CH-20 Strategy, Balanced Scorecards and Incentive Systems – Cost Management: Strategies for Business Decisions : Book Guide

Chapter 20 Strategy, Balanced Scorecards and Incentive Systems ANSWERS TO REVIEW QUESTIONS 20.1 See the list of key terms at the end of the chapter and the glossary at the end of the text. 20.2 Leading indicators are measures or otherwise observable actions or events that predict future outcomes. Lagging indicators, however, are results of previous actions or events. 20.3 Measuring employee capabilities is difficult because this concept is multidimensional. It includes employee talents, skills, knowledge, and motivation to perform. Ideally, an organization could assess all of these dimensions, but as a practical matter, it may focus on only a few that it feels are measurable and important. For example, some companies monitor average educational levels, voluntary turnover rates, and employee satisfaction. 20.4 Improvements in employee capabilities should result in better identification of problems, generation of innovative solutions, superior planning, competent implementation of plans, and continued learning. 20.5 Process efficiency affects customer value by improving cycle and order times, by reducing the chances that a customer will receive a defective product or service, and by cost reductions that can be passed on to the customer as lower prices or improved products. 20.6 Customer value is what customers are willing to pay for. More value should translate into higher revenues, but leading indicators of customer value include customer satisfaction and customer loyalty (or repeat sales).Improvements in customer value should lead to improved market share and revenues. Furthermore, these revenue improvements should lead to increased profits if improvements in customer value have not been “given away” or obtained with excessive service that is not recovered by sales prices. 20.7 All organizations can benefit from improved financial performance, but some organizations, such as charities and non-profits, may place higher priority on delivering customer or client value than on financial performance. Yet, even these organizations must be careful to use financial resources wisely and keep within financial constraints. 20.8 A set of leading and lagging indicators represent an organization’s important performance measures or key success factors. A balanced scorecard links four areas of performance: organizational learning and employee capabilities, internal processes, customer value, and financial performance. All four areas of the balanced scorecard might interact, although the usual explanation is effects flowing from organizational learning and employee capabilities to internal processes to customer value to financial performance. It is possible that organizational learning, for example, might directly affect financial performance by the creation of patents or copyrighted innovations that are licensed or sold to others. Likewise, employee capabilities can affect customer value by providing superior customer service; this is most common in service organizations such as travel and hospitality. Improvements in internal processes also might affect financial performance directly, for example by improving billing and collections and subsequent cash flows. In addition to these direct linkages, changes in areas provide feedback for future improvements in other areas. 20.9 In most non-profit organizations, the most important outcome is customer value provided. Thus, in the linear programming language of Chapter 12, many of these organizations try to maximize customer value subject to financial constraints. Unlike most profit-seeking firms, some non-profits may not show explicit links from customer value to financial performance, but many show the reverse – that is, linkages from financial resources to customer value to show how improvements in financial resources improve customer value. 20.10 Ideally, an improvement in employee capabilities (e.g., increased knowledge, qualifications or training) will result in improvements in internal processes. Improved internal processes will cause improved customer value, which then causes improved financial performance. A properly constructed balance scorecard reflects these cause-and-effect relations (usually with some time lag) by measuring and correlating levels or changes in performance. 20.11 “Pay for performance" is a foundation of incentive systems because at least some of compensation is not guaranteed but is tied to the individual's performance. This link between pay and performance improves motivation to work. 20.12 The key elements of an incentive compensation plan are measured performance that reflects achievement of objectives and compensation that is contingent on measured performance. 20.13 An incentive system can create disincentives by focusing behavior to achieve measured performance that does not truly reflect achievement of the organization’s goals. For example, an incentive system that is based on short-run earnings can create disincentives to invest in programs, equipment, or technology that will benefit the organization in the future but which also increases current expenses more than current revenues. 20.14 The starting point of an effective incentive compensation plan is the desired behavior. The incentive compensation plan is designed to encourage this desired behavior. 20.15 The basic principles of expectancy theory are that people will put out effort if they expect their efforts will lead to performance and if they expect their performance to lead to desirable rewards (or avoid undesirable penalties). In designing incentive plans, managers should assure that desired effort will lead to desired performance, desired performance will be measured and the effort/performance will lead to desired rewards. 20.16 Expectancy theory holds the view that people will act in ways that they expect will provide them with the rewards that they desire and prevent the penalties that they want to avoid. This theory links behavior to measured performance and to received rewards. The expectancy chain can be broken by an incentive system that reduces either the perceived effect of managers’ actions on measured performance or the belief that rewards will follow achieved performance. 20.17 Intrinsic rewards come from within the individual, whereas extrinsic rewards come from outside the individual. Intrinsic rewards include the sense of satisfaction from doing a good job or the satisfaction of doing a good deed. Extrinsic rewards include pay, promotions, praise from one's boss and praise from a customer. The opportunity for both types of rewards is important to creating and maintaining motivation. 20.18 In agency theory, the role of the incentive system is to align agents’ goals with those of principals. 20.19 In agency theory, the best incentive system is the one that results in the lowest overall agency costs, which include costs of incentives and opportunity costs of agents’ actions. 20.20 Absolute performance evaluation is a comparison of achieved performance against defined objectives, whereas relative performance is a comparison of achieved performance against that of other, similar individuals or organizations. 20.21 Advantages of formula-based performance evaluation are clear messages about what is expected of managers and employees – performance measures and their weightings are explicit. Such performance evaluation methods are not subject to unfair subjectivity. Disadvantages include dysfunctional behavior that can arise from efforts to manipulate or “game” the formula, unintended consequences from mis-specified formulas, and lack of flexibility in uncertain, changing environments. 20.22 A balanced scorecard is a model of an organization’s strategic and operating actions that is composed of financial and non-financial measures of performance. Moving this model to the context of incentive systems implies that the balanced scorecard can be used as a performance-based incentive system. In concept, the balanced scorecard could be a “mega” formula-based incentive system. 20.23 Defining performance narrowly has the advantage of focusing individuals’ efforts on a limited number of performance measures that are likely to be within the control of an individual. This can have the disadvantage of fostering selfishness and lack of cooperation, particularly when individuals compete for compensation. It may be difficult to develop very narrow measures of financial performance because of the need for many revenue and cost allocations. Defining performance broadly has the advantage of making individuals aware of the need for overall organizational success that requires cooperation and sharing of information. The primary disadvantage of broad measures of performance is that individuals may feel a disconnect between their jobs and the measure of performance. 