
In management control, measures must also have qualities relating to suitability to purpose:
- Relevance: How to choose a relevant set of indicators? The easiest way is to use readily
available measures, for example indicators from the company’s financial accounting system. As
companies are under the legal obligation to publish their accounts, accounting data are therefore
"available" for internal management purposes. Or data generated directly by production or
marketing processes: customer order taking, volumes delivered, stocks, staff (which are
necessary for the company's operational needs, therefore can also be "recovered" for
management purposes). However, the construction of measurement systems meets more
stringent requirements: not all available data are necessarily relevant, and it may be necessary
to build indicators specifically for the needs of performance management.

An indicator is relevant if it is suitable in terms of the type of decision or usage intended. For
example, the production cost is more relevant than cost price to measure the performance of a
plant, because cost price includes sales costs that are not directly related to manufacturing.
Moreover, measures are constructed differently if third parties or managers, “field” managers
or company executives should use them. They also differ depending on whether the measure is
used for evaluating the performance of activities or that of the managers in charge of these
activities, i.e. the purpose envisaged for the measure.
- Effectiveness: the indicator must help the manager to easily understand the situation and make
a decision. Effectiveness encompasses itself several qualities:
o Cost: producing a measure costs money, because data has to be collected, verified,
processed and interpreted, which generates costs in terms of time spent and IT systems.
The information content of the indicator has to be valuable enough to balance these costs.
o Time: information that is delivered “too late” is of little use. Certain measurement
systems will have to be rejected by management because they are too slow or too
cumbersome and not suited to the context of quick management decision-making.
o Legibility: a measure produces information, so its users must be able to read and
understand it without difficulty.

Beyond the difficulties to design “good measures”, measurement has limitations in itself. Quantification
can create the illusion that performance is objective, and make people lose sight of the subjectivity
inherent in the choice of performance dimensions8. However, while measurement systems reflect
strategic and managerial choices, they do not define them.
Furthermore, quantification can also give the impression that outcome measures are sufficient to
understand how the organization has been performing. In reality, important analytical work is needed
and it is intended to inform a management dialogue to guide subsequent decisions. Indicators are one
component of a performance management system that notably includes performance reviews, i.e.
meetings dedicated to the presentation and discussion of results based on performance indicators.

Quantitative and qualitative

It should be noted that there is frequent confusion between "quantification" and management of a
"financial" performance. We consider that an indicator (by extension, a performance measurement
system) quantifies a performance dimension (or the whole performance dimensions), by translating it

8
See in the general introduction to the book the discussion of the risk of “reification”.
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into measures. However, as we have seen, these dimensions are not necessarily of a financial nature:
some indicators refer to other kinds of performance such as quality, punctuality, employee motivation,
etc. Not everything that can be measured therefore refers to a financial vision of performance (see
chapter 3). Thus, criticizing measurement systems because they include financial measures only is not
the same as criticizing the excesses of quantification.

1.2.3. The learning loop

The difficulties involved in choosing a measurement system always impart a certain degree of fragility
in spite of the care taken in developing it. The performance model on which it is based is itself the result
of choices, strategies, analyses of the company's environment (the constraints it places on it or the
opportunities it offers), etc. The performance model is therefore intrinsically linked to the people who
designed it, to their standpoint, their competencies, as well as to the political context of the company.
Its quality will depend on this organisational configuration it comes out of. The performance model is
also contingent in temporal terms because it derives from the analyses and decisions of a particular
moment – which may evolve. The configuration of markets and competitors is constantly evolving. By
definition, markets and competition are always changing, action plans have a limited lifespan and
unforeseen events can occur in the company. The model is therefore always more or less provisional.
It is essential therefore to remain vigilant and to regularly check on the relevance of the model
underpinning the performance management systems. Variances between targets and results may be a
symptom of the weakness or obsolescence of the model and will therefore alert the manager to the
necessity of reviewing it. This is what we call a learning loop, which completes the regulation loop
presented above. In the feedback control loop, one tries to reduce a variance by reinforcing the action
plans already underway or by reviewing the objectives that have been set. In the learning loop, the
corrective action operates on the performance model which underpins the targets and action plans.

Example 1.1: the learning loop in a publishing company

Specialising in the publication of management books for the general public, the Sweet company has
enjoyed regular sales growth in recent years, although the market has become increasingly difficult. The
fact that shelves are bursting with this type of product coupled with the impact of fads have made the
selling process difficult and sales forecasts are hard to make. Still, the managers of Sweet have decided
to face these difficulties by adopting a proactive, ambitious approach. They set themselves a sales
growth target of 8% per year for the next three years and intend to maintain the ratio of margin to sales.
To achieve this end, they have decided to intensify their sales efforts to retail outlets, increasing the
frequency of visits by their salespeople to booksellers so they can present the most recently published
titles, check the positioning of their books on the shelves and gather precise information on the behaviour
of customers.
At the end of the first year, however, the results are far below the sales forecasts. What options does
Sweet have?
- Intensify their action plans, for example by improving the quality of the sales negotiation
(improving the sales presentation, training the sales team), by reorganising customer visiting
rounds, by more closely supervising their sales people or by hiring extra staff.
- Lower their targets for the year 201n+1 to pursue a more gradual pace of growth.
These first two courses of action constitute the feedback control loop.
- The company directors may also examine the appropriateness of their performance model more
thoroughly. Should they continue to sell through neighbourhood bookstores? How is the digital
book market evolving and should they try to position themselves on this very uncertain market
segment? Should they perhaps consider partnerships with educational institutions?
This third approach constitutes the learning loop.

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Here we glimpse one of the main difficulties of the dynamic of control: if action is not organised in
advance (planning, construction of a performance model translated into a measurement system), the
desired performance has little chance of being achieved. But in an unstable and uncertain context, the
relevance of this plan and this model is ephemeral. It is necessary therefore to provide guides for action,
to impart a predefined direction, to remain vigilant in case these action frameworks have to change, and
to be ready for change when necessary. A balance must be found between the two opposing dangers of
incoherence and rigidity.

Figure 1.7 The learning loop

Defining and modeling Designing measurement

Precedes and structures
performance Mobilized in systems

Learning

Control cycle (planning, results monitoring)

The role of controllers in the performance management system

Management control is naturally associated with one function in the company: the controllers, who may
be organised in separate departments or grouped together with other functions in the company.
But the performance management system is far from being the exclusive domain of the controllers.
Basically, it is an approach that concerns managers whether they be company directors, business unit
directors, managers of an operational department (factory, sales department) or a functional department
(marketing, finance, human resources, etc.).
When a manager is in charge of a business segment and has the authority to engage his business unit in
a course of action through operational decisions, it is vital that he does not act blindly and and that he
manages the performance of his unit in line with his responsibilities. He must therefore clarify the
objectives to be pursued and plan for the future in an active manner. He must oversee the convergence
of the results obtained and take necessary decisions when the results are not on track.
However, a lack of time and the need for expertise relating to certain tools may compel him to delegate
part of this process to another person, the controller, who thus takes on a part of the performance
management process. The controller plays an essential role in designing systems and tools (plans,
budgets, dashboards and so on) and in their implementation, as well as in the resulting economic
analyses and running the process. He thus plays a support role to the manager.
We will see in chapter 12 that this positioning has significant consequences on the required profile of
management controllers, their rank in the company and the organisation of their functions, as well as
the conditions for performing their duties.
At this stage it is essential to understand that the control process is implemented jointly by operational
managers and controllers, that it is not just an area for specialists, a fortiori numbers experts, but is a
broader approach in which numerous people participate. These roles are closely intertwined and can
have a different configuration depending on the company. For example, in organisations where
management control is not highly developed, such as non-market sectors, the management controller

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may have a significant role involving awareness building, information and the training of operational
managers, in addition to their more technical responsibilities. In certain companies managers depend
heavily on their management controllers to analyse business results, whereas in others they would
perform this function themselves.

Section 2. Management control within groups: a double level

Section 1 presented the basic approach to management control, describing:
- its dynamic organisation over time (planning, monitoring of results)
- and its structure around a performance measurement system (a set of indicators based on a
performance model).
This approach can be implemented in companies of very different sizes. The belief that management
control is reserved for large groups is ill-founded: the director of a small company is confronted with
potential uncertainty in his sector or activity, with a need to chart a course and to organize his or her
resources and action plans in a way that is consistent with this orientation9. S/he has to make sure that
the results are in line with the ambitions that he has set. His “need for control” is therefore quite real.
Nevertheless, in bigger organizations where many different people are involved and decision-making
processes are highly complex, management control has to face additional challenges which we will
present in this second section.
Large corporations require a clear structure for decision making. This structure can follow different
configurations of varying complexity: divisional (which themselves can be organised according to
different criteria: geographic areas, markets, products, etc.), functional and matrix structures or a
structure organised by projects. The structure may also entail a certain degree of decentralisation of
decision making. In management control, this will lead to create entities called “responsibility centres”
(see chapter 6).
This introduces a new difficulty: when decision-making authority is distributed among multiple actors,
at what level should the control cycle be carried out? In section 1 we saw that managers were directly
involved in the control process, but how are things organised between different levels of managers?

Autonomous control by entities

Part of the answer is provided by the very reasons that justify the delegation of decision-making
authority down the hierarchical line. In reality this responds to multiple preoccupations: shortening the
decision-making process, having decisions taken closer to local contingencies, and the heightened
motivation of the people to whom greater room to manoeuvre has been given, to cite just a few examples.
In order to preserve the advantages of decentralisation, it is important for managers in charge of
responsibility centres to be able to implement an autonomous control process at their own level. If target
setting and results monitoring were only performed by the directors of the corporation then local
managers10 would have no “visibility” of the progress of their activity; they would be navigating blind.
This would therefore be inconsistent with the decentralisation of decision-making authority.
Furthermore, senior executives would be overwhelmed with detailed data for monitoring results because
a corporation generally has multiple activity areas.

9
In small companies, performance management systems may be simpler than those of a large company, just as the position of
the controller may be combined with other related positions because of limited resources. However, this does not eliminate the
need for management control.
10
For purposes of simplification, we use the term “local” managers here to refer to all managers who report to a higher-ranking
manager, who is thus more “global”. This terminology is not meant to imply anything about the level of “localness” of the
manager, who may be situated at a very high level in the hierarchy (director of a division or branch in the group, for example,
the director of a central support function) or may be positioned at an intermediate level in the hierarchy (head of a department).
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Basically, the performance management of the company’s various activities comes under the
responsibility of the managers to whom the management of these activities has been delegated. Local
managers have to plan for the future and follow their results, based on performance indicators suited to
their activity areas, just like SME directors. These managers are therefore the first users of the various
control tools and systems.

Figure 1.8 The control process in a decentralised corporation: autonomous control by entity managers

Autonomous control

Control by the hierarchy

The decentralisation of decision-making authority engenders the need for autonomous control by the
managers concerned. This is not enough however, and control by the hierarchy is also essential. This is
carried out at the central level of the directors of the organisation, but also at all intermediate levels: for
example, a branch management body is both a level of "local" management, as we have seen above, and
a level of "global" management, provided that it delegates some of the decisions to lower levels.

Figure 1.9 The control process in a decentralised corporation: control by hierarchy

Control by hierarchy

This control by the hierarchy has three components: global control (at the considered level, which can
be either the organisation as a whole or any specific entity), control of centralised decisions (also at the
considered level) and control of delegated activities.

2.2.1. Global performance management

The executive level of a company has to define global objectives and an overall strategy for the
organization, and monitor its global results. Tools such as the strategic plan or performance modelling
methods are very useful in this perspective (see chapters 2 and 8). Global performance indicators will
also be essential (see chapters 3 and 9).
Global performance management is also necessary at intermediate levels: at high levels of responsibility,
managers’ decision also have strategic impacts, albeit in a more specific way. For example, in a
multinational group subdivided into large geographical areas, there may be significant differences in the
market expectations and levels of maturity from one zone to another, which will require defining specific
strategies in each one. The geographical areas are then both "local" entities of the group that align on
the corporate goals and overall strategy, and bodies which formulate specific strategies and implement
global control at their levels.

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Global performance management also includes a monitoring function of what is happening "within the
organization": it is about detecting problems, whether they have been previously identified as areas of
risk to be managed or whether they emerge unexpectedly. This vigilance to "weak signals", by making
it possible to identify a need for action very early on, is an essential dimension of the control towards
which performance management tends.
Global performance management entails selecting indicators grasping the overall performance of the
organisation. However, more analytical information is also necessary to support global decisions:
- To manage the company’s business portfolio, directors need to know the specific performance of
each business segment. Overall performance must therefore be broken down into smaller subsets:
(see chapter 4).
- To manager delegated activities, another type of analytical information is required: the performance
of the different responsibility centres (see below § 2.3).
The measurement systems supporting global monitoring can therefore be global or analytical indicators,
with various types of decomposition (by business segment, by responsibility centre). These two types
of analysis will be discussed in Chapters 4 (not included in this book) and 6 respectively.

2.2.2. The management of centralised decisions

The senior managers of the organization (or of high-level entity in the organizational structure) can make
operational decisions at their level, as not all decisions are necessarily delegated: the management of
key accounts, capital expenditure decisions, the management of the business portfolio, central policies,
etc. often remain centralized. In this case, managers need, beyond the overall management of the
organization, to manage more specifically these centralized areas of action. This will be one of the
functions of the indicators (see Chapter 9).

2.2.3. The management of delegated activities

A final component of control by hierarchy concerns the management of delegated activities, i.e. of the
responsibility centres, because the delegation of decision-making authority does not mean that the senior
managers are relinquishing their responsibilities!
This will create two additional functions for management control, beyond the regulation and learning
functions already mentioned: a motivation function and a coordination function.
Managing delegated activities entails motivating responsibility centre managers to make local decisions
that are coherent with the global objectives of the organization. A common way to do this is to implement
management by objectives: clear performance expectations must be defined for responsibility centre
managers. These objectives are negotiated between the responsibility centre managers and their
hierarchy in order to set up a real contractualization process between hierarchical levels. This
contractualization can be associated with "incentive systems", aimed at aligning interests and
motivations within the organization.
To do this, a performance measurement system will have to be built for each responsibility centre
through the procedures that we will develop in Chapter 6. This local performance measurement will be
useful:
- first of all to the manager in charge of the responsibility centre, for whom it will serve as a guide for
its operational actions.
- for the hierarchy, it makes it possible not only to deploy global objectives into local objectives by
responsibility centre (upstream phase of the control cycle), but also to monitor the results of
delegated activities (downstream phase). This is one of the functions of management reporting.

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Thus, the performance measurement system of a responsibility centre will be useful both to the manager
concerned, for autonomous control at their level, but also for their hierarchy for the contractualization
process.
The management of activities delegated by the hierarchy also has a function of coordination between
and across responsibility centres. Indeed, the effective performance management by the managers of
each entity at their level cannot guarantee that at a more global level, the overall organizational
objectives will be achieved.
- The first challenge is to ensure proper vertical coordination in the performance management
process, both top-down and bottom-up, which we call "strategic alignment". Indeed, the choices
made at the global level should serve as guidelines for local decisions. For example, if a corporation
has chosen a positioning that prioritizes a service offering in addition to a product offering, it is
important that this orientation be relayed to the various business areas in the company. Conversely,
"local" considerations related to with each business area of activity should be "sent up" to be taken
into account during the development of the overall strategy, to ensure that it is both informed and
realistic.
- Coordination must also be done horizontally between the different entities in the organization. For
example, if a commercial entity is seeking to conquer new markets, it is essential that information
be relayed at the level of production entities for the adjustment of production capacities and the
development of their own action plans. Similarly, the design of new products must mobilise the joint
expertise of the operational and functional departments to ensure that customer needs are integrated
throughout the value chain.
The different functions in the management of delegated activities are summarized in figure 1.10

Figure 1.10 The management of delegated activities: multiple functions

Strategic alignment Contractualisation/

Motivation

Horizontal
coordination

Management control and behavior orientation

In the academic world, the management of delegated activities is sometimes referred to as a behaviour
orientation function. Indeed, delimiting areas of responsibility, setting performance objectives for
managers and links between these objectives and "punishment/reward" systems create a challenging
environment for managers and influence their attitudes and behaviour. This suggests two comments:
Some authors tend to define management control by this behaviour orientation function:
" Management control is the process by which managers influence others towards organizational goals"
(Anthony, 1988: 10).
However, as we have seen in section 1, management control is necessary even in the absence of
delegation: it basically consists in managing the performance of activities, through a process of
clarification of the relevant performance dimensions and their management over time (planning, results
monitoring). In a previous book, Anthony himself defined management control as "the process by which
managers ensure that resources are obtained and used efficiently and effectively effectively and
efficiently in the accomplishment of the organization’s objectives" (Anthony, 1965: 17). The orientation
of behaviour, important as it may be, is therefore only one of the purposes of management control.

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Secondly, the behaviour orientation function sometimes leads to the view that management control has
a disciplinary purpose: control would be synonymous with "domination", and this vision would be
justified by the existence of risks of "behavioural deviation" (such as the use of decision-making power
to serve personal interests, or even more fundamentally "laziness"). Controlling would then mean
ensuring that individuals do not "slip". In our opinion, these concepts mask the fundamental role of
autonomous control and therefore the autonomy of managers in the principles of management control.
It also overlooks the desire to contractualize that guides the management of delegated actions, as P.
Drücker had already stressed for a long time:
" ‘Control’ means the ability to direct oneself and one’s work. It can also mean domination of one person
by another. Objectives are the basis of ‘control’ in the first sense; but they must never become the basis
of ‘control’ in the second, for this would defeat their purpose. The greatest advantage of Management
by Objectives is perhaps that it makes it possible for a manager to control his own performance."
(Drücker, 1954)
In addition to this, one of the main functions of the management of delegated activities is a coordination
function, and this is induced by the distribution of responsibilities, not by the deviant intentions of the
actors.
Admittedly, any structural division inevitably creates varied points of view, a global logic and local
logics, and therefore risks of divergence between these points of view. Certainly, when a manager is
given significant autonomy in an area of responsibility, there is always a risk of "excessive autonomy",
compartmentalization or even "baronies", which can be very harmful to the synergies that the entire
company needs (we will have a particularly marked illustration in the Environmental Services case study
at the end of this book). Finally, any system made up of "real" people is likely to give rise to "games"
of actors, as M. Crozier (1977) or G. Hofstede (1967) have long shown. But while safeguards are
necessary to avoid these excesses, they do not constitute the core, let alone the basis, of management
control, which is mainly focused on controlling the risks and difficulties associated with achieving
ambitious performance objectives.

The links between autonomous control and control by hierarchy

In decentralized organizations, performance management is therefore exercised at different levels. To
avoid excessive duplication between these levels and to articulate the whole in a balanced way, the
"results-based control", or results control system is essential. It requires that managers in charge of
responsibility centres will be evaluated on the achievement of results and not on the details of their
decisions. In other words, if managers will have to report on the achievement of this result, it is their
responsibility to choose the action plans to achieve these results.
The concepts of results-based control and management by objectives (MBO) are similar, but
nevertheless distinct. The objectives set for managers are indeed and more precisely "objectives of
results", but the MBO emphasises that expected results should be specified in advance and in a
negotiated way, while results-based control emphasises the partial and synthetic nature of supervision.
Moreover, it is possible to imagine results-based monitoring without prior objective setting, which is
the case, for example, in peer review systems. On the other hand, one could imagine objectives set so
precisely that the manager's degree of autonomy would be extremely limited (although this case is
unlikely at the managerial level in question here). We will see in Chapter 6 that results-based control is
different from other "forms of control", i.e. other behavioural guidance modalities.
A corollary principle to results-based control is subsidiarity. When the results do not meet expectations,
corrective decisions are primarily the responsibility of the manager concerned. However, the hierarchy
may have to intervene if this first level of management proves insufficient. This principle of subsidiarity
makes it possible both to preserve the autonomy of local managers and not to overburden the hierarchy
in terms of monitoring delegated activities. This is a second aspect of management by exception,
mentioned in section 1: the monitoring by the hierarchy of delegated results will focus mainly on what
is problematic (deviations from objectives).

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This complementarity between control by hierarchy and autonomous control will lead in particular to a
distinction, in local performance measurement systems, between indicators intended for the hierarchy
for the management of delegated activities (management reporting) and the more detailed indicators
intended for local managers for the management of decentralised activities.
Although complementary, management by the hierarchy and autonomous control by responsibility
centre managers can be conflicting in some circumstances. For example, hierarchically linking a
controller to the manager of a responsibility centre will facilitate autonomous control, as management
systems will be adapted to the particularities of the activity, its size, its particular strategy, etc. On the
other hand, these specificities may generate difficulties for reporting and therefore for performance
management by the hierarchy, because the measurement systems of the different centres will not
necessarily be homogeneous. Conversely, a link between the local controller and a higher-level
controller, while facilitating the homogeneity of practices, may generate more difficult relationships
locally between managers and their controllers, as well as management systems that are poorly adapted
to local contexts, making autonomous control more difficult.

To summarise this second section, the context of a decentralized organization complicates the diagram
of the control cycle presented in section 1:
On the one hand, planning (development of objectives, choice of action plans) is carried out at several
levels in the organization, which raises the difficulty of making these different levels of plans consistent.
We will see in Chapter 10 that iterations between planning at the global level and planning at the local
level are necessary.
On the other hand, results are also monitored at several levels: results and analyses must be carried out
for the managers in charge of the entities, and the entities' results must also "go up" along the line for
the purposes of central control.
Similarly, measurement systems will have to be built not only at the global level, but also at finer levels
such as business segments and responsibility centres. Figure 1.11 summarizes these different
components and levels of management control, as well as the chapters in which each of these issues will
be developed in this book.

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Figure 1.11 Management control in a decentralised group: summary

DEFINING AND MODELLING PERFORMANCE

- DESIGNING PERFORMANCE
- MEASUREMENT SYSTEMS

-
- M2 : Defining and modelling organizational M3 : Measuring organizational
performance performance: financial indicators
-
Organizational
performance
-
M8 : Building the organization’s M9 : Dashboards: indicators for
- performance model performance management and reporting (1)

-
- M4 : Breaking down organizational M5 : Measuring the performance of business
performance into business segments segments through cost accounting
-
Breaking down
-
organizational
performance M6 : Breaking down organizational M7 : Measuring the performance of
-
globale performance ito responsibility centres responsibility centres through Responsibility
Accounting
-
-
M9 : Dashboards: indicators for
- performance management and reporting (2)

CONTROL CYCLE

Planning
Results monitoring

M10: Setting budgets at organizational and

M11 : Variance analysis
responsibility centre levels

Conclusion
In this chapter, we have outlined the structure of the management control process, its various dimensions
and the fundamental concepts with which it is associated.
This overall vision is all the more necessary as some of these dimensions are sometimes conflicting. For
this reason, leading to trade-offs whose necessity would not be perceived without this overall vision.
For example, we will see that the coordination and motivation functions of managers are sometimes
difficult to combine; similarly, global management by senior managers and local management by
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managers of responsibility centres, however articulated they may be in theory, are often sources of
conflict in the daily lives of companies.
In the rest of this book, we will explore these first sketches in more detail. The first part of the book
(chapters 2 to 9) will deal more specifically with the question of performance and measurement systems.
The second part (chapters 10 and 11) will develop the two main phases of the control cycle: planning
and monitoring of results. The third part of the book (chapters 12 to 14) will have an integration function:
it will take up the question of the different actors involved in performance management and will propose
two summary cases articulating the elements of a management control system.

Bibliography

ANTHONY R.N., Planning and Control Systems : a framework for analysis, Boston, Harvard
University Press, 1965.
ANTHONY R.N., The management control function, Boston, Harvard University Press, 1988.
CROZIER M., FRIEDBERG E., L’acteur et le système : les contraintes de l’action collective, Paris,
Editions du Seuil, 1977.
DRUCKER P.F., The Practice of Management, New-York, Harper and Brothers, 1954.
HOFSTEDE G., The game of budget control, Tavistock, 1967.
MERCHANT K.A., Modern Management Control Systems, Prentice Hall, 1998.
OTLEY D.T., « Management Control in Contemporary Organizations: Toward a Wider Perspective »,
Management Accounting Research, 5, 289-299.
REEVES T.K., WOODWARD J., « The study of managerial control », in Joan Woodward (Ed.),
Industrial Organization : behaviour and control, Londres, Oxford University press, 1970.

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Part 1 - Performance measurement systems

Chapters 2 to 9

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Chapter 2 - Clarifying and modelling the organisation’s

performance
Introduction
In the previous chapter, we pointed out that the performance objectives of a company or organisation
can be expressed very differently depending on the time horizon considered, and that performance
representations can have different dimensions, which can be financial and non-financial. Defining the
performance of an organisation is not an immediate step, but it is an essential one, in making
management decisions and monitoring an organisation: setting priorities, defining them and defining the
actions to be undertaken, monitoring achievements, adapting what needs to be done. Defining
performance allows one to know where one wants to go, to imagine how to go, to control what one does
along the way. Comparing achievements and objectives is also a learning opportunity on how
organisational performance is formed and therefore on how to improve it.
In this chapter, we will explore this issue of organisational performance in more detail. First of all, we
will clarify what we mean when we talk about performance. We will then see that performance is defined
in relation to the identification of the stakeholders who are meaningful to the organization and their own
expectations or objectives. It is therefore a matter of points of view that can sometimes differ, and that
the corporate leadership must manage to integrate, reconcile or, at least, recognize in the decisions they
are called upon to make. Finally, we will explain that the definition of performance is a modelling
exercise and we will clarify the main issues.

Section 1. What is organisational performance?

A common definition approaches organizational performance in terms of a value/cost relation on the
one hand, and the goals of the organisation on the other. For example: " Performance in a company is
everything which – and only this – contributes to improving the value/cost relation... [and] which
contributes to attaining strategic goals”11 (Lorino, 2003, p. 9).
The reference to "strategic objectives" in the above definition indicates that an organisation's
performance is oriented towards achieving "something". But in our opinion, this idea indicates that
performance is more accurately defined in reference to the aims of the organization. While strategic
objectives are themselves defined in relation to the goals, they do not, as such, fall within the definition
of performance. The goals are more general in nature. They are expressed qualitatively and do not aim
to be quantified, whereas strategic objectives are quantifiable and measurable and most often expressed
in terms of quantified targets.
For example, the goals of a higher education institution are to contribute to the development and
dissemination of knowledge through research and training activities. The purpose of private sector
companies is often expressed in financial terms: profitability, return on investment, or shareholder value
creation (see Chapter 3). It is in relation to these goals that the long-term objectives, often called strategic
objectives, of the organisations are then defined. For the higher education institution, they may take the
form of an increase in the number of graduate students or research agreements signed with other public
or private bodies. For a private sector company, this may be, for example, a profitability target, or
regular growth and a target rate of earnings.
The definition of performance in terms of "value-cost ratio improvement" introduces a second idea,
namely that performance also consists in optimizing the resources consumed by the organisation for the
realization of an activity with economic and/or social value. This principle of comparing achievements
with the consumption of resources, or the activities of an organisation with the resources mobilized to
achieve them, is fundamental to understanding what characterizes a performance logic. This

11
Original in French; our translation.
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performance logic has now spread to many sectors of activity where it had long been absent. It differs,
for example, from a narrow budgetary logic in which the organisation's objective is not to consume more
than its budget, but to consume the entire budget, regardless of its real needs and the activities actually
carried out12. It also differs from an activity logic in which only the volumes achieved are important,
regardless of the resources consumed.
As attractive as it may be, defining performance with reference to a value-cost relation raises operational
difficulties that will lead us to propose an alternative definition. For example, technically, defining and
calculating costs is not a simple process: questions such as the allocation of indirect costs or the
apportionment of fixed costs to production volumes.13 These questions are intensified when it comes to
defining and determining a value, the value itself being relative to a point of view: should we consider,
for example, the value for the customer, the economic or shareholder value, the societal value of an
organisation's activities14 ? Then, how do we measure this value and compare it to the costs related to
the activities carried out by the organisation? Finally, the value-cost trade-off that it would be a matter
of optimizing is not binding as such on the leaders of organizations. Defining value leads to questions
about the aims of the organisation, which are usually multidimensional and the result of a proactive
approach: managers are often in a position to intervene in the choice of the organisation's aims; at the
very least, they are able to influence the choice of goals and manage priorities among these goals.
While maintaining the idea that performance must be defined with reference to both goals and means,
we prefer to propose a more general definition of organisational performance, which we believe poses
fewer problems in terms of operationalization. We will say that organisational performance covers two
aspects: the goals (where we want to go) and the main lines of action (what we undertake to do about
it). The latter may concern both the management of the necessary resources and the levers for creating
value.

Section 2. Organisational performance and stakeholder

expectations
Organisational performance is defined in relation to the expectations and objectives of stakeholders. The
notion of stakeholder often draws on the now classic definition put forward by R. Freeman (1984), that
we will reformulate slightly: “[a stakeholder is] any group or individual who can affect or is affected by
the achievement of the organization’s objectives”15 (Freeman, 1984, p.46). For example, through their
activities in the company and the way they perform them, staff members have an impact on the
achievement of the organisation’s goals and, therefore, on objectives. The knowledge and behaviour of
salespeople has an impact on customer satisfaction and on sales. They themselves are likely to be
impacted by the achievement of the organisation’s objectives which may require them to acquire new
language ability, learn new technology, or travel more frequently on business and further away, taking
them away from their social and family environment. Suppliers may contribute to the achievement of
the organisation’s objectives by meeting criteria of price, quality, reliability of deliveries and innovation.
They may be impacted if the achievement of their customer’s objectives entails making substantial cost

In Part 2, we will present much less restrictive issues in the budget process, particularly those focusing
12

on monitoring and learning.

13
We will provide an outline of the principles of cost accounting in chapter 4 of this book. For a more
detailed presentation, see Mendoza et al. (2009).
14
In most management control handbooks, the value which matters is customer value? It also leads to
many definitional and measurement problems. For a critical analysis of the management of the cost-
customer value ratio, see Malleret (2009).
15
For the sake of consistency we would substitute “goals” for “objectives” here.
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reductions on their part, coupled with quicker responses and shorter turnaround times or if they have to
relocate part of their operations to follow the relocation policy of a customer that is important to them.
The organisation’s stakeholders are not all equal in importance. Some of them control critical resources,
which forces company managers to take them into account. For others, it is the capacity for action that
they have vis-à-vis the managers or other stakeholders which determines their influence. In professional
football clubs, for example, fans exert significant influence on the decisions of managers. When the
results of their team are poor, fans can express their dissatisfaction very explicitly during matches and
in front of TV cameras. As stakeholders, and given their capacity for action, their influence is often
greater than that of the players themselves.16

Managing the balance between stakeholders

The stakeholders who are important to the company or organisation depend on the sector in which the
organisation operates, on the balance between stakeholders at a given moment – and therefore the
general institutional context in which companies pursue their activities, but also on a managerial choice.
It is not always easy to identify stakeholders and determine their relative importance: stakeholders may
be very diverse in nature, expectations and objectives, as well as in the relations they have or could have
with the company or organization.
It is therefore up to the executives and managers of the organisation to manage the balance between
stakeholders according to the assessment they make of their relative importance, the possibility of
reconciling priorities, if necessary, as well as the interests of the organisation. Managing this balance is
sometimes difficult when certain expectations are hard to reconcile or when they appear to be imprecise
or ambiguous. Finally, the balance that has been found may be upset (along with the relative importance
of stakeholders) if the company’s environment changes (see boxed text 2.1). The organisation’s senior
executives must therefore manage this balance pro-actively.

Example 2.1: General evolution of power relations between stakeholders: the case of large companies in
the US

Since the beginning of the 20th century the balance between the stakeholders of large companies in the
US has undergone numerous changes. Large corporations were formed at the end of the 19th and the
beginning of the 20th centuries in the United States through a vast movement of mergers and acquisitions
between companies that were initially smaller in size. Certain groups and coalitions of shareholders
came to the fore as dominant stakeholders in these newly- created companies. In response to the need
to better organise the new corporate groups in the interests of these investors, a managerial hierarchy
emerged with specific competencies for managing large corporations. The predominance of financial
elements in enterprise management tools stems from this historical context.
In the period after World War II and until the 1970s, the dominant stakeholders in large corporations
were the executives and managers of the companies themselves as well as employees. Company
executives belonged to what might be called a professional managerial class. For institutional reasons
(separation between capital ownership and management and the fragmentation of the shareholder body),
shareholders had very little influence over company managers. These managers were however opposed
by strongly unionised employees. Wage conditions and the growth in purchasing power of employees
were a central management issue for big companies. Financial measurement systems remained
preponderant in large corporations during this entire period.
The late 1970s and 1980s were marked by the difficulties of American industry in the face of the
successes of Japanese industry in the consumer goods and household appliances markets. Customers
became priority stakeholders for companies that were then trying to restore their competitiveness.

16
For an analysis of this example see Senaux (2008).
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Companies launched Total Quality Management, customer value development and innovation
programmes. More diverse measurement systems that were closer to operational processes were
developed during this period (see the work of the Consortium for Advanced Management – International
(CAM-I) on activity-based costing and the development of the Balanced Scorecard (BSC) at the end of
this period by R. Kaplan and D. Norton).
During the 1990s the institutional environment of large American corporations was marked by the rise
of investment funds: pension funds, mutual funds, etc. The development of this financial asset
management industry prompted executives to take into consideration expectations expressed in terms of
shareholder value creation for these minority shareholders who had now become influential in a context
of the globalisation and financialisation of the world economy. Financial measurement systems, and
notably systems oriented towards the creation of shareholder value, spread throughout large
corporations.
Other changes were also taking place during the first decade of the 21st century. With the development
of corporate social responsibility (CSR), companies were urged to consider the impact of their activities
on their natural and social environments in addition to purely financial and economic considerations.
This movement saw the rise of new stakeholders: communities, citizen groups organized into lobbies,
international governmental and non-governmental organisations. The measurement systems deployed
in companies are gradually incorporating these new non-financial dimensions of performance.
The financial and economic crisis of 2008-2009 has shifted the balance between stakeholders with the
increased intervention of public authorities in the regulation of economic activity and the governance of
large companies. At the beginning of the second decade of the 21st century, in a continuing climate of
great uncertainty, these institutional changes have not yet been stabilised, but it appears that the former
situation in which the financial asset management industry was predominant is being challenged. In this
context, large corporations may have to re-examine earlier models of performance or take these new
dimensions of performance into greater consideration.

With this definition in mind, let us look in more detail at the managerial trade-offs related to the
definition of the organisation's goals.

Managing multi-dimensional organisational performance

Performance is multidimensional, “like organisational goals; it is subjective and depends on chosen
references (goals, targets)”17 (Bourguignon, 1997:3). Consequently, the organisation’s performance is
expressed in different ways by the different stakeholders concerned.
For example:
- For the shareholders of a company, performance is expressed in financial terms.
- For customers, it focuses on meeting or reducing delivery times for goods and services, on
perceived quality and value for money, on services related to sales (financing, guarantee,
training, etc.).
- For employees, performance concerns work satisfaction, career advancement possibilities,
and/or skills development, compensation.
- For society, other performance dimensions such as the environment, employment and social
integration are important.
The ways that stakeholders view the organisation sometimes conflict, either totally or partly, when they
are speaking about intrinsically divergent dimensions of performance (see boxed text 2.2). Favouring
one point of view can result in one dimension of organisational performance being prioritised and

17
Original in French; our translation.
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pursued to the detriment of the others. These other performance dimensions are not entirely neglected,
but the objective is often to attain an acceptable level of performance rather than try to achieve the best
performance possible. These choices can either be made periodically – for a decision to be taken in a
given situation – or in a more systematic way within the framework of a general policy defined at the
level of the company or organisation as a whole.
Moreover, performance dimensions may be conflictive or multiple even in the absence of multiple
stakeholders. For example, the managers of a private sector company may need, at a given moment, to
combine profitability, growth and debt reduction that are all perspectives favoured by shareholders but
that can prove difficult to combine.

Example 2.2: Conflicting performance dimensions

Let’s take the example of a division in a large railway company that is in charge of maintaining the rail
network. The rail network itself does not belong to the railway company. This division carries out
maintenance work for the owner of the network which is a state-owned company. Three performance
dimensions have been identified for this division: safety, reliability and costs. Safety refers not only to
that of passengers and on-board personnel, but also to that of the workers who carry out maintenance on
the tracks. Maintenance operations that are carried out on sections of track where trains may be running
exposes these workers to a risk of accidents which absolutely must be kept under control. Safety is
therefore imperative for this division. The relevant stakeholders here are company employees (onboard
personnel and maintenance workers) and passengers.
Reliability refers to punctuality in terms of keeping to timetables and transport times. Proper
maintenance of the rail network is indispensable for reliable train service. It reduces the likelihood of
breakdowns and incidents (damaged track or overhead power cables etc.) and ensures that trains can
travel at their optimal speed across the entire network. Guaranteeing reliability is important for the
satisfaction of the railway company’s customers (passengers and freight transport).
Costs are those involved in the actual maintenance work: the cost of network surveillance, maintenance
and the replacement of track, railway ties, electrical equipment, etc. This economic dimension of
performance is fundamental to the balanced management of the division as well as the continuation of
its activities with the state-company that owns the network, which could decide to switch to another
maintenance company. The stakeholders here are therefore the employees of the division (who have an
interest in the division carrying on its activities), the state company that owns the network (as the client
of the maintenance activity), and the shareholders of the railway company itself.
The diversity of stakeholders makes defining the organisation’s performance a complex task. The
construction of a performance model is even more complex as goals and action areas partly conflict with
each other. For example, for safety reasons, traffic must be temporarily halted on sections of the network
where certain maintenance operations are being carried out. The reliability and continuity of service can
be maintained by scheduling maintenance operations at night when the tracks are not being used. But
this solution increases costs because maintenance operations have to be carried out in stages, which
lengthens the time of the intervention and increases personnel costs, which are higher for night work. It
is intrinsically impossible to maximise both the reliability objective and the cost reduction objective at
the same time; a choice has to be made between these two performance dimensions.

Conflicts between dimensions of performance can also occur due to differences in the time horizon
considered to consider performance (see example 2.3) The difficulty then consists for the organisation's
managers in avoiding compromising long-term performance by making choices focused on achieving
short-term performance.

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Example 2.3: Time horizons of organisational performance

For a large publicly-traded automobile manufacturer, performance is defined in different ways

depending on whether long-, medium- or short-term horizons are being considered. The relevant
stakeholders also vary depending on the time horizon.
In the long term, performance for a publicly-traded company consists in creating lasting shareholder
value.
For the medium term, performance involves satisfying customers by offering innovative products and
positioning the company optimally in terms of perceived value in relation to the selling prices of vehicles
and associated services.
For the short term, particularly in 2008-2009 at the outbreak of the financial and economic crisis,
performance consists in consolidating the company’s cash situation to avoid a liquidity crisis. Numerous
stakeholders are interested in the achievement of this performance objective in the short term: first and
foremost the company’s employees, of course, but also the national government and local authorities
that want a major employer to carry on its business activities and, to a lesser degree, former customers
who still have valid warranties on the vehicles they purchased.
The challenge for managers is to find a way for the company to get through the liquidity crisis while
maintaining or even enhancing its capacity for innovation and know-how so as to update and improve
its range of cars and consolidate its positions on the automobile market. Finally, they have to convince
long-term investors and shareholders that the action undertaken in the short and medium term will
contribute to the objective of creating shareholder value. The need to manage these different time
horizons simultaneously creates situations of incompatibility between the different performance
dimensions and forces managers to make choices and trade-offs.

Section 3. Issues involved in performance modelling

Defining the organisation's performance consists, as we have seen, in first clarifying the organization's
goals. These objectives depend on the stakeholders and involve managerial trade-offs because of their
multiplicity, their dynamic and sometimes contradictory nature. But we cannot only look at the goals to
define the performance of an organisation, the means implemented to achieve these goals must also be
taken into consideration and because of their variety, there are managerial choices to be made here too.
Defining the performance of an organisation thus also requires defining the action areas considered as
relevant to achieve these goals. By selecting certain means to achieve certain goals, we model the
organisation's performance. It is the challenges of this modeling that we will detail in this last section.

The organisation's performance model

A model is a schematic representation of the cause-and-effect relationships between different elements.
It lists and defines the concepts and variables that are supposed to be involved in the functioning of a
process and is most often based on a mathematical formalism (quantitative model based on equations).
There are also qualitative models (diagram-based).
Modelling is used in multiple disciplines, for example in economics to study the profitability of a
company or to control the money supply in a given economic area, or in cybernetics to map the control
and communication processes in living beings and machines. The fields of business management are
also very model-intensive. For example, marketers develop models to track the link between marketing
actions and the company's cash flow or to demonstrate the impact of a marketing action on an
intermediate performance variable. In management control too, models are widely used, particularly
during budget construction or investment decisions, to produce simulations or forecasts. These models
are quantitative, but management control also relies on qualitative models (BSC, OVAR, Performance
Prism, etc.) to inform managers' management practices and represent the causal links between different
performance factors. The dashboards are operationalizations of these performance models. They are
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presented in various forms: diagrams, graphs, indicators and not in the form of equations. They are used
for management purposes and not for simulation purposes (see Chapter 9). A dashboard is therefore the
final result of a qualitative performance modelling approach. Beyond the models producing dashboards,
clarifying an organization's performance model consists in identifying and clarifying the organisation's
goals and defining major operational priorities - thus also clarifying what can and should be done as a
priority to achieve the organisation's goals). An organisation's performance model is discussed, co-
constructed and adjusted by managers and executives on multiple occasions (performance review,
budget meeting, strategic plan preparation, etc.). Although it is not formally communicated to
stakeholders, it is reflected in institutional communications such as annual reports or institutional
websites. Let us practice clarifying an organisation's performance model based on the information
provided on its institutional website!

