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Performance Management

Module 5 of the Strategic Management Accounting course focuses on performance management and its critical role in strategy development and value creation within organizations. It covers various aspects such as financial and non-financial performance measurement, the design of performance management systems, and the importance of continuous improvement and organizational learning. The module emphasizes the need for management accountants to engage with senior management to implement effective performance measures and control systems that align with strategic objectives.

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0% found this document useful (0 votes)

48 views148 pages

Performance Management

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alirezajavadipour3

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Available Formats

Download as PDF, TXT or read online on Scribd

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STRATEGIC MANAGEMENT ACCOUNTING

Module 5
PERFORMANCE MANAGEMENT
380 | PERFORMANCE MANAGEMENT

Contents
Preview 383
Introduction
Objectives
Teaching materials

Part A: The role of performance management 386

What is ‘performance’ and ‘performance management’?
Performance management and its links to strategy
Financial performance management
Non-financial performance management
The measurability and reporting of performance
The multiple roles of performance management 396
Performance—a process of value creation
Performance and sustainability
Integrated reporting
Signalling
Governance, risk and performance management
Ethics and performance management
Theories related to performance management

Part B: Strategy, management control and performance

management 418
Performance management and control—their role in strategy
Limitations of traditional controls
Models of performance management 428
Operational and strategic performance
Leading and lagging measures of performance
Frameworks for performance management
The Business Model Canvas
The balanced scorecard
Designing a balanced scorecard
Public sector and not-for-profit performance management
Designing a strategy map for performance management
Cascading performance measures
The role of information systems in performance management
The role of performance management in implementing and monitoring strategy

Part C: Determining performance measures and setting

performance targets 459
Designing performance measures
Measuring efficiency, effectiveness and equity
MODULE 5

Designing SMART performance targets

Characteristics of performance measures and targets
Costs and benefits of performance management
Performance management, power and culture
Performance management for performance improvement 474
The importance of performance improvement
Targets
Trends
Benchmarking
Organisational learning and performance improvement
Behavioural consequences of performance management
Performance measures and performance targets
The role of incentives and rewards in performance management

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CONTENTS | 381

Review 488

Appendices 489
Appendix 5.1 489

Figure 5.1: Subject map highlighting Module 5

rnal environment
Exte

VISION

VALUE INFORMATION
STRATEGY

STRATEGY
MODULE 5

MANAGEMENT ACCOUNTANT

VALUE INFORMATION

OPERATIONS

Exte
rnal environment

Source: CPA Australia 2019.

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Study guide | 385

Objectives
After completing this module you should be able to:
• Explain the importance of performance management and the role of a performance
measurement system in value creation, sustainability performance, and strategic
implementation.
• Analyse how a properly designed balanced scorecard can implement and monitor strategy.
• Identify effective performance measures in a given scenario.
• Assess the root causes of performance issues in a given situation.
• Evaluate potential behavioural effects resulting from performance evaluation and
reward systems.

Teaching materials
• APES 110 Code of Ethics for Professional Accountants
• IESBA International Code of Ethics for Professional Accountants (Including International
Independence Standards) April 2018

MODULE 5

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Part A: The role of performance

management
In Part A the concepts of performance and performance management are introduced.
Financial and non-financial performance and the measurability of performance are considered.
The multiple roles of performance management, including its role in value creation and
sustainability, are explained. Corporate governance in terms of the links between risk management
and performance management, and the role of ethics in performance management, are reviewed.
Part A concludes with two theories that help explain differences in how accountants affect and
are affected by performance management.

What is ‘performance’ and ‘performance management’?

‘Performance’ and ‘performance management’ can mean different things to different people.

Performance
Performance may be a discrete event, as in achieving a certain level of profit or customer
satisfaction. Performance may be considered quantitatively (i.e. a numeric value)—for example,
that profit is $10 million, or that 85 per cent of customers are satisfied. It may also be considered
qualitatively (and typically more subjectively)—for example, the quality of a service or an
organisation’s reputation. There may be a trade-off between quantitative and qualitative
aspects of performance—for example, between achieving a certain level of profitability
and the organisation’s reputation. Similarly, there can be a trade-off between short-term
performance and longer-term sustainable performance, whether that be financial, societal,
environmental or reputational.

Performance may be understood either at the level of the whole organisation, or different
business units, products or services, geographic areas, distribution channels or customer
segments within the organisation. At each level of analysis, performance may be interpreted
differently. For example, the Australian airline Qantas achieves quite different results between its
international, domestic and low-cost subsidiary (Jetstar) business segments. Different strategies
and measures of performance may apply across each of these different segments.

Further, different stakeholders—for example, investors, lenders, customers, suppliers, employees,

local communities—may interpret performance in very different (and sometimes competing)
ways. For example, a Qantas customer may see Qantas’s performance in terms of on-time
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departures or the comfort of the cabin seating. An investor may be more interested in its financial
performance. A member of the public living near an airport may be more interested in the
airline’s environmental performance.

Performance measurement
Performance measurement implies a scientific technique involving comparison to a specific
scale (e.g. a metre in length, a tonne of weight, one thousand dollars). A performance measure
is therefore quite specific. Financial performance, such as profit or return on investment, can be
readily measured because it is:
• specified in a single unit—for example, dollars
• clearly defined
• based on a clear application of rules—for example, accounting standards or generally
accepted accounting principles.

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Study guide | 387

A performance indicator is less specific—it is a signal indicating a general direction or trend

rather than an exact comparison against a scale. For example, customer satisfaction can be
classified as an indicator because it can mean different things to different people and can
be judged in different ways, such as sales to returning customers or a survey of a sample of
customers. Performance indicators are often presented as a trend or in comparison to targets as
‘traffic lights’: green for acceptable, red for unacceptable and amber for borderline performance.

For a further explanation of performance measurement, please access the ‘Performance Measurement’
video on My Online Learning.

Other aspects of performance

There are many other functions relevant to the concept of performance:
• Performance monitoring involves surveillance of performance.
• Performance reporting involves the dissemination and interpretation of information about
performance to those inside and/or outside the organisation (see Module 2).

Performance management
The management of performance is an active rather than a passive process whereby actions
are taken to effect change in behaviour or results. Performance management is far more
than collecting or reporting information. It extends to analysing performance with a view
to understanding its causes. Only when there is an understanding of causality can change,
or recommendations for change, be implemented.

Performance management calls for a wider range of skills for the management accountant.
While performance measurement is the starting point, the management accountant needs to
synthesise complex data sets from different sources and analyse that data. The management
accountant then needs skills of persuasion and communication, backed by evidence, to put in
place actions or recommendations for change with the purpose of improving future performance.

Performance improvement implies changing behaviour to improve performance to achieve an

absolute or relative target—for example, a return on investment of 12 per cent or a market share
that is greater than a particular competitor.

Performance management and its links to strategy

The focus of this module is performance management and its links to strategy. As highlighted
in Module 1, an organisation’s strategy is concerned with value creation (not only for investors,

MODULE 5
but also for customers and other stakeholders) that is sustainable over time. The idea of
management control to ensure that strategy is achieved is therefore crucial to an understanding
of performance management. The performance management process incorporates all of the
aspects of performance discussed previously. These are:
• defining what the performance is that an organisation needs to achieve
• how to measure performance
• reporting and monitoring performance
• taking deliberate action to improve performance.

Performance can be seen as a method of value creation (‘If we are not creating value, what are we
doing?’) in terms of process or the results of a process. Performance is usually interpreted relative
to a target, a trend over time or by comparison to a benchmark. Targets, trends and benchmarks
are discussed later in this module.

An organisation’s performance should not be viewed from one dimension only (i.e. only from a
financial point of view). As shown in Figure 5.2, performance should be seen more holistically.

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Figure 5.2: Performance dimensions

Combination of financial Combination of financial and
measures (e.g. profit non-financial quantitative
before tax, return on terms (e.g. dollar sales

$+%
investment) per square metre of floor

$ space, earnings per share

(EPS)

Non-financial but Performance Subjective judgments and

quantitative (e.g. market opinions (e.g. employee
share (%), Net Promoter satisfaction, reputation
Score (NPS), quality or environmental
pass rate) awareness)

%
Source: CPA Australia 2019.

Organisations use different terms for their performance measures such as key performance
indicators (KPIs) or critical success factors (CSFs). Organisations may call their performance
management system a ‘dashboard’ (picture the dials in an aircraft cockpit), a ‘traffic light’ system
(discussed previously under ‘Performance measurement’) or a ‘scorecard’. These differences in
terminology matter less than understanding what an organisation is trying to measure and how
that measurement takes place.

Performance needs to be understood relative to an organisation’s strategy and the particular

industry in which it operates, as shown in Example 5.1. All listed companies report their
performance to investors and other interested stakeholders.

Example 5.1: P
erformance reporting by Event Hospitality
and Entertainment Ltd
Event Hospitality and Entertainment Ltd (EVT) (formerly Amalgamated Holdings Limited) is an Australian
provider of entertainment, hospitality and tourism and leisure services. EVT conducts its operations in
Australia, New Zealand and Germany. The company was established in 1910. It had annual revenue
MODULE 5

of $1.2 billion in the year ended June 2017. EVT is listed on ASX. Its market capitalisation in July 2018
was $2.13 billion.

EVT’s entertainment division operates Event Cinemas in Australia and New Zealand, the State Theatre
in Sydney, Moonlight Cinemas across Australia, Cinestar Cinemas in Germany and Edge Digital
Technology.

EVT’s hospitality division operates QT Hotels & Resorts, Rydges Hotels & Resorts, Atura Hotels brands
as well as the premier Australian ski resort township of Thredbo Alpine Resort. Both the entertainment
and hospitality divisions have loyalty programs. Across its owned and managed hotels at June 2017,
EVT had 9132 rooms across 58 different locations (EVT 2017a, p. 10).

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Study guide | 389

EVT’s strategic plan includes future expansion, depending on a number of internal and external factors,
including available capital and customer trends.

For the hospitality division, EVT wants to increase the number of hotel rooms through new
hotel management agreements and freehold acquisitions. It also aims to grow market share,
increase occupancy rates and increase customer spend in all its hotels (EVT 2017a, p. 13).

The most important financial performance aspects for EVT are explained in the annual report as:
• revenue
• earnings before interest
• taxation
• earnings before depreciation and amortisation (EBITDA)
• normalised profit before interest and taxes (PBIT).

Normalised profit, in many companies called underlying profit, supplements the financial statements,
and such figures are unaudited and not comparable to other companies. The underlying profits are
based on judgments by the directors as to what is the profit that best reflects the result of operations,
unencumbered by transactions that are required by Australian Accounting Standards and that do not
reflect ongoing performance.

For each of the divisions, performance is measured based on profit before income tax, which EVT uses
to compare to the performance of competitors.

The audited remuneration reports within annual reports provide a good guide as to what aspects of
(most commonly, financial) performance are important, as these are the basis for rewarding directors
and senior management. These are typically split into short-term incentives (STIs) and long-term
incentives (LTIs).

EVT’s remuneration policy aims to reward the CEO and other executives with a level and mix of
remuneration commensurate with their position and responsibilities within EVT. The rewards are linked
to specific targets, goals and KPIs. Parts of the executive remuneration packages depend on the
financial and operational performance of EVT. This element of remuneration is deemed to be ‘at‑risk’
because if the performance goals are not achieved, executives do not receive that component of the
remuneration package.

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➤➤Question 5.1
EVT’s Annual Report 2017 and the results presentation for the half year ended 31 December
2017 are available to download at https://www.evt.com/investors/.
Search both documents and identify as many performance measures as you can for the hotel
division.
MODULE 5

Check your work against the suggested answer at the end of the module.

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Study guide | 391

Financial performance management

Accountants are familiar with measuring, monitoring, managing, improving and reporting
financial performance through the income statement (or statement of profit or loss and other
comprehensive income), statement of financial position (balance sheet) and statement of cash
flows. Accountants can interpret financial performance through the use of ratio analysis to
discover trends and opportunities from the five perspectives provided by ratios, as outlined
in Figure 5.3.

Figure 5.3: Ratios for financial performance

Profitability

Shareholder
Liquidity
returns

Ratios

Activity or
Gearing
efficiency

Source: CPA Australia 2019.

Various approaches to measuring shareholder value from an investor’s perspective are also
available. Study of the effect of reported financial performance on capital markets is important
to understand stock market expectations and how reported performance influences share
price movements over time. Stock markets tend to value shares more on expectations of future
cash flows, discounted to present values, than on historical performance. While the analysis
of historical, externally reported performance is valuable, it is through a focus on strategy and
value‑adding activities that management accountants can contribute more to organisations.

While financial statements produced for external parties are governed (in Australia) by the MODULE 5
Corporations Act 2001 (Cwlth), International Financial Reporting Standards (IFRS) and the
requirements of external audit, these have limited usefulness to managers who are interested
in understanding organisational performance at the more detailed level necessary for planning,
decision-making and controlling operations. Strategic management accounting, however,
provides a more detailed analysis of performance, as shown in Table 5.1.

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Table 5.1: C
omparison of approaches to performance between financial accounting
and strategic management accounting

Financial accounting Strategic management accounting

Annual figures in external financial statements Monthly figures (or in some cases weekly or even
daily—e.g. retail sales) reporting

Consolidated data (even segmental reporting in Reporting for individual business units and
financial statements is highly aggregated) responsibility centres

Highly aggregated data on income and expenses Detailed analysis of individual income and expense
line items

Comparison to prior year Comparison to prior year, budget and external

benchmarks

Source: CPA Australia 2019.

Strategic management accounting also provides comparisons to budgets and standard costs, and
enables variance analysis, product/service profitability analysis, customer and distribution channel
profitability analysis, activity-based cost analysis and a variety of other tools and techniques.

Strategic management accounting information increasingly links the information in the general
ledger with other sources of data such as inventory records, labour routings, bills of materials
and standard costs.

Strategic management accounting techniques may move beyond the:

• financial year to encompass a multi-period, life cycle approach to understand performance
• hierarchical organisational structure of reporting to the analysis of its organisational value
chain and business processes, and
• organisation to assess the whole supply chain (industry value chain) of which the organisation
is a part, and to provide comparisons with competitor organisations and competitor
supply chains.

Increasingly, strategic management accounting can provide managers with increased information
about markets, customers, competitors, supply arrangements and production processes,
based on formal and informal sources.

Non-financial performance management

MODULE 5

Strategic management accounting increasingly links financial data with non-financial data and
reports them together to managers. Applying the EVT example (from Example 5.1), it is clear
that revenue, the normalised (or underlying) PBIT and EBITDA are the key financial performance
measures that are used to manage the performance of the CEO and senior executives. Non-
financial data, particularly the average room rate, occupancy rate and revenue per average
available room (RevPAR), are key determinants of performance and are metrics used to compare
relative profitability in the accommodation industry.

Most organisations maintain comprehensive statistical data to support planning, decision-making

and control. This information may come from:
• data captured as a by-product of the accounting process—for example, quantities of product
purchased and sold, labour hours worked
• data captured by the organisation from non-accounting systems—for example, on-time
delivery, product quality
• external surveys—for example, customer satisfaction
• published data—for example, Australian Bureau of Statistics or industry associations
• stock exchange data—for example, market capitalisation.

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Study guide | 393

Performance, whether it is financial or non-financial, needs to be interpreted in the contexts

of the industry and the organisation’s competitive strategy and business model. For example,
measures like occupancy and average room rates are essential in accommodation but not in
manufacturing; ‘sales per square metre’ is useful for retail stores, but is meaningless for airlines;
while ‘available seat kilometres’ has no relevance to retail stores.

All businesses have a finite capacity, whether it is a production line, a hotel, airline or retail store.
To better manage performance, managers need to be able to identify and improve their capacity
utilisation, which will reduce the fixed cost per unit of product sold or service supplied.

Performance measures will also reflect differences between the business segments. For example,
the entertainment division of EVT will have quite different performance measures compared with
the hospitality division. While seasonality may be less important for cinemas (some increase is
possible during school holidays), it will be very important for hotels, and weather conditions in
particular will have a significant impact on EVT’s Thredbo Alpine Resort. While holiday locations
will influence some hotel performance, CBD hotels may be influenced more by Monday to Friday
business travel and whether business confidence is rising or falling, as well as by capital city
sports and entertainment events.

Of course, hotels do not simply generate revenue from hotel bookings, but from ancillary
services, including restaurants and bars, laundry services and room service. One of EVT’s
strategies is to increase customer spend in its hotels. Performance measures will need to
cascade down (see later in this module) to lower levels of the organisation to be able to
manage performance—for example, restaurant utilisation. At the corporate level, EVT must
also focus on growth through its pipeline of new hotel management agreements and freehold
acquisitions, given its strategy to deliver growth via increased room inventory in key destinations
(discussed previously).

The measurability and reporting of performance

A favourite saying in performance management is ‘what gets measured, gets done’. This is
because measuring something focuses people’s minds on what is measured, especially if the
performance is reported, compared to some target, and where rewards are linked to achieving
the desired performance level—for example, sales representatives may receive a commission
on the value of sales or managers may receive a bonus on the reported profit. Those things
that are not measured or not reported are often deemed to be unimportant. Unfortunately,
organisations tend to measure what is easy to measure, rather than what is important to measure
(Denton 2005). This raises the issue of whether all performance is measurable.

MODULE 5
Some people believe that performance must be ‘measurable’ to be useful. But not everything
that is important can be objectively measured. Qantas has long held a reputation for safety.
However, safety incidents do occur. For example, in April 2017, 15 people were injured when a
Qantas 747 flying from Melbourne to Hong Kong had a ‘stick shaker incident in which the pilots
experienced ‘airframe buffeting’ at an altitude of 22 000 feet. The ‘stick shaker’ is a warning
system that causes the aircraft’s control stick to vibrate, alerting pilots they may be about to
stall. Stalling occurs when the wings stop creating enough lift to hold the aircraft in the sky.
The Australian Transport Safety Bureau, the airline safety watchdog, was treating it as a ‘serious
incident’, meaning there were indications that an accident causing loss of life or aircraft damage
nearly occurred (Hatch 2017).

Example 5.2 illustrates how airline safety ratings are independently assessed as a means of
informing travellers about the possible risks involved in travel, a critical area of importance for
passengers and airlines alike.

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Example 5.2: Safety index

The Top 20 Safest Airlines for 2018 rankings by AirlineRatings.com includes Qantas for the fifth year
in a row, making the Australian airline a leader in safety standards (Schultz 2018).

Various safety rankings of airlines around the world exist. The Jet Airliner Crash Data Evaluation Center,
or JACDEC (JACDEC 2017), calculates its safety index and annual rankings based on accidents and
serious incidents (including near-miss accidents) affecting aircraft over the last 30 years. The safety
index relates the number of accidents to revenue passenger kilometres.

The safety index is a good example of a performance indicator rather than a performance
measure because there is no objective way of measuring Qantas’s actual safety or its reputation
for safety. Any trend in passenger numbers or results of surveys of customers may indicate a
reputational effect, but could equally be a consequence of other factors, including economic
conditions, cost, service or comfort. So Qantas’s performance in terms of safety or reputation
is difficult, if not impossible, to objectively measure. But it remains an important element
of performance.

Similar difficulties exist with attempts to measure brand image, customer satisfaction or
employee morale, where surveys, a common method of evaluating performance in relation
to these issues, may provide limited, ambiguous or even biased information.

One development to improve the measurability of customer satisfaction is the Net Promoter
Score (NPS). NPS was developed by Bain & Company to measure the loyalty that exists between
an organisation providing goods or services (the provider) and a consumer. The focus of the score
is the question: ‘How likely is it that you would recommend our company/product/service to a
friend or colleague?’ Responses range from customers being complete detractors of the provider
to complete promoters of the provider. The measure has been adopted by many Australian
companies, including Qantas, where it features as a performance measure in its 2017 annual
report. The NPS measures the percentage of promoters minus the percentage of detractors.
Promoters are the loyal, enthusiastic customers who love doing business with the organisation.

For an example, see the Australia Post 2017 Annual Report where the company emphasised its
overall +1.4 point improvement in the NPS score, available at https://auspost.com.au/content/dam/
auspost_corp/media/documents/Annual-Report-2017.pdf?fm=search-organic.

The importance of NPS is that it provides a measure of sustainable customer satisfaction

necessary for future financial performance, not only in terms of repeat business for existing
customers but also extending to referrals to new customers. This helps the business to focus on
keeping profitable customers happy and CI in customer satisfaction. For example, it is quite likely
MODULE 5

that the NPS results of the four major Australian banks and AMP will suffer from the significant
criticism it faced during 2018 at the Royal Commission into Misconduct in the Banking,
Superannuation and Financial Services Industry.

In the public sector, where the primary focus is not on financial results, organisations also
communicate the success of their activities by reporting on their performance through a range
of non-financial measures, as shown in Example 5.3.

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Example 5.3: Performance reporting by Victoria Police

In its 2016–17 annual report, Victoria Police describes the role and function of police under five headings:
Preserving the peace.
Protecting life and property.
Preventing offences.
Detecting and apprehending offenders.
Helping those in need of assistance (Victoria Police 2017, p. 4).

Performance is reported against the objectives, objective indicators and outputs agreed by the Chief
Commissioner with the Government for 2016–17 in Victorian Budget Paper Number 3: Service Delivery
(Budget Paper Number 3).

The annual report lists three broad categories of performance measurement:

1. community feelings of safety
2. crime statistics based on reports from the public and crimes detected by police. Each offence
is recorded (e.g. fraud, robbery, drug possession, public nuisance, etc.)
3. road fatalities and injuries

The annual report identifies many performance measures, targets and actual results. Some of these are:
• based on quantity—for example, number of calls for assistance, number of offences recorded
• quality—for example, proportion of the public that has confidence in police, proportion of drivers
tested for alcohol who comply with limits
• time-based—for example, proportion of crimes resolved within 30 days.

Financial performance compared with budget is also reported, as are statistics on work health and
safety (WHS).

An interesting aspect of police performance is that the management of that performance can be difficult
to influence by the police agency alone. The use of the term ‘indicators’ rather than ‘measures’ in
the annual report is important, as no police agency has the ability to control behaviours of the public
and outcomes, although each has an important role to play in conjunction with other agencies in the
criminal justice system—for example, prosecution authorities, courts, prisons and probation services.
In addition, many factors affecting police performance are heavily influenced by social factors such
as mental health, unemployment and education.

Like other public services, care must be exercised in the extent to which agencies are held accountable
for aspects of performance over which they may have little or no control.

Note: Example 5.3 is CPA Australia’s analysis of the performance indicators in the Victoria Police

MODULE 5
Annual Report 2016–2017 and is illustrative for educational purposes only. It does not represent the
official position of Victoria Police.

Source: Based on Victoria Police 2017, Annual Report 2016–2017, accessed May 2018,
http://www.police.vic.gov.au/content.asp?a=internetBridgingPage&Media_ID=132934.

Appendix 5.1 explores the case of of Achmea Holdings N.V., the largest insurance provider in the
Netherlands, which has been operating since 1811. This is an interesting case because Achmea is
a ‘mutual’—that is, an entity not listed on a stock exchange but whose customers are, indirectly,
its owners. Appendix 5.1 is included because it provides an example of many of the concepts
included in this Study guide, including performance measures, strategy maps and sustainability.

Note: The concepts covered in this appendix (not the specific details of the case) are examinable.

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The multiple roles of performance management

Performance management has multiple roles that include providing information:
• for managers to aid in planning, decision-making and control in pursuit of value creation
• on environmental and social sustainability for integrated reporting purposes
• for signalling to investors and other stakeholders.

Each of these roles is described in the next section.

Performance—a process of value creation

Value creation is a process of turning one thing into something else, with the ‘something else’
having more value than the original. Value-adding may be seen as increasing shareholder
value to an investor. Value creation was discussed in Module 1 and will be considered further
in Module 6.

A value creation process in production may involve turning wood into paper and paper into a
printed book. A value creation process in services may be using knowledge and skill to construct
a contract between two parties that will enable them to carry on business together. Value creation
may also take place through improved efficiencies—for example, reducing the distance travelled
in making a delivery or the time taken to carry out a service.

Performance management can therefore be seen in terms of the value creation process.
Porter’s (1985) ‘value chain’ (as discussed in Module 1) shows the primary and support activities
that add value to a customer, and the margin that can be achieved as the difference between
the cost of providing those value-adding activities and the price the customer is willing to pay.
So the value added for which the customer is willing to pay must exceed the cost of performing
the activities that lead to the added value; otherwise, the activities should be eliminated.
Performance management should focus on the margin in value chain activities.

This idea of value creation is particularly important when considering for-profit organisations
whose purpose is to increase shareholder value. Shareholder value can be increased through a
combination of dividends and capital gains over time.

There are many ways value creation can be achieved. One is through technological innovation
that leads to products that customers want, as Example 5.4 demonstrates.
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Example 5.4: Value creation at Apple Inc.

The Global Top 100 Companies by Market Capitalisation 31 March 2017 Update by PricewaterhouseCoopers
(PwC) lists Apple as the world’s largest company by market capitalisation (USD 754 billion). Apple’s nearest
rival is Alphabet (previously known as Google). Both Apple and Alphabet have experienced the
largest increases in market capitalisation since the financial crisis of 2009. Apple increased its market
capitalisation between 2009 and 2017 by 705 per cent and its ranking from 33 in the Top 100 companies
in 2009 to number 1 in 2017 (PricewaterhouseCoopers 2017, p. 32).

Warren Buffett’s Berkshire Hathaway Inc.—long known as an exceptionally successful investor—became

Apple Inc.’s second-largest shareholder in May 2018 (Bloomberg 2018).

Apple’s 10-K annual report for 2017 describes its business strategy as designing and developing
operating systems, hardware and software to solve customer needs. It achieves this through a continual
high-level investment in research and development. In addition to advertising and promotion,
Apple’s in-store salesforce provides a high level of advice to customers to attract and retain customers.
Apple operates its own retail stores but also has space and sales staff within retail stores (e.g. within
JB Hi-Fi in Australia).

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Given its strategy for value-adding, Apple would be expected to measure and manage the following
aspects of its performance:
• customer satisfaction
• customer retention
• salesperson knowledge
• growth in retail locations
• growth in third-party distributors
• research and development investment.

However, value creation does not need to come only from innovation. It can also come from
more conventional businesses, as Example 5.5 demonstrates.

Example 5.5: Value creation at Woolworths

Although there are many ways that market share can be measured (and different methods are supported
or disputed by different interest groups), it is reasonably clear that Woolworths and Coles dominate
the grocery market in Australia, although more recent entrants such as Aldi have begun to erode the
dominance of the ‘Big 2’. While Coles is owned by the Wesfarmers group, Woolworths is listed on
ASX in its own right.

Woolworths is best known for its supermarket chain, its Big W department stores and its partnership
with Caltex in fuel retailing, but it also owns liquor retailers Dan Murphy and BWS, and the ALH leisure
and hospitality group, which owns restaurants, hotels and gaming venues. Woolworths’ strategy for
value creation has been to diversify from supermarkets into related retail fields and to expand its range
of stores geographically (including online shopping).

Because of the tightly held market share of Woolworths and its competitors, a key strategy is to
increase spending by existing customers. Woolworths has consequently expanded its product range,
introducing its own-brand products, from the less expensive to the more expensive Woolworths ‘Select’
brand. Woolworths’ supermarket advertising slogan, ‘The fresh food people’, has been successful
in creating value for the company, as has its ‘Everyday Rewards’ loyalty cards system (with nearly
8 million members in Australia) that is linked to Qantas Frequent Flyer points and reward points that
provide discounts on fuel purchases. One of Woolworths’ strategies is to use the large amount of data
gathered on customer buying habits that is available to it through the ‘Everyday Rewards’ card. It uses
this example of ‘big data’ (see Module 2) to target customers with specific promotional campaigns.
Woolworths is also expanding its multi-channel strategy, including online and social networking
channels. Woolworths has also expanded to New Zealand.

In its 2017 Annual Report, Woolworths identified various performance measures linked to its short-term
incentive plan (STIP) and long-term incentive plan (LTIP), which are part of the audited remuneration
report within the annual report.

Woolworths changed its STIP during the 2016–17 year by setting targets at each level of the business MODULE 5
to ensure that all team members ‘from top executives to store managers, were aligned to a common
effort but were rewarded for their achievement of business results largely within their own control’
(Woolworths Group 2017, p. 34). Five STIP measures are each equally weighted (i.e. 20% each): sales,
EBIT, working capital, customer satisfaction and safety. LTIP measures are relative total shareholder
return (TSR), sales per trading square metre and return on funds employed—each weighted at
33 per cent (Woolworths Group 2017, p. 38).

STIP and LTIP are regular features of listed company annual reports and are used by companies to link
the performance of the business to the remuneration of directors and senior executives. By focusing
on measuring, managing and rewarding performance in areas like working capital management,
customer satisfaction and employee safety, managerial behaviour is changed in ways consistent with
the company’s strategy. In the longer term, this changed short-term behaviour is more likely to lead to
the key financial performance areas of increased shareholder value (i.e. TSR), return on funds employed,
and probably the most common measure of retail efficiency, sales per square metre (which measures
the effective utilisation of the most expensive retail resource: i.e. rent).

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➤➤Question 5.2
Please access the Annual Report 2017 of JB Hi-Fi (an Australian consumer electronics and
entertainment retailer), available online at: https://www.jbhifi.com.au/General/Corporate/
Shareholder-Matters/Financial-Annual-Reports/.
Select ‘Annual Report – 2017 – with Chairman’s & CEO’s Report’ from the list.
(a) Who in the company is responsible for shareholder value creation?

(b) What is the company’s strategy to increase shareholder value?

(c) What performance measures does JB Hi-Fi use to measure the success of its shareholder
value creation activities?
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Check your work against the suggested answer at the end of the module.

The key issue for performance management is to understand the organisation’s strategy for value
creation and to measure the success of its value creation activities. As Example 5.5 illustrates,
value creation can be viewed from the shareholder financial perspective, or from a more internal,
operational perspective, although the two are clearly interrelated.

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The idea of value creation over time is important, because measuring value creation should not
be seen solely in terms of short-term gains such as current year profits or customer satisfaction in
a single survey. This highlights the importance of sustainable performance.

➤➤Question 5.3
Mega Markets Ltd (Mega Markets) is an ASX-listed chain of retail stores with branches in all the
major shopping centres in Australia. Mega Markets sells clothing, homewares and toys. Much of
Mega Markets’ product range is sourced from South-East Asia, enabling it to offer low prices for
a wide range of products. Over many years Mega Markets has become a popular department
store for families on a budget with young children.
However, over the past two years, Mega Markets has faced a flattening of sales. Mega Markets
has faced out-of-stock situations where customers have asked for a particular style/colour/
size combination that is not always available in every store. Market research has revealed that
customers are increasingly going online to source similar products from an overseas competitor
at even lower prices than Mega Markets can offer. The purchased goods are posted to their
home address from a large warehouse in South-East Asia.
Mega Markets has complained in the press that this competition is unfair because the overseas
suppliers do not have the high rental costs charged by the large shopping centre owners, nor the
high wages and on-costs that Australian retailers have to pay.
The sales director of Mega Markets said:
Our customers can go to our competitor online, choose the product they want, in the
colour they like, in any size, and have it delivered to their home within a week, all at a
price that is typically 10 to 20 per cent lower than our retail store prices and customers
can return or exchange their products if they are dissatisfied. No wonder our sales
are suffering.
Mega Markets has suffered from a deteriorating financial position as a consequence of its flat
sales, tighter margins and increased overhead costs. The company now faces considerable
pressure from investment analysts and institutional investors to improve its sales and earnings.
The board of Mega Markets has put pressure on senior management to develop strategies to
overcome competition from online sales.
(a) Explain the value creation process for Mega Markets.

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(b) Why is its value creation process now facing competition from online sales?

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(c) What can the company do in the face of online competition?

Check your work against the suggested answer at the end of the module.

Performance and sustainability

When we use the term ‘sustainability’ in relation to performance, we mean two things, as shown
in Figure 5.4.