20.24 An advantage of rewarding immediately is the strengthening of the motivational link between actions and rewards. An advantage of deferring rewards is that it gives incentives for managers to continue their employment with the company who expect the performance of their unit to be good in the future. It also provides incentives for managers to focus on the future, not just the present. Managers continually face trade-offs between the present and the future (e.g., advertise now or postpone until later, invest in employee training now or not). Focusing on the future gives managers incentives to make decisions now that will benefit the future. 20.25 Salary provides a safe form of compensation that may be necessary to attract employees who want some shelter from risk. A cash bonus based on performance provides motivation to improve measured performance, usually in the short-run. Stock awards provide incentives for employees to act like owners and to be concerned about long-run performance. Stock options provide rewards for upside performance without providing an out-of-pocket penalty on the downside. They motivate managers to act to increase the value of the company's stock, usually in lieu of salary or bonus. ANSWERS to CRITICAL ANALYSIS 20.26 The absence of a profit motive can reduce motivation to improve management of scarce resources. Profits or losses can give consistent signals to profit-seeking firms about successful or unsuccessful decisions. For example, if monetary benefits exceed monetary costs, the firm is moving toward its financial performance goals. Non-profits can have a more difficult time interpreting outcomes as successes or failures because they often must compare non-financial and qualitative outcomes to the costs of achieving them. That said, it seems likely that non-profits could greatly benefit from a valid balanced scorecard because it is just as important for them to understand the causes of outcomes in all areas. The costs of developing a balanced scorecard can be more difficult to justify because that use of scarce funds will reduce the organization’s ability to provide customer or client value in the short run. 20.27 All types of organizations should be concerned about financial performance, even if they do not have shareholders. Shareholders are just one type of stakeholder; others include partners, employees, customers or clients, creditors, suppliers, and the public at large. All stakeholders are affected by an organization’s financial performance because good financial performance, whether defined as stock return or operating within a budget, affects the organization’s ability to continue to provide valued products and services. Poor financial performance implies waste of scarce resources, and one should expect that monetary resources will flow to organizations that use them most efficiently. The balanced scorecard and other performance measurement systems that describe cause-and-effect relations can benefit all types of organizations regardless of the nature of stakeholder relationships. 20.28 Many organizations currently use performance information that reflects past performance. If this past information is useful for predicting the future or understanding how to improve current operations, it may be quite useful for management decision making. However, this information by itself usually requires analysis and interpretation so that its lessons can be applied to current decision making about the future. 20.29 Theoretically, it seems possible to overspend on improving customer satisfaction. This may be behind Xerox’s retreat from stating it will always improve customer satisfaction. That is, you should expect that improvements would be increasingly difficult and costly (e.g., increasing marginal costs of improving customer satisfaction). Likewise, you should expect the benefits of improving customer satisfaction would not increase indefinitely (e.g., decreasing marginal returns from improving customer satisfaction). At some point less than the maximum possible level, organizations should find an “optimal” level of customer satisfaction, beyond which further improvements cannot be justified economically. This is easier said than done, in most cases. 20.30 There is an old joke: If you are multilingual, you must be European or Asian. If you speak only one language, you must be American (meaning from the US). Knowledge of foreign languages is just one sign of appreciation for other cultures, but a powerful one. Because US consumer and popular culture is so strong and so widely imitated abroad, many US citizens do not perceive the need to immerse themselves in another culture. The costs of this include forgone opportunities or costs of hiring the knowledge (consultants, foreign subsidiaries, etc.). Many international companies seek to hire people with international knowledge (language, culture, etc.) so that they can operate more effectively in the global economy. Learning a foreign language, travel or study abroad, and participation in international groups and clubs may be effective ways to increase one’s awareness of other cultures. 20.31 Many organizations still believe that their employees are the most important assets. This is especially true in “knowledge-based” companies that are heavily dependent on innovations and high technology. Yet, none of these companies has an asset account labeled “Employees.” The most important factor that accounts for this lack of accounting is the difficulty of measuring the value of employees (a counter-example are some professional sports teams that capitalize the value of players’ contracts). Most employees work “at will” and may leave at any time, taking their value with them. Therefore, organizations cannot be said to own or control this resource. While it might be possible to estimate the value of Shaquille O’Neal to the Miami Heat, would the Heat be justified in listing that value as an asset, when Shaquille could (and will) retire when he wishes? 20.32 An unreliable balanced scorecard could mislead employees into making the wrong or excessive efforts to improve one part of the organization, when expected benefits will not materialize. Creating a causal balanced scorecard that reliably guides decision making promises to be a difficult task. 20.33 Capable employees must be motivated (and usually must have incentives) to increase and share their knowledge within the organization. Furthermore, the organization must have a way to institutionalize that shared knowledge (or “learn”) so that others can benefit and so that knowledge can be translated into more tangible benefits (e.g., improved processes). 20.34 Individuals are motivated by both intrinsic and extrinsic rewards, and one can substitute for the other. Dormino probably is motivated by the intrinsic reward of fighting hunger. One might speculate that the intrinsic reward is worth at least $20,000 per year to her. She might also appreciate the extrinsic recognition she receives from co-workers, the community, and the needy that she helps. Dormino also may place less importance on extrinsic, monetary rewards. Morenez is not necessarily soulless, though. She may prefer to earn extrinsic financial rewards that she can use to benefit others, perhaps through donations to Freedom from Hunger. 20.35 This plan clearly ties your performance to the stock performance of the company, which stockholders would see as a good thing. However, managers whose performance is tied to stock performance are subject to a great deal of risk from stock performance that fluctuates based on factors outside of the managers' control (e.g., political changes, economic shocks, pronouncements by the Chair of the Federal Reserve System). Managers subject to this level of risk usually demand a large premium in the form of very large stock-based compensation. Newspapers generally trumpet very large gains made by successful managers (e.g., Michael Eisner of Disney) but we hear little about those that have failed. Cynics argue that even failed executives do well because they also demand “golden parachutes” going in. 20.36 In part, this decision depends on your attitude toward risk and your belief in your abilities. If you are willing to accept some risk and are confident in your ability, you might take the top management position at a poorly performing division in a high-profit industry if you could be assured of sharing in the growth of the division’s absolute profits. If all companies in the industry see the same profit potential, it might be difficult to move up the ranking. In this case, you would be less inclined to accept the position if the evaluation is based on relative performance, either ranking or improvement in ranking. 