Example 2.4: The Pôle Emploi performance model

Pôle Emploi was formed in 2008 from the merger between two national public agencies involved in
assisting unemployed workers in France: the French employment agency (Agence Nationale Pour
l’Emploi) and ASSEDIC, the agency in charge of administering unemployment benefits to jobseekers
and the collection of contributions to the national unemployment insurance scheme.
The goal of Pôle Emploi is to contribute to the fluidity of the labour market and thus to keep
unemployment under control. The institutional website of the agency presents Pôle Emploi as “the main
mover in getting people back to work”.18
The website also presents the “missions” of Pôle Emploi which enable us to identify the organisation’s
goals:
- reception and registration of jobseekers;
- payment of unemployment insurance benefits to entitled jobseekers;
- assisting each jobseeker in his job search until placement;
- prospecting the employment market by reaching out to companies;
- assisting companies in hiring staff;
- employment market analysis.
Finally, the website presents a new range of services that can be considered as the action areas that have
been identified to achieve the goals of Pôle Emploi. The following are the principle areas:
- personalise the service to jobseekers;
- simplify administrative procedures for jobseekers;
- develop services for companies;
- work in cooperation with local actors and partners.;
It is possible to identify cause-and-effect relationships between goals and action areas. For example:
- Simplifying administrative procedures for jobseekers by setting up a single appointment process
for both registration and unemployment benefits and by creating a website and a single
telephone number are ways of contributing to goals of improved access to information,
assistance to jobseekers and administrative follow-through. Setting up various communication
channels with jobseekers help to optimise the interactions between Pôle Emploi counsellors and
the people who are looking for work.
- Developing services to companies by analysing their needs, pre-selecting job applicants and
organising forums, contributes to achieving the goals of prospecting the employment market
and assisting companies.

18
http://www.pole-emploi.org, accessed December 2010.
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The contributions of performance modelling

Explaining an organisation's performance model is a very useful approach for managers. This approach
is first of all intended to strengthen strategic alignment since modelling an organisation's performance
should make it possible to discuss and represent the supposed relationships between local action areas
and objectives and the organisation's goals. That said, it all depends on how performance modeling is
conducted and driven within the organisation. It may happen that the corporate leaders of an organisation
take this alignment for granted and "buy" for example a "standardized" performance model (for example
a strategy map, an ERP module or a cost calculation model) from external service providers without
going through a phase of explaining the performance levers of their organization. Alignment between
model and strategy is never guaranteed in advance, it is a work in progress and we will return to this
issue of strategic alignment in more detail in Chapter 8.
Explaining an organisation's performance model must also improve coordination between functions. As
we have pointed out above, this is an exercise in co-construction between managers. The discussion of
the goals and main action areas takes place at meetings that bring together managers from various
functions (e.g. meetings of the Executive Committee). The performance model of an organisation allows
managers to understand and visualize the links between the actions of different entities on the
performance of the organisation and thus promotes coherence between these actions, i.e. coordination.
Thus, if the model shows that a priority is to develop the perceived quality of products, it is possible to
verify that the different entities that contribute to this perception (design, production, after-sales service,
marketing) have taken this priority into account in their own objectives.
Finally, modelling the performance of an organisation is a potential learning tool. It can even be assumed
that this is a condition because learning is based in particular on the validation or rejection of hypotheses.
However, the performance model is an expression of hypotheses on causal relationships between actions
and the goals underlying the strategy. They can therefore be validated or rejected by analysing the results
finally obtained following the implementation of the selected actions. For quantified models, learning
can be achieved through statistical testing of hypotheses. In the case of the performance model, which
is qualitative, it serves as a heuristic in the learning process. Here again, everything depends on the
quality of the reflection carried out within the organisation on the performance model. Indeed, to support
learning, the model should not be considered as a stabilized and definitive element: the learning loop
we defined in Chapter 1 requires regular discussion of the implicit assumptions underlying it: after
analysis of the results obtained, an adjustment of the assumptions expressed in the model - and therefore
of the strategy - is possible.

Limitations of performance modelling

Modelling the performance of an organisation has, as we have already pointed out, considerable
potential virtues. However, its use involves certain biases and risks that are important to have in mind
as a manager, to avoid irrelevant analyses and inconsistent decisions, in other words to avoid any
organisational short-sightedness.
First of all, it is important to remember that a model cannot encompass all dimensions of an
organisation's performance. It necessarily results from a simplification of reality. For economists, the
first quality of a model is not to be realistic: "It is only when a simplifying assumption leads to a model
that provides incorrect answers to the questions it is supposed to answer that its lack of realism can be
considered an imperfection. [...] Otherwise [the] lack of realism [of a model] is a virtue. In this case, the
simplifying assumption makes it possible to isolate certain effects and facilitate their understanding"
(Romer, 1996). This is not a problem as long as managers and stakeholders in organisations do not give
the models the quality of realism or exhaustiveness they do not have. However, it often happens that the
choices made during performance modelling are no longer visible when the model is used to make
decisions. Managerial decision-making (e. g. allocation of resources or choice of action plans for an
entity) is therefore sometimes disconnected from the initial parameters that determine it. When the basic
assumptions of the model are no longer verified (e. g. when information is imperfect or when applied to

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different products or entities), the conclusions of a quantitative simulation model are false, and the
representations of a qualitative model may not be relevant.
Another risk of the models lies in the ambiguity that characterizes them, between representational and
predictive forces. A model does not only reflect certain dimensions of performance. It guides behaviour
to the point where it sometimes creates the reality it is supposed to reflect. This is called the
performativity of the models.
The performativity of models is the subject of significant criticism from the media, civil society and
some academic circles (particularly heterodox economists) because they "provoke" or produce an
economy with deleterious effects (Muniesa, 2014). For example, rating agencies use models to assign a
rating corresponding to the prospects of repaying a company's or a government’s commitments to its
creditors—corporate bonds or sovereign bonds. This rating has a major influence on the financial
solvency of the company. Estimating financial risk becomes a self-fulfilling prophecy that can lead a
company or even a country into a spiral that is difficult to reverse. The downgrading of a security’s
rating leads to much more draconian credit conditions, which can eventually further worsen the financial
situation of the rated company or country. The performative biases of the models also concern the
management control models used within companies. For example, the application of a particular costing
model may lead to irrelevant decisions to discontinue products whose unit costs are shown to be too
high, and that may lead to ultimately degrading the profitability of the entire company. Indeed, the
unavoidable fixed costs relating to the other products remain in the portfolio and increase the unit costs
of those products, making them appear less profitable in their turn.
Qualitative models such as the organization's performance model discussed in this chapter are not
immune to performative biases. For example, by balancing the expectations of certain stakeholders, a
company's managers may ultimately overlook the expectations of a stakeholder considered unimportant
to the organisation. But in doing so, this stakeholder becomes absent from the performance
representations used in the organisation and no manager is encouraged to take it into account in his or
her practices and thinking. This can create considerable short-sightedness and lack of agility, as we have
seen that the balance between stakeholders is dynamic over time.
This bias in the performativity of models goes hand-in-hand with another of their limitations: models
tend to capture legitimacy in organisations. Thus, what is not easy to model is often considered as not
very legitimate. In the case of modelling the performance of an organisation, potentially important but
difficult to quantify purposes (e.g. product or market diversification, change in governance, etc.), or
whose main action areas are difficult to determine, will often be discarded by decision-makers because
they do not easily fit into the model.

Conclusion
Managing the activities of any organisation requires defining its performance. We have seen in this
chapter that defining this organisational performance is not an easy exercise. First of all, it is necessary
to clarify this notion of organisational performance itself. We have proposed to define it in relation to a
combination of organizational purpose and main lines of action.
Explaining the purposes of a given organisation requires identifying the stakeholders in that
organization. These stakeholders can be very diverse. The configuration of the institutional environment,
the sector in which the organisation carries out its activities, but also the choices made by the company's
or organisation's managers, define the balance of stakeholders for the organisation. Institutional changes
alter the terms of this balance, which must therefore be reviewed and managed dynamically by corporate
leaders.
Each stakeholder has a particular perspective on the organization's performance. It is therefore expressed
in several dimensions and time horizons that the organisation's leaders must monitor and reconcile.
Defining the main lines of action that will serve the organisation's goals leads to modelling the
organisation's performance. An organisation's performance model thus specifies its goals, the lines of

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action chosen to achieve them, and the cause-and-effect relationships between the lines of action and
the goals. We stressed that performance modelling is useful for learning, strategic alignment and
coordination, especially if it is co-constructed by managers. We also discussed possible biases in
performance modelling. Biases essentially lie in the blind use of the model for decision-making, whether
through ignorance of the model's initial assumptions, negligence of its performative effects or lack of
attention to everything that is not easy to model.
The following chapters will lead us to explore the financial dimension of performance, first at the global
level of the organisation (Chapter 3) and then at more decentralized levels (chapters 4 to 7).
We will return in Chapter 8 to the methods used to identify and build the performance model of a
company or organisation and the resulting dashboards (Chapter 9).

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Lorino P. (2003), Méthodes et pratiques de la performance, 3ème édition, Les Editions d’Organisation.
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Chapter 3 - Measuring an organisation’s performance:

financial indicators
Introduction
Management control systems were initially built based on financial-type measurement systems and even
today the overall performance of companies is very often measured using financial indicators. The
purpose of these indicators is to qualify and quantify the financial performance of companies by
answering simple questions such as: is this company profitable? Is it more or less profitable than the
main competitors operating in its business sector? Or again: how has its profitability progressed
following the investments it has made in recent years? Does it provide a satisfactory return for its
shareholders, given the risk associated with their investment in this company? Does the company create
value for its shareholders? These questions interest not only company owners and directors, but also
other stakeholders: financial analysts, bankers and investors, competitors, employees and their
representatives, as well as public authorities, notably when the company operates in a regulated sector.
In this chapter, we will see which indicators can be used to answer these different questions – an
undertaking which requires precise definitions for some of the notions that these questions are based on:
what is profitability, return on investment and value creation for the shareholders of a company? We
will see how these notions and their associated indicators enable us to apprehend the overall financial
performance of a company and we will analyse, in a general way, their advantages and drawbacks as
metrics for measuring the performance of a company.

Section 1. The main financial indicators

Before presenting the main financial indicators that are generally used to measure the overall financial
performance of a company, we will provide a general definition of what is, for us, a financial indicator.
In this book we consider that a financial indicator provides a measure of the financial performance of a
company and some of its subdivisions based on data drawn from the company’s accounting system, which
today is often referred to as the financial reporting system. As we will see, the data generated by the
reporting system can later be reprocessed and the construction of indicators can also use economic or
financial data that is not found in the accounting database. Nevertheless, the reporting system remains the
source of shared information used in the calculation of financial indicators.

Profitability indicators
The profitability of a company is its capacity to generate a positive result or profit. Using this notion we
try to determine whether the company is “making money” during a given period, in other words, if the
revenues obtained from its activity are greater than the resources it has consumed to generate those
revenues (costs), or to put it differently if the net income (revenues minus costs) is positive.
A parallel can be drawn between this notion of profit and net income in financial accounting which is
obtained by subtracting total expenses from total revenues in a given period. Indeed, the net income (or
net earnings) that one finds in the profit and loss account (P&L) that the company publishes in
compliance with accounting standards is one of the first indicators of profitability. It is easy to obtain
because every company is required to publish its P&L account and it is easy to understand. Like all
indicators directly obtained from accounting information, it is a reliable indicator that is characterised
by a certain objectivity given that most companies are subjected to the statutory auditing of their
accounts. The auditors guarantee the company’s compliance with the relevant accounting standards as
well as the quality of the system which generates the accounting data. Another advantage of net income
is that it provides a very comprehensive view of company performance during a given period.

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However, this last quality may also constitute a shortcoming. Indeed, net income does not explain how
profits or losses were made. For example, the sale of an asset at a substantial capital gain could conceal
losses made in the core business of the company. Similarly, high levels of interest paid on borrowings
may erode a company’s net income even though its operations are profitable.
It is important therefore to try to isolate and separate the impact of extraordinary items and the impact
of financing from the data that only concerns the company’s business operations, strictly speaking. There
are several profit margin indicators that can be used to do this. Boxed text 3.1 provides an example of
the breakdown of earnings in a format frequently found today.

Boxed text 3.1 Example of earnings breakdown

Sales
- Cost of sales
= Gross margin
- S, G&A – Selling, General and Administrative Expenses
= Operating income
- Extraordinary items
= EBIT – Earnings Before Interests and Taxes
- Interest expense
- Income tax expense
= Net income

Operating income is an indicator of the profitability of the company’s activities without the impact of
borrowing costs and taxes. It is often calculated before the impact of extraordinary items. For example,
restructuring costs, or capital gains or losses generated by the unusual disposal of assets are not included
in the calculation of operating income. The latter indicator is used as the basis for calculating another
profit metric: NOPAT (Net Operating Profit After Tax). NOPAT deducts a notional amount of income
tax from operating income: what the company would have to pay if it were entirely financed by equity
and neutralising the fiscal calculations (add-backs, deductions) that are used to compute the actual
income tax.
NOPAT = (1 – corporate tax rate) × operating income
This indicator allows us to measure the profitability of companies irrespective of their financial choices
while still taking into account the tax to be paid on operating income. For this reason it is often used as
a basis for comparisons between companies or between subdivisions of activities within the same
company, in order to evaluate the performance of operations, strictly speaking.
Upstream from operating income, another metric that is often used is EBITDA (Earnings Before
Interests, Taxes, Depreciation and Amortization). It allows us to evaluate the capacity of a company to
generate cash flows, as depreciation and amortization are simply calculated costs which do not involve
any cash disbursement. For this reason, EBITDA is a relevant indicator to evaluate the profitability of
the company’ operations, notably in capital-intensive industries.
EBIT (Earnings Before Interest and Taxes) EBIT (Earnings Before Interest and Taxes) is the income
before taking into account interest expense and income tax expense. It is therefore another indicator of
the profitability of a company's activities. It also allows comparisons to be made over time for the same
company, or between companies, without taking into account the impact on the profitability of financing
and taxes.

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The plus or minus sign and changes in the various profit indicators allow us to evaluate the performance
of the company; they have to be interpreted in relation to the competitive environment and the economic
situation of the company, its market position and the maturity of its activities. For example, one might
expect a recently formed company or one that has experienced a sharp fall in demand on its markets to
report negative operating income for several periods. Company owners and directors, bankers and
shareholders will therefore pay more attention to how the results evolve rather than their absolute level.
In general, in the absence of any other reference, a profit metric is itself a comparison: that of selling
price to costs, taking into account the volume sold. Using the notion of profit or loss we measure whether
the market logic which leads to a selling price and volume sold, is consistent with the production logic,
which translates into the costs to bear.
However, the economic and financial performance of a company is sometimes hard to interpret based
solely on the absolute profit level. Other questions have to be asked: is the company more profitable
than its competitors? Is its level of profitability growing or, on the contrary, is it shrinking? To answer
these questions we need the figures for several periods or else the figures for a sample of comparable
companies during the same period. If they are to be compared, however, figures that are expressed in
numerical values have to be related to the size of the companies concerned. This is why different profit
levels are often presented as ratios of profit to turnover. Using these ratios it is possible to perform much
more meaningful comparisons either for the same company over several periods or between companies
with similar characteristics or between business segments of the same company.
Among the most frequently used profit ratios, we find “operating profit margin” and “net profit margin”.
Operating profit margin constitutes a measure of the performance of the company’s business operations
that does not take into consideration the way the company is financed. It tells us, for instance, out of 100
euros of sales realised during a period, how much is available to pay interest charges, to pay income
taxes and to pay dividends to shareholders.
Operating profit margin = Operating income/sales
A variant of operating profit margin is net operating profit margin, which is calculated using operating
income after notional tax or NOPAT in the numerator.
Net operating profit margin = NOPAT/sales
Net margin relates the net income earned by a company during a period to the sales made during the
same period. This is the profitability ratio for the company’s shareholders. Comparisons can be made
between companies which now include the impact of financing. It tells us how much, out of 100 euros
of sales made during a period, is finally left over to pay dividends to shareholders or to increase equity
through retained earnings.
Net profit margin = net income/sales

Income levels and profit margins are useful indicators for measuring the overall financial and operational
performance of a company. They can all be readily calculated from the information contained in the
company’s profit and loss account. Their main limitation is that they do not include the amount of capital
that the company has employed to generate income and profit margins. All else being equal, the more
capital that is invested, the greater the amount of earnings expected. This is why it is useful to complete
the income and profit margin metrics with a return on investment indicator.

Return on investment indicators

Return on investment indicators compare the profits made during a period to the amount of capital
employed to generate those profits. Once again, it is possible to define and calculate several different
return ratios, as long as we make sure that the numerator and denominator in the equation are coherent.

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For this, we only need to ask one simple question: what capital was used to generate the earnings in
question?
In practice, only two categories of return ratios are frequently identified: return on equity ratios and
operating return on investment ratios. These ratios are sometimes referred to as financial and economic
return ratios, respectively.

1.2.1. Return on equity

This is the profitability of the company from the point of view of its shareholders. The most frequently
used return on equity ratio compares the net income generated by the company’s activities to the amount
of shareholder equity. This ratio is generally referred to simply as ROE (return on equity):
ROE = net income/shareholder equity
ROE is an indicator that succinctly sums up the overall financial performance of the company. It is
useful in making a comparative assessment of companies, taking the standpoint of an investor who may
be interested in buying shares in a company or who wants to compare different investment opportunities.
One drawback, however, is that it changes depending on the company’s financial policies. It is therefore
useful to use an operating return ratio in addition to ROE.

1.2.2. Operating return on investment

Operating return ratios seek to measure the profitability of the company’s activities before the impact
of financing. The point of view taken is, therefore, that of the manager. A ratio that is very frequently
used is ROCE (return on capital employed) which compares operating income after taxes to the capital
that has been invested in the company’s activities to generate these earnings.
ROCE = NOPAT/Capital Employed

A variant of this indicator uses operating income (i.e. before taxes) in the numerator instead of NOPAT.
In the denominator, capital employed can be calculated either from financing or from the sums invested
in the activity in the form of capital assets and working capital. This principle is illustrated in figure 3.1.
In this simplified representation of the balance sheet, the company is financed by equity and debt.19
- equity represents the share capital of the company plus share premium and reserves;
- debt is calculated after deduction of cash and cash equivalent assets;
- net fixed assets are the fixed assets used in running the company’s operations after deduction of
cumulative depreciations and amortization;
- net working capital represents the investment needed to finance the operating cycle. It is calculated
from inventories (if they exist and depending on the activity of the company: raw materials,
components, merchandise, as well as work in progress and finished goods) plus accounts receivable
and other currents assets, minus accounts payable and other current liabilities.

19
We will refer to this representation as a financial balance sheet to distinguish it from the accounting
balance sheet.
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Figure 3.1 Financial balance sheet

1.2.3. The “Du Pont” equation and the company’s business model
The Du Pont equation (see figure 3.2) is used to break down the operating rate of return using operating
profit margin and the asset turnover ratio. This breakdown shows that it is useful to combine a profit
margin analysis with a measure of the amount of capital invested in the business.

Figure 3.2 The Du Pont equation

Two companies can have the same rate of return with very different activities both in terms of profits
generated and working capital needed. Table 3.1 illustrates this phenomenon. Company A has a low
operating margin, but needs very little capital to operate: its asset turnover ratio is 2.5, which means that
every euro invested in the business generates 2.5 euros in sales. Company B has a much higher operating
margin than company A: 20% compared to 6%. However, this company needs comparatively much
more capital to operate: on average, 1 euro invested in operating assets only generates 0.75 euro in sales.
Companies A and B therefore have very different business models: low margins coupled with fast asset
turnover for one; high margins coupled with slow asset turnover for the other. Nevertheless, in the end
these two models generate the same operating rate of return: 15% in this example.

Table 3.1 Business models and operating returns

Company A Company B

Operating margin 6% 20%

Asset turnover ratio 2.5 0.75

Operating return 15% 15%

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1.2.4. Limitations of return on investment indicators

While they do provide a more complete measure of performance by combining sales figures, profits and
capital, return on investment ratios nevertheless suffer from certain shortcomings and difficulties of use.
First of all, the capital that is considered in the denominator of the various ratios is evaluated based on
accounting data and may therefore be a distorted evaluation of the capital that is actually used to generate
the income that appears in the numerator. For example, depending on the accounting standards followed
by the company and the choices that it makes regarding accounting and fiscal policy, certain fixed assets
will be valued at their fair value and others at their historical cost. If, for instance, a company applies
the principle of fair value to assets and records the depreciation of an asset stemming from a decrease
in its market value, this will, all else being equal, appear as a decrease in the amount of capital employed
and therefore an apparent improvement in returns.
Likewise, old assets that are valued at historical cost less cumulative depreciation will be recorded as
capital employed at a value that is very different from their replacement cost. The book return on capital
employed will probably be overestimated and if managers estimate the impact of their decisions on book
returns, they will have little incentive to invest in asset renewal.
Similarly, fixed asset depreciation gradually decreases book capital employed, all else being equal.
Operating returns will therefore change over time, following the progress of the company in its
investment cycle and the renewal of assets, even if the conditions of its business and earnings remain
unchanged.
Furthermore, if performance objectives are translated into short-term operating return targets, then it
would be in the managers’ interests to decrease the amount of capital employed. This could lead to
decisions to sell off assets or outsource certain operations, which could undermine the responsiveness
of the company or the control it exerts over the quality of its operational processes. Or the managers
may decide to favour less costly investments, but ones of poorer quality or which generate higher
operating costs. In the short term, such decisions will have a positive impact on the operating return, but
may undermine the economic performance of the company in the medium to long term.
Another limitation of return on investment ratios emerges if we try to measure the performance of the
company from the point of view of an investor interested in buying shares in the company. Investors are
not only interested in the relative return generated by the different assets; they consider this measure
together with the risk associated with holding each of the assets. Going back to the example in table 3.1,
the two companies may report identical rates of return, but do they present the same level of risk?
If company B is considered riskier than company A, then investors seeking to optimise the risk and
return on their investment should choose company A. Return on investment as such is therefore not
sufficient to evaluate the performance of a company.
The various shortcomings of return on investment ratios in measuring the economic and financial
performance of companies lead us to examine a final category of indicators: value creation indicators.

Value creation indicators

The indicators known as “economic value or shareholder value” indicators and more generally the
subject of shareholder value spread throughout the business world during the final decades of the 20th
century, first in the United States and then in Europe and other countries, in particular for large publicly
traded companies.
In the 1980s and 1990s many consulting companies sought to promote alternate performance metrics to
the profitability and return on investment indicators that had been mostly used thus far. The proposed
rationale for the new metrics stemmed both from the shortcomings of traditional indicators as well as
the theoretical superiority of the new indicators. Indeed, the new indicators were supposed to be more
congruent with the objective of creating value for shareholders, which was presented as the main goal
that managers should strive to achieve and which should guide all of their decisions. As shareholders

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want to minimise their risk for a given rate of return, value creation indicators should be constructed
that incorporate a reference to risk, expressed through the opportunity cost of the capital that is invested
in the company’s activities.
The spread of these ideas about shareholder value can be linked to the growing weight of investment
funds as shareholders of large listed corporations during the same two decades of the 20th century.
Managed by or for pension funds and the asset management departments of banks and insurance
companies, these funds saw their own management objectives expressed in terms of both risk and return.
The asset management industry thus became a major stakeholder for the managers of large corporations
and the objective of shareholder value took on greater importance.
Here we will present a few of the best known value creation indicators: EVA (Economic Value Added)
and MVA (Market Value Added) developed by the Stern, Stewart & Co.20 consulting firm and TSR
(Total Shareholder Return) used mainly by the Boston Consulting Group. In general, value creation
indicators can be classified in two categories: external indicators and internal indicators. The former
(MVA and TSR) provide a measure of performance from a point of view outside the company. Financial
analysts and investors to obtain an overall measure of performance often use these indicators. As we
will see, they are constructed with a reference to observed or theoretical market values. Internal
indicators, such as EVA, can be calculated for the company as a whole or at the level of operational
divisions and are useful in introducing the objective of shareholder value creation into the company.
They are essentially calculated on the basis of accounting information, for which various restatements
and adjustments are suggested.

1.3.1. External indicators of value creation

MVA – Market Value Added

MVA is obtained by subtracting the amount of capital invested in a business from the market value of
the company
MVA = Market value of the company – Capital Employed
It is nevertheless important to note that in this approach capital employed is not obtained directly from
the information found on the company’s balance sheet. Various adjustments and restatements are
recommended to arrive at a more relevant measure of the capital effectively used by the company during
a given period.
For example, asset depreciation recorded by applying the principle of fair value can be added back into
capital employed so as to avoid undervaluing the latter. Likewise, certain research and development
expenses recorded as period costs are treated as investments in this approach. The corresponding
amounts are therefore deducted from the total costs of the period and added to capital under the heading
of intangible assets and depreciation is calculated on these assets.
Figure 3.3 provides a graphical illustration of how MVA is calculated. Assuming that the value of
financial debt recorded in the balance sheet is not very different from its market value,21 MVA represents
the return to the company’s shareholders. MVA is also obtained by calculating the difference between

20
EVA is a trademark of Stern, Stewart & Co.
21
The accounting value of debt, recorded as the amount of capital borrowed minus any repayments
made, may differ from the market value. For example, if the company has taken out a fixed rate loan at
3.5% and now it would need to pay 5% to borrow under the same conditions, the market value of the
existing debt is greater than the amount of capital borrowed: the company has benefited from an
opportunity gain. If interest charges on the debt are calculated at a variable rate and/or if the debt is
expressed at its fair value such as defined by IFRS (international financial reporting standards), then the
market value of the debt is not very different from its accounting value.
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the market value of company shares (market capitalisation if the company is listed on the stock
exchange) and the amount of equity, expressed after restatements and adjustments:
MVA = Market value of company shares – Equity

Figure 3.3 MVA

MVA illustrates how a company functions as an economic entity in a market economy: available savings
are brought to companies by shareholders or lenders, either directly or indirectly. These amounts can be
invested in projects and activities that are likely to create value. The risk for shareholders is greater than
for lenders: they are considered residual claimants in the event of bankruptcy and their income is not
guaranteed. Offsetting this, they will benefit from any value that may be created by the company.
If a company’s MVA is positive then it has created value for its shareholders.
This indicator provides a comprehensive measure of performance. This advantage is however impaired
by several drawbacks:
- MVA is very sensitive to the way that capital employed has been calculated. Even when
adjustments and restatements are performed, it is sometimes difficult to find a reliable measure of
the capital that is actually used by a company for its activities. This indicator has a built-in tendency
to overestimate the performance of companies with intangible assets that are not recorded on the
company balance sheet (media companies for example), compared to those that need substantial
tangible assets to carry out their activities.
- MVA is also sensitive to the market valuation of the company; we will examine this point in greater
detail below.
- The “value created” that this indicator is supposed to measure is defined in a very general way:
market value is compared to the sum of all capital brought to the company, irrespective of the age
of each item. We are therefore comparing investments that have not been updated, gathered together
under the heading “capital employed”, to a market value for the company which itself is based on
an actuarial calculation. This raises a problem of consistency and does not help us determine how
a company’s capacity to create value may have changed.

The first and third limitations mentioned above are corrected when we consider the change in MVA
between two dates rather than its level at a given point in time. Most of the distortions that affect the
evaluation of capital employed disappear when we study its variation. Variations in MVA tell us about

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changes in company performance in terms of value creation – which is more useful information for
company directors, analysts and investors.

TSR – Total Shareholder Return

TSR is another way to estimate value creation. Basically it is a calculation of the internal return on an
investment in shares between two dates for a theoretical shareholder who holds all the company’s shares.
If the company is publicly traded, the starting value for TSR is the market value of the company’s shares
in year x. For the purposes of this calculation we will assume that this shareholder bought all the
company’s existing shares at stock market prices.
The end value is equal to market capitalisation in year x+n. The shareholder is assumed to sell all of the
shares at this date. Between these two dates the company may have paid dividends to its shareholders,
bought back its own shares or increased its capital by issuing new shares. These transactions between
the company and its shareholders constitute the intermediate flows for the calculation of TSR (see boxed
text 3.2).

Boxed text 3.2: Calculation of intermediate cash flows for TSR

Intermediate cash flows for the calculation of TSR

= Cash flows received by shareholders (dividends paid, shares bought back by company)
– Cash flows paid out by shareholders (new shares issued by the company)

TSR is thus a measure of the average annual return on the investment made by our theoretical
shareholder between the dates x and x+n. It can be compared to the minimum rate of return expected by
shareholders in relation to the risk attached to their investment. A company is said to have created value
for its shareholders if it provides them with a return that is greater than the minimum expected rate of
return that compensates their risk. This compensation is generally called “opportunity cost”: the return
that shareholders could have obtained from another investment with a risk equivalent to that of the
company’s shares.
These two indicators, MVA and TSR, differ fundamentally from profitability and return on investment
indicators in that they introduce references to market values. The reference to market values is consistent
with the goal of measuring the performance of the company from the point of view of shareholders. It
is important however to point out that these performance metrics differ in nature from indicators that
are calculated directly from accounting data:
- The market value of a company’s shares is supposed to reflect investors’ expectations about the
future performance of the company.
- Share prices are supposed to reflect the fair value of the company’s shares.
Depending on the current economic situation, the share prices generated by the stock exchange may
invalidate these two principles.
For example, investor’s expectations can be quite different from those of company executives. It is of
course up to the executives to try to get investors to adjust their expectations and thus reduce the
discrepancy between internal and external estimates of performance. This is why the executives of large
companies, supported by their finance department and investor relations office, spend a considerable
amount of their time communicating with investors and other key figures in financial markets.
Still, in spite of effective and transparent financial communication, a significant discrepancy can develop
between the value of the company’s shares and their price on the stock exchange. Depending on
investment fund managers’ more general expectations for macroeconomic or industry changes or the
relative attractiveness of various business sectors, or even market phenomena where there are bursts of
enthusiasm for certain companies or certain sectors, the shares of some companies may be ignored or
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abandoned while others, on the contrary, are very much in demand. The share prices of companies can
sometimes fluctuate rather abruptly depending on shifts in investors’ general expectations. For example,
with the outbreak of the financial crisis in 2008 investors shifted away from stock markets in favour of
other assets such as commodities.
Prices in financial markets are formed therefore through multiple and complex mechanisms. Many of
them are not controllable by company directors and do not reflect the “fundamental” growth and
progress of the company, in other words the determinants of its performance. Indicators that refer to
market values must therefore be interpreted cautiously.

1.3.2. Internal indicators of value creation: the example of EVA

EVA: Definition
EVA is a measure of value creation that has no direct reference to market values, but one which does
take into consideration the opportunity cost of the capital employed by the company. Its principle is to
deduct a theoretical cost – the cost of the capital employed – from the company’s net operating profit
after tax (NOPAT):
EVA = NOPAT – k × Capital Employed
In this equation,
- k is the opportunity cost of capital invested in the company. This cost, also known as the cost
of capital, or weighted average cost of capital (WACC) is equal to the weighted average of the
returns expected by investors for each category of financing. An example of a calculation of this
cost is presented in table 3.2. If the company is financed by both equity and debt, then the cost
of capital is obtained from the cost of equity, the cost of debt and the proportion of each of these
two kinds of financing in the company’s total financing. Note that, as a percentage, the cost of
equity is higher than the cost of debt, as shares are considered riskier than financial debt from
the point of view of investors. In addition, the cost of debt for the company is expressed after
corporate tax since interest expenses are tax deductible.
- Net operating profit after tax (NOPAT) and capital employed are taken after adjustments and
restatements, as mentioned above concerning MVA. For example, significant marketing
expenses at the beginning of a product’s life cycle or at the launch of a new brand can be
considered as investments, not costs. The corresponding restatement will consist in first
deducting the total amount of these expenses from operating income and increasing the capital
employed by the same amount, restated as an investment in intangibles. Second, a depreciation
schedule – over 3 or 5 years, for example – is calculated for this investment. Third, for each
year of the depreciation schedule, the corresponding annual depreciation will be added back to
operating expenses in the income statement and deducted from the net value of the intangibles
in the balance sheet.

Table 3.2 Example of a cost of capital calculation

Cost of equity = 8%
60% equity → k

40% financial debt = 0.6 × 8% + 0.4 × 3.25%

Cos of financial debt after tax = 4.8% + 1.3%
= (1 − 35%) × 5% = 3.25% = 6.1%

The message of EVA therefore is that the profit generated by a company’s activities should be high
enough to provide a proper return to capital providers: banks or other financial creditors and
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shareholders, taking into consideration the risk they bear. Profit must therefore compensate investors
for the risk of the capital used by the company. If its EVA is positive, this means that the company is
creating value over the given period.
We will present the main benefits and shortcomings of this indicator below.

Benefits of EVA
- A relation between internal and external value creation. It is possible to show that an algebraic
relation exists between MVA and EVA. Indeed, the MVA of a company is equal to the sum of
all discounted future EVA that the company will generate. This relation is interesting because
any improvement in EVA should lead to an increase in MVA and therefore create value for
shareholders.
- Compared with MVA, EVA highlights value creation areas. All else being equal, creating value
is achieved through an increase in volumes and/or an increase in operating margins; a decrease
in invested capital; the optimisation of the cost of resources used through financial policy and
effective communication with investors: the various components of EVA all constitute areas to
act on MVA.
- Emphasis placed on the cost of capital as the threshold of financial performance. This simple
calculation clearly shows that the capital employed has a cost and, in particular, that
shareholders expect a certain rate of return on their investment. For example, increasing sales is
not an objective in and of itself; the capital that must be employed to increase sales still has to
generate an operating income that is sufficient to remunerate investors at their opportunity cost.
Failing that, this increase in sales will destroy value for the company and its shareholders.
Inversely, an investment project whose rate of return is lower than that of existing activities
while remaining higher than the cost of capital still creates value for shareholders. In this regard,
EVA has an advantage over ratios such as ROCE which are expressed as a percentage and can
lead to improper comparisons and unsound decisions from an economic point of view.

Limitations of EVA
- No proven correlation between EVA and MVA or between EVA: numerous studies have tried
to identify these relations based on statistical evidence, but have not led to conclusive results.
Two main factors may explain this situation. As we mentioned above, MVA is calculated using
the market value of publicly traded companies and share prices are formed through complex
mechanisms in which the performance expected from the company itself is only one component.
The market value observed at a given date therefore reflects elements other than just the
fundamentals of the company. In addition, MVA is supposed to reflect expectations about future
performance whereas EVA is often calculated from available accounting information and
therefore tends to convey past performance records. In practice, it is hard to say that an
improvement in EVA will be matched by a simultaneous increase in MVA.
- A performance indicator based on conventions: EVA is not a bias-free performance
measurement indicator. By design, it is better adapted to situations in which the investments
that the company has to make can be divided or spread out over time and quickly produce the
expected results, and where investments for existing asset renewal are approximately equal to
asset depreciation. These biases can be corrected, of course, but restatements would make the
construction of these indicators less legible.
- Subjectivity in the restatements and adjustments of operating income and capital employed:
these operations are intended to correct the biases imputed to accounting standards, but they
may also seem arbitrary. Returning to our example of marketing expenses that are “depreciated”
or spread over several periods in a non-accounting manner, how should we determine the
depreciation period? Should we use the straight-line depreciation method or accelerated
depreciation? There is seldom a single answer to these questions and they make it harder to
perform comparisons between companies.

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Consequently, in spite of the benefits it offers, EVA is not exempt from some of the limitations that
have already been identified for return on investment ratios. Furthermore, it should be pointed out that
constructing an indicator that directly includes the cost of capital in its definition is not a requirement to
take this cost into account in the evaluation of performance. In practice, it is easy to compare ROCE to
the cost of capital or ROE to the cost of equity. In fact, the comparisons appear if we simply rearrange
the equation for EVA (see boxed text 3.3).

Boxed text 3.3: EVA and ROCE

As we have seen, EVA is calculated as the difference between NOPAT and the remuneration of capital
employed:
EVA = NOPAT – k × Capital Employed
By factoring in capital employed on the right side of the equation, we get:
EVA = (NOPAT / Capital Employed – k) × Capital Employed
Or
EVA = (ROCE – k) × Capital Employed

Cash flows
Although they are not strictly speaking indicators of value creation, cash flows are at the basis of every
value calculation. Indeed, from a financial point of view, the value of an asset is equal to the sum of
future cash flows that this asset is supposed to generate, discounted at a rate equal to the opportunity
cost for an investor of holding the asset in question.
In the TSR calculation that we presented above, the assets under consideration are the company’s shares.
The corresponding cash flows are the flows received by shareholders (dividends paid or share buybacks)
minus their outflows of cash (new stock issues). As we have seen, to perform this cash flow calculation
is useful for shareholders. In particular, TSR provides a retrospective evaluation of the performance of
a financial investment and allows for comparisons with similar investments. However, these cash flows
have a residual character: the dividends paid, which are the main flows received by shareholders, do not
as such tell us much about the operational performance of the company. Indeed, dividends are distributed
out of net income, which incorporates the consequences of financing decisions. The amount of the
dividend payment is itself one of the company’s financial policy decisions.
Consequently, in evaluating the operational performance of the company, investors, financial analysts
and company directors prefer to follow the cash flows generated by the company’s operations, once the
needs of the activity are covered (see boxed text 3.4). These cash flows, known as net cash flows or free
cash flows (FCF), are the cash flows that appear in the numerator of the discounted value equations for
calculating the value of a company or the net present value (NPV) of an investment.

Boxed text 3.4: Calculation of net cash flows using NOPAT

NOPAT
+ depreciation
– changes in working capital
– Net investments
= Net cash flow

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Net cash flows are calculated starting with NOPAT. Next, depreciation is added back to NOPAT since
this expense does not involve cash disbursement. The sum of NOPAT and depreciation enables us to
evaluate the capacity of the company to internally finance the growth of its activities. From this
intermediate level of cash flow, sometimes called gross cash flow, we then subtract changes in net
working capital to get operating cash flow (or cash flow from operations). Finally, we subtract net
investments to get Net cash flow.22
Net cash flow is what is available once growth has been financed. When positive, this flow can be used
to pay dividends, pay the interest on loans, pay back debt or strengthen the company’s cash position.
Cash and cash equivalents can improve the company’s capacity to invest in the future and its strategic
flexibility.
A negative net cash flow means that the company’s activities are net consumers of funds. The
corresponding financing needs are covered by shareholders (new share issue), lenders (increase in debt)
or, if need be, by a reduction in the company’s cash reserves (see boxed text 3.5).

Boxed text 3.5: From net cash flows to changes in the cash position

Net cash flows

+ New stock issues
– Dividends paid
+ New loans
– Debt repayments
– Net interest
= Changes in cash position
+ Initial cash position
= Final cash position

During a project’s life cycle, we expect that net cash flows, which are substantially negative during the
initial periods of the project owing to the investments to be made and/or the growth in working capital
needs, will be compensated in the end by positive cash flows (see figure 3.4). The funds needed to start
a project or a business vary from sector to sector. For example, industry sectors such as raw material
transformation or car manufacturing are very capital intensive. On the contrary, hypermarket chains
have developed by financing their growth with negative working capital requirements: customers
generally pay in cash and suppliers offer payment terms that improve in proportion to the size of
hypermarket chains’ central purchasing agencies.

22
Net investments are capital expenditures less the net book value of disposed assets.
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Figure 3.4 Net cash-flows and the life cycle of a project/activity

For a company, investing in profitable projects diminishes cash flows today with a view to increasing
the cash flows of tomorrow, enabling the company to pursue future developments. Both the level and
variations in net cash flows should therefore be interpreted in relation to the business sector that the
company operates in, to its past developments and to its future investment projects. It also provides
information on the economic performance of the company’s existing activities, their mode of
development and the way they are financed. For these reasons, net cash flows are financial indicators
that are closely followed by all parties interested in the performance analysis of companies.

Section 2. Advantages and limitations of financial indicators

In this section, we will present the advantages and limitations of financial indicators in measuring a
company’s performance.

Advantages of financial indicators

Financial indicators are indispensable measures of performance for companies:
- they provide a summarised view of a company’s performance. A single indicator or a small number
of indicators can allow us to form an overall assessment of the company’s performance during a
given period;
- as they are expressed in monetary terms or in the form of ratios, they can easily be compared
between companies or over time, provided that they are based on homogeneous calculation
standards;
- these indicators are simple to calculate, especially profitability and return on investment indicators;
as calculations are based on only two or three variables;
- the cost of obtaining them is moderate as the accounting information has already been made
available for financial reporting requirements;
- they have good qualities in terms of objectivity and reliability; companies are under a legal
obligation to have the financial information they report audited (compliance with accounting
standards) as well as the process by which this data is produced (quality of the reporting system).
Objectivity and reliability make it possible to compare the performance of different companies on
the basis of these indicators.

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Limitations of financial indicators

In spite of their advantages, financial indicators do also have a certain number of limitations in
measuring performance, in addition to those already identified in each indicator category studied in this
chapter.

2.2.1. Indicators which only focus on one of the dimensions of performance

We saw in chapter 2 that an organisation often has multiple performance dimensions.
For private companies, while the financial dimension of performance is often the first priority, it does
not necessarily exclude other performance dimensions, such as respect for the natural environment.
For other types of organisation, associations, state-owned companies and institutions, the financial
dimension remains important, but only constitutes one dimension of performance among others.
Whatever the organisation in question, by their very nature financial indicators ignore all of the non-
financial dimensions of performance and consequently only constitute a partial measure of
organisational performance.