Figure 5.4: Sustainability in relation to performance

Performance Meeting the

(e.g. financial, needs of today without
customer satisfaction, compromising the
quality) must ability of future
be sustained generations to meet
over time their own needs
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Performance Longer-term
achieved in one perspective (e.g.
year, which cannot avoiding over-fishing,
be achieved in the deforestation, global
following year, is not oil supplies pollution,
sustainable carbon emissions and
waste disposal)

Source: CPA Australia 2019.

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Most companies listed on ASX now produce a CSR or sustainability report in which they
address issues, including sustainability and pollution reduction, and often include performance
measures of their effectiveness. This is the so-called ‘triple bottom line’ reporting of economic,
environmental and social performance.

Sustainability reporting tends to be distinct from other elements of (mainly financial) reporting
and is often addressed in a supplementary statement, rather than being integrated with financial
reports or other elements in the annual report. Integrated reporting, which was introduced
in Module 2 and is discussed later in this module, is aimed at providing a wider range of
stakeholders with reports that integrate the various dimensions of performance, including
financial and sustainability performance. While some stakeholders (including ethical investors)
are interested in sustainability reporting, others have little or no interest. Boards of directors often
see their responsibility, as it is prescribed in the Corporations Act (for Australian companies),
to the company and its shareholders, not to broader stakeholder groups. Hence, short-term
financial motives often drive out longer-term aspirations for sustainability. The problem is how to
convert the long-term benefits of sustainability into current period measures of performance and
how to balance these long-term needs with the current financial need to satisfy shareholders.

Consequently, performance measures for financial issues and sustainability issues do not always
gain the same exposure and are not always accorded similar importance in annual reports,
despite the importance of sustainability in both its meanings. However, reputational issues
have increased the importance not just of reporting sustainability performance, but of actually
engaging in sustainable practices. Importantly, many organisations now see engaging in
sustainable practices as necessary for long-term shareholder value and sustainability reporting
as a means for enhancing their reputation.

Increasingly, some investors and some customers expect businesses to be more socially and
environmentally responsible. Brand image can be tarnished by companies that use, for example,
child labour in developing countries, or source products from factories that have a poor health
and safety record for workers. Some customers are even willing to pay a premium price for more
ethically sourced products such as clothing and coffee.

Further detail on CSR is presented in the Ethics and Governance subject of the CPA Program.

Returning to Appendix 5.1, we see that Achmea reports its performance against both financial
and environmental criteria. Achmea recognises that its success comes from satisfying customers,
yet it must operate in a sustainable way in order to balance financial, social and environmental
responsibilities.

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While one can be cynical and consider that companies engage in sustainability reporting for
purely reputational reasons, there can be sound business reasons for engaging in sustainable
practices as long-term value creation opportunities can be affected. The mining industry is a
good example, as shown in Example 5.6.

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Example 5.6: Sustainability at Newcrest Mining

Newcrest Mining is Australia’s leading gold mining company, with operations in Australia,
Papua New Guinea and Indonesia.

In addition to its strategy to deliver long-term growth in shareholder value, Newcrest’s annual
report discloses that Newcrest recognises the importance of sustainability in its broadest meaning.
The opening paragraph of its Chairman’s report begins with the importance of the health and safety
of its employees. Its key performance measures for 2017 are safety, earnings, costs per ounce and free
cash flow, each with a 25 per cent weighting (Newcrest Mining Limited 2017a, p. 81).

Like many businesses that recognise that a focus on sustainability is not only morally and ethically
appropriate but is also necessary for sustained financial performance, Newcrest produces a separate
sustainability report in accordance with the Global Reporting Initiative (GRI) (discussed later in this module).

The Sustainability Report identifies Newcrest’s newly developed sustainability objectives to:
have a safe, healthy and diverse workforce; reduce, reuse and recycle resources responsibly
to minimise environmental impact; and, work with local communities and other stakeholders,
to achieve our vision as Miner of Choice (Newcrest Mining Limited 2017b, p. 8).

The report contains substantial information about People (safety), Economic, Social and Environmental
performance and includes 14 pages of data covering these aspects of performance (Newcrest Mining
Limited 2017b, pp. 87–100).

The GRI G4 content index is also available at the same website and identifies where data can be found
to match the GRI G4 reporting requirements.

The Newcrest example suggests that companies do consider environmental issues in their
strategy. GRI G4 Guidelines address the need to adopt a more holistic approach to reporting
performance.

The GRI (see http://www.globalreporting.org) is a multi-stakeholder process aimed at developing

and disseminating globally applicable sustainability reporting. The GRI Sustainability Reporting
Standards (GRI Standards) offer reporting principles, standard disclosures and an implementation
manual for the preparation of sustainability reports by organisations, regardless of their size,
sector or location. The GRI Standards are required for all reports or other materials published
on or after 1 July 2018.

The consolidated PDF of GRI Standards includes the three universal standards—GRI 101, 102 and
103—and the three series of topic-specific standards:
1. 200 (Economic topics)
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2. 300 (Environmental topics)

3. 400 (Social topics).

It is available at: https://www.globalreporting.org/standards/gri-standards-download-center/

consolidated-set-of-gri-standards/.

The GRI argues that ‘sustainability reporting helps organisations to set goals, measure
performance, and manage change in order to make their operations more sustainable.
A sustainability report conveys disclosures on an organisation’s impacts—be they positive or
negative—on the environment, society and the economy’ (GRI 2014, p. 3). GRI sustainability
reports under the GRI Standards include the disclosure of the governance approach and the
environmental, social and economic performance and effects of organisations. Importantly,
the economic dimension of sustainability concerns the effects of the organisation’s activities
on the economic conditions of its stakeholders and on economic systems at local, national and
global levels, rather than on the financial condition of the organisation.

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Not all of these have to be disclosed, only those where the organisation deems them to be
material. Note that in Example 5.6, Newcrest produced a separate GRI G4 content index that
links to where the data in the G4 can be found in the annual report or sustainability report.

Successful companies in the future will need an integrated strategy to achieve strong financial
results and create lasting value for the company, its stakeholders and society. The value created
by companies in the future cannot be expressed by isolated financial and sustainability reports,
with no clear links between the ‘single bottom line’ and the sustainability impacts caused or the
value created in order to generate its financial results. Consequently, the GRI co-founded the
International Integrated Reporting Council (IIRC) because it believed the future of corporate
reporting is the integration of financial and sustainability strategy and reporting. ‘Understanding
the links between financial results and sustainability impacts is critical for business managers,
and is increasingly connected to long- and short-term business success’ (GRI 2012).

The move towards integrated reporting has important implications for accountants in terms
of performance information.

Integrated reporting
The International Integrated Reporting (IR) Framework document (‘the Framework’) was issued
by the IIRC in 2013. In relation to performance management:
The Framework takes a principles-based approach … It does not prescribe specific key
performance indicators, measurement methods, or the disclosure of individual matters, but does
include a small number of requirements that are to be applied before an integrated report can be
said to be in accordance with the Framework (IIRC 2013, p. 4).

The Framework refers to a collection of ‘capitals’. ‘The capitals are stocks of value that are
increased, decreased or transformed through the activities and outputs’ (IIRC 2013, para. 2.11)
of the organisation:
• financial capital (funds for use in the business)
• manufactured capital (machines)
• natural capital (air, water and land)
• human capital (skill, experience and motivation)
• intellectual capital (the intangibles)
• social and relationship capital (community stakeholders).

The ability of an organisation to create value for itself enables financial returns to shareholders.
This is interrelated with the value the organisation creates for stakeholders and society at large

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through the resources and relationships that are used by, and affected by, an organisation.

More information is available online at: http://integratedreporting.org.

While the initial focus of the IIRC is on reporting by larger companies and on the needs of
their investors, it may have important implications for organisations and accountants in the
longer term.

There are important links between integrated reporting and the GRI.
GRI is supportive of integrated reporting as it develops as an important and necessary innovation
of corporate reporting.
GRI advocates for the inclusion of robust sustainability metrics (based on a multi-stakeholder
approach) to integrated reporting, in support of its overall vision of a sustainable global economy
(GRI 2018).

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Integrated reporting provides companies with a broad perspective on risk, and GRI encourages
those that want to do integrated reporting to use the GRI Standards. United by the shared vision
that businesses should focus on value creation over the short, medium and longer term, GRI and
the International Integrated Reporting Council (IIRC) continue to work together, aligning the GRI
Standards and the International <IR> Framework to improve corporate reporting.
…
As the global standard setter for sustainability reporting, GRI is committed to supporting integrated
reporting – including through the Corporate Leadership Group on integrated reporting 2017 (CLGir)
… The CLGir 2017 is exploring how best to leverage the GRI Standards and the International <IR>
Framework for integrated thinking and reporting, with the aim of learning together and identifying
best practice guidance in reporting (GRI 2017).

CPA Australia believes that bringing together all the strands of corporate reporting will help
satisfy the growing demands of investors for information about performance beyond the
bottom line.

Integrated reporting is also discussed in the Advanced Audit and Assurance, Contemporary Business
Issues and Ethics and Governance subjects of the CPA Program.

XBRL
Integrated reporting takes advantage of new and emerging technologies such as eXtensible
Business Reporting Language (XBRL) to link information within the primary report and to facilitate
access to further detail online where that is appropriate.

XBRL (‘a language for the electronic communication of business and financial data’) is becoming
a standard means of communicating information between businesses and on the internet.
‘Instead of treating financial information as a block of text – as in a standard internet page or a
printed document – it provides [a unique, computer-readable] identifying tag for each individual
item of data’ (XBRL 2018) (e.g. net profit after tax). Computers can treat XBRL data intelligently.
They can recognise the information in an XBRL document, select it, analyse it, store it,
exchange it with other computers and present it automatically in a variety of ways for users.

Further information about XBRL is available online at: http://www.xbrl.org.

XBRL is also discussed in the Advanced Audit and Assurance subject of the CPA Program.

Signalling
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While governance is concerned with conformance and performance, and with making value-
adding decisions, signalling is aimed at trying to influence someone else’s decisions. Signalling
occurs when a measure is used to communicate information (either a forward goal or an actual
achievement). One of the key roles of senior management is to communicate with stakeholder
groups. Financial statements, for example, are a signal, prepared by directors for shareholders,
about the performance of directors and managers in carrying out the operations of the
organisation (the statement of profit or loss and other comprehensive income) and in building
the assets of the organisation (the statement of financial position or balance sheet). The key
financial performance measures presented in financial reports include various measures of
profit, cash flows, assets and liabilities.

Most organisations choose to disclose other financial and non-financial measures to investors
and other stakeholders in their annual reports, in investor briefings and through other public
communications. However, organisations need to be careful as to how much information they
voluntarily disclose (as opposed to disclosing information that is required by law) because
competitors will be one of the groups looking for competitively sensitive information that may
help them.

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As seen in Example 5.5, Woolworths disclosed limited non-financial information in its annual
report, at least in part because of the commercially sensitive information this would give to its
competitors. Interestingly, a comparison of annual reports over several years reveals that each
year Woolworths has disclosed less non-financial performance information, no doubt due to the
concern that this information could be advantageous to its main competitor Coles (while Coles,
a division of Wesfarmers, had no equivalent practice of disclosing this type of information).

Being given sufficient information to understand and assess investment risk is crucial to the
ability of investors to make informed investment decisions (ASX CGC 2014, p. 28). Signalling will
be insufficient unless investors understand the risks the company faces and the extent to which
future performance may be impacted by those risks. Boards recognise and manage risk through
establishing and reviewing the effectiveness of the company’s risk management framework,
and annual reports typically disclose the company’s approach to risk management as a form
of signalling to the company’s stakeholders. As has been shown in the preceding examples of
EVT, Woolworths, JB Hi-Fi and Newcrest, remuneration reports included in annual reports now
contain information about how performance is measured for remuneration of directors and
senior executives. These reports send an important signal to shareholders that the short-term
and long-term remuneration of directors and senior managers is inextricably linked to improving
shareholder value, as shown in Example 5.7.

Example 5.7: Risk management and signalling at Westpac

Like all Australian banks, Westpac is subject to a large number of regulatory agencies, including the
Australian Prudential Regulation Authority (APRA), Reserve Bank of Australia (RBA), Australian Securities
and Investments Commission (ASIC), Australian Securities Exchange (ASX), Australian Competition
and Consumer Commission (ACCC), Australian Transaction Reports and Analysis Centre (AUSTRAC)
as well as the regulatory agencies of the other countries in which it operates.

The Basel Committee on Banking Supervision (BCBS) provides a global regulatory framework known
as Basel III. Basel III, among other things, has increased the required quality and quantity of capital
held by banks and introduced new standards for the management of liquidity risk.

Westpac’s annual report highlights risk management as a key area that needs to be addressed in order
for Westpac to achieve its vision, because risk management affects all aspects of Westpac’s business
and its stakeholders.

Westpac has an ‘Operational Risk Management Framework’ and ‘Compliance Management Framework’
it uses to manage risks, and also a ‘Sustainability Risk Management Framework’ it uses to assess and
manage CSR-related risks.

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Westpac’s annual report notes that the culture in the bank is that all staff are responsible for identifying
risk, managing risk and working according to Westpac’s nominated risk profile.

You can access the details of Westpac’s approach to risk management in its annual report, which is
available at: https://www.westpac.com.au/about-westpac/investor-centre/. Click on ‘2017 Annual
Report’ and navigate to p. 105.

Signalling does not just occur between the organisation and outside stakeholders. Managers in
large organisations often devote much time to competing for resources for their business unit,
project or team. The need to manage and improve performance can lead to claims by managers
for additional resources for their business units. Often, managers who can demonstrate success
in achieving their performance goals are more likely to be given increased access to resources in
the future.

Organisations need to ensure that the signals they send are accurate. Public relations and
marketing are important elements of communication, including investor relations, but a very
real risk is when an organisation puts too much faith in its own press releases rather than the
underlying reality of performance.

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At the time of writing, Australian financial institutions, including Westpac and other banks, were
facing considerable reputational and potentially financial risks arising from the Royal Commission
into Misconduct in the Banking, Superannuation and Financial Services Industry. Criticism of all
financial institutions has focused on their STI-driven profit focus possibly directing the behaviour
of some employees towards unethical practices. Time will tell what the consequences are of
the Royal Commission for banks and other financial institutions. From a signalling perspective,
the Royal Commission draws to our attention to the idea that we cannot rely on the statements
of any business without considering other relevant factors in the public domain.

Further information about the Royal Commission is available at: https://financialservices.

royalcommission.gov.au/Pages/default.aspx.

A historical example, the HIH case (Example 5.8), illustrates the impact on a financial institution
of an earlier Royal Commission.

Example 5.8: HIH Insurance

The collapse of HIH Insurance Group, placed into provisional liquidation in March 2001, was—and
remains—the largest corporate failure in Australian history. The subsequent suspicions about a serious
level of corporate mismanagement within HIH saw the appointment of a Royal Commission later that
year. The Royal Commission’s report was publicly released in April 2003 and had a significant influence on
the ASX’s Principles of Good Corporate Governance and Best Practice Recommendations, from which
the ASX’s current (2014) definition of corporate governance was derived.

The ‘Royal Commission did not find fraud or embezzlement to be behind the collapse. HIH’s failure was
found to be ‘more the result of attempts to paper over the cracks caused by over-priced acquisitions
and too much corporate extravagance’ (Parliament of Australia 2003). There was a misconception in
the company that ample funds were available to fund these activities.

According to the Parliament of Australia (2003), ‘The primary reason for the failure was that adequate
provision had not been made for insurance claims. Past claims on policies had not been properly
priced. HIH was mismanaged in the area of its core business activity’.

The Royal Commission further found that ‘the acquisition of FAI Insurance Ltd in Australia, combined with
re-entry into the US market and the expansion of the UK operations’ (Parliament of Australia
2003), were poor commercial decisions. All were afflicted with under-provisioning for mandatory
claims reserves.
While HIH had a corporate governance model, the Royal Commission found that HIH had
failed to review the model to assess its suitability for changing circumstances in the insurance
industry. HIH’s audit committee focused almost exclusively on the financial statements,
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rather than taking on the function of overall risk identification and assessment.
…
The Royal Commission noted that a culture appeared to have developed within HIH not to
question leadership decisions (Parliament of Australia 2003).

Alcock and Bicego (2003) wrote that the Royal Commissioner was:
… frustrated by what he described as the disinclination of HIH middle managers to accept
responsibility for undesirable practices. He identified the difficulties for the Royal Commission
in considering conduct where middle managers had taken steps that resulted in the falsification
of the corporation’s accounts or returns lodged with statutory authorities. In some instances,
he observed … someone prepared a report knowing it to be false but did not sign it. The more
senior officer who then signed the document would assert as ‘reasonable’ his or her reliance
on the more junior employee who prepared the report, to argue that the senior officer’s
conduct did not constitute a breach of the law (Alcock & Bicego 2003).

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HIH is a clear example of the failure of corporate governance, and the failure to provide
appropriate signalling to investors. It is also a clear case of the failure of management controls
and risk management, especially in relation to provisions for insurance claims and acquisitions.
The performance of HIH was misinterpreted, through a combination of a lack of competence
and poor ethical practices.

Corporate failures are a feature of all capitalist economies. In Australia there have been many
failures before and after HIH (see Example 5.9 for a more recent case), but there have been no
corporate failures since HIH that approach its magnitude.

The role of regulatory bodies and auditors always comes under scrutiny following large-scale and
high-profile corporate collapses. This is likely to happen as a result of the Royal Commission into
Misconduct in the Banking, Superannuation and Financial Services Industry in which questions
about corporate governance and organisational culture have (at the time of writing in 2018)
already been raised.

Example 5.9: Dick Smith Group

The Dick Smith Group (DSG) operated consumer electronics retail stores and an online consumer
electronics retail business throughout Australia and New Zealand from in excess of 390 locations with
in excess of 3000 employees. It was listed on ASX in 2013. In January 2016, DSG and its Australian
subsidiaries were placed into voluntary administration by its directors. Banks subsequently appointed
receivers and managers to recover the assets over which they held security.

The report to creditors by administrators McGrath Nicol identified the reasons for the failure:
Although DSG reported profits, its growth required considerable financial commitment,
during a period where DSG was losing market share. The competitive electronics environment
resulted in tightening credit terms, the need for major inventory impairment, and significant
cash pressure in late FY16. Increased borrowings and new finance facilities were required and
ultimately DSG could not operate within the terms of those facilities (McGrath Nicol 2016, p. 10).

The administrators believed that DSG failed because of its high cost base due to its large network of
stores, a loss of market share in a highly competitive market, an expansion plan requiring considerable
financial resources and purchase of inventory that was not justified by consumer demand. Ultimately,
its cash flows were unable to satisfy the covenants it had made with bank lenders.

Banks were paid a proportion of their secured debt but unsecured creditors and shareholders received
nothing. The total shortfall to creditors was about $260 million (McGrath Nicol 2016).

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The example of Dick Smith, like HIH, shows the importance of sound risk management as part
of governance processes. It also reveals that signalling risk factors to investors is not always as
clear as it should be. The suppliers, lenders and customers of Dick Smith are not likely to have
understood the risk of rapid expansion, competition and increases in inventory holdings.

Company annual reports require extensive disclosure of risk management information, but rely on
the due diligence of investors. Unfortunately, many small investors do not sufficiently understand
the nature of risk in their investments and perhaps take too much comfort from audit reports and
bank lending (which is typically secured).

While signalling is an important element of understanding performance and the risks associated
with performance, the examples of corporate failure here perhaps reveal:
• failures in risk management at board level
• failures of adequate regulatory body oversight
• a lack of understanding of risks of investment by investors.

Further detail on governance is presented in the Ethics and Governance subject of the CPA Program.

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The context in which the accountant operates is dictated by the organisation’s approach to
governance and risk management and how these are connected to performance management.

Governance, risk and performance management

In Australia, the Corporations Act provides the broad legal framework under which companies
operate. Two organisations provide regulation for companies and securities in Australia: the
Australian Securities and Investments Commission (ASIC) and the Financial Reporting Council.
ASIC is Australia’s corporate, markets and financial services regulator. It ensures that Australia’s
financial markets are fair and transparent, supported by confident and informed investors and
consumers. ASIC administers and enforces the Corporations Act and is required to:
• maintain, facilitate and improve the performance of the financial system
• promote confident and informed participation by investors and consumers in the
financial system
• administer and enforce the law
• make information about companies and other bodies available to the public as soon
as practicable.

The ASX Corporate Governance Council has produced corporate governance guidelines
for Australian listed entities in the third edition of its Corporate Governance Principles and
Recommendations (effective from July 2014). Corporate governance is defined in this publication
as ‘the framework of rules, relationships, systems and processes within and by which authority
is exercised and controlled within corporations. It encompasses the mechanisms by which
companies, and those in control, are held to account’. Further, it defines good corporate
governance as promoting ‘investor confidence, which is crucial to the ability of entities listed
on the ASX to compete for capital’ (ASX 2014, p. 3).

It is interesting to note that the ASX guidelines have taken the definition of corporate
governance from Justice Owen in the Report of the Royal Commission into HIH Insurance,
volume 1: ‘The failure of HIH Insurance: A corporate collapse and its lessons’ (HIH Royal
Commission 2003, p. xxxiv). HIH focused the minds of regulators and boards of directors on
their roles and responsibilities, much of which is now reflected in the ASX publication.

There are eight general principles in the ASX Corporate Governance Principles and
Recommendations, which also contains 29 recommendations to give effect to the principles.
Listed Australian entities are required to make disclosure in their annual reports regarding
the extent to which they do or do not follow the principles and recommendations.

You can access the Corporate Governance Principles and Recommendations at: http://www.asx.com.
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au/documents/asx-compliance/cgc-principles-and-recommendations-3rd-edn.pdf.

Accountants, as significant advisers to the board, play a significant role in contributing to

good corporate governance, not only in terms of safeguarding the integrity of financial
reports (the fourth principle), but also in contributing to a system of management control that
monitors and evaluates performance (the first principle); and establishing and evaluating a
risk management framework (the seventh principle).

Corporate governance can be described as constituting the entire accountability framework

of the organisation, with two dimensions:
1. conformance, and
2. performance.

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Conformance takes place through assurance (including audit), ensuring that the organisation
understands and is managing its risks effectively. While conformance is an essential aspect
of corporate governance, it needs to be balanced with performance.
Performance is the need to take risks to achieve objectives, and to do this, risk management
needs to be integrated with decision-making at each organisational level. Performance focuses
on strategy, resource utilisation and value creation, helping the board to make strategic decisions,
understand its appetite for risk and the key performance drivers [in order to achieve shareholder
value] (Collier 2009, p. 21).

The board’s role is to set objectives, monitor performance in terms of achieving those objectives
and report to shareholders on how well the organisation has performed. Risk management,
in this context, is managing the risks of achieving—or not achieving—those organisational
objectives. In a positive sense, the risk–return trade-off is that risks need to be taken in order to
take advantage of opportunities for the organisation. In its negative sense, the risk is that those
objectives will not be achieved. Management controls are put in place to help manage both
kinds of risk. Boards will often delegate some of their role to a finance committee (to monitor
financial performance), to an audit committee (to monitor the effectiveness of controls) and to
a risk committee (to oversee the risk management process), although in practice some of these
committees may be combined. These different approaches are recognised in the ASX Corporate
Governance Principles and Recommendations (2014).

One of the key roles of the board in determining strategy is to articulate the risk–return trade-
off and the organisation’s risk appetite. There is, generally speaking, a relationship between
risk and return such that a higher return is expected when there is a higher risk, and a lower
return accepted where the risk is lower. To guide management plans and decisions, boards
need to be clear about whether the organisation’s strategy is risk averse, risk neutral or risk
seeking, and make explicit the expected returns for risk-taking (e.g. minimum payback periods,
internal rates of return, hurdle rates).

The Committee of Sponsoring Organizations of the Treadway Commission (COSO) Enterprise

Risk Management—Integrated Framework (COSO 2004) defines enterprise risk management
as a process, effected by an entity’s board of directors, management and other personnel. It is
applied across the enterprise and is designed to identify potential events that may affect the
entity, to manage risk within its risk appetite and to provide reasonable assurance regarding the
achievement of entity objectives.

COSO updated the framework in 2017 as Enterprise Risk Management—Integrating with Strategy
and Performance, which highlights the importance of considering risk in both the strategy-setting
process and in driving performance. The updated framework gives explicit focus to performance.

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The framework ‘Enhances alignment between performance and enterprise risk management to
improve the setting of performance targets and understanding the impact of risk on performance’
(COSO 2017, p. iii). It further states that:
Enterprise risk management allows organizations to anticipate the risks that would affect
performance and enable them to put in place the actions needed to minimize disruption and
maximize opportunity (COSO 2017, p. 4).

The International Standards Organization also produced an updated risk management standard
in 2018: ISO 31000:2018 Risk management—Guidelines, which provides principles, a framework
and a common process for managing risk of any type. It can be used by any organisation
regardless of its size, activity or sector. The new standard is an update of AS/NZS ISO 31000:2009
Risk Management—Principles and Guidelines, the Australian-developed international standard for
risk management. Risk is now defined as the ‘effect of uncertainty on objectives’, which focuses
on the effect of incomplete knowledge of events or circumstances on an organisation’s decision-
making (Tranchard 2018).

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A brief summary of the new standard (which is only available to purchase from ISO) is at:
https://www.iso.org/obp/ui#iso:std:iso:31000:ed-2:v1:en.

Performance management is fundamental to helping the board or its committees exercise

the function of governance and risk management by monitoring performance information in
terms of goal achievement, assessing risks and the effectiveness of management controls.
Accounting information is one of the main sources used by boards to support the governance
function. Accountants are involved in performance reporting to the board and in establishing
and monitoring internal controls.

Management accountants in particular are commonly involved in risk management processes

(Collier, Berry & Burke 2007).

Risk management is an important element of performance management because it establishes

the boundaries of what is acceptable and unacceptable in terms of the risk appetite set by the
board. This function results in the board defining the corporate strategy, the management controls
and the performance measures necessary to manage risks and achieve organisational objectives.
In particular, the board of directors must balance short-term and long-term expectations about
performance—the notion of sustainability (discussed previously)—and also to some extent
balance the needs of shareholders and other stakeholders. Finally, actual performance needs
to be monitored against performance expectations, thereby satisfying the need for good
governance. These relationships are shown in Figure 5.5.

Figure 5.5: Relationship between elements of the management control system

Corporate governance sets

objectives in line with
stakeholder expectations
and competitive situation

Management controls
Performance measures
(financial, non-financial; Enterprise risk management
and targets
quantitative, qualitative)

Strategies and plans are

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implemented and result in

organisational actions

Feedback
Organisational outcomes

Source: CPA Australia 2019.

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➤➤Question 5.4
Consider the role of risk management and performance management in your organisation. If your
organisation produces a publicly available annual report, do a word search on ‘risk management’,
‘performance’ or ‘KPIs’. If you work for a smaller organisation, you may be able to ask the CEO
or chief financial officer (CFO) how they view the relationship between risk management and
performance management.
How does risk management relate to performance management?

Check your work against the suggested answer at the end of the module.

Ethics and performance management

CPA Australia members must comply with APES 110 Code of Ethics for Professional Accountants
(the Code). The standard is based on the previous version of the Code of Ethics for Professional
Accountants issued by the International Federation of Accountants (IFAC) (at the time of writing,

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the APESB had issued an Exposure Draft 02/18 outlining the proposed changes to APES 110,
with a proposed effective date of 1 January 2020). The Code applies to members in business as
well as members in public practice.

A CPA member’s responsibility is not exclusively to satisfy the needs of an individual client
or employer, as the accountancy profession also has a responsibility to act in the public
interest. The Code establishes a conceptual framework that requires CPA members to identify,
evaluate and address threats to compliance with the fundamental principles. The conceptual
framework approach assists a member in complying with the ethical requirements of the
code and meeting their responsibility to act in the public interest.

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The fundamental principles in the Code are:

(a) Integrity—to be straightforward and honest in all professional and business relationships
(b) Objectivity—not to compromise professional or business judgments because of bias, conflict of
interest or undue influence of others.
(c) Professional competence and due care – to:
i. Attain and maintain professional knowledge and skill at the level required to ensure that a
client or employing organization receives competent professional service, based on current
technical and professional standards and relevant legislation; and
ii. Act diligently in accordance with applicable technical and professional standards.
(d) Confidentiality—to respect the confidentiality of information acquired as a result of professional
and business relationships.
(e) Professional behaviour—to comply with relevant laws and regulations and avoid any conduct
that the professional accountant knows or should know might discredit the profession
(s. 110.1 A1).

The circumstances in which members operate may create specific threats to compliance with
the fundamental principles.
Threats to compliance with the fundamental principles might be created by a broad range of facts
and circumstances. It is not possible to define every situation that creates threats. In addition,
the nature of engagements and work assignments might differ and, consequently, different types
of threats might be created (s. 120.6 A2).

Threats to compliance with the fundamental principles fall into one or more of the following
categories:
(a) Self-interest threat—the threat that a financial or other interest will inappropriately influence a
professional accountant’s judgment or behavior;
(b) Self-review threat—the threat that a professional accountant will not appropriately evaluate the
results of a previous judgment made; or an activity performed by the accountant, or by another
individual within the accountant’s firm or employing organization, on which the accountant will
rely when forming a judgment as part of performing a current activity;
(c) Advocacy threat—the threat that a professional accountant will promote a client’s or employing
organization’s position to the point that the accountant’s objectivity is compromised;
(d) Familiarity threat—the threat that due to a long or close relationship with a client or employing
organization, a professional accountant will be too sympathetic to their interests or too
accepting of their work; and
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(e) Intimidation threat—the threat that a professional accountant will be deterred from acting
objectively because of actual or perceived pressures, including attempts to exercise undue
influence over the professional accountant (s. 120.6 A3).

Where an ethical conflict exists, a CPA member should determine the appropriate course of
action that is consistent with the fundamental principles in the Code. CPAs should also weigh
the consequences of each possible course of action. If the matter remains unresolved, a CPA
member should consult with other appropriate persons within the employing organisation—
particularly the board—for help in obtaining a resolution. A CPA member should also consider
obtaining legal advice to determine whether there is a requirement to report the matter to an
appropriate authority.
If after exhausting all feasible options, the professional accountant determines that appropriate
action has not been taken and there is reason to believe that the information is still misleading,
the accountant shall refuse to be or to remain associated with the information (IESBA Code,
s. R220.9).
In such circumstances, it might be appropriate for a professional accountant to resign from the
employing organization (IESBA Code, s. 220.9 A1).

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Ethics has a great deal of relevance to those responsible for performance management,
whether this is reporting performance in an organisation in which an accountant is employed
or reporting performance to a client. Accountants may feel under pressure to manipulate
or report performance information as a result of any of the threats identified in the Code
(some of these behaviours are described in Example 5.10).

Example 5.10: WorldCom, Enron and Arthur Andersen

WorldCom filed for bankruptcy protection in June 2002. At the time, it was the biggest
corporate fraud in history. The US Securities and Exchange Commission said WorldCom had
committed ‘accounting improprieties of unprecedented magnitude’ (SEC 2002). The company
used accounting tricks, largely by treating operating expenses as capital expenditure to
conceal a deteriorating financial condition and inflate profits. WorldCom admitted in 2004
that the total amount by which it had misled investors over the previous 10 years was almost
USD 75 billion and reduced its stated pre-tax profits for 2001 and 2002 by that amount.
Former WorldCom chief executive Bernie Ebbers resigned in April 2002 and is currently
serving a 25-year prison term. Scott Sullivan, former chief financial officer, entered a guilty plea
and was sentenced to five years in prison as part of a plea agreement in which he testified
against Ebbers.
In December 2001, US energy trader Enron collapsed. At the time, it was the largest bankruptcy
in US history. Even though the United States was believed by many to be the most regulated
financial market in the world, it was evident from Enron’s collapse that investors were not
properly informed about the significance of off-balance sheet transactions. US accounting
rules may have contributed to this, in that they were more concerned with the strict legal
ownership of investment vehicles rather than with their effective control. The failure of Enron
highlighted the over-dependence of an auditor (Arthur Andersen) [on one particular client]
(Collier 2015, p. 86).

