Chapter 5 extract from our ExPress notes for use with the current video. A full set of P5 ExPress notes can be downloaded free of charge at www.theexpgroup.com.
Notes ACCA Paper P5 Advanced Performance Management For exams in 2011
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ExPress Notes ACCA P5 Advanced Performance Management
Chapter 5
Performance Evaluation and Corporate Failure
START The Big Picture There are additional models which provide perspective on performance measurement. One of them is the: Balanced scorecard The balance scorecard addresses a number of parameters (or “perspectives”) in monitoring business performance by asking the following questions:
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Financial perspective: “To succeed financially how should we appear to our shareholders?”
Customer perspective: “To achieve our vision how should we appear to our customers?”
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ExPress Notes ACCA P5 Advanced Performance Management
Internal business processes: “To satisfy our shareholders and customers what business processes must we excel at?”
Learning and growth: “To achieve our vision how will we sustain our ability to change and improve?”
Critical success factors can be linked to the above: Financial: Sales, profitability, liquidity, fair value of shares; Customer: Customer base, customer loyalty, customer satisfaction, dealer relationship, marketing performance; Internal processes: Quality, productivity, safety, flexibility and readiness to changes in operations;
Learning, growth and innovation: New product development, new process development, new market development, human capital development
Another model which depicts the linkages between strategy and operations, on a vertical axis, and internal and external measures (horizontal) is the: Performance pyramid (Lynch & Cross)
Corporate vision
Objectives
Market
Customer Satisfaction
Quality
Measures
Business units
Financial
Flexibility
Delivery
Productivity
Cycle Time
Business operating systems
Waste
Departments and work centers
Operations
External effectiveness
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Internal efficiency
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ExPress Notes ACCA P5 Advanced Performance Management
In this model, the strategy (based on corporate vision) is expressed in the form of objectives that flow down through the organization; in return, various measures of operating and business unit performance flow upwards. One can observe the criteria necessary to satisfy the customer (external, or “market” side of the pyramid) as well as what needs to be achieved in order to generate the required return for shareholders (internal, or “financial”side). Finally, a third model exists under the name of:
Fitzgerald and Moon This model addresses itself to service companies.
Dimensions Profit Competiveness Quality Resource utilisation Flexibility Innovation
Standards
Rewards
Ownership
Clarity
Achievability
Motivation
Equity
Controllability
The Dimensions refer to what is measured; among them, one must distinguish between:
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Results (Profit; Competitiveness) and
Determinants (Quality; Resource utilization; Flexibility and Innovation)
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ExPress Notes ACCA P5 Advanced Performance Management
The Standards define the “rules” by which business performance is judged and the Rewards are available to those achieving good performance. Notice that much emphasis is given to human motivational factors: Standards must be achievable and fair (equity); employees must “buy-in” to the rules; Rewards must be clear and within the possibility (controllability) of the employee to be motivating.
Performance Prism This is a model developed by the Cranfield School of Management which seeks to reconcile the multiple performance frameworks (that at times seem to conflict with one another). Imagine a (triangular) bar of Toblerone chocolate standing on its end. The model assigns
Stakeholder contribution to the base and Stakeholder satisfaction to the top end of the bar.
In other words, stakeholders are the beginning and the end (goal) of the business. The three sides of the bar refer to three facets:
Strategies: The route selected to achieve goals Processes: Necessary to execute the strategy; and Capabilities: Necessary to operate the processes
The Five Facets of the Performance Prism
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Stakeholder Satisfaction Strategies Processes Capabilities Stakeholder Contribution
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ExPress Notes ACCA P5 Advanced Performance Management
Strategic performance issues in complex business structures
KEY KNOWLEDGE Ansoff’s matrix (the Product – Market Mix) This allows companies to identify a number of options to grow the business via existing and / or new products in existing and / or new markets.
Existing Products
Existing Markets
New Markets
New Products
1. Consolidation 2. Penetration 3. Withdrawal
4. Product development
5. Market development
6. Diversification
1. Consolidation. This is not “doing nothing”. It is doing enough to maintain the existing position. 2. Penetration. Actively trying to increase the share of the market through techniques such as advertising and PR. 3. Withdrawal. Pulling out of a particular market. Reasons could include it’s loss making or a company wants to utilise resources elsewhere. 4. Product development. Developing new products to sell to existing markets. An example would be a soft drinks manufacturer launching a new healthy range of drinks. 5. Market development. Existing products are sold in new markets. This can either be for example geographical (McDonalds establishing restaurants in new geographical areas) or can be repositioning the market (e.g. Land Rover developing from an agricultural market vehicle to mainstream car producer).