2.2.2. Limited capacity for explanation

The financial indicators studied in this chapter provide a comprehensive measure of performance, which
is an advantage but can also be a limitation. As we pointed out above, it is imperative to know whether
a company’s return on investment has improved or declined, and whether its profitability has increased
or decreased over a given period. Yet the corresponding return on investment and profitability ratios
rarely allow us to understand what actually happened during the period in question.
For example, for a company operating in the clothing industry, is an increase in profitability due to
growth in the volume sold, which leads to better absorption of fixed costs, or is it due to a decrease in
certain selling expenses? In the case of sales growth, is this the result of better positioning of the
company’s products on the market, the consolidation of its brand image, or an improvement in the
organisation of logistics which has allowed them to ship orders more quickly and efficiently?
Financial indicators are essentially indicators of outcomes. They tell us about the level and progress of
the company’s financial performance, but rarely allow us to precisely trace the causes of this
performance.
We should immediately qualify this remark, however. Indeed, a detailed analysis of one or several
indicators may allow us to identify a first set of factors which may have led to the observed performance
and in this way to diagnose it, or at least to refine the questions that need to be asked in order to
understand how the company’s financial performance is generated. However, the analysis of financial
indicators and underlying factors of performance rarely allow us to trace all the way back to the root
causes. It is nevertheless essential to identify the latter in order to be able to act and take the necessary
corrective decisions (see boxed text 3.6).

Boxed text 3.6: Understanding the factors of performance: the example of EVA

Through an in-depth analysis of the change in EVA between two periods it is possible to understand
whether a decline in EVA is due to an increase in capital employed that is not offset by a corresponding
increase in operating income. The analysis of capital employed may also be studied more closely to
detect any abnormal change in working capital, which may for instance be due to an increase in days
of sales outstanding (DSO). It is possible therefore to perform a first analysis of the situation.
However, is the increase in DSO due to the inefficient management of receivables at the level of the
company’s administrative and financial departments? Is it due to a change in selling practices where
customers are offered better payment terms in order to secure sales? Or is it simply due to late customer
payments? The company’s reaction and corrective measures to each of these possible causes are very
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different. The first case calls for a reorganisation of the administrative system for collecting customer
receivables and the company should perhaps outsource this operation. In the second case, general
management would have to make sales staff aware of the cost of financing customer receivables and
introduce strict rules in company sales policy. In the last case, customer credit risk has to be managed
either internally or externally, for example by setting up credit scoring and insurance systems.

2.2.3. Focus on short-term performance

The following criticism is often heard regarding financial indicators: measuring performance using
financial indicators causes managers to focus on the short-term consequences of the choices they make
and neglect the medium- and long-term consequences of these choices.
For example, developing a new product often causes a decline in ROCE: it is necessary to make
investments and build up inventories of the new product, which causes a rise in capital employed,
whereas the numerator, NOPAT, is impacted by promotional expenses which are not yet matched by
the profits made on products sold. Yet innovation and product portfolio renewal are essential for the
company’s medium- and long-term competitiveness. Positive effects on financial performance are
therefore expected, but on a timeframe that is longer than the coming year.

2.2.4. Indicators with limited capacity to predict future performance

Another limitation of financial indicators is that they measure results without providing much
information about future performance. Returning to the previous example, once the investment has been
made, it is not possible to wait for it to produce the expected results to find out whether the company is
on the right track. The fact that financial indicators have little capacity for prediction reinforces the
short-term tendency in business management. Performance measurement using financial indicators
needs therefore to be complemented by other indicators that have a greater capacity to predict the future
performance of the company, for example, the growth rate of the new product’s sales, its rate of market
penetration, an index of product awareness in the target market, etc.
We will come back to performance modelling in chapter 5 of this book. It should be noted here that it is
not the intrinsic nature of financial indicators that leads managers to focus their attention on short-term
horizons. Rather, it is the way they are used in management control systems that needs to be examined,
making sure that there is an analysis of overall company performance on a multi-year timeframe,
including financial indicators as well as non-financial indicators that can predict future performance.

2.2.5. Comprehension and reliability issues

As we have seen, it is possible to construct financial indicators made up of several variables so as to
produce a more valid measure of the overall financial performance of the company. An indicator such
as EVA for example, offers a much more sophisticated measure of performance than a simple profit
metric.
Nevertheless, the greater sophistication of these indicators makes them more complex and harder to
interpret for managers who may not have a strong financial background. Furthermore, the gains obtained
in terms of the validity of the metric are sometimes eroded by the lack of reliability of these indicators.
EVA, for instance, requires numerous restatements and adjustments to be made to capital employed and
operating income. These operations are partly subjective, if not arbitrary. In addition, calculating the
weighted average cost of capital used by the company entails, in practice, solving numerous technical
difficulties and many of the choices that have to be made in order to do this will introduce a measure of
subjectivity into the calculation. Subjectivity, conventions and approximations result in the reduced

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reliability of composite metrics, such as value creation indicators, compared to indicators that are no
doubt less valid but more reliable, coming directly from the company’s P&L account.

Conclusion
In this chapter we have presented the main indicators used to measure the overall financial performance
of a company: profit levels, profitability ratios, return on investment ratios and indicators of value
creation. These indicators offer an increasingly complete measure of financial performance in this order:
return on investment ratios improve on profit and profitability measures by relating profits to the capital
employed during a given period to generate these results. Value creation indicators introduce an
additional factor: remuneration at the opportunity cost of the capital employed.
These indicators are indispensable for monitoring the financial performance of companies and some of
them can also be used to measure the performance of entities within the company. The question of local
performance measurement using financial indicators will be examined in chapter 4 (not included here).
Finally, we have seen that in spite of their utility financial indicators also present certain limitations in
measuring and managing the performance of business activities and they must be complemented by
systems for monitoring non-financial indicators. We will return to these issues in chapter 5 (not included
here).

Bibliography
Boston Consulting Group, The 2010 Value Creators Report, 2010:
http://www.bcg.com/documents/file59590.pdf
Gray, R., Bebbington, J., & Collison, D. (2006), NGOs, civil society and accountability: making the
people accountable to capital, Accounting Auditing and Accountability Journal, 19(3), 319-348.
Koller, T., Goedhart, M. & Wessels, D., McKinsey and Company, Valuation: measuring and managing
the value of companies, 5th edition, John Wiley & Sons, Hoboken, NJ, 2010.
Young, S. D. & O’Byrne, S. F., EVA and Value-Based Management: A Practical Guide to
Implementation, McGraw-Hill, New York, 2000.

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Chapter 4 - Breaking down the organizational performance

by business segment

[Not included in this book]

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Chapter 5 - Measuring business segment performance

through cost accounting

[Not included in this book]

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Chapter 6 - Breaking down the overall performance of an

organization by responsibility centres

Introduction
In a decentralized organization, overall performance should be broken down to assist management. We
outlined in chapter 4 a first breaking-down criterion, the business segments (BS), which offers managers
a more analytical view of the targeted performance and the results obtained, using an appropriate
measurement system such as cost accounting (Chapter 5). This measurement of the BS performance, of
a financial nature in cost accounting, can be enriched on non-financial dimensions within dashboards
(chapter 9).
We refer here to a second type of decomposition of the organization's performance, by responsibility
centres (RC), which serves different purposes and is based on different principles. A first measurement
system, developed in the 1960s, is Responsibility Accounting, which we will cover in Chapter 7. As
cost accounting and the first management control systems in general, it is of a financial nature. Today,
non-financial indicators are also used to enhance RC performance measurement system (chapter 9).
Before examining the concrete aspects of these measurement systems applied to RC, we must first give
a definition for the RC concept, identify the purposes of the associated measurement systems and outline
the measurement principles that prevail for their operational construction. This is the subject of this
chapter. In doing so, we will highlight the differences with the performance measurement systems of
business segments.

Definition of a responsibility centre

A responsibility centre, whatever its particular form, is characterized by several elements, which we
present here. On this generic basis, a distinction is traditionally made between several types of
responsibility centres. We will present these types in chapter 7.
Basically, a responsibility centre is defined by the following characteristics:
- it is a subdivision of the organizational structure,
- decision-making authority on a defined set of action levers has been delegated to its
manager…,
- in parallel with the allocation of resources,
- and the assignment of performance objectives.

A subdivision of the organizational structure

While the notion of business segment refers to operational subdivisions of the activity (by product,
market, geographical area, etc.), the notion of responsibility centre corresponds to an element of the
organizational structure.
A responsibility centre can be defined at different levels of the structure: it can be a fairly global unit,
such as a branch of activity or a product division for example, or a finer subdivision such as a factory, a
sales department, an IT department, a head office. As a result, responsibility centres can be nested
within each other: a factory could be a responsibility centre included in a broader responsibility centre
such as a product division, itself included in a branch of the organization, etc.
The scope of a responsibility centre depends directly on the type of structure chosen by the organization's
leaders: divisional structure, functional structure, matrix, etc. Responsibility centres can thus be set up

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both for operational units (factory, division, branch) and for functional entities (support services). As
such, the head office of a group may itself constitute a responsibility centre.
A responsibility centre is first and foremost characterized by the fact that it is under the responsibility
of a manager. It refers to how responsibilities are split. Within an organization, there is therefore not
necessarily a match between the perimeters of responsibility centres and those of business segments.
For instance, the manager in charge of the French division of a group (responsibility centre) may be
responsible for managing all the products distributed in the country, and each product may constitute a
business segment; the manager in charge of a particular product division (responsibility centre) may be
responsible for sales in different countries, and each country zone may constitute a business segment. A
manager may have several business segments under his/her responsibility. Conversely s/he may have
only partial responsibility for a given segment: for example, when a factory manager is responsible for
product manufacturing, but not for sales; the manager of a country division has only part of the
responsibility for a product that is marketed internationally.
The notion of responsibility centre must also be distinguished from another type of entity that we have
presented in Chapter 4: the legal entities within an organization that can be either subsidiaries or the
company headquarters. This subdivision, of a legal nature, is the relevant scope for the preparation of
the legal financial statements.
Thus, the "responsibility centres", "business segments" and "legal entities" axes are not necessarily
aligned: they may overlap partially, fit together or cross each other.
In some cases, they may match: this is the case, for example, when a division corresponds to a clearly
defined product segment, when it constitutes a responsibility centre under the direction of a manager,
and when it has the status of an autonomous legal entity. Nevertheless, even in this particular
configuration, these modes of segmentation are conceptually distinct, and the decomposition of overall
performance according to each of these axes follows a specific logic for the design of disaggregated
measures.
Because of its direct link with managerial structure choices, the configuration of responsibility centres
is always specific to an organization. Two companies with similar activities may organize managerial
responsibilities in very different ways. This point will be reinforced by other arguments that we will
develop below.

Clear authority
The scope of business operations is not sufficient to define the scope of a manager's responsibilities. The
way in which decision-making is organized is also important. Indeed, a manager's responsibilities may
be more or less broad, depending on the degree of decentralization.
In general, senior managers delegate many decisions to "field" managers. For example, when the
responsibility centres have heterogeneous customers, it is important to give managers commercial levers
of action (possibility of granting price reductions, offering different payment terms, etc.) so that they
can adjust their commercial approach taking into account the distinct needs of their customers. Similarly,
managers are responsible for managing their own teams, in terms of workforce adjustment (hiring
decisions, dismissals), compensation (salaries, bonus increases, benefits in kind), training, etc. Capital
budgeting decisions (acquisition of machinery, vehicles, real estate, etc.), procurement (negotiation with
suppliers), inventory management, design of new products or services, etc. can all be delegated in the
same way.
In other cases, managers consider that certain decisions must be taken at an upper level: a central
procurement office may thus be in a better position to negotiate with suppliers, centralized cash
management and financing may lead to better offers from banks; managers may choose to coordinate
commercial activities closely with a common marketing approach, or by directly managing certain
negotiations, for example with "key accounts". In the same way, training, IT equipment, property assets,
research, etc. are sometimes managed by central departments in companies.

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The advantages of delegation are well known: it allows managers to free themselves from operational
decisions and to focus more strongly on strategic decisions; it offers more flexibility in the field to adjust
to heterogeneous local contexts; it nourishes the motivation of managers who are given greater
autonomy (Deci and Ryan, 1985). Its limits are clear as well: excessive autonomy can create difficulties
for the management of highly interdependent activities, if synergies and the need for coordination are
overlooked; dialogue between operational staff and upper level managers can be more difficult, with
information asymmetry fostering misunderstandings between overall management logics and
operational considerations in the field; delegation can be costly, as it involves giving managers resources
consistent with their responsibilities and can lead to the duplication of services within the same
organization, as is the case for example when each responsibility centre has its own HR department.
Leaders must therefore strike a delicate balance between these advantages and disadvantages.
Depending on the degree of delegation, the extent of decision-making power of responsibility centres is
more or less broad. Thus, the same organizational structure (by product division, geographical area, etc.)
can lead to very different responsibility centre configurations. To be able to design a RC performance
measurement system, the controller will therefore have to identify not only the type of responsibility
assigned to its manager, but also the extent of authority that has been delegated to them.
This is not always easy in practice, as responsibility schemes can be difficult to analyze.
For example, certain types of decisions may involve several managers in order to promote good
coordination within the organization. This is the case when a division manager has the freedom to decide
on certain commercial actions with its customers, while being part of an overall commercial policy
defined by the group's commercial director. It is important to identify who holds the final decision. In
some cases, central management has a power of "recommendation", leaving the field manager
responsible for the final decision, whereas in other contexts, central management will have a more
binding power. Similarly, it is important to identify who has the decision-making power and who
participates in the decision-making process: for example, for the design of new products, it is important
to involve marketing and sales managers to take in account the needs of customers, production managers
to take in account technological and operational constraints, financial and legal managers also need to
be involved, etc. But participating to the decision making is not the same as being responsible for the
decision. However, this design process will generally be under the responsibility of a manager.
Some organizational patterns are also more complex than others, with deliberate overlaps of
responsibilities. This is particularly the case for matrix organizations, which organize responsibilities
according to cross criteria, for example product managers and geographical area managers: the person
responsible for a product in a given country will then have to comply with the guidelines of the two
schemes, which are not necessarily perfectly consistent since they are established by different managers.
When the decision is shared between several managers, it can also be difficult to identify their respective
responsibilities, as when a manager is empowered to take certain decisions while being "supervised":
this is the case, for example, if a sales manager has the possibility of granting advantages to his clients
within "authorized ranges", when a division manager can make his own investment choices but these
are subject to prior authorization by the hierarchy, etc.
Finally, the scope of a manager's responsibility raises the question of the role of "external" factors, which
can significantly limit the scope of his/her possibilities: the extent of a manager's power will not be the
same depending on whether s/he is in charge of a business sector that is thriving or in crisis. The weight
of legal regulations in the industry, the degree of market stability… also influence the scope of
managerial responsibility. We will see in paragraph 2 how this can be taken into account in practice for
performance measurement.

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Resources
Means or resources on which a RC manager can rely should be assigned clearly to them. These can be
financial, human, material (buildings, machines, etc.).
Allocated means should be coherent with the assigned objectives (see next paragraph):
"A responsibility centre is an entity whose manager commits to achieving certain results provided that
s/he has been granted predefined resources. What specifies the responsibility centre is the idea of an
objective-means pair. " (Bouquin, 1994, translated).
It is sometimes considered that the resources necessary to achieve the objectives should be under the
direct authority of the manager: s/he should be able to rely on clear and dedicated teams and material
resources, and it is advisable to ensure in advance that these resources are correctly calibrated in relation
to the assigned objectives.
Another view is that the manager's authority over resources can be more indirect: the manager's role the
amounts to as knowing how to mobilize these resources, even when they are not under their direct
authority. In this understanding, a good manager should possess a strong capacity to influence decisions
and they must be able to take on responsibilities in complex environments that are difficult to break
down perfectly. This view is more consistent when resources are shared. It highlights the risk of
compartmentalization associated with overly individualized responsibilities and the need for interaction
between responsibility centres. However, it creates ambiguity about what is expected from its managers
(Vancil, 1978).

Objectives
Finally, one or several clearly defined objectives should be assigned to responsibility centre managers.
These objectives reflect the expected contribution of the responsibility centre manager to the overall
performance of the organization, i.e. the objectives for which they will be held "accountable".
Objectives quantify the expected contribution and thus require to design an adequate performance
measure for the responsibility centre.
It should be noted that in the French language, the term "responsabilité" covers two concepts, which are
referred to by different terms in the English language: the extent of the manager's scope of action
(Responsibility), which is closely linked to his decision-making power and the resources allocated them,
and what they are accountable for to their hierarchy (Accountability), which refers to the type of
objective assigned to them and the choice of a performance measurement system enabling this
"accountability".
Defining specific objectives for the responsibility centre does not necessarily mean that they are
restricted to local considerations alone, even if, as we will see, this is often the case in practice. The
objectives assigned to a centre can be based in part on more collective criteria: for example, the
contribution of a division manager can be measured partly by the profit of that division and partly by
the profit of the branch in which that division is located, according to weights that may vary from one
company to another. We will discuss this issue later on in this chapter.
We will now explain how to design a RC performance measurement system.

Designing the performance measure of a responsibility centre:

aims and principles
Talking about the "design" of a performance measure is not an empty word, because unlike the
standardized nature of measurement systems produced for external users, measurement systems
intended for internal performance management are tailor-made. The design is also very concrete and
operational, and sometimes has an important technical dimension. To address these operational aspects
of measurement in a relevant way, it is important to put them in perspective in order to give clear
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guidelines: we will therefore begin by clarifying the purposes, then the principles that guide the design
of a performance measure for a responsibility centre.

The aims of the measure

2.1.1. Different users
Like all performance management measurement systems, responsibility centres performance measures
enables decisions that are internal to the organization. However it is dedicated to different users and
supports different kinds of decisions.
For senior managers, performance measurement systems based on responsibility centres helps to
empower managers.
- First, it enables to set specific objectives to each RC, i.e. to specify the nature of their expected
contribution and to set the targets to be achieved in the short, medium or long term (see
Chapter 1): for example, the manager in charge of a division could be asked to achieve a
profitability objective (type of performance) of 8% (target) in two years (horizon). Just as
what happens at the level of the organization as a whole, one or several indicators have to be
chosen to materialize this objective: in our example, will the RC profitability be measured by
net income, operating income or another type of profitability margin?
- The measurement system then enables to assess the actual results achieved by the
responsibility centre managers and compare them with the expected targets. For this reason,
measuring the performance of a responsibility centre is an integral part of management
reporting, i.e. the transmission of management information to higher hierarchical levels.

For the managers concerned, the performance measurement system is a guide for their operational
management. Their concrete action plans and the consumption of resources are directly linked to the
pursued objectives.

2.1.2. A contractualization function

The empowerment of managers by executives, coupled with managers’ operational commitment to act
in the defined direction, leads to a contractualization between these two hierarchical levels and delimits
their respective fields of intervention. This is the principle of management by objective and results-
based control presented in Chapter 1, which often takes the form of "contracts of objectives".
Contracts are often associated with incentive systems, i.e. tangible or intangible "rewards" for the
achievement of objectives. The measurement system can then inform the decision to grant the rewards,
by providing the manager's superior with tangible information on the manager's performance through a
reporting system. The measure then contributes to support a managerial decision, whereas in other
contexts, the result achieved can directly feed a reward calculation system. This is the case, for example,
when sales representatives receive commissions as a percentage of turnover: the measurement of
turnover has a direct and mechanical impact on the amount of commissions paid.
Sanctions are generally considered as the way to manage the opposite situation, when managers have
been facing difficulties to achieve their objectives. In reality, the process is more complex:
- Difficulties in achieving objectives are managed primarily by the manager in charge of the
responsibility centre, because it is part of the autonomous control process (see chapter 1). The
notion of responsibility would lose all its meaning without this possibility of self-regulation.
This takes place "along the way", i.e. before the final deadline set for the objectives, in order
to leave room for reaction if necessary. In terms of measurement system, this means that the
"overall" performance of the responsibility centre will need to be relayed with more detailed
measures for local management: while the former provides general guidelines for managerial

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action, the latter makes it possible to monitor the progress of action plans and take corrective
decisions in the event of a drift.
- To manage difficult situations, performance measures also play a role of alert for the upper
managerial level. The purpose is not necessarily to penalize managers for their poor
performance but to enhance the management dialogue between managers and their hierarchy:
the latter has a supportive role, gives advice and sometimes intervenes, according to a
principle of subsidiarity.
- Ultimately, performance measurement systems are sometimes used to inform decisions
sanctioning managers’ poor performance: absence of rewards, allocation of more limited
resources, reduction in the scope of their responsibilities, or even dismissal decisions. The
balance between support and sanction in the relationship between a manager and his or her
superior varies according to personality, corporate culture and the way each person sees his
or her role.

In summary, measuring the performance of responsibility centre managers serves as a guide for
operational decisions of the managers in charge of the centres. It also allows their hierarchy to analyze
and make decision relating to their performance evaluation (granting of bonuses or intangible rewards,
promotions, sanctions). It also enables the hierarchy to be more involved in lower echelons’ operational
decisions when it becomes more appropriate.

2.1.3. Alternative modes of control

Contractualization does not come without difficulties or limits. First, research indicates that the
contractual relationship is more or less emphasized across cultures: it would fundamental, for example,
in Anglo-Saxon cultures, while Eastern cultures would favour other modes of regulation (d'Iribarne,
1989).
Secondly, contractualization emphasizes expectations that can be measured, which sometimes
impoverishes the scope of managers' responsibilities and creates behavioural biases: for example, it is
difficult to figure out how to measure the performance of a research department.
Moreover, the asymmetry of power and information between managers and their hierarchy can strongly
bias the process: objectives are not always negotiated but imposed on managers instead; the information
used as a basis for negotiation is not always shared in full and "games" around information can be
frequent.
Contractualization also emphasizes "extrinsic” drivers of action (hope of reward, fear of punishment):
the more "intrinsic" drivers of motivation are ignored and may even be reduced (on the distinction
between extrinsic and intrinsic motivation, see Decy and Ryan, 1985).
Finally, contractualization is not the only way to influence behaviors. Alternatives to results-based
control exist (Ouchi, 1979, Merchant, 1998). Among the other "modes of control", two dominate:

- Action (or behavioural) controls: it consists in controlling the actions (behaviour) directly
rather than inducing them through results to be achieved. Examples are work rules and
procedures, physical or administrative authorizations and constraints: access restrictions,
passwords, ceilings on the amount of capital expenditure that managers may authorize,
approval of action plans before action can be undertaken, separation of tasks, etc.
- Personal, cultural and social controls: here, behaviours are influenced in more indirect ways,
through forms of socialization within the organization. Examples are codes of ethics, internal
organizational rites, dress and verbal codes, etc.

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All forms of control have strengths and weaknesses, so a relevant behavioural guidance system requires
a combination of these different forms rather than the choice of a single one.

The principles
To create a performance measurement system that objectively reflects the contribution expected from a
responsibility centre, four principles prevail:
- The contractual principle;
- The congruence principle;
- The controllability principle;
- The simplicity principle.

2.2.1. The contractual principle

The contractual principle stipulates that a manager can only be evaluated by comparison with previously
negotiated objectives. Therefore results will not be analyzed in themselves, i.e. in absolute terms, but on
their deviations from pre-established targets.
Indeed, whatever their nature, results are subject to the influence of external factors: the degree of
maturity of the sector, the actions of competitors, the economic and political context and various risks.
For example, if the manager is in charge of a product in the launch phase, the margins of his activity can
be low, but this cannot be attributed to the manager’s bad performance. Similarly, some sectors of
activity are inherently less profitable than others, or more competitive, so it is difficult to compare the
performance of managers based on the performance of the activities that they manage.
The contractual principle helps to mitigate this problem. The external conditions under which the
activity is carried out are supposed to be taken in account when setting the budget objectives, which
makes it possible to estimate a level of performance that is "reasonably achievable". Comparing actual
performance against this contextualized target then becomes more relevant than assessing it in absolute
terms. The manager will be successful if s/he is able to "fulfil her or his contract", i.e. to achieve the
objectives set at the beginning of the year.
The difficulty in the implementation this principle resides, of course, in the quality of the benchmark
objective. If it is not very ambitious, the target is then easy to reach without there necessarily being any
real performance on the part of the manager. On the other hand, if the objectives were imposed by the
superior without any consultation or in a way that is too coarse in relation to the possibilities "in the
field", the manager will perceive it as unfair to be evaluated on this basis. How to set "fair" objectives
for managers in charge of a wide variety of activities? As we will see in Chapter 10, the way in which
the budget is prepared will determine its degree of realism and therefore its ability to constitute a valid
gauge for the evaluation of managers.

2.2.2. The congruence principle

The congruence principle aims to ensure that the performance measure of a responsibility centre is
consistent with the organization's overall performance objectives.
This principle can be pursued by applying the same type of measure at the central and local levels. For
example, if profitability objectives are set at organization’s level, responsibility centres could be
assigned similar objectives; if the organization has a quality objective, it may be considered appropriate
to translate this objective with the same indicators in the roadmaps of the different responsibility centres;
etc. In this case, the only distinction between overall and local performance indicators will be their scope
of measurement: profitability or quality will be measured at the group level in the first case, at
responsibility centre level in the second one.
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But the "contribution" of a responsibility centre to the organization's performance can lead to different
types of performance depending on the hierarchical levels, especially when the number of levels is large.
While financial objectives, by their very overall nature, make sense at high levels of the hierarchy, they
do not reflect well the expectations of a more circumscribed responsibility: for a commercial service,
volume objectives may be more relevant; for a support service, the contribution is more indirect (it could
be related to the efficiency in staff management, to the quality of the expertise provided, etc.). Overall
and local performance measurement systems therefore usually differ. The congruence principle then
aims to ensure that these systems, although different, are nevertheless coherent, i.e. that local indicators
"reflect" the overall orientations. Conversely, field logics should be taken in account in overall strategic
intentions. The congruence principle means both a top-down and bottom-up consistency.
This principle is all the more important that the performance expected from RC managers is not always
defined according to a linear and progressive process. It may be defined by a manager and her/his direct
hierarchy only, leading to inconsistency at a broader scale if communication in the group is not good.

2.2.3. The controllability principle

The controllability principle requires that a manager be held accountable only for performance items on
which s/he can act, or more precisely on which s/he has a certain level of control. In other words, her/his
span of control and her/his span of accountability should be made consistent (Simons, 2007). The larger
the power of a responsibility centre manager, the broader the performance on which they will have to
report. If, on the other hand, the managers’ scope of action is limited, their responsibility will be limited
as well.
Like the congruency principle, this principle has direct impact on the construction of the RC
performance measure. It leads to neutralize the "uncontrollable" items in this measure.
Take the example of an organization willing to achieve a breakthrough in international sales. The
manager in charge of a French division will not necessarily have the opportunity to act on this subject.
An indicator like "export turnover" will therefore have an important meaning at the overall level, but
not at the level of this division, because the performance objective cannot be controlled at this level.
Similarly, if a company pursues a ROI objective (measured for example by a return on capital employed
indicator), a responsibility centre that would not have the possibility of making investment decisions,
nor managing shorter-term assets such as inventories or trade receivables, would lack control over the
assets needed for its activity: a profitability indicator like operational income then better identifies the
contours of its span of control. For instance, to neutralize the impact of uncontrollable external factors,
it may be decided to evaluate the RC performance by isolating variations in exchange rates. As can be
seen from these examples, uncontrollable factors can be internal (decisions taken at a higher hierarchical
level or by other managers within the organization) or external (impact of the market, competitors,
headquarters, etc.).
The controllability principle responds first and foremost to a concern for fairness in the evaluation of
managers: as we have seen, a RC performance measure is often associated with more or less formal
"sanction/reward" systems that give it particular importance in the eyes of its manager. If the latter is
evaluated on criteria beyond his/her control, these rewards are then disconnected from his/her concrete
actions and lose their incentive power. Even in the absence of formal rewards, a manager may simply
seek to measure the result of his/her actions, for operational reasons but also for the sake of "work
accomplished": it is then important that the way in which this result is measured is directly related to
his/her actions/decisions. As we can see, the controllability principle has strong stakes in terms of
managers' motivation, whether this motivation is extrinsic or more intrinsic.
The controllability principle also responds to a concern for efficiency, because if a manager has no
control over an element of performance, holding him/her accountable for this aspect will not make it
possible to restore the situation in the event of a problem.
Despite its apparent simplicity, the controllability principle is not always easy to apply, as we will see
in concrete terms in Chapters 7 and 9. Controllability is not a binary notion: some performance items
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appear clearly controllable by a RC manager, others are clearly uncontrollable, but the situation is more
intricate when a manager has "part of control" over things.
Moreover, controllability is not observed, it is assessed. Research on "control psychology" shows the
distortions, biases and errors that can occur when assessing controllability for oneself or for another
person (see for example Alloy et al., 1993). Building a performance measure for accountability purposes
is therefore not a technical and mechanical exercise only, it implies taking in account the subjectivity of
the actors in the assessment of controllability, as well as the stakes for individuals. For example, some
authors support the idea of an "internality norm", i.e. a social propensity to value so-called "internal"
individuals, who spontaneously attribute themselves the controllability of events, to the detriment of
"external" individuals, who explain events by causes such as chance, circumstances, the intrinsic
difficulty of a task, etc. The high social value of internality thus encourages individuals to present
themselves as internal, even if their effective control is weak.
Finally, the relevance itself of the controllability principle is sometimes questioned. For some authors,
it hinders creativity and innovation (Simons, 2007).
The controllability principle has limits. In its fundamental logic, it leads to a clear distribution of
responsibilities. But on the other hand, it can generate a risk of creating silo effects if responsibilities
are defined too exclusively and if the incentive system focuses managers' attention overly on the
performance of their own entity.
In contexts where responsibility centres have strong operational links, where synergies are required, the
controllability principle can generate excessive silos if it is applied too strictly.

2.2.4. The simplicity principle

The simplicity principle aims to build a performance measure that is easily readable and understandable
by the people concerned. An indicator that is too complex may not be very motivating for a manager
and may lack clarity to guide behaviour in an appropriate way.

2.2.5. Potential conflicts between the four principles

The four guiding principles for measuring a RC performance (contractual, congruence, controllability,
simplicity principles) can be conflicting in some situations.
First, there is a tension between the congruence and controllability principles. When a performance item
is partially controllable by a manager, the controllability principle prescribes to neutralize this element
for the evaluation of the manager's performance, while the congruence principle leads to maintaining it
in order to encourage the manager to act as best he can on this item.
For example, should the operational divisions be charged the costs of a central service, whose main
activity is the maintenance of computer equipment? Hardware or network failures may be due to local
negligence or more structural problems of hardware quality. If we decide not to allocate these costs to
the operating divisions, the controllability principle is respected for these divisions, but we neglect the
part of influence that their managers can exert on this expense. The evaluation system will not encourage
responsibility centres to act as best they can on these induced costs, so the system will be a little less
"congruent". Conversely, attributing the corresponding costs to them may be perceived as unfair and
demotivating by the divisions’ managers, especially if the costs are high.
It is also this conflict between congruence and controllability that has initiated some debates on the
relevance of EVA as a divisional performance measure (Larmande and Ponssard, 2007).
The more this conflict is arbitrated in favour of the congruence principle, the more it can lead to diluting
responsibilities: if we take the reasoning to the extreme, we should not only evaluate entities on the basis
of an overall measure (margin, EVA, etc.), but also calculate these measures at the organizational level
(the overall margin of the company, and not that of the entity). In this configuration, congruence would

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be perfect, but everyone would be responsible for everything, which would generate the risk of "free-
rider behaviour", where in the end no one feels responsible for anything.
The controllability and simplicity principles may also clash: the former may lead to a strong reprocessing
of the performance measure in order to neutralize uncontrollable factors, at the risk of constructing an
overly complex measure contrary to the simplicity principle.
In conclusion, the principles governing the construction of a performance measurement for a
responsibility centre are many and sometimes difficult to apply, they are both complementary and
conflicting, which requires compromises in their practical implementation (Merchant, 1989).

2.2.6. Potential conflicts with other performance measurement systems

In addition to this, the four principles may conflict with those that govern other performance
measurement systems.
In the same way we had identified the differences in principles between financial accounting and
business segment valuation systems, we can highlight the differences in principles between business
segment valuation systems and responsibility centre valuation systems:
- The former break down the organization's performance by business segment, the latter by
responsibility centre, which do not necessarily overlap.
- The former incorporate into the measure the performance items linked to the business
segments through cause-and-effect relationships (causality principle), while the latter include
the performance items that the RC manager can control (controllability principle). A
performance item (e.g. headquarters costs) may or may not be included in the measure
depending on the perspective.
- In the first case, an absolute value may make sense (for example, in cost accounting,
measuring a BS margin provides information on the degree of profitability of that segment);
however, to measure the performance of a responsibility centre, an absolute value makes no
sense, an evaluation in comparison with the objective is more relevant (contractual principle).

Bibliography
Alloy L.B., Clements C.M. and Koenig L.J. (1993), “Perceptions of control: determinants and
mechanisms”, dans Control Motivation and Social Cognition, Weary G. Gleicher F. Marsh K.L (Eds.),
Springer Verlag, pp.33-73.
Bouquin H. (2011), Les fondements du contrôle de gestion, Paris, PUF.
Deci, E. L., & Ryan, R. M. (1985). Intrinsic motivation and self-determination in human behavior. New
York, NY: Plenum.
D’Iribarne P. (1989), La Logique de l’honneur, Seuil.
Merchant, K.A. (1998), Modern Management Control Systems: Text and Cases (1998). Upper Saddle
River, NJ: Prentice-Hall.
Ouchi, W. G. (1979), A Conceptual Framework for the Design of Organizational Control Mechanisms.
Management Science, 25(9), pp.833-848.
Simons R. (2007), « Revisiting the controllability principle in the XXI century »,
Graduate School of Business Administration , Harvard University.
Vancil R.F. (1978), Decentralization: managerial ambiguity by design, Dow Jones, Irwin, Homewood,
Ill.

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Chapter 7 - Measuring responsibility centre performance

through Responsibility Accounting

Introduction
Here we will focus on a second system to measure “local” performance: Responsibility Accounting.
Theorized in the 1960s along with theories of decentralization, responsibility accounting remains
marked, even in its name, by the financial nature of the measurement systems of that period: like cost
accounting, it measures costs and profits, and we will see in Chapter 9 how both can be enriched by
non-financial indicators.
Like cost accounting, responsibility accounting contributes both to management reporting, i.e. to the
feedback of local information to higher hierarchical levels, and to local management.
Despite this apparent closeness, cost accounting and responsibility accounting are separate measurement
systems. First, they do not aim at the same managerial analyses and decisions, which results in different
decomposition criteria: while management accounting focuses on measuring the performance of the
different business segments, responsibility accounting aims to measure the performance of
responsibility centres. The differences in purposes also lead to distinct measurement principles (see
Chapters 4 (not included here) and 6). Responsibility accounting enables a contractualization process
between senior management and the managers in charge of responsibility centres, which is based on
four principles: congruence, controllability, simplicity and a contractual principle. Thus, the concrete
construction of "local" performance measures is different in both systems.
In Chapter 6 we have given a generic definition of a responsibility centre: it is a subdivision of the
organizational structure, under the responsibility of a manager, whose scope of decision-making power
and resources are identified, and whose objectives have been defined and translated into an appropriate
contribution measure.
On this basis, responsibility accounting distinguishes four types of responsibility centres. Their
characteristics are presented in §1.We will see in §2 that this basic typology needs to be refined, as
decision-making is most often organized in a more nuanced way. Finally, this chapter will highlight the
limitations of responsibility accounting, which will open up to broader ways to measure the RC
performance (see chapter 9).

Different types of responsibility centres

RC typology and principles guiding RC evaluation
Responsibility accounting distinguishes four types of responsibility centres, depending on the extent of
the responsibilities delegated to their managers: cost, revenue, profit and investment centres.

These four types share a common characteristic: they rely on financial measures of the RC performance.
This reflects the concern for congruence (see chapter 6) that motivated the early designers of
responsibility accounting systems. Born at the time of massive decentralization movements within large
companies, RA aimed above all to develop a "sense of profit" among entity managers, a concern that
was limited to senior managers in centralized organisations. As organizational objectives were defined
exclusively in financial terms, the aim was to align the local objectives of managers with those of the
organization. Theorists have clearly linked the concepts of decentralization and divisionalization:
- Decentralization corresponds to the delegation of a significant decision-making power, and
thus qualifys a choice of structure;

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- Divisionalization means holding a RC manager accountable for a profit, and thus qualifys the
type of performance on which the manager is objectified/evaluated).
"Unfortunately, there is no uniformity in the way the term division is used. In some companies, it is
equivalent to the term "department", so that the organization chart of the marketing, management control
and other "divisions" will appear. In others, the term refers to a commercial area, production being
organized differently. For our part, we give another meaning to the term "division". For us, a business
segment will be recognized as a "division" when it is responsible for both the production and marketing
of a product or group of products. For any lower degree of responsibility, it is impossible to consider
the manager as answerable for the profitability of the business segment for which he is responsible (that
it controls); and to the extent that the delegation of profit responsibility constitutes the essence of
divisionalization, in the following text, no business segment will be considered as a division if it is not
a profit centre. " (SOLOMONS, 1965, p.9)
For Solomons, the divisionalization, as defined above, has several advantages:
- It makes it possible to have a common organisation with diverse activities;
- Taking on the responsibility of a profit centre can be a "training ground" for future group
leaders.
If holding managers accountable for financial results was considered congruent with organizational
performance in the 1960s, as will also be the case in the early 1990s with the emergence of new division
metrics like EVA, we will see that the congruence principle is not always met using only financial
indicators (see chapter 9).
The RC typology was also established with a view to respecting the simplicity principle: financial
indicators are simple to understand by the RC managers, who have a certain management culture
because of their functions. Here again, we will have to put this assessment into perspective later on.
Finally, this typology is based on the controllability principle. RC are considered to have unequal
influence over the organizational profit. Their performance measures should then be chosen in
accordance with their span of control (see below).

The four types of responsibility centres

The Responsibility Accounting typology is based on the assumption that organizational performance
can be measured in terms of a return on investment indicator, which results from the aggregation of
three elements: costs, revenues and assets.

Components of a ROI indicator: Revenues Costs Assets

Revenues and costs are taken from the income statement, assets are taken from the balance sheet.
The typology of responsibility centres then distinguishes four possibilities, depending on the elements
that the responsibility centre can control (its span of control)

1.2.1. Cost Centres

Traditionally, a cost centre is defined as an entity which, considering the decision-making power granted
to it, can act on profitability only through an action on costs. He cannot control either the income or the
assets.

Span of control of a cost centre

Revenues Costs Assets

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Concrete examples of cost centres are plants, support services (marketing, human resources, etc.),
operational departments with limited responsibilities (logistics, supplies, etc.). Sometimes a distinction
is made between operational cost centres, which are directly involved in the production process, and
discretionary cost centres, which have more functional responsibilities, as in the case of support services.
The contribution of the latter to organizational performance is more indirect than that of operational cost
centres.
The controllability principle requires neutralizing uncontrollable items for performance measurement.
The table below indicates in grey areas the balance sheet and income statement items that need to be
neutralized for a cost centre.

Income Statement Balance sheet

Sales

- Cost of sales

= Gross margin

- General and administrative

expenses
=Operating income

- Extraordinary items

= EBIT

- Interest expense

- Income tax expense

= Net income

Fixed assets

Inventories

Receivables

- ST Liabilities

The simplest way to neutralize non-controllable items is to exclude them from the performance measure.
Thus, a cost centre cannot be responsible for a whole P&L account. It cannot be made accountable either
on a profit indicator, because it contains revenues, or on a return on investment indicator, which also
includes assets: the span of control and the span of accountability would then be inconsistent (see chapter
6). In responsibility accounting, that the most appropriate measure for a cost centre is a cost indicator.
In the table, only the different types of costs (white areas) can be included in this indicator.
But the costs themselves may be more or less controllable by the cost centre, so it will be necessary to
choose a cost indicator including only controllable costs. For example, a factory does not control

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marketing and administrative expenses, interest on loans or taxes. In this case, "cost of sales"23 is a more
relevant indicator than the sum of all costs.
In general, the lines of a P&L account are too global to identify the costs that are actually be controllable
by a centre and it is necessary to further analyze costs. For example:
- A purchasing department does not control the entire cost of sales, because it includes
manufacturing costs that are not controlled by this department. Its span of control focuses
more on just the "purchasing cost", which corresponds only to the first stage of production;
- Support services like a human resources management department or a legal department only
control some of the administrative costs. It will therefore be necessary to include only the
costs each of them can control in their cost indicator;
- A plant director does not always have the possibility to choose and pay his staff
independently, his real estate costs can be managed by the head office, etc.
Therefore, we will see below that this basic scheme needs to be nuanced. We will also outline the limits
of the cost centre concept.

1.2.2. Revenue centres

A revenue centre is a RC that can contribute to profitability by acting on revenues, but which does not
have control over the cost of products or services sold, nor over assets.

Span of control of a revenue centre Revenue Costs Assets

s
Commercial entities, which have no production activity, are generally considered as revenue centres.
To respect the controllability principle, the performance measurement will have this time to neutralize
the costs and assets items.

Income Statement Balance sheet

Sales

- Cost of sales

= Gross margin

- General and administrative

expenses
=Operating income

- Extraordinary items

= EBIT

- Interest expense

- Income tax expense

= Net income

Fixed assets

23
Cost of sales corresponds to the production cost of the products sold. It does not include selling costs,
overhead costs nor interest expense.
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Inventories

Receivables

- ST Liabilities

In responsibility accounting, the most appropriate measure to grasp the performance of a revenue centre
is a revenue indicator. As for cost centres, holding the manager accountable for a profitability indicator
would be inconsistent because it is too broad.
A revenue centre does not necessarily control all types of revenue: for example, a sales department has
no control over the financial revenue linked to group's investment decisions. Similarly, when customer
segmentation is carried out and "key accounts" are managed at headquarters level, part of the turnover
is beyond the control of the local manager and must be neutralized for the evaluation of his performance.
It is therefore necessary to sort among the revenues those that are controllable by the centre and those
that are not.
As for cost centres, we will see that reality calls for more nuances, and that the concept of revenue centre
also has intrinsic limitations.