It also highlighted the employment of staff by Enron who had previously worked for their auditors,
the process of audit appointments and reappointments, the rotation of audit partners, and how
auditors are monitored and regulated.

Before the Big 4 accounting firms, there was a ‘Big 5’, one of which was Arthur Andersen. The firm was
found guilty of criminal charges in relation to the audit of Enron and its actions in relation to disguising
Enron’s off-balance sheet transactions, with the firm having instructed its employees to destroy
documents pursuant to its document retention policy. As a result, the firm surrendered its licence to
practise as accountants in the United States. While the criminal verdict was subsequently overturned
by the US Supreme Court on the basis that the jury was misdirected as to the law, the damage to
Arthur Andersen’s reputation was substantial and the firm ceased to exist, with other accounting firms
taking over its client business.

WorldCom’s and Enron’s focus on performance was almost exclusively financial, oriented on short-term MODULE 5
profits and share prices. This focus was supported by bonuses and share options to reward executives
for short-term profits that resulted in a culture under which ethical principles were largely ignored.
The focus on short-term financial performance obscured more fundamental non-financial measures
that might have provided signalling to those outside the companies that something was wrong.

The examples of HIH in Australia and WorldCom and Enron in the United States highlight the role
of accountants in measuring and reporting performance with integrity, objectivity, competence
and due care. Not only is a failure to do so a breach of professional ethics but it can lead to
criminal penalties (there is often a fine line between a breach of ethics and a breach of the law).
In addition, the practice of auditing was permanently affected by these cases. In particular,
audit firms are required to demonstrate independence and clearly separate their audit and
non‑audit—for example, consulting—services.

Further detail on ethics is presented in the Ethics and Governance subject of the CPA Program.

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Two theories—agency theory and contingency theory—are relevant to gaining a better

understanding of how accountants affect and are affected by performance management.

Theories related to performance management

Agency theory
Agency theory is about the relationship between principals (owners of a business) and directors
and managers, who act as the agents of the owners. This is particularly relevant where there is a
separation between owners and managers, as is most common in listed companies.

Control systems and performance management are used by principals to monitor the actions
of their agents. The principals delegate authority to agents, but the agents may act in their own
self-interest rather than in the interests of the principals.

A simple example of the agency problem is when selling a property. The real estate agent is the
agent of the seller and is expected to obtain the highest price for the property in an open market
in return for a commission—typically a percentage of the selling price. But the reward for the
agent in obtaining an additional amount—say $5000—on the sale price may not warrant the extra
effort, so they may recommend to their principal a lower, but easier to obtain, sale price.

Similarly, managers may award themselves high levels of remuneration, without exercising
enough effort. To overcome this potential problem, the ‘sharing rule’ rewards the agent for
performance that benefits the principal. So managers will typically receive at least some of their
remuneration through, for example, profit-related bonuses and share options. For example,
as discussed previously, director and senior executive remuneration is linked to performance
management through STIP and LTIP as disclosed in the remuneration reports within
annual reports.

Agents may avoid their responsibilities, as principals can never really be sure whether reported
performance is the result of the agent’s own efforts or of business conditions generally. One of
the criticisms of executives that emerged from the Global Financial Crisis (GFC) of 2007–08 (see
Example 5.21) was the level of remuneration paid to executives, even when market conditions in
many industries collapsed. The same concern has been raised at hearings of the Royal Commission
into Misconduct in the Banking, Superannuation and Financial Services Industry in relation to the
payment of senior executives of banks that may have led to unethical practices with customers.

Agents may also be tempted to disguise true performance levels to inflate their remuneration
packages and their reputations as managers. Financial reporting to shareholders is one
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way principals can hold agents accountable for their performance. However, the notion of
‘information asymmetry’ is that agents have far greater access to performance information than
do principals. This means managers always have access to detailed management accounting
information, including non-financial performance reports, that are unseen by shareholders.

Being aware of potential problems in the agency relationship is important in understanding the
role of accountants in performance management.

Further detail on agency theory is presented in the Ethics and Governance subject of the CPA Program.

Contingency theory
Another theory that is relevant to performance management and the role of the accountant is
contingency theory, which states that there is no universal best way to measure performance.
Each organisation needs to develop an appropriate performance management system that is
relevant to its needs. This theory suggests that the performance management system used by
an organisation will depend to a large extent on such factors as the size of the organisation,
its environment and its technology.

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Table 5.2 provides a hypothetical example of the performance measures that may be used by two
businesses in the retail food industry. The technology and systems in place for a large multi-store
retail chain and a small local shop reflect the contingency theory approach.

Table 5.2: C
omparison of control systems and performance measures for large
and small food retailers

Large multi-store food retailer Owner-managed suburban food retailer

Management control system:

Comprehensive performance information by Simple performance reporting system, probably

store and product group, which is necessary both cash-based with sufficient record keeping to satisfy
for management planning and decision-making taxation requirements
and to provide the information needed to report
to shareholders

In-store barcode scanner and integrated cash Simple cash register and separate EFTPOS facility
register and electronic funds transfer at point of
sale (EFTPOS)

Likely performance measures:

Daily sales by hour of day—to help with rostering— Daily sales

and by product group

Average revenue per customer—provided by Average revenue per customer—may be provided

cash register by their bank, which provides information on all
EFTPOS/credit card transactions

Customer retention—based on loyalty card Customer satisfaction with staff service—

approximation based on observation

Sales per square metre and sales per employee

Time to scan customer’s shopping basket—per Waiting time for customer—approximation based
item scanned on observation

Gross margin per day—point of sale (POS) scans Periodic physical stocktake verifies margin
barcode and calculates margin

Stock reordering—POS scans barcode and updates Owner/manager orders stock by physical
inventory, identifying when to order and may observation and manual reordering
automatically place order on suppliers

Number of stores and locations based on Single site—location based on rental cost

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demographics and competition

Technology investment—percentage of sales Technology cost—dollars

Profit by store location Cash at bank

Number of products—maximise variety and choice Number of products—minimise inventory

and wastage

Stock losses—difference between physical stock

count and computer inventory record

Stock turnover—financial statement ratio Investment in inventory—dollars

Employee turnover—from human resources Time spent by owner/manager recruiting and

(HR) records training new staff—informal judgment

Source: CPA Australia 2019.

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➤➤Question 5.5
Barbara Smith (CPA) works as the CFO of a privately owned company with annual sales of
$10 million. Kevin Jones, the CEO, is the main shareholder, who also acts as chair of the board.
The only other directors are you and Kevin’s wife.
After producing the draft end-of-year financial statements, Barbara discusses the results with
Kevin. His response is that the profit of $250 000 is too high and the tax bill the company will
have to pay will prevent the company from repaying its bank loan in the following financial year.
As the company does not keep a perpetual inventory system but relies on standard costs of goods
sold (COGSs) and periodic stocktakes, Kevin suggests to Barbara that the year-end stocktake
figure be reduced in order to reduce the taxable profit to around $150 000.
Barbara responds that such a practice is illegal. Kevin’s reply is that the inventory level at year
end was close to $1 million, so any adjustment could be readily disguised. Over Barbara’s further
objections, Kevin demands that Barbara adjusts the inventory downwards by $100 000 and that if
she is not prepared to make the adjustment, then she might as well resign from the company today.
(a) Discuss the implications of Kevin’s demand in relation to the following:

(i) Governance

(ii) Signalling
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(iii) Ethics

(b) Recommend any actions that Barbara may be able to take.

Check your work against the suggested answer at the end of the module.

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Part B: Strategy, management control

and performance management
Part A considered the role of performance management (both financial and non-financial) in
value creation and sustainability. Performance management was outlined in the broader context
of corporate governance and risk management, as well as the importance of ethics. Part B looks
in detail at the role of strategy in performance management and how performance management
can be seen as an important element in management control. The limitations of some traditional
accounting performance measures are considered. The different models of performance
management, including the Business Model Canvas, balanced scorecard, the role of strategy
mapping and the role of information systems in performance management, are introduced.

Performance management and control—their role in strategy

Mintzberg and Waters (1985) defined strategy as a pattern in a stream of decisions. They
separated the intended from the realised strategy, arguing that deliberate strategies provided
only a partial explanation, because some intended strategies were unable to be realised
while other strategies emerged over time. As discussed in Module 1, a common description
of intended or deliberate strategy formulation is to begin with establishing objectives and
goals. This is followed by an internal appraisal of strengths and weaknesses and an external
appraisal of opportunities and threats (the SWOT analysis). This leads to a choice from various
strategic options of decisions such as diversification or the formulation of a competitive
strategy (Ansoff 1988).

Strategy must be implemented after it is formulated, and it is here that performance management
is important. Ansoff (1988) established a hierarchy of objectives that were centred on performance
measures such as return on investment. Similarly, Galbraith and Nathanson (1976, p. 10) argued
that ‘variation in strategy should be matched with variation in processes and systems as well as
in structure, in order for organisations to implement strategies successfully’. These variations in
processes and systems would include variations in performance management.

As discussed in Module 1, various approaches to strategy have been developed by Michael Porter.
Porter (1980) developed his five forces model for analysing an industry’s strategic environment:
1. the threat of new entrants to the market
2. the threat of substitutes
3. the bargaining power of customers
4. the bargaining power of suppliers
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5. rivalry (competition) within the industry.

Porter (1980) also identified three ‘generic strategies’ for competitive advantage:
1. cost leadership
2. differentiation
3. focus.

All strategies should contain goals and organisations need to introduce a system of performance
management comprising processes for measuring, monitoring, reporting and improving
performance to ensure that goals and strategies are achieved. Different strategies require
different approaches to performance management. For example, an organisation facing
substantial industry competition may measure market share (e.g. the motor vehicle sales and
retail supermarkets industries). An organisation facing substantial bargaining power by customers
may measure customer profitability (e.g. clothing manufacturers selling to department stores
such as Myer and David Jones in Australia). Similarly, if an organisation adopts a cost leadership
strategy, we would expect to see performance measures that focus on efficiencies in purchasing
and production to achieve cost reduction and competitive pricing (e.g. the manufacture of

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mobile phones). By contrast, an organisation adopting a differentiation or focus strategy (where

cost and price are less important) may give more attention to performance measures related
to innovation, product features and benefits, advertising effectiveness or brand reputation.
For example, the performance measures used by Ford and BMW are likely to be different.
Although it is likely that both companies will focus on performance measures for cost and brand
reputation, the emphasis they give to those performance measures is likely to be quite different.

The particular performance measures adopted by any organisation will depend on its strategy
and objectives. This follows from contingency theory—that is, an organisation will select
appropriate performance measures contingent on factors including its strategy and competitive
position, as well as its technology and size. These performance measures will then be used to
monitor how well the organisation achieves its strategy.

Porter (1985) also introduced the ‘value chain’ as a tool to help create and sustain competitive
advantage through recognising the need to add value in each of the organisation’s primary
activities.

The concept of creating value was explained in Module 1 and in Part A of this module. Porter
argued that customers are prepared to pay for the value created but that organisations need
to keep the cost of generating this value lower than the premium customers are willing to pay.
This is the margin in the value chain—the difference between the cost of providing the primary
and support activities, and the revenue gained from customers.

As for different approaches to strategy, an organisation’s value chain is likely to influence its
performance measures. Example 5.11 shows performance measures for a retail store, based on
the primary and support activities in the value chain.

Example 5.11: P
erformance measures and the value
chain—a retail store example
Value chain activity Examples of performance measures

Primary activities

Inbound logistics On-time deliveries from suppliers

Operations Out-of-stock products on store shelves

Outbound logistics Queuing time for customers at checkouts

Marketing and sales Store recognition (survey)

Service Customer complaints MODULE 5

Support activities

Procurement Days’ payables outstanding

Technology development Computer downtime

HR management Staff turnover

Firm infrastructure Sales per square metre of floor space

Source: CPA Australia 2019.

These performance measures might be developed by identifying key value-adding activities for
the retail store, on the assumption that sales revenue and margin are affected by each of these
aspects of performance. It is important to note that Example 5.11 lists examples of performance
measures. Each organisation would develop the performance measures it deems appropriate to
achieve its strategic objectives.

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➤➤Question 5.6
Revisit the information in Question 5.3 about Mega Markets—both the question and suggested
answer. Using Porter’s generic strategies, complete the following table.
(a) How would you describe Mega Markets’ strategy?

(b) Compare the value chain for Mega Markets with one of its international online competitors.

Mega Markets Online competitor

Primary activities

Inbound logistics

Operations

Outbound logistics
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Marketing and sales

Service

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Mega Markets Online competitor

Support activities

Procurement

Technology development

HR management

Firm infrastructure

Check your work against the suggested answer at the end of the module.

Review Appendix 5.1 for a good example of how strategy influences performance management.

Strategy and decision-making

Strategy is concerned with achieving organisational objectives. Objectives are achieved by
allocating organisational resources (e.g. property, equipment, people and finances) to activities
that are effective (i.e. that generate revenue) and cost-efficient (i.e. the cost of the activity is lower

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than the revenue generated).

Decision-making is concerned with making choices from alternative courses of action. This requires
an understanding of the desired objectives, some knowledge of the alternatives and the ability to
estimate the likely results of each alternative.

Often there will be conflicting objectives, including long-term and short-term financial objectives.
In the short term, profits and cash flow must satisfy investors, but not at the expense of long-term
sustainable profits and cash flow.

There will also be non-financial objectives such as maintaining environmental and social values.
When non-financial performance objectives are added (e.g. market share objectives or the need
for innovation), the resulting multiple objectives will impact on management decisions.

Alternative courses of action may be imperfectly known as they will require information about
customers, markets and suppliers that may be unknown. The results of those alternatives are
based on predictive models (the assumed cause-and-effect relationships) that are also imperfect.

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Management control is most commonly seen as a critical element of strategy implementation,

which is a process of establishing targets, measuring actual performance and taking corrective
action where actual performance differs from the targets. The most common definitions of
management control relate to achieving an organisation’s strategic goals and influencing
behaviour during environmental change (e.g. Anthony 1965). A management control system
implies an integrated set of individual controls that is intended to help accomplish strategy
by controlling resource inputs, influencing the production process and monitoring outputs
(Daft & Macintosh 1984).

Management controls are focused on objectives set during the organisation’s strategic planning
and budgeting cycles. However, market conditions change between these planning and budget
cycles as competitors’ strategy and economic conditions alter and customer demand fluctuates.
Decision-making needs to consider current circumstances rather than be overly focused on
an objective that was set at a different time when conditions were different. So there may be
tension between the needs for management control and for more flexible decision-making.

Decision-making by managers will focus on objectives, but it must also consider approaches
besides passing on higher costs through increased pricing, and the impact they might have on
revenue, market share and profitability.

Strategy and management control

The most easily recognisable forms of control are ‘cybernetic’ forms of control, based on a
feedback cycle. Cybernetics is the science of communication and control processes in both
natural and human-made systems. Feedback is the process by which variations between actual
and desired performance are fed back into the process to achieve corrective action and bring
actual performance in line with expectation. The simplest example of a cybernetic control is a
room thermostat. A thermostat has a set standard (the desired room temperature), a method
of measuring the temperature (a thermometer), a comparison (between desired and actual
temperature) and a means of correction (heating where the room temperature is too low;
cooling where the room temperature is too high).

In this simple feedback model, decisions need to be taken about the standard to apply,
the method of measurement, a means of comparison and the ability to take corrective action.
In the business environment, the cybernetic approach and feedback can be illustrated by a
comparison between target and actual sales performance. The target (or budget) performance
for a sales department may be a specified level of sales revenue. The accounting system is
the method by which the business measures actual sales revenue. Comparison takes place
by reporting both the target and actual sales income and calculating the variance. Feedback
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takes place by using the comparative data to determine corrective action by management
to improve future performance relative to target. These actions may include sales force
training, additional marketing, incentives or perhaps modifying the target. This is the heart
of performance management—using performance information to manage actual performance
so that goals and objectives are attained.

➤➤Question 5.7
SalesVol Ltd (SalesVol) uses a ‘budget versus actual’ comparison. The company budgets to
sell 10 000 units of a product at an average selling price of $3.50. At the end of the period,
the accounting system records actual revenue of $33 750 for 9000 units. Three versions of
reporting from an accounting system are shown. The first two use a traditional budget approach,
while the third uses a flexible (or flexed) budget approach (as discussed in Module 3).

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(i) Traditional budget

Budget Actual Variance

Sales revenue $35 000 $33 750 –$1 250 (Unfavourable)

(ii) Expanded information

Budget Actual Variance

Sales volume 10 000 9 000 –1 000

Average selling price $3.50 $3.75 $0.25

Sales revenue $35 000 $33 750 –$1 250 (Unfavourable)

(iii) Flexible budget

Flexed Quantity Price

Budget budget Actual variance variance

Sales volume $3 500 $2 250

10 000 9 000 9 000 (Unfavourable) (Favourable)

Average selling price $3.50 $3.50 $3.75

Sales revenue $35 000 $31 500 $33 750 –$1 250 (Unfavourable)

(a) Use the information in each version of the report to explain the elements of cybernetic or
feedback control that led to corrective action.

(i) Traditional

(ii) Expanded

(iii) Flexed MODULE 5

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(b) Explain how each report could be useful to management decision-making.

(i) Traditional

(ii) Expanded

(iii) Flexed

Check your work against the suggested answer at the end of the module.

Question 5.7 focuses on cybernetic control because it tends to dominate accounting systems.
However, there are many ‘informal’ kinds of control that might not always be readily observable,
particularly those based on employees’ culture and belief systems.

Internal control is:

the process designed, implemented and maintained by those charged with governance,
management and other personnel to provide reasonable assurance about the achievement of
an entity’s objectives with regard to reliability of financial reporting, effectiveness and efficiency
of operations, and compliance with applicable laws and regulations (AUASB 2018).
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Management control is a much broader concept, covering all the processes used by managers
to ensure that organisational goals are achieved and organisations respond to changes in
their environment. Performance management is an integral part of management control,
and while relevant to internal control, it is more concerned with performance improvement
than compliance, which is the greater concern of internal control.

Otley (1999) argued that performance management provides an important integrating framework
for the different elements of management control systems, containing both formal and informal
kinds of control. A further framework for performance management systems (PMSs), developed
by Ferreira and Otley (2009), contains eight core elements:
1. vision and mission
2. key success factors
3. organisation structure
4. strategies and plans
5. key performance measures

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6. target setting
7. performance evaluation
8. reward systems.

These are influenced by four other factors:

1. PMS change
2. PMS use
3. strength and coherence of the core elements
4. information flows, systems and networks.

The PMS exists within a set of broader contextual and cultural influences.

Chenhall (2003) writes that the definition of management control systems has evolved from
formal, financially quantifiable information to include:
• external information relating to markets, customers and competitors
• non-financial information about production processes
• predictive information
• a broad array of decision support mechanisms and informal personal and social controls.

So management control and performance management, which has financial, non-financial,

quantitative and qualitative dimensions (as already discussed), have become almost synonymous.

➤➤Question 5.8
Reconsider the information in Question 5.7. Apart from the financial controls shown in the various
‘budget versus actual’ reports, what additional formal and informal controls are likely to influence
sales behaviour in a company like SalesVol Ltd? (In responding to this question, think about the
kinds of controls listed in the previous discussion.)

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Check your work against the suggested answer at the end of the module.

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Limitations of traditional controls

Traditional management controls, especially those that are accounting-based, have been
criticised for their limitations.

Return on investment (ROI), for example, is often used to measure financial performance, but it
has long been argued that ROI has significant limitations. There are substantial questions around:
• the level of investment that should be used: total capital employed or net assets;
• whether assets should include non-current, current or both; and
• whether assets should be valued at cost or book value (Solomons 1965).

Johnson and Kaplan (1987) pointed out two other limitations:

• whether a high rate of return on a small capital investment was better or worse than a lower
return on a larger capital, and
• that managers could increase their reported ROI by rejecting investments that yielded returns
in excess of their organisation’s (or division’s) cost of capital, but that were below their current
average ROI.

For example, assume that the organisation’s cost of capital was 15 per cent and that Division A
is currently operating on an ROI of 25 per cent. However, the manager of Division A rejects an
investment that is going to return 20 per cent, because it would lower Division A’s ROI. This is
problematic for the organisation as a whole, because the 20 per cent return from that investment
is still higher than the organisation’s cost of capital (15%).

As traditional accounting measures are criticised for being less relevant in the modern business
environment, non-traditional approaches that are industry- and organisation-specific take on
new meaning, while non-financial performance measures take on a greater level of importance
in guiding organisations towards their goals. Example 5.12 illustrates how one company
(TNA) created a different approach where traditional accounting tools failed to help the
organisation’s strategy.

Example 5.12: T
NA—a strategic management accounting
approach to performance management
TNA is a privately owned engineering company based in Australia, with multinational sales of
computer-controlled packaging equipment to large food manufacturers. TNA’s global success was
derived from its innovative design, worldwide patent protection, continual investment in research
and development (R&D), and the development of export markets. From the start-up of the business,
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accounting performance was of limited value to TNA’s owners. Accruals accounting on a financial year
basis did not take into account the long lead times (often several years) between R&D and export market
development expenditure and income from sales. For the same reason, budgets (other than budgeted
sales volume) were of limited use. TNA rewarded its marketing and research staff through high salaries
and bonuses in order to retain their expertise. The company also expended many millions of dollars
in legal fees in patent litigation against much larger companies that were infringing TNA’s patents.
It took many years for TNA to win these actions and recover costs and damages. While accounting
was necessary for regulatory and taxation purposes, it was not used for management control.

TNA designed its computer numerical control (CNC) equipment but subcontracted manufacture of
the components to various suppliers, then assembled the final machines in its Melbourne factory,
before delivering them to customers. This avoided the problems of capacity utilisation that are inherent
in manufacturing companies.

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TNA had a pricing policy that discouraged discounting because of the technical superiority of its
machines. This enabled a high margin between the selling price and the cost of the components.
In its early years, TNA’s owners exercised management control through a cash flow based spreadsheet
model, where the only real performance measures were the number of machines sold, the percentage
of sales reinvested in R&D and the availability of cash to fund business growth. The model used sales
volume to drive purchasing of components and assembly planning, included data on outstanding
orders and inventory, and cash flow projections over several years. It was updated on an almost daily
basis as new orders were received.

As the company grew, a much more sophisticated spreadsheet model was developed that thoroughly
documented the industry in which TNA sold its machines, including the customers targeted for future
machine sales and the competitors whose customers may be more susceptible due to the financial
constraints of their current suppliers. Much of this data was gathered at engineering exhibitions,
from websites and from informal conversations with suppliers and employees of TNA’s competitors.

Over a long time period, TNA’s owners developed this spreadsheet model to a point where it became
the central management control tool used within the company. TNA’s performance measures now
expanded to include a focus on growing market share and reaching what the owners termed a ‘critical
mass’. TNA defined critical mass as:
having enough capital to withstand serious fluctuations in general business levels, being
able to fund sufficient development to maintain the company’s leading edge in technology,
and being able to withstand the onslaught from the competition (Collier 2005, p. 327).

The information in this spreadsheet enabled TNA to target the customers of weaker competitors and
win more business than it might otherwise have been able to do.

The second version of the spreadsheet model is a good example of strategic management accounting.
It looks beyond the current financial year, applying a life cycle perspective; it looks beyond the
organisational boundary to the whole industry; and uses information to drive strategy implementation
(Collier 2005).

As a privately owned company, TNA’s owners were unconcerned with short-term profits, seeing longer-
term market share growth and reinvestment in research and export market development as far more
important. Hence, profit targets and traditional financial performance measures held little importance,
although cash flow was critical.

Example 5.12 illustrates the importance of performance management and a very informal kind
of management control used to achieve the goals set by the organisation. It also shows that the
accountant’s natural focus on financial performance is not always the most appropriate one.

There are other limitations of traditional controls, notably that gaming and biasing

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accompanies them, the tendency to focus on short-term performance at the expense of
sustainable performance, and the masking of cause-and-effect relationships. These behavioural
consequences are discussed in more detail later in this module.

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➤➤Question 5.9
Assume you are the CFO for an organisation with responsibility for financial reporting, accounts
payable (AP) and accounts receivable (AR). Make a list of the management controls that could
be implemented to help ensure that the organisation’s operations are efficient and effective.

Check your work against the suggested answer at the end of the module.

Models of performance management

MODULE 5

Performance management should not be seen as a list of measures without any underlying
framework. Example 5.11 provided a framework, the value chain, which developed performance
measures for each of the organisation’s primary and support activities. In the section that follows,
alternative models of performance management are discussed.

Operational and strategic performance

One of the key elements of performance management is to distinguish operational from strategic
performance. All business organisations, particularly listed organisations, need to achieve
short-term financial performance that satisfies shareholder expectations. This is a function of
agency theory. Each business unit, product, service or geographic segment of the business must
contribute to whole-of-organisation performance, which needs to be achieved throughout the
financial year in order to meet annual corporate targets. This relies on operational performance
management, but there also must be a balance between the needs of short-term shareholders
and the sustainability of performance over the longer term—for example, as discussed in Part A
where companies report performance-related remuneration through STIPs and LTIPs.

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Strategic performance is concerned with sustainable performance over time at the whole
organisational level, over multiple time periods, taking into account strategic goals, economic
conditions and the competitive environment. Strategic performance is also concerned with
product life cycles (see Module 6) and supply chains, and maintaining or increasing market
share through competitive strategy (e.g. cost leadership, differentiation or focus strategies).
Strategic performance is linked to risk management through the risk–return trade-off and the
organisation’s risk appetite as determined by the board of directors.

Measuring strategic or operational performance requires a different set of key performance

measures for each. Operational measures help to measure the short-term performance of
an organisation, while strategic measures focus on the implementation of the organisation’s
long‑term strategy.

What these strategic performance measures are will be determined by the organisation’s
strategy. Chenhall (2003) has argued that financial and non-financial measures cover different
perspectives which, in combination, provide a way of translating strategy into a coherent set
of performance measures. Chenhall (2005) argues that a key element of strategic measures is
that they provide integrated information to help managers deliver positive strategic outcomes.
He identifies three attributes of strategic measures:
1. Strategic and operational linkages: these capture the overall extent of integration
between strategy and operations and across elements of the value chain.
2. Customer orientation: linkages to customers including financial and customer measures.
3. Supplier orientation: linkages to suppliers and includes business process and innovation
measures (Chenhall 2005).

Example 5.13 highlights the importance of balancing short-term operational performance with
longer-term strategic performance, and extending the corporate view of performance beyond
the organisation’s own boundary to its supply chain.

Example 5.13: C
losure of the Australian automotive
manufacturing industry
General Motors Co. closed its Holden factory in South Australia in October 2017, ending more than
a century of car manufacturing in Australia. Shortly before, Toyota Motor Corp. had shut its plant
in Victoria, where Ford Motor Co. had closed two sites in the previous year. The loss of jobs in the
automotive sector was not limited to the big three but extended to the suppliers of automotive parts
that fed into the Holden, Ford and Toyota assembly lines.

Over many years, Ford, General Motors (GM) and Toyota have all said they intended to cease their

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Australian production in the absence of continued government subsidies. In 2014, the Productivity
Commission estimated that up to 40 000 people would lose their jobs as a result of the closure of these
assembly plants and the resulting effect on other firms in the supply chain (Australian Government
2014, p. 2).

Companies like GM, Ford and Toyota, being listed on global stock exchanges, needed to satisfy
short-term stock market expectations. Therefore, there was always an emphasis on financial measures
such as ROI, return on capital employed (ROCE), sales growth, profit growth and cash flow—in fact,
all the traditional financial ratios used to interpret business performance from the income statement
and balance sheet.

Strategically, GM has suffered from falling market share and profits and was effectively saved from
bankruptcy by the US Government during the GFC, while Ford narrowly escaped that predicament.
Many of the problems faced by both companies have been caused by legacy health insurance and
pension-fund contributions for past and present employees in the United States, sales demand that has
fallen well short of GM and Ford’s production capacity and the high fixed costs that result from excess
capacity. By contrast, Toyota steadily won global market share at the expense of the US companies,
largely as a result of its longstanding commitment to quality and its emphasis on lean production,

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which it terms a ‘cost down’ approach. However, Toyota faced increased quality problems in the
United States, which caused it some reputational damage, and suffered a major disruption to its supply
chain as a result of the 2011 earthquake and tsunami and subsequent nuclear reactor damage in Japan.

Automotive companies like GM, Ford and Toyota are mainly designers and subsequently assemblers
of those vehicles, with components sourced, often globally, from multiple suppliers. Automotive
companies need to continually invest in new product designs to develop and introduce new model
vehicles that meet anticipated economic conditions, market demand and competition. Given the
time taken to bring a new product to market in the industry, this can be a complex process, involving
identifying what customers may want several years into the future, the efficient design of new models,
cost-effective purchasing of components and efficient assembly capacity utilisation.

Despite the needs of short-term financial performance reporting, automotive companies often adopt
life cycle costing for their models (see Module 6), recording the profits (or losses) for each model
of vehicle over each year of its life from initial design through to abandonment, in order to learn
lessons that can be applied in future models. Japanese companies like Toyota appear to have been
more effective in applying target-costing approaches (see Module 6) before a new model goes into
production, and collaborating with suppliers to achieve the most cost-effective design, purchase cost
and assembly processes. Japanese companies have also emphasised kaizen (continual improvement)
approaches during production to drive costs down, while Toyota’s emphasis on lean production and
‘cost down’ through the Toyota Production System has been recognised as an important factor in
Toyota’s success over its US automotive rivals.

The closure of assembly plants by Ford, GM and Toyota in Australia was a consequence of these
companies having an inefficient scale of production due to Australia’s small market size and competition
from imported vehicles, exacerbated by the strength of the Australian dollar relative to other currencies
(especially the US dollar). The final element in Ford, GM and Toyota’s decision was the reduction,
and then cessation, of government financial support for the industry. The Commonwealth Department
of Industry has stated that the Australian vehicle manufacturing industry has not returned a profit
since 2003. These are measures of strategic performance that these companies are unable to ignore.

As stated in Example 5.13, there is a substantial effect of these closures not just on direct
employment but on the automotive component sector that supplies Ford, GM and Toyota.
Many of these suppliers would have been aware of repeated press reports about the problems
faced by the automotive industry in Australia. However, they may not have incorporated more
strategic performance measures into their strategic plans—measures that would likely have
addressed the life cycle of automotive products and the profitability of the whole supply chain.

Leading and lagging measures of performance

While the pursuit of shareholder value is crucial for listed organisations and for most businesses,
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performance management based on financial performance has two distinct limitations:

1. Financial measures (as mentioned previously) tend to focus on short-term performance,
sometimes at the expense of longer-term performance.
2. They are lagging rather than leading measures of performance.

Lagging means to follow, come afterwards or occur later on—in other words, lagging measures
provide information about what has happened after the event, when it may be too late to take
corrective action. A leading measure, on the other hand, provides a more ‘here and now’ view of
performance and is likely to help explain, predict or even cause the result of a lagging measure.

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Any accountant will know that by restricting certain expenditures, there is likely to be
an improvement in short-term profits, the consequences of which will only be felt in the
medium or long term. For example, if an organisation restricts its expenditure on advertising,
employee training, repairs and maintenance or R&D, there is not likely to be any significant
negative impact on financial performance in the current year, but it is inevitable that financial
performance in later years will suffer. Similarly, delaying new capital expenditure will defer higher
depreciation charges, but will also delay any efficiencies or volume expansion that rely on capital
expenditure. So an emphasis on leading measures (e.g. reducing expenditure on advertising,
R&D, etc.) may improve current profits, but the lagging effect will almost certainly be felt on
revenue and profits in later years.

Sales revenue (a lagging measure) may fall because of a decline in customer satisfaction,
a consequence of performance reflected in a combination of many leading measures, such as
quality of the product or service, how well the customer was treated, how fast the customer’s
order or query was attended to, and the price of the product.