20.37 Non-profit organizations have difficulty designing incentive systems to attract executives who also have private sector opportunities. Some non-profits have tried to imitate private-sector incentive systems, complete with stock options. However, this is controversial because many believe that the primary motivation of all non-profit employees should be to achieve the service goals of the organization, and non-profits cannot have their own stock options. Too much focus on meeting private sector incentives could attract executives who are less committed to service goals and who might alienate co-workers and donors. Thus, you must carefully design a system that will attract capable executives who could take private sector positions but who believe the non-profit’s goals are important enough to perhaps give up some extrinsic financial compensation. This does not mean that the incentive system should not have performance-based incentives, but if possible they should be tied to meeting the non-profit’s service goals. SOLUTIONS TO EXERCISES 20.38 (15 min) Balance scorecard perspectives. Following is one possible matching. Organizational learning and growth Employee satisfaction Employee turnover Business and production process efficiency Employee productivity On-time delivery performance from suppliers On-time delivery performance to customers Product quality Customer value Customer satisfaction Percent of customers who are repeat customers Financial performance Return on assets 20.39 (15 min) Balance scorecard perspectives. Following is one possible matching. Organizational learning and growth Percent of sales dollars invested in employee training Employee retention Business and production process efficiency Throughput time Ratings of supplier performance On-time delivery performance to customers Product quality Customer value Customer satisfaction Financial performance Return on sales Increase in market share 20.40 (20 min) Here is one possible ordering of the 15 items. There may be some that are simultaneous and some that are counted as overall outcomes comparable to profitability (e.g., compliance with environmental regulations). 1. Employee skills 2. Employee satisfaction 3. Anticipation of customer needs 4. Product innovations 5. Product quality 6. Compliance with environmental regulations 7. Supplier reliability and quality 8. Process efficiency 9. On-time deliveries 10. Customer satisfaction 11. Customer retention 12. Acquisition of new customers 13. Customer profitability 14. Market share 15. Overall profitability 20.41 (30 min) Learning and growth. Answers will vary. Presentations should include no more than 3 to 5 slides. Slides should not be packed margin to margin with text. Possible slide titles might be: Management of Learning and Growth at XYZ Corp Goals and Objectives of Learning and Growth at XYZ Corp Measures of Learning and Growth at XYZ Corp Effects of Managing Learning and Growth at XYZ Corp 20.42 (30 min) Customer satisfaction. Answers will vary. Summaries might be tabulated as follows: Firm Summary of Customer Satisfaction Management Goodyear Tire & Rubber Abercrombie & Fitch Southwest Airlines 20.43 (30 min) Customer Satisfaction. Answers will vary. Summaries might be tabulated as follows: Industry and Firm Summary of Customer Satisfaction Management Auto Mfg – Company ABC Coffee & Tea – Company QRS Life Insurance – Company XYZ 20.44 (30 min) Answers will vary. Presentations should include no more than 3 to 5 slides. Slides should not be packed margin to margin with text. Possible slide titles might be: Management of Customer Satisfaction at XYZ Corp Goals and Objectives of Customer Satisfaction at XYZ Corp Measures of Customer Satisfaction at XYZ Corp Effects of Managing of Customer Satisfaction at XYZ Corp 20.45 (30 min) Measuring customer satisfaction A B C D E F G 1 Customer satisfaction variable response 1 2 3 4 5 Score* 2 Automated bank services meet customer needs 16 25 22 22 15 2.95 3 Trust Bank services are superior to competitors’ services 8 17 24 36 15 3.33 4 Employees give prompt service 6 14 22 41 17 3.49 5 Employees are courteous and friendly 7 12 20 38 23 3.58 6 Employees can and do respond to special requests 12 26 20 21 21 3.13 * For example, the first score is computed as G2 = SUMPRODUCT($B$1:$F$1,B2:F2)/SUM(B2:F2). Other scores are computed similarly by copying the formula in G2 to cells G3, G4, G5, and G6. Responses indicate satisfaction with employees’ services, but less satisfaction with automated bank services and employees’ ability to respond to special requests. Both may be caused by inflexible, unresponsive information technology at the bank. 20.46 (30 min) Measuring customer satisfaction A B C D E F G 1 Customer Satisfaction Variable 1 2 3 4 5 Score 2 Montpelier’s products are defect-free 20 21 22 22 15 2.91 3 Mont.’s products are superior to competitors’ 8 17 24 36 15 3.33 4 Montpelier’s products perform reliably 6 14 22 41 17 3.49 5 Montpelier’s repair services are prompt 7 12 20 38 23 3.58 6 Mont.’s warranty is superior to competitors’ 12 21 20 26 21 3.23 * For example, the first score is computed as G2 = SUMPRODUCT($B$1:$F$1,B2:F2)/SUM(B2:F2). Other scores are computed similarly by copying the formula in G2 to cells G3, G4, G5, and G6. Responses indicate satisfaction with product performance and repairs, but less satisfaction with defects and warranty coverage. Product defects might be greater than the industry norm while warranty coverage is less than what competitors provide. Both problems are caused by poor product quality. 20.47. (30 min) Answers will vary. Presentations should include no more than 3 to 5 slides. Slides should not be packed margin to margin with text. Possible slide titles might be: Design of the Balanced Scorecard at XYZ Corp Implementation of the Balanced Scorecard at XYZ Corp Balanced Scorecard Use at XYZ Corp Effects of Using the Balanced Scorecard at XYZ Corp 20.48. (30 min) Answers will vary. Presentations should include no more than 3 to 5 slides. Slides should not be packed margin to margin with text. Possible slide titles might be: Balanced Scorecard Design Mistakes at XYZ Corp Balanced Scorecard Implementation Mistakes at XYZ Corp Impediments to Use of the Balanced Scorecard XYZ Corp Negative Impacts of the Balanced Scorecard at XYZ Corp 20.49 (20 min) Motivation and behavior. This is based on an actual situation, which caused disruption for a number of years, but also improved the university’s funding base and research reputation. Advantages of the new incentive plan include aligning faculty interests with those of the university administration and governing board, generation of research funds (a large percentage of which pays for other programs and services), and an improved research reputation. Disadvantages of the plan include disruption of teaching-oriented faculty careers, student programs, and the teaching reputation of the university. Research-oriented faculty generally command higher salaries and require laboratories and graduate students, often in advance of external research funding. So this strategy poses some risks if newly hired faculty members do not quickly generate external research funds. 20. 50 (20 min) Motivation and behavior. One way to increase ROI (and RI/EVA) is to eliminate assets that do not return at least their opportunity cost of capital. It is difficult to identify revenues added by support services, and many companies are tempted to outsource them to reduce the asset base. To be effective, however, the quality of service must remain high and costs of outsourced services must not be higher than internal services. These costs include service costs, the costs to monitor and administer contracts, and the opportunity costs of possibly outsourcing sensitive information. Following are some possible bullet points for a visual presentation • Costs and benefits of internal support services o Quantitative and qualitative • Costs and benefits of outsourced support services o Quantitative and qualitative • Evaluating tradeoffs of internal versus outsourced support services o Net quantitative benefits o Qualitative tradeoffs SOLUTIONS TO PROBLEMS 20.51 (30 min) Organizational learning and growth. Answers will vary. eToys personified e-commerce in the late 1990s and early 2000s – unlimited promise but less than stellar execution. KB Toys has acquired eToys allowing the virtual retailer to emulate more traditional retailers and build marketing, logistics and distribution skills that are more like WalMart. Thus, the company can benefit from skilled warehousing managers and employees, market researchers who can broaden the company’s product lines and appeal, and financial managers who understand and can work with financial markets. Lead indicators of employee capabilities might include prior positions and years of relevant experience of newly hired employees, formal training programs or hours, past accomplishments, and sources of specific employee suggestions. 