1.2.3. Profit centres

A profit centre is a RC that can act on both costs and revenues, but not on assets.

Span of control of a profit centre Revenue Costs Assets

s

These are, for example, operational divisions (product division, geographic areas, etc.) with control over
the entire production chain, from purchasing to sales.
The non-controllable factor that should then be neutralized is the asset.

Income Statement Balance sheet

Sales

- Cost of sales

= Gross margin

- General and administrative

expenses
=Operating income

- Extraordinary items

= EBIT

- Interest expense

- Income tax expense

= Net income

Fixed assets

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Inventories

Receivables

- ST Liabilities

In responsibility accounting, the most appropriate measure to grasp the performance of a profit centre is
a margin indicator, such as the entity's net income.
Unlike cost and revenue centres, a profit centre can manage a whole P&L account. It has greater
autonomy: in particular, when a managerial decision leads to an increase in both costs and sales (which
is the case, for example, when deciding to invest, hire, incur communication costs, etc. even if the impact
on sales is not immediate), the trade-off between the two components of profit is made at the RC level,
whereas such a trade-off would fall out of the responsibility of both cost and revenue centres and be
made at a higher hierarchical level.
However, a profit centre does not have as much autonomy as an investment centre, because it does not
control the assets. It cannot therefore be held accountable for a return on investment indicator or EVA
(see for example Larmande and Ponssard, 2007).
In theory, a profit centre should not only have a high level of autonomy, but also a certain independence
from other profit centres. Holding him accountable for the profit of his activity is relevant only if this
profit results essentially from his own decisions. Therefore, we will see later that the profit centre
concept shows limitations in highly interdependent environments.
A profit centre's controllability over margin may be partial, so non-controllable revenue and cost items
will have to be neutralized. For example, interest expense is not necessarily controllable by the managers
in charge of the operating divisions, if financial decisions are centralized: in this case, EBIT or operating
income would better fit the controllability principle than net income.
Similarly, within operating income, some costs may not be controllable: this is often the case for the
cost of central support services, which will then have to be excluded from the calculation.
The P&L presentation can then separate controllable from non-controllable items and outline an
intermediate contribution that is consistent with the controllability principle:
Revenues from operations
- Controllable costs
= Contribution
- Non-controllable costs
= Profit

1.2.4. Investment centres

Finally, an investment centre corresponds to the broadest responsibility: it is a RC that can act not only
on the costs and revenues generated by its activity (and therefore on its profit), but also on the assets
incurred to produce this profit. These may be long-term assets (investments) or shorter-term assets
(working capital items: inventories, receivables, current liabilities).
Contrary to what the term may suggest, an investment centre does not only control investments, but also
an whole P&L account. It is a profit center that also has the controllability of assets. In addition, assets
are larger than investments, which are only the long-term part of them.

Span of ontrol of an investment centre Revenue Costs Assets

s
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Concretely, investment centres are the same kind of entity as profit centres (product divisions, country
divisions, etc.), but with a wider delegation of responsibility: investment centre have latitude over assets
whereas profit centre do not.
As a consequence, the three components of ROI must be integrated into the performance measurement
of the centre.

Income Statement Balance sheet

Sales

- Cost of sales

= Gross margin

- General and administrative

expenses
=Operating income

- Extraordinary items

= EBIT

- Interest expense

- Income tax expense

= Net income

Fixed assets

Inventories

Receivables

- ST Liabilities

In responsibility accounting, the most relevant performance measure for an investment centre is a return
on investment indicator, such as ROCE, residual profit, EVA. Of course, only items corresponding to
RC level should be taken in account: although the indicators used to measure the overall organizational
performance and the local ones are similar, the latter remains a "contribution" to the organization's
overall performance.
An investment centre may not control all revenues and costs, it may control short- and long-term assets
or only some of them, which should have an impact on the calculation of the contribution indicator. For
example, if the performance indicator is a residual income, the percentage of asset deducted from profit
can apply only to controllable assets.

Concepts that may be poorly applied

In managerial language and corporate practice, these basic concepts are sometimes deviated from their
strict definition, leading to confusions.
The concept of profit centre is rather hackneyed. Among the main misconceptions, a profit centre is not
an entity where one “can measure” a profit but, as defined above, an entity which has a significant degree
of control over this profit. Hence, an IT department located at the head office of a corporation which
bills its services to the operational divisions of the group generates “turnover”, but since it controls
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neither the demand for services rendered, nor the prices charged, it does not control this internal sale: as
a consequence, it is not a profit centre but a cost centre. Likewise, when an operational division “sells”
a product to a division in the same company, this is generally invoiced at a transfer price, which therefore
generates turnover at the level of the selling division. Nevertheless, this division is not necessarily a
profit centre, unless it has real freedom of action concerning this internal transaction: this implies
freedom to choose between this internal sale and a sale on the outside market, as well as control over
the selling price. In very integrated companies, the internal sales may be imposed by the company. Nor
is there any control over the sale if there is no external market for the product in question. In such cases,
even though we can measure a profit at the level of the selling division, it does not constitute a profit
centre because there is no controllability of income.
In practice, some entities are qualified as profit centres in an "abusive" way, because they do not have
the required autonomy over all costs and sales, due to the centralisation of certain decisions to higher
hierarchical levels. This is the case, for example, when the costs related to the staff of a division (salaries,
training, etc.) are managed by a Human Resources Management department at Group headquarters.
Others do not always have sufficient independence from each other: the more closely the activities are
linked, the less the concept of profit centre applies, because the result generated by one entity may result
from decisions made by another (for example, when the sales department of a product division sells
several products to a customer in a group, generating related sales for another division).
It can also be seen that companies make little use of the term "investment centre" and mobilise the term
"profit centre" equally for entities that have control over assets and for those that do not.
Finally, as we will develop now, the reality is often more complex than this basic scheme in four types
of responsibility centres.

A more complex reality

A need to adjust to the specificities of the organization
The four types of responsibility centres described above are ideal forms: the reality within organisations
is more complex, as we have already seen with situations of partial controllability. As the range of
possibilities for allocating responsibilities is very wide, it is therefore not possible to retain a standard
and overall indicator for each type of responsibility centre, it is necessary to enter into the specificities
of each organizational structure and to construct ad hoc indicators for each responsibility centre.

Shared responsibilities
Some cost, revenue or asset items, even when measured in detail, cannot be clearly attributed to a
responsibility centre because they are a joint responsibility.
Are purchasing costs the responsibility of the Purchasing department, which negotiated the prices with
suppliers, or of the plant, which induces the quantities of raw materials required for production? Are the
costs of central support services (IT department, human resources management department, legal
department, etc.), their responsibility, since their decisions (recruitment, investment) really have impact
on these costs, or should they be borne by operational divisions, which consume the services that these
departments provide (legal advice request, training requests, etc.)?
How to proceed when a sales department has control over the quantities sold but not over the price,
which is imposed by a central policy?
In these examples of joint responsibilities, a transfer pricing system can be used to split responsibility
between the departments concerned, using a transfer price based on a standard cost.

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Transfer pricing at standard cost

Let’s return to the case of the purchasing department that negotiates prices with suppliers based on the
quantities of raw materials ordered by the plant. Both entities are cost centres. According to the
contractual principle, both should be evaluated by comparing their actual cost to their budgeted cost.
Let us assume the following:
- during the budgeting process, the purchasing department agreed to buy raw materials at €100
per unit and the plan committed to buying 3 tonnes of this material (1.5 kg per product and a
production volume of 2000 units). The budgeted purchasing cost is therefore €300 000 euros.
- Actual costs amount to €336 000, which results from an actual volume of 2000 units, a unit
consumption of 1.6 kg of material per unit and a materials unit cost of €105/ tonne.
The variance of €36 000 is due to a combination of costs being higher than expected in the purchasing
department and an overconsumption of materials by the plant. Responsibility is therefore shared.
To split responsibilities, the internal transaction between the two departments can be valued in the
budget of the purchasing department, even though it is a cost centre: a transfer price based on the
standard cost, here €100, will be used. By doing so, budgeted “revenues” just balance costs, which is
coherent as the department has no profit objective. This standard cost will also be used for actual
quantities charged to the plant.

Table 4.1 Example of internal invoicing at standard cost

Budgeted Actual

Purchasing Costs: 3 000 kg × €100 = 300 000 Costs: 3 200 kg × €105 = 336 000
department
Invoicing: 3 000 kg × €100 = 300 000 Invoicing: 3 200 kg × €100 = 320 000

Budgeted result: 0 Actual result: −€16 000

Corresponding to €5 per kg

Factory Purchases: 3 000 kg × €100 = 300 000 Purchases: 3 200 kg × €100 = 320 000

Variance/objective: excess cost of €20 000

Corresponding to the value of the excess

consumption of 200 kg of material

The variance on the purchasing costs has thus been split into two subvariances, reflecting the respective
performances of the purchasing department and the plant.

This solution can also be used when a support department provides services to operational divisions, as
long as those services can be quantified using objective criteria. For example, a central IT department
whose activity would consist in development for the divisions, could bill them for development hours,
valued at a standard hourly cost. If the cost of the service is greater than planned, any excess stemming
from a variation in the hourly cost is imputed to the central IT department, while excess consumption in
hours is imputed to the operational division in question.
A variant of this system is transfer pricing at a standard rate. Let us take the example of an operating
division who has been granted the authority to make investment decisions and to control its short-term
assets. Rates are negotiated with the banks by a central finance department.
In this case, we can consider that: interest expense = capital requirement * financing rate

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The divisions can be charged a financial cost, applying a standard rate to their capital requirements. A
rate slippage then remains the responsibility of the finance department, whereas a slippage in the capital
requirement is the responsibility of the operational division.
Trying to split shared responsibilities using a transfer pricing system postulates that the service provided
is measurable. In the previous examples, the “service” of the purchasing department was measured by a
weight of raw materials, that of the IT service by a number of development hours, that of the financial
department by an amount of capital. Sometimes, it is difficult to quantify the service and transfer pricing
is thus impossible. A choice will then have to be made between allocating the costs entirely to the entities
who benefit from the service, or not allocating them at all: in the first case, the congruence principle is
preferred to the controllability principle, in the second case it is the opposite. As discussed in chapter 6,
these two principles of Responsibility Accounting, while complementary, can be operationally
conflicting, requiring compromises (Merchant, 2005).
Transfer pricing has many other functions than just splitting responsibilities. It is a complex issue, where
economic, strategic, human, tax, accounting and other considerations overlap. We will not develop these
questions any further in this book dedicated to the “fundamentals of management control”, referring the
reader to more advanced textbooks24.

Overlapping responsibilities
It may be difficult to determine whether a revenue or an expense are controllable when responsibilities
overlap to some extent.
This can be observed in companies where responsibilities are loosely defined, and when such
overlapping is desired, as is the case in matrix organisations.
In these contexts, controllers must encourage managers to specify the actual responsibilities of each
other in order to be able to build appropriate measurement systems.

Hybrid responsibility centres

Just as there is a wide variety of situations within the same type of responsibility centre, a given
responsibility centre is rarely "purely" one of the four types of centres provided for by Responsibility
Accounting, but more often a "hybrid" form of several of these types.
For example, we have seen that a cost centre is characterized by a lack of control over revenues and
assets. But it may happen that, without having control over revenues, it has some control over assets.
For example, the IT department of a group in the retail sector corresponds, basically, to a cost centre.
However, if this department purchases the computer equipment used in the group's stores and other
services, it has a major influence on the amount of this fixed asset. Similarly, a plant manager who
manages the stocks of its entity has impact on assets. In both cases, the responsibility goes beyond a
single cost, but cannot be linked to any of the broader types, profit or investment centre. The situation
is intermediate and does not correspond perfectly to any of the four types of RC.
In the same way, a revenue centre is basically characterized by a lack of control over costs and assets,
but it has nevertheless some impact on these elements. As it barely has control over the production costs,
it often has authority over distribution costs (salespeople's remuneration, promotional actions, etc.).
Since cost control is not total, it cannot be qualified as a profit centre, but it is "more" than just a revenue
centre. While it may also act on certain assets such as the vehicles purchased for salespeople, its span of
control can extend to certain balance sheet items, although it cannot be qualified as an investment centre.
We are still in an intermediate situation here.

24
The Art of Management control : issues and practices, chapter 4.
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There are many examples and concrete situations that could be multiplied ad infinitum, as the choices
for the distribution of decision-making power within organisations can be so varied. It should be noted
here that in the reality of organisations, it is rare for an entity to correspond perfectly to the characteristics
of the four types provided for by Responsibility Accounting: we are most often dealing with hybrid
types of RC.

Differences between responsibility accounting and cost

accounting
The differences between responsibility accounting and cost accounting can be summarized as following:
- Cost accounting measures the performance of business segments, whereas RA measures the
performance of responsibility centres. Those perimeters that can overlap or cross.
- Calculating a margin in absolute value makes sense in cost accounting, because it provides
information on the BS profitability, whereas only comparison with the objective is relevant
in RA (contractual principle).
- Cost accounting allocates revenues and expenses to the segments that cause them (causality
principle), while RA allocates them to responsibility centres according to the principles of
congruence and controllability. Allocations can therefore be different depending on whether
the purpose is to evaluate the BS or the RC performances: the cost of a segment will include
all costs that it induces and consumes (direct costs and a part of indirect costs); as for a
responsibility centre, only costs that can be controlled by its manager are relevant. Costs
caused by a segment are not necessarily controllable by the manager and vice versa.
This framework sheds light on how headquarters costs should be allocated to an organization’s
“operational entities”, an issue which is often confusing and debated: if one seeks to grasp the
performance of a business segment (first type of “entity”), headquarters costs will be qualified as indirect
costs. As some of them can be induced and consumed by the BS (e.g: management costs, training costs),
they can be allocated to the BS cost or margin. On the other hand, headquarters costs can less frequently
be qualified as controllable by the RC managers (other type of “entity”). It can be the case when the
service provided is induced by the RC manager request and can be quantified (see § 2.2). Otherwise,
they will not be allocated to the RC performance measure.
How can these differences between the two systems be managed? When BS and RC overlap, the systems
can be articulated. The controllable costs can be separated from the uncontrollable one in the income
statement: the margin before uncontrollable costs can be used for responsibility accounting purposes
and the final margin taking into account all costs for cost accounting purposes
But in practice, cost accounting and responsibility accounting are seldom distinguished within
companies (Zimmerman, 1979). Using only one measurement system to assess both the performance of
BS and RC can be argued to be cost effective, but in reality it has an indirect cost. If cost accounting is
used alone, there is a risk of demotivation of managers when the weight of non-controllable costs is too
high. The cost of this demotivation is difficult to assess, but any manager knows that it is very real and
that its consequences will be felt sooner or later. Separating these systems therefore seems a more
relevant solution.

The limits of Responsibility Accounting

Beyond the difficulties mentioned above, responsibility accounting has more intrinsic limitations.

Limits of a financial measure of RC contributions.

In chapter 3, we highlighted the limitations of financial measures to grasp the organisation's overall
performance. These limits also apply at the responsibility centre level:
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- Financial indicators can create short-sightedness among managers (Merchant & Bruns, 1986);
- They are synthetic result measures. As RC managers are at the heart of the action, a reporting
system is not sufficient to help them manage, the measurement system must also feed more
detailed and operational indicators to enhance autonomous control.
- In some organisations, the organisation's performance is broader than just the financial
dimension. In these contexts, a financial typology of responsibility centres does not match the
congruence principle, insofar as certain dimensions of overall performance are not reflected in
the contract with local managers.
Moreover, a financial typology of responsibility centres is based on an additive model of contributions:
the components of profitability, once identified and detailed, are assigned to the various RC but remain
of a financial nature. As explained in chapter 6, the congruence principle does not necessarily mean
replication of overall indicators at RC level. It can require a transformation of the performance nature.
For example, in a company with a profit objective and a differentiation strategy, the expectations of an
operational manager can be expressed in terms of product quality. So the contribution of a RC can be
expressed in different terms while remaining congruent. We will see in chapter 8 that a relevant
measurement system should be based on a performance modelling, which identifies how the final
objectives can be translated into levers action and, at least in some of the modelling methods, how they
are deployed within the structure.

Limits of the cost centre and revenue centre concepts

The concepts of cost centre and income centre have weaknesses regarding the congruence principle:
they are based on the assumption that responsibilities for costs and revenues can be separated, which is
an over-simplification.
Indeed, it is not because a plant has no commercial activity that its manager has no impact on turnover:
for example, the quality of the products has an real impact on revenues. Similarly, the responsibility of
a research and development department cannot be limited to controlling its costs either.
In practice, being considered as a "cost centre" is generally poorly perceived because it focuses
exclusively on the "negative" dimension of performance, i.e. consumption, and erases the value created
by these centres: quality, delivery time, innovation, etc.
As for revenue centres, their managers are considered to have no control over the costs of the products
or services it sells. In real life, they can affect these costs indirectly through some of their decisions:
very short delivery times granted to customers may, for example, generate additional manufacturing
costs.
Therefore, the span of control of cost and revenue centres goes beyond controlling either costs or
revenues. It would be more accurate to evaluate these centres integrating both costs and value created,
or as we will see later, with multi-dimensional measurement systems.

Limits of the profit centre and investment centre concepts

The concepts of profit centres and investment centres correspond to broader responsibilities than those
of cost centres or revenue centres. We have already pointed out the limitations due to the financial nature
of the measures, as well as how these concepts can be misused in the practice of organisations.
These concepts have another important limit: they can a partitioning effect on managerial behaviour
(Mc Nair, 1990). Strictly applied, they limit the responsibility of the managers concerned to the
profitability of their responsibility centre. When activities are effectively independent of each other, this
is not necessarily embarrassing. On the other hand, when activities are interdependent, holding managers
accountable for a financial indicator specific to their centre may not encourage the search for synergies
with other responsibility centres.

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Conclusion
In this chapter, we have seen how the principles developed in chapter 6 can apply concretely in a
financial measurement system, responsibility accounting.
We also have given examples of the difficulties encountered:
- Difficulties in applying each of the responsibility accounting principles: we have seen for
example that the controllability principle is not always simple to apply, particularly in cases
where responsibilities are unclear or shared. It is the same for the contractual principle and
the congruence principle.
- Difficulties in combining these principles, which sometimes conflict. For example, we have
seen the tensions that might develop between the congruence and controllability principles
within responsibility accounting.
- Difficulties combining responsibility accounting principles with those of other measurement
perspectives: as the measurement systems should be distinct, they are sometimes merged in
practice to avoid excessive complexity, but the way managers are informed is then less
accurate.
Measuring "local" performance is thus not straightforward.
In the following chapters, we will move to another kind of measurement systems, dashboards, and see
how they can enrich the financial measurement systems.

Bibliography
Ardoin J.L., (1995) « L’abus des centres de profit peut être dangereux pour la santé des entreprises »,
Echanges, n° 110.
Dearden J. (1987), “Measuring profit centre managers”, Harvard Business Review, septembre-octobre,
p.84-88.
Giraud F., Saulpic O., Delmond M.H., Bonnier C., de Geuser F., Laulusa L., Mendoza C., Naulleau G.,
Zrihen R. (2009), “Les prix de cession internes”, dans L’art du Contrôle de Gestion: enjeux et pratiques,
Paris, Gualino, pp.171-219.
Larmande O. and Ponssard J.P. (2007), “The lack of controllability of EVA® explains its decline- a
field study », Cahier de recherche 19, Laboratoire d’économétrie, Ecole Polytechnique.
Mc Nair C.J. (1990), « Interdependance and control : Traditional versus Activity-based responsibilty
accounting », Journal of Cost Management, vol 4, n°2, summer, pp.15-24.
Merchant K. (1989), Rewarding results: motivating profit center managers, Harvard Business School
Press.
Merchant K.A. and Bruns W.J. (1986), « Measurements to cure management myopia », Business
Horizons, may-june, pp.56-64.
Solomons D. (1965), Divisionnal Performance: measurement and control, Richard Irwin, Homewood,
Ill.
Zimmerman J.L. (1979), « The costs and benefits of cost allocations », The Accounting Review, vol LIV,
n°3, juillet, pp.504-521.

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Chapter 8 - Constructing organisational performance

models
Introduction
Aligning performance measurement systems with business strategy is a common-sense
recommendation. However, research on performance indicators has shown that this is not easy to
achieve (Ittner & Larcker, 2003).
The measurement systems studied in the previous chapters have been constructed on financial
performance dimensions. As outlined earlier, while financial indicators are essential to monitor a
company's performance, other indicators are also necessary. This raises the question of identifying
relevant financial and non-financial indicators.
To increase the relevance of performance indicators and promote their alignment with the company's
strategy, it is first necessary to create the performance model. As presented in Chapter 2, this involves
identifying the goals and objectives pursued by the organisation and the action areas that will have to be
implemented to achieve the goals and objectives. In other words, it is also necessary to clarify the cause-
and-effect relationships between action areas and objectives or goals. The main action areas are specific
to each company and directly linked to the strategic choices that have been made. Therefore, we first
clarify, for the purpose of our presentation, the meaning of the concept of strategy (section 1).
We then present two tools that aim to facilitate performance modelling: the strategic map (section 2)
and the O/CPV grid (section 3). Having a tool to model performance is important in order to be able to
implement a structured approach to building the measurement system.
Strategy map and O/CPV grid are actually subsets of dashboard construction methods: the strategy map
is an element of the Balanced Scorecard (BSC) method and the O/CPV grid is part of the OVAR method.
To conclude this chapter we will compare these two methods.
We will present in chapter 9 the dashboards derived from these methods and the uses of performance
management indicators compiled in dashboards.

Section 1. Clarifying the meaning of the concept of strategy

As mentioned above, it makes sense to say that a performance model must be consistent with the
company’s strategy. However, what is meant by the notion of strategy needs to be clarified. Henceforth,
we will consider that the concept of strategy covers three dimensions:

- The key success factors that are linked to the sector, to the generic performance levers in a
given business line. For example, maximizing occupancy rates is a key success factor in the
hotel industry. This performance lever is induced by the high amount of fixed costs in this
industry and must therefore be managed effectively for both luxury and low-cost hotels.
While key success factors may already exist in any given industry, players may also seek to
“change the rules of the game” in the industry by modifying its performance levers: examples
thereof are the strategies of Internet platforms in personal services (hospitality, transportation)
or retail.
- The strategic positioning chosen. Generic strategies are examples of strategic positioning:
cost leadership or differentiation, or the typical strategies defined by Kaplan and Norton (see
appendix to this chapter): customer intimacy, operational excellence, product leadership. The
organisation’s strategic positioning guides the choice of priority action levers and balances
their relative importance. Thus, cost control is a more important line of action for a low-cost
strategy than for a strategy of differentiation through innovation. There may be different
strategic positionings within the same company, including within a same Strategic Business
Unit (SBU). For example, the strategic positioning of different geographical entities may be
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adapted to take into consideration the competitive environment or customer expectations that
are specific to local markets. The combination of key success factors and strategic positioning
defines the entity's business model. The business model qualitatively expresses the medium-
and long-term objectives pursued at entity level and the main levers for action chosen.
- Immediate priorities, for the short term. They can be linked to:
o changes in the company's business model (changes in its strategic positioning, changes
in the sector's KSFs entailed by a breakthrough innovation or the identification of new
levers for action): the company is then temporarily focused on the implementation of a
successful path to change;
o specific cyclical factors: for example, following a change in the macroeconomic context
and interest rates, reducing the debt burden of a highly leveraged company may become
a priority;
o specific internal difficulties: if a decline in quality is observed, for instance, the
organisation may focus on turning the organisation around;
o particularly high ambitions on certain objectives: it is the magnitude of the target and
not its nature which places a certain urgency on the priority here. Reducing the time-
to-market for new products may be an ongoing objective that is defined by the
company’s strategic positioning, but if the target is to halve the time and this target is
considered particularly ambitious, it may become an immediate priority.
Bearing in mind these three dimensions is useful to understand how the concept of strategy is mobilized
in OVAR and BSC performance modelling methods. These dimensions will also be useful when we
define in Chapter 9 the uses of performance indicators.

Section 2: The strategy map in the BSC method

The BSC method conceived by Robert Kaplan and David Norton (K&N) is based on the construction
of a strategy map that model and the key objectives of a company. Objectives are organized into four
perspectives and are linked to each-other through cause-and-effect relationships. Objectives are then
translated into indicators.

Guidelines for constructing the strategic map

The following are the main guidelines given by K&N for constructing the strategy map:
- Identify objectives along four perspectives: financial, customer, internal business processes,
learning and growth.
- Choose objectives that are consistent with the organisation’s strategy.
- Connect the objectives to each other through causality linkages.
We will now present the four perspectives, the identification of objectives and the construction of the
strategy map.

2.1.1. The four perspectives

Let us examine in detail the four perspectives, objectives and corresponding types of indicator:
- The financial perspective contains objectives linked to the expectations of the company’s
shareholders. Traditionally these expectations are expressed in terms of growth, return on
investment and financial structure, and are translated into financial performance indicators
such as sales growth, ROCE, EBITDA and financial structure ratios such as leverage ratios.
- The second perspective focuses on customer expectations. To formulate these objectives we
adopt the customers’ point of view and identify their desires vis-à-vis the product or service,
customer relations and the brand. For example: “I want flights that leave and arrive on time”

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or “I want a brand that has a reputation for reliability.” The corresponding indicators concern
either the products and services themselves, or the customer’s perception of them. Indicators
of business results such as market share or customer retention rates do not correspond to
customer expectations. Rather, they correspond to objectives in the financial perspective.
- The third perspective corresponds to objectives of improving internal processes. Key internal
processes are selected which will enable the company to achieve objectives in the customer
and financial perspectives: production processes, new product development processes,
logistic processes, etc. Here we find indicators of quality and productivity (for example, cost
indicators), lead time, etc. To determine these objectives we can use a representation of the
entity’s value chain and identify the key objectives of each link in the chain.25.
- The “learning and growth” perspective concerns the key resources that are needed to attain
the objectives of the other three perspectives. According to Kaplan and Norton, these
resources can be categorised in three groups: human capital (competencies, training,
knowledge), information capital (systems, databases, networks) and organisation capital
(culture, leadership, teamwork). Kaplan and Norton also propose another classification: staff
motivation, information and training; strategic competencies; strategic technologies; and
climate for action. In this perspective we find indicators such as employee turnover, the
number of suggestions made by employees, training hours, the availability of information,
etc.

It should be emphasised that this representation in four perspectives can be adapted by the company,
either by adding other perspectives (for example a perspective relating to environmental performance),
or by modifying the perspectives to take into account the nature of the organisation’s stakeholders. The
financial perspective can be enlarged to encompass stakeholders to whom the company is accountable.
For a municipality, for example, we can replace the financial perspective with a perspective that
corresponds to the question: “How are we perceived by voters?” The customer perspective could be
replaced by a perspective to include the constraints in terms of financial resources that the municipality
has to cope with.26.

2.1.2. The strategy map

The strategy map is a representation of objectives classified according to these four perspectives and the
causal links between these objectives. Figure 8.1 provides a generic representation.

25
It should be noted that K&N (2000, 2004) propose generic representations of the value chain.
26
This perspective would be financial in nature as it concerns financial resources, but not in the traditional sense of the BSC financial
perspective.

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Figure 8.1. Generic representation of a strategy map

The strategy map is a support to present in a structured way the strategic priorities of an entity. It is also
a methodological support to make a choice between different priorities. The process of thinking about
and discussing cause-and-effect relationships is what enables managers to make sure that objectives are
relevant: when envisaging an objective in one perspective, one also has to consider the objectives in
other perspectives to which it will contribute. If this contribution is not obvious, then it may not be
relevant to retain the objective matter.
Drawing the strategy map is an issue in itself. Indeed, it is necessary to include a significant number of
causal relationships in order to fully understand the performance model. However, a representation that
seeks to be exhaustive can make it difficult to read and understand the map. Consequently, a choice has
to be made between the completeness of the map and its readability. In practice, several representations
of the same strategy map are sometimes proposed according to who is going to use the map and what it
is intended for. A map can be used to build the performance model, communicate it, communicate the
objectives only in order to deploy them... In some cases, one may also try to represent the objectives but
not their causal relationships.

2.1.3. Formulation of objectives: dynamics and precision

Objectives must be expressed using a verb and they have to be precise.
As we will see in Chapter 9, using a verb is a way to energise the management of performance. For
example, the objective may be: "reduce structural costs", or "increase market share". It is recommended
to avoid the verbs "optimize" or "maintain" (unless it is clear that maintaining performance at the current
level is clearly an ambitious objective).
The objectives must be expressed precisely so that different actors in the organization will understand it
in the same way. The aim is to facilitate actors’ understanding of the organisation’s strategy and thus to
enable the alignment of the views of the actors involved in the construction of the strategy map who are,
in general, the members of the organisation’s executive committee. If objectives are not precise enough,
there is a risk that everyone will be able to find what they want. The topics for discussion are then erased
and agreement on priorities may remain superficial.
In practice, it can be useful to have two versions of the objectives: a long version that will be very
accurate, but cannot be included in the strategy map for reasons of space and readability, and a short
version, often reduced to the title of the objective, that will be used for the drawing of the strategy map
itself.
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Example

At an IT services company, the short formulation of an objective for big accounts and companies
(customer perspective) might be the following: “I want to reduce my costs, the complexity of my
information systems and my risk.” The following detailed definition may be added to the title of the
objective: “I want an IS provider who helps me to increase my financial results, who guarantees a quick
return on investment and who reduces both my operational costs and my IT costs. I want an IT provider
who offers end-to-end solutions and fast implementation, that leads to a reduction in the complexity of
my information systems and my risks so I can concentrate on my core business.”.

Example of a strategic map

The following figure is a fictitious strategy map for an airline in a former Soviet bloc country.27 The
purpose of the different types of line (solid, dotted, etc.) is to make the map easier to read by highlighting
coherent sub-assemblies.

27
This example was developed by Nexance, a consulting firm specialised in the implementation of Balanced Scorecards, for communication
purposes and is reproduced here with their authorisation.
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Discussion: The underlying generic model and its possible adaptations

2.2.1. A balanced model?
According to the promoters of this tool, the strategy map is intended to lead to a set of indicators that
provide a balanced representation of performance, as indicated by the name of the method (Balanced
Scorecard). The strategy map is based on a generic causal model that links different dimensions of
performance. The different perspectives of the generic causal model are linked by cause-and-effect
relationships, where final performance is that of shareholders' expectations (see Figure 8.2).

Figure 8.2: Generic BSC causal model

Customer’s Shareholder’s
Learning Internal Processes
expectations expectations

The strategy map therefore does not give equal weight to the different stakeholders (as some
interpretations suggest). It is therefore not from this point of view that the performance model to be built
will be balanced.
On the other hand, this tool provides a certain balanced representation of performance by taking in
account two levels of objectives28:
- objectives relating to external expectations (shareholders and customers), which can also be
described as objectives relating to goals,
- and objectives relating to levers for action to achieve these goals (themselves divided into two
levels, internal processes and learning).

2.2.2. Adaptation of the tool to non-profit organisations

To use the strategy map for organisations that are not companies, it has to be adapted. This adaptation
is encouraged by K&N themselves, which indicates that it is possible to modify the perspectives or even
add another one.
For example, there are several proposals for adapting the model for public hospitals (Figures 8.3 and
8.4)

28
These two "levels" of objectives are then translated into two levels of indicators qualified by K&N as lead and lag indicators, terms sometimes
translated into action plan indicators and outcome indicators.

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Figure 8.3. Example of perspectives adaptation for the hospital sector

In this example, the three external stakeholders - population, patients and funders - are positioned at the
same level, and a perspective is used to express the hospital's goals or mission.
Another example shows a more radical adaptation since the financial perspective is placed at the bottom
of the strategy map. It is therefore possible to adapt the model to non-profit organisations.

Figure 8.4. Example of a strategy map for a healthcare organization (Saint Mary Duluth Clinic,
Minnesota, from Bisbe and Barrubes 2012)

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Section 3: The Objectives/ critical performance variables grid in

the OVAR method

The OVAR method was initiated by Michel Fiol and Hugues Jordan. (Fiol 2008; Fiol & Jordan 2008.
The acronym OVAR stands for Objectives (O), Critical Performance Variables (Variable d'Action in
french) and Responsibilities (R). The method is based on the construction of an "O/CPV grid" combining
objectives and critical performance variables, then a more complete grid integrating responsibilities.

Linking Critical Performance Variables / Objectives

The O/CPV grid contains 3 parts:

1. Identification of objectives for the entity whose dashboard we are trying to build (O). The
idea here is to show “where” the entity wants to go in the form of the results to be attained
(cf. details below). In general there are between four and six objectives.
2. Identification of critical performance variables, i.e. a selection made from among the entity’s
performance levers; those that are considered priorities for action in order to achieve
objectives. They answer the question of “how” to attain objectives. There are generally two
to three times as many CPV as objectives.
3. A representation in grid form that shows the cause-and-effect relationships between CPV and
objectives graphically and which also serves as a tool to check that CPV and objectives are
coherent with each other (see Table 8.1).

Table 8.1. Generic O/CPV grid

Objective 1 Objective 2 Objective 3 Objective 4

CPV 1 × ×

CPV 2 × ×

CPV 3 ×

CPV 4 × ×

CPV 5 × ×

CPV 6 ×

CPV 7 × ×

CPV 8 × × ×

CPV 9 × ×

CPV 10 ×

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Objectives
To define the objectives, it is recommended to use the following rules, some of which are common to
the BSC method (Fiol 2008; Fiol & Jordan 200829):
- An objective must contain a verb in the infinitive.
- An objective has to be expressed very precisely so that all the different stakeholders will
understand it in the same way.
- An objective must incorporate the notion of progress and hence a suitable verb such as
“grow”, “reduce”, “develop”, etc. “Maintain” the number of customers is not an acceptable
objective unless this constitutes a challenge given the current situation. It is also suggested that
the verb “optimise” be avoided, even though it is sometimes convenient.
- A performance dimension constitutes an objective if, when one considers its purpose (the
“why” question), it cannot be linked to another performance dimension. If it can be linked to
another performance dimension then it will be a CPV. For example “increase sales” can be an
objective if this is one of the entity’s goals. However, it will be a CPV if the entity’s objective
is profitability and “increasing sales” is simply one lever for achieving this objective.30
- An objective has to be aligned with the strategy of the entity. Specifically, using the terms
defined at the beginning of this chapter (section 1), an objective must correspond to a
temporary priority linked to a change in strategic positioning, to the current business context,
to specific internal difficulties or to particularly ambitious objectives of strategic positioning
(and not to on-going elements relating to the specific goals of the entity, the industry Key
Success Factors or the organisation’s strategic positioning).
- It is important to clarify the time horizon considered; an objective must be dated;
- The objective must be formulated in such a way that it is possible to measure its achievement.
- It is often useful to set a target value in specifying the objective. Different CPVs may be
required for different target values. For example, if the objective is to increase market share,
the CPVs will not be the same if target is to increase market share by 10% or to double it.

The following guidelines are used in selecting from among the all objectives that meet the preceding
criteria:
- The number of objectives should be between four and six.
- If the objectives are too numerous, the choice should correspond to strategic priorities, on one
hand, and to those whose achievement is considered particularly difficult for the time horizon
under consideration, on the other.
- Objectives that partially or fully overlap must be avoided.
- Example:
o O1: increase operating income,
o O2: reduce overheads.
Either objective O1 is too broad for the entity and it is preferable to keep objective O2
which is more focused, or O2 is actually a CPV of objective O1.
- Following the above guidelines often leads to no objective or CPV being chosen for human
resources. If these resources are considered strategic, it may be advisable to insist that one
objective be dedicated to human resources.
- In general, it is important to make sure that all of the entity’s stakeholders have been taken
into consideration (including employees), even if ultimately only some of them are retained,
since with four to six objectives it is not always possible to cover all the stakeholders

29
Fiol M., Jordan H (2008), Formuler les objectifs d’une grille OVAR, document pédagogique, HEC ; Fiol M. (2008), La démarche OVAR
au service de l’élaboration d’un projet commun au sein d’une équipe, document pédagogique, HEC.
30
As we will see in Chapter 9, revenue growth, CPV at a level n – that of the general management team of a geographical area for example -
can become an objective to be achieved for an entity located at a hierarchical level closer to operations.
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Therefore, the construction of the O/VA grid is not based on a frame predefined by performance
dimensions. For this reason, the construction process is a little less structured than for the strategy map;
it is also more open.

Critical performance variables

CPVs are a selection of performance levers considered to be priorities for achieving objectives. CPVs
must meet conditions which partly overlap with those relating to objectives:
- A CPV must contain a verb in the infinitive.
- The “why” question points to one or more of the objectives selected.
- A CPV has to be expressed very precisely so that it will be understood in the same way by all
the different stakeholders.
- It must be possible to observe and measure the CPV.
An example of a CPV could therefore be: “expand the technical competencies of sales staff in new
products and new technologies”.
Since the time horizon used for determining objectives is annual, some CPVs may resemble action plans,
i.e. a set of organised and time-bound actions, which are therefore more precise than the CPV (for
example, to train 100% of the sales team in new technologies every twelve months).

Overall balance of the O/CPV grid

The grid is a tool used to ensure a good balance between objectives and between CPVs. The following
problems must be avoided:
- An objective without a CPV. This is a sign of a weak or irresolute strategy.
- An objective column with a single X. In this case there is some confusion between the objective
and the CPV. Either the objective is really a CPV or other CPVs corresponding to the objective
have been overlooked.
- A CPV without an objective. This is a sign that actions are not oriented towards priority
performance objectives.
- Too many CPVs for the same objective. This is either a sign that the objective is too broad and
must be broken down into several objectives or that too much importance is being accorded to
this objective.
- Imbalance in the number of CPVs per objective. This indicates a poor choice of objectives or a
poor choice of CPVs.
- Xs forming diagonal lines (cf. Table 8.2). This is an indication of too narrow thinking on the
causal links between CPVs and objectives and also that some CPVs which “cut across”
objectives have been overlooked (see the example of Monoprix).

Table 8.2: Situation to be avoided 1

O1 O2 O3 O4

CPV 1 ×

CPV 2 ×

CPV 3 ×

CPV 4 ×

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CPV 5 ×

CPV 6 ×

CPV 7 ×

CPV 8 ×

CPV 9 ×

CPV 10 ×

Two objectives with Xs that overlap (cf. Table 8.3). In this case, if objective 1 is achieved, then objective
3 will be achieved automatically. The two objectives are not independent. Either objective 3 is in fact a
CPV of objective 1 or the thinking on CPVs is incomplete and a CPV that is specific to objective 3 has
yet to be found.

Table 8.3: Situation to be avoided 2

O1 O2 O3

CPV 1 ×

CPV 3 × ×

CPV 4 ×

CPV 7 × ×

CPV8

Illustration

We will illustrate the construction of an O/CPV grid by applying it to the context of a company that is
freely based on Monoprix – a French retail chain (supermarket, clothing, etc.) that operates in city
centres. We will use this example again in the following section for the construction of a panoramic
dashboard.
The main organisational goals of the company correspond to three stakeholders:
- shareholders, with an return on investment objective;
- customers, in a particular market segment: city dwellers;
- the environment and sustainable development have been incorporated into the strategic
priorities of the company: “Our company spirit is also expressed through a commitment to
sustainable business. We think, buy and sell responsibly. We strive to respect the environment
and to promote fairness. We hope to share this spirit with all of our partners, at every level of
our organisation.”
The business model is that of large supermarket retailer where food sales represents a significant
proportion of the business. The key feature of this model are: market share, capacity to attract customers,
particular financing structure with negative working capital, staffing adapted to busy/slack periods,
proximity to customers, product freshness, etc.
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The specific strategic positioning of the company is upmarket (“Doing your shopping at Monoprix costs
15% more than at Leclerc...”) aimed at working urban people with relatively high purchasing power,
living in towns of more than 50 000 inhabitants. This means having a fairly balanced, quality product
range, adapting to the pace of life of active people in terms of opening hours and accessibility,
developing product-related services such as a delivery service and in-store services in order to enable
one-stop shopping, etc.
In addition, the company has expanded its store formats with: Monop, Dailymonop, Beauty Monop, etc.
Current development needs to be continued and consolidated. Having convened to examine the priorities
for next year, the executive team points out that although store formats and points of sale have developed
as planned, there have been some setbacks:
- There is a significant delay in attaining return on investment objectives, mainly owing to new
stores opening too slowly. The objective of “increasing ROCE from X% to Y%” has therefore
been decided.
- Given the past positioning of the company on low-cost products, the upmarket urban positioning
of the flagship brand still remains to be consolidated so as to assert its differentiation with
respect to competitors. This objective therefore remains one of the company’s priorities.
- The company is not perceived as being at the leading edge in terms of sustainable development,
in spite of numerous campaigns carried out over the past two years. The executive team has
translated this into the objective of “improving the credibility of the company’s sustainable
development actions”.
- Finally, the executive team perceives increasing difficulties in opening new retail locations.
Consequently it insists on the priority of “continuing the diversification of store formats at the
same pace”.