There are many performance measures available for different functional areas of an organisation.
For example, possible measures for the marketing and sales function include:
• number of promotional events
• number of sales calls
• advertising exposures
• distribution outlets
• products carried per outlet
• delivery time
• percentage of perfect orders (correct products delivered on time)
• average time to resolve customer problems (Clark 2007).

Possible measures for the operations function fall under five broad headings:
1. quality pass rate
2. dependability
3. speed
4. flexibility
5. cost (Neely 2007).

Other measures apply to HR management, procurement and supply chains, as we saw in

Example 5.11.

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➤➤Question 5.10
Chocabloc Ltd (Chocabloc) produces a wide range of chocolate bars. The company’s raw materials
are mainly cocoa, imported from Brazil, and milk, sourced locally from dairy farms. The chocolate
bars are distributed by a national logistics company to retail stores around the country.
Chocabloc has patented the formulas for its range of chocolate bars, many of which have been
sold for a decade, while others have been sold for only a few months. The company spends
considerable funds on R&D for new chocolate bars, and before each new product launch it engages
in an exhaustive and expensive market research program to assess customer demand for the
new product. If there is any doubt about the market potential of a new product, it is withdrawn.
Where market research indicates a strong likelihood of success, Chocabloc invests heavily in
advertising and has a team of sales representatives in each sales region who visit retail stores
and take orders for the chocolate bars. Those orders are processed at Chocabloc’s headquarters
and are fulfilled by the logistics supplier. Extensive management attention is given to minimising
wastage and ensuring product consistency through quality control.
Based on the information in this scenario, identify the performance measures that might be
recommended to the management of Chocabloc. Consider strategic and operational measures
(including leading and lagging measures). Include financial and non-financial performance measures
in your list.

Strategic performance
measures

Operational performance measures

Leading measures
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Lagging measures

Check your work against the suggested answer at the end of the module.

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Frameworks for performance management

The use of measures of performance other than financial is not new. One of the earliest was
the French tableaux de bord, a kind of instrument panel as would be used by a pilot. It was
developed as a set of performance measures used in French factories and relied on the
definition of a causal model at each organisational unit level by its manager.

Another interesting framework is the performance pyramid of Lynch and Cross (1991).
The pyramid has descending objectives and ascending measures, beginning with corporate
vision and cascading through successive layers of business units, core business processes,
departments, work groups and individuals. One side of the performance pyramid is concerned
with market performance (customer satisfaction, flexibility, quality and delivery) and the other
side with financial performance (flexibility, productivity, cycle time and waste).

A framework that was developed specifically for service industries was the Results & Determinants
Framework (Fitzgerald, Johnston, et al. 1991). In this framework, results (competitiveness and
financial performance) were distinguished from the determinants of results (quality, flexibility,
resource utilisation, innovation).

The European Foundation for Quality Management (EFQM) Excellence Model separates five
enablers (leadership, people, policy and strategy, partnerships and resources, and processes)
and four result areas (people, customer, society and key performance), all underscored by
innovation and learning, with performance measures identified for each enabler and result area
(see http://www.efqm.org). The EFQM model is used widely in the public and not-for-profit
sectors as well as in many business organisations.

‘Six Sigma’ was originally developed by Motorola to reduce variability in manufacturing and
business processes. It recognises the cost and impact of failure in any single process on the
overall yield using a methodology known as DMAIC: define, measure, analyse, improve, control.
Six Sigma relies extensively on statistical techniques. The Six Sigma Business Scorecard has seven
elements covering all of the functional business areas:
1. leadership and profitability
2. management and improvement
3. employees and innovation
4. purchasing and supplier management
5. operational execution
6. sales and distribution
7. service and growth.

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The performance prism was developed by Cranfield University academics. This framework
has five facets:
1. stakeholder satisfaction (what stakeholders want)
2. stakeholder contribution (what the organisation needs from its stakeholders)
3. strategies
4. processes
5. capabilities that an organisation needs to satisfy the wants and needs.

Each of the five facets has its own measures, but the overall focus of the performance prism
is on stakeholder satisfaction.

Notably, the performance prism takes a multi-stakeholder approach to performance management,

reflecting the importance of CSR, whereas most other models (with the exception of the EFQM)
take a predominantly shareholder value focus. Two frameworks are perhaps best known:
1. the Business Model Canvas, a marketing-oriented strategic framework
2. the balanced scorecard, a more financially oriented approach.

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The Business Model Canvas

The Business Model Canvas was developed by Alexander Osterwalder as a strategic management
template for analysing a business strategy or for designing a new strategy. It comprises a visual
representation of nine building blocks centred on a value proposition, as shown in Figure 5.6.

Figure 5.6: The business model canvas

strategyzer.com
Version:

Customer Segments
Date:

Customer Relationships
Designed by:

Channels

Revenue Streams
Value Propositions
Designed for:

http://creativecommons.org/licenses/by-sa/3.0/ or send a letter to Creative Commons, 171 Second Street, Suite 300, San Francisco, California, 94105, USA.
This work is licensed under the Creative Commons Attribution-Share Alike 3.0 Unported License. To view a copy of this license, visit:
The Business Model Canvas
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Key Resources
Key Activities

The makers of Business Model Generation and Strategyzer

Source: Strategyzer 2018, ‘The business model canvas’, accessed June 2018,
https://strategyzer.com/canvas/business-model-canvas.

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You can access the Business Model Canvas website and its various resources free by registering at
https://strategyzer.com/canvas/business-model-canvas.

The Business Model Canvas template links the value proposition with the business’s customer
segments, customer relationships and distribution channels (the right-hand side of the canvas)
to key activities, key resources and key partnerships that satisfy customers (the left-hand side).
These are all in turn linked to revenue streams and cost structures (occupying the bottom of the
canvas). A separate Value Proposition Canvas helps identify what products or services are offered
to customers and what motivates them to buy.

The Business Model Canvas approach is that strategies can be developed by focusing on the:
• value proposition and its related customer segments, relationships and channels as drivers
of revenue
• infrastructure of activities, resources and partnerships that drive costs.

You can try out a Business Model Canvas template either at the Strategyzer website or using a free
online template available at https://canvanizer.com/new/business-model-canvas.

This marketing-oriented view of the world focuses on value as perceived by customers, certainly
an essential element in creating value for the business. Its weakness lies in the absence of
performance measures that determine whether strategy is being achieved. This is the benefit
of the second framework, the balanced scorecard.

The balanced scorecard

The balanced scorecard (BSC) was developed by Harvard academic Robert Kaplan and
consultant David Norton based on their work with US organisations. Their work on the BSC has
been published in the Harvard Business Review and is still widely used (Kaplan & Norton 1992;
1993; 1996a).

The BSC takes four perspectives on performance:

1. financial
2. customer
3. business process
4. innovation and learning.

The customer, business process, and innovation and learning perspectives are considered
as leading measures, with financial measures being the lagging measures of performance.
Kaplan and Norton (1992; 1993; 1996a) do not prescribe the performance measures that should

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be used, but suggest that organisations use performance measures and targets linked to their
objectives, affirming the clear link between strategy and performance measures. This reflects
the contingency approach discussed previously in this module. The BSC ‘translates a company’s
strategic objectives into a coherent set of performance measures’ (Kaplan & Norton 1993, p. 134).

Examples of performance measures in the customer perspective include market share, customer
satisfaction, customer retention, NPS and brand reputation. Performance measures in the business
process perspective may include quality pass rate, on-time delivery, cycle time (from order to
delivery) and productivity. In the innovation and learning perspective, performance measures may
include employee retention and satisfaction, investment in training, R&D expenditure and new
patent registrations.

There is no rule that says a particular measure should go in a particular perspective. Sometimes
market share will be in the financial perspective (as it is based on revenues), and other times it will
be in the customer perspective (as it reflects how many customers an organisation has).

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Some other examples include the measure of ‘on-time delivery’, which could be classified
as either a customer perspective or a business process perspective. It would depend on the
purpose of the measure for the organisation (i.e. whether the focus was on customer satisfaction
or the organisation’s effectiveness in operations).

Similarly, capital expenditure measures would typically be found in the financial perspective.
However, the capital expenditure may appear in other perspectives if it specifically relates to
improvements in efficiency (investment in new or improved business processes) or training
facilities (investment in innovation and learning).

The important thing is for an organisation to be able to logically explain why an item is placed
or classified in a particular perspective. This is a further example of contingency theory.
An organisation will determine the performance measure and the perspective that best reflects
that measure based on its strategy, competitive position, size, etc. For example, a strategy to
improve workforce skills would lead to performance measures being developed in the innovation
and learning perspective. A strategy to improve on-time delivery would mean performance
measures being developed in the business process perspective. Both strategies would be linked
(with others) to the overall business objectives of improving financial objectives such as sales
growth, cost reduction and increased profitability.

There is no exact or correct number of measures to include in a BSC. Too few measures will mean
the organisation does not have a clear picture of what is going on in the organisation and it may
miss detecting issues because it does not have enough leading measures. Too many measures
means it may be distracted or unable to focus on the most critical items.

Kaplan and Norton (1992; 1993; 1996a) recommend three or four measures for each of the four
perspectives in the BSC (12 to 16 in total). However, this is only at the top level. For lower levels
of the organisation there may be many more measures that all link together and are summarised
by these final 12 to 16 measures. The cascading of performance measures to business units is
discussed further under ‘Cascading performance measures’.

The relative importance of performance measures is addressed to some extent in the BSC
by the assumption of a hierarchical relationship between the four perspectives, and hence
between the four sets of performance measures. Improving learning and growth (achieving
innovation) will transform business processes, which will in turn lead to more satisfied customers
and ultimately to improved financial performance. Between each hierarchical level, some value
creation is assumed.

Figure 5.7 illustrates the relationships between the elements in the BSC.
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Figure 5.7: Illustration of the balanced scorecard

Performance on all dimensions satisfies stakeholders

Financial perspective
Goals, performance measures and targets

Satisfied customers leads to financial performance

STRATEGY

Customer perspective
Goals, performance measures and targets

Efficiency of process reduces costs and satisfies customer

Internal process perspective

Goals, performance measures and targets

Leads to continuous improvement

Learning and growth perspective

Goals, performance measures and targets

Source: Based on Kaplan, R. S. & Norton, D. P. 1992, ‘The balanced scorecard:

Measures that drive performance’, Harvard Business Review, Jan–Feb 1992; Kaplan, R. S. &
Norton, D. P. 1993, ‘Putting the balanced scorecard to work’, Harvard Business Review, Sept–Oct
1993, pp. 134–47; Kaplan, R. S. & Norton, D. P. 1996, ‘Using the balanced scorecard as a strategic
management system’, Harvard Business Review, Jan–Feb 1996, pp. 75–85.

There has been an almost continuous development of the BSC approach through articles and
books, but one of the distinguishing features of the BSC compared with other frameworks
is the notion of ‘balance’. Balance in the BSC implies that organisations cannot maximise
performance on all four perspectives simultaneously. Rather, there should be balance between
these perspectives with optimum overall performance being the result of finding the right
balance between performance as measured by all four perspectives.

The following benefits have been identified for the BSC:

• It summarises complex information.
• It focuses management attention on the most important variables.
• It enables management by exception and manages areas of underperformance.
• It balances the need for short-term performance with sustainable performance.
• It limits the number of performance measures used.

For a further explanation of the BSC please access the ‘R Kaplan explains the Balanced Scorecard’ MODULE 5
video on My Online Learning.

Criticisms of the balanced scorecard

Despite the undoubted value of the BSC, one criticism of it is the ability to find a true balance
between different performance measures, especially when these are measured in very different
terms (e.g. a measure of on-time delivery performance is difficult to compare with an employee
retention figure). How does an organisation balance, for example, employee satisfaction with
customer satisfaction, let alone find the right balance between these and financial measures
such as ROI and ROCE?

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Another criticism of the BSC approach is its assumption of cause-and-effect relationships.

Norreklit (2000) questioned whether such causal relationships exist.

What is meant by causal relationships is that when you do one particular thing right it will
directly lead to or cause an improvement in another item—for example, assuming that increased
advertising will cause or lead to more sales revenue, or that high customer satisfaction levels
will cause or lead to higher profits.

The measures in each of the BSC’s four perspectives are meant to successfully link together.
Figure 5.7 shows this cause-and-effect situation or relationship, but the criticism is that this might
not be the case. An example is a monopoly situation where a company is able to increase profits
by providing lower levels of service, which would actually annoy customers (and the customers
cannot switch to another provider, because there isn’t one). In a different situation, satisfied
customers may not lead to higher profits because the organisation may be charging prices that
are too low.

Therefore, it cannot be assumed that a change to the leading measure will have a cause-
and-effect change on the lagging measure. One of the difficulties in setting objectives and
performance measures is the ‘predictive model’ used by the organisation. The predictive model
is the set of assumptions that lie behind an organisation’s strategy implementation. It may be
useful in developing strategy to start by using the Business Model Canvas and then translate this
into a BSC set of performance measures.

Concerns have also been raised by Norreklit (2000) about how effective the goal-setting and
performance management process really is. In Otley and Berry’s words:
organisational objectives are often vague, ambiguous and change with time … Measures of
achievement are possible only in correspondingly vague and often subjective terms … Predictive
models of organisational behaviour are partial and unreliable, and … different models may be held
by different participants … The ability to act is highly constrained for most groups of participants,
including the so-called ‘controllers’ (Otley & Berry 1980, p. 241).

Otley and Berry’s critique was that organisational goals are often ambiguous (i.e. that different
goals are held by different organisational participants). For example, sales managers may prefer
sales growth, while operating managers may be pursuing greater efficiencies and economies of
scale. This is the case even in a stable environment, while rapidly changing environments can
quickly change organisational goals in response to emerging threats and opportunities.

Predictive models are inherently difficult as they assume agreement by organisational participants
as to cause-and-effect relationships. For example, the predictive models of Qantas and Jetstar are
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different, despite their common ownership, because they assume different expectations about
frequency of flights, on-time departures, in-flight service, pricing, etc. However, not everyone at
Qantas and Jetstar would be likely to share the same assumptions that are contained in those
predictive models. Equally, not all Jetstar customers would be likely to accept the different
standard of service inherent in those different models (witness, for example, any of the airline
documentaries about customer response to late check-ins or flight delays with low-cost airlines).

Finally, Otley and Berry (1980) drew attention to the limited capacity of organisational participants
to effect change, either because of budgetary constraints, organisational policies or other formal
management controls that are aimed at feedback: reducing the gap between target and actual
performance, rather than as tools for learning and CI. To be truly effective, performance measures
should lead to organisational learning and improvement. Organisational learning takes place by
using performance information to communicate and continually re-evaluate the predictive model
used within the business, the appropriateness of the selected performance measures and their
associated targets, and the kinds of corrective actions that managers are able to take to reduce
performance variations relative to targets.

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Many organisations have additional perspectives to the four in the Kaplan and Norton version.
These perspectives may recognise additional stakeholders—for example:
• donors to a not-for-profit organisation
• social outcomes in the public sector
• quality in health services
• environmental performance.

Appendix 5.1 shows how Achmea uses a BSC with six perspectives in its strategy implementation.

Designing a balanced scorecard

Understanding the strategy of the organisation or business unit is essential for the construction
of a BSC. The notion of ‘balance’ relies on an understanding of the organisation’s goals
and objectives that needs to encompass its approach to its customers/customer segments,
distribution channels, activities and resources, etc. (as shown for the Business Model Canvas).

The first question to answer when designing a BSC is: ‘What are the organisation’s goals and
objectives that are inherent in its strategy?’

EVT (Example 5.1) showed that its BSC should include aspects of strategy such as market share,
room inventory and customer spend. The case of Apple (Example 5.4) shows that continual
R&D is an essential strategy and needs to be reflected in a BSC, as do retail store numbers and
employee knowledge.

The second question is: ‘Which stakeholders do we need to consider?’ Goals and objectives
may well—perhaps should—consider stakeholders other than shareholders. Victoria Police
(Example 5.3), because its performance is of so much concern to the public, press and
politicians, needs to balance a large number of performance measures to deliver on multiple
strategies. The case of Newcrest Mining (Example 5.6) showed the importance of employee
safety, environmental protection and relations with local communities in ensuring sustainable
financial performance.

These examples highlight that an organisation-specific BSC does not have to be limited to
four perspectives. As seen previously in the module under ‘Frameworks for performance
management’, the performance prism has facets that include stakeholders. There is no reason
why the scorecard cannot include social and environmental aspects of performance.

Where organisational strategy is reflected in director or executive remuneration, as cases

including Woolworths (Example 5.5) show, the BSC needs to include short-term measures of
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sales, EBIT, working capital, customer satisfaction and safety; and long-term measures of TSR,
sales per trading square metre and return on funds employed.

Consequently, each organisation’s BSC will be unique to its business, its key stakeholders,
the environmental and competitive context in which it operates, its size (see Table 5.2), its goals
and objectives and competitive strategy. This is a further example of contingency theory.

Table 5.3 shows how the design of a BSC should proceed. Steps 3, 4 and 5 are covered in more
detail later in Part B.

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Table 5.3: Designing a balanced scorecard—a step-by-step approach

Steps Question Tasks

1. Assess the organisation’s What are the organisation’s • Source a copy of the
strategy overall strategic goal, vision, organisation’s strategy,
mission and objectives? usually contained in its
annual statements.
• If no accounts are available,
consult directly with senior
management.
• Identify the most important
strategic goals (financial and
non-financial; short-term and
long-term)

2. Assess the organisation’s Who are the organisation’s key • List the key customer groups
stakeholders stakeholders and how should the of the organisation.
organisation meet their needs? • How is the organisation
currently meeting the needs
of each group?
• How can the organisation
best meet the needs of its
customers?

3. Compile a strategy map How are the various strategic • Construct a strategy map,
goals interlinked? clearly identifying any links
that exist.
• Identify any overlap in
objectives.

4. Define the key performance How will the strategic goals • Construct a list of key
measures and SMART targets be aided by each of the four performance measures
for each of the four BSC perspectives? for each of the four
perspectives perspectives.

5. Cascade the BSC How will the organisation • Duplicate the previous steps
measure its performance at for each business unit and
various hierarchical levels? department that contributes
to organisational goals
and objectives.

Source: CPA Australia 2019.

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An example of how strategy is developed into performance measures for Achmea is given in
Appendix 5.1.

Example 5.14 shows how a BSC could be developed for the company TNA.

Example 5.14: Designing a balanced scorecard for TNA

Revisiting the TNA case in Example 5.12, a BSC for the company might be developed in the following
way. TNA’s strategy was not focused on financial performance but on growing the business to a critical
mass. TNA’s strategies were R&D, export market development and growth in market share. A further
focus was cash flow to enable the company’s investment in R&D, export development and growth.
The following performance measures might be recommended to TNA’s management.

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Perspective Example performance measures

Financial • Cash flow

• Gross margin
• Sales growth

Customer • New export markets opened

• Number of new customers
• Number of machines installed
• Number of outstanding orders
• On-time delivery
• NPS

Business process • On-time delivery of components from suppliers

• Quality of supplied components
• Time to assemble finished machines
• Quality pass rate from testing of assembled machines

Innovation and learning • Employee retention

• Employee satisfaction
• Investment in R&D
• New patents
• Patent litigation actions won

Strategic • Market share growth

• Competition

TNA’s financial goals required sales growth to achieve its business strategy of reaching critical mass
(shown in Example 5.12), which was defined as having sufficient capital to enable TNA to withstand
general business fluctuations and competition while maintaining its investments in R&D. Cash flow was
not only to maintain organisational viability during its high-growth strategy but also to underwrite its
obligations to the banks that had lent the company money. As TNA subcontracted the manufacture
of all components and assembled the final machines, gross margin was an important measure,
but accounting profits were not important to TNA. A focus on short-term profit would likely have
detracted from the company’s strategy of long-term market growth and its investments in export
market development, patent litigation and R&D.

TNA’s customer goals focused on developing new export markets as those markets it entered became
saturated. Within each geographic market, new customers and new machine installations were the key
measures of marketing success, with outstanding orders, on-time delivery and customer satisfaction
important supporting measures to enable sales to new customers and sales of new machines. NPS is
a useful measure of customer satisfaction as it reflects whether a customer would recommend the
supplier to a friend or colleague.

TNA’s business process perspective was centred on its strategy of outsourcing the manufacture MODULE 5
of components, using its skill base to assemble the components it had designed and retaining its
intellectual capital in-house. So performance management was focused on the quality and delivery
of components from suppliers, the time taken to assemble those components and the quality pass
rate—the quality of assembled machines before delivery to customers.

Innovation and learning were critical to TNA and the measurement of staff retention, staff satisfaction,
investment in R&D and the ability to develop new patents from its R&D matched TNA’s strategy of
continual development of products ahead of competitors in order to retain a strong market position.
Patent litigation measured the success of the company’s court actions against those competitors who
had infringed TNA’s patents.

TNA’s overarching strategic goal was market share growth to achieve and maintain its critical mass,
linked with its targeting of weaker competitors (explained in Example 5.12).

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Linking performance management with strategy is critical to long-term sustainable performance

(compared with a focus on short-term financial results).

For practice in creating a BSC, please access Stage 2 of the ‘Save or close the hotel?’ Business
Simulation on My Online Learning.

Questions for strategic planners to ask: the Balanced Scorecard Institute has a series of questions that
link performance measures to strategic initiatives, available online at: https://balancedscorecard.org/
Resources/Cascading-Creating-Alignment/Metric-Features.

The benefits and challenges of implementing a BSC are highlighted by Balanced Scorecard Australia
at: http://www.balancedscorecardaustralia.com/bsa/main/frequently-asked-questions/.

Public sector and not-for-profit performance management

The public sector and the not-for-profit (NFP) sector have particular challenges in terms of
performance management, as shown in the Victoria Police example. First, they have multiple
stakeholders and, second, they have multiple objectives, and while financial performance is often
a constraint on activities (rather than a goal), non-financial measures of performance (e.g. the
quality of health outcomes) are often more important than financial ones.

Charitable organisations may receive funding from government or other bodies tied to achieving
specific outcomes, so performance measures need to be developed contingent on the outcomes
for specific projects. Within a single organisation with funding for multiple projects, performance
measures may be different for each project in line with the outcomes expected for each project.
These are further examples of the contingent approach to designing BSCs.

In the Australian public sector, public hospitals are a state government responsibility and
performance measures are tied to funding, but funding for specific initiatives comes from both
state and federal governments. As a result, hospitals must have performance measures for
reporting on actual results and the achievement of targets to the funding agencies to be able
to show they are managing the outcomes tied to each different parcel of funding.

Likewise, a not-for-profit organisation such as a charity will have stakeholders, including its
donors and the beneficiaries of its services. Compliance with charitable rules will incorporate
the regulatory body as a further stakeholder. Because charities rely extensively on volunteers,
they are a further stakeholder group.

Appendix 5.1 provides a good example of how the BSC is applied in a mutual, non-profit
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distributing organisation.

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➤➤Question 5.11
Refer again to Questions 5.3 and 5.6, including the suggested answers. Given the different
strategies of Mega Markets and its online competitor, identify some possible performance
measures (covering each of the four BSC perspectives) for each company, and explain how
the performance measures for each company are likely to differ as a result of the different
strategies adopted.

Mega Markets Online competitor

Financial perspective

Customer perspective

Business process perspective

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Innovation and learning perspective

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Explanation of differences

Check your work against the suggested answer at the end of the module.

The need to design an effective BSC for an organisation involves a close relationship with
strategy. Kaplan and Norton (2001) have developed the BSC and its relationship with strategy
through what they call a ‘strategy mapping’ process.

Table 5.3 showed a step-by-step approach to designing a BSC. Step 3 is compiling a strategy
map. This involves deciding how the various strategic goals are interlinked.

Designing a strategy map for performance management

Strategy mapping (Kaplan & Norton 2001) is a development of the BSC. It is driven by strategy
and goals. The strategy map for an organisation reflects the assumptions of its predictive model.

Strategy maps are a visual approach that helps to identify assumed cause-and-effect
relationships and where critical areas of performance need to be measured. Kaplan and
Norton (1996b) describe a simple example of linked performance measures through the four
BSC perspectives. In the learning and growth perspective, employee morale leads to employee
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suggestions. These suggestions lead in the business process perspective to a reduction in

rework, while employee morale leads to customer satisfaction in the customer perspective.
In the financial perspective, increased customer satisfaction and reduced cost of rework both
lead to improved financial performance.

In EVT (see Example 5.1 and solutions to Question 5.1) the design of a strategy map could look
something like the example in Figure 5.7, but candidates should note that there is no ‘one best
way’ of creating a strategy map. For any organisation, it will be based on the predictive model—
that is, the set of cause-and-effect relationships that the manager assumes to be the basis of
business success. The logic and relationships in Figure 5.8 are drawn from the EVT annual report.

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Figure 5.8: E
vent Hospitality and Entertainment Ltd group strategy map
(hypothetical)

Grow shareholder value

EPS and TSR growth

Growth in
Sales Profitability
market share
revenue EBITDA and normalised profit before tax
Market share %

Occupancy Average room Cost control

Average no. of rooms utilised revenue Expenses as
compared to total available rooms RevPAR and a % of
average room rate

Brand Total rooms

promotion available

Increase hotel Increase room

management inventory by
agreements acquisition

Source: CPA Australia 2019.

An important element of strategy mapping and performance management is setting

performance measures and targets (see step 4 in Table 5.3). A performance measure is the
characteristic that is important to the organisation and its strategy—for example, return on
investment or market share. A performance target is the desired level of performance against
that measure—for example, a return on investment of 12 per cent or a market share of
10 per cent. Actual performance is measured and compared against the target to identify

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what corrective action may be needed. The criteria for setting performance measures and
targets are discussed in more detail later in this module.

The board sets criteria for financial returns to shareholders, which may be based on past trends,
benchmarking with competitors and, for listed companies, the expectations of stock market
analysts. These financial targets become the focus for the strategy developed by the board and
senior management. To achieve the target returns, the board and senior management agree
that it is necessary to increase sales revenue through greater market share and to improve the
profitability of those sales through improved cost efficiencies.

In Figure 5.8, performance measures have been included in the strategy map where appropriate,
reflecting those performance measures in the EVT annual report and drawn from the solution
to Question 5.1.

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Strategy maps are developed through workshops at several levels. They could also be based on
what the organisation learns through the Business Model Canvas approach described previously
in this module. Customer focus groups can identify those product benefits and elements of the
value chain that customers value most and are prepared to pay for. This helps the organisation
identify those business processes it should emphasise and measure.

For example, Figure 5.9 shows a strategy map for a manufacturer.

Figure 5.9: Example of a strategy map for a manufacturer

Return on investment,
earnings per share etc.

Market share Net profit after tax

Improve customer Increase sales revenue Cost efficiency

satisfaction per customer in production

Quality Efficient production

scheduling
On-time Material purchasing
delivery (price, quality, delivery)

Market research, Supply

Labour skills
advertising and promotion arrangements

Source: CPA Australia 2019.

In Figure 5.9, customer focus groups have been presented with a question as to how the
manufacturer can increase its market share. The focus group findings indicate that customer
satisfaction is a function of both product quality and on-time delivery. Customer focus groups
have also identified that to increase sales revenue from existing customers, quality rather than
price is the main motivating factor for customer spending.
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This customer-generated information on cause-and-effect relationships is then used in internal

management and employee workshops to determine how the best quality and on-time delivery
can be achieved. These internal workshops take place across the sales, marketing and production
functions. They identify two particular issues:
1. Labour skills are essential to improving quality and delivery.
2. Market research, advertising and promotion are key elements in raising customer awareness
and perceptions of quality relative to competitors.

So the strategy mapping process shows that it is not only real product quality, but also customer
perceptions of quality that are important. Product quality is the responsibility of the production
department, but marketing has the task of improving brand awareness and perceptions
of quality.

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Internal workshops are then focused on production and the need for cost efficiencies.
Investigations by corporate finance staff have identified that the most significant impact on
profitability—other than sales growth—is production cost efficiency relative to competitors.
Internal cross-departmental, team-based workshops—which include employees from the
manufacturing, distribution and purchasing functions—identify that there are two major
impacts on production efficiency and manufacturing costs:
1. Labour skills (already identified as a driver of quality and on-time delivery) are also critical
in setting achievable production schedules and meeting those schedules.
2. Issues with the price, quality and delivery of raw materials from suppliers.

This internal workshop leads to a project within the purchasing department to work collaboratively
with suppliers to improve raw material purchasing, with the aim of obtaining the best mix of price,
quality and delivery from suppliers to support the production schedule.

Figure 5.9 is an example of how a strategy map is developed to identify the most significant
cause-and-effect relationships to achieve organisational goals. There are elements of a top-down
approach, as the board needs to set overall targets and the strategic direction for the business.
There is also a bottom-up approach in which employees with first-hand knowledge of the
business identify obstacles to performance and develop ways of overcoming those obstacles.

Performance measures and their associated targets would need to be developed for each of the
elements in the strategy map. The board can use these measures and targets to monitor strategy
implementation. Those measures may include:
• financial returns
• market share
• customer satisfaction (through a combination of customer survey results such as NPS
and measures of spending per customer and customer retention)
• quality pass rates
• on-time delivery
• labour turnover
• employee satisfaction
• cost reduction per unit of production
• compliance with production schedules
• material purchase variances
• on-time delivery from suppliers
• supplier product quality.

Where performance needs to be improved, the strategy mapping process involves making
resource reallocations through changing budgets. This approach is challenging to the traditional

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accounting view of budgets as fixed resource allocations for the year. In practice, budgets are
commonly incremental (or decremental) based on the prior year plus or minus a percentage
change factor. Budgets are rarely revised mid-year due to performance shortfalls. However,
reallocating budgets mid-year is a logical extension of managing performance more flexibly in
the strategy mapping process and there is no reason why accountants cannot be more flexible
in supporting such a process.

Strategy mapping is a continual learning process whereby learning what works, and what does
not, from performance measures should lead to changes to the assumed cause-and-effect
relationships, and to the resulting performance measures and targets. This approach should,
wherever necessary, continually re-evaluate and modify the assumptions in the relationship
between strategy, performance management and budget.

An example of strategy mapping linked to strategy and the BSC can be seen in Appendix 5.1.

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➤➤Question 5.12
Recommend a set of performance measures (without the associated targets) that would be
suitable for a three-partner organisation of CPAs operating in public practice with 40 employees.
The organisation has three objectives:
1. to make a satisfactory profit
2. to have a strong cash flow
3. to increase the value of the organisation as measured by billings (i.e. annual professional fees
charged to clients).
(a) Using Figure 5.9 as an example, construct a strategy map that shows what might be the key
success factors—that is, the cause-and-effect relationships in the business model that the
organisation needs to get right in order to achieve its three objectives.
Note: You will either need to do this separately on a piece of paper, or you may prefer to
create the strategy map in a drawing program before adding your response to the answer
field.
If you choose to use a drawing program, save your strategy map as an image file. Then in
the interactive PDF of this Study guide, you can insert your response by selecting the answer
field and browsing for the image file that you saved on your device.
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(b) Explain the main features of your strategy map, and why you included each element.

(c) For each of the elements in the strategy map, identify suitable performance measures,
keeping a balance between financial and non-financial measures, as well as a balance between
each of the four perspectives in the BSC.

Financial or
Key success factors non‑financial
BSC perspective in strategy map Performance measure (N/F)

Financial

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Client (customer)

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Financial or
Key success factors non‑financial
BSC perspective in strategy map Performance measure (N/F)

Business process

Innovation and
learning

(d) Explain your thinking behind the performance measures you have selected.
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Check your work against the suggested answer at the end of the module.

A further feature of the BSC and strategy mapping approach is the cascading of performance
measures within the hierarchical organisation structure (step 5 in Table 5.3).

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Cascading performance measures

Performance measures at the whole-of-organisation level can only be achieved if individual
business units, customers/customer segments, and products and services contribute to that
performance. For example, an ROI target can only be achieved for the whole organisation if each
business unit, product or service and, ultimately, each asset makes a contribution that achieves
the target. While business units, products and services and assets will achieve higher and
lower levels of ROI, a key management task is to ensure that resources are allocated where the
highest (in this example) ROI will be achieved, and to improve the performance of (or dispose of)
underperforming business units, products, services or assets.