20.52 (45 min) Evaluation of customer service. Current data: Annual sales $11,000,000 Average cost of sales as % of sales 60% Sales growth 3% Predictions related to new customer service: Increase in customer satisfaction 5% Software and training costs for new customer service $300,000 Ongoing operating costs for new customer service $2,500,000 Cost savings from reduction of email response service ($100,000) Additional sales growth 20% Without new customer service Year 1 Sales, $11,000,000 x (1 + 0.03) $ 11,330,000 Cost of sales @ 60% 6,798,000 Gross margin $4,532,000 With new customer service Sales, $11,000,000 x (1 + 0.03 + 0.20) $ 13,530,000 Cost of sales @60% 8,118,000 Gross margin 5,412,000 Change in gross margin $ 880,000 Changes in operating costs (assume other costs are unchanged) Software and training costs for new customer service 300,000 Ongoing operating costs for new customer service 2,500,000 Cost savings from reduction of email response service (100,000) Total increased operating costs 2,700,000 Difference in profit caused by new customer service -$1,820,000 Although the new customer service program might increase customer satisfaction, it does not improve profitability in the first year. If one extends the spreadsheet analysis to future years and makes conservative assumptions about annual changes in operating costs (e.g., 3%) and an assumption about continued annual sales growth (23%), benefits exceed costs in the third year. It does not become a positive NPV project (at 10%) until year 5. It’s this type of optimistic growth assumption that got so many e-tailers in trouble in the early 2000s. One can also perform sensitivity analysis on the assumed parameters, as explained in Chapter 12. Excel solutions are found on the chapter solutions manual opening screen 20.53 (45 min) Evaluation of customer service. Current data: Annual sales $15,000,000 Average cost of sales as % of sales 60% Sales growth 4% Predictions related to new customer service: Increase in customer satisfaction 10% Software and training costs for new customer service $300,000 Ongoing operating costs for new customer service $400,000 Cost savings from reduction of email response service ($100,000) Additional sales growth 6% Without new customer service Year 1 Sales, $15,000,000 x (1+ 0.04) $ 15,600,000 Cost of sales @60% 9,360,000 Gross margin $6,240,000 With new customer service Sales, $15,000,000 x (1+ 0.04 + 0.06) $ 16,500,000 Cost of sales @ 60% 9,900,000 Gross margin 6,600,000 Increase in gross margin 360,000 Changes in operating costs (assume other costs are unchanged) Software and training costs for new customer service 300,000 Ongoing operating costs for new customer service 400,000 Cost savings from reduction of email response service (100,000) Total increased operating costs 600,000 Difference in profit $ (240,000) Although the new customer service program might increase customer satisfaction, it does not improve profitability in the first year. If one extends the spreadsheet analysis to future years and makes conservative assumptions about annual changes in operating costs (e.g., 4%) and sales growth (10%), benefits exceed costs in the second year. It becomes a positive NPV project (at 10%) in year 3. One can also perform sensitivity analysis on the assumed parameters, as explained in Chapter 12. EXCEL SOLUTIONS ARE FOUND IN EXCEL SOLUTIONS FILE 20.54 (45 min) Evaluation of Learning and Growth improvements. This is a breakeven problem (Chapter 12) that incorporates the time-value of money (chapter 14). Solve for the breakeven annual benefit by first finding the present value of the costs over the six years. Equate this cost to the present value of the unknown annual benefit, which is the annuity factor for sums received at the end of each of five years plus 1 (for year 0). Solve for the equal annual benefit, as shown in the last row of the following table. EXCEL SOLUTIONS ARE FOUND IN EXCEL SOLUTIONS FILE 20.55 (45 min) Evaluation of Process Improvements. This is a breakeven problem (Chapter 12) that incorporates the time-value of money (chapter 14). Solve for the breakeven annual benefit by first finding the present value of the costs over the six years. Equate this cost to the present value of the unknown annual benefit, which is the annuity factor for sums received at the end of each of five years plus 1 (for year 0). Solve for the equal annual benefit, as shown in the last row of the following table. Year Year Year Year Year Year Investments in process improvements 0 1 2 3 4 5 Cost of capital 8% Robotic equipment $ 400,000 Computers & software 250,000 75,000 75,000 75,000 75,000 75,000 Training 40,000 40,000 40,000 40,000 40,000 40,000 Annual costs $ 690,000 115,000 115,000 115,000 115,000 115,000 Discount factor 1 0.92593 0.85733 0.79383 0.73503 0.680582 Present value of costs $1,149,162 Annuity factor, including year 0 4.9927 Breakeven annual benefit $ 230,168 EXCEL SOLUTIONS ARE FOUND IN EXCEL SOLUTIONS FILE 20.56 (40 min) Performance measurement. Answers will vary, but should outline the presentation of VCB’s scorecard development presented in the chapter. First, understand the organization’s strategy. Second, identify and develop measures that are appropriate for employee training and financial performance that are consistent with the strategy, environment, and financial constraints of the organization. Third, test for the validity of the relations between sets of measures statistically, if possible, or by thoroughly presenting and discussing proposed relations with affected and knowledgeable employees. A pilot test might be a prudent first application before committing to a large-scale implementation. 20.57 (20 min) Performance measurement. Answers will vary, but should recognize that the model is directly applicable to service organizations such as consulting firms. Simply replace “higher quality products” with “higher quality service” and the model fits service organizations, too. Measures in each box of the model will vary across manufacturing companies as well as across service companies. 20.58 (30 min) Implementation of balanced scorecards Answers will vary but should outline general principles presented in the chapter (and at the end of Chapter 1) about successfully introducing and leading change. Most likely, a top-down, forced design and implementation will not be successful and may explain why past management innovations were resisted as merely another fad. Enlisting store managers’ help to recognize problems with performance measurement and create solutions has been important in other settings. Mack may prefer to not label the effort as a balanced scorecard exercise, as some firms have also done, to lessen the chance that improving performance measurement will be seen as a fad. 20.59 (45 min +) Identify balanced scorecard measures Solving this problem could involve a purely “ivory tower” exercise, library or Internet research on actual performance measurement practices, or a small field study. If the last approach is used, note that many universities require prior approval by a human subjects research committee. Following are some questions successfully used by an author’s student groups to identify performance measures that are consistent with an organization’s strategy: 1. Could you describe your current position and work at XYZ? 2. Could you describe the purpose of the current performance measurement system? 3. Could you describe how often you use the current performance measurement system? If “Never” Why? Ask for conditions that inhibit use of performance measurement. Then skip to question 7 If “occasionally” or “often” Why? How? When? All or Part? Then continue to question 4. 4. What performance measures are most valuable? Why? 5. What performance measures are least valuable? Why? 6. What performance measures should be added? Why? 7. In your opinion and experience, what drives [product, program, new product, etc.] revenues? Are these drivers measurable? How? 8. In your opinion and experience, what drives [product, program, new product, etc.] costs? Are these drivers measurable? How? 9. What does the company do to improve a. Employees’ ability to develop new products? b. New product development processes? c. New products and services? d. Financial performance of new products? 