These objectives were then used to identify CPVs and build the following O/CPV grid:

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Increase Finalise the Improve Continue

ROCE from upmarket urban credibility of the diversification
X% to Y% positioning of company’s of store types
the Monoprix sustainable at the same
brand development pace
action
Accelerate the achievement ×
of profitability objectives
for the new stores

Find and convert new × ×

locations

Develop domestic help × ×

services31
Improve perceptions of the × ×
retail brand

Reposition the Beauty × ×

Monop brand toward the
high end of the market
Develop fast-food products ×

Improve the quality of fruit × ×

and vegetables and develop
the organic food range
Integrate the warehouses of × ×
the various store formats
Train cashiers in customer × ×
reception and relations
Train buyers and × ×
department managers in
sustainable development

Communicate about ×
actions to promote
diversity and equal
opportunities

31
Household repairs and decoration, cleaning and housework, childcare, home computer assistance…
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Conclusion: Comparison of the strategy map and the O/CPV grid

As we have presented them, the common objective of both tools is to build performance models before
thinking about indicators. To this end, they are based on common principles:
- Identification of objectives
- Similar rules for the formulation of these objectives;
- Qualitative identification of cause-and-effect relationships;
- Possibility of identifying several causes contributing to the same objective. This principle leads
to a more sophisticated performance model than representations in which each objective,
independently from the other ones, is translated into action plans. This is consistent with a
transversal approach to performance, based on coordination between entities and between
managers;
- Identification of two levels of concepts: in the case of the strategy map, a level corresponding
to external expectations (financial and customer perspectives) and a level corresponding to
levers for action (internal process and learning perspectives), in the case of the O/CPV grid, the
objectives and critical performance variables. In practice, these two levels of concepts are useful
to support managers’ engagement in the construction of the model. Indeed, levers for action or
critical performance variables are usually more concrete and therefore more meaningful
concerns for many managers.
These principles are intended to promote a balanced representation of performance.
The main differences are as follows:
- The support to ensure the consistency of the performance model is different: double entry grid
or map and therefore leads to different strategic priorities;
- The BSC method provides a more structured framework for achieving a balanced representation
of performance;
- The preferred horizon for the construction of a strategy map is the medium-term. It is therefore
particularly suited to direct the attention of, and energize a team around priorities related to
strategic change. The preferred horizon for the O/CPV grid is the year. It is therefore particularly
suited to focus the management of performance on priorities that are more temporary (see
Chapter 9).

Other tools do exist; they present, as do strategy maps and O/CPV grids, characteristics that are specific
to them. Therefore, each tool opens up possibilities for implementation but also constrains in some
aspects the possible uses.

Bibliography
Bisbe J. and Barrubès J. (2012), The Balanced Scorecard as a Management Tool for Assessing and
Monitoring Strategy Implementation in Health Care Organizations, Revista Española de Cardiología,
65(10), pp. 919–927
Ittner C.D. and Larcker D.F., «Coming Up Short on Non Financial Performance Measurement», Harvard
Business Review, November 2003, pp.88-95.
Fiol M., Jordan H. and Sulla E., Renforcer la cohérence d’une équipe, Dunod, 2004.
Kaplan R.S. and Norton D.P., The Balanced Scorecard, Harvard Business School Press, 1996.
Traduction française : Le tableau de bord prospectif, Editions d’Organisation, 1998.
Kaplan R.S. and Norton D.P., The strategy focused organization, Harvard Business School Press, 2000.
Traduction française : Comment utiliser le tableau de bord prospectif, Editions d’Organisation, 2001.

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Kaplan R.S. and Norton D.P., Strategy Maps: Converting intangible assets into tangible outcomes,
Harvard Business School Press, 2004.

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Chapter 9 - Dashboards: indicators for performance

management and reporting
Introduction
A set of performance indicators, generally combining financial and non-financial indicators, is called a
dashboard, scorecard or performance report. Rather than a dashboard, one also sometimes talks about
managers monitoring a set of Key Performance Indicators (KPIs).
In this chapter, we propose a conceptual framework for analysing dashboards, and the indicators that
compose them, in relation to their uses.
To this end, we first draw on some commonly accepted ideas on dashboards: the generally expected
properties of dashboards, and the often-recommended good practices (Section 1). While these ideas are
consistent, further analysis indicates that they are not unambiguous. To clarify the analysis of dashboards
characteristics, we propose to focus on the uses of indicators: performance management on the one hand,
and reporting on the other (Section 2). In Section 3, we detail the performance management use by
distinguishing a use to energize the activity in a entity from a use to monitor its performance. In Section
4, we detail two sub-uses for reporting: reporting indicators can be used to evaluate managers'
performance; they can also be used to inform managers in other entities of changes in business
performance. In Section 5, we propose a specific method for building a measurement system for
monitoring activity. This method is based on the OVAR and BSC methods presented in Chapter 8, and
therefore complements them.

Section 1. Some commonly accepted ideas about dashboards

As we have mentioned in the general introduction to this textbook, texts presenting management tools
often have a descriptive approach and focus on how to build these tools. They focus on the "how" and
present methods to develop new tools. However, this too often overshadows the question of the "why",
i.e. the clarification of the objectives and principles that guide the choice of operational solutions. We
will try to clarify these foundations here.

Properties of “good” dashboards

Dashboards take a wide variety of forms, but are presented generically in the form of a list of indicators
with various values shown for these indicators (see Table 1 and examples at the end of the chapter).

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Table 1. Generic example of a dashboard

Indicator Actual n–1 Planned Actual n Variance / Variance /

n–1 planned

Volume (activity)

Lead time
Quality index

Customer satisfaction index

Turnover
etc.

Defining more precisely what a dashboard is is not easy. A first approach would be to describe the
practices of companies. However, works published on dashboards tend to move rapidly from analysing
practices and highlighting more prescriptive discourses on the problems posed by these practices and
what should be done to address them (see, for a classic example, Ridgway, 1956 and for a more recent
analysis, Ittner & Larcker, 1998).
In the late 1980s and early 1990s, several publications at the intersection of managerial literature and
management accounting research led to a renewed interest in the issue of performance indicators. This
body work highlighted the limitations of financial indicators for monitoring companies' activities
(Johnson & Kaplan, 1987): in particular, financial indicators would guide managers towards achieving
short-term objectives, focus their attention only on performance for shareholders, and have little
explanatory power as to the causes of performance (see Chapter 3). Performance should therefore be
measured in a more integrated and balanced way. In particular, it involves renewing the list of
performance indicators used to improve the efficiency of the company's internal operational processes
and the quality of the products or services it offers to its customers (Berliner & Brimson, 1988, Deming,
1993, Kaplan and Norton, 1992).
Summarizing these recommendations, three characteristics are expected of a "good" dashboard:
- Do not limit measurement to a single performance dimension. Instead, provide a more
“balanced” representation of performance (expectation 1);
- Orient measures to a longer-term representation of performance (expectation 2);
- Facilitate decision-making by managers (expectation 3).

Recommendations for "good practices"

These expected properties are reflected in recommendations for good practice, according to which:
- KPIs must comprehensively cover the organisation’s entire set of objectives and goals.
- They must focus both on outcomes as well as the performance levers that can be used to achieve
these outcomes.
- They must include both financial and non-financial indicators.
- The indicators chosen must be consistent with the organisation’s strategy.
- They must be limited in number.
- They must deliver their information quickly.
- They must be presented in a legible and vivid way.

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Indicators covering the entire set of organisational goals and objectives

In Chapter 2 we saw that the performance of an organisation is usually multidimensional because it can
be defined with respect to several stakeholders who have different expectations. Either the organisation’s
goals are intrinsically multiple (as is the case for a public hospital for example), or the final performance
is mono-dimensional but pursuing it requires the organisation to satisfy other stakeholders in the shorter
term or even implies taking into account the possible impacts of the company's activities on of these
stakeholders in order to manage risks.
For a dashboard to be “balanced” (expectation 1), the first requirement is therefore that the set of
indicators it contains must encompass the diversity of the organisation’s objectives.

Indicators focusing both on desired outcomes and on performance levers

As we have seen in previous chapters, financial indicators are not only focused on a single dimension
of performance but also on desired outcomes: they do not make it possible to monitor the actions carried
out but provide information on the financial impacts of these actions. As aggregate measures, they bring
together numerous accounting items (different types of cost, revenues, assets, liabilities) and gather them
into a final indicator, which may be net income, operating income, profitability, etc. depending on the
situation. When used for future planning, they characterise the “financial goals” that the company is
striving for – the results that it hopes to achieve.
However, if performance measurement only focuses on targeted results, it generates a risk of “short-
term bias”, as we saw in chapter 3. Decisions may have been taken that are at odds with improving the
company’s profitability in a sustainable way (for example, a decision to manufacture low-quality
products) though the consequences of these decisions will not yet have made an impact on its financial
results in the short run. Symmetrically, beneficial decisions may result in a decline in financial results
in the short term, as their impact will only be fully felt in the long term and in a relatively diffuse way.
This is the case, for example, of staff training his is the case, for example, of staff training expenses,
which can be considered decisive in preserving the company's ability to adapt, to achieve productivity
gains, to continue to innovate, or of research and development expenditures.
Adding measures that focus on the “determinants” of these results, i.e. on the performance levers that
enable the company to achieve these results, allows the performance horizon to be lengthened (objective
2). In our examples, indicators can be designed for the quality of products manufactured (for example,
the number of defective parts in a manufacturing line), staff training initiatives (for example the average
number of training hours per employee) research and development efforts (for example, the amount of
the budget expressed as a percentage of turnover).
This is the second type of balance sought in a dashboard (expectation 1): the balance between results
metrics and indicators associated with performance levers.
This good practice also improves decision-making by managers (expectation 3). It is easier for managers
to analyse the causes of deviations from expected performance using non-financial indicators that are
more operational in nature. In the event of poor results, for example in terms of customer satisfaction, a
diagnosis will make it possible to identify whether the problem lies more in the quality of the products
or their production time, the latter in turn causing delivery delays or stock shortages, which is the cause
of the drop in customer satisfaction. It is therefore easier, once the diagnosis has been made, to
implement corrective actions to address the causes of the problem. On the other hand, financial results
are not directly "actionable", i.e. it is difficult, on the basis of this information only, to go back to the
root causes explaining the performance gap, and to identify the corrective actions to be implemented.

Using indicators that are not exclusively financial

To recommend that dashboards must include financial and non-financial indicators is, in part, a
consequence of the two good practices above. Once we are not longer focusing exclusively on
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performance for shareholders, indicators may lose their financial character (for example if we measure
customer satisfaction by the number of complaints). And as soon as we direct our attention to
performance levers and not only results, there again the financial dimension may fade away (as shown
by our example of the number of defective products).
Nevertheless, this principle also complements the first two principles. We might imagine, for instance,
though this scenario is not very realistic, that we are able to measure performance vis-à-vis different
stakeholders with exclusively financial indicators. For example, a profitability ratio to measure
performance with regard to shareholders, sales volumes or marketing costs to measure performance with
regard to customers, and average salary as a performance indicator with regard to employees. Likewise,
an indicator for a performance lever can be financial. This is the case, for example, of export sales
figures when a company has chosen to focus on this performance area with the aim of increasing its total
sales figures when a company has chosen to internationalize its markets to increase its overall revenue.
This leads us to distinguish between two meanings of the word “financial”: an indicator can be financial
because it reflects a “financial point of view” or because it is expressed in accounting values.
The principle whereby non-financial indicators are included in a dashboard aims not only to balance
different points of view, but also to strengthen the long-term vision. If we take another look at the
example of export sales figures, it certainly constitutes a lever which can be used to increase overall
sales figures, but it remains very general. If we take a look at the performance levers that might be used
to influence export sales figures, we may consider, for example, increasing the number of overseas sales
people. The corresponding indicator will then have lost its financial character. Thus the further we move
up the chain of causality, the more financial the indicators become and the more performance tends to
be captured in the long term, in keeping with the previous principle.
The non-financial character of indicators is also beneficial because it separates the performance measure
from the accounting information that always takes a certain amount of time to produce. Certain non-
financial indicators will be obtained more quickly, which also contributes to expectation 3.

Indicators that are consistent with organisational strategy

To All dashboard construction methods underline the importance of an integrated vision of performance,
or one that is consistent with the company's strategy even if, as we saw in Chapter 8 for the OVAR and
BSC methods, building a performance model aligned with the company's strategy is not immediate.
A company that chooses to follow a low-cost strategy, for instance, will have performance indicators
that are substantially different from those of a company that has chosen a differentiation strategy,
because their performance levers are very different, or at least the relative importance of each of them
will be different in the two cases. For example, indicators of business volume and unit costs for a cost
leadership strategy; indicators of margin, perceived quality, brand awareness for a differentiation
strategy.

A limited number of indicators

It is difficult to identify the origin of this recommendation; it often refers to common sense as in the
proposal "too much information is no information": only a limited number of indicators could and should
be monitored by managers. This "good practice" could refer to a contradiction between the views of
controllers and managers. For the former, being able to provide detailed and exhaustive information to
be in a position to explain all causes of discrepancies is often perceived as good professional practice.
For the latter, considerations of efficiency in the production of information and the relevance of the
information produced for the management of activities should be given priority.

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Quick access to results

It is often stressed that a manager needs information quickly to decide and take action, especially when
a performance indicator shows a drift whose causes must be analysed and managed as quickly as
possible.
It is therefore good practice to ensure that dashboards are available quickly. This good practice also
applies to financial results: in many large groups, the objective is to have monthly results available a
few days after the end of the month.

Presenting indicators in a vivid and legible way

Just as the number of indicators can slow down a manager’s analysis and decision-making processes, so
can the way the information is presented in the dashboard. Tables full of figures, however relevant their
content may be, can sometimes be impenetrable and do not facilitate the understanding of results.
On the other hand, the same results presented graphically with colour-coded information enable the
manager to immediately visualise positive areas and problematic areas. They are more vivid and
meaningful. The visual design of the dashboard can therefore contribute to managerial decision making
(expectation 3).

Synthesis

Table 2 summarizes the relationship between the three expected properties of dashboards, and the
characteristics of "good" dashboards generally highlighted in the managerial literature on performance
measurement systems. It illustrates that there is some consistency between these good practices and the
expected properties: considered as a whole, good practices would make it possible to meet what is expected
from a performance dashboard - which can help explain their success.

Table 2. Good practices and expected properties for dashboards

Offer a balanced Orient towards a Facilitate

representation of longer-term decision making
performance representation of by managers
performance

Cover the organisation’s entire set of X

goals and objectives

Focus BOTH on results and on X X X

performance levers
Include BOTH financial and non- X X X
financial indicators
Contain indicators consistent with X X
organisational strategy

Limit the number of indicators X

Quick access to results X

Presented in a legible and vivid way X

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Section 2: Recommendations that are not unambiguous

Despite the coherence highlighted above, a more in-depth analysis leads to the emergence of
contradictions and ambiguities on some important points.

Conflicting recommendations on the number of indicators

A first contradiction appears regarding the number of steering indicators: do we need many indicators
or, on the contrary, a reduced number?
- If one wants to follow certain good practices (to cover the organisation’s entire set of goals, to
include indicators for results as well as for performance levers, to include both financial and non-
financial indicators), then it will be necessary to have a wide variety of indicators, which also tends,
mechanically, to increase their number. The idea implicit in these recommendations is that
“everything must be controlled” and the danger to be avoided is that of overlooking something, of
a “gap” in performance measurement, of non-exhaustiveness, or the incompleteness of the
indicators. As it would certainly be rather difficult in practice to formulate an objective in terms of
“exhaustiveness”, it is formulated more moderately in terms of “balance”. But, fundamentally, the
pitfall to avoid is that of serious omissions (such as focusing only on the financial dimension).
- Other principles (limiting the number of indicators, alignment with strategy), on the contrary, urge
managers to focus the dashboard on particular orientations, on priorities. Managers should select
certain indicators because they are more relevant than others.
As we will see later in this chapter, these two sets of good practices are relevant but in relation to specific
uses of dashboards.

How to use performance indicators?

The expected properties and recommendations for good practice presented above leave aside the
question of how performance indicators are used:
- While it is reasonable to say that performance indicators should ultimately facilitate managers'
decision-making, it should be specified how the indicators are used at the different stages of this
decision-making process. Indeed, performance management is based on the identification of
problems, risks and opportunities, their analysis, the identification of the actions to be taken and the
implementation of these actions. The information needs are not the same at these different stages.
In particular, in an organizational context, the interpretation of performance variations and the
identification of actions to be taken is almost always a step carried out jointly by several actors:
members of an executive committee, or the operational and functional managers whose activities
are impacted by these performance variations. Periodic performance reviews are a key moment for
this. As they bring together several interlocutors with busy schedules in an often very short space of
time, it is imperative to select the topics covered to focus the meeting on important issues. However,
this selectivity requirement does not necessarily apply to the preparation phase of performance
reviews or to other times or places of analysis.
- Different parties may use performance indicators: controllers, entity managers, and operational
managers in the entity and at other levels in the organisation. They do not all have the same role and
are not necessarily involved at the same stages in the decision-making process.
- he recommendations for good practice leave out the question of how to link the performance
dashboards used at two adjacent hierarchical levels: it is not easy to know when and why the
indicators should be the same or whether, on the contrary, they should be specific to each level. We
return to these issues in section 4.4.

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Two main uses for performance indicators: performance management and

performance reporting
To solve these difficulties, we propose to analyse the uses of indicators, which implies studying why,
how and by whom dashboards are used in the performance management process.
First, the question of why makes it possible to identify two main types of uses.
Managers, regardless of the scope of their responsibilities, must manage the performance of the activities
for which they are responsible. The construction of a measurement system, based on prior performance
modelling, makes it possible to structure the performance management of activities. This is a first use
of performance indicators: providing information for performance management.
Managers are also expected to provide their supervisors with information about the activities that are
under their scope of responsibility. This is a second use of performance indicators: providing
information for reporting.
We detail these uses in the following two sections.
In section 3, we identify two sub-uses for performance management – use of indicators to energize the
management of performance, and use of indicators to monitor performance – distinguishing how
indicators are used and by whom they are used. We deduce the characteristics of the indicators for each
of these two uses.
In section 4, we distinguish two sub-uses for reporting, again by distinguishing how the indicators are
used: a use to evaluate of managers' performance by their supervisors i.e., to check whether delegated
objectives have been or are going to be achieved, on the one hand, and a use to inform of other managers
in the organisation, on the other hand.

Section 3: Two uses of indicators for performance management:

Energising and monitoring
Broadly speaking, it is possible to distinguish these two types of uses as follows:
- A use to energise: indicators serve as a support to focus the attention of managers and executives on
"some" priorities associated with strategic, or more cyclical, objectives. They structure the
representations of these priorities and promote the construction of a shared point of view among the
various members of a management team. They are therefore collectively constructed and are
reviewed quite frequently as priorities evolve. Building these indicators is a way to agree on
priorities and associated target objectives or to collectively identify and validate action plans. The
monitoring of these priorities is systematic and focuses both on the ability to achieve the targets and,
where appropriate, on the implementation of action plans.
- A use to monitor: the indicators are defined downstream of a "complete modelling of the formation
of performance in the organization". It is a question of taking into account the important recurring
levers in order to bring them under control. The organization’s goals, its strategic positioning and
its performance model will guide the choice of indicators. The identification of the most important
stakeholders (who are not only shareholders and customers) and their expectations is a prerequisite
for the construction of the performance model. Monitoring is carried out by exception, when a
significant deviation or drift is identified.
In this section, we detail these two types of uses, and their consequences on the characteristics of the
dashboards.

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Indicators used to energize

Indicators are used to energise and focus an entity on a few priorities. For this, the executive team has
to be closely involved in making decisions and directing action concerning these priorities.
Consequently, priorities must be examined regularly in monthly management meetings or performance
reviews. This explains why the number of topics dealt with (and hence ultimately the number of
indicators) must be limited.
As these performance review meetings deal with the topics (or objectives) that are deemed to be
priorities as well as the review of the main variances in indicators of the most frequently recurring
elements of strategy or the business model (see below), we estimate that between four and six topics
will be examined during each meeting. Given the fact that most areas do not require monthly tracking,
the total number of objectives monitored may be around fifteen and the number of corresponding
indicators around thirty.
Given these constraints, the choice of objectives has to be very selective. The purpose is not to follow
all the dimensions of the entity's business model, but its cyclical priorities as defined in Chapter 8:
changes in strategic positioning, priorities relating to the current economic and business context, specific
internal difficulties, and particularly ambitious elements of strategic positioning. Once the objectives
have been chosen, senior management will regularly get involved in following them, at the time of
periodic review meetings.
The performance management dashboard is used at two levels:
- At the time of their construction, at the beginning of the year or at the end of the previous year: they
lead to questions about the priorities for the coming year, and the associated action plans. This
reflection can be carried out in conjunction with the construction of budgets, which also combine
objectives to be achieved and the identification of action plans (see Chapter 10). As priorities change
frequently, the performance management dashboard must be modified substantially every year.
- During the year, and in particular during monthly management reviews: to track the achievement of
objectives on these targets.
The executive team, with the goal of heightening the involvement of the various participants and
ensuring good coordination, must build the objectives that structure the dashboard and clearly describe
priorities collectively. The task of selecting indicators for tracking the achievement of objectives can
however be delegated.
Since objectives are priorities, they should be monitored systematically, along with indicators and
associated action plans, regardless of whether or not pre-set targets are achieved. It is therefore possible
to set the agenda for monthly performance reviews in advance, according to the frequency and time
horizons deemed relevant for each objective.
Monitoring can be organized by objective or, as suggested in the OVAR method, by action plan. The
follow-up of each objective or action plan will therefore be placed under the responsibility of one of the
participants in the Management Committee. It will then be his responsibility to prepare the points to be
discussed in the performance review meeting and submit proposals for decisions to the executive team.
Consequently, the indicators used to energize the management of performance are well intended to
facilitate managers' decision-making and the management review is the space to do so.
Given the temporary nature of these priorities, it is not always necessary to incorporate the indicators in
the organisation’s information systems to automatically generate information; it depends on the
associated IT costs compared to what it would cost to compute the indicator manually for a temporary
period.

Indicators used to monitor

From a monitoring perspective, dashboards are used to monitor key performance parameters. More
performance objectives may be set than for dynamic indicators because the treatment of subjects will be
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done by exception, i. e. by focusing only on significant differences. It is therefore possible to monitor

several dozen indicators as part of a monitoring use.
More precisely, the indicators must make it possible to cover all the entity's objectives, as well as the
key success factors and the strategic positioning chosen. Since, in the context of this use of dashboards,
it is not necessary to limit oneself to a small number of indicators, the question of their choice raises
fewer issues. Consequently, the performance model and the corresponding indicators can be defined by
the management controller and then validated by the management committee or by the manager in
charge of the entity.
The dashboard is used to detect deviations that appear abnormal at first sight, either from a trend, a
standard or a target value (defined at the time of budget construction, for example). The analysis of
variances between targets and results is prepared by the controller in order to lighten the workload of
the operational manager who does not have enough time to study a large number of figures in a short
space of time. From this analysis, the controller suggests topics to be put on the agenda of the
performance review meeting.
There are two ways to do this:
- Analyse trends in indicators and examine any major discontinuities (a sudden increase in an
indicator that has historically been stable, for example);
- Analyse variances with respect to a target or a standard and select the most significant variances.
In management review, these topics can be put on the agenda and dealt with, for example, following the
dynamic topics, and in a different way. By definition, since monitoring focuses on a priori abnormal
deviations, i.e. deviations that were not anticipated, it is a question of jointly determining whether the
deviation reveals a problem and whether it warrants further analysis or the implementation of an action
plan.
It is possible that the deviation was detected and analysed by the management controllers, and that the
entity's management decided to implement an action plan without waiting for the next management
review. In this case, the management review is only used to inform participants that an action plan has
been implemented. If not, the action plan is determined in a meeting or, failing that, the managers will
plan to organise an ad hoc meeting between the persons concerned to identify the action plan to be
implemented. Due to the often unexpected nature of the subjects treated, this second case is the most
frequent.
In addition, variations in only a few indicators are analysed, so the total number of indicators monitored
as part of this monitoring use can be much larger.
The target or reference values have an essential role, since part of the analysis will be based on the gap
between the achievements and these values.
Unless the performance model evolves, there is no reason to change the list of indicators monitored. As
a result, they do not change as frequently as the indicators used to boost the entity's management.

Synthesis
The main characteristics of the two types of uses are summarised in table 3:

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Table 3. Characteristics differentiating energizing and monitoring uses for performance indicators

MONITORING USE ENERGISING USE

Purpose Control the entire set of key Energise and focus action on priorities.
performance parameters.
Indicators’ Balanced/taking into account all the Selective, focused on current priorities
characteristics different goals and objectives of the and on corresponding action plans.
organisation.

Consistent with the business model.

Who builds the The controller directs the construction The executive team determines
indicators of objectives and indicators. The objectives collectively. The selection of
executive team approves them. indicators may be delegated.
Computation of Done automatically by the information May be done manually.
indicators system.
Evaluation of Comparison with pre-set targets or Systematic evaluation of achievement
results analysis of trends. of objectives and progress on action
plans.

Modes of Only variances and significant All priorities are included on the agenda
utilisation for discontinuities are put on the agenda of of review meetings (but not necessarily
performance review meetings every month).
reviews
During performance review meetings:
discussion between manager and
During performance review meetings:
operational team leaders on all of the
assess the seriousness of variances,
objectives and action plans; decision-
decision on whether corrective action is
making.
advisable.

Actors involved Controllers play key role in Operational managers in charge of

highlighting significant variances action plans prepare review meetings.
Significant involvement of entity
manager (mobilisation role)

Number of Fairly large, in order to ensure balanced Reduced, in order to focus the attention
indicators oversight of the activity of managers on current priorities

Frequency of Regular, frequency can differ Ad hoc depending on the timeframe of

measurement depending on the nature of the action plans
indicators
Changeability of Low (depending on the changeability of High
indicators activities and strategic positioning)

In both cases the objective ultimately is to make useful decisions, but through different processes.
Although the BSC and OVAR methods do not refer to these two types of uses, they are suitable for the
construction of indicators that will be used to energize the management of performance.

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Information systems and indicators used for performance monitoring

Should systematic performance monitoring cover all indicators in management information system
databases? In other words, is it useful to build a list of monitoring indicators and bring them together in
a dashboard or should one simply give the controller access to these databases and have him perform an
analysis of them?
As there is no empirical literature available on this subject, we propose the following points for
consideration:
- The information contained in the databases have multiple uses and users. There is, therefore, a risk
that analysts will be overwhelmed with information when they have to prepare performance review
meetings;
- Selecting the information to build a dashboard is a useful exercise to align the representations of the
entity's various stakeholders with the entity’s performance goals and the key elements of its
performance model.
It therefore seems preferable to us to identify the indicators used to monitor activity to ensure that all
the key parameters are being controlled, which does not exclude using the databases to perform specific
analyses. A method to identify the indicators used to monitor activity is presented in Section 5.

Section 4. Two management reporting uses: Evaluation and

information
Evaluation
In a company organized into responsibility centres, the measurement system makes it possible to set
objectives for the managers of the entities and to evaluate their performance by comparing the results
obtained with the targets defined at the beginning of the period (see Chapter 6). Depending on the scope
of delegated responsibilities, and in accordance with the principle of controllability, these may include,
for example, cost and quality of service indicators (for a cost centre), sales growth and sales margin rate
indicators (for a revenue centre), profitability and revenue growth indicators (for an investment centre),
etc.
The indicators used to set objectives for a manager at the n-1 level by his or her superior at the n level
are key performance indicators at these two adjacent hierarchical levels.
They are included in the manager's dashboard at the n-1 level since s/he knows that her/his performance
will be evaluated according to the achievements obtained, measured by these indicators. It is therefore
in her/his interest to monitor developments very closely, to understand the reasons that determine these
developments and the origin of any discrepancies.
Symmetrically, the indicators in question are reported at level n as part of management reporting. Indeed,
it is the responsibility of a manager's superiors to check during the year that the achievement of the
objectives they have set for him or her is on track. In particular, if the deployment of objectives is based
on relevant performance modelling, then whether a manager at level n will achieve their objectives will
depend closely on whether managers who report to them will achieve theirs. It is therefore important
that a manager can regularly monitor the achievements of his subordinates, including in a Management
by objectives system combined with delegation. For superiors, a balance must therefore be found here
to keep the activity under control without interfering too much in the management of delegated activities.
Indicators are analysed at the end of the year to assess the performance of n-1 level managers and often
serve as the basis for an incentive system to reward the achievement of objectives. They are also
monitored during the year, in particular as part of periodic performance reviews, to check with these n-
1 level managers that they can effectively achieve their objectives. Otherwise, it is a question of

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discussing action plans to correct the gaps identified, particularly if the implementation of these plans
requires the coordination of activities involving several managers (within the responsibility centre at
level n, or linked to other responsibility centres within the company). It is also possible that the
implementation of action plans requires the allocation of additional resources at the n-1 level, which can
only be granted following arbitration by the n-level managers. This also justifies the intervention of the
latter in the regular monitoring of the objectives delegated to the n-1 level managers.

Information
In addition to the indicators used to set objectives and evaluate results, management reporting from level
n-1 to level n generally includes other indicators useful to managers at level n for monitoring the
performance of their entity.
Indicators can be related:
- to activities managed by several n-1 level entities, and on which the n level needs consolidated
information;
- to activities for which management responsibility is shared between the n and n-1 levels;
- to activities managed at level n, but for which information is available at level n-1, and therefore
must be reported back to level n as part of management reporting.
To illustrate the latter case, let us take the example of a large group specialised in the production and
sale of cosmetic products, organised on a commercial level by geographical zones, each zone covering
several countries. In this group, supply chain management is carried out at the zone level and not at the
level of individual countries, but it is the country managers who hold the information on insufficient
and/or obsolete inventory. Therefore, this information needs to be reported at the zone level, to enable
managers at that level to optimize supply chain management.
At level n, indicators can correspond to priority objectives defined by the managers of the entity for their
level (in our previous example, a priority on the reduction of out of stock products or a reduction in the
amount of obsolete stocks). They can also correspond to indicators used to monitor the fundamental
performance levers at the same n level (in our example, periodically checking that the level of obsolete
stocks does not exceed the usual thresholds, or the standard threshold levels).
Some of these indicators may also be used to supplement the assessment of the performance of n-1 level
managers. In particular, if excessive incentives are associated with the achievement of objectives, there
is a risk that managers will pay more attention to the evolution of the indicators on which they will be
evaluated than to the more global and long-term management of performance within their area of
responsibility.
In all cases, it is a question of making relevant information available at level n for performance
management at its level, or at other levels in the organisation. This explains why sometimes managers
at the more operational levels in their organisation, or the controllers attached to them, complain about
the cumbersome reporting required of them. Indeed, they bear the cost of producing this information but
do not have direct use of it at their level.

Multiple uses for a same indicator; different uses for indicators used at
the same entity level
In practice, entity managers and their controllers do not necessarily have a separate dashboard for the
two types of uses identified above, reporting or performance management. In other words, it is possible
that the same dashboard may include indicators that are not directly useful to a manager within his or
her area of responsibility, on which he or she will also not be assessed, but which are part of the
management reporting to his or her hierarchy.

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Indeed, even if n-1 level managers do not control the levers that determine the performance measured
by the reported indicators, the latter often have at their level information that makes it possible to explain
the evolution of these indicators. As a result, their superiors, or the controllers attached to a higher level
in the organisational hierarchy, usually ask n-1 level managers or controllers for explanations to
understand the changes observed, particularly when they are unusual or not in line with what had been
anticipated. For n-1 level managers, monitoring these indicators and being able to interpret their
evolution is therefore part of their missions.
Symmetrically, at a given organizational level, the same indicator can be used for different purposes.
For example, the revenue growth rate may be an indicator used to energise the management of
performance in an entity because it measures the achievement of a priority objective of growth in sales,
defined for the annual period for the entity in question. If this objective corresponds to the deployment
at the entity level of a strategic priority defined for the company as a whole, then it is likely that the
revenue growth rate has also been used to set objectives for the entity manager and to support the
evaluation of his or her performance at year-end. Consequently, two uses are associated with the rate of
growth in sales in this entity for the year under consideration: a performance management use by
energizing the activity on the one hand, and a reporting use to evaluate the performance of the entity's
manager on the other hand.

Deployment of objectives and uniqueness of performance indicators

An objective may change in nature depending on the level involved in the organization. For example, a
financial objective to increase profitability, defined at the level of the company's general management,
can be deployed in the form of an objective to decrease inventories and reduce procurement lead times
at more operational levels in the organization.
In general, the further down the organizational hierarchy, the higher the proportion of indicators related
to operational management. Symmetrically, one can expect that the share of financial indicators will be
higher in the dashboards of a company's general management.
Therefore, if we now consider the dashboards used at two contiguous organizational levels, one can
expect them to include identical indicators but also indicators specific to each level.
Indeed, indicators can be used simultaneously at two contiguous organizational levels for reasons that
arise from each of the four uses we have identified because:
- they correspond to a strategic or operational priority common to both levels and jointly managed at
both levels: managers at each level have the means to act on the performance objective
corresponding to this priority (performance management use to energise);
- the performance levers that determine the evolution of the indicators are partly controlled at each of
the two levels; the indicators relate to key parameters of the performance model but no priority
objectives are attached to them (performance management use to monitor);
- they correspond to objectives on which n-1 level managers’ performance is assessed at the end of
the year by their direct supervisors (use of management reporting to evaluate);
- they correspond to indicators that are useful for managing the activity at level n, when managers at
level n-1 have the information that allows them to explain the variations of these indicators, even if
they do not have the levers at their level to act on these variations (use of management reporting to
inform).
Other indicators will be included in managers’ dashboards at only one of the levels because:
- they correspond to a specific priority at the level in question;
- they are the translation of key parameters of the performance model managed mainly at one of the
levels.

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Consequently, at any level in the organization, performance management is based on indicators that are
unique to the entity in question, whether in their form (what indicators are used) or in their use (who
uses them, how and for what purpose). It is therefore impossible to imagine being able to build a
dashboard that is common to all entities in an organization. On the other hand, it can be recommended
that the dashboards used at each level be articulated in a coherent way.

Section 5: Constructing indicators for performance monitoring

We propose below a method to identify the performance management indicators that can be used to
monitor the performance of en entity.
As discussed above, this involves monitoring the key parameters that control the entity's performance.
To do this, the challenge is to build the entity's performance model in order to translate its business
model into a measurement system.
We believe that, with a few modifications, the OVAR method, i.e. building a grid of intersecting
objectives and CPVs, can be used.
In addition, taking inspiration from the BSC method, we recommend that objectives be related to the
expectations of shareholders and customers and that action areas correspond to key internal processes
(which can be determined using a representation of the value chain) and to key resources from the human
and information systems point of view. Thus, the panoramic dashboard construction proposed is based
on a combination of the BSC and OVAR methods.
The result is the following method that we will call OOAA for On-going Objectives and Action Areas.
We present it by contrasting its principles with those of the OVAR method

5.1.1. Determining on-going objectives (OO).

- The number of objectives is not limited to six.
- Objectives correspond to the expectations of shareholders or customers. They must be consistent
with the company’s strategic positioning.
- Objectives do not necessarily have to correspond to progress. The parameters to be controlled can
also include elements for which the concern is simply that performance does not decline. If progress
is sought, it is not expressed in the objective itself, but rather in the target value attached to it (see
below). On the other hand, as we explained above, it is better if the objective expresses the scale of
the ambition, because this can influence the kind of performance levers that are chosen (for example,
maintain market share, increase market share or increase market share dramatically).
- In planning objectives, the time horizon under consideration is three years rather than one year. The
idea is not to set a reduced number of priorities but to determine on-going parameters that must be
controlled.
- It is not a matter of trying to identify what will cause problems next year, but rather determining the
key expectations of shareholders and customers in a more structural way.

5.1.2. Determining action areas

There is no longer a restricted choice of performance levers to be used to achieve objectives. Instead,
the performance levers that are considered important to control are chosen. We will call them “action
areas” (AA).

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While objectives express the expectations of shareholders and customers that are considered structural
for the entity, key action areas correspond to internal elements. The differences with the CPVs of the
performance management dashboard are as follows:
- They can be greater in number.
- They correspond to the more perennial performance levers: key elements in the business model or
important performance factors with respect to the strategic position adopted.
- AA are areas where it is considered important to make improvements to reach objectives, but they
are also areas where it is important that there be no deviation without organising specific corrective
action or setting an improvement objective.
- For action areas that concern processes, one can use a representation of the value chain with the
double objective of identifying key elements in the chain for achieving objectives and not
overlooking important elements in the business model.

5.1.3. Determining targets

It should be kept in mind that setting targets is essential because the principle at work here is control by
exception. Contrary to performance management dashboards, targets are not set during the process of
building the grid, because these dashboards have a longer lifespan. In general, targets are set annually
during the budgeting process. It is not always necessary however to set targets using figures; in some
cases it is enough to monitor trends. Moreover, targets do not necessarily correspond to objectives that
are negotiated annually (and linked with incentive schemes). Instead they may be alert levels that are
set for longer timeframes (which are nevertheless still validated when the budget is being built).

Illustration

We will now return to the illustration introduced in Chapter 8, inspired by the case of the Monoprix
company. Based on the elements already provided, it is possible to build the following OO/AA grid:

development” image
Increase market share

Build a “ sustainable
offering that matches
Balance the portfolio

strategic positioning
of store formats and

Adapt the services

Increase return on

Have a product
Reduce debt
investment

offering
brands

etc.

Increase the number of customer × ×

loyalty cards
Attract customers and build

Adapt promotions to strategic × × ×

customer loyalty

positioning
Optimise the management of shelf × × ×
space
Professionalise merchandising × ×
Renew product ranges to match to × × ×
strategic positioning
Develop domestic services × × ×
etc.

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Organisation of Adjust staffing to customer flows ×

points of sale Reduce inventory shortages ×
(shrinkage)
Reduce energy consumption × ×
Adjust checkout opening to customer ×
flows
etc.
Lengthen supplier payment periods ×
Ensure the freshness of perishable × ×
Purchasing and logistics

foods
Reduce the energy consumption of ×
transport
Ensure the traceability of products ×
Reduce the number of suppliers ×
Integrate the purchasing and logistics × ×
functions of the different store
formats and brands
etc.
Define and implement a suitable × × ×
Human resources

training plan
management

Launch actions to promote diversity ×

and equal opportunities and
communicate about them
Develop a job rotation policy × ×
etc.
Find new locations × × ×
Reduce time taken to open new × × ×
New stores

locations
Ensure that the positioning of the × × ×
new store formats and brands is
consistent with the image of the
company
etc.
etc.

This example illustrates the formulation of objectives and action areas and the differences with the
O/CPV grid. By modifying the principles concerning the number of objectives, levers for action and
their formulation, we achieve very different objectives and, ultimately, very different indicators.

Bibliography
Berliner, C. and Brimson, J.A. (1988). Cost Management for Today’s Advanced
Manufacturing,Harvard Business School Press
Deming, W. E. (1993). The new economics. Cambridge: M.I.T.

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Ittner C.D. and Larcker D.F. (2003) «Coming Up Short on Non-Financial Performance
Measurement», Harvard Business Review, 88-95.
Kaplan, Robert S., and H. Thomas Johnson (1987). Relevance Lost: The Rise and Fall of
Management Accounting. Boston: Harvard Business School Press.
Kaplan, Robert S., and David Norton (1992). "The Balanced Scorecard: Measures that Drive
Performance”. Harvard Business Review 70, no. 1, 71–79.
Ridgway, V. (1956). Dysfunctional Consequences of Performance
Measurements. Administrative Science Quarterly, 1(2), 240-247.

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Part 2 - The control cycle

Chapters 10 and 11

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Chapter 10 - Business planning

Introduction
Business planning is one of the most complete processes in the economic and financial control of a
company. As we saw in the first chapter, business planning tools differ depending on the time horizon
being considered. Strategic plans are formulated for the long term, which are then translated into
operational plans for the medium term and finally defined as budgets for a one-year time horizon.
Budgets are the most frequently used business planning tool. In practice, virtually every company and
organisation has a budget planning process. A study carried out in 2007 by the Hackett Group shows
that 97% of the companies surveyed use budget management.
In this chapter we will present first the principles (section 1) and then the operational implementation
(section 2) of business planning. We have decided on this approach – beginning with an analysis of the
purpose and function of business planning – to avoid the pitfall of focusing excessively on the technical
aspects of planning tools. Indeed, before trying to understand how planning tools work, we feel that it
is necessary to understand why companies and organisations use them. As we will see, this “why”
question is not straightforward: the purposes and functions of business planning tools are multiple and
sometime contradictory. Combining them is not simple and it is essential to understand and master the
issues involved.

Section 1. The principles

The management control process is based on planning and on the monitoring and analysis of results (see
figure 1.1 of chapter 1). We will first present the main purpose of business planning and then look at the
functions that are assigned to it.
In order to simplify the presentation of these functions, we will begin by situating ourselves at the level
of a particular entity; this could be a company or an organisation taken as a whole or it could be an entity
within this company (a division, for instance).32 Our aim is, first of all, to show the functions that
planning serves within this entity. We will then enlarge the scope to the entire structure in order to reveal
the supplementary functions that are brought on by the multiplicity of organisational actors and entities.
Finally, we will study the difficulties arising from certain incompatibilities between the multiple
functions of the planning process.

The main purpose of business planning

The aim of business planning is to project the company into the future, in a perspective of progress, by
constructing a coherent system of objectives, action plans and resources (see example 10.1).

32
Most of the following discussion concerns any kind of company, whether private, public or state-owned, as well as any other type of
organisation. For the sake of simplicity and to avoid repetition, however, we will just use the word “company” throughout the text. Unless
otherwise specified, it should be understood that we mean both companies and non-commercial organisations.

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Boxed text 10.1: Objectives, action plans, resources – how to win the Dakar Rally?