The Balanced Scorecard Institute (2013) explains the function of cascading:

the enterprise-level scorecard is ‘cascaded’ down into business and support unit scorecards,
meaning the organizational level scorecard (the first Tier) is translated into business unit or support
unit scorecards (the second Tier) and then later to team and individual scorecards (the third Tier).
Cascading translates high-level strategy into lower-level objectives, measures, and operational
details. Cascading is the key to organization alignment around strategy. Team and individual
scorecards link day-to-day work with department goals and corporate vision. Performance
measures are developed for all objectives at all organization levels. As the scorecard management
system is cascaded down through the organization, objectives become more operational and
tactical, as do the performance measures. Accountability follows the objectives and measures,
as ownership is defined at each level. An emphasis on results and the strategies needed to produce
results is communicated throughout the organization (Balanced Scorecard Institute 2013).

Performance measures should cascade so that, at each successive organisational level, the
measures are different, but lower-level performance on one measure contributes to higher-level
performance at the next level. For example, the board may consider ROI as a critical performance
measure. At the business unit level, this may be translated into a measure of PBIT. Below this
level, sales managers may have measures for the volume (quantity) and value (dollars) of sales as
well as the margin achieved on cost. Operations managers may have the same volume (quantity)
measure as sales managers, but the measure relevant to them may be cost.

Performance measures and the targets that accompany them must cascade from organisational
level through each business unit, to individual products and services and assets and, ultimately,
to individual people within the organisation. For example, in a sales department, a contribution
to the organisation’s sales target must be achieved by each sales team, within the team by each
salesperson, and even within each salesperson’s target this may involve sales targets for each
of the salesperson’s customers or products and services. Where targets are set, performance
must be measured with performance management involving comparison of actual to expected
sales levels and the taking of action aimed at improving performance.

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As stated previously, Kaplan and Norton (1992; 1993; 1996a) recommended three to four
performance measures for each of their four perspectives. This is at the whole-of-organisation
level. Once these high-level performance measures are cascaded, the total in use in an
organisation may be very large and, in a complex, multidivisional organisation, may be in
the hundreds. However, any one manager will be focused on only those performance measures
for which they are responsible, and the total number is unlikely to be more than about 12,
for the reasons previously given.

Typically, lower-level employees in an organisation have fewer financial targets and more non-
financial ones (i.e. the leading measures) because their role is mainly concerned with tasks such
as production, distribution or administration. Senior managers tend to have more targets for the
financial performance of their business unit or the whole organisation—the lagging measures.

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Sometimes, targets within business units may be in competition with each other. For example,
achieving a sales target may cause difficulties in operations if there is insufficient capacity to
fulfil customer orders on time. It is important therefore to ensure the integration of performance
targets so that no business unit will be disadvantaged by another achieving its target. A problem
faced by complex organisations where there is intra-organisational charging for services is the
tendency for each business unit to pursue achievement of performance measures for itself rather
than for the organisation as a whole. This is no different to the problems caused by transfer
pricing, where business units may be motivated to improve their own profitability even where
the overall effect on the organisation may be to worsen performance.

Strategy implementation (rather than formulation) and alignment with organisational goals,
coordination across different functions and projects, and across different individuals can only be
achieved if goals, measures and targets are effectively cascaded. There are a number of ways
cascading can be made more effective: by cascading organisational goals, measures and targets
to functional departments, to cross-functional teams, or to particular initiatives or projects.

However, if measures are inconsistent or in competition with each other, individuals, departments,
cross-functional teams or projects may be working towards different goals and targets, perhaps
even measuring their performance in different ways (see Example 5.15).

In the EVT example, performance measures for all of EVT—for example, average room rate,
occupancy, RevPAR, total rooms available, etc.—will cascade down to the separate divisions
(QT Hotels, Rydges, Atura & Thredbo) and from there to each individual hotel, where performance
management will involve comparing actual performance with targets and taking appropriate
corrective action at the individual hotel level.

Appendix 5.1 provides an example of how Achmea cascades its performance measures through
the organisation.

Example 5.15: Performance management in a public hospital

Hospitals have many performance measures and targets, including waiting lists for elective (non‑urgent)
surgery and waiting times in the emergency department before admission to a hospital bed. Targets may
also exist for minimising hospital-acquired infections and patient complaints. Many of these measures
and targets are set by government in response to public expectations and election promises. Because of
the need for public accountability, many of these performance measures are audited, to avoid the
reality or perception that, for example, waiting lists and times are being manipulated.

Public hospitals also generally operate within a fixed budget that may be unrelated to the actual levels
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of patient demand on the hospital. Hospital budgets are often an outcome of economic conditions
and the government’s spending plans across all sectors of public service delivery.

The role of management—and any board of directors or governing body—is to best allocate and
manage resources within the fixed budget allocation to achieve the performance targets set by
government. Hospital-wide targets will be cascaded down to each department (e.g. emergency,
surgery, medicine) and to clinical directors (e.g. medical specialists) within each department. Ultimately,
individual clinicians may be responsible for performance on the days when they are on duty. So the
director responsible for the emergency department on a Sunday will be responsible for trying to achieve
the target for reducing the time between a patient arriving in emergency and being discharged or
admitted to a ward for ongoing treatment.

Hospitals are faced with decisions to open or close wards and to reallocate resources to where they are
most needed. These decisions may need to be made on a daily basis in response to patient demand,
but closing wards may itself cause performance targets to be missed. The particular problem for
public services is that many of their performance measures and targets are politically derived, and not
necessarily integrated with each other or with the budgetary resources available.

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An example of the problem of competing performance targets can be seen in a hospital where there
is a high number of patients admitted through the emergency department. This can lead to either
(or both) the surgery capacity being used up, or a lack of available beds. As a consequence, elective
surgery patients can be disadvantaged because their surgery may be cancelled at short notice. This is
a difficult problem to manage as the emergency department cannot be closed to people who need
urgent treatment.

In the public hospital, there will be conflicts between meeting performance targets for elective surgery
and treatment of patients admitted for emergency treatment. There will also be conflicts between the
management demand to stay within budget while achieving performance targets and the clinicians’
focus on proper medical treatment, irrespective of the impact on reported performance.

Performance management in hospitals is largely about balancing available funds with performance
targets that may not relate to resources or to actual demand for services. This kind of problem is
unique to public services and the not-for-profit sector. In this sense, for-profit organisations should
find managing performance easier because, generally, higher levels of customer demand will lead
to higher revenues. In the absence of politically motivated targets, for-profit organisations have far
more scope to change what is measured and how it is measured, and to set specific targets.

One way to address the complexity of modern business and the variety of performance measures
is through the use of information technology, which can become critical in a cost-effective
performance management system.

The role of information systems in performance management

Information systems more generally were covered in detail in Module 2. This module discusses
information systems from the perspective of performance management.

Balanced scorecard (or similar) performance management systems collate and report
information about customers, suppliers, employees and business processes to supplement
financial performance measures. Therefore, organisations need to capture information from
their marketing, purchasing, production, distribution and HR activities. Information about key
factors such as customer satisfaction, cycle times, quality, waste and on-time delivery need
to be part of an information system.

Data collection in many organisations takes place as a by-product of transaction recording

through computer systems. For example, retailers make extensive use of electronic point of sale
(EPOS) technology, including barcode scanning to price goods, printing a cash register listing for
the customer, reducing inventory, and calculating and reporting profit margins. Taking advantage

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of new technologies can improve productivity and reduce the ratio of staff to sales value,
a common performance measure in retailing.

The outputs from EPOS include business volume—for example, number of customers, number
of items sold—sales analysis, product profitability and inventory reorder requirements. Sales and
profitability reporting can be generated by store and time of day. Additional benefits of EPOS
include information about:
• peak sales times during each day
• products that may need to be discounted
• sales locations that may need to be expanded
• time taken to scan a customer’s basket of goods.

Even small businesses like restaurants can take advantage of modern POS terminals that
are relatively inexpensive, enabling them to monitor customer seating by time of day and
day of week, generate orders for the kitchen, price goods and calculate bills, and provide
detailed management reporting on inventory and sales trends. This information can be used
for management accounting purposes to improve inventory management, reduce wastage,
enable staff rostering to the busiest times and identify the most profitable products.

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For larger organisations, an enterprise resource planning (ERP) system helps to integrate data
flow and access to information over the whole range of a company’s activities. Examples of these
systems are the relational databases provided by SAP and Oracle. ERP systems take a whole-of-
business approach. They typically capture transaction data for accounting purposes, together
with operational data and customer and supplier data, which are then made available through
data warehouses from which custom-designed reports can be produced. ERP system data can be
used to update performance measures in a BSC and can also be used for:
• activity-based costing
• shareholder value
• strategic planning
• customer relationship management
• supply chain management.

Cloud computing has enabled access to larger sources of data and made it easier to analyse
data from any location. It relies on sharing resources through the internet to achieve economies
of scale. With cloud computing, end users access applications through the internet, with both
software and data stored on servers at remote locations.

Large volumes of information are now available from public sources. The term ‘big data’ refers
to very large and complex data sets, which can be seen in the massive data resources of the
internet and the results provided by search engines such as Google or data held on Facebook.
Organisations are able to access (for a fee) this information to enable targeted marketing.

According to management consultants McKinsey, big data will become a key basis of
competition, underpinning new waves of productivity growth and innovation (McKinsey Global
Institute 2012).

The Australian Taxation Office accesses multiple sources of data to identify potential targets
for tax audits based on spending patterns. Retail stores such as Woolworths (as mentioned
previously) target customers for special promotions based on their individual spending habits
recorded through its ‘Everyday Rewards’ card system, which collects data on customer purchases
at the POS.

The ability to collect vast amounts of performance information means that it is important but
increasingly complex to report management information in a concise and decision-useful
way. Approaches to reporting management information include graphical presentation of key
performance data. As mentioned, traffic lights (red/amber/green) draw attention to those
aspects of performance that:
• are meeting their target (green)
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• are in need of urgent attention (red)

• need to be considered because they are borderline (amber).

A ‘drill-down’ facility may also be used to cascade down from highly aggregated performance
data to a more specific and detailed level—for example, customer, product or service,
or business unit.

Organisations need to determine what performance information is important from the volume
and variety of information that is now available. Big data requires specialist computing power and
software tools as the volume and variety of data is beyond the capability of relational databases.
Examples of such specialist software include Oracle’s ‘Big data appliance’ and ‘Hadoop’, which is
an open-source platform for consolidating, combining and transforming large data volumes.
Linking platforms to analyse big data and the organisation’s own relational database provides
what Oracle refers to as a ‘360-degree view’ of the organisation.

Oracle’s White Paper ‘Integrate for Insight’ on integrating big data is accessible at: http://www.
oracle.com/us/technologies/big-data/big-data-strategy-guide-1536569.pdf.

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The role of performance management in implementing and

monitoring strategy
Market research carried out by Oracle (2011) comprising almost 1500 interviews in 13 countries
found that there was an emphasis on sales growth rather than profits, with 82 per cent of
businesses admitting to not having complete visibility of their profits by line of business. This lack
of knowledge led to a misallocation of resources, poor decisions and poor pricing policies.
Criticisms by respondents included an over-reliance on spreadsheets, working with out-of-
date data from multiple ‘silos’ of information and a lack of data sharing between departments.
Seventy-one per cent of Oracle’s respondents described the links between strategic goals,
operational plans and budgets as ‘fragmented’.

An important implication of Oracle’s research is the finding that, on average, 1.7 months will pass
before the finance department becomes aware that operational plans or market circumstances
for the company have changed. In terms of performance data, for the 89 per cent of managers
with departmental performance measures who responded to the survey, it takes, on average,
just under two months for information about departmental performance against targets to filter
up to the senior management team or the board of directors.

The lack of reliable, accurate and timely data is compounded by the lack of stability in the
organisation’s environment and strategic plans that must be continually updated to stay relevant
to the latest business conditions. Turbulence in the business environment is caused by:
• economic uncertainty
• changing technology
• the rapid introduction of new products
• changing customer demand
• increased regulation and competition.

Strategy&, the strategy consulting group of PwC, argues that execution of strategy is critical
to success. It recommends ‘strategic performance management’, an approach that ‘makes an
organization’s strategic goals more transparent to line executives and provides an ongoing
mechanism to monitor progress toward these goals through simple and intuitive performance
measures’. The authors argue that there is often:
a lack of clear linkage between strategic objectives and operational performance measures,
limited accountability for outcomes at the operational level, an unmanageable number of
sometimes random metrics, fragmented and redundant systems and efforts, and a greater focus
on metric analysis than on management decision making (Chandrashekhar et al. 2017).

A key recommendation of the Strategy& report is for senior managers to focus on ’metrics that

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matter’. This involves becoming more agile in responding to change, changing performance
benchmarks and cascading those changes down through the organisation to deliver on strategic
goals (Chandrashekhar et al. 2017).

Researchers at UK’s Cranfield University are critical of traditional approaches to performance

management, which rely on stability and predictability. They developed a Performance
Management for Turbulent Environments (PM4TE) model (Barrows & Neely 2012).
They argued that:
many traditional performance management practices do not work well in turbulent environments.
In turbulent environments the need for timely information grows significantly. Managers must
detect and interpret information much more rapidly. They have to make faster decisions. They have
to execute more quickly with a narrower margin for error. And they must embrace new ways of
operating versus exclusively focusing on exploiting core businesses (Barrows & Neely 2012, p. 17).

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The PM4TE model comprises:

• a performance management cycle
• an execution management cycle that explicitly links projects to performance (as it is through
projects that most organisations drive change and improvement)
• enablers such as leadership and strategic intelligence.

A key enabler is the recognition that performance management should be used for learning
rather than control, as learning is central to success in turbulent environments.

Strategic intelligence and learning are more possible with the advent of technologies to access
big data. It is now possible to collect data about every potential customer interaction through a
business’s website and social media such as Facebook and Twitter. While this kind of big data can
be a powerful tool for business, it does raise issues of access to private information.

Further information about the Facebook and Twitter example is available in a 2018 New York Times
article available at: https://www.nytimes.com/interactive/2018/06/03/technology/facebook-device-
partners-users-friends-data.html.

A report by McKinsey Analytics argues that most companies are capturing only a fraction
of the potential value from data and analytics. Data and analytics can underpin disruptive
business models while granular data can be used to personalise offerings of products and
services to customers. However, many companies struggle to incorporate data-driven insights
into their day‑to-day business operations. Large technology investments have been made but
organisational changes have not always been in place to take advantage of the technology.
The report argues that ‘organizations need to build the capabilities of executives and mid-level
managers to understand how to use data-driven insights—and to begin to rely on them as the
basis for making decisions’ (McKinsey Global Institute 2016, p. 9). The report concludes that:
Data and analytics have even greater potential to create value today than they did when companies
first began using them. Organizations that are able to harness these capabilities effectively will
be able to create significant value and differentiate themselves, while others will find themselves
increasingly at a disadvantage (McKinsey Global Institute 2016, p. 24).

There is now widespread support for the belief that performance measures should be developed
from strategy. Kaplan and Norton’s (1996b) recommendation for a strategy mapping process
identified four barriers to implementation of performance management systems in relation
to strategy:
1. Failure by the senior management team to achieve consensus, leading to different groups
pursuing different agendas not linked to strategy in an integrated way.
2. Strategy that is not linked to department, team and individual goals—that is, an absence
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of cascading.
3. Strategy that is not linked to resource allocation decisions—that is, where budgetary
allocations are incremental/decremental and not linked to strategy.
4. Feedback to managers that focuses on short-term financial performance rather than on
a review of measures of strategy implementation and success.

The keys to successful integration of strategy with performance management can be

summarised as:
• top management commitment to a unified strategic vision, including synthesising the
performance expectations of multiple stakeholders
• developing performance measures that are consistent with the vision and that enable
attention to be drawn to whether the strategy is being implemented and is successful.
This involves balancing the attention on short-term/operational and long-term/strategic
aspects of performance
• ensuring that resource allocations are consistent with strategic priorities
• ensuring that individual and team performance measures are linked to organisational
performance measures

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• integrating all available sources of information into a single suite of cascaded performance
measures that all accountable managers in the organisation have access to and use
• using performance measures as a learning tool, not just as a means of control. Learning
facilitates modifications to strategy, resource allocations and what (and how) performance
is measured.

Appendix 5.1 provides an example of how Achmea focuses on using strategy mapping and a
BSC of performance measures, not just in strategy formulation, but more importantly, in strategy
implementation.

➤➤Question 5.13
Giant Products Ltd (Giant) manufactures ‘triffids’, a product that has many purchased components.
The board of directors of Giant has set a goal of 10 per cent reduction in the total cost of
components used in manufacturing triffids during the next financial year (assuming constant sales
volume). The board believes that the high cost of the components may be due to a combination
of poor purchasing practices and/or wastage during production.
Giant has the following organisational structure.

Managing
director

Marketing Finance and

Publishing Production
and sales administration

(a) Recommend performance measures that Giant could implement to achieve its goal of a
10 per cent reduction in the cost of components.

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(b) Explain how these performance measures could cascade to lower organisation levels in
each department.

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(d) How might information technology—for example, using an ERP system—assist in this process?

Check your work against the suggested answer at the end of the module.
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Part C: Determining performance

measures and setting performance
targets
Part B looked at the role of strategy in performance management and how performance
management can be seen as an important element in management control. Part C of this module
is concerned with how to design a set of appropriate and meaningful performance measures
and, having determined those measures, how to establish SMART (see later in this module)
performance targets. This part of the module:
• discusses the characteristics that ensure that performance measures are valid and reliable
• looks at the costs and benefits of performance measures
• reviews how power and culture affect performance management.

Designing performance measures and setting targets has no real value in improving efficiency,
effectiveness and equity unless those performance measures are used to improve performance.
This part discusses how performance improvement relies on three levels of analysis:
1. targets
2. trends
3. benchmarks.

It also considers the role of knowledge management and organisational learning in improving
performance. This part concludes with a discussion of the behavioural consequences of
performance management.

Designing performance measures

In considering the BSC framework, while there are many possible performance measures for each
of the four perspectives, selecting the most appropriate measures can be a difficult choice.

Given the almost unlimited measures that could be used, the ones that organisations should use
are those that are linked to achieving the organisation’s strategic goals. The number of different
performance measures needs to be limited to what is manageable, because too many measures
may result in none of them being seen as important. As mentioned in Part B, Kaplan and Norton
(1992; 1993; 1996a) recommend three or four from each of the four perspectives. Once cascaded
down, these broader measures may be replaced by more detailed measures, so in total an

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organisation may have many more than 12 to 16 measures. The measures may be different at
each organisational level, but at any one organisational level the number of measures needs to
be manageable.

As was discussed in Part B, the design of a performance management system will be linked
to the organisational strategy through the strategy mapping process and will most likely be
contingent on the organisation’s competitive environment—for example, size, technology,
strategy. It is important to distinguish what should be measured from what is easy to measure.
Organisations often avoid measuring performance that is important because measurement is
time-consuming or costly (cost–benefit is discussed later in this section). However, it is even
worse to measure performance just because it is easy to measure, if it is not critical to business
success. This practice leads to too many, often unimportant, performance measures.

The cascading of performance measures reflects the agency relationship between higher-
and lower-level managers—an extension of the principal–agent relationship. At the whole
organisational level, and at each subsidiary level, the measures that are important to achieving
strategy—for that organisational level—need to be determined. This relies on an understanding
of the organisation’s predictive model.

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In the EVT example, the entertainment and hospitality divisions have different predictive models,
and even for hotels different predictive models will apply because they are influenced by different
factors—business travel to CBD locations compared with holiday destinations in resort locations,
with seasonality affecting occupancy differently, especially for the skiing season at Thredbo.
They are therefore likely to have some performance measures that are different, although there
would also be much commonality.

The overall business strategy is cascaded to each business unit, which will develop subsidiary
strategies in accordance with the predictive model for that business unit. Once the strategy
is understood for each business unit, each department and even each individual employee,
performance measures can be defined that monitor whether the strategy is being achieved;
as shown in the EVT example, cascading is down to the individual hotel level.

It is important to remember the difference between a performance measure (what is being

measured) and a performance target (the desired level of performance). That is, the performance
measure may be used as an objective comparison to a predetermined target or an external
benchmark—for example, a competitor or industry average.

Many types of performance measures exist. Table 5.4 provides an overview of some of the more
common types.

Table 5.4: Types of performance measures

Type of measure Example

Input Resources: human, physical, financial

Activity Processes: number of hours worked, number of material issues, number of deliveries

Output Quantity of goods and services produced, sales revenue

Efficiency Ratios of outputs to inputs, such as process efficiency, wastage

Effectiveness Measures of output conforming to specified characteristics such as absolute

quantities, on-time delivery and meeting an agreed quality standard

Impact How outcomes contribute to strategic organisational objectives, such as customer

satisfaction, and environmental and CSR goals

Investment Capital expenditure, distribution channel expansion, research and development

expenditure
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Source: CPA Australia 2019.

Remember also that some performance measures are used for signalling to external stakeholders
as part of an organisation’s accountability. Others are used for planning, decision-making and
control, so the purpose of the performance measure needs to be considered.

Example 5.16 reveals the problem of inappropriate performance measures in a changing market.
Part 2 of this example is explored in Example 5.17.

Example 5.16: Mammoth Printing—Part 1

Mammoth Printing was a large stock exchange–listed printing business in a very competitive market
in which most competitors had modern—and expensive—production equipment. As a consequence
of high levels of capital investment and price competitiveness to win business, profits across the
sector were low.

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Mammoth Printing measured its performance through some common measures:

• Sales performance was measured by the level of invoiced sales.
• Production performance was measured in terms of:
– printing machine running time as a percentage of total time
– wastage
– on-time delivery.

Due to pressure from the board to increase profits, Mammoth sought to increase volume, but to achieve
its sales targets, sales representatives—who were paid a commission based on sales value—tended
to reduce prices and so, while volume was high, margins remained tight.

In this sector of the printing industry, production was based on customers’ orders and a job order
manufacturing process was in use. The time taken to produce an order on printing machines was
consumed partly in:
• set-up—also called make ready (i.e. setting up the machine before the paper is printed)
• machine running time—when paper is being printed through the presses.

Market changes had taken place over time, resulting in customers placing orders for smaller volumes
more frequently. The effect of this change was that Mammoth’s production capacity was being eroded
as more machine time was consumed in set-up rather than running time, which reduced Mammoth’s
overall capacity to produce the necessary volume. A further impact of the smaller volume orders
was the increased number of non-production employees handling the increased number of sales
orders, production orders, deliveries and invoices. The overall effect was declining profits despite
increasing sales.

The production department was overwhelmed by the volume of business brought in by the sales
department and late deliveries became more common. The production manager argued that too
much production time was being used for set-up times for the small-volume orders. He argued that
the prices being charged were insufficient to cover the loss of overall production capacity and the
administrative burden caused by the small-volume orders.

The following summary of key performance data for Mammoth Printing, comparing its performance
over time, reveals substantial changes in financial and non-financial performance.

Prior to
implementation Percentage
Three years prior of changes change

Sales volume (tonnes of paper) 160 000 220 000 +37.5%

Sales revenue $80 million $100 million +25%

Total costs $72 million $99 million +37%

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PBIT $8 million $1 million –87%

Average printing machine 10% 25% +150%

set-up time as a percentage
of total time

Average printing machine 90% 75% –17%

running time as a percentage
of total time

Wastage 5% 7.5% +50%

On-time delivery performance 90% 80% –10%

Mammoth’s business model had changed over time but the company realised that its performance
measures had not kept up with these changes. Consequently, Mammoth re-evaluated its performance
management system. The problem of capacity erosion through set-up times was accepted, and a
trial activity-based costing exercise recognised that costs to service small-volume orders were not
being passed on to customers through the price. A number of changes were introduced to the
performance measures.

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• In the production department, wastage, on-time delivery and machine running-speed performance
measures were supplemented by reporting the mix of set-up and running times on each machine,
to identify where too much time was being spent on smaller orders with long set-up times.
• Sales performance was judged not only on sales value but on ‘value added per machine hour’.
This was a value close to that used under throughput accounting (i.e. sales value less the cost of
materials). The value added was divided by the total number of machine hours (set-up and running)
to produce the job. The new ‘value added per machine hour’ measure became one of the most
important measures in managing Mammoth’s business—it identified those small jobs that had
both lower prices and higher set-up times as the value added per machine hour would be very low.

However, Mammoth faced considerable resistance from the sales representatives who were discouraged
from accepting orders where the value added per machine hour was too low. Attempts by the CFO
to replace the sales representatives’ commission on sales value with a commission based on value
added per machine hour failed because of the power of the sales and marketing director. Mammoth
failed to move fast enough to change its behaviour or its performance measures, and the company
was subsequently taken over by a multinational competitor.

Example 5.16 reveals the need for continual reassessment of the business model and
performance measures. It shows the need for management accountants to be able to interpret
performance information and recommend appropriate strategies to respond to changes in
performance. It also highlights the importance of power and culture, and the behavioural
consequences of performance measures (discussed later in this part).

Measuring efficiency, effectiveness and equity

One consideration in designing performance measures is to balance the measures between
those concerned with efficiency, effectiveness and equity, as summarised in Figure 5.10.

Figure 5.10: Efficiency, effectiveness and equity

Efficiency Effectiveness
Conversion of inputs or Focus on the end
resources (physical, human result of production,
and financial) into outputs on quality and customer
(products and services) satisfaction—whether the outputs
achieve what was intended, or
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Focus on improving productivity ‘doing the right thing’

and reducing cost—‘doing
more with less’ Particularly important
and ‘doing things right’ in the public and not-for-
profit sectors

Equity
Fairness and equal
treatment—managing differences
such that the costs and benefits of
economic activity are spread equally
among different customer or other
stakeholder groups

Source: CPA Australia 2019.

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Both efficiency and effectiveness are important. In the Mammoth Printing example, the company
was neither efficient (too much time was spent on set-up) nor effective (profits were too low,
while customers received late deliveries).

Finding the right balance between efficiency and effectiveness is important, and organisations
need to recognise the trade-off between these aspects of performance. For example,
a customer needs a service call for some equipment that is not working and wants the service
call on Monday, but it is not efficient for the service technician to go to every location on every
day of the week. Service calls are grouped to similar areas for set days of the week. The day
set for service calls to the customer’s area is Wednesday. There is a trade-off here between
the performance measure for service efficiency and the performance measure for customer
satisfaction. One may be achieved in this scenario, but not both. Recognition of trade-offs needs
to be built into performance measures.

This raises the issue of equity. Should all customers be treated equally? In Example 5.15, there is
an equity issue surrounding the treatment of emergency patients and elective (i.e. non-urgent)
surgery patients. While it might be unacceptable not to treat an injured person, neither is it
equitable for elective surgery patients to wait many months for their treatment. In the Mammoth
Printing example, is it equitable for all customers to be treated in the same way, with the risk of
late deliveries, when some customers have paid a higher price—generating a higher value added
per machine hour—than others for what they have ordered?

Issues of equity also appear in the HR function, where performance measures may exist in
relation to gender equality, the treatment of people with disabilities, or those from Indigenous
or ethnic backgrounds.

Designing SMART performance targets

Once performance measures are determined, the target to be achieved also needs to be
determined. The targets may be different for different business units or products and services,
based on a study of past performance, available resources and capabilities. Targets will, like
performance measures, cascade down through the organisational hierarchy to the individual level.

One way of looking at performance measures and targets is through the acronym SMART,
as outlined in Figure 5.11.

Figure 5.11: SMART performance targets

S M A R T MODULE 5
Specific Measurable Achievable Relevant Time-based
• Measures and • Should be and agreed • Measures and and timely
targets should capable of • Targets may targets should • Targets should
be clear and being be ‘stretch’ be relevant to cover a
unambiguous accurately targets rather the strategies defined time
measured than easy to in the business period
• Should be achieve but model • Measures
clear whether must be must be
a target has achievable produced on
been and agreed a timely basis,
achieved, or between so that
how close the managers and corrective
performance subordinates action can
is to target be taken

Source: CPA Australia 2019.

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It is good practice to review all performance targets to ensure they are SMART. If measures are
difficult to measure or are ambiguously worded, irrelevant to the organisation’s strategy, too late
to lead to action or not agreed between the target setter and the accountable manager, they are
unlikely to be helpful in identifying performance gaps or improving performance.

Table 5.5 shows two examples of performance targets that are SMART, as well as two examples
of performance targets that do not satisfy the SMART criteria.

Table 5.5: Examples of performance targets

Performance target Analysis

Satisfies SMART criteria

Return on capital employed (ROCE) The ROCE target is specific, measurable and achievable in
of 14% in FY 20X4 compared with comparison to prior year, relevant and time-based (FY 20X4).
13.5% in FY 20X3

Customer satisfaction of 95%, The target is specific, measurable and time-based. It may be
based on survey of products achievable provided past customer satisfaction is within a realistic
delivered during the month of June range of the target figure, and is likely to be relevant to most
businesses that need satisfied customers to maintain and/or
grow sales revenue.

Fails to satisfy SMART criteria

Product quality of 100% The quality target is not specific—it does not say how quality
is measured; it may be measurable (if how quality is measured
is defined) but is unlikely to be achievable as 100% quality is
unrealistic given the costs likely to be incurred to achieve perfect
quality; the target may be relevant, but only if it is critical to
achievement of organisation goals; it is not time-based as no
time period is specified.

Staff turnover less than or equal to While the target is specific and measurable (although there may be
25%—historical staff turnover is 45% some definitional issues around part-time or casual staff), it may not
be achievable given past performance. The target may be relevant
if staff continuity is especially important for the business, but the
target is not time-based.

Source: CPA Australia 2019.

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Characteristics of performance measures and targets

Effective performance measures are those that achieve what is intended. To be effective,
performance measures need to be able to:
• help management implement and monitor strategy
• support decision-making
• motivate managers and other employees
• communicate with, or signal to, stakeholders.

To be effective, performance measures need to satisfy several criteria, although it is normally

impossible for any single performance measure to satisfy all criteria. Most performance measures
have shortcomings or limitations and this is one reason why using multiple performance
measures is recommended—each measure captures some important aspect of the performance
to be measured and satisfies at least some of the characteristics shown in Figure 5.12 and
discussed in the next sections.

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Figure 5.12: Characteristics of performance measures

Validity
How well a measure
helps evaluate the issue
or item of performance
being considered

Reliability
Controllability
Whatever is being
Must be controllable
monitored can be
by those whose
measured consistently
performance
and in an objective and
is being measured
specific manner
Characteristics
of performance
measures
Accessibility
Can be accessed
Clarity
by all authorised
Easy to understand with
organisational
little or no ambiguity
participants who need
the information

Timeliness
Provides information
early enough to allow
corrective action

Source: CPA Australia 2019.

Validity
Validity (or accuracy) refers to how well a measure helps evaluate the issue or item of performance
being considered. If a measure does not accurately describe what it is supposed to, all other
attributes are meaningless. A performance measure like operating profit is objectively known from
financial statements and is subject to audit, being based on accounting standards. In reality, the
practice of accruals and provisioning can influence reported profit. Market share may be measured

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objectively by reputable and independent industry sources based on sales data reported by each
company in the market. This data tends to be accurate, although sales can be misreported by
individual companies.

Some concepts are quite difficult to measure directly, so indirect measures are used. The problem
is whether or not they accurately capture what is meant to be measured. Customer satisfaction
is often measured in a restaurant by asking customers whether or not they were satisfied with
their meal. Because customers may be more inclined to say they were satisfied rather than
risk offending the restaurant staff, a business can be misled by those responses. A measure
of the same customer returning would be more valid, perhaps through a loyalty card scheme.
An anonymous ‘tick box’ feedback form left with the customer’s bill may also provide more valid
information about customer satisfaction.

