Performance management—the processes that ensure organisations meet their objectives—is core to the F5 syllabus, and understanding modern performance measurement systems is an important area within this topic. F5 students should already be familiar with Kaplan & Norton’s Balanced Scorecard which is a regularly examined topic and one of the foundations of modern performance measurement. Fitzgerald and Moon’s Building Block Model is an evolution of the Balanced Scorecard, developed to meet the needs of service organisations. It is a tool that helps management set a forward-looking performance management framework that links an organisation’s strategy and objectives to employee targets and motivation.
This article will review the importance of the modern approach to performance measurement, discuss the Building Block model, and apply this model to an exam-based scenario.
An approach to measuring performance that we are familiar with is, ‘looking at the numbers.’ Classic questions which are often asked about a company are, 'How much profit has it made?' 'How much have sales grown?' 'What’s its market share compared to the competition?' However, these traditional, financial performance metrics which are regularly calculated for accountancy exams are no longer sufficient, according to leading thinkers on strategy and performance management.
Profit-based performance metrics measure past performance. They are also distorted by accounting policies. Just look at the famous auto and engine maker Rolls Royce; its recently reported profits would be £900m lower under new IFRS revenue recognition requirements. Financial metrics are also criticised as leading to ‘managerial myopia,’ or short-termism, whereby management make decisions which sacrifice future performance for profits today. Managers can be motivated to postpone investments and other costs to maintain their quarterly or annual profits if their success is judged solely against financial performance targets.
Performance management experts argue that in the increasingly competitive modern business environment, organisations now need forward-looking performance measurement systems, linked to their critical success factors, to achieve long-term success. The new question to ask is, 'what areas of performance are critical to achieving our strategic objectives and how do we measure them?'
The following scenario will be used to discuss and illustrate the Building Block Model.
SmartCourier is a package delivery company located in the developing country of Maxland. Since its formation in 1970, SmartCourier has evolved into one of the largest and most successful shipping companies in the country. Its mission is 'to exceed customers’ expectations in the transfer of packages by offering the highest-quality services at competitive prices.'
SmartCourier offers a range of delivery services such as:
- Standard overnight delivery
- A premium add-on of guaranteed 10:30am delivery
- A cheaper, three-day service for less time-critical deliveries
SmartCourier has recently launched an app that lets customers set pickup times and locations on their smartphones which has received positive reviews in the technology press.
SmartCourier has identified the following critical success factors:
- Deliver sustainable profits to shareholders
- Leave customers highly satisfied at every interaction with SmartCourier
- Provide a range of products which meet our clients’ evolving needs
- Lead the industry with constant innovation
Managers at SmartCourier have a dynamic compensation package which includes share options, goal-based incentives, commissions, and non-monetary public recognition. SmartCourier also allows for flexible work schedules and is piloting an on-site child care programme at one of its locations.
SmartCourier receives positive coverage in the press about its work environment and is considered to be an attractive employer, with motivated employees and a good reputation among job seekers.
However, SmartCourier’s profits have dropped in recent years due to increasing competition from global transport companies who have recently entered the market in Maxland.
The Building Block Model
The Building Block model looks at three areas of performance: dimensions, standards, and rewards.
Companies compete across a range of dimensions besides financial performance. The Building Block model considers this and describes two categories of dimensions: ‘Results’ and ‘Determinants.’
‘Results’ are the outcome of decisions and actions taken by management in the past. These are captured under the first two dimensions of the model, financial performance and competitiveness.
‘Determinants’ refer to the forward-looking dimensions of the model: what areas of future performance are most important for a company to achieve positive financial and competitive results? Quality, innovation, flexibility and resource utilization are the determinants of future success.
Dimensions at SmartCourier
As a listed company, the management of SmartCourier will be very interested in measuring financial success—is it delivering the right profits and returns for its shareholders? Competitiveness is also critical to measure as new competitors are entering the market in Maxland—is SmartCourier maintaining or losing market share?
SmartCourier’s managers and staff need to focus on the dimensions of performance that will determine positive financial and competitive results. For example, on-time deliveries will lead to customer loyalty. This falls under quality of service. The company’s varied product range should meet the needs of different customer segments; this is an example of flexibility of service. Flexibility and quality of service should in turn drive positive financial results, for example, higher sales revenue.
