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Vector-Based Performance Measurement: Linking the Subjective and Objective Dimension into One System of Performance Measurement

News categories: The New Economy Economics, Finance and Acounting, Performance Management and Controlling

 

by    Juergen H. Daum, SAP AG, Walldorf, Germany1 and 
        Peter Bretscher, Ing. Büro für Wirtschaftsentwicklung, Eggersriet, Switzerland2

 

 

The concept of Vector-Based Performance Measurement is a brand new and innovative way of performance measurement & visualisation that has been developed specifically to deal with the managerial challenges of the global knowledge economy.

 

It has been presented publicly for the first time at the PMA 2004 Conference in Edinburgh, UK (29-30 July 2004). The following article is the long version of the paper that has been submitted by Juergen Daum and Peter Bretscher and that has been published in the conference book:  Andy Neely, Mike Kennerley and Angela Walters (Editors from the Cranfield School of Management): Performance Measurement and Management: Public and Private, 28-30 July 2004, Edinburgh, UK, ISBN 0 9533761 3 3.

 

Paper (long version) as PDF file                                

 

Presentation of the concept by Juergen H. Daum at the conference (Winzip file of PDF)

 

 

Here the HTML version of the paper:

 

 

Abstract:

 

Today, customers or other important stakeholders demand that businesses or non-profit organizations act according to their stakeholder’s subjective, qualitative values and criteria. Organizations therefore must take increasingly qualitative, subjective ratings and values into account in managerial decision-making. They need performance measurement systems that are able to handle subjective, qualitative measures and to combine them with quantitative, i.e. financial information. The vector-based concept of performance measurement & visualization introduced in this paper offers a practical solution that can be applied for example in public service organizations or to support R&D management of a software company.    

 

 

Table of Content:
Introduction and Problem Description

The Concept of Vector-Based Performance Measurement & Visualization

Practical Application Cases of the Concept

Conclusion and Outlook

About the Authors

Additional Ressources

 

 

Introduction and Problem Description

 

As long as demand exceeded supply, management’s attention was focused on efficient production processes and efficient resource utilization: the focus was on internal efficiency. This is reflected in traditional financial control-based[1] performance measurement concepts where the emphasis is on costs and return on capital – that is, on efficiency measured in “objective” financial terms.

 

However, this proven and practical model for evaluating and managing the performance of organizations is falling short today. When supply began to exceed demand in the industrialized economies (beginning in the 1970s), organizations started to compete more and more on quality, differentiation, and customer satisfaction, rather than only on cost/financial efficiency. The ability to create a positive “effect” for customers from their “subjective” perspective – and increasingly for other stakeholder groups that today have power over the “license to operate” of an organization – became the critical success and survival factor for any organization, whether business or non-profit (Daum, 2002).

 

Efficiency is still important today, but it no longer creates competitive advantage. The main driver for competitive advantage today is what we call external effectiveness, which is effectiveness from a subjective stakeholder perspective. This becomes obvious especially in the service sector,  particularly in public services, where for centuries organizations have been managed only on the basis of budgets and funds. But today, when citizens are expecting more value for the taxes they pay, these organizations need something more than just the budget to optimize their operations and create value for their “customers”.

 

Performance of an organization can no longer be defined and expressed just in financials terms (profit / return on investment for commercial organizations or meeting the budget for a public service organization). As long as performance measurement systems are still based mainly on financial information[2], they are too exclusively focused on financial efficiency and ignore the external effectiveness of an organization.

 

Instead, we need performance measurement systems that are able to express subjective valuations, experiences, and ratings in a way, that an organization is able to combine it with quantitative, financial information. In addition, the result has to be easy to understand and “manageable” from a managerial perspective, meaning that measurement is scalable (independent of time and location), and that it can be aggregated and de-aggregated so that it can be used across the entire organization, linking different areas of measurement into one system of performance measurement .

 

The vector-based concept of performance measurement and visualization that we describe in this paper offersing a practical solution to this problem.

 

 

Requirements for an Alternative Concept of Performance Measurement

 

Subjective measurement systems based on qualitative “measures” are nothing new. In fact they are at the root of many of our objective quantitative measurement systems to which we have become so accustomed used to that we sometimes forget that they didn’t exist 200 or 300 hundred years ago.

 

One example is how we measure temperature. Before the advent of we had our current today's objective, quantitative temperature measurement systems, people have been used for millenniaums to “measured” and defined temperature by categories like “cold” and “warm” – measures that need subjective interpretation and that are highly context sensitive (“cold” in Norway probably means something different than “cold” in Italy). It was not until only in the 17th/ and 18th centuriesy when Réaumur (1683-1757), Fahrenheit (1686-1786) and Celsius (1704-1744) introduced the first standard temperature scales that were based oriented on natural and /common temperature reference fix points ( like such as the temperature of the human body or the dew point and freezing point temperature when of water) is transformed from a fluid state to vapor or ice, so that people have been able to measure and compare temperature through with an objective measurement system that is that is based on context and interpretation independent interpretation independent measurement scales. And it was not only until in the 19th century that Kelvin (1824-1907) developed the Kelvin -scale – a measurement concept which of which no scientist today (e.g. in physics) can imagine to live without it.