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Reliability
Reliability means that whatever is being monitored can be measured in an objective and
specific manner. Reliability is concerned with consistency, or the extent to which the reported
performance is the same over repeated measurement attempts—for example, does a customer
satisfaction survey carried out by different people give the same results no matter who carried
out the survey? A reliable measure is one that is trustworthy.

Reliability is sometimes confused with the term ‘validity’ because it is interpreted to mean
‘a measure I can rely on to tell me what I need to know’. However, this is not an accurate
understanding or interpretation of what reliability means. Many things can be measured
‘reliably’, but this does not mean they are useful for analysis.

A measure can be highly reliable but completely invalid for decision-making purposes.
For example, we could measure growth in company sales revenue to assess customer
satisfaction. Sales revenue is both a valid and reliable measure, but it has tenuous links with
individual customer satisfaction, so using it to measure customer satisfaction may not be valid.
A more valid measure of customer satisfaction may be customer retention—that is, how long
the customer stays a customer and whether purchases by the customer are increasing or
decreasing. The reliability of this measure can only be gauged if over time customer retention
equates to customer satisfaction.

It is often difficult to measure ‘valid’ measures in a reliable way. Consider the restaurant example
about measuring customer satisfaction. Reliability of the performance measure will be improved
by repeating the method of measurement in a consistent way—for example, using a standard
customer feedback form over a long period of time. However, even here, caution must be
exercised in interpreting the data because it could be affected by the particular customer or
waiting staff on duty or by a variety of other factors such as the level of heating or noise from
other customers.

A common performance measure in many service businesses is the time taken to answer an
incoming telephone call. The assumption is that customers will be more satisfied when they
do not have to wait for long periods. There is a cost in calculating, storing and reporting this
information, even though it is largely carried out behind the scenes through communications
technology. The performance measure may be reliable because it may be collected as a
by‑product of the technology used, but may not be valid as a measure of customer satisfaction
because the customer may weigh the quality of the answer as being far more important than
the time taken to answer the phone. The time taken to answer a telephone is a useful measure
because it indicates whether staffing is sufficient to minimise customer queuing, but as a valid
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measure of customer satisfaction it needs to be supplemented by another measure that focuses

on the quality of the contact. For this reason, organisations like Telstra routinely follow up
telephone calls with emails asking customers to respond to a short survey to assess customer
satisfaction more holistically.

Clarity
If a measure is to be meaningful, it should be easy to understand with little or no ambiguity in
interpreting the results. For example, a measure of ‘product quality’ usually has a high level of
clarity. It begins with a specification of the product. The final product can then be compared with
the specification and tested to see if it meets the specification.

An example of a measure that often has a low level of clarity is a popular measure of shareholder
value—economic value added (EVA). This is a valid and sometimes reliable measure, but it is
difficult to understand due to its complexity and the number of choices that are made in the
construction of the measure. This makes it difficult to use when comparing results between
business units or organisations.

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Timeliness
To be useful, performance measures need to provide information early enough to allow
corrective action to be taken. If a measure is not available when it is needed for decision-making,
then it is of little use. Many financial measures such as profit are not timely. These are lagging
measures and inform about what has already happened, but provide little guidance for future
action. However, sales data collected daily for a retail chain store is a very timely measure of
likely future financial performance. Such data can influence immediate actions such as increasing
advertising, purchasing inventory and price discounting.

Accessibility
Performance measures should be able to be accessed by all authorised organisational
participants who need the information. Accessibility refers not only to the measure, but also
to the information that drives the measure.

Controllability
In order to be effective in motivating behaviour, what is measured must be controllable by
those whose performance is being measured. Controllability refers to the ability to influence the
quantity or value of the measure through action. Aggregate measures such as the organisation’s
profit are normally only partially controllable by any individual in an organisation. On the other
hand, production quality is a measure that should be controllable by the process owner.

Costs and benefits of performance management

In many organisations, much data is collected that is never used. The cost–benefit issue
may be difficult to assess, because the benefits of good performance information are rarely
received in cash—they come in the form of the characteristics of validity, reliability, clarity
and timeliness discussed previously. Performance measures do, however, need to be cost-
efficient—that is, the expected benefits of using the measure must exceed the associated cost
of undertaking the measurement.

A cost–benefit analysis compares the outputs or outcomes with the costs to produce those
outputs or outcomes. Cost–benefit analysis is one method of evaluating performance
measures. The measurement of performance, its monitoring, management and reporting
is an organisational cost. Data must be collected, summarised, analysed and interpreted,
and corrective action must be taken to improve performance where necessary. This often
involves both a technology cost (the information system) and a human cost. Therefore, it is

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important that the design of a performance management system recognises the cost of
measuring performance and compares this cost with the benefits that are likely to accrue
from it. Performance measures that are very costly but yield little benefit should be avoided or
eliminated. Costs here are not just cash costs, but opportunity costs—that is, the alternative
use and the benefits from that use to which the resources consumed could be put.

In the TNA example discussed previously (Example 5.12), the owner–manager abandoned most
traditional performance measures—including reported profits, except to comply with statutory
requirements—because they were not cost-effective. Traditional accounting-based measures
did not reflect the reality of TNA’s business model, where the largest costs for R&D, export
market development and patent litigation were incurred many years before revenue was earned.
TNA saved the cost of comprehensive monthly accounting performance reports that were
not useful.

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The lean accounting approach argues that the costs of detailed time recording and material
issues against jobs and carrying out price and efficiency variance analyses are prohibitive and
yield little benefit compared with the cost. Lean accounting uses backflush costing to record the
cost of time and materials based on standard costs once a job is complete. This is a far less costly
accounting process. While the argument for lean accounting approaches seems logical, it is
contingent to a large extent on how effective other controls are within the organisation.

There may be an opportunity cost in backflush costing if there are variances that are not
identifiable. If a physical stocktake at year end results in only minor adjustments, it can
be assumed that backflush costing is a cost-effective method and that abandoning time
recording, material issues and variance analysis has reduced organisational costs. If there are
serious discrepancies at the time of a stocktake, this highlights significant control weaknesses.
Whether time recording, material issues and variance analysis may be effective controls is another
matter, but this example highlights the need to consider the cost and benefits of performance
measures in light of each organisation’s circumstances, as shown in Example 5.17.

Example 5.17: Mammoth Printing—Part 2

Returning to the example of Mammoth Printing (see Example 5.16), one of the performance measures
used historically was a measure of the length of paper that was produced by the printing machines.
Paper is the most significant raw material in printing and this measure was thought to be an important
measure of the volume of paper printed. The data was collected at the end of each print job and
recorded on the job paperwork, then entered into a computer system and reported along with other
data on management reports. However, there was no evidence that the data was used, or had ever been
used. Someone had thought it was a good idea to collect the data, and no one had ever questioned
whether it was still needed. There was a cost in printing machine operator time to calculate and record
this data, which over the number of machines and over time would have amounted to a significant cost.

The questions that can be asked with regard to the value of performance measures are:
• Can they be understood?
• Can they lead to action to improve reported performance?
• Will (and if so, how will) improving performance as reported by a particular measure help
achieve organisational strategy and goals?

If the answer to any of these questions is ‘no’, then it should be asked why that performance
is being measured. There is a tendency by some managers and organisations to look for new
performance measures, but often insufficient attention is given to abandoning performance
measures that may once have been useful, but are no longer useful.
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What is important in these examples is that, at the very least, organisations should question
taken-for-granted practices and not continue them just because it is ‘the way we have always
done things here’.

➤➤Question 5.14
Review the following 10 performance measures and their associated targets for XYZCo’s latest
financial period. Evaluate the performance measures and targets with reference to SMART
(specific, measurable, achievable, relevant, time-based) design principles, and the characteristics
of effective performance measures and targets (validity, reliability, clarity, timeliness, accessibility
and controllability).

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Performance
Performance measure target SMART Characteristics

1. Head office recharge $1 million

of corporate costs to
business units based
on a percentage of
sales revenue in each
business unit

2. Survey of brand 75%

recognition among
members of the public

3. Receivable days 45 days

4. Percentage of 90%

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incoming telephone
calls answered in
one minute

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Performance
Performance measure target SMART Characteristics

5. Percentage of sales 80%

revenue from return
customers

6. Dollar value of $100 000 p.a.

donations to charities

7. Reduce employee Reduce

turnover turnover by
10% p.a.

8. Sales revenue growth 15% p.a.

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Performance
Performance measure target SMART Characteristics

9. Headcount 120

10. Compliance with Full

legal requirements

Check your work against the suggested answer at the end of the module.

For further practice in the concept of effective performance measures, please access the
‘Characteristics associated with performance measures’ learning task on My Online Learning.

Performance management, power and culture

The preceding examples of unquestioned performance management practices reflect the
importance of power and culture within organisations. In describing various approaches to
performance management and management control, the role of culture has been highlighted,
whether this is a clan culture (Ouchi 1980) or more general belief systems (Simons 1994; 1995).

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Cultural elements can be seen as part of the control package (Malmi & Brown 2008) but cultural
factors also influence the design of performance management systems (Ferreira & Otley 2009).
Euske, Lebas and McNair (1993) contrasted the individual performance measures, used to direct
short-term attention, with cultural norms as the basis for guiding long-term behaviour.

An organisation’s culture will influence the kind of performance measures used. In a culture where
accounting controls are seen as very important, it is more likely there will be time recording,
material issues and variance analysis than lean accounting approaches. In an organisation
whose culture is focused on short-term profits, then that will dominate the approach to
performance management.

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Power is also important in determining what performance measures dominate in an organisation.

Markus and Pfeffer (1983, pp. 206–7) argued that accounting and control systems are related to
intra-organisational power ‘because they are used to change the performance of individuals and
the outcomes of organizational processes’. The most powerful group in an organisation is the
‘dominant coalition’ (i.e. those who are making the choices) (Child 1972). This may not necessarily
be the same as shown on the organisational chart of reporting relationships. Dominant coalitions
are more subtle centres of power. Some organisations are dominated by the accounting and
finance function, others by engineers, others by marketing and sales-focused roles.

Understanding how power influences the design of performance management systems is

important because it enables a view of why certain performance measures exist and remain.
The power of dominant coalitions also influences the relative importance of performance
measures and targets. In a sales-driven organisation, it would be expected that more
prominence would be given to measures of sales performance. In an R&D-focused organisation,
relative importance might be given to new products or patent registrations. For example,
the culture and power at Mammoth Printing was quite different to that at TNA.

Malmi and Brown (2008, p. 291) noted that ‘different systems are often introduced by different
interest groups at different times’ and so control systems, including performance management,
will be implemented when they are consistent with:
• other sources of power
• the dominant organizational culture in their implications for values and beliefs
• shared judgements about certainty, goals and technology (Markus & Pfeffer 1983, p. 205).

Example 5.18 highlights these issues as they apply to the advertising industry.

Example 5.18: International advertising agency

Advertising agencies are dominated by large international conglomerates that are listed on international
stock exchanges. As for all listed companies, short-term financial performance—primarily EBIT
measures—and sales growth are key success factors.

In the advertising agency business though, creativity is also essential. Agencies recruit creative people
who must succeed in designing advertising that works for the agency’s clients. Investing in talent
recruitment can conflict with short-term financial pressures. One particular tension is whether to win
sales revenue to finance new talent (which causes pressure on existing staff until the talent is recruited)
or whether talent is recruited first (which causes pressure to win sales to fund the new talent).
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While financial performance is important, advertising agencies measure their performance in terms of
employee satisfaction and client satisfaction, and also by winning creative advertising industry awards.
These awards enable the agencies to recruit talent, even though they do not necessarily reflect work
that is valuable to the client, whose interest is less in the creativity than the ability of the advertising
campaign to generate sales revenue.

In one international advertising agency, these different aspects of performance are managed
simultaneously. Performance measures for finance, employee satisfaction and client satisfaction,
as well as industry awards, are maintained. Attention is paid to both client satisfaction and employee
satisfaction so that problems or trends identified through regular surveys of each group result in action
to remedy the problem. Although there are no targets to win awards, the agency knows that failure
to do so will detract from its ability to attract and retain creative staff. Most importantly, perhaps,
creative talent is insulated from financial pressures, with senior managers protecting them from any
financial information. Risk-taking by senior managers results in talent recruitment ahead of revenue
generation. In the history of this agency, this has proven to be a successful strategy, because newly
recruited talent has generated additional client income.

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Creative organisations like advertising agencies need to manage competing priorities in a flexible way
to survive—both in terms of satisfying short-term expectations and investing in talent—that reduces
profits in the short term, to achieve sustainable performance.

Of course, not all organisations can balance competing demands in an effective way. A contrasting
example is the BP and Deepwater Horizons oil rig disaster (see Example 5.19), which demonstrated
what can happen when a single aspect of performance is pursued at the expense of all others.

Example 5.19: B
P and Deepwater Horizon in the
Gulf of Mexico
The world’s largest accidental marine oil spill took place in the Gulf of Mexico when the USD 560 million
Deepwater Horizon oil-drilling rig exploded in April 2010. This followed a blowout of the Macondo oil
well, resulting in the death of 11 workers and an estimated five million barrels of oil spilling into the gulf.

Reports suggest that the main fault lay with BP and its subcontractors. The well was six weeks behind
schedule due to a number of technical drilling problems and the delay was reported to have been
costing BP more than half a million dollars a day. Best practice for drilling wells had not been followed
and BP had chosen to drill in the fastest possible way. Despite concerns expressed by employees
and consultants to BP, a number of shortcuts were taken to reduce costs. Each decision taken by BP,
while legal, saved BP time and money yet increased the risk of a blowout (Bourne 2010).

An independent 15-member committee headed by University of Michigan engineering Professor

Donald Winter released a report in November 2010, which found that BP’s focus on speed over safety
contributed to the accident.

In its final report, the National Commission on the BP Deepwater Horizon Oil Spill and Offshore
Drilling placed most of the blame for the disaster on BP and its partners who placed financial interests
before safety.

Following the incident, BP reported a second-quarter loss of USD 17 billion, its first loss in 18 years,
which included a one-time USD 32.2 billion charge, including USD 20 billion for the fund created for
reparations and USD 2.9 billion in actual costs (AC) incurred at that time. In October 2010, the CEO
resigned. The total amount of claims paid or approved for payment by BP as at mid-December 2010 was
USD 4.3 billion. In the aftermath of the disaster its market capitalisation fell by about USD 100 billion.

The information available suggests that BP’s culture of cost cutting to achieve short-term profits and
the power of dominant coalitions to push ahead despite safety concerns were significant contributors
to the accident. As a consequence, the reputational as well as financial cost to BP has been enormous.

Note: Candidates may be familiar with this example from their study of the Ethics and Governance

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subject of the CPA Program.

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➤➤Question 5.15
This module has drawn on the difference between performance measurement and performance
management. Several examples have suggested that performance measurement needs to be
customised to each specific organisation.
Explain why performance measurement needs to be customised and the role of the management
accountant in performance management.
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Check your work against the suggested answer at the end of the module.

Performance management for performance

improvement
The importance of performance improvement
While performance management has been considered in relation to strategy and control,
one of the most important aspects of performance management is using the results as part of
the feedback cycle (see Part B) to make decisions aimed at improving performance. This is an
area where management accountants can add value to their organisations. Such a contribution
requires a more ‘soft skills’ approach because management accountants need to move beyond
performance reporting.

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There is a significant opportunity for management accountants to collaborate with managers in

other functional areas to identify where improved performance is possible. The management
accountant has access to information that is not always readily available to non-financial
managers. Management accountants can exercise their professional judgment to identify:
• problems with performance targets
• operational issues that may be leading to sub-optimal performance
• data inadequacies.

Management accountants then need the personal skills to be able to use their knowledge to
influence senior managers in relation to performance management by:
• setting SMART measures and targets consistent with strategy
• providing relevant information to support other managers’ decision-making
• identifying and recommending potential approaches to performance improvement.

The opportunity for performance improvement through using targets, trends and benchmarking
is reviewed in the following section.

Targets
As outlined previously, at the first level targets need to be set for each performance measure
and performance measures should cascade down the organisational hierarchy through each
business unit to the individual level. Performance targets need to be SMART and meet the six
characteristics of effectiveness.

Targets that are set can range from those that are easy to achieve to those that are difficult or
impossible to achieve. The achievement of a target, therefore, is not necessarily a sign of ‘good’
performance because it is relative to the target set. Improving performance is often seen as a
process of continually increasing the target and expecting that target to be achieved, but there
are three problems with this approach:
1. the cost–benefit trade-off in continually achieving more stretching targets
2. the impact of achieving some targets on other targets
3. the accuracy of assumptions in the predictive model.

Cost–benefit
As discussed previously, the costs and benefits of achieving an ever-increasing target need to
be weighed against improving performance.

For example, a student who has a target of 80 per cent in an exam may achieve 82 per cent.
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The same student may then decide to increase the target to 85 per cent or 90 per cent. However,
the student needs to evaluate whether the costs (e.g. time spent studying and its opportunity
cost, such as working fewer hours at their part-time job) are worthwhile to achieve the higher
mark. It may be that the additional cost to get a mark of 90 per cent (compared to the existing
82%) is not worthwhile and the student could expend their efforts elsewhere.

By contrast, a student who sets a target of 70 per cent and achieves a mark of 60 per cent should
be sufficiently motivated to work harder to improve performance, but it may be that the student
decides to lower expectations to a revised target of 65 per cent. The actual target will depend on
the student’s goals and may be quite different between individual students, depending on their
abilities, motivation and aspirations.

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Keeping targets in balance

In Part B of this module the balanced scorecard was introduced. One of the key aspects of the
BSC is the idea of ‘balance’—that is, it may not be possible to always maximise performance
on every measure, but an optimum result should be sought. In the student example, one of
the costs of increasing a target for examination performance on one subject and working
towards achieving that performance is that performance on other subjects may suffer.
Equally, the relentless pursuit of profit may damage customer satisfaction, or the relentless
pursuit of customer satisfaction may impact on business process efficiency.

The idea of strategy mapping was that organisations set performance targets based on their
strategic goals and then regularly review their performance against those targets. The result of
this review may be to reallocate resources, or management attention, to underperforming areas
(which may result in a detrimental effect on those areas deemed satisfactory), or to modify the
target if it is considered that the target is inappropriate in relation to other targets.

Predictive model
Parts A and B discussed the idea of the predictive model. The predictive model is the set
of assumptions that drive the business:
• why customers buy products and services
• how those products and services are produced to fulfil customer orders.

The predictive model suggests that if particular actions are taken, they are likely to lead to
defined levels of performance. However, Otley and Berry (1980) argued that predictive models
are partial and unreliable. It is not certain that actions (e.g. an increase in advertising expenditure)
will lead to performance improvement (e.g. an increase in sales). Organisations work on the basis
that assumptions about their predictive model are correct, but they need to continually challenge
their assumptions and ask whether the performance targets they have set are still appropriate.
Continual poor performance compared to targets may suggest broader problems with the
taken-for-granted business model. A good example of the failure of predictive models was the
GFC and the purchase of complex financial products like mortgage-backed securities in an
overheated housing market.

Trends
The second level of analysis for performance improvement is trend. Accountants are familiar
with trends in the analysis of financial ratios from financial statements. The same principle
applies to all performance measures, but organisations will typically monitor non-financial ratios
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more frequently (monthly, weekly or even daily for some measures) than for many of the ratios
calculated from annual financial statements.

Trends show improving or worsening performance over time, and are more reliable measures
of performance than comparing performance to targets, which may be set more subjectively.
Rather than taking corrective action based on single period comparisons between actual
and target, trends can identify short-, medium- and longer-term changes in performance that
deserve attention. Performance needs to be sustainable over time, so short-term improvements
compared with targets need to be re-evaluated by looking closely at trends over longer
time periods.

Benchmarking
The third level of analysis for performance improvement is benchmarking—that is, comparing
performance to competitors, industry averages, or acknowledged ‘best practice’ or ‘world class’
performance. Benchmarking enables an organisation to see where its performance might be
improved relative to others. Figure 5.13 shows the benchmarking process for performance.

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Figure 5.13: Benchmarking performance

3.
2.
1. Study the
Identify
Decide what processes in your own
benchmarking
to benchmark organisation and
partners and sources
gather information

5.
4. 6.
Analyse the
Obtain Learn and
information and
benchmarking implement changes
understand it relative
data where necessary
to the benchmark

Source: CPA Australia 2019.

Benchmarking requires other organisations’ data to benchmark against, and sometimes

access to this data can be very difficult. In some industries, performance data is held quite
closely—for example, the Big 4 accounting firms or large law firms, where it is difficult to obtain
competitively sensitive data. In other industries, data is publicly available, such as the automotive
and retail industries, usually because of the economic impact of these industries, which results
in a lot of statistical data being published. Much data is collected and reported by industry
associations. Industry associations, such as the Master Grocers Association in Australia, provide
data (see http://www.mga.asn.au), although detailed information is usually only available to
members. Data is collected by government authorities, such as the Australian Bureau of Statistics
(http://www.abs.gov.au). Private sector research organisations such as IBIS World (http://www.
ibisworld.com.au) produce detailed reports, although the cost of obtaining research reports can
be quite high.

Some common areas benchmarked by businesses are:

• sales revenue and profitability
• products and services
• pricing structures, fees and overheads
• quality control processes
• customer service standards or the number of customers
• staff management and turnover.

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For example, the Australian Bureau of Statistics reports aggregate data for retail sales per square
metre of floor space, labour cost per employee and inventory turnover data. Supermarkets use
various data to compare their performance, such as financial results, sales revenue and number
of stores. Competitor financial statements will of course be used to compare financial ratios.

Other data shown in some company annual reports includes performance measures of sales
per square metre of floor space and sales per employee, both key performance measures
in the retail industry. Benchmark comparisons of data such as this are useful in making
comparisons of efficiency in use of floor space and staffing levels. Woolworths’ annual report,
for example, also shows the number of customers linked to its ‘Everyday Rewards’ accounts
and Qantas Frequent Flyer points.

Whereas EPS data is regulated, data on non-financial performance measures is not required
under financial reporting standards. So it is often the case that benchmark comparisons
cannot be made or can only be made based on estimates derived from data shown in the
annual report—for example, using reported sales figures, estimates of supermarket size or
employee numbers.

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Two kinds of benchmarking are most common:

1. internal
2. external (industry), although sometimes benchmarking with organisations in other industries
is also possible.

Internal benchmarks
Where an organisation has multiple business units, especially when those units have similar
operations, comparisons between units may be useful. For example, retail stores make extensive
use of benchmarking, comparing sales per square metre and sales per employee between
store locations and between departments—for example, homewares, clothing, electrical.
Internal benchmarks would be particularly valuable to compare hotel performance within EVT’s
hospitality division.

Banks have used internal benchmarking of performance measures as a method of introducing

internal competition and learning. Each branch receives a report indicating how they score on
various measures compared with other branches. Some banks do not allow any branch to stay
constantly in the lowest category and low-ranking branches may be closed, or there may be
managerial changes or an investigation of the causes of a branch scoring in the lowest category
with an aim towards improvement.

External (industry) benchmarks

Industry benchmarking provides a comparison of an organisation’s performance against either
industry averages or best practice. The organisations used for comparison are usually in the same
market segment and have similar products, processes or technology.

One method of benchmarking is to obtain data directly from the organisation identified as
having the best practices, but if this is a competitor, direct access to data is not normally possible.
Indirect data may be obtained through business intelligence (BI)—for example, from websites,
trade exhibitions or speaking informally with competitors. A common practice in some industries
is to hire employees from competitors to obtain first-hand knowledge of competitors’ practices,
although this is generally regarded as being unethical; and such employees are often restricted
by non-compete and confidentiality clauses in their employment contract and exit package.

One way to have reliable industry benchmarks is to set up a benchmarking consortium that
includes a number of organisations operating in the same industry. Universities do this to
compare their performance on research, teaching quality and graduate outcomes. Independent
organisations are commonly selected to collect the information and provide each organisation
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with its own results as well as those of other organisations, in a format that does not allow
individual organisations to be identified. In many public sector organisations, such as schools
and hospitals, government departments benchmark data and make some publicly available,
with other data being restricted to the participating organisations.

Increasingly, governments produce data to enable benchmarking of government-funded

services. In Australia, some websites include:
• ‘My School’ (http://www.myschool.edu.au)
• ‘My Hospitals’ (http://www.myhospitals.gov.au).

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Benchmarks for small businesses can be downloaded from the Australian Taxation Office website at:
http://www.ato.gov.au/Business/Small-business-benchmarks.

Sometimes there is an opportunity for benchmarking against best practice organisations outside
the organisation’s own industry, but care needs to be exercised as to whether practices can be
translated between industries.

Problems with benchmarking

Benchmarking is not without its problems. Many issues need to be considered when
benchmarking is undertaken, including:
• obtaining the participation of benchmarking partners, all of whom must see some value
in the process
• determining why performance is different compared to a benchmark
• the sometimes widely different contexts of organisations—for example, regulatory,
technological and historical legacies
• non-standardised data—that is, data is measured differently or has a different meaning
between organisations—for example, gross profit may be measured differently
• the historical nature of the data itself, which may not reflect more recent changes.

All benchmark data needs to be interpreted carefully. Accountants and managers need to
look behind the data provided and try to understand why differences in performance between
organisations exist. Sometimes performance may vary due to different strategies or business
models, different regulatory regimes, or differences in legacy investments—for example,
in technology or infrastructure. In the absence of standardised data, all comparisons need to
consider whether the assumptions behind reported data are common between the benchmarked
organisations. Finally, the data derived through benchmarking is historical and reflects decisions
of the past, not current practices or recent decisions that are yet to be implemented. In relying
on past benchmarking comparisons, accountants and managers need to be aware that the
pursuit of continual improvement and sustainable competitive advantage by all benchmarked
organisations leads to continually evolving processes, and therefore continually changing
performance relative to others.

In aiming for performance improvement, targets, trends and benchmarks all provide useful
information in learning what works and what does not, but all available information should be
used when seeking to improve performance. In comparing actual performance against targets,
remember that the variance may lead to a decision to change behaviour to improve performance
relative to targets, or to change a target to one that is more realistic. It is also important to
recognise that there is a time lag between making changes and when the effect of changes

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can be seen in performance measures.

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➤➤Question 5.16
(a) Briefly explain the main steps involved in undertaking a benchmarking exercise.

(b) Identify the main problems associated with undertaking a benchmarking exercise.
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(c) Identify at least four benchmarking opportunities for an organisation.

Check your work against the suggested answer at the end of the module.

Organisational learning and performance improvement

The process of learning from performance comparisons using targets, trends and benchmarks
involves a continual process of improvement through organisational learning or knowledge
management. Failure to learn and improve, as reflected in the innovation and learning
perspective of the BSC, will likely lead to a loss of competitive advantage and ultimately to
organisational decline.

Organisational learning
Performance management through improving performance is a learning process. Data is
collected, analysed and interpreted by individual organisational members. When behaviours
or performance targets (or even what elements of performance are measured) need to change,
organisational systems, processes and procedures may prevent these changes from being
enacted. Organisations commonly have members who know what needs to be changed, but the
organisation can sometimes seem incapable of change because the ‘organisational memory’
is institutionalised (or embedded) in IT systems, procedure manuals, taken-for-granted working
practices, budgets and performance targets. Consequently, existing systems, procedures or
working practices may need to be ‘unlearned’. This is a process of organisational learning,
meaning how organisations as institutions (rather than the individuals within them) are able
to learn and improve. This is a distinction between learning in organisations by individuals,
and learning by organisations made by Popper and Lipshitz (1998).

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Organisational learning is concerned with the acquisition, sharing and utilisation of individual
knowledge within organisations (see Nonaka 1991). It is also concerned with how assumptions
about cause-and-effect relationships are shared within organisations, as well as how redundant
information is unlearned (e.g. Hedberg 1981). Organisational learning is about managing
knowledge at the level of the organisation.

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Performance improvement
Performance improvement requires a learning process that makes performance comparisons
using targets, trends and benchmarks; identifies changes needed to the assumptions about
cause-and-effect relationships in the predictive models held by individuals about business
models; and changes any or all of:
• behaviour
• performance measures
• targets, where necessary.

These are within the domain of the management accountant to influence, as discussed
previously. Learning and knowledge management are particularly important in fast-changing
markets or technological environments, as Example 5.20 demonstrates.

Example 5.20: Technological change in music and video

The case of value creation at Apple Inc. highlighted rapid technological change and product innovation.
However, many downstream organisations are affected by the pace of change, which is often outside
their direct control.

In the music industry, music recordings were originally on gramophone records and subsequently on
large reel-to-reel tape recorders. Further innovations were cassette tapes and compact discs (CDs).
With computer and internet technology, there is no need to buy music on any particular type of media—
it can be purchased and downloaded from e-commerce sites and stored and played on a computer
or mobile device. Similar changes have taken place in video with VHS tapes (Betamax tapes failed
quickly in competition with VHS) giving way to CDs, DVDs and Blu-ray technology (Blu-ray effectively
beating its Toshiba HD-DVD competitor). Movies can now be purchased and downloaded from the
internet in the same way as music. Foxtel, which was a major supplier of downloadable content, is facing
considerable competition from Netflix. In music streaming, we have seen the failure of Pandora and
its replacement by Spotify, which provides features valued more by customers.

These technological changes have had significant impacts on the business models of recording studios,
manufacturers of audio and video equipment, and media devices like records, tapes, CDs and DVDs.
Performance measures in those industries would likely have focused on numbers of units sold and
sales revenue, etc. Without knowledge of rapidly changing upstream technologies, these companies
may have been caught unaware by declining sales volume and profitability and may have ultimately
failed. Performance measures that are more strategic, such as awareness of patent registrations,
collaboration agreements with upstream supply chain partners and environmental scanning of emerging
technologies, would serve to avert the effect of such changes.

Similarly, retailers would have had to adapt quickly to new technologies, and the likely impact of
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downloading music and videos on the types of recording and playing equipment required. As for
equipment suppliers, attention to performance measures on sales volume and value, floor space and
employee numbers could have led to serious consequences. Retailers who were better informed about
technology change could introduce measures for reducing inventories of products that were likely to
become obsolete and for expanding the product range to spread the risk, such as the number of new
product launches or advertising expenditure on new products. Awareness could lead, for example,
to a shift in the business model from retail stores to online sales, something that has become evident
in retailers such as JB Hi-Fi; while Amazon’s launch in Australia has generated much discussion about
the threat to ‘bricks and mortar’ retailers from its online platform.

Behavioural consequences of performance management

This section is concerned with how performance management influences the behaviour of
managers and individuals within the organisation. Some of the consequences are unintended
and some can be quite dysfunctional. Again, it is generally accepted that ‘what is measured
by organisations is what gets done’, because management attention to certain aspects of
performance focuses the behaviour of individuals on that performance. If particular performance
is rewarded, then this is even more likely to result in individual behaviour being directed at
meeting targets and achieving the rewards offered.

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Performance measures and performance targets

Performance measures focus on what is important for the organisation, based on what it has
learned about its business model. When performance is measured, it directs attention towards
what is measured. Simons (1994, 1995) differentiated diagnostic from interactive forms of control:
• Diagnostic controls use feedback to monitor performance and correct deviations from plans.
• Interactive control systems are used by managers to involve themselves more directly in the
decision activities of employees.

A performance measure that is used interactively is more likely to influence behaviour than
one used diagnostically, because subordinates will be aware that senior managers are paying
attention to particular aspects of performance.

In a similar way to compiling budgets, those who determine performance measures and their
associated targets derive a considerable source of power in organisations. Targets need to be
achievable (the ‘A’ in the ‘SMART’ acronym) but may be on a continuum from ‘stretch’ targets
to easy-to-achieve ones. Managers are more likely to accept targets and be motivated to strive
to achieve them if they feel that they have participated in the target-setting process, even if
the final targets are difficult to achieve. By contrast, if targets are simply imposed without any
participation, managers are unlikely to be motivated towards achieving them. The example
of Mammoth Printing showed how performance measures—like sales targets—resulted in
behaviour that was not necessarily in the organisation’s best interests. In that example, many
of the sales achieved were unprofitable due to the impact of smaller orders on production
efficiency, but the commissions paid to sales representatives rewarded these unprofitable sales.