10. Do you have any comments or recommendations for improving XYZ’s performance measurement system? 20.60 (45 min) Leading indicators of fraud Answers should incorporate the following lead indicators of vendor fraud from the article: • Unexpected increases in prices • Decreases in quality of goods or services • Noticeable changes in vendor’s lifestyle • Missing or altered documentation for services or goods • Multiple bills for same services or goods • Unusual transactions in purchases, accounts payable, accounts receivable and cash • Lack of separation of duties for above accounts • Inadequate authorizations and verifications for above accounts Lead indicators of fraud prevention include: • Corporate code of conduct • Employee training for dealing with vendors • Code of sanctions for fraudulent vendors • Reference checks on all vendors • Internal controls over disbursements • Staff rotation policy • Adequate internal audit function 20.61 (20 min) Leading and lagging indicators of casualty losses Answers will vary. Clearly insurers are concerned about expected impacts of global warming (e.g., more severe weather, rising sea levels) and are assessing their exposure to forest fire, flood, and storm damage. One might expect higher premiums or even un-insurability for some properties and business activities. 20.62 (30 min) Analyze alternative incentive system features a. Each of these four formulas sets a target for managers to hit. Three major issues are whether (1) managers can manipulate revenue unfairly, (2) the revenue target is attainable or unattainable, and (3) the bonus percentage is sufficient to motivate managers to exert effort. b. Advantages of the formula approach include use of an objective measure, clear expectations of performance, and predictable rewards. EXCEL SOLUTIONS ARE FOUND IN EXCEL SOLUTIONS FILE 20.63 (20 min) Analyze alternative incentive system features a. Each of these four formulas sets a target for managers to hit. Three major issues are whether (1) managers can manipulate defect rates unfairly, (2) the defect rate target is attainable or unattainable, and (3) the bonus percentage is sufficient to motivate managers to exert effort. b. Advantages of the formula approach include use of an objective measure, clear expectations of performance, and predictable rewards. EXCEL SOLUTIONS ARE FOUND IN EXCEL SOLUTIONS FILE 20.64 (25 min) Using performance measures as leading indicators a. Income before tax $ 1,500,000 Tax rate 35% WACC 15% Total assets $ 7,000,000 Current liabilities $ 1,000,000 Economic value added Income after tax, $1,500,000 x (1 – 0.35) $ 975,000 Investment, $7,000,000 – 1,000,000 6,000,000 Capital charge, 0.15 x 6,000,000 900,000 Economic value added, $975,000 – 900,000 $ 75,000 b. Most banks have policies that allow exceptions for customers with good loan histories and reputations. An exception might be appropriate in this case if the loan applicant can explain how and how quickly the new equipment will increase income. The new equipment will increase depreciation expense, so at the same level of revenue the company must reduce costs by at least $184,615 (3.51%) plus the net increase in depreciation. This required expense reduction is shown below with some more-or-less reasonable assumptions. This estimate also is conservative because the cost of new equipment was not included in total assets. Assumed WACC 15% Assumed tax rate 35% Assumed total assets (no change) $ 4,000,000 Assumed current liabilities 0 Capital charge (.15 x $4,000,000) 600,000 EVA (given) (120,000) Actual Required Operating income after tax, $600,000 – 120,000, $600,000 480,000 600,000 Operating income before tax, $480,000÷(1-0.35), $600,000÷(1-0.35) 738,462 923,077 Revenues (given) 6,000,000 6,000,000 Expenses 5,261,538 $ 5,076,923 Expense reduction target, $5,261,538 – 5,076,923 $ 184,615 3.51% EXCEL SOLUTIONS ARE FOUND IN EXCEL SOLUTIONS FILE 20.65 (20 min) Ethical impacts of alternative incentives The proposed change in incentive plan to use relative performance evaluation would probably be an improvement if division managers are not expected to seek new markets outside of the industry in which they operate. If that were the case, relative performance evaluation suffers because it does not motivate a manager to move outside of his or her existing industry. Thus, a division manager who performs reasonably well against the competition in a poor performing industry may not take the chance to move into a better industry where the manager may not perform as well against the tougher competitors. The company's proposed method of identifying peers is typical and appropriate. One difficulty with using other companies and their divisions as peers for the performance comparison is the difficulty in getting performance data. Publicly available data are limited. It would be possible to compare EVA results between the company's divisions and its peers, but difficult if not impossible to obtain data for balanced scorecard comparisons. 20.66 (40 min) Ethical impacts of alternative incentives a. Answers will vary. Our bias is that Toys R’ Us focuses on the short-run, whereas Cisco and United Way focus on the long-run. This bias is based on the comments of top managers. However, we are open to persuasion that our bias is incorrect. Here are a few examples: Because of problems with internet-based retailing, Toys R’ Us must make decisions about its future in retailing. Perhaps it should stress its physical store advantage over e-tailers and develop promotions to encourage parents to take children to stores. Stores could be configured to allow children to play with more durable toys. Cisco would continue its seminal work on internet-based hardware and software. It would anticipate a variety of products for various types of users. It would reduce costs. United Way would overcome negative publicity in previous years by building awareness of the benefits of its member organizations and by increasing the percentage of collected funds that reach intended individuals. b. The incentive plans would provide a large reward in the form of stocks and/or cash if the organization is performing well five to ten years in the future. Managements’ current earnings would be reduced. 20.67 (20 min) Ethical impacts of alternative incentives a. The bonus plan motivates financial fraud because such a substantial bonus is based on accounting numbers. b. It is generally easier to commit fraud in a remote location than when under the noses of top management. This is one reason why most companies keep the corporate financial offices at corporate headquarters. 20.68 (40 min) Ethical impacts of alternative incentives Reports will vary, but should attempt to describe the following table. Example entries from companies’ websites follow: Goals Objectives Incentives Patagonia Everyday, we strive to understand how we can best serve our community. Through our unique and diverse staff we offer excellent service and quality products while maintaining our commitment to the environment." In 1991, we started a comprehensive environmental review to examine all of the methods and materials used in our clothing. We promised to continue to seek those materials and processes that lessened our environmental impact. The Patagonia Internship Program offers eligible employees or groups the opportunity to take a paid leave of up to two months to work full- or part-time for a nonprofit group of their choice. Retail: Management of the retail store consistent with the short and long term interests of the company, its employees and the local environment in which we work and live. Consistently provide our customers the highest level of service possible. Achieve budgeted revenue goals and monitor expenses. Be a voice in the community on environmental and community issues by using the store as a theater to bring the issues to life to educate and inspire our customers. CitySoft CitySoft, a leading site development and management service provider, delivers high quality, cost appropriate Internet solutions to corporations, governments, and social enterprises. We have combined sound business practices with winning strategies to help organizations create and evolve their Web sites. Our strategy and advantage is rooted in our commitment to recruit talented people; to use efficient and well-developed service methodologies; and to provide attentive, responsive customer care. With these fundamental principles, we've built a foundation for success. Incentives for aggressive growth, strategic, financial, and business development, financial, accounting, tax, and operations