Innovation is also important to SmartCourier as it is investing in new technology and improving processes with its smartphone app. Resource utilisation is critical to its financial success as efficient use of delivery vehicles, staff and financial resources will reduce costs and improve profitability. In other words, innovation and resource utilisation are driving financial success (higher profits) and competitiveness (maintaining market share).
After an organisation’s dimensions are understood, standards can be set. These will be the benchmarks, or targets, directly linked to performance metrics under headings for each dimension. There are three aspects to consider in setting standards:
- Who is responsible for achieving the standard (ownership)?
- What level are the standards set at (achievability)?
- Can we use the standards for a fair appraisal across the company (equity)?
These three criteria are important. If it is unclear to whom targets are assigned, managers and staff will not have accountability and performance management will fail. If personal targets are unachievable, people will not work harder to achieve their goals and there will be little motivation. If appraisal is not fair and transparent, employee morale will suffer.
Standards at SmartCourier
Based on the dimensions above, we can suggest standards of performance for SmartCourier:
Growth in sales, net profit margin, and return on investment are potential targets for regional managers. For example, fixed targets could be set, such as 8% annual growth in sales or a target ROI of 14%. Or, SmartCourier could use a league table approach by ranking the regions according to these standards and then rewarding managers accordingly.
With new players on the market it is important for SmartCourier to measure this area of external performance. It can set absolute market share as a standard for measuring competitiveness by dividing SmartCourier’s revenue by the total revenue of the industry in Maxland. A target for regional managers could be to maintain market share as competitive rivalry is increasing in the industry.
As a service organisation, it is critical that SmartCourier delivers quality of service to retain its customer base. It can set targets for courier agents such as 98% on-time delivery, or for call centre representatives average time to take an order of 3 minutes. It will be important to ensure that these targets are both fair and achievable to ensure employees are motivated (see below).
SmartCourier can measure resource utilisation by using efficiency standards such as average time per delivery or average number of deliveries per day. However, equity should be considered here, as urban regions could potentially out-perform rural regions as urban customers will be clustered closer together.
Flexibility of service and innovation
Flexibility of service can be measured with a targets such as 90% of orders scheduled to customers’ request and Innovation can be measured with % of customers using the smartphone app.
The last part of the model looks at the overall reward structure of the organisation and is the link to HR systems. Do compensation packages in the company lead people to achieve the standards of performance which are set out above? This part of the model has three aspects:
- Is the system understandable to all employees (clarity)?
- Will the system drive employees to achieve their objectives (motivation)?
- Do employees have control over their areas of responsibility (controllability)?
The reward system should be clearly understood by all employees: this means unambiguous performance appraisal and bonus triggers. Rewards should be sufficiently desirable so that employees are motived to work hard towards gaining them. Finally, if employees are assessed against factors out of their control, they will lose interest in working towards their rewards.
Rewards at SmartCourier
It seems like SmartCourier has an effective reward system. The compensation package covers a range of financial and non-financial rewards and benefits, which probably contributes to the motivation of employees by meeting their different needs. For example, new parents will be motivated by the child care facilities, other staff may be motivated by the flexible work place arrangements. It also appears that rewards are performance based (for example, 'goal based incentives') which will lead to increased motivation.
It’s important for SmartCourier to ensure that rewards are controllable and clear, for example, by making sure that targets are well defined and then agreed in appraisal meetings.
Like other modern performance measurement frameworks, the Building Block model connects an organisation’s strategic objectives to a range of forward-looking, non-financial performance measures. Where the Building Block Model differs, however, is that also considers reward systems and aims to create a framework of clearly understood and communicated individual metrics that aligns individual performance targets with organizational objectives.
Steve Willis is head tutor for Management Accounting exams at PwC Academy
(1) Philip Moon and Lin Fitzgerald, Performance Measurement in Service Industries, Making It Work, Chartered Institute of Management Accountants, 1996
(2) Philip Moon and Lin Fitzgerald, Delivering the Goods at TNT: the Role of a Performance Measurement System, Management Accounting Research 1996