Professor David Otley (1999) provided two illustrations of the unintended and dysfunctional
consequences of performance measures.

1. Otley, an international expert in performance management, undertook research at British

Airways (BA) and observed baggage handlers at Heathrow Airport. As soon as an aircraft
landed, one of the baggage handlers unloaded the first available passenger’s suitcase and
ran to the baggage conveyor belt. The rest of the baggage was unloaded and stacked on
trolleys, which were then driven to the conveyor belt and unloaded. Otley asked what the
baggage handler was doing with the first suitcase. The BA manager’s response was that a
performance measure for baggage handling was the time taken to put the first suitcase onto
the conveyor belt. The performance measure achieved the desired performance, but only for
the first suitcase—the others were being unloaded without any change in behaviour.

2. Otley was buying his weekly groceries from Tesco, a major UK supermarket chain. Otley was

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surprised that the checkout operator waited until the conveyor belt was full of groceries
before she commenced scanning and packing. Otley’s interest in performance management
led him to ask the operator why she waited before commencing the scan. The checkout
operator replied that one of her performance measures was the average time it took to scan
a customer’s trolley, based on the time elapsed between the first and last item scanned and
the number of items scanned. If the operator had to wait for the customer to take goods
out of the trolley it would negatively impact on her performance, which would be seen by
everyone on an office chart that ranked the speed of checkout operators.

In both cases, the performance measures were well-intentioned, but resulted in unintended
consequences:
• an absence of any improvement in the unloading speed of baggage from BA flights
• customer dissatisfaction in what, from the customer’s perspective, appeared to be a lazy
checkout operator (Otley 1999).

Efforts to report performance that is desired by senior management can lead to a variety of
unintended and dysfunctional consequences, such as those outlined in Table 5.6.

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Table 5.6: Types of unintended and dysfunctional behaviours

Tunnel vision Focusing on a single target to the exclusion of all others

Sub-optimal behaviour Achieving a performance target and failing to try to further improve because
the target has already been achieved

Substitution Reducing effort on performance that is not subject to management attention

Being fixated on a Rather than the underlying performance, by ignoring the cause-and-effect or
performance measure action-and-outcome relationships

Gaming and biasing Making performance appear better than it is, either by misrepresenting
performance by providing inaccurate reasons for not achieving targets or
even falsifying reported performance

Smoothing reported Removing fluctuations between reporting periods

performance

Source: CPA Australia 2019.

Although they were writing about budgeting, the classic research by Lowe and Shaw (1968)
identified several sources of bias that are equally applicable to performance measures.
These are the:
• reward system
• influence of recent practice and norms
• insecurity of managers.

The same sources of bias apply to non-financial performance measures where, in a similar way to
compiling budgets, there is ‘the desire to please superiors in a competitive managerial hierarchy’
(Lowe & Shaw 1968, p. 312).

These behaviours distort not only target setting and reported performance, but may also result
in actions taken by organisations that detrimentally affect performance. Dysfunctional and
unintended consequences can easily result from inappropriate performance measures and
targets. In these organisations the pressure for short-term financial performance ignored issues
of the sustainability of that performance over time, and the associated reputational issues.
Often this focus on short-term financial performance is driven by the rewards offered to directors
and senior managers.

The role of incentives and rewards in performance management

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As Lowe and Shaw (1968) identified, rewards significantly influence behaviour. The examples of
EVT, Woolworths, Newcrest Mining and others highlighted that audited remuneration reports
now take up many pages in listed company annual reports. These remuneration reports typically
contain STIP and LTIP that reward directors and senior managers for achieving financial and non-
financial targets. These targets, particularly in the LTIP, are usually consistent with shareholder
value goals. Cascading will result in some of these targets, supplemented by more operational
targets as well as sales and cost targets, flowing down to each business unit and often being
embedded in individual performance appraisal processes.

Employees can be motivated either through a ‘carrot’ or ‘stick’ approach. ‘Carrots’ are the rewards
employees receive for achieving the desired levels of performance. ‘Sticks’ are the sanctions or
penalties that result from not achieving desired levels of performance.

Rewards can be financial (e.g. bonuses, profit sharing, share options), but can also be non-financial
(e.g. promotion, transfer to desired positions, a better office, a bigger budget, recognition, a better
performance appraisal). Sanctions include the loss of financial reward; being identified as a poor
performer; a negative personal reputation; or perhaps demotion, transfer or even dismissal.

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Consequently, rewards and sanctions are powerful motivators of behaviour, and can of course
lead to the unintended and dysfunctional consequences discussed in the previous section.
Rewards should be designed so that the needs for short- and long-term performance are in
balance. Short-term (especially financial) results should not be achieved at the expense of
sustainable longer-term performance and achievement of the organisation’s goals and strategy.
Company LTIPs will often reveal the need for sustainable performance over time before rewards
are awarded.

This module has used the example that reducing expenditure on advertising, employee training,
repairs and maintenance, or R&D would improve short-term financial results, but would likely
detrimentally affect the organisation in the longer term. One impact of rewards for short-term
performance is that managers may achieve targets and be rewarded financially and promoted.
A replacement manager could then be at a disadvantage. The lack of prior investment makes an
incoming manager’s performance appear worse, because they have to remedy the deficiencies
of the previous manager who improved short-term performance through failing to invest in the
longer term.

The process of tying reward to performance requires two issues to be considered:

1. timing
2. group versus individual rewards.

Timing
To reinforce the relationship between performance and reward, rewards need to be timely. If too
much time elapses between performance and rewards, the important association between
rewards and actions becomes less obvious to people. This suggests that annual bonuses are
potentially ineffective and that bonus payments more closely linked in time to the achievement
of the desired performance level are likely to be more highly motivating. On the other hand,
making bonus payments too soon after performance is achieved can lead to a focus on short-
term profits rather than profits that are sustainable in the longer term.

Group versus individual performance

There is an inherent conflict between the teamwork required for effective organisational
performance and the use of individual reward systems. For effective motivation, managers must
feel that their effort has a direct impact on their performance and the related performance
measure and reward. This is the principle of ‘controllability’ (discussed previously). The choice
between individual and group rewards depends to an extent on the interdependencies that
exist within the organisation. High levels of interdependency will mean that identifying individual

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performance, and then paying appropriate compensation, is difficult.

In many organisations, performance rewards are based on aggregate measures such as profit.
As has been noted previously, the influence any individual has on corporate profit is likely to be
small, so the motivational effect of a profit-based bonus on the individual is likely to be equally
small. This approach is popular, because reward systems based on group performance measures,
such as profit, enhance teamwork, or at least reduce the potential for dysfunctional conflict,
and—as agency theory tells us—they align the goals of managers with those of shareholders.
However, the incentive to engage in gaming behaviour to achieve desired performance targets
can be a negative influence, and at the extreme, managers and employees may behave
dishonestly in their profit-reporting activities, as the examples of Enron and WorldCom revealed.

The most high-profile example of the focus on short-term financial performance affecting longer-
term performance has been the GFC. This is explored in Example 5.21.

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Example 5.21: Global Financial Crisis

The GFC, which commenced in 2007 and reached its peak in 2008, had wide-ranging impacts on
individual countries, global financial markets and institutions and national economies. A recession
affecting most global markets lasted until 2012. Australia has been insulated from any sovereign debt
crisis, although there have been corporate failures and severe personal losses as a consequence of
the failure of some smaller financial institutions.

Two particular causes of the GFC have been given by commentators.

1. The practice of securitisation, where loans are packaged and resold by banks to other financial
institutions, including insurance companies, to raise funds for further lending.

2. A related cause of the GFC was said to be the rewards offered to directors and senior managers,
especially in the financial services industry, for continuously improving performance that was
unsustainable and did not take into account the risks that were being faced. The initial round
of blame in financial institutions that lost billions on subprime mortgage-linked investments
focused on their chief executives. CEOs at Citibank, UBS and Merrill Lynch were forced to leave
their companies.

There were severe effects from the GFC. The national income and output of the United States fell by
about 4 per cent in June 2009. That made it by far the sharpest US recession of the post-war period.
In the Eurozone, the peak-to-trough fall in output was even larger at around 6 per cent, and in the
United Kingdom it was 7 per cent. Further, in Europe, many countries were affected by a sovereign
debt crisis—that is, an unsustainable national debt caused by continual deficits—with Iceland, Greece,
Ireland, Portugal, Spain and Italy particularly at risk. The banks in many countries in the Eurozone,
in particular in Greece and Spain, faced difficulties in meeting their debt obligations, which caused a
downturn in demand and globally depressed stock markets (RBA 2014).

Example 5.22 provides an example of an alternative approach to performance management

and sustainability of performance.

Example 5.22: Svenska Handelsbanken

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Svenska Handelsbanken’s goal was to be the most profitable bank in Sweden, but size was unimportant
to its CEO Jan Wallander. The bank’s strategy was to be radically decentralised, with nearly all lending
authority independent of head office.

Wallander abandoned budgeting at Handelsbanken but this had no effect on the bank’s performance.
Reflecting the contingent nature of performance measures, Wallander said that organisations will
use ‘different types of key indicators, ratios, graphs, etc. Modern companies already have myriads
of operational, financial and physical measures. The problem is to choose a limited number of
those measures which really show if the company and its different units are on the right track or not’
(Wallander 1999, p. 419).

Without a budget, no budget/actual comparisons could be made at Handelsbanken. Instead,

the real target was not in absolute monetary terms but a relative one, a return on capital better than
other businesses were achieving, not just in the banking industry but in other industries as well.
Handelsbanken thus adopted a true shareholder value model.

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In the absence of targets, the emphasis in performance management was on benchmarking: relative
performance compared between Handelsbanken’s branches, but also compared with other Swedish
banks. In addition to benchmarks, trends were compared from quarter to quarter, benchmarking from
one time period to another.

The final element of Wallander’s strategy at Svenska Handelsbanken was a profit-sharing system for
employees, with the profit share dependent on the profitability of the bank relative to other Swedish
banks. Interestingly, the employees’ share in the profits of the bank was only paid to them when they
retired, which encouraged attention to the sustainability of performance.

➤➤Question 5.17
After reading Example 5.22, compare what has been learned about performance management
throughout this module with the approach that Jan Wallander took in Svenska Handelsbanken.
Critically evaluate the Handelsbanken approach in relation to non-bank organisations, considering:
(a) the type of performance measures used

(b) the reward system.

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Check your work against the suggested answer at the end of the module.

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Review
Performance management focuses on shareholder value through customer value and achieving
a strong competitive position for the organisation. Such a focus would not be possible without
understanding the key role that performance management plays in strategy and value creation.

Part A looked at the definition of what was meant by performance and performance management
and emphasised the importance of balancing financial with non-financial measures. Value creation
and the sustainability of performance over time were outlined, as well as sustainability in the
sense of CSR. The implications of performance management for accountants and its links with
governance and signalling were introduced. Part A also described the importance of ethical
responsibilities, and agency and contingency theories that underlie much of the study of
performance management.

Part B looked at the links between strategy, management control systems and performance
management, and the limitations of some traditional accounting-based controls. The various
models of performance management, including the Business Model Canvas, were introduced.
The BSC and the strategy mapping process was emphasised, as well as cascading performance
measures and the important role of information systems in performance management.

Part C looked at how performance measures and their associated SMART targets are designed
and the characteristics that make performance measures useful, including the need to compare
the costs and benefits of performance management. This part also briefly introduced the role of
power and culture in performance management. It focused on improving performance through
targets, trends and benchmarking, and the importance of CI through organisational learning
and knowledge management processes. This is a role in which management accountants can
use their ‘soft skills’ to add value through interpreting performance and recommending ways
to improve performance. Finally, Part C looked at the often unintended and dysfunctional
consequences of performance management and how reward systems are implicated in
performance management.

Appendix 5.1 explores the case of Achmea including examples of how Achmea develops its
performance measures using a BSC linked to strategy through the strategy mapping process.
This process is cascaded down through the organisation to enable strategy to be implemented.
Achmea reports its performance in financial and non-financial terms and emphasises its
commitment to broader sustainability through its GRI index.

The key themes emerging throughout the module were:

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• the importance of performance being both socially responsible and sustainable

• the leadership role of the professional accountant in performance management
• the importance of value-adding activities.

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Appendix 5.1 | 489

Appendix
Appendices

Appendix 5.1
Achmea Holding N.V.

Achmea Holding N.V. (hereafter Achmea) is a Netherlands based:

insurance company established in 1811 and is the largest insurance provider in the Netherlands.
The group was formed by mergers and acquisitions of numerous mutual and cooperative insurance
providers over a period of more than two centuries. It operates internationally in selected markets,
including Turkey, Greece, Slovakia, Ireland and with partner Rabobank in Australia where it is an
insurer of farms.
As a result of its cooperative background and identity, Achmea (a ‘mutual’) is not listed on the
stock exchange.
The majority of Achmea’s shares (65%) are held by Vereniging (Association) Achmea, which

MODULE 5
represents all of Achmea’s customers—so Achmea’s customers are its owners. Partner Rabobank
holds 29 per cent of the shares and the remainder is held by like-minded European insurers
(Achmea 2015).

Achmea’s Annual Report 2017 can be downloaded at https://www.achmea.nl/en/investors/reports/

Paginas/default.aspx.

The annual report comprises three parts:

Part 1 is the ‘Annual Review’. This is aimed at a broader target audience and contains a description
of the progress made by Achmea in 2017 and our vision of the future. Part 2 is the ‘Year Report’.
This describes the main financial developments. Among other things it contains the financial
statements, the report of the Executive Board and a report on our Governance. Part 3 comprising
the ‘Supplements’ contains sustainability-reporting information and appendices to the other parts
(Achmea 2017, p. 47).

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Achmea makes clear it is a stakeholder-oriented company:

As an insurer, by our very nature we are alert to the long-term interests of all stakeholders.
Sustainability is therefore logically of great importance to us. Corporate Social Responsibility
forms the foundation for our business operations and strategy (Achmea 2017, p. 9).

The company identifies four main stakeholder groups:

Customers are our most important stakeholders. … Employees are the human capital and beating
heart of our company … We have several business partners. Rabobank and the brokers are
important distribution partners … Our capital providers (shareholders, bondholders and other
equity providers) supply our financial assets (Achmea 2017, p. 11).

Candidates should note that this structure of stakeholders could be aligned with the Business Model
Canvas described in Part B of this module.

Achmea identifies five main product groups, or ‘value chains’ as Achmea calls them: Non-Life,
OBJECTIVES
Health, Retirement Services, Pension & Life, and International (Achmea 2017, p. 20). Its strategy
CONTEXT & STRATEGY & PROGRESS OTHER INFORMATION APPENDICES
‘Delivering Together’ covers the period 2017–19. The business strategy focuses on:
strengthening our current business models and on developing new products, services and business
models … evolving from its traditional role as an insurance company … to one that focuses more
on services (Achmea 2017, p. 19).

SIGNIFICANCE
The strategyFOR ACHMEA
is described We see a dual challenge
in detail on pp. 19–20. Importantly, for ourselves:
the strategic themes on the one hand,
Achmea hasto
strengthen our current business models, and on the other, to
adopted incorporate sustainability as a leading motive (see below).
The precise direction and speed of change is unknown. A part develop new products, services and business models.
f or potential of the existing propositions will disappear, new propositions
due to the The strategy
will present has been
themselves, marketdeveloped infading
boundaries are the context
and of a way
The SWOT analysis,
in which shown
we will do in FigureinA1
this is described the 5.1.
me automation. competition is changing. Armed with this knowledge and Delivering Together section.
can contribute within this context, Achmea has formulated its strategy. We
claims. Improved are anticipating
Figure A1 the
5.1:developments
Achmeamentioned.
SWOT analysis
cker intervention or

STRENGTHS WEAKNESSES
m, these are risks
g economy. In the • Customer base, brands; customer ratings • Financial results not yet at target level
ed need for dealing • Broad portfolio and advantage of diversiﬁcation • Growth of Free Capital Generation required to be
iability. For some of • Leading in health and property & casualty insurance able to continue investing in innovation
n prevention and risk • Variety in distribution; strong in banking and direct • Restricted scale of international activities
channels • Large market share in mature home market
• Broad access to Dutch businesses
nd businesses
s will continue to
g jobs and income OPPORTUNITIES THREATS
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place the use of

business models and • Increase the number of Rabobank customers with • Introduction of new revenue models in existing
y in combinations an Interpolis insurance policy Achmea markets
even disrupt existing • Use technology for new services, prevention and • Declining risk of use and need for insurance
cost savings • Vertical integration (reinsurers, car manufacturers)
• Expand business model to include services • New ecosystems relating to supply and demand
• Convert data into value for customers platforms
• Revenue models for new risks (cyber, climate) • Changing concept of solidarity
• Partnering in new ecosystems • Impact of climate change

Source: Achmea 2017, Annual Report 2017, Part 1, p. 16.

Achmea Annual Review 2017 I 16

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Achmea makes explicit use of a BSC and strategy map:

Achmea’s activities are managed on the basis of six perspectives. The essential elements of
the strategy have been translated into a strategy map. Achmea has key performance indicators
for each perspective to guide us in achieving our objectives for the planning period 2017-2019
(Achmea 2017, p. 23).

Performance measures are described for each of the perspectives on pp. 22–3 of the annual
report, Part 1. Further details of the performance against each of these perspectives is shown on
pp. 56–9 of the appendix to the annual report, Part 1. In the 2016 annual report, the performance
measures or ‘key performance indicators’ as they were called were shown diagrammatically and
are reproduced in Figure A1 5.2.

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MODULE
PROFILE AND STRATEGY 5
OF ACHMEA - STRATEGY 492

KEY PERFORMANCE INDICATORS

KPI TARGET FOR 2019
We have set one or more Key Performance Indicators
CUSTOMER PERSPECTIVE
(KPIs) for each of the six perspectives of our strategy.
By measuring these periodically and, where necessary Relational NPS Score1 Top 5 in the market
making adjustments based on the measured values, we Achmea’s score on KBC dashboard 4.2
try to achieve our strategic objectives and hence respond
Number of customer council Each customer council convenes twice
to societal developments. meetings a year
| PERFORMANCE MANAGEMENT

SOCIETAL PERSPECTIVE
Implementation of innovative
ideas which promote safety and
health as part of the revenue At least 2 per brand1
model

EMPLOYEE PERSPECTIVE
Indicator of availability Minimum of 722

PARTNER PERSPECTIVE
Level of market penetration of
Interpolis Insurance
Private More than 25%
Commercial More than 29%

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PROCESS PERSPECTIVE
Reduction in number of letters sent More than 25%; down from 2016

FINANCIAL PERSPECTIVE

DTP: Mira
S&P Rating Rating for insurance entities
Reduction in operating expenses,
€200 million
2016-2019

2PP
Figure A1 5.2: Achmea key performance indicators—2016 annual report

1) Centraal Beheer, Interpolis, Zilveren Kruis

2) Score based on yearly employee engagement survey.

2nd edn
07-11-18
Source: Achmea 2016, Annual Report 2016, p. 32.
Achmea Annual Report 2016 32
Appendix 5.1 | 493

Achmea’s six perspectives add two to the four standard perspectives in the BSC: society (both
in terms of its mutual customers/shareholders and to the wider society); and partners (Rabobank
and the businesses that distribute Achmea’s products). It also reflects an employee perspective
(rather than learning and growth). Performance on each perspective is described in detail on
pp. 24–39 of Part 1 of the 2017annual report.

In particular, candidates should note that Achmea highlights its use of the NPS to measure
customer commitment to brands in the customer perspective; and profit before tax as the main
measure in the financial perspective.

Achmea’s strategy map, which links the six BSC perspectives, is shown in Figure A1 5.3.

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OBJECTIVES
INTRODUCING ACHMEA CONTEXT & STRATEGY & PROGRESS OTHER INFORMATION APPENDICES
494

Our objectives for 2017-2019

Strategy map 2017-2019

Customers are closely involved

Customers feel strongly Customers are served well by in improving our
Customer perspective connected to our brands our insurances and services insurances and services
| PERFORMANCE MANAGEMENT

Together with Vereniging Achmea we strengthen the Based on our expertise we contribute to a healthier,
Society perspective cooperative foundation of Achmea safer and a more future-proof society

Management leads the way and

We excel in customer focus, Working on employability
Figure A1 5.3: Achmea strategy map

Employee perspective works together on the realisation

being professional and adaptability is at everybody’s heart
of our strategy

Partner perspective With our (distribution) partners we improve and innovate Insurance is successful for Rabobank
our insurances and services

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Our processes lead to the We work digitally and We use information as
Process perspective highest NPS based on standards the diﬀerentiating factor

DTP: Mira
We optimise our portfolio and We ensure a robust balance and We realise a competitive
Financial perspective realise proﬁtable growth eﬀective capital and below market cost level

2PP
liquidity management

2nd edn
Additional information strategy map 2017-2019 can be found in the appendix (p.56).

07-11-18
Source: Achmea 2017, Annual Report 2017, Part 1, p. 22.
Achmea Annual Review 2017 I 22
Appendix 5.1 | 495

The links between performance management and remuneration are disclosed in the
remuneration committee report within the annual report, Part 1:
The process of performance management and variable remuneration was conducted in a balanced
manner within Achmea in 2017, while it was also extended to the various organisational levels.
In modifying the process, it was decided to opt for greater simplicity and stricter management
by restricting the number of Key Performance Indicators (KPIs), while also defining them more
precisely, in a manner that matches the company’s risk profile and risk appetite, in a way that aligns
the strategy and long term value creation … there is a sound balance in the type of performance
indicator, short and long-term performance management and in the criteria used as a basis for
variable remuneration (Achmea 2017, p. 43).

Mentioned previously is Achmea’s commitment to sustainability issues. The annual report is:
compiled in line with the G4 Guidelines (Core option) of the Global Reporting Initiative (GRI).
The Annual Report’s structure complies in part with the principles of the International Integrated
Reporting Framework laid down by the IIRC. Both the IIRC and GRI stress the importance of
reporting on material topics … Achmea intends to conduct a completely new materiality analysis
next year and use the revised material topics as the starting point for its external reporting
(Achmea 2017, p. 47).

Achmea also identifies with the United Nations Social Development Goals (SDGs) under which
the United Nations set out, in July 2016, arrangements for monitoring progress and measurement
using indicators. Figure A1 5.4 shows the four themes and eight related SDGs (described on
p. 45).

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OBJECTIVES
INTRODUCING ACHMEA CONTEXT
MODULE 5 & STRATEGY & PROGRESS OTHER INFORMATION APPENDICES
496

Sustainable Development Goals

The Sustainable Development Goals can be found in the societal themes of Achmea.

Healthy Safe Future-proof

| PERFORMANCE MANAGEMENT

Good health Clean, safe and Safe home and (Financial) solutions for
closer to everyone smart mobility working environments today, tomorrow and later
Figure A1 5.4: Achmea social development goals

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DTP: Mira
2PP
2nd edn
07-11-18
Source: Achmea 2017, Annual Report 2017, Part 1, p. 46.
Achmea Annual Review 2017 I 46
Appendix 5.1 | 497

Part 2 of Achmea’s annual report focuses on its commitment to socially responsible investment as:
always being able to fulfil our financial obligations to our customers and invest in a socially-
responsible manner, with respect for the world around us and for future generations …
contributing to a healthier, safer and more future-proof society (Achmea 2017, p. 27).

For example, ‘Achmea does not invest in tobacco producers, as this would be inappropriate for
a major health insurer. We also exclude manufacturers of controversial weapons’ (Achmea 2017,
p. 27). Achmea’s social themes include energy, paper, waste and corruption (Achmea 2017, p. 31);
and employee and gender diversity (Achmea 2017, pp. 33–5).

Part 3 of the 2017 Achmea annual report includes a GRI index (pp. 3–5) that shows where
information complying with the GRI G4 reporting guidelines can be found. Part 3 also includes
information about Achmea’s corporate social themes linked to the insurance industry’s Principles
for Sustainable Insurance (pp. 8–10). There is also a large amount of information about
environmental issues (emissions, energy, paper, waste, etc. pp. 17–21).

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Suggested answers | 499

Return to Question 5.1 to continue reading.

Question 5.2
(a) The 2017 annual report (p. 5) discloses that the primary role of the board is to protect and
enhance long-term shareholder value and recognises that the board is accountable to
shareholders for the company’s performance. The table on p. 36 of the annual report shows
how shareholder value has been created annually for each of the last five years. JB Hi-Fi
defines shareholder value as the increase in the enterprise value, plus cash dividends and
share buy-backs paid during the financial year.

(b) JB Hi-Fi’s strategy to create shareholder value is to:

encourage innovation and diversification with new products, technology, merchandising
formats, advertising and property locations in a controlled and responsible manner.
This approach provides opportunities to increase revenue, margin and productivity
(JB Hi‑Fi 2017, p. 3).

This strategy clearly shows the goals that are desired (revenue, margin and productivity) but
also how those financial goals are achieved. It is only through expanding the product range,
improving technology, improving store layouts, effective advertising campaigns and investing
in the best retail locations that the desired financial performance can be achieved.

(c) JB Hi-Fi’s performance context during the 2017 year is important because its performance
was influenced by the timing of The Good Guys’ acquisition in November 2016 (JB Hi-Fi 2017,
p. 2).

A key measure is the number of stores. The Group CEO’s performance involves an
assessment against both financial and non-financial performance measures (JB Hi-Fi 2017,
p. 15).

The remuneration report discloses that the STIP rewards both financial and non-financial
measures (JB Hi-Fi 2017, p. 30) where the main element is statutory EBIT—this annual growth
MODULE 5

in EBIT is considered the most relevant measure of the Group’s financial performance as it is
‘a key input in driving and growing long term shareholder value’ (JB Hi-Fi 2017, p. 33).

Targets for senior executives, in addition to EBIT, include various store operating metrics,
inventory, supply chain and online performance measures. Specific targets are commercially
sensitive and are therefore not disclosed but performance management—and the rewards
attached to that—is focused on succession planning, investor relations, strategic initiatives,
internal process improvements, inventory management, property portfolio, shrinkage
control, online initiatives, expenditure control processes, workplace health and safety,
risk management, and engagement with key initiatives (JB Hi-Fi 2017, p. 34). The LTIP is
based on EPS growth (JB Hi-Fi 2017, p. 35).

Return to Question 5.2 to continue reading.

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Suggested answers | 501

Question 5.3
(a) Mega Markets has provided affordable products—sourced from overseas—targeting the
budget-constrained customer. The major benefits of Mega Markets’ historic strategy have
been the ease of shopping for customers in major shopping centres, and the affordability and
range of its products. However, with the increased availability of low-cost computers in homes
and the expansion in online shopping, Mega Markets is now facing global competition,
perhaps even from its own suppliers in South-East Asia.

(b) The value previously offered by Mega Markets has been almost completely eroded as
customers can order online and receive the equivalent goods in a week at a lower cost.
Buying online also avoids the problem of the customer’s choice of style, colour and size being
out of stock in their nearest shopping centre. As the kind of products sold by Mega Markets
are largely discretionary as to time—that is, the purchase can readily be delayed—there is
little advantage in going to a shopping centre when it is more convenient for customers
(especially those with young children) to buy online and have the goods delivered to
their home.

(c) In the face of strong online competition, the unique factor that Mega Markets can adopt
is personal customer service. While this may be expensive, customers often appreciate
a friendly and helpful staff member who can advise and assist in selection of products,
sizes and colour combinations. Candidates in Australia who have visited some of the larger
department stores recently may have noticed that they have reduced staffing to cut costs
and, as a consequence, there is often very little customer service available and long queues
to pay for goods selected by customers. This has perhaps exacerbated the shift by customers
to smaller boutique stores and online purchasing.

Of course, Mega Markets could adopt a strategy of selling its products online as well as
in stores, as many Australian retailers have done—for example, JB Hi-Fi, Myer and David
Jones. This would enable customers to exercise their shopping preferences by purchasing
in store, online or through both channels. This would enable Mega Markets to more
effectively compete with other online stores, but there is a substantial investment required
to implement this strategy. Information technology needs to be designed and introduced,
as does a warehousing, stock picking and distribution function, which would increase the
company’s overheads.

It would be difficult to compete with online-only suppliers who do not have the rental and
salary costs associated with a chain of retail stores in shopping complexes, and unless Mega

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Markets opened a warehousing and distribution facility near its suppliers in South-East Asia,
it would not be able to take advantage of the cost advantages in those countries.

Return to Question 5.3 to continue reading.

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Question 5.4
There are many possible responses to this question, and it is impossible to cover them all,
but you may have identified:
• the roles and responsibilities of the board of directors, a chief risk officer (if your organisation
has one), and the CFO in relation to risk management and performance
• whether your organisation is risk-averse, or takes managed risks in pursuit of its objectives
• whether the internal control systems enable or impede risk-taking
• whether performance accountability is centralised, or decentralised to individual managers
• whether risk management is centralised, or decentralised to individual managers
• whether the accountability for performance and risk management is integrated at the same
organisational level or diverges to different people in the organisation
• what performance measures and measurement processes the company has in place.

Some additional information on this topic

IFAC (2011) carried out a global survey of risk management. Some of its findings were:
• guidelines for risk management tend to be compliance-based and are poorly linked to
performance issues without sufficiently acknowledging the need to make risk-based decisions
in pursuit of improved performance
• creating better linkage between risk management, internal control and performance
management
• making line managers accountable for overall performance, including risk management
and internal controls
• making risk management and internal control part of individual goals and objectives and
holding people accountable
• aligning compensation with performance in the area of risk management and internal
control, and
• carrying out regular reassessments of risks and controls due to changes in the organisation
and its environment, leading to better organisational performance.

Return to Question 5.4 to continue reading.

Question 5.5
(a) Discuss the implications of Kevin’s demand in relation to the following:
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(i) Governance As a director, Barbara is responsible for the company’s financial statements,
a responsibility that is even more pronounced as the CFO. What has been asked
of Barbara is high risk, both for the company and its directors, as it is illegal,
with directors and officers facing severe penalties for such action, which also
would lead to severe reputational damage for the company and individual
perpetrators. Accounting information is one of the main sources of information
to support the governance function. As a director and CFO, Barbara is also
responsible for a system of internal controls, which includes control over the
inventory asset of the company.

In Australia, making a deliberate adjustment to the financial statements is a clear

breach of the Corporations Act 2001 (Cwlth), relating to correct financial records
(s. 286), compliance with accounting standards (s. 304), and presenting a true
and fair view (s. 305). Similar legislation is applicable in many countries. It would
be a fraud to mislead the auditors by disguising the true value of inventory by
removing stocktake sheets, and the accounts prepared for taxation purposes
would be similarly misleading. Barbara should be reminded of the illegalities at
WorldCom that resulted in the conviction and imprisonment of the CFO.

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(ii) Signalling Financial statements are not produced just for the owner-manager of a privately
owned company. The financial statements provide signals to all shareholders,
taxation authorities, banks and financiers, payables, customers and employees.
Even from a shareholder perspective, Barbara does not know the position of
Kevin’s wife with respect to what Kevin wants her to do. As the company has bank
loans, there may also be an undeclared intent to deceive the bank in relation to
the loan, and certainly to avoid income taxes.

(iii) Ethics Kevin’s request presents a clear ethical dilemma for Barbara, irrespective of the
illegality of what she has been asked to do. The HIH case highlighted the culture
in that organisation of not questioning leadership decisions. The fundamental
principles in the Code apply not only to public practitioners in relation to clients
but also to employee–employer relationships. The Code includes a responsibility
to act in the public interest:
• the principle of integrity would be breached as the demanded action would
be dishonest
• the principle of objectivity would be breached because of the undue
influence of Kevin and the resulting conflict of interest (Barbara is expected
to resign if the demand is not met)
• the demand is also a breach of professional behaviour as the action would
breach legislation and accounting standards, and would be a behaviour that
would discredit the profession.

Inappropriate signalling through the financial statements would be a clear

failure of corporate governance, a breach of legislation (in Australia) under
the Corporations Act and income tax legislation, and a clear breach of
professional ethics.