functions, Working Assets Working Assets is a long distance, credit card, Internet services and broadcasting company that was created to build a world that is more just, humane and environmentally sustainable. Every year, a percentage of Working Assets revenue is placed in a donations pool for annual distribution. These funds come from the top line (sales), not bottom-line (profits), so donations are made whether or not we make a profit. All full-time positions at Working Assets include a generous benefits package, including: medical, dental, vision and life insurance; profit sharing; a 401(k) retirement plan; and public transit subsidies. Pride Industries Pride Industries' mission is simple and unchanging: to create jobs for people with disabilities. We measure our success by the number of jobs created, the quality of those jobs, the environment we create within our organization, the service we deliver to our customers, and our impact in the community. Implied incentives consistent with objectives SOLUTIONS TO CASES 20.69 (60 min) Corporate intelligence and leading indicators of performance a. An abundance of sites exist on the WWW devoted to corporate intelligence – search on “corporate intelligence” and “information broker.” b. Corporate intelligence, when used legally and ethically, can be justified to provide valuable and important information about competitors, potential employees or partners, and government regulatory activities. Using publicly available information and legal investigative techniques to develop strategic information is allowed, and may be necessary in some situations. Melcher’s planned ambush appears to be close to an unethical practice (it is at least distasteful), though probably not illegal unless the information is obtained from competitors’ proprietary files. Hiring an agent to do something illegal also does not absolve Melcher or IFI from responsibility if the agent discloses his or her tactics and Melcher approves. c. Answers will vary, but should consider the costs and benefits of corporate intelligence. 20.70 (45 min) Implementation of balanced scorecard measures a. This will be an opinion because there is not much evidence for or against the argument that balanced scorecard relations among areas of performance must be quantified to be useful. Relationships among drivers of value can be derived logically and with sufficient data could be estimated statistically. If the logic is strong and based on real understanding of the organization and its environment (similar to building a valid theory), it seems plausible that non-quantified relationships still could be useful management guides. b. The categories of performance are not labeled precisely the same as in the chapter, but it appears that all four categories are represented. If “lead by innovation” reflects organizational growth and employee capabilities, there are not measures relating directly to human capital itself. Other than that, though one could always offer more measures, it appears that most major activities are covered. Other biotechnology companies, such as Amgen, discuss the importance of basic research, keeping the product “pipeline” filled, and licensing new knowledge from universities. Conceivably, these could be measured, too. c. Answers will vary. 20.71 (30 min) Impacts of a balanced scorecard in a university a. Some organizations are concerned that names of new programs label them as the latest fads and that employees will automatically resist them for that reason. Part of this is the well-documented NIH syndrome (not invented here), that causes many to resist imported solutions. Believe it or not, university employees are among the most resistant to change and many non-business faculty might automatically reject the application of a “corporate” model to a university setting. It has happened before. b. Many large organizations experiment with pilot projects to evaluate the feasibility of new management programs or solutions. It is far easier to design and implement something like the balanced scorecard on a small scale. A danger of relying on the results of a pilot project for more extensive applications is that the subunit used for the pilot project might not be representative of other subunits or the organization as a whole. Thus, it pays to be cautious even after a successful pilot project. Because the university’s support services are similar to those found in businesses, the results of the reported pilot study may be more applicable to other support services. On the other hand, applying the pilot study results to an academic unit might be much more difficult because the goals and objectives of an academic unit are likely to be greatly different than those of a support service. The concept of a balanced scorecard might be applicable, but the design and implementation details surely will differ. c. The authors clearly love universities and have chosen to spend our professional lives in them. However, the many differences between universities and businesses or even many non-profit and governmental organizations will make application of the balanced scorecard quite difficult. For example, some describe university faculty as independent agents who conduct their research and teaching without regard to any explicit overall goals or objectives beyond considerations of quality. While this might be a bit of an overstatement, most faculty resist being told what to do or how to do it. Whether this is a sustainable organizational model in the era of electronic education is an interesting issue, but beyond this discussion. The general lesson is that importing successful management techniques to new types of organizations is bound to be difficult. 20.72 (150 min) Analyze impacts of a quantified balanced scorecard EXCEL SOLUTIONS ARE FOUND IN EXCEL SOLUTIONS FILE This extensive case mirrors the development of an actual balanced scorecard. This semi-structured task can be used as a major class project, covering a week or more. Completion of the final requirement involves statistical analyses that can range from rudimentary to complex. Data should be provided to students in electronic form. Answers to all requirements can vary greatly. Requirement 1: The text provides a summary of the balanced scorecard, but more detail is available in the literature. Of course, Kaplan and Norton’s 1996 and 2000 books are primary sources of their recommended approaches. Key points that memos should cover include: importance of refining strategy, reflecting strategy in operational measures, combining the measures in a way that communicates the organization’s “story of success,” and involving employees in a meaningful way. The completed scorecard is an ongoing experiment that is used for planning but is revised as conditions and knowledge changes. Less clear is how and whether the balanced scorecard should be used as a performance evaluation device. Requirement 2: The three interviewed executives have voiced common, valid concerns about the balanced scorecard. Statistical analysis of historical data is filled with pitfalls as well as opportunities. Having sufficient valid data is a major concern of anyone who attempts this type analysis. One executive told an author that he would rather be using data that is 50 percent correct (meaning data that is relevant but probably inaccurate) than data that he knows is 100 percent incorrect (meaning irrelevant data). One needs to start somewhere, and that state is usually less than ideal. Often the initial scorecards are based on employees’ understanding of the organization’s “business model” and how making changes in one area of performance should affect other areas. As performance measures are developed and more data are collected, these propositions might be tested statistically. If, as is usually the case, organizations learn from using the scorecard and change processes and activities, historical data can become obsolete. This makes investigating any time lags among the model’s various lead and lag indicators quite difficult if not impossible. Bemoaning the inability to conduct statistical tests might miss the point if the organization really is learning and changing as a result of the new scorecard. Managers always must make decisions on less than perfect information, and a balanced scorecard will never be perfect. Managers do pay attention to what is measured, particularly if the measures are the basis for evaluations or compensation. Research shows that “soft” measures (e.g., subjective measures) can be the source of much conflict, gaming, and manipulation if they are used for evaluation and compensation (see Ittner et al, 2000 and Malina and Selto, 2001). Organizations should think