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ExPress Notes ACCA P5 Advanced Performance Management
6. Diversification. Generally considered to be the most risky. There are a number of types of diversification: a. Backwards vertical integration whereby an organisation takes on the role of its supplier. An example would be an oil refining company taking on the role of its supplier of oil exploration – i.e. it would now be in a position to supply itself with its raw materials. b. Forwards vertical integration whereby an organisation takes on the role of its customer. For example, a farmer sets up a farm shop to sell direct to the public rather than to shops. c. Unrelated diversification refers to a new product or service in a completely new market.
KEY KNOWLEDGE Boston Consulting Group (BCG) Matrix This matrix helps organisations analyse their product lines or business units. It helps identifies priorities and where resources should be allocated. Items are allocated to the various quadrants according to how attractive the market is (measured as the growth rate) and how strong a position they hold within the market (their market share)
High
Stars
Low
Cash Cows
Question Marks
Growth Rate Dogs
High
Low
Market Share
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ExPress Notes ACCA P5 Advanced Performance Management
A balanced portfolio would have: 1. Stars to ensure the future. 2. Question marks to convert to Stars. 3. Cash Cows to provide funding to develop the Stars and Question Marks.
Structural analysis of industries (Porter) This model examines the role of 5 forces close to an organisation that impact on its ability to make a profit and hence how attractive a particular market or industry is.
Entrants
Suppliers
Competition
Customers
Substitute
The 5 forces are as follows: 1. Threat of substitute products If there are similar products, a customer will be more likely to switch rather than stay with a product when there are price rises (elastic demand).
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© 2011 The ExP Group. Individuals may reproduce this material if it is for their own private study use only. Reproduction by any means for any other purpose is prohibited. These course materials are for educational purposes only and so are necessarily simplified and summarised. Always obtain expert advice on any specific issue. Refer to our full terms and conditions of use. No liability for damage arising from use of these notes will be accepted by the ExP Group.
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ExPress Notes ACCA P5 Advanced Performance Management
2. Competitive rivalry The rivalry will depend on the number and strength of competitors, economies of scale and exit barriers. 3. Threat of new entrants Markets generating high returns will attract new entrants which in turn could reduce industry profits. Barriers to entry such as government licenses (mobile phone operators) are important in reducing the threat of new entrants. 4. Power of customers The stronger the power of the customer the more pressure it can place on the company. Issues to consider include the size of the customer relative to the firm’s customer base, switching costs and availability of substitute products. 5. Power of suppliers Suppliers of materials and services can exercise power over an organisation. This depends on the level of differentiation of the product, presence of substitute products, etc. Compare the power of Intel supplying computer chips to the computer industry vs. a sugar producer supplying sugar to a soft drinks manufacturer.
Support
KEY KNOWLEDGE Porter’s value chain
Support Activities
Firm Infrastructure Human Resource Management Technological Development
Service
Marketing & Sales
Outbound Logistics
Operations
Inbound Logistics
Primary
Procurement
Primary Activities
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ExPress Notes ACCA P5 Advanced Performance Management
The value chain was introduced by Porter and represents an approach to looking at the development of competitive advantage within an organisation. All organisations consist of activities which “link” together to develop the value of a business. Together these activities represent the value chain. The value chain represents a series of activities that both create and build value. Combined they represent the total value delivered by an organisation. The “margin” in the diagram is the added value (the difference between the total value of the activities and the cost of performing them). Primary activities: related with production. Support activities: provide the background for the effectiveness of the organisation (e.g. HRM)
Predicting and preventing corporate failure Empirical studies have been performed in search of predictive models of corporate failure. Models such as Altman’s Z-score were developed to predict corporate distress. The corporate distress index (denoted Z) is defined as Z = 1.2X1 + 1.4X2 + 3.3X3 + 0.6X4 + 1.0X5 where X1 X2 X3 X4 X5
= = = = =
working capital/total assets, retained earnings/total assets, earnings before interest and taxes/total assets, market value equity/book value of total liabilities, sales/total assets
A score below 1.8 is an indication of probable failure, and a score above 3 indicates financial soundness.
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