In order to assess whether or not performance improvement is taking place, one should be able to measure performance. Carleton (2009:37) observed that “experts and CEOs have long told us that what gets measured gets done. What we measure is what matters”. Neely (2007) defines measurement as the process of assigning numbers to things in such a way that the relationships of the numbers reflect the relationships of the attributes of the things being measured. Moullin (2003:3) citing Neely (1998), described performance measurement as “the process of quantifying the efficiency and effectiveness of past actions through acquisition, collation, sorting, analysis, interpretation and dissemination of appropriate data”. A performance measure therefore
is a metric used to quantify the efficiency and effectiveness of an action. The objective and context must be clearly defined in order to measure an organization's performance.
According to Neely (1999), the question of how business performance can be measured is complicated by two factors:
i) It is not always obvious which measures a firm should adopt ii) The measures that are most relevant to the firm change over time.
Researchers that have studied the measurement of firm performance have classified performance measures as either traditional or non-traditional.
2.5.2.1
Traditional Measures of PerformanceTangen (2004) observes that despite the remarkable progress made in recent years in performance measurement, many organizations are still primarily relying on traditional financial performance measures. Earlier, Chakravarthy (1986) made a similar observation stating that performance measurement has developed using profitability indicators as key measures. These included quantitative measures such as Return on Investment, Return on Sales, Growth in Revenues, Cash Flow /Investment, Market Share, Market Share Gain, Product Quality relative to Competitors, Product R&D, Variations in Return on Investment, Percentage Point Change in Return on Investment, Percentage Point Change in Cash Flow /Investment. Of all these quantitative measures, Chakravarthy identified Return on Investment, Return on Sales and Cash flow to Investment as the most important financial measures of performance. However, he observed that none of these measures of profitability was able to clearly distinguish ‘excellent’ firms from ‘non-excellent’ ones, where excellent firms are those that were considered to be best performers and non-excellent firms were considered to be poor performers.
Traditional accounting-based performance measures have many limitations including: too historical and backward-looking, lacking predictive ability to explain future performance, rewarding short-term or incorrect behavior, lacking actionability, lacking
timely signals, too aggregated and summarized to guide managerial action, reflecting functions instead of cross-functional processes, and giving inadequate guidance to evaluate intangible assets (Ittner and Larcker, 1998). Chakravarthy (1986) also adds that accounting measures of performance record only the history of a firm. However, monitoring of a firm’s strategy requires measures that can also capture its potential for performance in the future.
Henri (2004) citing Atkinson et al. (1997) concluded that performance measurement systems based primarily on financial performance measures lack the focus and robustness needed for internal management and control. Kaplan and Norton (1992:71) argue that such measures “worked well for the industrial era, but they are out of step with the skills and competencies companies are trying to master today”. Therefore, in this research study, traditional financial measures will not be relied upon completely for the reasons highlighted.
2.5.2.2
Non-traditional Measures of performanceAccording to Aziz and Mahmood (2011), firm performance can be attributed to internal and external factors of the firm. They explain that past studies have shown positive relationships between entrepreneurial orientation and firm performance. They have also shown that market orientation, strategic planning and innovation also affect firm performance. Aziz and Mahmood cite studies by Malone et al., (2006) and Zott & Amit (2007) as suggesting that the business model plays a significant role in determining the firm’s performance.
Aziz and Mahmood (2011) citing Bagozzi and Phillips, 1982; Benson, 1974; Keats, 1983; Chakravarthy, 1986 have also argued that instead of searching for a single measure which most significantly determines performance, a multi-factor model of performance assessment should be used. Their argument is based on the fact that excellence is a complex phenomenon requiring more than a single criterion to define it. Other researchers (Barnard, 1938, and Chakravarthy, 1986) argue that a truly excellent
firm must also balance the competing claims of its various other stakeholders in order to ensure their continuing cooperation.
The profit performance of a firm and the strategies that it pursues can often be interpreted differently by the firm’s multiple stakeholders. For example, investors may welcome a firm’s shift to robotics in its manufacturing plans, while the workers union may find the option unacceptable. The community at large may be unhappy with the option’s impact on the local economy. Freeman (1984) as cited by Aziz and Mahmood (2011) maintains that the increasing power of various stakeholder groups and their multiple, contradictory and often changing preferences highlight the need to address their satisfaction.
In order to take into account the competing claims of all stakeholders in an enterprise, it is necessary to use both financial and non-financial performance measures. Chakravarthy (1986:449) supports this view arguing that “maximizing stockholder wealth should not be the sole guiding principle of ‘excellent’ companies. A necessary condition for excellence is the continued cooperation of the firm’s multiple stakeholders. Minimizing their dissatisfaction should be a concurrent objective of ‘excellent’ companies”. Therefore, it is important for firms to also use non-financial performance measures.
Ittner & Larcker (2003:2) have observed that “Increasing numbers of companies have been measuring customer loyalty, employee satisfaction, and other performance areas that are not financial but that they believe ultimately affect profitability”. Managers can therefore get a glimpse of the progress being made by the business well before a financial verdict is pronounced and the soundness of their investment allocation becomes a focus for discussion. Investors can also have a better sense of the company’s overall performance because non-financial indicators usually reflect spheres of intangible value that accounting rules do not recognize as assets. Ittner & Larcker also discovered that those companies in their study that adopted non-financial measures and then established a causal link between those measures and financial
outcomes produced significantly higher returns on assets and returns on equity over a five-year period than those that did not. Thus establishing a causal link between non- financial and financial measures is a key to successful performance measurement. In the absence of such causal links, management simply relies on its preconceptions about what is important to customers, employees, suppliers, investors and other stakeholders rather than verifying whether those assumptions had any basis and this can lead to measuring aspects of performance that do not matter very much.