very carefully before using the balanced scorecard, which might be a valid conceptual and communication tool, as its performance evaluation and bonus compensation device. Requirement 3: The interviews reveal a number of potential measures that might be linked in a balanced scorecard. These include: • Cost of labor • Skill, training, and knowledge of employees • Process errors or defects • Cycle time • Service quality • On-time delivery • Customer satisfaction • Return on assets • Economic value added • Employee voluntary turnover rate • Regional population One of many possible models relating these measures follows: Requirement 4: The available data for the 18 divisions of SecondData Corp. are cross-sectional in nature. Using these data to test the scorecard relations assumes that divisions are similar, except for age and regional population. Using these data also assume that the measures are accurate proxies of the underlying factors that describe the company’s strategic activities and performance. One obvious deficiency is the lack of time-series data, which are necessary to test for lead and lag relations. It is difficult to establish causal relations without evidence of lead and lag relations. Also missing are (1) the company’s opportunity rate, which is required to compute residual income or economic value added, (2) measures of process errors distinct from service errors, and (3) customers’ perception of quality distinct from customer satisfaction. Credibility of the model depends on its internal logic and the reasonableness of any confirmed contemporaneous relations. Statistical analyses of the data are restricted here to correlations and linear regressions within each scorecard area and across no more than two adjacent areas. These restrictions are for three reasons. First, absence of time-series data prevents valid causal modeling because it is highly unlikely that all effects are contemporaneous, even in the annual data provided. Second, this text has not used software beyond MS Excel, which has many statistical analysis tools, but does not have causal modeling. Third, it is unlikely that most students using this text have had exposure to causal modeling. However, these constraints should not restrict use of causal modeling tools if students and instructors desire to use them. The table shown is a correlation matrix of all available data plus computed ROA. Correlation coefficients that exceed 0.40 are highlighted, except those that are purely mechanical (i.e., involving ROA and its components). This table indicates some relations that are consistent with the interview data, but, as is usually the case with real data, the relations are not as strong as one expects if the interviews and data fully describe the company’s “story of success.” These data suggest the following relations: • Employee grade level is negatively related to division age and number of employees, but this seems unrelated to management actions. It suggests more, less educated employees are used by older divisions, perhaps because they are less capital-intensive (also suggested by the negative correlation between division age and assets employed). • Voluntary turnover rate is negatively related to average hourly wage. • Average defects per month are negatively related to average grade level of employees. • Average cycle time per order is positively related to average defects per month. • Percentage on-time deliveries is negatively related to cycle time. • Customer satisfaction is positively related to division age, negatively related to cycle time, and positively related to percent on-time deliveries. • ROA (computed as throughput less operating expense divided by assets employed) is positively related to division age, negatively related to average hourly wage, and positively related to customer satisfaction. The incomplete “story” that emerges from these preliminary analyses is this: Divisions that achieve the highest financial performance (ROA) are older and have high customer satisfaction scores. These divisions have achieved higher customer satisfaction because of long-standing relations with customers and have managed defects and on-time deliveries. On-time deliveries are the result of controlling cycle time, which requires controlling defects. More highly educated employees favorably affect defect rates. These findings are not completely internally consistent because older divisions have less educated employees. However, this story is partially consistent with the interview data, but insufficient data are available to fully test or better describe this company’s strategic activities with a single causal model. Analyses of individual areas follow. Age of division (years) Number of employees Voluntary turnover rate Average grade level completed Average hourly wage Average defects per month Cycle time per order (hours) Percent on-time deliveries Customer satisfaction score Regional population (000) Through-put ($millions) Operating expense ($millions) Assets employed ($millions) ROA Age of division (years) 1 Number of employees 0.189 1 Voluntary turnover rate 0.368 0.172 1 Average grade level completed -0.433 -0.446 -0.360 1 Average hourly wage -0.326 -0.048 -0.426 0.099 1 Average defects per month 0.206 0.174 0.165 -0.590 -0.146 1 Cycle time per order (hours) -0.179 0.083 0.105 -0.131 -0.124 0.473 1 Percentage on-time deliveries 0.350 0.008 0.190 -0.045 -0.059 -0.199 -0.772 1 Customer satisfaction score 0.542 -0.104 0.336 -0.076 -0.280 -0.002 -0.524 0.647 1 Regional population (thousands) 0.191 0.481 0.072 -0.266 -0.113 -0.102 -0.043 0.195 0.141 1 Throughput ($millions) 0.025 0.248 -0.051 0.099 -0.105 -0.431 -0.292 -0.003 0.134 0.561 1 Operating expense ($millions) -0.315 0.529 -0.334 0.037 0.642 -0.084 0.068 -0.234 -0.298 0.317 0.229 1 Assets employed ($millions) -0.530 -0.415 -0.379 0.441 0.194 -0.071 0.314 -0.423 -0.358 -0.237 -0.165 0.105 1 ROA 0.450 -0.106 0.311 -0.195 -0.555 -0.071 -0.267 0.330 0.464 0.135 0.386 -0.660 -0.570 1 Analysis of learning and growth area. Correlation analysis of data that might describe this area of the scorecard is not promising. Typically, this is the most difficult area to describe statistically because good measures of learning and growth are difficult to obtain. The correlation results below indicate a link between average hourly wage and voluntary turnover rate that is in the right direction (r = -0.43), but little else. Higher average wages are associated with lower voluntary turnover. Simple and multiple regression analyses confirm the general lack of explanation of this performance area by the available data. Correlation analysis Average hourly wage Regional population (thousands) Age of division (years) Voluntary turnover rate Average grade level completed Average hourly wage 1 Regional population (thousands) -0.1134989 1 Age of division (years) -0.3257401 0.19121221 1 Voluntary turnover rate -0.4262368 0.07210718 0.3679 1 Average grade level completed 0.0986266 -0.26552844 -0.43269 -0.3595905 1 Analysis of business and production process area. Correlation analysis of data that might describe this area of the scorecard is promising. There is a strong, intuitive relation between cycle time and on-time deliveries (r = -0.77) and a possible link between average defects and cycle time that also is intuitive (r = 0.47). Simple and multiple regression analyses confirm that the following simple relations are the statistically significant relations. Correlation analysis Average defects per month Cycle time per order (hours) Percentage on-time deliveries Average defects per month 1 Cycle time per order (hours) 0.47280699 1 Percentage on-time deliveries -0.1989075 -0.77217666 1 Regression analyses Dependent variable = Cycle time Regression Statistics Multiple R 0.47280699 R Square 0.22354645 Adjusted R Square 0.1750181 Standard Error 6.68867438 Observations 18 ANOVA df SS MS F Significance of F Regression 1 206.08785 206.0878498 4.606512774 0.04753132 Residual 16 715.81384 44.73836498 Total 17 921.90169 Coefficients Standard Error t Stat P-value Intercept 27.0154591 15.3322952 1.761997059 0.097160954 Average defects per month 0.21710987 0.10115641 2.14627882 0.047531319 This output is expressed in equation form as follows: Cycle time (hours) = 27.02 hours + 0.217 hours/defect x Average defects per month Dependent variable = On-time deliveries Regression Statistics Multiple R 0.77217666 R Square 0.5962568 Adjusted R Square 0.57102285 Standard Error 0.01748952 Observations 18 ANOVA df SS MS F Significance F Regression 1 0.0072277 0.00722776 23.62915013 0.00017341 Residual 16 0.0048941 0.00030588 Total 17 0.0121219 Coefficients Standard Error t Stat P-value Intercept 0.98624741 0.0346621 