The main goal of most of the participants in the Dakar Rally is to win the race. To accomplish this
objective, the participants have to determine how they hope to achieve it, in other words they have to
draw up an action plan: physical training, participation in similar competitions, fundraising, etc. And
they have to define the means and resources necessary to carry out the project: the choice of a vehicle
and engine size, fuel type, model of tyres, the team of mechanics, etc. Physical and technical preparation
is indispensable in getting ready for the race and for anticipating difficulties and avoiding errors during
the competition.
The optimal choice of action plan and resources will be made in relation to the experience and training
of the participant and data on the environment such as probable weather conditions, the number of
kilometres to cover, the topography of the route and the calibre of the other competitors in the race.
Preparation for the rally can be summarised as follows:
1. Set an objective: in our example it is to win the competition, but we could have chosen another
objective such as simply participating in the race.
2. Formulate action plans that are consistent with the objective chosen: for the teams this involves
preparing themselves physically, signing up for similar races, making a trip to reconnoitre the
route, studying maps, as well as drawing up a list of potential sponsors to finance the race and
making contact with them to present the project.
3. Choose and assemble all of the necessary resources: operational means (vehicle, tyres, fuel);
human skills and resources (driver, co-pilot, maintenance and monitoring team); financial
resources (own funds, bank loan, external sponsors).

When the directors of a company or an organisation start a planning process, they are faced with similar
questions:
- What are the objectives to be reached in the coming years? These may be objectives of sales growth,
increase in market share, cost reduction, etc.
- Depending on the economic and business environment and the current situation of the company,
how can they anticipate future difficulties and opportunities? How can they mobilise the company
to reach their objectives? In other words, what are the action plans that need to be implemented?
- What resources will be needed to carry out these action plans? What operational means and
resources are needed? What skills and competencies – both quantitatively and qualitatively – will
they need to have? What financial resources will be necessary?
Business planning provides a framework for reflection in which the company sketches out its desired
future and chooses the orientations necessary to ensure coherent development and improve its
performance, while keeping the company balanced.
Business planning is a dynamic process which evolves along with information about the economic and
business environment, the analysis of the current situation and the freedom of action available to senior
executives.
The objective is to identify areas for progress, for example, by analysing the life cycle of products in the
portfolio (aging and obsolete products generate little revenue; on the other hand, innovative products,
which consume resources during their launch phase, may be more profitable in the medium term), or by
choosing to make investments that will improve production and selling capacities or again by supporting
and accompanying innovative projects. In general, the planning process should encourage the pursuit of
productivity gains and performance breakthroughs.
Business planning is not only a framework for reflection, but also a framework for action. While
executives sometimes have very little latitude for action in the short term, they have more room to
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manoeuvre in the medium term and long term. Knowing where one wants to go in the medium and long
term allows one to define the stages, principles and policies that will the guide day-to-day decision
making of managers and enable them to make corrections if things go off course.
Business planning helps to organise and manage change. Managing change means training and
motivating employees so they can understand the issues and challenges involved in modifications of the
environment and be ready to accompany the organisation’s evolution. Training initiatives also help to
ensure that the company will have the competencies and knowledge that it will need in the future.
Once action plans have been formulated, they need to be costed out in order to measure their financial
consequences and estimate the foreseeable results. This is the planning phase in which the desired results
objectives are evaluated.
Local objectives and action plans – at the level of the different organisational entities – derive from the
overall objectives of the company. These action plans must be coordinated with each other (see example
10.2). Choosing and building action plans that are consistent with performance objectives constitute one
of the main goals of the planning process, to ensure coherent development in a perspective of progress.

Boxed text 10.2: Objectives – action plans – forecasts

1.Objective:
Company E sets itself the following target on 31/12/201x: an after-tax ROCE of 12%.

2.Action plan:
This overall objective is then translated into local objectives and action plans. They are assigned to the
entities that are in charge of implementing them within a specified timeframe. These local objectives
are interdependent and must therefore be coordinated through action plans. For example, the objective
of reducing production costs by 5% can only be achieved if the “Design office” and the “Production”
department work together: the design office develops a new manufacturing process while the production
department carries out trials and implements the new process. In addition, the “Purchasing” department
also contributes to reducing production costs by searching for new suppliers and negotiating less costly
contracts.

Table 10.1 Local objectives and action plans

Local objectives Action plans Entity Date

(Who?) (How?) (Who?) (When?)

Increase sales by 5% Hire and train a salesperson Salesperson 31/12/201x

Reduce production costs Negotiations with new suppliers Purchasing 31/03/201x

by 5%
New, faster production process Design office 31/03/201x

Test the new process Production 30/04/201x

Implement the new process 30/06/201x

Reduce general and Renegotiate building rent, Administrative 30/06/201x

administrative expenses insurance policies…
by 20%

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Increase stock rotation Optimised planning of Sales, 30/06/201x

(maximum 20 days to manufacturing in relation to Production
sell) seasonality and increase in sales
volume

Shorten customer terms Renegotiate payment terms Financial, 31/12/201x

of payments (maximum (deadlines) with customers Sales
2 month from invoice
date)

3.Financial forecasts:
The various actions planned are costed out and their financial consequences are recorded in the financial
statements of the company: profit and loss account, balance sheet and cash-flow statement.

Table 10.2 Financial forecasts

Actual on 31 Forecasts for 31

In millions of €
December 201x−1 December 201x
Sales 3.8 4.0
Production costs 2.0 1.9
General and 0.8 0.6
administrative
expenses
Margin 1.0 1.5
Net assets 8.4 9.5
Stocks 1.3 1.2
Receivables 1.3 1.2
Total assets 11.0 11.9
ROCE (return on 9% 12%
capital employed)

Basic functions
In order to facilitate the analysis of the basic functions of business planning, we will now situate
ourselves at the level of the organisation as a whole, bearing in mind that these functions also apply to
each entity. We identify three basic functions connected with the objective of performance management:
- Anticipation,
- Regulation,
- Organisational learning.

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We will also point out another important role, though one that is less directly connected to the objective
of performance management: the forecasts made during the planning process also serve as a basis for
communication with the company’s financial partners.
1.2.1. Anticipation
The planning process is the occasion for members of the organisation to take stock of their activities in
a formal and organised fashion which forces them to step away from the “heat of the action”. Managers
have to handle numerous decisions on a daily basis, very often in urgent circumstances. There are few
opportunities to step back and view their activities in relation to long-range objectives and so one of the
functions of planning is to create these moments for reflection.
Anticipation consists in defining values or hypotheses for certain factors that concern, for example, the
general economic context, trends in the markets that the company operates in and the intensity of the
competition. More broadly, it is also about building a strategic position for the company – one that senior
executives wish to attain, taking into account the predictions made concerning changes in the business
context. This means coming up with new activities to be developed and alternative markets for the
company’s products or services. Managers are expected to show initiative and creativity and put forward
new ideas that will contribute to improving the company’s performance.
Anticipation also enables managers to recover or create a certain amount of freedom to develop the
company’s activities. In the short term, the amount of room to manoeuvre on operational options is often
limited. For example, if the company intends to rethink its sales policy, it must take into account the
inertia of customers vis-à-vis a new pricing, service or distribution policy. If they wish to overhaul the
production process, then in-depth technical analyses, specific investments and/or the training of
specialised staff will certainly be necessary. Implementing numerous operational decisions takes time
and generally can only be achieved in the medium term. These decisions may concern a reorientation of
sales policy, prospecting new markets, renewing the product range, re-engineering the production
process and changes in the company’s structure.
At the same time, the company has to analyse its capital needs and make sure that it can obtain sufficient
financial resources to develop its projects. If internal resources (self-financing, using surplus cash, the
sale of assets) are insufficient, then external resources (new share issue, loans) will have to be found.
Convincing shareholders or bankers to participate in financing the company’s projects takes time.
Investors and financial partners attach a great deal of importance to the quality of the company’s
financial communications (see paragraph 2.4 below).
This is why it is important to anticipate the decisions that cannot be implemented immediately.

Boxed text 10.3: The expansion of Simple Stores

Within the framework of its strategic plan, the multinational company Simple Stores, specialised in
retailing books, CDs, DVDs and so on, has decided to enter the French market. It plans to open a store
in Paris in November 201x and then similar specialised outlets in other large French cities in the
following months. Although Simple Stores already has a location available in Paris and the funds
necessary to finance its expansion, it cannot execute its plan immediately. First of all, it must organise
a certain number of action plans: carry out renovations to convert the location and outfit it, obtain the
necessary permits and authorisations, hire and train the staff needed to run the store, reference the
products, build inventory and plan a PR campaign for the grand opening of the store, etc. Expanding
into the French market is an anticipated decision which has been studied, checked, approved and planned
long in advance.

The anticipation function is crucial because certain decisions require the company to make commitments
over the long term and are irreversible. In the case of Simple Stores, converting and outfitting stores are
investments that have to be amortised over five or even ten years.

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Anticipating also enables the company to coordinate the various timeframes it has established for rolling
out its action plans. For example, if a company predicts sales growth in a rapidly expanding market, it
is assumed that the company has the corresponding production or supply capacity available. If capacity
is insufficient and will not cover the amount of sales forecast, the company has to think about investing
in new facilities, reorganising its production plants in order to achieve productivity gains, hiring and
training extra staff, etc. At the same time, it has to study the financial consequences of these investment
and hiring policies and make sure that it has sufficient funds to cover future expenses. And if not it has
to find external sources of financing (bank loans, share issue).
In the short term, budget forecasts provide information for managing the supply and distribution chains.
Concerning procurement, if the company negotiates long-term contracts with suppliers in order to keep
its costs down, it must provide them with an estimate of annual orders at the time of these negotiations
and then inform them as quickly as possible of any changes so that they can adjust their output levels
and meet the prices negotiated. Concerning distribution, the business planning process is the occasion
to re-examine distribution channels or to think about new ways and methods of selling (installing
vending machines, negotiating with new representatives, e-business, etc.).
The anticipation function of business planning enables the company to be responsive to changes in the
business environment, to avoid short-term errors and to anticipate difficulties by identifying options for
action.

1.2.2. Regulation
The second function of business planning is to contribute to the regulation of performance (see chapter
1). This provides reference standards which will serve to measure actual performance. The periodic
comparison of actual results with these standards will indicate whether or not the company is on the
right track to reach its objectives. Detecting and analysing variances will allow managers to take the
necessary corrective action to bring the company back on course.
In the short term, budget objectives are milestones which allow the organisation to measure
performance. If the company makes an operating loss, this result needs to be examined in comparison
with the budget objective. Analysing the variance will either reveal an improvement or a degradation
with respect to the objective and can thus give some indication of the trend in performance. Regular
monitoring of the progress of actual results in comparison with the budget reference enables the
company to quickly detect variances and take corrective steps to reach the objective it has set. This
periodic monitoring and control process operate in a loop which is called a “feedback loop” (cf. chapter
1, figure 1.4). The goal of planning is to anticipate difficulties that the company may run into, whether
in reaching its objectives or implementing its action plans. It enables the company to analyse risks: to
what extent will the company’s activities be impacted if the general business environment does not
progress as initially forecast (worsening of an economic crisis, return of inflation, for example), if the
company has to face heightened competition, if its range of products or services does not meet with the
hoped-for success? Setting milestones lets the company compare actual performance achieved with
these references that were defined during the planning stage and alerts managers if need be. Milestones
and references concern results indicators as much as the follow-through on action plans. Considering
different scenarios in relation to these references also helps to identify and evaluate corrective action
that may be implemented if it became necessary to adapt the action plans that were formulated during
the planning phase.

Boxed text 10.4: Simple Stores

After six months of operation, the results are very different for the Paris store and the two other French
stores.
The opening of the Paris store was a great commercial success and sales were 20% higher than the initial
forecasts. Customers loved the sales concept with its very wide range of items, attractive product

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displays, helpful and approachable salespeople, useful advice and extended opening hours (open
weekdays from 10.00 a.m. until midnight).
Outside Paris, the company’s direct competitor decided to counterattack Simple Stores’ offensive move
by starting a price war: a 20% discount was offered on all new products which generally represent
between 30% and 40% of sales depending on the section. This price war reduced the stores’ contribution
expressed as a percentage of sales.
This was not the scenario that Simple Stores had used as a reference for setting up its stores in France.
The fact that they had set milestones in terms of sales growth and profit margins and had set up a system
to monitor these indicators store by store, nevertheless allowed company directors to detect the striking
contrast between the results of the Paris store and the other two stores sufficiently early. The progressive
opening of stores outside Paris allowed them to assess the reaction of the market and the competition.
Right from the anticipation phase Simple Stores had, therefore, imagined the possibility of adapting its
action plans. The success of the Paris store and the gradual opening of stores in the rest of the country
allowed senior executives to retain a certain amount of room to manoeuvre to adjust their retail offering
in other French cities. In response to the difficulties encountered, senior executives can decide to alter
their short-term and medium-term action plans.
In the short term, for stores that are already open and for which rental contracts have been signed for the
use of the selling space, action plans will focus on cutting costs by reducing store opening hours (from
10.00 a.m. to 9.00 p.m., for example) by reducing staff through a policy of greater versatility for
administrative staff and cashiers and by reducing the stock of certain products by transferring inventory
to the Paris store.
Medium-term action plans can also be revised in order to adjust expenses to the lower sales forecasts
and contribution rates. In order to reduce the investments and operating costs of future stores, they can
decrease the amount of retail space, negotiate the rent of commercial locations more carefully and draw
up less costly budgets for converting and outfitting locations, while at the same time trying to strengthen
marketing and sales, for example by developing partnerships with other retailers.

Through this example we can see that operations do not always go as planned, but that the reference to
the budget helps to guide and orient decision making so the company can react as quickly as possible.
The variance analysis methods that we will present in chapter 11, allow companies to take the analysis
further in order to identify the causes of the variances observed. This example also illustrates the
importance of anticipating certain situations, of making simulations and of preparing action plans to
react and make mid-course corrections when it is out of phase with the objective.

1.2.3. Learning
Through business planning the company sets in motion a veritable learning process (figure 10.1). First
of all, detecting and highlighting variances with respect to anticipated results provides some information
about the management of entities which enables the company to adjust or modify its action plans
(feedback loop). Second, a diagnosis of the current situation and surveillance of the business
environment feeds the process of strategic thinking with new information that may lead the company to
reconsider or modify its objectives and strategy (learning loop).

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Figure 10.1 Planning is a learning process

DEFINITION OF MEASUREMENT CONTROL

PERFORMANCE SYSTEM PROCESS

PLANNING
Dimension A Indicator 1 Objectives/Action plans
Indicator 2
Dimension B
Indicator 3
Monitoring results
Dimension C Indicator 4

etc.

LEARNING

Analysing the variances between actual performance and forecasts provides the company with a better
understanding of its business. As we saw before, a decline in results with respect to forecasts is a sign
of possible problems that may require the company to modify its action plans or may justify rethinking
the hypotheses made and the performance model adopted during the formulation of strategy.

Boxed text 10.5: Simple Stores

A year after entering the French market, Simple Stores has recorded significant losses for its first year
of operations. The success of the Paris store did not falter, but in spite of setting in motion new action
plans to reduce operating costs and lower the break-even point for the other French stores, business
remains far below forecasts and the contribution rate achieved by the provincial stores (there are now
four in operation) barely reached 25% of the objective. The price war launched by Simple Stores’ main
competitor was fierce and turnover suffered from this pricing effect. Because of the price war, Simple
Stores was not able to capture the market share it had been aiming for: customers did not switch from
competing retailers in the numbers and proportions expected. Finally, in a context of economic
recession, consumers have become more price conscious and the price war between city centre retailers
has clouded Simple Stores positioning with respect to the book and CD/DVD sections of hypermarkets
and department stores.
This situation has led Simple Stores to examine the business model of its provincial operations and to
rethink its expansion strategy. The experience of operating stores outside Paris has shown that 1500m2
stores are too big for the local market. Moreover, city centre locations in historic or distinctive buildings
are costly because the rent, the initial investment to convert the property and maintenance costs are all
high. Finally, the extended opening hours are not justified; the volume of sales after 8.00 p.m. is
relatively low. This information has prompted senior management to modify its concept for new
locations to be opened and to opt for smaller stores (from 700 to 1000 m2 maximum), preferably in

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shopping centres on the outskirts of town, reduced opening hours (10.00 a.m. to 9.00 p.m.) and a
simplified range of products, adapted to the local market.

This example shows that organisational learning is based on the analysis of the hypotheses and
performance model that were used to establish forecasts. In the case of Simple Stores, the model adopted
in the initial strategic plan was that of the Paris store, but as it turned out, this concept did not work in
the provincial stores and consequently must be rethought and adapted to local market conditions.
Organisational learning is fed by an ongoing process of variance analysis with respect to the
performance model and the hypotheses made during the planning process. This is one of the key factors
in the planning process because it allows the company to rethink strategy in order to ensure coherent
and lasting development. The planning process can be said to be a veritable “learning machine” in that
it contributes to managing the activity, controlling costs and profits, limiting risk and gaining knowledge
of the business environment.

1.2.4. Financial communication

Anticipation, regulation and organisational learning are three fundamental functions of business
planning. Planning also constitutes a tool for internal communication and coordination as well as
external communication with the company’s financial partners. We will look at coordination issues
associated with business planning in part 1.3 below. Here we will focus on a few issues of business
planning in relation to the company’s external financial communication.
Business planning ultimately allows the company to make estimates for a few key financial variables
on different time horizons. These estimates provide some answers to fundamental questions both for
senior executives and for financial partners: shareholders, bankers and creditors, as well as suppliers
who may extend credit to the company through agreed terms of payment or who may make a multi-year
commitment to work with the company. For example, is the company able to meet its debt obligations
both in the short term and in the longer term? Does it possess the financial resources needed for its
development or is it able to raise these funds? Can it offer a satisfactory return to its shareholders over
a long period?
Planning is used to anticipate the level and progression of economic results and to assess the capacity
of the company to generate cash flows and thus validate its investment initiatives while ensuring the
overall financial balance of the company. Being able to communicate robust and realistic financial
information helps to build the confidence placed in senior executives by the company’s financial
partners. These financial forecasts enable financial partners to make their own analyses, to discuss
hypotheses and underlying action plans, as well as the performance objectives announced with senior
company executives in order to better understand the characteristics of the company’s various lines of
business, its strategic orientations and its priorities.
However, the company’s financial partners will have different expectations depending on whether they
are shareholders of a listed company, investors represented by a venture capital company or financial
institutions.
Fund managers and financial analysts attach particular importance to the quality of the reporting system
of publicly traded companies. Quality financial information is reliable, detailed, quickly updated and
disseminated and transparent. Owing to changes in European regulations,33 companies are less inclined
to publish results forecasts because in order to do so they also have to publish the details of the
hypotheses which led to these forecasts, which would raise serious problems of confidentiality in most
situations. Consequently, analysts and investors no longer expect published forecasts as such. Instead,
they develop their own financial models based on the publication of past results, projects announced by

33
See in particular the consequences of European regulation nº 809/2004 of 29 April 2004.

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the company and operational data on the company’s activities. The people involved in the company’s
financial communication – top management, the finance department, managers in charge of investor
relations – are therefore responsible for managing the anticipations of financial market players and
bringing them into line with their own anticipations regarding the company’s future results.
Companies whose capital is held by venture capital companies are not confronted with these issues
regarding the formal compliance with the principle of equality of access to information for all financial
market players. On the contrary, for their executives it is important to be able to draw up business plans
for a multi-year timeframe and to present them effectively to the company’s shareholders or their
representatives. The aim of these presentations is to convince investors that their objectives are realistic,
that their strategic orientations and priorities are suitable and effective, and that company executives are
able to implement these priorities and achieve the announced objectives. Business planning is thus an
opportunity for investors to evaluate the credibility of the company’s senior executives: the ability to
anticipate and make projections and the ability to achieve what has been planned.
For financial institutions and other creditors, it is important to be able to assess the liquidity and solvency
of the company, in other words its capacity to meet its financial obligations in the short and medium
terms, respectively. Consequently, lenders expect the senior executives to communicate annual and
multi-annual forecasts in addition to past results. This means making sure that the company’s business
activities will be able to generate sufficient cash flows to service its debt (interest payments and
reimbursement of capital borrowed), given the development initiatives envisaged and, moreover, that
the company has sufficient assets to guarantee their debts in the event of liquidation. The planning
process is therefore important as it allows senior executives to formulate their strategy in a clear fashion
and present realistic data on future results.
Whatever the financial partners concerned, it is clear from these examples that financial communication
is not confined to the publication of financial forecasts, but also concerns the strategy, projects and
operational priorities of the company. The planning process, including the formulation of action plans
for the organisation’s different timeframes, helps the company achieve the function of financial
communication.

Boxed text 10.6: Simple Stores

The losses incurred by the two provincial stores have seriously harmed the consolidated results and cash
reserves of the company. Confronted with these circumstances, Simple Stores has to find funds to bolster
its short-term cash flow situation. First of all, it negotiates a new payment schedule and longer terms of
payment with its suppliers.
It then applies to banks for lines of credit. Before approving any credit, the banks analyse the company’s
results in detail and carefully study its plan for turning the situation around, the feasibility of its proposed
corrective measures and whether its financial forecasts are realistic. The quality of financial projections
and sensitivity analyses are key factors in the bankers’ decision, but they are not the only criteria used.
The credibility of the management team and belief in their ability to successfully carry out their
restructuring plan are also assessed in the decision-making process.

Functions linked to company organisation

The complexity of companies makes the delegation of decision making and responsibilities inevitable.
The planning process is a way of contributing to decentralisation:
- by ensuring that the company’s local objectives are consistent with its overall objectives: this is the
strategic alignment function;
- by overseeing the coordination between the different responsibility centres: this is the horizontal
coordination function;

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- by orienting managers’ behaviour and decisions toward the achievement of the organisation’s
objectives: this is the motivation and incentive function.
In this section we will study these three functions of the planning process.

Strategic alignment
During the planning process the company defines its overall strategic objectives which are then
translated into specific orientations for each of its entities. In preceding chapters, we saw how to define
the nature of the organisation’s overall objectives and how to translate them into the type of contribution
expected at the level of the entities. This is the first dimension of strategic alignment. In addition to the
question of building performance measurement systems, there is also the problem of cascading long-
term objectives – normally set at the level of the organisation – into short-term targets at the level of
each of the entities. The question of strategic alignment is therefore twofold: achieving consistency
between both performance dimensions and targets across the different levels of the organisation.
Thanks to this approach, the organisation is “powered up” and top management conveys its vision of
the business and communicates objectives to members of the organisation to be integrated at their level.
Specific objectives for each entity are generally the result of negotiations between top management and
the entity managers in order to reach an agreement and a compromise on the targets to reach and the
allocation of necessary resources. This process, which can either be bottom-up or top-down, defines
objectives that are consistent with strategic choices and coordinates the action plans of the organisation’s
different entities.
The planning process stimulates dialogue within the company and gives rise to meetings and discussions
between the managers of divisions, entities and different responsibility centres in which to debate, at
least once a year, the future of the company and the action plans to be set in motion. In some companies
this is an opportunity for managers to meet with senior executives and discuss the previous year’s
performance and also give their opinion on the company’s business activity and environment. Planning
is an instrument for integration that mobilises the company around overall objectives, using a common
management language so that everyone understands each other and reasons from a common basis.
In a top-down process, the executive management level imposes its vision on the managers of the
different entities who are then responsible for implementing it. Head office determines most of the
objectives for the divisions that are directly attached to it. In turn, the manager of each division sets
objectives for the entities and responsibility centres that report to him, whose managers are likewise in
charge of conveying them to lower levels. This procedure guarantees the strategic alignment at every
level and saves time in developing action plans. On the other hand, it can undermine the motivation of
managers who have not been consulted beforehand and who may therefore consider that the objectives
are not realistic and that it is hard to formulate action plans to attain them.
In a bottom-up process, the managers of lower levels participate in business planning and propose
objectives and action plans which are then consolidated at higher levels and then finally at the executive
management level. This participative approach is probably more motivating for the managers involved
who have more latitude for conceiving their objectives and corresponding action plans. The active
participation of managers also helps to build more reliable projections because they have a better grasp
of their activities and know their business environment particularly well. Furthermore, the bottom-up
approach fosters managers’ creativity. It does however have several limitations. First of all, there is the
temptation for managers to suggest objectives that are easy to reach. This procedure also has the
drawback of being relatively slow because it requires a lot of back and forth consultation; multiple
discussions and exchanges of views between hierarchical levels are necessary to arrive at a compromise
to finally ensure that local objectives are consistent with the company’s overall performance objective.
As a result, time is an important constraint in a bottom-up approach. If managers do not reach an
agreement on objectives in the amount of time allotted, senior management may have to step in and
arbitrate and impose its point of view on local objectives, which again runs the risk of adversely affecting
managers’ motivation.

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Boxed text 10.7: Development of a strategic plan at Rodix plc

Rodix plc is a large industrial corporation, a leader in specialised chemical products, made up of five
international divisions and operating in 25 countries. The company employs more than 10 000 people
and has a turnover in the region of 4.5 billion euros. In such a corporation, business planning helps to
ensure the strategic alignment of the company’s objectives.
To begin with, the procedure is top-down: executive management communicates the strategic
orientations it has decided upon to the divisions. These are then cascaded down by the divisions to the
operational units. These objectives are taken under consideration and the manager of each entity
formulates action plans.
Next, the procedure is bottom-up: operational entities submit the strategic plans (objectives, detailed
action plans, performance indicators, financial projections and cash-flow analyses) that they have
worked on to the next hierarchical level up which checks and approves them and then sends them on to
the company’s executive management. The various strategic plans are then consolidated at this level.

Figure 10.2 Strategic alignment of objectives and action plans

Executive management

T Statement of B
O orientation O
P T
- Divisions T
Objectives
D Action plans O
O Performance indicators M
W Financial projections -
N Cash flow U
Operational P
Units

In general, companies adopt a compromise between top-down and bottom-up procedures, as we have
seen in the above example. The top-down procedure helps to ensure the homogeneity of the plans with
strategic options and the soundness and realism of the actions proposed in relation to the company’s
overall objectives. The bottom-up procedure seeks to maintain the motivation of managers and make
good use of their knowledge and know-how. The various parties must work together for the planning
process to be an effective and motivating tool and not rigid or restrictive.
Strategic alignment can go as far as the definition of individualised objectives. As we have just seen,
business planning can be used to express long-term strategic objectives as objectives and action plans at
the level of the entities and then translate them into individualised objectives and action plans.
Individualised objectives can be used to devise incentive schemes (see §1.3.3). This process is illustrated
by the “Ambition to Action” programme developed by Statoil.

Boxed text 10.8: The planning process at Statoil

The Norwegian petrol company Statoil has set up a planning programme called “Ambition to Action”,
with the aim of translating its long-term strategy into concrete, individualised actions. The programme
is decentralised and each company entity carries out the process of translating the strategic objectives at
its level. The planning principles are as follows:
- Overall strategic objectives are defined and express the company’s medium-term ambition. These
objectives are reviewed twice a year and can also be reviewed exceptionally at other times
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depending on the circumstances. Strategic objectives mark out a precise direction which guides the
company in its actions.
- Overall strategic objectives are translated into strategic objectives at the level of each entity in the
company.
- Next, the managers of each entity devise performance indicators with which to track the
implementation of their strategy. They formulate and validate the action plans that will enable them
to reach their objectives. The choice of indicators and the development of action plans are closely
linked to the construction of objectives. Indeed, the company’s chief executive considers that the
right performance indicators and appropriate action plans will only be determined if the objectives
are fully understood and properly interpreted.
- While the entity’s objectives and action plans are being validated, the objectives of managers are
defined at the same time.

Figure 10.3 Ambition to Action

Source: Bogsnes (2009)

Horizontal coordination
Executive management has to make sure that action plans are coordinated between the different entities
because responsibility centres have activities that are often interdependent and interests that are
sometimes contradictory.
The planning process enables them to resolve any dysfunction and make sure that the actions planned
by the various responsibility centres are consistent with each other. It also serves to identify and harness
possible synergies between activities.
During the planning process, the general objectives of the company are divided up according to the
hierarchy of responsibility centres (vertical coordination). The objectives of the different hierarchical
levels are not necessarily of the same nature and are defined in relation to the responsibility centre’s
activity. For example, the sales department has two units under its authority: marketing and the sales
force. The sales department’s objective is to increase turnover. For marketing, this objective is translated
into an objective of cost optimisation (advertising campaign expenses) and for the sales force the
objective is the volume of sales to be made (number of units sold). The two objectives are heavily
interdependent but may be contradictory: diminishing certain advertising expenses may hurt sales while,

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inversely, a good campaign will help to increase them. Coordination between the managers of these
units and with their hierarchy is therefore indispensable.
Business planning helps to achieve coordination across the activities of the company by ensuring the
coherence of objectives and associated action plans, for example, sales, production, procurement and
logistics. Cross-functional coordination causes responsibility centres to negotiate objectives from a
common point of view. For example, the commercial division has to make sure that the production
division has enough capacity to produce the units needed for sales. At the same time, the production
division has to consider achieving productivity gains by improving maintenance, in order to meet the
increases planned for production and sales. The objective of increasing the volume of sales reveals this
interdependence between the objectives of the different entities. If the production division does not have
the means to increase its capacity, then the sales division may not be able to meet its objectives.
Communication and dialogue between divisions is therefore indispensable in clarifying objectives and
properly coordinating the actions to be set in motion. This communication has to be organised during
the planning phase to promote the exchange of information and ideas between departments – which are
sometimes compartmentalised – and get them to work together on different scenarios that will enable
them to converge on the overall objective. The aim of these discussions is to adopt the best action plan
for each of the responsibility centres.

Boxed text 10.9: Five-year action plan at Rodix plc

Rodix’s five-year strategic objective is to become the leader on its market. To accomplish this objective,
it is considering the following actions: strengthening Rodix’s position on existing markets, developing
new products, improving the efficiency of its supply chain, reorganising the company and reducing
costs.
The first action to consolidate existing markets concerns an objective to increase market share by 30%
over the next five years. In order to achieve this, the company has to sell 4000 extra tonnes of product
in the next two years and launch a marketing campaign. The “Sales” division is in charge of prospecting
for and finding new customers and the marketing department has to launch a promotional campaign.
The company’s sales volume objective can only be reached if the “Production” division is able to supply
the 4000 extra tonnes (horizontal coordination). The production objective is translated into more local
actions for the maintenance department in charge of increasing the output of machines to produce 1000
extra tonnes and for production plant #1 to reorganise its batches in order to free up capacity and
manufacture 3000 extra tonnes (vertical coordination).

Figure 10.4 Horizontal coordination at Rodix

INCREASE MARKET SHARE +30%

Production: + 4000T. Commercial: + 4000T.
Maintenance: increase output Sales: find new
+1000T. customers
FIVE-YEAR Workshop 1: reorganisation Marketing: advertising
STRATEGIC of batches +3000T. campaign
PLAN:
TO BE THE
MARKET LEADER
DEVELOP NEW PRODUCTS

IMPROVE THE SUPPLY CHAIN

At the end of the planning phase, decisions concerning the allocation of resources often reveal
underlying conflicts between responsibility centres. It is up to senior management to weigh in and decide
between action plans and the allocation of resources for the departments under their control.

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Coordination between entities is necessary during the planning phase and must be continued during the
stage of monitoring progress: the interdependence of activities makes it crucial to carry out a cross-
departmental analysis of the causes of any variance and provide a coordinated response to the problems
identified, with the support of senior management if necessary. Let’s take the example of a purchasing
department that is assigned a cost reduction objective. This department negotiates with a new supplier
to buy a certain kind of raw material at a lower price, but of inferior quality. This lower quality material
leads to a greater number of defective products which slows down manufacturing and increases
production costs. The purchasing department met its objective, but to the detriment of the production
department. It is therefore necessary for the two departments to analyse the consequences of any
operations planned and take corrective action together to turn the situation around.

Motivation and incentives

Controlling performance objectives depends largely on the dedication and involvement of members of
the organisation. How can these members be made to work together in a coordinated way and in the
interests of the company? One of the key issues in business planning is how to guide behaviour towards
coordination in order to achieve local objectives that are in phase with the company’s overall objectives.
Here we will present the incentive function through short-term business planning, i.e. within the
framework of budgeting,34 given that incentives often appear to be more powerful when the objective to
be reached is not too distant.
At the level of the individual, the budget represents an operational manager’s commitment to achieve
an objective by following an action plan he has formulated, which has been negotiated and which has
been approved by his superiors. By setting ambitious and motivating objectives the budget has an
energising effect on managers. It includes a formal obligation to produce results and can be seen as a
contract between an operational manager and his superiors (see chapter 6 on the contractual principle).
However, this objective is not only expressed in financial terms; it is often expanded to include the
achievement of non-financial targets which constitute operational performance levers, as we saw in
chapter 9.
The budget is motivating because the value of the people involved in its building is recognised and
because they are held accountable for their performance. Its power to motivate is affected by the amount
of involvement and the influence of managers in determining their own budgets. Consequently, as we
pointed out earlier concerning strategic alignment, a bottom-up procedure for setting objectives is
generally more motivating for operational managers than a top-down procedure.
However, the level of motivation also depends on the feasibility of the objective and how much control
managers have over it. The results of a study comparing motivation to the difficulty of objectives
(Merchant, 1998) show that the easier an objective is to attain, the less motivating it is.

34
We will describe budgets and the budgeting process in detail in the second part of this chapter.
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However, starting from a certain level of difficulty, motivation increases until it reaches level A (figure
10.5) where individuals begin to perceive their own limits in terms of their education, training and
professional experience. If the degree of difficulty is too high, individuals become discouraged, make
less effort and abandon their commitment. The highest level of motivation is obtained when objectives
are situated at an intermediate stage where they represent a challenge for employees but also remain
within reach.

Figure 10.5 Performance target achievability and motivation/performance

Motivation
/
performance

Easy A Impossible
Performance target achievability

Source: Merchant (1998)

Setting ambitious objectives to optimise the motivation of organisational members is, therefore, in itself,
a managerial issue.
What drives motivation is partly linked to the compensation scheme and career progression policy of
the company. Other, less formal, incentive schemes such as praise and recognition also help to maintain
motivation levels. In addition to these extrinsic factors of motivation, employees can find intrinsic
motivation in accomplishing their work, which is a source of satisfaction for them and positively
reinforces their identity. Nevertheless, achieving budget objectives remains a reference for evaluating
employee performance and determining financial bonuses in many companies.
Incentive schemes are not only based on the achievement of individual objectives; they also include a
component which is linked to the accomplishment of the objectives of the entity or even the company
as a whole. Incorporating overall objectives into the remuneration system incites employees to work in
the collective interest.

Boxed text 10.10: Determining managers’ bonuses at Rodix plc

The payment of managers’ bonuses depends on the achievement of individual objectives, local financial
objectives and company-wide financial objectives. The respective weight of each of these components
in the bonus calculation is 33%.

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Individual objectives concern workplace safety and other goals such as the professional development of
employees, innovation, the management of Free Cash Flow35 (FCF) and other company priorities.
The entity’s financial objectives pertain to improvement in indicators such as EVA and FCF. Depending
on the responsibility centre and the degree of control it exerts over the indicator, EVA and FCF may be
calculated at the level of the company, the division, the region or the entity.
The definition of collective objectives concerns the achievement of the company’s overall performance
objective and its outperformance of its direct competitors in the areas of ROCE, TSR and FCF.

In addition, the budget guides the behaviour of employees through action plans. In this sense it may be
considered as a stabilising element in that it provides a secure frame of reference in an uncertain
environment. This is also why the budgeting procedure is a kind of management ritual that takes place
at the same time every year and reassures people vis-à-vis the future, especially concerning financial
aspects.

Theoretical difficulty: incompatibility between functions

As we have seen, the business planning process performs various functions: anticipation, regulation,
learning, communication, coordination and motivation. These multiple roles may at times be
contradictory and conflicts can appear between regulation and motivation, between coordination and
motivation and between organisational learning and motivation36. As these conflicts involve the
incentive function, which we have seen is more powerful in the budget, we will focus here on the
budgeting process.
One source of conflict appears when the hypotheses that were used to set objectives at the beginning of
the year are no longer relevant. In this case does it make sense to adjust the objective? Following the
logic of regulation, the answer would have to be “yes”. It is essential to adjust the allocation of resources
to avoid the creation of imbalances: a cash-flow crisis, over- or under-staffing, excess or insufficient
inventory, for example. The coordination function will lead to the same answer: modifying the
objectives will require both objectives and action plans to be re-coordinated for all of the company’s
entities. If we consider the incentive function, however, the answer is not so clear: in order to be fair,
objectives should be adjusted to changes in the business environment. This is also what is prescribed by
the controllability principle (presented in chapter 6 concerning performance measurement in
responsibility accounting). If the objectives are not revised, then managers may feel frustrated and lose
their motivation when they see that, in spite of the efforts made, the objectives remain out of reach owing
to situations or events beyond their control. At the same time, however, care must be taken not to
compromise the role of the budget in the motivation process. If managers know that their objectives may
be revised during the course of the year due to unexpected events, they may be inclined to make less
effort to achieve them and the motivation factor will therefore be less powerful.
The horizontal coordination function can also conflict with the incentive function. Indeed, assigning
individual objectives can strengthen motivation of the people concerned, but may also increase the risk
of compartmentalisation which is very harmful to the company when the performances of entities are
highly interdependent.
Other incompatibilities may exist between the vertical/horizontal coordination functions and motivation.
We have seen that the budget objective is determined during negotiations between managers and their

35
Also known as net cash-flow, i.e. the cash-flow remaining after financing investments and growth. This financial indicator, along with EVA,
TSR and ROCE, which also appear in this example, are presented in chapter 3 of this book.
36
For a detailed analysis of these oppositions, see “Should We Deep-Six the Budget?”, The Art of Management Control, Giraud et al.,
Pearson,Paris, 2011.

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superiors. The result of these negotiations is therefore crucial for managers because very often their
variable remuneration and/or promotion in the company depend on achieving the objectives decided. It
is in the interests of these managers to put forward objectives which they believe are easy to attain. In
practice, situations of information asymmetry often occur and as a result hierarchical superiors rarely
possess all the information needed to assess the difficulty of the objectives and action plans proposed.
In seeking to maintain these asymmetries of information, local managers may be tempted to hide
information that is important for the coordination of the company’s overall objectives or horizontal
coordination and thus harm the organisation’s overall performance.
Similarly, the organisational learning function requires great transparency in the communication of
information, both for determining objectives and for monitoring the implementation of action plans and
measuring results.
Strong incentives, even more so when they are combined with very ambitious objectives, may cause
local managers to be reluctant to communicate all the information they have at their disposal or they
may hold on to it so that it arrives late. It will then be harder to analyse and understand the causes of
variances and take the necessary corrective decisions.

Section 2. Operational implementation

Having examined the purpose and goals of business planning, in this next section we will look at how
it is carried out operationally. We will begin by examining the various time horizons covered by the
planning process and coordination between the long term and the short term. Then we will narrow our
focus to the short term, i.e. the way the budgeting process is carried out and the main practical difficulties
that companies may run into in preparing their budget.

Business planning over time

The purpose of business planning is to define targets, to formulate suitable action plans and to allocate
the resources needed to achieve them. The planning horizon will differ depending on the nature of the
objectives and the timeframe needed to implement them. In the energy sector, for example, the
construction of a generating station represents a 20 or 30-year commitment for the company, while in
the service sector tangible investments have shorter lifespans. In practice, business planning is made up
of three main planning cycles: the strategic plan, the operational plan and the budget, which correspond
to different planning horizons: the long term, medium term and short term, respectively (figure 10.6).

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Figure 10.6 The planning process

The strategic analysis process constitutes the starting point of the business planning process. It consists
in analysing the company’s strengths and weaknesses with respect to the opportunities and threats of its
economic, technological and competitive environment. If the company or activity under consideration
already exists, the strategic analysis will include an analysis of past results; the context is then that of an
organisational learning process. If a company is being formed or a new activity launched, the strategic
analysis will be carried out in absolute terms. In every case, the strategic analysis process leads to the
development of a strategic plan, which constitutes the starting point of the planning process.
The strategic plan expresses the company’s main strategic orientations. Based on these orientations,
company executives then set targets that they intend to reach in the long term. In addition to setting
long-term objectives, strategic planning also includes the development of long-term action plans which
often involve setting up new operations, innovations and the acquisition of companies to promote
external growth, among other projects. The decisions taken in the context of the strategic plan commit
the company to a distant time horizon with many uncertainties. The principle difficulty of long-term
planning lies in finding the best compromise between anticipation and risk. This causes executives to
consider different scenarios and hypotheses and to carry out sensitivity analyses that will help them
prepare for different eventualities.
The objectives and action plans defined in the context of the company’s strategic plan are not only
financial in nature. More and more often, objectives flow from the mission statement (What do we want
to be?) and the vision statement (How are we going to fulfil our mission?).

Boxed text 10.11: The objectives of Transpublic

Transpublic, a company specialised in urban public transport, has defined its mission and its vision, as
well as its values within the context of its strategic plan for 2008-2012:
- Mission: “To be the most socially profitable transport option and the closest to passenger
expectations.” The company’s mission reiterates two main strategic orientations: first, to constitute
a sustainable public transport option that is socially, economically and environmentally profitable
for the entire community; second, to be the option that is closest to the needs and expectations of
present and future passengers.
- Vision: the vision is made up of action plans designed to accomplish the company’s mission. First,
plans concerning passengers are built around the excellence of the service provided and user

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satisfaction. Second, plans are aimed at improving and developing the network. Finally, some
actions concern complementary activities such as travel advice and concessions.
- Values: the behaviour of employees should be guided by values. These are established at the
corporate level (excellence of management, public service, dynamism and innovation), the
organisational level (orienting behaviour towards the achievement of results, contribution and
development) and the personal level (professional integration, teamwork, pro-activeness and
participation).
Working from the bases laid down in the strategic plan and according to perspectives inspired by the
balanced scorecard (see chapter 8), the company has set objectives that will enable it to accomplish its
mission. A selection of objectives and corresponding action plans is given in the table below.

Table 10.3: Selection of objectives for Transpublic

Perspective Objective Action plans

Value Attract customers and Broaden the transport offering by expanding the
build loyalty hours of service so as to reach new customer
segments.