(b) There are few options available to Barbara. Barbara could wait a couple of days before
discussing the matter again with Kevin, in the hope that after further consideration, she could
change his mind. The delay could be used to prepare a forward financial plan and cash
forecast to show the impact of both the tax payment and debt repayment. Failing this,
Barbara could request a board meeting to discuss the matter with Kevin’s wife.

Beyond these actions, Barbara should obtain ethics advice and legal advice in accordance
with the Code, but may have no alternative but to resign from the company to avoid being
associated with the illegal and unethical act requested.

If the company’s accounts are required to be audited, the auditors may well identify such
a material misstatement of the inventory value. In the event of a purposeful misstatement,

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the auditors may have to report a breach to the authorities.

Return to Question 5.5 to continue reading.

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Question 5.6
(a) Mega Markets is what Porter termed as ‘stuck in the middle’. Mega Markets is not sufficiently
low cost to be adopting a cost leadership strategy and its products are undifferentiated from
what can be acquired online. While Mega Markets has focused on the budget-conscious
family with young children, the susceptibility of that customer group to online sales at a lower
price is a significant weakness.

By comparison, an internationally based online competitor is more likely to have a cost

leadership strategy, without the investment in retail stores or a high staffing cost, with a
single central warehouse and an investment in technology for the online sales and
ordering platform.

(b)
Mega Markets Online competitor

Primary activities

Inbound logistics Sourced from South-East Asia Sourced locally

and imported into Australian
warehouses

Operations Distributed from warehouses Distributed from a large central

to shopping centres in various warehouse in South-East Asia
style/colour/size combinations direct to customers, avoiding
stock holdings in multiple
locations

Outbound logistics Customers shop with young Customers shop online, make
children in their nearest store, their product choice and then
involving travel, parking, await delivery to their home
queuing, etc.

Marketing and sales Significant cost of maintaining Relatively inexpensive online

and staffing multiple retail presence with no retail store
stores and marketing the Mega overhead or retail staffing cost
Markets name

Service Customers can return or Customers can return or

exchange goods in store exchange goods by post

Support activities

Procurement Identify and contract with Manufacturer in South-East

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suppliers in South-East Asia, Asia holds inventory in large

place orders for sufficient central warehouse awaiting
inventory holdings and monitor online orders
quality control

Technology development Not applicable Extensive investment in online

ordering system

HR management Large investment in retail staff Relatively low investment in

and training of staff staff for technology support
and warehouse staff for picking
and delivery of ordered goods

Firm infrastructure Heavy investment in Relatively low investment in a

warehousing, distribution single central warehouse
and shopping centre rental
properties, leasehold
improvements, fittings, etc.

Return to Question 5.6 to continue reading.

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Question 5.7
(a)
(i) Traditional The standard to be applied is the budget of $35 000. The method of measurement
is the accounting system that reports sales revenue of $33 750. The comparison is
a simple calculation of budget minus actual of $1250 unfavourable variance.

The only means of feedback correction with this information is to hold the sales
manager accountable for the shortfall in revenue.

(ii) Expanded There are two standards—the volume of sales quantity and the average selling
price. The method of measurement is an accounting system that not only records
and reports sales revenue but also records and reports sales volume.

The comparison is of both quantity and sales revenue. The ability to take corrective
action is improved because the additional feedback information enables a focus
on both unit selling price and volume.

(iii) Flexed While the original budget standard is retained, the standard to be applied is the
flexed budget—that is, the actual volume multiplied by the budget selling price
per unit.

The method of measurement is as per the expanded information but is enhanced

by the additional reporting—in the accounting system or through a spreadsheet—
of the flexed budget and the ability to more clearly see the impact of the quantity
and price variations.

The comparison enables separation of the selling price variance (actual quantity
sold multiplied by the difference between $3.75 and $3.50) and the sales volume
variance (the difference between the target of 10 000 units and the actual sales of
9000 multiplied by the budget selling price of $3.50 per unit).

Using the additional feedback, two quite separate pieces of information can lead
to two different corrective actions: one volume-related and one price-related,
which identifies the likelihood that by increasing price over and above the target
price, sales volume has fallen and this has led to a revenue shortfall.

(b)
(i) Traditional Management decision-making is almost impossible because there is no indication
of the causes of the variance.

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(ii) Expanded Management can see that there is both a volume and a price variance but still has
insufficient information other than to question the responsible managers as to why
volume is lower than expected but prices higher.

Although it can be assumed that there may be an offsetting factor involved (i.e. that
higher prices may have led to lower volume), any trade-off cannot be quantified.

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(iii) Flexed Both the value of the volume variance and the price variance are quantified.
More meaningful discussions can take place with sales managers to determine
explanations for these variances, the likely effects of higher prices on volume and
what corrective action can be taken.

Management decisions may also be taken on the basis of the reports in terms of:
• the accuracy of the budget standard—and whether this is in value only, or value
and volume
• the validity and reliability of the method of measurement—sales revenue will
be collected by an accounting system, but sales volume may require additional
non-financial performance measurement outside the accounting system
• the preferred means of comparison and method of reporting variances in
future—traditional budget versus actual reporting, or flexed budget reporting
• the means of investigating variances and seeking feedback to support
corrective action—separating price from volume variances, and the likely
interaction of each element of sales revenue.

Return to Question 5.7 to continue reading.

Question 5.8
There are many possible controls that could affect sales behaviour at SalesVol, and which could
have resulted in the level of sales being below target (remember, volume was lower than targets,
but average selling price was higher than targets):
• Market controls are exercised through competitive pricing. Prices cannot be increased such
that customers are likely to move their business to competitors unless a price premium can
be generated from brand or reputation. In SalesVol’s case, higher pricing may have led to
customers moving their business elsewhere.
• Non-financial targets may emphasise sales volume, or the lack of such targets may result in
volume being disregarded.
• The absence of a market share target may lead to premium pricing.
• Bureaucratic rules may require approval by more senior managers of changes to target
prices, particularly if discounted prices are to be applied.
• Incentives and rewards may be based on compensation linked to volume, sales value or even
to premium pricing on particular orders.
• The reliance on feedback controls (diagnostic controls) compared with interactive controls
(where managers draw attention to particular areas of performance) may create a financial or
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non-financial, or a volume/value emphasis.

• The organisational culture—which is built through recruitment, training and socialisation,
as well as supervision and performance appraisal processes—may reinforce a particular
emphasis on achieving sales volume targets, increasing prices or simply achieving the sales
revenue target, irrespective of the combination of price and volume.
• Organisational belief systems may reinforce at employee level that increasing prices will lead
to higher revenue.

Return to Question 5.8 to continue reading.

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Question 5.9
The following are examples of the different types of controls that could be introduced, although
you may be able to think of others.

Personnel controls:
• recruitment (reference checking, qualification checks, assessment centres, in-depth
interviews)
• training of new employees
• performance appraisal on a regular basis
• establishing a strong culture to support a work ethic (e.g. towards timeliness and accuracy)
• incentives for consistently high levels of performance (e.g. bonus, promotion)
• staff turnover.

Financial controls:
• cost management within agreed budget.

Planning controls:
• annual planning process that is consistent with the organisation’s strategic plan
• identifying key success factors with the CEO
• developing a service level agreement with internal customers.

Process controls:
• standard operating procedures or procedures manual
• regular monitoring of staff by managers and supervisors
• regular meetings to identify problems and solutions.

Performance measures:
• on-time production of reports
• quality errors (e.g. journal adjustments to correct errors after close of reporting period)
• internal customer satisfaction survey
• number of complaints received from internal customers
• adjustments required by auditors after end of year (number and value)
• days’ sales outstanding
• days’ purchases outstanding performance compared to target (and improvements over time).

Return to Question 5.9 to continue reading.

MODULE 5

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Question 5.10
Strategic performance • Sales volume and value for each product bar over the whole product life cycle
measures • Profitability of each product over the whole product life cycle (after deducting
R&D, market research and advertising costs)
• On-time deliveries of imported cocoa from Brazil
• On-time deliveries of milk from dairy farms
• On-time deliveries by logistics supplier
• Damaged or returned stock from retail stores
• Number of patents
• Number of new product launches (and number withdrawn as a result
of market research) over time

Operational performance measures

Leading measures • Advertising spend

• R&D spend
• Market research spend
• Number of sales visits to retail stores
• Orders taken by sales team in each region
• Number of new product launches
• Wastage in production
• Quality problems and production faults
• Productivity
• Time from order to delivery

Lagging measures • Sales volume for each product

• Sales value for each product
• Profitability of each sales region
• Profitability of each product
• Customer satisfaction (retail stores)
• Customer satisfaction (end user)

Note: This list is based on the information in the scenario question. Some measures may be
considered either operational or strategic. The categorisation is less important than developing
some performance measures that reflect Chocabloc’s dependence on its upstream and
downstream supply chains. Leading measures provide an earlier indication of likely financial
performance. Note also the large number of non-financial performance measures compared with
financial performance measures. Remember that if non-financial measures are revealing poor
performance, this will likely be reflected in financial performance at a later time.
MODULE 5

Return to Question 5.10 to continue reading.

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Question 5.11
Mega Markets Online competitor

Financial perspective

• ROI/ROCE/PBIT • ROI/ROCE/PBIT
• Cost • Cost
• Total revenue • Total revenue
• Gearing/interest cover • Gearing/interest cover
• Working capital and asset efficiency • Working capital and asset efficiency
• Shareholder returns • Shareholder returns

Customer perspective

• Number of customers • Number of customers

• Sales per customer • Sales per customer
• Returning customers (e.g. based on • Returning customers (this will be more accurate
loyalty cards) as more accurate customer details will be
• Number/percentage/value of returns available for online sales where customer
• Number/percentage of complaints address and payment details are obtained)
• NPS • Number/percentage/value of returns
• Number/percentage of complaints
• Number of website hits, time on website
• NPS

Business process perspective

• Sales per square metre • Cycle time (time from receipt of order to
• Sales per employee despatch)
• Out-of-stocks (lost sales due to style/colour/size • Out-of-stocks (less likely as there is one
combination being out of stock) central warehouse holding all style/colour/size
combinations)
• Delivery accuracy percentage (returns due
to inaccurate picking/delivery)

Innovation and learning perspective

• Employee turnover • Employee turnover

• Employee training investment • Employee satisfaction/morale
• Employee satisfaction/morale • Investment dollars in online technology
• Number of innovative techniques adopted in
online ordering

Explanation of differences

There is unlikely to be much difference in the lagging financial indicators between both companies,
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both of which are likely to pursue similar financial outcomes for their shareholders.

There is also likely to be similarity in the measures for the customer perspective, although the online
competitor is far more likely to be able to target its customers with special offers because it will have more
detailed and accurate information about each customer who places an order. The online competitor will
also have more accurate information about prospective customers who visit its website without ordering,
than will a retail company that has no information about potential customers who do not make purchases.

The business process perspective is where performance measures are likely to vary most, with the retail
store measuring the efficiency of sales for its retail store and staff investment. The online competitor will
also need to measure cycle time from order to delivery (where it is most susceptible to competition from
the retail store as purchase and delivery are simultaneous) as well as delivery accuracy.

Equally, there will be significant variation in the innovation and learning perspective. The retail store will
emphasise staffing measures over systems, whereas the online competitor will place far greater emphasis
on the reliability of systems as it is far less dependent on staffing.

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Note: there are some differences between the performance measures of each company based
on their different strategies. You may be able to think of others.

Return to Question 5.11 to continue reading.

Question 5.12
(a)

Profit Cash flow Value of company

Debtors’ collections

Cost Revenue

Client retention

New client growth

Hours worked Hourly charge-out rates

Billing per client

Quality of work

Maintaining Recruitment
up-to-date and retention
knowledge of staff
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Partner contact Marketing and

Prospecting
with clients promotion

Source: CPA Australia 2019.

Note: this is an illustration of the kind of things that could be part of a strategy map for a
small professional services company. The strategy map may be simple or complex—this is
just one example.

(b) The strategy map shows many of the assumed relationships required for a successful
accounting practice. Starting from the bottom and moving upwards, the left-hand side
reflects the importance of HR: recruitment and retention of staff, and maintaining up-to-date
knowledge through continuing professional development (CPD). Staff with knowledge lead
to quality work and the ability to charge fair prices—charge-out rates are the rates charged
to clients for the work carried out by staff of the company. While staff are usually the most
significant cost to the company, it is only through staff that revenue is earned by working
hours that are chargeable to clients.

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The right-hand side of the strategy map shows a focus on clients. Marketing is important to
develop new business opportunities. Prospecting (making contact with potential clients) is
important to winning new business. Partner contact with existing clients is also important to
maintain existing client satisfaction. Through these activities, the company can build its new
client base, maintain existing clients and increase the revenue earned from clients through
value-adding services.

As the main financial asset of any professional services company is its receivables, good
billing practices and collection of debts are essential for cash flow. There are many other
possible CSFs and cause-and-effect relationships in a strategy map, with many possible
variations between companies (even in the same industry). Factors such as information
technology and company reputation may be relevant, even though they are not shown in
the illustration. The actual strategy map adopted by any one company will be a reflection
of its strategy, competitive position and business model.

Financial Profit, cost and Net profit

revenue Net profit as percentage of revenue
Revenue growth year-on-year
Direct salaries as percentage
of revenue
Indirect salaries as percentage
of revenue
All F
Non-salary costs as percentage
of revenue

Cash flow Free cash flow

Cash flow as percentage of revenue

Value of company Growth in value as a multiple

of average annual billings

Client (customer) Client retention Number of clients lost NF

New client growth Number of new clients NF

Number of active prospects NF

Billing per client Growth in billing (calculated for F

each client)

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Partner contact Number of visits by partners to NF
with clients existing clients per annum

Business process Quality of work Number of errors identified by NF

supervisors, managers, partners

Hours worked Chargeable hours as a percentage NF

of paid hours

Write-offs/ons (i.e. hours charged to NF

clients that cannot be recovered in
billing, or due to efficiencies resulting
in a higher than expected margin)

Hourly charge-out Cost recovery F

rates

Receivables Days billing outstanding (equivalent NF

collections to days sales outstanding)

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Financial or
Key success factors non‑financial
BSC perspective in strategy map Performance measure (N/F)

Innovation and Marketing and Expenditure on marketing and F

learning promotion promotion

Prospecting Number of activities aimed at NF

winning new clients

Percentage of partner hours spent NF

on marketing and prospecting

Maintaining up-to- Compliance with CPD requirements NF

date knowledge
Investment in staff training F

Recruitment and Staff turnover as percentage of total NF

retention of staff staff employed

(d) The indicative performance measures are shown for each of the key success factors in the
strategy map. Different businesses will define different performance measures, based on
the business strategy, competitive position and business model. There are 25 performance
measures included. These are fairly evenly spread over the four perspectives, although there
are a few more measures in the financial perspective. Of the suggested measures, 13 are
financial and 12 non-financial. So the scorecard suggested for this company is quite balanced.

Many possible performance measures have not been included. Other measures that could be
adopted include:
–– revenue or profit per partner (or per employee)
–– the ratio of partners to staff
–– the office space (in square metres) per employee.

These have not been considered as critical, but they are important measures, and may be
particularly useful in benchmarking exercises.

Return to Question 5.12 to continue reading.

Question 5.13
MODULE 5

(a) A reduction in the total cost of components can be achieved either through:
–– purchasing improvements—reducing the price per component, or
–– productivity improvement—reducing the quantity of components used, such as reducing
waste or damaged components.

Performance measures should be set for Purchasing—the cost for each component is the
most relevant measure for that department. This measure could cascade to individuals
or work groups within the department with measures of, for example:
–– number of alternative suppliers identified
–– number of quotations sought from suppliers
–– successful price negotiations with suppliers
–– number of tender comparisons of suppliers.

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(b) Performance measures could be set for Production—the total number of components used
for the number of finished triffids produced is the most relevant measure for that department.
This measure could cascade to individuals or work groups within the department with
measures of, for example:
–– number of components received—that is, comparing standard quantities with actual
quantities of components received for the production of triffids
–– number of out-of-stock notifications requiring special purchasing
–– number of components wasted
–– number of components reworked
–– number of components damaged or lost
–– number of quality defects.

(c) The Finance and Administration department needs to provide the information required by
purchasing, production and the board of directors to enable monitoring of performance.

In addition, the Finance and Administration department must ensure sufficient control
exists over goods that are received into inventory (including checking of quantity and
quality of received components) to ensure that only components received are paid for.
Often, premiums are paid for components ordered due to out of-stock situations, so the
number of special purchases due to components being out of stock needs to be reported,
together with the price variation.

Care should be taken that the Purchasing department does not achieve a lower cost for
each component by simply increasing the ordered amount to take advantage of volume
discounts—tying up additional funds in inventory could have disastrous consequences
for organisational cash flows and also increase the risk of inventory becoming obsolete,
damaged or lost while in storage.

(d) An enterprise resource planning (ERP) system should:

–– record inventory levels of purchased components
–– forecast sales demand and production plans
–– automatically order purchased components based on the organisational plans
(e.g. minimum stock levels, economic order quantities, seasonal demand fluctuations,
order to delivery times)
–– record approved suppliers and agreed prices
–– place purchase orders on suppliers at the agreed price
–– match supplier invoices against purchase orders, highlighting variations in quantity
or price
–– report actual usage of components (e.g. separating wastage, damage and rework)

MODULE 5
–– report variations between purchased cost and standard cost of components.

Return to Question 5.13 to continue reading.

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Question 5.14
Performance
Performance measure target SMART Characteristics

1. Head office recharge $1 million This measure is not This measure can be
of corporate costs to relevant for planning, calculated reliably but it is
business units based decision-making or not a valid measure of the
on a percentage of control, because if sales business units’ demand
sales revenue in each revenue exceeds the for corporate services.
business unit target, the head office It is not controllable by
recharge will be higher business unit managers.
than the target.

2. Survey of brand 75% This measure is specific This may be a valid

recognition among and measurable but measure of the
members of the public achievability may effectiveness of
depend on the level of advertising in terms
advertising. It also may of awareness, but it is
not be relevant in terms not a valid measure of
of conversion of brand sales. It may be reliable
recognition into sales. if a standard form of
For example, many statistical survey is
consumers are aware of properly carried out.
the ‘Coca Cola’ brand but
do not buy the product.

3. Receivable days 45 days This measure and This measure is a valid

target satisfies all the and reliable method of
SMART criteria, but calculating the level of
the achievability of the outstanding receivables,
target depends on the which is clear, can be
organisation’s trading produced in a timely
terms (which in this case fashion, is accessible
might be assumed to be and controllable. It leads
30 days). to improved activity in
collections and approval
of credit limits, etc.

4. Percentage of incoming 90% This measure and This performance

telephone calls answered target satisfies all the measure is usually reliable
in one minute SMART criteria, but because it is a by-product
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the achievability of the of telecoms technology.

target depends on the However, it is not valid by
organisation’s staffing itself because it is usually
of positions that involve a proxy for customer
answering telephone service and needs to
calls. be supplemented by a
measure of customer
satisfaction with the
quality of the service
provided.

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Performance
Performance measure target SMART Characteristics

5. Percentage of sales 80% While this measure The measure is valid

revenue from return meets most of the and reliable as it does
customers SMART criteria, it is not accurately capture
necessarily time-based information about
(i.e. it does not reveal the customer retention.
elapsed time between However, it is not
customers placing repeat controllable as there are
orders, nor the value of many factors outside
their orders compared managers’ control that
with their prior orders). influence returning
customers.

6. Dollar value of donations $100 000 p.a. While this measure and This measure can be
to charities target meets most of reliably calculated
the SMART criteria, it is and is valid in terms
not likely to be relevant of measuring financial
in terms of something contributions to charities,
that is important for the but by itself it does not
organisation, unless it is necessarily reflect how
an organisation whose well the organisation’s
purpose is to donate social, environmental
to charities. or ethical obligations
are satisfied.

7. Reduce employee Reduce This measure meets the This measure is valid and
turnover turnover by SMART criteria. It may reliable. It is controllable
10% p.a. be achievable provided through a variety of
managers have authority retention strategies
over remuneration and including remuneration
motivation strategies. and motivation.
As employee turnover
incurs the high cost of
recruitment and training,
this is likely to be an
important measure.

8. Sales revenue growth 15% p.a. This measure meets This is a valid and reliable
the SMART criteria, measure. It is clear and
with the possible available quickly but many
exception of whether factors affecting revenue

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it is achievable based growth are outside
on past performance managers’ control.
and economic and
competitive conditions in
the particular industry.

9. Headcount 120 The measure may not While this measure is

be relevant as, in many reliable it may not be
organisations with valid, as headcount does
headcount targets, not reflect a number of
this is circumvented factors (e.g. the level
by appointing casual of business activity, the
staff through agencies quality of the workforce,
or consultants where long-term illness,
(sometimes higher) costs maternity or long service
are incurred even though leave being taken).
the payroll headcount
target is satisfied.

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Performance
Performance measure target SMART Characteristics

10. Compliance with legal Full This measure and target It is a valid measure
requirements is not specific and it of compliance, but
is difficult to measure, not a reliable one
being based on subjective as different people
judgments and probably may make different
without full knowledge judgments based on
of all requirements different knowledge
and the organisation’s and experience.
experiences.

Additional explanation of the answers

The following table outlines the method used to determine whether the performance measures
and targets were SMART and effective.
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SMART criteria Characteristics of effective performance measures

Specific Measurable Achievable Relevant Timely Validity Reliability Clarity Timeliness Accessibility Controllability

1. Head office Y Y ? N ? N Y Y ? N N
recharge

2. Survey of brand Y Y ? N N ? ? ? N N N
recognition

3. Receivable days Y Y Y Y Y Y Y Y Y Y Y

4. Incoming Y Y ? Y Y N Y Y Y Y Y
telephone calls

5. Sales from Y Y Y Y N Y Y Y N Y N
return
customers

6. Donations to Y Y Y N Y Y Y N Y Y Y
charities

7. Employee Y Y Y Y Y Y Y Y Y Y Y
turnover

8. Sales revenue Y Y ? Y Y Y Y Y Y Y N
growth

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9. Headcount Y Y Y N Y N Y N Y Y Y

10. Compliance N N Y Y ? Y N N ? ? Y

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It should be clear from these examples that few performance measures are perfect. It may
be better to consider most measures as indicators of performance, as they each have their
limitations. It is also important to take a contingent view in evaluating measures and targets,
as the example of the donations to charity illustrates. Similarly, a measure and target for
receivable days is only relevant for a business selling on credit, not for a retail store like
Woolworths. It should also be noted that assessment of performance measures and targets
can be subjective and requires judgment, and so there may be alternative views or assessments
to those described previously. In addition, as no information is given in the question as to
current levels of performance or organisational strategies or priorities, you could assume that
all elements of performance are achievable.

Return to Question 5.14 to continue reading.

Question 5.15
Different companies have very different approaches to performance measurement. The measures
used in retail stores such as Woolworths and JB Hi-Fi are quite different to the measures used
in a hotel chain such as EVT, by Apple in its high-tech environment or by Newcrest in the
mining industry. Public sector organisations such as policing and hospitals have very different
approaches to performance measurement.

The failings of performance measures at Mammoth Printing contrast with the abandonment
of most traditional performance measures (including financial ones) at TNA. Public and not-for-
profit organisations have quite different needs. The international advertising agency example
illustrated how competing priorities need to be balanced, whereas BP in the Gulf of Mexico
demonstrated the consequences of a relentless pursuit of short-term profits. These examples
illustrate the importance of customising performance measures to the unique position of
each organisation.

Despite the differences in what is measured, the focus of performance management should be
the same in all organisations, business, not-for-profit or public sector. Management accountants
need to be able to add value to their employers or clients by moving beyond the mere reporting
of performance against targets, trends and benchmarks and add value by interpreting that
information and making appropriate recommendations to senior management.

Despite pressure for short-term financial performance, management accountants need to be able
to demonstrate where an excess focus on the short term may detrimentally impact on sustainable
MODULE 5

financial performance. Management accountants also need to be able to look at financial

and non-financial performance holistically, recognising the relationship between lagging and
leading performance and identifying the trade-offs between different aspects of performance—
for example, high quality and short lead times may not be consistent with low costs.

Management accountants need to focus on performance improvement. They can suggest ways
in which performance can be interpreted, and recommend methods of improving performance
based on their holistic views of all the available performance information. This means moving
away from the desk and computer screen and talking with non-financial managers who will be
able to explain the context in which performance reports.

Return to Question 5.15 to continue reading.

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Question 5.16
(a) 1. Decide on the performance measures to be benchmarked
Performance measures are selected for benchmarking where differences in performance
can be understood and acted on. Only strategically important measures and processes
should be selected for benchmarking.

2. Decide who you are benchmarking against

Organisations can select internal measures from different organisational units, industry-
wide benchmarks or benchmarks from outside the industry.

3. Find out how to obtain benchmarking measures

Data can be obtained directly from the organisation identified as having the best
practices, perhaps through a benchmarking consortium. Another option is to rely on
secondary sources, such as consulting organisations, newspapers and trade journals,
or internet materials. Many organisations rely on BI gained from common suppliers or
from discussions at exhibitions and conferences, etc.

4. Compare and interpret the data

A comparison of the data is what benchmarking really focuses on, but just comparing
the data does not tell us why there are differences. As for all data, it needs to be
interpreted sensibly, by not ignoring different contexts. Further investigation is almost
always required.

5. Use information for decisions, control and performance evaluation

After comparison and interpretation, benchmark data can be used to improve business
practices, motivate behaviour or signal the organisation’s performance relative to others.

(b) – The commitment by other organisations—especially in a consortium—to provide

benchmarking data. The level of participation by organisations can be improved if they
perceive there is a benefit to be derived from their involvement.
–– A lack of knowledge about why there are performance differences. While benchmark
figures give an indication of where problems may exist, they are diagnostic. Diagnostics
tell us that the problem exists, but not what is causing the problem, and therefore do not
tell us how to fix it. Accountants and managers need to go beyond the data provided and
understand why the differences exist. Sometimes performance differences may be due to
different strategies or business models, different regulations under which organisations
operate, or different technologies or investments in infrastructure.

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–– The standardisation of data. Data may be collected, summarised and interpreted in
different ways, leading to performance comparisons that are not appropriate. Questions
must therefore be asked about the comparability and usefulness of benchmark data.
–– The historical nature of the data. While benchmarking data may give an understanding
of what other organisations or business units have done in the past, it does not tell
us what they are doing now or in the future. It is no substitute for constant proactive
improvement within organisations.

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520 | PERFORMANCE MANAGEMENT

(c) Every organisation will be different, will have different opportunities for benchmarking and
different performance measures will be important. One example is university teaching,
where a benchmarking consortium does exist. Some examples of benchmark data for
teaching include:
–– staff–student ratio
–– student retention—that is, the proportion of students who discontinue studies prior
to completion
–– student progression—the proportion of students who fail and have to repeat
–– student satisfaction
–– graduate outcomes—employment, salary levels.

The last two examples come from standardised surveys of university students.

Return to Question 5.16 to continue reading.

Question 5.17
(a) The need to have a limited number of performance measures is consistent with the proponents
of the BSC, provided there is balance in the range of measures used. The example does not
explain the performance measures used, but does mention ‘operational, financial and physical
measures’, so it might be assumed that there is balance.

Importantly, the example argues that performance measures are useful in determining
whether the organisation is on the right track. If performance measures are not useful in
making improvements, then they are unnecessary. The absence of targets—budgetary or
otherwise—contrasts with the role of targets in performance management. Despite the
absence of targets, the example shows the importance of relative performance, trend—
improvement relative to the past—and benchmarking.

(b) The importance of rewards is also emphasised in the example. Importantly, rewards are not
for absolute performance but based on relative (to other banks) profitability. This seems
a valuable approach to linking performance with rewards and may overcome some of the
criticism of financial institutions during the GFC for excessive executive remuneration.
Under this approach, if any whole industry improves its performance, this is more likely a
consequence of the economy, technology and customer demand than managerial action
and should not be rewarded. By contrast, if relative performance in an industry improves,
this is more likely due to management actions that are more successful than competitors’.
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Agency theory would support this kind of relative performance-linked reward.

A further element of the profit share in the example was that it was only payable when an
employee retired. This has at least three advantages:
1. It prevents a focus on short-term at the expense of long-term performance (i.e. it adheres
to the sustainability principle).
2. It encourages employees to remain with the company over the longer term to reap the
benefits of their behaviour.
3. This kind of approach to rewards linked to sustainable performance is likely to have fewer
unintended and dysfunctional consequences than more traditional approaches.

Return to Question 5.17 to continue reading.

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References | 521

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Performance Management

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Performance Management

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STRATEGIC MANAGEMENT ACCOUNTING

Part A: The role of performance management 386

Part B: Strategy, management control and performance

Part C: Determining performance measures and setting

Designing SMART performance targets

Suggested answers 499

Figure 5.1: Subject map highlighting Module 5

Source: CPA Australia 2019.

Part A: The role of performance

What is ‘performance’ and ‘performance management’?

Further, different stakeholders—for example, investors, lenders, customers, suppliers, employees,

A performance indicator is less specific—it is a signal indicating a general direction or trend

Other aspects of performance

Performance improvement implies changing behaviour to improve performance to achieve an

Performance management and its links to strategy

Figure 5.2: Performance dimensions

$ space, earnings per share

Non-financial but Performance Subjective judgments and

Performance needs to be understood relative to an organisation’s strategy and the particular

Financial performance management

Figure 5.3: Ratios for financial performance

Source: CPA Australia 2019.

Financial accounting Strategic management accounting

Comparison to prior year Comparison to prior year, budget and external

Source: CPA Australia 2019.

Strategic management accounting techniques may move beyond the:

Non-financial performance management

Most organisations maintain comprehensive statistical data to support planning, decision-making

Performance, whether it is financial or non-financial, needs to be interpreted in the contexts

The measurability and reporting of performance

Example 5.2: Safety index

The importance of NPS is that it provides a measure of sustainable customer satisfaction

Example 5.3: Performance reporting by Victoria Police

The annual report lists three broad categories of performance measurement:

The multiple roles of performance management

Each of these roles is described in the next section.

Performance—a process of value creation

Example 5.4: Value creation at Apple Inc.

Warren Buffett’s Berkshire Hathaway Inc.—long known as an exceptionally successful investor—became

Example 5.5: Value creation at Woolworths

(b) What is the company’s strategy to increase shareholder value?

(c) What can the company do in the face of online competition?

Performance and sustainability

Figure 5.4: Sustainability in relation to performance

Performance Meeting the

Source: CPA Australia 2019.

Example 5.6: Sustainability at Newcrest Mining

The GRI (see http://www.globalreporting.org) is a multi-stakeholder process aimed at developing

2. 300 (Environmental topics)

It is available at: https://www.globalreporting.org/standards/gri-standards-download-center/

More information is available online at: http://integratedreporting.org.

Further information about XBRL is available online at: http://www.xbrl.org.

Example 5.7: Risk management and signalling at Westpac

Further information about the Royal Commission is available at: https://financialservices.

Example 5.8: HIH Insurance

Example 5.9: Dick Smith Group

Governance, risk and performance management

Accountants, as significant advisers to the board, play a significant role in contributing to

Corporate governance can be described as constituting the entire accountability framework

The Committee of Sponsoring Organizations of the Treadway Commission (COSO) Enterprise

Performance management is fundamental to helping the board or its committees exercise

Management accountants in particular are commonly involved in risk management processes

Risk management is an important element of performance management because it establishes

Figure 5.5: Relationship between elements of the management control system

Corporate governance sets

Strategies and plans are

implemented and result in

Source: CPA Australia 2019.

Ethics and performance management

The fundamental principles in the Code are:

Example 5.10: WorldCom, Enron and Arthur Andersen

Two theories—agency theory and contingency theory—are relevant to gaining a better

Theories related to performance management

Large multi-store food retailer Owner-managed suburban food retailer

Management control system:

Comprehensive performance information by Simple performance reporting system, probably