28.4531666 3.94228E-15 Cycle time per order (hours) -0.0028 0.0005760 -4.86098242 0.000173408 This result expressed in equation form follows: On-time delivery (percent) = 98.6% - 0.0028/hour x Cycle time (hours) Analysis of customer value area. Only one measure of customer value is available, Customer satisfaction scores. Analysis of financial performance area. Only one measure of financial performance is available, Return on assets. Analysis of relations between Learning and growth and Business and production process areas Dependent variable = Average defects per month Regression Statistics Multiple R 0.590377446 R Square 0.348545528 Adjusted R Square 0.307829624 Standard Error 13.34223764 Observations 18 ANOVA df SS MS F Significance F Regression 1 1523.88703 1523.887026 8.560427009 0.00989583 Residual 16 2848.24488 178.0153051 Total 17 4372.13191 Coefficients Standard Error t Stat P-value Intercept 321.5245844 58.4470268 5.501128146 4.83481E-05 Average grade level completed -15.61385721 5.33657342 -2.92582074 0.009895829 This result in equation form is: Average defects per month = 321.5 – 15.61 defects/grade level x Average grade level completed Analysis of relations between Business and production process and Customer value areas. Although the customer satisfaction score is related to both on-time deliveries and cycle time, these two explanatory variables contain redundant information. In a multiple regression, only on-time deliveries are significant. Only the simple regression is shown. Dependent variable = Customer satisfaction Regression Statistics Multiple R 0.647431772 R Square 0.4191679 Adjusted R Square 0.382865894 Standard Error 5.152248622 Observations 18 ANOVA df SS MS F Significance F Regression 1 306.514492 306.514492 11.54668689 0.00367532 Residual 16 424.730654 26.54566586 Total 17 731.245146 Coefficients Standard Error t Stat P-value Intercept -48.7955415 38.3431219 -1.27260221 0.221342168 Percentage on-time deliveries 159.0157723 46.7962991 3.398041626 0.003675323 This result expressed as an equation is: Customer satisfaction score = - 48.8 + 159.02 points per percentage point x Percent on-time deliveries. Analysis of relations between Customer value and Financial performance areas. Correlation analysis does not indicate extensive relations of ROA with other data. The most plausible (but not most statistically significant) regression follows: Dependent variable = ROA Regression Statistics Multiple R 0.464368897 R Square 0.215638473 Adjusted R Square 0.166615877 Standard Error 0.086280342 Observations 18 ANOVA df SS MS F Significance F Regression 1 0.03274565 0.032745654 4.398756754 0.05220692 Residual 16 0.11910876 0.007444297 Total 17 0.15185441 Coefficients Standard Error t Stat P-value Intercept -0.434198895 0.26061199 -1.66607413 0.115152471 Customer satisfaction score 0.006691837 0.00319066 2.097321328 0.052206918 In equation form, this result is: ROA = - 0.434 + 0.0067 x Customer satisfaction score Summary The preliminary data analysis suggests a slightly modified model (shown on the next page) that fits with interview data, but does not fully describe the company’s activities. The company should consider developing refined or different measures in each area and should collect data over time. Nonetheless, the available data suggest the possibility of a much-improved model, and the company should be encouraged to continue its efforts. Revised scorecard model based on preliminary data analysis 20.73 (45 min) Alternative incentives from proxy statements Presentations will vary. Following is a paraphrase from Kodak’s proxy statement. • Three-year performance cycle for senior executives • Performance goal is total shareholder return equal to at least that earned over the same period by 50th percentile firm within the S&P 500 Composite Stock Price Index • No award is paid unless the performance goal is achieved; 50% is earned if the performance goal is achieved; 100% is earned if performance equals the 60th percentile firm • The compensation committee can reduce or eliminate any participant’s award based on any appropriate criteria • Awards are paid as restricted stock, which restrictions lapse at age 60 • A table shows the threshold (i.e., attainment of the performance goal), target and maximum number of shares for the Chief Executive Officer and the other named executive officers for each cycle 20.74 (45 min) Pay for performance EXCEL SOLUTIONS ARE FOUND IN EXCEL SOLUTIONS FILE a. Performance area Performance measure Current Bonzo average Current Industry 90th percentile Employee productivity Sales per employee $175,000 $200,000 Product quality Customer-found defect rate 2.00% 0.02% Customer satisfaction Customer satisfaction score (1 to 100) 72 89 Profitability Return on investment 10.30% 30% Performance measure Low performers Medium performers High performers Number of divisions 6 10 4 Sales per employee 158,333 $175,000 $200,000 Customer-found defect rate 3.33% 2.00% 0.01% Customer satisfaction score (1 to 100) 59 72 92 Return on investment -9.50% 10.30% 40% Average salary $ 75,000.00 $ 75,000.00 $ 75,000.00 Bonus percentage 1% 1% 1% Average bonus amount $ - $ - $ 2,250.00 Total bonus amount $ - $ - $ 13,500.00 If all are high performers $ 45,000.00 b. Performance measure Low performers Medium performers High performers Number of divisions 4 10 6 Sales per employee 158,333 $175,000 $200,000 Customer-found defect rate 3.33% 2.00% 0.01% Customer satisfaction score (1 to 100) 59 72 92 Return on investment -9.50% 10.30% 40% Average salary $ 75,000.00 $ 75,000.00 $ 75,000.00 Bonus percentage 1% 1% 1% Average bonus amount $ - $ - $ 2,250.00 Total bonus amount $ - $ - $ 13,500.00 If all are high performers $ 45,000.00 c. The bonuses seem rather low for the level of achievements. Perhaps the bonus percentages should be increased. Other issues relate to the achievability of goals and linkage of performance to rewards, which are out of reach for some divisions. Perhaps the company should consider a plan that does reward improvement as a way to motivate low performing divisions to improve. d. Possibilities abound, but here is one. Benchmarking against the industry is a good idea and the company could grant bonuses for moving up in the industry percentiles, but also require steady progress (e.g., gains in all goals 2 out of 3 years). One has to be careful to keep bonuses relatively high for absolute high performers. 20.75 (60 min) Incentive system design. a. This case is taken from life and was motivated by a conversation an author had with one of the founders of CMP Media. When asked how the company measured performance against its operating principles, he replied that they made no measures other than traditional financial measures. Because the company was small and family owned, they had never felt a need to measure progress in such areas as “be an excellent company to work for…” These things were understood and referred to in every operational and strategic decision. However, now that CMP Media is owned by a more bottom-line oriented company and following the bust in the technology sector, CMP Media predictably was feeling pressure to focus more on financial performance. The case puts students in the role of consultants to design a more explicit incentive system and form it in balanced scorecard format. The instructor should expect great variation in solutions, but some common elements should include: b. Completed table (or narrative) that describes how operating principles are translated into objectives, performance measures and incentives. The chapter’s discussion of incentive systems illustrates differences for workers, managers, and executives. Application of lessons of motivation implies that workers should have incentives based on measures close to their activities, whereas managers and executives might have incentives based on more aggregate performance. c. Discussions of tradeoffs among performance measures. Evaluating individuals on multiple performance measures can create conflicts. If incentives are formula-based, individuals might focus on the easiest measures to manage. In part, this might explain why some incentive systems continue to be based primarily on high-level financial performance, which forces employees to figure out favorable tradeoffs, but also might create short-run, myopic decisions. d. A graphical representation of the incentive system in balanced scorecard format, similar to those in the chapter. Solution Manual for Cost Management: Strategies for Business Decisions Ronald W. Hilton, Michael W. Maher, Frank H. Selto 9780073526805, 9780072430332, 9780072830088, 9780072299021, 9780072881820, 9780072882551, 9780070874664, 9780072388404, 9780072343533