Customers Excellence of the service Provide passengers with quality service (safety,
provided speed, comfort, information).
Develop the quality of infrastructures (appearance of
stations, extra information).

Internal Improve accessibility Facilitate access to the network for handicapped

processes people, parents accompanied by small children
(pushchairs) and passengers carrying luggage.

Improve maintenance Reliability and cost efficiency of maintenance for

efficiency infrastructure and transport equipment.
Internal Improve network Avoid incidents and optimise energy consumption.
structure management Develop new projects within budget and on
schedule.
Stimulate the professional Develop managerial qualities and technical
development of employees competencies and build knowledge of the business.

The strategic plan describes the long-term future desired for the organisation. Objectives derive from a
thorough, in-depth reflection and require a good knowledge of the company and its potential, as well as
environmental factors (macro-economic, political, social, commercial, technological and financial
factors). Given the turbulence of the economic context and the uncertainty of markets in the long term,
strategic planning involves making rolling plans. Every year, depending on new information on the
business, on performance and on environmental factors, the long-term objectives are adjusted and
strategic plans are updated.
The operational plan covers the medium-term time horizon – generally three years – and serves to
coordinate the long term with the short term at the organisational level. It also serves to make the
objectives defined within the framework of the strategic plan more concrete. The action plans defined
in the operational plan concern decisions whose operational consequences reach beyond the one-year
timeframe and involve irreversible elements such as investment in new production facilities or setting
up a new product distribution policy. The operational plan includes financial forecasts – more detailed

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than those of the strategic plan – which help to ensure the economic and financial balance of action plans
and to assess capital needs. However, given that the strategic plan covers a timeframe which for many
companies is getting shorter and shorter, it seems the operational planning stage is being blurred more
and more into the strategic plan.
The budget is the detailed expression of the operational plan for one year. It is expressed, for instance,
in terms of sales objectives or production cost per product. It is set for the short term, which is the most
reliable part of the plan. Budgets are employed at the level of every entity in the company. These are
not mere forecasts; as we saw above, they express the commitments and the ambitious, pro-active
attitude of managers to achieve annual performance objectives. Once approved, the budget serves as a
frame of reference, both financially and operationally, for evaluating future results and directing the
company and, at the personal level, for devising incentive schemes for managers. Monitoring the
progress and results achieved enables managers to oversee the execution of action plans, to highlight
variances with respect to targets and to oversee the allocation of resources in relation to the plans.

Boxed text 10.12: Business planning at a large company in the construction sector

The starting point in the planning process is a five-year plan that is prepared during the second quarter
and updated every year.
Drawing up the five-year plan is an exercise of particular importance from a strategic point of view.
During its preparation, which is done by product line and by market, the following points are discussed:
- the analysis of strategic areas;
- the development of new lines of business. For the construction division, for example, the company’s
vision on topics such as the natural environment and energy savings are taken into account;
- technological innovation needs;
- investment and divestment decisions (where? which line of business? when? how much?);
- finance needs.
There is a tendency when formulating the plan to limit the expression of objectives in the form of
financial indicators but to favour information in strategic action plans. Financial models are used to
study the various possible scenarios, to review alternative scenarios and to select the one that best fits
the company’s strategy. Thanks to this very complete strategic analysis, the planning process reduces
the time needed to make decisions.
The first year of the five-year plan contains the strategic objectives of the following year and serves as
a basis for building the annual budget.

Through the planning process then, the long term is connected to the short term. The strategic plan serves
as the starting point for the operational plan, which in turn constitutes the basis for building the budget.
The coordination between the various planning horizons should ensure a good fit between the actions
undertaken and the long-term strategic objectives of the company.
The strategic plan is usually established during the first quarter of the year, the operational plan is built
between June and September and the budget is prepared during the final quarter of the year. The strategic
and operational plans are generally formed at the level of the company as a whole or at the level of the
divisions. The budget, on the other hand, is more detailed and is prepared at the level of the responsibility
centres.
Depending on the timeframe under consideration, the functions of business planning that we presented
in the first part of this chapter do not all have the same importance. For example, the anticipation
function is given great importance in the context of the strategic plan, as is the organisational learning
function, which may cause the company to review its hypotheses and performance model (see figure
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10.1). The coordination function neither takes the same shape nor has the same operational intensity
depending on the time horizon we are considering. Although the strategic planning process is mainly
carried out at the level of the company’s top management, its relevance nevertheless rests on information
and specificities coming from “the field”. As we move closer to the short-term time horizon, business
planning moves down to the smallest level of the organisation. The coordination function then ensures
the convergence and coherence of objectives at the level of the different entities. The regulation and
organisational learning functions serve to guide the company’s progress by quickly taking suitable
corrective measures in the event of variances. Finally, as we have already mentioned, the incentive
function is more powerful in the short term, which may constitute a barrier by focusing the attention of
employees on short-term results to the detriment of medium- and long-term performance.

The budgeting process

We will now study the short-term part of the planning process: budgeting. The goal of budgeting is to
identify action plans that are consistent with organisation-wide performance objectives and then
translate organisation level action plans and objectives to the local level of entities and coordinate them.
The issues involved in budgeting concern the analysis and validation of objectives and action plans
which will serve as a frame of reference for monitoring the business within the context of the budget.

2.2.1. The budgeting procedure

The budgeting procedure is an organised process that is orchestrated by the management control
department in collaboration with executive management and involving all the company’s responsibility
centres. It is important to involve all the entities in the procedure because this fosters thinking about
action plans and encourages the sharing of different points of view as well as dialogue between managers
on action plans and not only on financial forecasts. The starting point in the budgeting procedure is
usually a set of budget guidelines that is addressed to the managers of all the company’s entities. These
guidelines set out the main strategic directions for the coming year and give indications to follow in
preparing the budgets.

Preparation
In the first phase of the budgeting procedure, executive management sets the objective for the coming
year as well as the policies and directions that operational managers will have to follow. In general, the
objective adopted is derived from the strategic planning process. However, long- and medium-term
planning will have been done several months before the budgeting process begins and certain parameters
in the external environment and within the organisation may have changed. In the preparation phase, the
company has to analyse the results in progress and examine environmental data in order to situate itself
in its short-term economic and competitive context and identify threats to be faced (the emergence of a
new competitor, a decrease in consumption, etc.) and the opportunities to be seized (diversification,
innovation, technology).
The diagnosis of the current situation provides elements for analysing the company’s strengths and
weaknesses in the area of sales (product range, pricing policy, distribution channels), operations
(production facilities, investment policy), finance (cash flow), logistics and human resources in order to
strengthen its assets and correct its weaknesses.

Boxed text 10.13: Condor Voyages

As of September 20n, Condor Voyages, a network of travel agencies, which is the leader on the French
market, has changed ownership – there is a new shareholder. The company’s top management is in the
middle of its annual reflection and preparation for the budgeting process. The following year, 20n+1,
will be complicated because Condor Voyages is under heavy pressure from its suppliers: they are
increasingly developing direct sales and have just announced changes in their remuneration system –
less favourable for agencies – which are to come into effect on 1st January 20n+1. On top of that, the
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new shareholder is expecting return on equity to be optimised. Given these circumstances, before
launching its budgeting process, Condor Voyages must study the impact of the announced decrease in
remuneration by suppliers on its operating margin and consider ways of improving the profitability of
the agencies. First of all, it needs to make financial forecasts in order to measure the impact of the
suppliers’ new remuneration scheme and devise new action plans that initially focus on short-term
action. After carrying out several analyses and financial simulations based on the main variables of the
company’s business model, the head office of Condor Voyages takes the following decisions in
preparing its 20n+1 budget:
- discontinue low-profit products such as train ticket sales;
- charge customers a processing fee to offset the decrease in remuneration from suppliers.
At the same time, head office launches an analysis of its cost structure in order to ascertain profitability
by type of product/service, by supplier and by point of sale, with the aim of building a new business
model. This study will take time and the results will not be taken into account until the start of the
following financial year.

The learning and regulation functions in the planning process allow the company to review the set of
hypotheses used in planning, to formulate an initial approach for the policies to be implemented in the
coming year and perform simulations of key performance indicators in order to assess whether the
objective set in the budget can be achieved. As a result, top management is able to provide operational
managers with a useful framework and guidelines for the remainder of the management process.

How the budgeting procedure is carried out

Formalising the budgeting procedure serves to:
- describe the role of each of the participants in the process (top management, controllers, operational
managers);
- define the structure and nature of the documents that have to be provided to reach a coherent
consolidation (consistency of concepts and content of the categories used);
- establish the level of detail needed in information (the kind of data expected);
- ensure that a shared management vocabulary is used (dictionary of the categories used and technical
definitions).
One of the essential components of the budgeting procedure is to draw up a calendar with deadlines
along the entire process and to ensure that they are met.
The budget horizon – usually one year – matches the duration of the financial or fiscal year. The
reference period can be different depending on the constraints of the environment. The budgeting
procedure usually mirrors the annual timeframe (figure 10.7).

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Figure 10.7 Sequence of events in the budgeting procedure

Generally, the procedure begins in September when the budget guidelines are issued and the first
versions of the entities’ budgets are consolidated in late October/early November. The budget building
cycle ends in December with the definitive approval of the budgets, before the start of the new financial
year. The later the procedure starts, the more accurate the annual plans and budgets are because the
company will have access to updated information on economic parameters and the actual performance
of the current year. It should not begin too late however, because time must be allowed for reflection
and discussion in choosing and validating action plans, the negotiation of objectives between
responsibility centres and the back-and-forth budget negotiations that are necessary so that the decisions
taken will be the least arbitrary possible.

Budget guidelines
Issuing the budget guidelines signals the start of the budgeting procedure. They are transmitted
hierarchically to all the responsibility centres in the company. Based on scenarios in the strategic plan,
they express top management’s expectations concerning operational objectives (e.g. productivity,
market share) and financial objectives (e.g. operating income, ROI, EVA) for each entity. They also
define economic hypotheses made (economic growth, growth of the company’s sector, inflation rate,
interest rates, etc.) as well as the procedure to follow (everyone’s role, concepts and definitions, models
to observe, calendar). This document also sets out the policies to be adopted: compensation policy, hiring
and staff assignment policy, sales policy, changes in general and administrative expenses, investment
and finance policies.
Before drawing up the budget guidelines, top management and controllers will have performed an initial
simulation of the budget to establish the expected orientations, to analyse sensitivity to variations in the
environment and to establish a coherent set of general hypotheses (figure 10.8).
The budget guidelines tell the responsibility centres what is expected of them and guide them in
designing the action plans and activity programmes that will culminate in a budget proposal.

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Figure 10.8 Budget guidelines

ECONOMIC SITUATION STRATEGIC PLAN

AND SHORT-TERM MARKET STUDY –
CONSTRAINTS RESEARCH

GENERAL OBJECTIVES:
HYPOTHESES:
PERFORMANCE LEVEL,
GROWTH, EXCHANGE
OPERATING INCOME,
RATES, SALARY
MARKET SHARE,
INCREASES,
PRODUCTIVITY, CASH
INVESTMENTS
FLOW

BUDGET SIMULATION

BUDGET GUIDELINES: Objectives of the main responsibility centres, economic hypotheses to consider, policies for
the coming year

The purpose of the information contained in the budget guidelines is to organise the budgeting procedure
and limit the number of back-and-forth iterations in the negotiation phase. In addition, the budget
guidelines are intended to guarantee vertical and horizontal coordination.

2.2.2. The budget-building process

Once the budget guidelines have been transmitted to the divisions and responsibility centres, we enter
the phase of building the budgets of the different entities. Their managers have to build coherent systems
of local objectives/action plans. Local objectives have to be aligned with the company-wide objective
set by top management and the action plans have to be coordinated with those of interdependent entities.
In the first part of this book we saw the principles that guide the choice of a good objective. Here we
will follow the principles for setting the corresponding target. A target must be SMART (Specific –
Measurable – Achievable – Realistic – Time-bound), in other words:
- Specific. This means that it is explicit, clear and precise. For example, company Y sets an objective
to achieve a market share of 15% for a given product by 31 December 201x.
- Measurable. The objective has to be followed with a performance indicator to verify periodically
whether is has been achieved or not. In the above example, the indicator may be market share by
volume.
- Achievable. The objective will be motivating if it is attainable given the foreseeable conditions of
the business and economic environment.
- Realistic. Objectives have to reflect the company’s ambition, but must also be feasible.
- Time-bound. The objective must be defined in time. In our example the objective must be achieved
by the end of the financial year.
Defining specific, quantified, realistic and dated objectives is done jointly with the selection of action
plans.

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One of the goals of the planning process is to prepare action plans, in other words to mount operations
by which the company will achieve its overall objective:
- by clearly specifying the initiatives to be undertaken in order to achieve the objective;
- by identifying the role and contribution of each member of the organisation;
- by positioning actions in time;
- by determining the means to be employed and the allocation of resources (material, human and
financial).
Designing action plans and setting objectives are generally not done separately. In the context of the
planning process, they are often carried out at the same time to ensure that they match before launching
into the action.
Studying and choosing long-term objectives can sometimes be done independently – in the case of a
company that wants to launch a new activity, for instance. The company then draws up a business plan
which includes a description of the project, a market study, technical data, the necessary investments
and a study of how it will be financed. The data in the business plan are used to assess the benefits and
feasibility of the project and to ratify it. Once the objective has been approved, the planning process sees
to the design and implementation of relevant action plans which will contribute to achieving the
objective.

Choosing and validating action plans

Each manager receives instructions and guidelines from his superiors (a quantified objective, hypotheses
to be used, policies to implement) and has to evaluate them in the light of the results from previous
years, the outlook for key variables in his activity and changes in the local environment.
Based on the objective transmitted by their superiors and their analysis of the current situation,
operational managers put forward action plans, analyse the impact of these plans on results and
determine the resources necessary to carry them out. The objective of forecasting is not to predict the
final result exactly, but rather to estimate the costs and results of the various possible actions in order to
choose the ones that are most realistic and effective for attaining the objective with the available
resources.
In practice, the controller assists the managers in preparing these action plans. He provides them with
the analyses that they may need and helps them to formulate their action plans so they will be complete
and explicit. The budget building calendar should accommodate regular progress meetings between
operational managers and their superiors to discuss the preparation of these action plans. During these
meetings, senior managers stimulate the operational managers’ thinking, urge them to be creative and
to simulate different action plans in order to bring potential sources of performance to the surface. The
analysis of the different scenarios will provide elements for the monitoring phase which can be used to
bring results back into line in the event of deviation.
In addition, the controller has to make sure that responsibility centres consider all the interdependencies
with other centres in preparing their action plans. Budget building should not be thought of as a string
of budgets for different entities, but rather as the result of coordination between these entities. As we
have seen, one of the goals of the budget building procedure is to promote dialogue between operational
managers so that they will consider all the interactions between their entities. The volume forecasts of
the sales department will have an impact on the production budget. If production capacity is insufficient,
either the planned volume of sales will have to be revised or investments will have to be studied for
increasing capacity. Once the sales and production departments have reached an agreement, the
purchasing department can plan its schedule for buying the materials necessary for manufacturing. The
preparation of action plans must therefore be coordinated and take into account the interrelations
between sales, production, procurement, human resources and so on.

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During the budgeting procedure, standard documents are prepared containing the main hypotheses used
by operational managers and documenting their action plans. These forms can also include the main
points of discussion between responsibility centres, which will help to understand the decision-making
process. This information will be useful during the monitoring phase to adjust action plans to unforeseen
events.
An important element in the budgeting process is the selection of action plans. The feasibility of action
plans has to be examined in relation to the constraints on human, material and financial resources. The
process of planning and anticipation ensures that action plans can be implemented under good
conditions. For example, if the production department needs to invest in new facilities to increase its
capacity, the initial forecasts have to guarantee that the technical installations will be operational from
the start of the financial year, that the technicians will be properly trained and that the company has the
means to finance the investment. If the installation deadlines are not met, the organisation runs the risk
of not meeting its production schedule and consequently not fulfilling its sales plan.
Moreover, at the end of the process, top management must have an overview of the entities’ action plans
and a quantified account of all the resources needed to implement them. It must compare this data to the
financial, human and material resources available in order to determine the simultaneous feasibility of
all these plans. For example, constraints on financial resources may cause the company to make choices
between different action plans. These choices will be made on the basis of operational projections,
financial forecasts and in relation to performance criteria. The company may also ask the entities to
place the action plans in order of priority and position them in time, so as to have additional elements
for analysis.
The final quality of the forecasts depends on the soundness of the detailed action plans designed by
operational managers.

Negotiating budgets
The budget is an iterative process which requires numerous back-and-forth proposal/counterproposal
cycles to ensure the coherence and good fit of local action plans with overall company objectives.
Regular progress meetings between operational managers and their superiors help to reduce the number
of cycles. The budgeting process is time-bound and it is crucial that deadlines be met if the company
wants to start the new financial year with a finalised and approved budget.
The back-and-forth budget negotiations are important both for horizontal coordination, as they ensure
the coherence of action plans between entities, and for vertical coordination, by ensuring the
convergence of local objectives with company-wide objectives. These back-and-forth negotiations are
carried out in meetings and discussions which can reveal incoherencies and threaten the construction of
the budget. The main difficulty of the budget process is to reach a consensus among all the participants
and avoid getting bogged down in an unwieldy and cumbersome procedure.
Moreover, it is important in negotiations with upper management that the discussions not only focus on
financial objectives. Action plans and the resources needed to implement them should be at the centre
of these discussions.
The budgets put forward by responsibility centres are, therefore, studied and evaluated by the next higher
level. In short, in this iterative phase, budgets are defended, negotiated, corrected and modified at each
level until they are approved by the hierarchical superior, who assesses whether the action plan is
realistic, the rationality of the resources to be mobilised and the chances of it delivering the hoped-for
results. This method of sending up and analysing information is carried out all along the hierarchical
line. At the local level, controllers play an important role in the process by helping the operational
managers they work with to present and defend their budget in front of their hierarchical superiors.

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Consolidation and approval

Once the budgets have been approved at the different hierarchical levels, they are consolidated and sent
to top management for approval. Top management compares the financial figures in this budget to
performance objectives before giving its final approval. The forecasts advanced by responsibility centres
then become formal objectives and constitute the basis of an explicit contract between top management
and operational managers. The various stages in the budgeting process and their reproduction along
hierarchical lines promotes the delegation of authority and allows each level to assume its specific
responsibility.
It is important that the final document be complete and include, in addition to the objectives, a detailed
description of the key hypotheses and action plans that will be used in monitoring results and will serve
to determine the way objectives are to be revised, if need be. A final document only containing objectives
neglects the regulation and coordination functions (see previous sub-sections).
The final document serves as a frame of reference for managing the business activity and for external
communication with financial partners. It contains all the operational and financial objectives, resources
chosen and validated by top management and the main hypotheses and actions which underpin the
achievement of objectives.
As the competitive environment changes quickly, these hypotheses and action plans may soon become
obsolete. Budget revisions during the course of the year provide a certain amount of flexibility and allow
the company to respond to major changes in the business environment and to new economic data.
However, as we have seen, in order to maintain staff motivation and to avoid compromising the incentive
function of the planning process, objectives should not be modified too frequently. A recent survey
carried out among Canadian and American companies shows that roughly half of the companies will
allow budget objectives to be modified after the budget has been approved (Libby and Lindsay, 2010).
However, in 50% of organisations, the budget expresses the determination to achieve an objective that
has been communicated internally and externally. In these companies the objective must be achieved in
spite of changes in the business environment. When budget monitoring reveals deviations in its course,
the company can draw on all the work of preparation and coordination carried out prior to the approval
of action plans to quickly decide on any adjustments. If the objective remains unchanged, then the action
plans have to be adapted in a coherent and coordinated fashion in order to keep the company on course.

2.2.3. Coordination between different budgets

Just like the company’s accounting information system, the budget generates, at the end of the process,
a set of summarised financial statements. The expression of objectives and action plans in economic
terms gives rise to the presentation of a P&L account, a balance sheet and a cash-flow analysis for the
coming year. These statements constitute a financial illustration of the action plans and encompass all
the operational, human and financial resources needed to achieve the objective.
We will present the way budgets are coordinated through the example of a company that has a production
and a sales activity and a simple organisational structure built around these two functions. The principle
is identical for service providers or companies that only have a sales activity, and the process is
duplicated as many times as necessary for companies whose organisational structure is more complex.
Three main budget categories can be identified: the operating budget (production/sales cycle), the capital
expenditure budget and the general and administrative expenses budget (administrative and financial
departments, discretionary cost centres, head office). These budgets are then collected into condensed
budgets: the P&L account, the cash budget and the projected balance sheet.

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Figure 10.9 Interrelation of budgets

SALES BUDGET
– TURNOVER
– SELLING EXPENSES

PRODUCTION BUDGET
COST OF PRODUCTION SOLD BUDGETED P&L
ACCOUNT

MANUFACTURING
PROCUREMENT BUDGET FACILITY RELATED COSTS
LABOUR

STRUCTURAL AND HEAD

OFFICE EXPENSES

INVESTMENTS
CASH FLOWS: FINANCE PLAN
-Assets
- Inventories
- Receivables
- Payables

PROJECTED
BALANCE
SHEET

2.2.4. The operating budget

The first stage in quantifying the budget is the construction of the operating budget, which is based on
the sales plan and the corresponding production budget.

Sales plan
In most companies, the process of building the operating budget begins with the sales budget. Indeed,
production plans, financial balancing, return on investment and so on are greatly influenced by the sales
volumes and turnover that a company can achieve. However, certain limiting factors in production,
procurement and investment may sometimes guide the determination of sales objectives.
Sales forecasts are generally established by the sales team who possess good knowledge of the local
market, customer expectations and changes in the competition. The sales people also work closely with
the marketing department which provides a forward-looking vision of the market and its trends.
The sales plan contains two major elements: projected sales figures and the selling expenses budget.
Projected sales figures are based on the volume of sales and the average selling price by product line,
by customer type or by distribution channel. The forecast of quantities to be sold is made from the
information available on the previous year’s sales, the order book, growth objectives, market potential,
the competitive situation, and taking into account the resources employed and initiatives such as
promotional and advertising campaigns and the capacity of the sales force. The sales plan should not be
a simple repeat of the data from the previous year, but should express orientations made in the strategic
plan. Selling prices can be set according to the market and the competition but must be compared with
internal production costs to make sure that the gross margin is acceptable to the company. Finally, the
figure for turnover has to take into account all the discounts and rebates granted to customers.
Once the annual forecasts have been made, it is important to break them down into monthly figures,
depending on the seasons, to determine the repercussions on the production plan and on cash flow
(receipts).
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The budget for selling expenses includes staff salaries, advertising and promotional expenses and
logistics and distribution expenses.

Production plan
The quantities to be produced and the production plan are based on the forecasts for sales volume,
seasonality, manufacturing lead time and the policy for stocking finished goods.
The entity in charge of production must therefore devise action plans to produce the planned volume.
These action plans are based on an analysis of the existing means of production (capacity of production
facilities, qualifications and competencies of the labour force), the production team (new employees to
be hired, staff leaving, taking on temporary workers, subcontracting), production methods (possible
productivity gains, technical improvements), the raw materials used (availability, possibility of
substitution, switching suppliers) and the outsourcing policy, etc.
Production forecasts are used in establishing the procurement budget which takes into account the
volumes to be manufactured, technical standards for manufacturing (quantity of raw material per
product, reject rate) and changes in raw materials inventory – necessary criteria, but ones where progress
can also be envisaged. Apart from the purchasing price of raw materials, the procurement budget also
includes transport costs, insurance, customs duties, storage costs and the wages of the purchasing
department staff.
The production budget also incorporates the expenses of the manufacturing facilities including labour
costs (production hours, hourly wage), amortisation of the facilities and equipment, energy and
maintenance costs.
The costs of other departments that are ancillary to production must not be overlooked: organisation and
methods, security and administrative departments (accounting, IT, human resources). These budgets
essentially contain personnel costs and overheads.

2.2.5. The general and administrative expenses budget

The general and administrative expenses budget (G&A) encompasses the budgets for support
departments such as accounting, IT, human resources and finance. These budgets essentially include
personnel costs, the cost of external services (auditing, legal, consulting, training), client entertainment
and travel expenses as well as investment in equipment (computer hardware, furniture). Most G&A
expenses are discretionary costs because it is hard to establish a relationship between the amount of
expense and the volume of sales or the volume of production.
Administrative departments have to set up action plans to control or even reduce their expenses while
still providing the best possible service to other company entities.

Boxed text 10.14: ZBB

When preparing the budget for support departments, companies tend to reuse past data and simply apply
a percentage increase. They thus consider the costs of administrative functions to be acceptable without
challenging their efficiency or their utility. Developed in the 1980s, the ZBB method (zero-based
budgeting) seeks to curb the continuous increase in G&A expenses. References from the previous year
are not taken into account and the costs of administrative departments are reset to zero. For each
department:
- the activities necessary for providing services are analysed; only the activities that are essential to
the proper running of operations are maintained;
- the resources that are indispensable to the development of each of these activities are quantified and
retained for the budget.

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The ZBB method ensures a better allocation of resources and contributes to controlling administrative
costs by questioning the way that departments function. However, this method is very time consuming
and expensive to put in place.

2.2.6. The capital expenditure budget

This is made up of the programme of each entity’s planned investments and their financing plan.
Investment projects put forward by centres must contribute to achieving the long-term objective set out
in the strategic plan. Investments may involve the maintenance or expansion of production capacity
(replacement of an existing production facility that is reaching the end of its useful life), expansion
projects, new product development, adaptations to comply with current legislation, improvement of
working conditions (hygiene and safety) or renovations and outfitting.
As the choice of an investment policy constitutes a long-term commitment for the company, the
authorisation of capital expenditure is carried out in a separate procedure to avoid the negative effects
of a vision that might be overly focused on short-term results. This procedure carefully examines the
definition of the project, the economic figures and the programme’s anticipated return on investment.

2.2.7. Financial statements

The data from the operational and functional budgets are used to establish condensed financial
statements: the budgeted P&L account, the cash budget and the projected balance sheet.
The consolidation of the different sales, production and administrative expense budgets gives rise to a
projected P&L account, which indicates the operating income for the financial year. However, the final
result is not known until the finance costs are calculated (cash budget).
The projected P&L account thus obtained is compared to the expectations of top management. If the
planned objective will be achieved, the budget is ratified. However, if the anticipated performance will
not be achieved, the different entities have to revise their budgets in order to obtain a consolidated result
that is acceptable with respect to the initial objective (budget negotiations), as we have already seen in
the phase of validation and approval.
The cash budget corresponds to the receipts and disbursements of the operating budgets (sales and
production), the general and administrative expenses budget and the capital expenditure budget. It
translates all the operational decisions of the company into monetary terms. The cash budget provides
information on the solvency of the company and indicates surplus or insufficient liquidities for the
financial management of the company. By analysing cash projections the company can determine
financing requirements, choose a mode of financing and calculate finance costs and revenues.
Cash-flow projections should be done on a monthly basis and are based on a proper monthly breakdown
of the budget that takes into account seasonal variations in sales.

Practical difficulties
The budgeting procedure is complex in that it involves numerous members of the organisation. It is
important that the controller structure and organise the process in order to take account of interactions
between different departments as well as financial, human and material constraints. In practice, the
procedure involves difficulties of form and substance.
Difficulties of form essentially concern the following points:
- the timetable, which must be adhered to so that the budgets will be completed before the start of the
financial year;

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- the definition of formats for budget documents, which must follow a similar logic in every
department in order to focus managers’ attention on the important points to consider, to facilitate
the analysis of data by hierarchical superiors and to simplify the work of consolidation. These
documents must also have a space reserved for the description of action plans which underpin the
financial forecasts;
- the use of a common language and vocabulary so that all participants understand each other and
reason from the same basis. For example, in the retail sector when speaking of turnover, it is
important to specify whether one is referring to sales figures before tax or including VAT. When
speaking of hourly labour costs, we need to know if it is an hour’s pay or the effective cost of an
hour’s work;
- the technical quality of the budget system depends on its ability to provide useful and relevant
information without being cumbersome or unwieldy.
The difficulties of substance, which we will examine in more detail, involve the lack of time and
availability of operational managers, the creation of budgetary slack and the lack of flexibility in the
process.

2.3.1. Deadlines and their consequences

The budgeting procedure is time consuming; in general, it represents between three and five months of
preparation work (PwC Advisory, 2007).
The biggest difficulty lies in meeting deadlines, between the beginning of the procedure when entities
envisage their objectives and their action plans and the final approval of the budget by top management,
following the financial consolidation of all the action plans. If the consolidation of the budgets is not
satisfactory, the budget cycle must, in theory, be reviewed from the beginning. This means that
operational managers have to take their objectives and action plans back and make new proposals. At
the same time, in order to ensure the coherence of the budgets, a new process of back-and-forth
negotiations is necessary. In practice, for large companies where a lot of people are involved in building
the budget, it is difficult to carry out any additional discussions and back-and-forth negotiations between
the base and the apex. Indeed, at this stage there is often little time left to finalise the definitive budget
and the operational managers have little available time, especially as they have already devoted much
time to the preparation of the first version of the budget. In order to save time, top management may
have to take unilateral and arbitrary decisions, for example, increasing the turnover objective by 5%
with respect to the objectives proposed by all the divisions, or a cost reduction of 10%, to be applied to
all the budgets. While these decisions may allow the company to achieve the desired financial objective,
they are extremely demotivating for operational staff who devoted themselves to building their own
budgets and action plans. Furthermore, there is a significant risk of impairing the coherence and
coordination of action plans and losing all the richness of the thinking that was done on the budget.
Ideally, companies should search for tools that would enable them to shorten the time between the choice
of action plans and their definitive approval following the consolidation of financial forecasts. Setting
up integrated IT systems could help save some time. A recent study shows that 70% of companies use
spreadsheets for all or part of their budget building process and that only 16% of companies use an
integrated IT system such as ERP (Enterprise Resource Planning, PwC Advisory, 2007). There is
therefore significant room for automating financial planning to accelerate the consolidation of budgets
and free up time for analysing objectives and action plans.

2.3.2. Budgetary slack

As we have seen, receiving a promotion or a bonus is often linked with the achievement of a budgetary
objective. In order to ensure that they will receive their variable remuneration, managers may be tempted
during the preparation of their budget to suggest objectives that are easy to attain. They may also be

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tempted to “pad the budget” or to create “budgetary slack”. Budgetary slack is the propensity of
managers to give themselves some breathing space. Sales managers may, for example, deliberately
underestimate sales forecasts and production managers may forget to take into account improvements
in productivity. Budget padding also includes overestimating costs and the resources required to
accomplish a task. It must be pointed out however that budgetary slack is not always intentional and that
it may be due to errors in making estimates.
Budgetary slack is a widespread practice in most companies. Operational managers tend to cover
themselves out of fear of the sanctions they may suffer if the budget is not attained or because they are
worried that their hierarchical superior may arbitrarily cut back on expenses. This practice of creating
slack may have negative or positive effects on the management of the company.
The negative effects of budget slack are that it leads to unambitious objectives, the misallocation of
resources, less effort on the part of operational staff and a skewed evaluation of their performance. Faced
with an overly rigid budget system, operational staff adopts a prudent and defensive attitude leading to
budgetary slack.
One of the positive effects of budgetary slack is that it constitutes a reserve, a safety valve which protects
operational staff in the event of contingencies and unforeseen problems and thus increases the chances
of reaching the objective that has been set. It also serves as a stabilisation mechanism in the face of the
uncertainty of the business environment. Using this mechanism, operational managers build
“provisions” that can be used to cover any potential deficits.
In any case, the controller should be aware, as far as possible, of the amount of slack that has been
introduced into each budget. For this, he has to establish a climate of trust with the operational managers
so that they will disclose their “padding”. He can also compare forecasts with historical data or make
comparisons between departments or with an external point of reference.

2.3.3. The lack of flexibility in the budget process

Once it has been approved, the budget constitutes a single reference which is maintained throughout the
year, but market uncertainty can render forecasts obsolete very quickly. Indeed, the economic
environment of the company evolves at a faster pace than the budgeting procedure. To solve this
problem, companies may introduce a certain amount of flexibility into the procedure by making
quarterly reforecasts (or rolling forecasts) which allow them to increase their short-term visibility, to
check key indicators and to adjust action plans. The budget can be thought of as a snapshot that provides
a view of activities at a fixed moment in time, while reforecasts are like a video which offers a more
dynamic view of the near future.

Figure 10.10 Quarterly reforecasts

Financial year
Q1 Q2 Q3 Q4
Budget
1st revision
2nd revision
3rd revison

Forecasts

Actual data

Reforecasts are usually done quarterly. The first revision is carried out in February/March. The budget
is re-examined in the light of actual data from the previous year-end closing. During the preparation of

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the budget in October/November this data was estimated at as closely as possible. The revision serves
to update the balance sheet and above all the cash flow projections which are essential to good financial
management. The second revision takes place in June and provides an updated view of the operations
carried out during the first half of the year as well as trends in the activity and the business environment
for the coming months. It allows the company to react to any deviation in its progress and to envisage
measures to take so as to achieve its objectives by the end of the year. The final revision, in
September/October contributes to defining the basis for preparing the next budget. Some companies go
even further, setting up a system of rolling forecasts which take into account five or six rolling quarters.
Reforecasts rarely replace the budget internally, which remains the objective to reach, as we saw in the
paragraph on incentives (cf. section1, point 3.4).
Still, reforecasts alone are not enough to ensure the flexibility of the process; action plans must also be
modified in response to new conditions in the business environment.
For this revision of action plans to be fully effective, it must take into account the interactions between
the various entities, as was done during the initial phase of budget validation. In the event of reforecasts,
the company should follow the same method as in budget building: working together in a coordinated
fashion, organising and promoting dialogue between the departments concerned by the modifications so
as not to overlook any interactions or the consequences of local decisions. In practice, due both to a lack
of time and to the personal interests at stake, this re-coordination rarely takes place.

Conclusion
In this chapter we have presented the principles, the issues and the methods of implementing business
planning in companies and organisations. Business planning contains a set of dynamic tools and methods
which are coordinated according to the time horizon (budgets, operational plans, strategic plans) and
which are used to build a coherent system of objectives, action plans and resources.
Business planning responds to numerous functions in organisations: anticipation, regulation, learning
and financial communication. In addition to these functions, which are found even in the smallest
structures made up of a single entity, there are other functions used to organise and manage the
decentralisation of activities in more complex organisations. These functions concern the strategic
alignment (or vertical coordination) of the organisation, the horizontal coordination between entities as
well as incentives and the motivation of members of the organisation or company. Combining these
functions in a single process can raise certain problems as some of them appear partially to conflict with
each other.
In the second section of this chapter we presented the main methods used in the operational
implementation of planning tools and systems. We explained how the different tools interact with each
other and we presented the budgeting process in greater detail: the launch of the budgeting procedure
with the dissemination of budget guidelines to entity managers, the principles that govern the preparation
of the budget at the level of each of the entities, as well as the interrelation and coordination between
entity budgets. We then pointed out some of the practical difficulties of budget management: in
particular, the management of the time devoted to the process itself, the phenomenon of budgetary slack
and the lack of flexibility for which budgets are sometimes criticised.
In presenting the planning process we touched on the questions of regulation and organisational learning,
which involve the comparison of actual performance with the references defined in the context of the
anticipation process. In chapter 11, which deals with the analysis of results, we will examine these
principles in greater detail as well as the tools that are used to analyse and monitor the realisation of
plans and budgets.

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Bibliography
Barrett, E.M. & Fraser, L.B. (1977) “Conflicting roles in budgeting for operations”, Harvard Business
Review, July-August 1977, pp. 107–146.
Berland, N., Le contrôle budgétaire, Repères, Editions La Découverte, Paris, 2002.
Bogsnes, B., Implementing Beyond Budgeting, John Wiley & Sons, New Jersey, 2009.
Hackett Group, “EPM Planning, Performance studies”, 2007:
http://thehackettgroup.com/research/results.jsp?Fn=904774045
Libby, T. & Lindsay, M., “Beyond budgeting or budgeting reconsidered? A survey of North-American
budgeting practice”, Management Accounting Research, 2010, vol. 21, pp. 56–75.
Merchant, K.A., Modern Management Control Systems - Text and cases, Prentice Hall, Upper Saddle
River, NJ, 1998.
PwC Advisory, “2007 Budgeting and Forecasting Study”, PwC Advisory, Performance improvement,
2007.

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Chapter 11 - Analysing results

Introduction
The aim of this chapter is to present the principles and tools used to structure and carry out the analysis
of results.
As we have seen (see figure 1.4, chapter 1), the aim of analysing performance is to enable managers to
take corrective decisions (regulation) or to revise the performance model or strategy (organisational
learning). However, this analysis is often reduced to variance analysis and is associated with the notion
of budget monitoring, which gives a restricted view of it because this notion is often used in a static,
financial view of the budget. In practice the analysis of performance is seen as a laborious and not very
useful exercise. The process is also accused of generating behaviour patterns characterised by endless
justifications and explanations instead of facilitating decision making. This chapter provides a much
broader view of this process by putting it into perspective in relation to objectives and offers some
suggestions for curbing these dysfunctions.
As in the preceding chapters, we will begin by situating ourselves within an entity, temporarily
disregarding the fact that it is part of an organisation. In section 1, we will present a method for setting
up a variance analysis based on any cost accounting model, followed by a variance analysis using
dashboards. We will show that these two approaches are complementary and will discuss the
organisation of the management processes that use these variance analyses, in particular performance
reviews and the role of the controller. Section 2 will show how the interdependence of entities and the
link with systems for evaluating managers affect the analysis of performance.

Section 1. Principles and tools

Objectives and principles of results analysis
The analysis of performance is based on measuring variances between actual results and objectives or
in comparison with previous period. This measurement is one of the elements of the diagnosis intended
for taking corrective decisions with the aim of achieving objectives (regulation). It can also be used to
assess the validity of the performance model and the strategy (learning).
As we saw in chapter 10, forecasts and objectives prepare for the analysis of results and improve its
effectiveness by limiting the scope of analysis: observing a variance with respect to forecasts raises an
alert, whereas simply observing a result without any reference to an objective would provide less
information.
This alert must trigger a reaction on the part of the entity manager. Given the limited time of managers,
it is better to have information that will enable them to understand the variance. Indeed, if a division
manager observes that his monthly result is far below the forecast and he has no additional information,
he will have no idea what caused the variance. But it is necessary to understand these causes in order to
develop adequate solutions. As their time is limited, it is better if managers do not have to perform an
ad hoc analysis every time a significant results variance is observed.
This is why this analysis is based on the performance measurement model that is made up of indicators
for which annual targets have been set. This model will structure the search for causes. It provides a
framework which helps to speed up the analysis, but which also limits its scope, hence the importance
of building the model carefully.
To fully understand how important this is, let’s consider a variance analysis based on financial
accounting, which is the most elementary model for breaking down results. Such an analysis is based
on variances between the actual figures and the forecasts for each item in the P&L account (which
assumes that a target was set for each of these items during budget preparation). Variances can be

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presented in absolute values, as a percentage or by indicating the level of significance of the variance in
comparison with a threshold set in advance for each item (cf. table 11.1).

Table 11.1 Variance analysis in financial accounting

Budget Actual Variance (1) Variance Significant

(numerical (percentage variance
value) )

Turnover 265 000 243 212 −21 788 −8.22 % YES

Materials usage 112 000 110 252 1 748 −1.56 % NO

Salaries and payroll 91 500 97 261 −5 761 6.30 % YES

costs

Depreciation 21 200 21 051 149 −0.70 % NO

Other operating 18 130 22 121 −3 991 22.01 % YES
expenses

Operating income 22 170 11 629 10 541 −47.55 % YES

(1). By convention, favourable variances (i.e. whose impact on results is positive) are positive and
unfavourable variances (i.e. whose impact on results is negative) are negative.

This model is very limited. This is why performance models are more elaborate in practice, as we saw
in part 1 of this book.
The analysis of performance is then prepared with two levels of modelling: the indicators and the targets
set during budgeting that performance will be measured against, which constitutes a refinement of the
model taking into account elements that are specific to the period in question. Knowing what hypotheses
were used in setting targets can also be useful in analysing results.
We will examine variance analysis in the framework of the two models that were presented in part 1 of
this book: a measurement model based on financial indicators whose structure is provided by cost
accounting (2) and dashboards (3).
Still, the analytical elements provided by these models are often just a first stage in understanding the
real causes of the overall performance variance. Quantitative variances can structure this analysis of
course, but it may require supplementary, more ad hoc analyses, in the framework of a collective
diagnosis approach: the figures have to be “made to speak” because they do not spontaneously provide
all the elements of the diagnosis. A variance in raw material consumption, for example, can be explained
in several ways: a variation in the price of the material which may be linked to a different unit price or
different quantities than planned; a variation in production yield, which itself may be explained by the
quality of the material or by problems unrelated to the material itself, etc. Sorting through these
explanations cannot always be done by analysing the figures; the information held by different managers
has to be exchanged. The results analysis process is therefore more managerial than technical. We will
examine this question in §4.
The purpose of analysing results is not only to take corrective decisions (regulation); it also serves to
revise and update the performance model (learning). For this, managers have to determine which of the
variances may require them to rethink the hypotheses that the model is based on, and this on two levels:
- That of the hypotheses that the targets are based on: if they see that it is impossible to reach
certain objectives, managers may be led to conclude that the underlying hypotheses are false and to
revise the objectives accordingly. If, for example, a sales plan was based on false hypotheses

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concerning the launch of a new product by a competitor, it may be advisable to revise the sales
objectives and other dependent objectives;
- That of the causal links in the performance model. Since these links are a representation of
strategy, the variance analysis may lead managers to rethink certain elements of it. For example, if
a change in positioning based on an increase in services associated with the sale of products does
not improve profitability in keeping with forecasts, they may reconsider this change.

Results monitoring using a cost accounting approach

In this section we will look at variance analysis when performance is measured with a costing P&L
account, for example in the following form:

Sales volume 100

Unit price 50
Turnover 5 000

Material yield (kg/unit) 3.2

Unit price – material 8.80
Unit cost – material 28.16
Total material cost 2 816
Other manufacturing costs (fixed) 1 000

PRODUCTION MARGIN 1 184

Until recently in France the “plan comptable” (chart of accounts) defined a model for analysing
variances that is often associated with the notion of budget monitoring. This association is erroneous.
Indeed, as we have seen, monitoring the budget through the analysis of variances between actual
performance and planned performance can be based on any performance model: an accounting model
or a broader model translated into a dashboard containing indicators of every type.
There are also models used in English-speaking countries which do not fundamentally differ from the
French model. A simplified version of this model is based on four drivers: volume, mix, yield and price.
We will present a generic method here which generalises this model.

1.2.1. The steps

The different steps in the method are as follows:
1. Determine the variables that may be a source of variance;
2. Make a spreadsheet to calculate all the variances, i.e. for each line of the P&L account
and each variable;
3. Calculate the variances;
4. Group the variances together in a meaningful way;
5. Present the results.

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1.2.2. Determining the variables

The variables that the variance analysis are based on are the parameters of the P&L account, which are
the data that can be used to calculate the different items in the P&L account.
In the example given above:
- Turnover is calculated from volume and price. The volume of sales and the selling price are therefore
two variables for the variance analysis;
- The materials cost is derived from the sales volume, the yield of the raw material and the unit cost
of this material, which are thus all variables for the variance analysis;
- Finally, the result is obtained by deducting other manufacturing costs from the gross margin
(turnover – materials costs).
- The variance analysis can thus be performed on the following variables: sales volume, selling price,
material yield, unit cost of material and other manufacturing costs.
When there are intermediate variables, a choice has to be made. Let’s take a look at this example:

Volume of product A 100

Volume of product B 80
Total volume 180
Proportion of product A (Mix) 56%
Proportion of product B (Mix) 44%
Unit price A 20
Unit price B 30
Average unit price 24
Turnover product A 2 000
Turnover product B 2 400
Total turnover 4 400

There are several possibilities. Indeed, we can consider that total turnover is the sum of the turnovers of
product A and B. In this case, the turnover per product can be calculated as:
- The result of a total volume, a mix and a unit price per product;
- The volume of each product multiplied by the product’s unit price;
- The sum of the volumes of product A and product B, multiplied by an average price.
The choice made among these different options will depend on the type of reasoning usually followed
by operational managers, which depends on markets. If the volumes of products A and B are
interdependent then the notion of total volume and mix makes sense. If, on the other hand they are
variants of a base product, the notion of average price may be essential.

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1.2.3. Spreadsheet for calculating variances

Once the variables have been determined, we can prepare a spreadsheet to calculate the intermediate
P&L accounts to determine the impact of the variation of each variable selected on the different lines of
the P&L account.
Selling Material Fixed
Planned Actual Volume Yield
price price costs

Sales volume

Unit price

Turnover

Material yield (kg/unit)

Unit price – material

Unit cost – material

Total material cost

Other manufacturing costs

(fixed)

PRODUCTION MARGIN

The only choice at this stage is the order of the variables. It has relatively little importance in practice,
because although it changes the result of the calculation, it does not alter the scale of the amounts and
therefore the analysis.
We can choose to place the variables that have an effect on several P&L items first. In this example,
sales volume has an impact on turnover and on materials cost.

1.2.4. Variance calculation

The next step is to calculate the variances. For each column of the table we calculate an adjusted P&L
account where only the parameter corresponding to the variable in question is altered.
Thus in our example, the “Volume” column shows a P&L account where the figure given for volume is
the actual amount (115) and all other entries are budgeted amounts. For each line, the volume variance
will be the difference between the amount entered in this fictional P&L account and the planned amount.
For example, the turnover variance is 750 (5750–5000).

Selling Material Fixed

Planned Actual Volume Yield
price price costs

Sales volume 100 115 115

Unit price 50 48 50

Turnover 5 000.0 5 520.0 5 750.0

Material yield (kg/unit) 3.20 3.10 3.20

Unit price – material 8.8 8.9 8.8

Unit cost – material 28.2 27.6 28.2

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Total material cost 2 816.0 3 172.9 3 238.4

Other manufacturing costs

1 000.0 1 050.0 1 000.0
(fixed)

PRODUCTION MARGIN 1 184.0 1 297.2 1 511.6

Variance

Turnover 750

Variable
(422)
costs

Fixed costs 0

PROD
328
MARGIN

The “Yield” column is the P&L account obtained by starting with the “Volume” column and only
changing the figure for yield: from the planned amount (3.2) to the actual amount (3.1). In this way we
calculate the “yield variance” for the different items of the P&L account, i.e. the impact on these items
of the difference between the actual and planned figures for yield.

Selling Material Fixed

Planned Actual Volume Yield
price price costs

Sales volume 100 115 115 115

Unit price 50 48 50 50

Turnover 5 000.0 5 520.0 5 750.0 5 750.0

Material yield (kg/unit) 3.20 3.10 3.20 3.10

Unit price – material 8.8 8.9 8.8 8.8

Unit cost – material 28.2 27.6 28.2 27.3

Total material cost 2 816.0 3 172.9 3 238.4 3 137.2

Other manufacturing costs

1 000.0 1 050.0 1 000.0 1 000.0
(fixed)

PRODUCTION MARGIN 1 184.0 1 297.2 1 511.6 1 612.8

Variance

Turnover 750 0

Variable
(422) 101
costs

Fixed costs 0 0

PROD.
328 101
MARGIN

By applying this rule to the other variables, we obtain the following table in which all the variances are
calculated:

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Selling Material Fixed

Planned Actual Volume Yield
price price costs

Sales volume 100 115 115 115 115 115 115

Unit price 50 48 50 50 48 48 48

Turnover 5 000.0 5 520.0 5 750.0 5 750.0 5 520.0 5 520.0 5 520.0

Material yield (kg/unit) 3.20 3.10 3.20 3.10 3.10 3.10 3.10

Unit price – material 8.8 8.9 8.8 8.8 8.8 8.9 8.9

Unit cost – material 28.2 27.6 28.2 27.3 27.3 27.6 27.6

Total material cost 2 816.0 3 172.9 3 238.4 3 137.2 3 137.2 3 172.9 3 172.9

Other manufacturing costs

1 000.0 1 050.0 1 000.0 1 000.0 1 000.0 1 000.0 1 050.0
(fixed)

PRODUCTION MARGIN 1 184.0 1 297.2 1 511.6 1 612.8 1 382.8 1 347.2 1 297.2

Variances

Turnover 750 0 (230) 0 0

Variable
(422) 101 0 (36) 0
costs

Fixed costs 0 0 0 0 (50)

PROD.
328 101 (230) (36) (50)
MARGIN

1.2.5. Grouping variances together

When there are a large number of variances it may be advisable to group certain variances together in
order to simplify the analysis. We will group those variances that can be considered to be linked to each
other. In our example, the number of variances is limited, but we can nevertheless consider grouping
selling price and materials price effects together if we think that there is a relation between these two
factors, i.e. that the selling price might be adjusted when the material price changes, or at least that it is
useful to control the unit margin on materials cost. We can add fixed costs to this, resulting in a “prices
and costs” effect.

Volume Yield Prices and costs

Turnover 750 0 (230)
Variable costs (422) 101 (36)
Fixed costs 0 0 (50)
PRODUCTION MARGIN 328 101 (316)

1.2.6. Presentation of results

It may happen that the number of variances still remains high even after grouping some of them together.
In practice, there may be as many as twenty variables. Moreover, variances can be calculated for each
product or for each entity. Since the number of elementary variances is the product of the number of

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variables multiplied by the number of lines in the P&L account and the number of entities or products,
it can easily be very high.
In this case, the last step in the analysis is to make a summary to present the results clearly so that they
can be used by operational managers in their analysis.

1.2.7. Putting the method in perspective

This method can be used to obtain a breakdown of variances whose sum is equal to the total variance.
It can be applied to every kind of costing P&L account or items of the P&L such as costs. In the following
example it is used to analyse the cost variance of an after-sales service department. Its work consists in
carrying out repairs for customers, who are divided into two categories depending on the type of product
they own:

Number of type A customers 100

Number of type B customers 50
Total number of customers 150
Percentage of type A customers 67%
Percentage of type B customers 33%

Number of repairs per customer

0.30
A
Number of repairs per customer
0.20
B
Average number of repairs 0.27

Duration of repair type A (hours) 1.0

Duration of repair type B (hours) 1.5

Cost of parts per repair 22.0

Hourly cost of technicians 35.0

Total cost 2 455

In this case, the variables used to perform a variance analysis may be the following: the total number of
customers, the customer mix, the number of repairs per customer A, the number of repairs per customer
B, the duration of repair type A, the duration of repair type B, the cost of parts per repair and the hourly
cost of technicians. By varying these variables one by one we can calculate different adjusted total costs
and the corresponding variances.
The VMYP (volume, mix, yield, price) method, sometimes presented as a generic method derived from
the accounting method, constitutes a particular form of this method:
- The variables used are total sales volume (V), the sales mix (M), the yields of the different factors
making up direct costs (direct labour, materials), the selling price and the unit cost of the different
factors that make up direct costs;
- The yield variance of the different factors are grouped together (Y) and the selling price variance
and the unit cost variance are also grouped together in a single variance called price variance (P);

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- Although the variables used are often relevant when we analyse margin after manufacturing costs,
this method cannot be applied in numerous situations where other variables may be relevant.
The different variance analysis methods are often criticised because they cannot be used to make a useful
analysis of indirect fixed costs, which constitute a growing portion of costs. In fact, the analysis of fixed
costs is based on the ability to identify the drivers for these costs. This concerns the way cost
accounting37 is structured more than the method of calculating variances. Still, if these cost drivers are
identified, the method presented here can be used to treat them in the same way as the variables identified
for direct revenues and costs.
Finally, this method can be applied to the analysis of variations over time instead of variances with
respect to an objective. We simply have to replace the “Planned” and “Actual” columns in the analysis
table with “Period n” and “Period n+1” (see illustration, § 2.9).

1.2.8. Benefits and limits of calculating cost variances or margin variances

Whatever the method used, the analysis of variances based on a costing of the P&L account allows
managers:
- To have a systematic and structured approach that breaks down the overall variance into sub-
variances and therefore to have a first level of analysis that can be used to initiate a diagnosis and
lead to decisions;
- To measure, in monetary terms, the impact of variances on the elementary variables that structure
the result. The advantage of this is that it orients the analysis toward the operational variances which
have the most impact, whereas the perception of operational managers may lead them to focus their
attention on what they see as substantial deviations but whose consequences in terms of results are
less significant than other variances which are apparently less problematic. For example, if a
workshop manager had to deal with a quality problem which kept him very busy during the previous
month, management will tend to focus on the yield variances of this workshop. His actions may
have succeeded in containing these variances and the economic impact is moderate with respect to
a change in the price of a material which did not cause the operational teams so much trouble.
However, this type of analysis has several limitations:
- First of all, it is connected to the cost accounting system in which the actual results are sometimes
not available until a few days after month’s end. Operational managers have their own information
which is available more frequently and more quickly. It is therefore likely that they will have already
taken corrective decisions by the time the variance breakdown table is produced. Analysing it may
lead to the frustrating feeling that it only serves to justify decisions that have already been taken;
- Second, by its very construction, it is restricted to the variance analysis of causes whose impact on
results can be quantified. However, the explanations for results variances are not limited to these
causes and it may be necessary to investigate further upstream. For example, a materials yield
variance may have multiple causes: a problem with the quality of the material supplied, problems
directly related to production, the desire to improve quality and so on;
- Finally, the structure of the model leads managers to consider different performance levers as
independent from each other. Yet a materials cost variance may be connected to variations in sales
volumes which affect purchasing volumes and ultimately the purchase price of the materials, if they
have been negotiated in terms of volume. There is also often a link between the quality of
services/products and prices and volumes.
Just as the performance measurement system must contain both indicators linked to cost accounting as
well as other indicators, the analysis of actual figures using cost accounting must be completed with an

37
See Mendoza et al. (2009)

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analysis of the variances focusing on the most predictive performance levers which are monitored
through dashboard indicators (see § 3).

1.2.9. Illustration
In this section we will provide an illustration of how the variance analysis method is used by the top
management of an international company that produces and markets commodities. The method is used
to analyse both past data and to prepare data for forecasts (three-year planning procedure).
This company is made up of line-of-business divisions. The division that we are interested in produces
and sells products used in the construction industry. They are all variations of a single basic product.
The division is made up of geographic operational units (countries) that produce and sell the products.
Variance analysis is used to prepare for strategic reviews with the divisions. It helps top management to
analyse the forecasts made by these divisions so as to make the strategic review more productive. Indeed,
by determining the weight of the various factors in the forecasts made by the divisions (variance between
the current situation and the planned future situation), it provides information that allows managers to
effectively discuss the strategic orientations of the division and to evaluate the credibility of the forecasts
made on the basis of this strategy.
The P&L account of each operational unit is presented in the following way:

Costing P&L account

Market volume 100

Volume of basic product sold (domestic market) 50

Market share (as a percentage) 50%

Exports 20

Price of the basic product on the domestic market 1.4

Price of the basic product for export 1.0

Turnover – basic product 70

Other sales 8

Export sales 20

Total turnover 98

Variable unit cost – domestic 0.68

Total variable costs – domestic 34

Fixed costs – domestic 21

Variable unit cost – export 0.7

Total variable costs – export 14.6

Fixed costs – export 5

EBIT 23.4

As the basic product is undifferentiated, it is sold at market price, which is known. Variations of this
product are sold at slightly higher prices thanks to the work of the marketing department of each entity.
Moreover, the export price is different from the domestic price for each division.

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Turnover is therefore made up of the sales revenue from the basic product (basic product price × basic
product volume) and an item called “other sales”, which represents the difference between the actual
turnover and the basic product turnover, i.e. the difference between the actual turnover and the turnover
that would have been realised if all products had been sold at the same price as the basic product.
Furthermore, costs are broken down into fixed costs and variable costs. Cost accounting cannot isolate
the costs specific to the variations on the basic product. Thus we will consider these to be basic product
costs and no costs will be attributed to “other sales”.
The unit’s P&L account is drawn up in the local currency of each division and then converted into euros.
The first level in the variance breakdown identifies the effects that are linked to external and internal
factors in order to neutralise the impact of elements that are beyond the control of the divisions. Among
the external factors, apart from the impact owing to market changes, the “inflation” effect measures the
“natural” increase in EBIT due to inflation; the “exchange” effect measures the impact of the exchange
rate on EBIT in euros; the “consolidation scope” effect accounts for variation in EBIT owing to the
acquisition or sale of businesses.
The second level in the breakdown focuses on internal factors which better reflect the true performance
of the divisions. In order to take the analytical breakdown into account, the variables included in the
variance analysis are the following: market share, exports, marketing (which correspond to other sales),
prices, costs and market.
The variance analysis table for a unit is as follows:

VARIANCE

Total Performance Environment Exchange Scope

Market share Export Marketing Prices Market Inflation
Costs

UNIT X

The company’s director of strategy is charged with writing a report for executive management to prepare
the strategic review with the division. The variance breakdown using this model will help him analyse
the plan put forward by the division and will serve in writing up the report.
As company structure is made up of geographic regions, the results are analysed by region. The above
table is therefore prepared for each year and major geographic region (continents) based on previous
(four years) and projected (three years) P&L accounts for the different units in the division.
This data is then put into perspective, either by grouping certain factors together or by grouping different
years together, for example, past vs. future.
We will present the analysis made by the director of strategy based on data supplied by the division.
The financial data presented here are obviously not the real data. It corresponds to a typical situation
where the forecasts are improving while the results from past years are declining (the classic “hockey-
stick” forecast). However, this progression masks discontinuities which can only be identified by
performing a variance breakdown.
The analysis begins with a breakdown of the overall variation in EBIT into four effects (figure 11.1).
Then, depending on the elements brought to light by this breakdown, focuses on the “market” and
“performance” effects by region (table 11.2) and finally on the “price” and “marketing” effects on one
hand and “cost” effects on the other (table 11.3).

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Figure 11.1 Illustration – breakdown of variation in EBIT

150

100

50

Variation in
e EBIT
Performance
0 Environment
n-2 n-1 n (estimated) n+1 n+2 n+3
Exchange

Scope

-50

-100

-150

On the basis of this information, the report to executive management may emphasise the following
points:
- Although a general overview shows growth in EBIT variation until current year (n), followed by a
levelling off for the next three years, breaking it down into the four major factors reveals a
discontinuity due to the “performance” effect, which was negative in the past and is strongly positive
for the coming years (see figure 11.1. N.B. This graph does not show the EBIT itself for each year,
but rather the variation in EBIT compared with the previous year.)
- When the effects of exchange rate, consolidation scope and inflation are excluded, the anticipated
variation in EBIT is much higher than that recorded in the past. This observation is not true for all
regions: certain regions have posted a strong increase, whereas others predict a decrease in the
variation in EBIT. The increase is thus based on a strong improvement in performance particularly
in emerging countries (see table 11.2)

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Table 11.2 Analysis of market and performance effects by region

Annual variations last 3 years next 3 years

TOTAL Variation in EBIT 53 3% 172 10%
Market effect 99 91
Performance effects –46 81
"Mature" region 1 Variation in EBIT 35 11% 10 3%
Market effect 35 0
Performance effects 0 10
"Mature" region 2 Variation in EBIT –9 –1% 23 4%
Market effect 7 –1
Performance effects –16 24
Mature countries Variation in EBIT 27 3% 33 3%
Market effect 42 –2
Performance effects –15 34
"Emerging" region 1 Variation in EBIT 11 12% 18 14%
Market effect 15 16
Performance effects –4 2
"Emerging" region 2 Variation in EBIT 27 22% 1 0%
Market effect 17 12
Performance effects 10 –11
"Emerging" region 3 Variation in EBIT 31 24% 35 16%
Market effect 21 21
Performance effects 10 14
"Emerging" region 4 Variation in EBIT –20 –10% 27 22%
Market effect 4 11
Performance effects –23 16
"Emerging" region 5 Variation in EBIT –24 –14% 57 75%
Market effect 0 33
Performance effects –24 24
Emerging countries Variation in EBIT 26 4% 139 19%
Market effect 57 93
Performance effects –31 46

Furthermore, it is expected that market growth will have an overall impact similar to that observed in
the past. Still, this observation depends on the regions: in emerging region 5 this impact is much greater
in the future than in the past, whereas in mature region 1 it is the opposite.
Concerning the change in the impact of “performance” on variations in EBIT, significant discrepancies
are observed between regions: some of them expect a strong improvement of this impact, while others
envisage a deterioration.
If we detail performance effects, concentrating on price and cost effects and analysing changes in
margin, we obtain the following results:38

38
As table 8.13 only uses some of the variables making up the “performance” effect, it is impossible to make a direct link with the figures in
the previous table.
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Table 11.3 Illustration – analysis of “price and marketing” and “cost” effects

Annual variations last 3 years next 3 years

TOTAL Price and marketing effect 63 –57

Cost effects –92 60
Sum –29 4

The change in prices and costs is not expected to have an impact on EBIT in the future. This is a very
significant change with respect to the past. Furthermore, prices are supposed to fall in the future, while
they rose in the past and the opposite is true for costs.
Transmitted to head office, this information will underpin the discussion with division managers during
the meeting to discuss their plan. It is not a matter of passing judgement on these forecasts but rather
being able to communicate with the division in a richer, more detailed way than would have been
possible with just the consolidated results.
This case illustrates the utility of structuring a variance analysis and shows that the variance analysis
methodology is not only used to analyse results ex post against the budget. It is also useful for refining
the study of variations over time.

Monitoring results with dashboards

Dashboards group indicators together that are linked to the objectives and critical performance variables
of an entity. They are used in the performance management cycle in comparing actual performance for
the various indicators to targets that were set during the budget building phase.39
The dashboard for the manager of a department in charge of maintaining facilities may show variances
in the following way (table 11.4):

39
It is not correct, therefore, to oppose dashboards and budgets, as has sometimes been written, because dashboards are used in the budgeting
cycle both for setting objectives and for analysing results. A dashboard can be distinguished from a particular type of measurement system
which focuses on an exclusively financial performance model and leads to a specific budgeting process. But it cannot be compared to the
budgeting system itself, which is an exercise in performance management over time (setting targets, analysing results).
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Table 11.4 Performance variances for the manager of a facility maintenance department

Indicator Year n−1 Year n

Actual Planned Actual Variance Variance

absolute value as a percentage

Overall cost (in millions of euros) 105.5 102.3 101.9 0.40 0.39 %

Cost per visit (in thousands of euros) 4.96 4.69 4.78 −0.09 −1.89 %

Number of visits 21 251 21 800 21 312 −488 −2.24 %

Productivity (hours/year) 1 450 1 460 1 465 5 0.34 %

Customer satisfaction 3.5 4 3.8 −0.2 −5.00 %

Length of visit 0.05 0.04 0.056 0.016 40.00 %

Facility downtime (hrs) 521 300 320 −20 −6.67 %

Number of down times > 1hr 25 12 16 −4 −33.33 %

Absenteeism 9% 8% 10 % 0.02 25.00 %

The ways of analysing results using a dashboard are not the same as in cost accounting. Moreover,
comparison with respect to objectives is not the only way to use dashboards to analyse actual
performance. We will examine these two points in order.

1.3.1. Comparison with the cost accounting model

Contrary to cost accounting models, there is no mathematical link between the different indicators in a
dashboard and as a result the analysis cannot calculate the impact of the different performance levers on
the overall results objective, even less so given that objectives can be multiple, as we saw in chapter 9.
The evaluation of the impact of the different variances on margin or on any other objective cannot be
quantified in an objective way.
It is not, therefore, possible to mechanically determine the relative importance of each variance. This
leads to the necessity of setting up a proper diagnosis, i.e. having managers evaluate the importance of
the different factors. Partly subjective then, this diagnosis will ideally be carried out collectively,
involving exchanges and discussions which are beneficial to coordination and collective learning about
the conditions of performance.
Moreover, the fact that it is not linked to the accounting system increases the responsiveness of the
analysis because the information about actual performance is produced more frequently and usually
more quickly. In addition, the analysis concerns indicators that are linked to performance levers which
capture the effects of managerial decisions further upstream than those of cost accounting, which makes
it possible to perform an earlier analysis.

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These performance levers are also more diversified than cost accounting, although their number is
limited. The analysis of results is therefore richer without necessarily being more laborious, providing
that the dashboard has been designed according to the principles developed in chapter 9.
Finally, modelling with a dashboard is less restricted than in cost accounting, it is easier to modify and
update. This facilitates the organisational learning process, while performance monitoring using cost
accounting is less favourable to learning and more focused on regulation.

1.3.2. Different monitoring approaches

The monitoring approach differs depending on the type of dashboard.
Concerning the performance management dashboard, whose aim is to energise the organisation to focus
on a few priorities, the analysis of performance is often done at two levels: continuously, by the person
in charge of monitoring the achievement of the objective and discontinuously, by the entity’s executive
committee. As we saw in chapter 9, thanks to the focused nature of the performance management
dashboard, the monitoring of selected objectives can be placed on the agenda of executive committee
meetings in a systematic and organised fashion, which is not the case for the indicators of the panoramic
dashboard (see below). The manager of the objective prepares the analysis of its progress in advance.
He can put forward action plans which may require a decision from top management.
The aim of the panoramic dashboard is to control the organisation. It is therefore used to detect possible
deviations, either with respect to the past or with respect to the more general objectives of the entity. As
exhaustive monitoring is not possible owing to the number of elements under surveillance, it focuses on
the detection of negative variances with respect to targets. Moreover, the monitoring process is different
than for the performance management dashboard. Indeed, the tight scheduling of executive committee
meetings means that only a limited number of points can be dealt with. A selection has to be made before
the meeting. The variance analysis is carried out by the controller who decides along with the entity
director what should be examined during the monthly review. Certain variances may have already
prompted corrective decisions, while others do not concern urgent subjects and it is not necessary to
deal with them in the executive committee meeting. For the others, the role of the committee is to
validate the identification of problems to be resolved and place them in order of priority. Action plans
will generally be decided in other ad hoc bodies after a more thorough investigation.
Whether for performance management or panoramic dashboards, the purpose is to take corrective
decisions, which corresponds to the function that we call “regulation” (see chapter 1).
The analysis of actual results using dashboards can also be done from an organisational learning
perspective, i.e. re-examining and rethinking either strategic positioning or the performance model.
Organisational learning can be achieved through two very different approaches:
- Through discussion between different senior managers on a subject corresponding to a strategic
uncertainty and, therefore, for which top management wants to have detailed information
systematically sent up from the field. We have called this type of dashboard the “interactive
dashboard” in keeping with the interactive use of indicators observed by R. Simons (see chapter 9).
This discussion can be carried on directly between a senior executive and managers located several
hierarchical levels below him. It does not necessarily follow the chain of command.
- Through the analysis of data contained in the panoramic dashboard or more generally in the
company’s databases. This work is done by analysts who are not part of the operational line, for
example, by controllers (this function is also known as “business analyst” or “performance” analyst”
in some companies). It does not follow the monthly calendar (which corresponds to the function of
regulation) and is not directly linked to the performance management cycle and performance
reviews. The purpose is to identify points where the performance model needs to be adjusted. The
idea of statistically testing cause-and-effect links fits this context. Kaplan and Norton (2000) were
among the first to suggest this type of test to validate the cause-and-effect relationships of the
strategy map. This has only been documented for a few cases: Sears (Rucci et al., 1998) and

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McDonald’s (Ittner and Larcker, 2003). What these companies have in common is that they are
made up of a large number of comparable entities (stores and restaurants); the experiment cannot
necessarily be generalised to every type of organisation. Still, as most companies now have
databases which provide them with information on a large number of parameters over several
periods, there is certainly considerable potential to be exploited by statistical analysis.

Other methods
As we have just seen, analysing results in the form of variances is often not enough to decide on action
plans. Controllers and managers must therefore be proficient in other methods which will lead to action
plans within the framework of a diagnostic approach.
We will illustrate the diagnostic approach and provide an example of how to use the Ishikawa diagram
through the example of Sloan Automobile Finance (SAF).

Example

Sloan Automobile Finance is a subsidiary of a banking group specialised in car loans for private
individuals. Its services are marketed directly by car dealerships and the agents of several automakers.
The company has been confronted with the erosion of its market share in Germany for over a year now:
it has fallen to 13%, far below the objective of 14.5%. The German subsidiary must submit an action
plan to the executive management of the group which has provided the help of a team from its
“organisation” department.
This team’s diagnosis is as follows:
- SAF’s product offering is well positioned with respect to that of other competitors in the German
market. For several years, the interest rates offered as well as other contractual conditions have been
among the three best in the market.
- The sales staff of the dealerships and agents have satisfactory knowledge of SAF’s product range.
They know the sales arguments well and are able to present and explain the different financing
products to customers, in spite of their inherent complexity.
- However, the time taken to process loan applications is longer than customers would like, which
may explain why some potential contracts are lost to the competition. Applications are processed
by the central services of the subsidiary, which makes the decision to accept or deny the loan
application. A high rate of application cancellations has been observed in the hour following the
completion of the application when there is no response. Yet only 30% of applications receive a
response during this time period – a rate which appears to be far below that of several competitors.
This performance diagnosis is based on the analysis of the unit’s dashboard. The more relevant the
indicators, i.e. corresponding to strategic positioning and the business model, the less necessary it is to
conduct additional field investigations and the faster it is. We will illustrate the process of formulating
action plans that follows this diagnosis. This process is one of the elements of the management control
process and we will attempt to show its ad hoc nature.
In the present case the process focused on the search for ways to reduce the loan application processing
time. It was necessary to form a specific task force made up of the different parties involved in examining
loan applications: dealership salespeople, analysts, the information systems manager and the head of the
analysis department.
First of all, the task force determined the main steps in the process leading either to the approval or
refusal of a loan application:
- completion of the loan application by a salesperson in a dealership or agency;
- transmission of the application to head office;

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- analysis of applications using a credit scoring methodology, which results in a letter

grade being assigned to each application:
o A: acceptance (45% during the last three months);
o R: refusal (19% of applications during the last three months);
o C: complementary information; applications requiring additional information
before a decision can be made (36% of applications during the last three
months);
- the point of sale is informed of the decision;
- for type C applications, the file is reviewed after the additional information is received.
The task force then held a meeting to investigate the causes, structuring the meeting and the analysis
using an Ishikawa diagram (also known as a “fishbone” diagram). The following is the diagram that was
drawn up during this meeting (figure 11.2):

Figure 11.2: Ishikawa diagram

Analysis
HR
process
Analysts with little
experience on the job
Process jammed with C-type Many manual operations
applications
Lack of staff during peak
hours

High rate of
A single process absenteeism
Some applications are
faxed

Application
processing time is
too long
Legibility problems
with
Very uneven workload documents Connection
(during the week) received problems Equipment
missing
IS
Manual data entry
for applications sent Sales people not trained to use the
by fax system

Old models
Workload Central IT Equipment in
dealerships Breakdowns
Fax

Each main branch of the diagram corresponds to a category of causes. The task force identified five of
them: HR, the analysis process, workload, central IT and the equipment at dealerships. Once one has
identified the sub-categories, one can draw further branches. For example the “equipment at dealerships”
category is divided into two sub-categories: information systems and fax. Then the causes are positioned.
This analysis highlights the following problems:
- inadequate equipment at dealerships;

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- head office procedure not suited to the response time objective;

- large number of manual operations in dealerships and at head office;
- the number of analysts does not match the shifting workload.
On the basis of this analysis, the task force has suggested the following actions:
- train staff and upgrade equipment at dealerships:
o carry out an individual study of options for installing a suitable computer in
dealerships that do not have one (purchasing assistance, configuration, etc.);
o ensure that 100% of dealerships are connected with head office;
o make 100% of dealership software compatible with head office software;
o draft and disseminate a data-entry instruction manual for salespeople at
dealerships;
o train salespeople if the above measures do not result in applications being
submitted electronically;
- Overhaul the process of examining applications:
o review the information required in the application form to limit the number of
applications receiving C status;
o create a separate procedure for processing C applications so they do not
perturb the examination of other applications;
- make staffing changes:
o reduce absenteeism;
o organise schedules and set up incentive mechanisms to increase the number
of staff present during peak hours, especially Saturdays;
o develop actions to increase staff experience and assign the examination of
applications to analysts according their complexity.

The implementation of these action plans can be assigned to a manager with milestones and dates for
reviewing the project, the allocation of a budget and indicators set up to monitor it. These indicators can
be included in the subsidiary’s performance management dashboard.
In addition, if certain key performance levers that have been identified by this diagnosis are not
monitored by suitable indicators in the panoramic dashboard, then it should be completed with new
indicators such as an indicator to measure the fit between the number of analysts and the number of
applications received.
The process of diagnosis and decision making based on the analysis of results thus encompasses several
stages. The first is the analysis of variances with respect to targets for the various indicators of cost
accounting or dashboards. This analysis is facilitated and structured by the indicators used. It is followed
by additional detailed analyses of processes for refining the identification of the precise causes of
dysfunctions which are specific to each process and each problem. The above example provides an
illustration of this type of analysis. The entire process is managerial and therefore requires competencies
much broader than proficiency in variance analysis methods.

Summary
The analysis of results is based on two types of complementary model: cost accounting and dashboards.
In cost accounting, the calculation of variances involves a phase of structuring and calculation for which
we have provided a generic methodology.
The analysis of actual results enables managers to take corrective decisions (regulation) and to validate
or amend strategy and the performance model (learning).
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Whatever the performance model, it is important to avoid the danger of focusing on the search for
explanations to the detriment of decision-making. This danger takes different forms depending on the
performance model. In cost accounting, variances are broken down into sub-variances to explain the
overall variance, for example by breaking a product line down by product, by customer, by region, etc.
For dashboards, as the amount of quantitative information available in information systems is very large,
there is a danger of drowning in all this data without achieving a suitable analysis.

To limit this danger is it necessary to:

- model performance properly, both through cost accounting and dashboards;
- rigorously organise performance reviews and/or executive committee meetings around:
o monitoring performance management dashboards with a review scheduled
and prepared for each objective so that appropriate action plans can be
decided;
o significant variances highlighted by cost accounting and panoramic
dashboards, focusing meetings on prioritising problems and setting up a
decision-making process adapted to each problem;
- be proficient in the various diagnostic methods and ways of conducting the diagnosis.
Organisational learning is mainly based on panoramic dashboards and, if the case applies, on the
interactive dashboard. In this case the analyses are disconnected from the monthly cycle of performance
reviews.

Section 2. Coordination of results monitoring between different

levels
Coordinating the monitoring of results between different hierarchical levels raises the questions of the
coherence of the information that is sent up for reporting purposes with that which is monitored at the
local level (section 2.1), the nesting of managerial results analysis processes (section 2.2.) and the impact
of the twofold function of management reporting: the evaluation of business activities and the evaluation
of individuals (section 2.3).

Coordination between reporting/autonomous local control

The analysis of an entity’s performance is done at two levels:
- The entity: the analysis leads to decisions in relation to the performance levers delegated to the
entity to achieve its performance objectives (autonomous local control);
- The hierarchical superior of the entity: makes sure the entity provides the contribution to
overall performance that is expected of it; he may take decisions relating to performance levers
that concern the entity’s activity but which are not delegated, relating to the allocation of
resources between entities and decisions concerning the manager and his evaluation (see § 2.).
The analysis concerns information sent up by the entity through the reporting process.
In addition to these “regulation” objectives, there are also learning objectives which lead senior
management to analyse data provided by the interactive dashboard and, for publicly traded companies,
the objective of external communication, which requires that information be reported for purposes that
are not tied to decision making. This information gives rise to an analysis to justify variations in results
to the market.
The coherence of the information analysed at the different levels depends on the quality of the
performance measurement systemwhich must ensure that the superior is properly informed of the results
obtained by the entity and that he has the information needed to take decisions within his responsibility.
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This is not always the case, either for historical reasons or because the information systems are not
integrated, which often happens following acquisitions, or simply because the measurement systems are
badly designed. This is a problem concerning the construction of measures which does not specifically
relate to the performance management cycle.
Having coherent indicators is not sufficient, however. Local-level autonomous control is exercised on
the basis of the targets associated with indicators. The following example shows that problems of
coherence in decision making can arise not because of the incoherence of the indicators but rather
stemming from target setting.

Example

Let’s take the example of a company that manufactures products in factories made up of two entities:
one in charge of preparing fuel to generate heat in a kiln and the other in charge of transforming materials
into finished products using this kiln. The kiln can be fired by different combinations of fuel.
In order to take advantage of variations in fuel prices, the head of the fuel preparation workshop proposes
a change of fuel in April to reduce the cost of operating the kiln and therefore that of the final product.
This modification is introduced at the start of May. The kiln workshop then runs into production
problems: an increase in the number of kiln stoppages which decreases daily output and problems with
final product quality. Working with his teams, the manager implements actions to solve these
difficulties. At the end of May, the indicators for output and quality, which appear on the factory’s
dashboard, are as follows (see table 11.5):

Table 11.5 Extract from the factory’s dashboard

Actual Objective Variance

Capacity (t/day) 24.9 31 −6.1

Quality (index) 86 94 −8

Kiln capacity during the month of May is as follows (figure 11.3):

Figure 11.3 Daily capacity

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Faced with the impossibility of achieving his output objectives, the head of the kiln workshop convinces
the preparation workshop manager to return to the original fuel combination starting on the 31st of May.
On the 4th of June, the director of production receives the monthly reports which show an increase in
the cost of the product. After a discussion with the heads of the workshops, he completes the report with
the help of his controller; he puts the variances down to the decision concerning the combination of fuel
that was taken at the beginning of May and announces the return to the cost objective for the month of
June, thanks to the decision to return to the previous fuels.
However, a more thorough analysis would have shown that continuing to use the new fuel would lead
to a significant decrease in costs. As a matter of fact, the production cost for May includes the difficulties
encountered at the beginning of the month. With the capacity achieved at the end of the month and
taking into account the significant cost reduction for heat produced, the cost of the product would be
much lower.
This cost decrease is only possible in exchange for a slight reduction in capacity and quality. But given
the overcapacity that exists in other company factories and a level of quality that is higher than current
customer requirements, the most appropriate decision would be to maintain the new fuel combination
to benefit from the cost reduction. This decision would involve revising the capacity and quality
objectives of the kiln manager.
The decision error from the point of view of overall performance is therefore linked to:
- The fact that reporting focuses on financial parameters (the cost of production) whereas
autonomous local control focuses on technical parameters (capacity and quality), i.e. a
performance model problem;
- Technical targets for the workshop managers which no longer correspond to a new combination
of factors that are not controllable by these managers (fuel price, overcapacity in other plants…).
To resolve this problem, it is necessary to:
- Revise the dashboards to include financial parameters in the local control dashboards and
technical parameters in the reporting dashboards;
- Encourage managers to do re-forecasts;
- Authorise the revision of local objectives.

Finally, reporting for external communication results in top management having detailed information
on subjects that are supposed to be managed locally. In this case, there is a danger of decisions being
recentralised because it is often hard to resist using information that one has at one’s disposal.

Coordination of management processes

Another challenge is to organise the process of analysing the results from different hierarchical levels.
In organisations with several levels, management/performance reviews are sometimes scheduled
sequentially so that the level n review is held after that of level n−1. This type of organisation raises a
problem of responsiveness, because the higher one moves up the hierarchy, the later the meetings are
held. A symptom is that management reviews focus on explaining results for the purposes of external
communication (without taking decisions).
To avoid this problem, the organisation may consider:
- Separating monthly decision-making meetings, the process of reporting information for external
communication and the analysis processes that are carried out in a perspective of organisational
learning, which are not done monthly and which do not require quick responses;
- Identifying the relevant decision-making levels for which monthly performance reviews might
be appropriate;
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- Checking whether these decisions require the lower-level performance reviews to have been
held already.

The link with evaluating managers

In chapter 6 we presented the contractual principle whereby a manager cannot be evaluated on absolute
results, but rather on results in comparison with a previously negotiated objective. This important role
of the budget was also developed in chapter 10. But the process of evaluating the performance of
individuals is complex and cannot be reduced to the analysis of variances between objectives and actual
results. In this chapter, our aim is not to discuss this process but to highlight its consequences on the
analysis of performance and especially with respect to the objectives of regulation (responsiveness) and
learning which were developed in section 1.
The objectives of analysing results for the purposes of regulation and learning (focusing on activities)
and the objectives of evaluating managers’ performance (focusing on people) are partly contradictory:
- The communication of information used to analyse the performance of individuals may be
distorted to improve the evaluation of this performance (it is also true during the preparation of
forecasts, when managers have to discuss coherent action plans and negotiate their objectives at
the same time);
- As we saw in chapter 6, the structure of activities does not necessarily match that of the
responsibilities that the evaluation of managers is based on.
From this point of view, the performance model underlying cost accounting is often too crude to be
useful in analysing the performance of managers. In the illustration provided in section 1.2 the
distinction between a variance linked to performance and a variance linked to the business environment
can be useful in zeroing in on the portion of the variance which comes under managerial responsibility.
But it is still too crude because the elements included in performance variances are not all controllable.
Concerning dashboards, we saw that it is easier to assign indicators if the principle of controllability is
observed.
Still, as we have seen, the separation of responsibilities is not always clear. If a quality indicator being
monitored in the production dashboard declines, it is not always possible to find indicators that can be
used to separate the responsibility of producers from that of buyers. If the quality indicator is included
in the dashboards of both departments, there will be a risk of “free rider” behaviour, where each
department concentrates on its own objectives and hopes that the other department will make the extra
effort needed to improve quality. If the indicator is only included in the dashboard of one department,
for example production, the danger is that they will blame purchasing in the event of poor performance.
Furthermore, observing the controllability principle often requires breaking performance down into a
number of indicators too large to allow for an unequivocal evaluation of managers’ performance. Indeed,
when one has a large number of measures where actual results can be above or below target, it is hard
make an overall summary in order to determine the manager’s performance.
In addition, this evaluation may be connected with diverse procedures and have a variety of
consequences: an objective or subjective evaluation; an impact on the manager’s compensation, his
promotions, etc.
The process of analysing people’s performance thus has an influence on the analysis of the results of
business activities, such as it was presented in section 1. The interactions between these two processes
as well as their links with the incentive system are complex and are beyond the scope of this book’s
aims.
It is important to bear in mind that these two processes are based on different performance models.
Using a single performance model may impair performance. On the other hand, these processes cannot
be designed independently.

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Conclusion
This chapter completes the description of the performance management cycle, offering methodologies
for structuring the phase of analysing results and discussing the impact of the coordination of this phase
between hierarchical levels.
It shows that there are strong interactions between structuring performance measurement and its use in
the performance management cycle, as well as the different functions associated with the performance
management cycle (regulation and learning relative to activities, the evaluation of managers).

Bibliography
Ittner C.D. and Larcker D.F., «Coming Up Short on Non-Financial Performance Measurement»,
Harvard Business Review, November 2003, pp.88-95.
Kaplan R.S., Norton D.P., The strategy-focused organisation, Harvard Business School Press, Boston,
2000.
Mendoza C., Cauvin E., Delmond M-H., Malleret V., Zilberberg E., Coûts et Décisions, Editions
Gualino, 2009.
Rucci A.J., Kirn S.P., Quinn R.T., «The employee-customer profit chain at Sears», Harvard Business
Review, 1998, pp.82-98.

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Part 3 – The management control actors

[Not included in this book]

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