 

Subjective, qualitative measurement systems are still typically used – also today - when qualitative criteria are the focus in the measurement or/ valuation process that require interpretation through third-party experts or external company stakeholders. An example for of a qualitative measurement system is the rating of a company’s credit worthiness by Standard & Poor's (S&P) with ratings ranging from “AAA” to “D”. While S&P has probably has internal rules and standard procedures governing how they rate a companiesy, the rating results are nevertheless “subjective”: they are based on a S&P's -specific valuation/measurement methods and on personal qualitative expert -judgments by the analysts in charge are required. Because no objective measurement scale for the credit worthiness of a company exists (at least not yet), the S&P rating cannot be compared directly with the ranking of e.g. another rating agenciesy or with the rating of a company's e.g. the housebank of a company. Nevertheless,  is the S&P rating is widely accepted and provides useful information about a company for capital market participants or suppliers.  

 

Subjective, qualitative measurements are made every day  happens also, when individual stakeholders, such as customers or investors, value what a company is offering to them. Every customer places a is valueing on the products or services offered according to subjective qualitative criteria. That valuation is drivesing his the customer's or her decision to buy or not to buy at it for a specific price. Suppose Consider Mrs. Miller who is intending to buy a new dress. What might drive her decision to buy it from a designer boutique, where the price is where twice as high as she has to pay double of the price at than at an ordinary department store – even if the production costs of the dress of the boutique dress are is the same as of that of the dress from the department store dress? Decisive factors might include be that the dress from the boutique dress corresponds more with the latest international fashion trends, that its color is her favorite color, that it carries the name of a famous designer, that she is treated differently at the boutique than at the department store, and so on etc. – all intangible, qualitative values. But the willingness to pay a specific price- premium will probably differs from person to person, as everyone person has a different set of personal qualitative (i.e. subjective) valuation criteria. That is also true for investors who considering whether or not to invest in a company: . Ddifferent investors have different strategies and objectives that create a different context for that investment and thus different criteria and different subjective values.

 

 

The Concept of Vector-Based Performance Measurement & Visualization

 

Since supply exceeded demand in the industrialized economies, subjective, qualitative factors, the intangibles, become at least as critical as the quantitative, objective (financial) factors in managerial decision making, because in a supply rich economy customers and other stakeholder have a choice: they can choose between various offers, and that means they are able to invest in a company or  buy something that is more in line with their personal, subjective qualitative value scale than other offerings. Thisat doesn’t mean that the quantitative, objective measurement that the financials provide (e.g. costs, price – all measured in monetary units that allow objective comparison independent from context and subjective interpretation) become irrelevant. It is still an important measurement of performance. But it covers only one dimension: the dimension of economic/financial efficiency. Missing is the dimension of external non-financial effectiveness from a subjective stakeholder perspective.

 

Only if we take both dimensions into consideration are , we are able to assess the true performance of a company, a business unit, a product line, or even of a public service organization. We consider the vector-based approach to performance measurement & visualization as a good method to do that in a systematic way and allow aggregations and de-aggregations (that is mathematical operations) on the compound result, which we define as the total or compound performance.

 

 

The Bbasics of the cConcept

 

The intention of the vector-based concept for performance measurement is to combine subjective, qualitative measurement of performance with objective, qualitative measurement of performance in a such a way, so that total or compound performance (the compound of qualitative and quantitative performance) can be easily calculated and visualized. The solution is the concept of vector-based measurement and visualization of performance (Bretscher, 1996, 1998).

 

The basic principle of the concepet is simple (see diagram 1): 

 

The third dimension (the length of the vector = v) represents the absolute total performance, the compound result of qualitative and quantitative performance. It can be calculated as:
. The gradient of the vector can provide users with additional relative performance information. It can be calculated as α= arctan (y/x) 

 

 

diagram Diagram 1

 

 

Here is an eExample of a simple managerial application for measuring and visualizing performance of a company, business unit or product group (see diagram 2):

 

 

diagram Diagram 2

 

Whereas the approach depicted in diagrams 1 and 2 requires a direct rating of both dimensions (of the subjective dimension e.g. by a customer survey or by a systematic product use value analysis), the approach depicted in diagram 3 allows values to be to determined values for the second -axis indirectly: they are derived via the vector from the values of the other dimension.  

 


diagram Diagram 3

 

In this case the vector (i.e. its length and direction/gradient scale) is not defined by a value on the x -axis and one on the y -axis but by two values on either the x- or y axis. The value for the other -axis is then derived from the vector. A possible application for this variant is the valuation of enterprises by different investors with different investment strategies: values on the x -axis represent book value and the price / market value a specific investor is willing to pay. The entries on the y -axis that are derived from the two values on the x -axis show then the different subjective use values the investment represents for different investors.

 

This application example is drawsing the attention to the difference between price and value. If this difference is not recognized, there is a tendency exists to confuse cause and effect. But in reality price is always – sometimes with a time lag – dependent on the subjective value a potential buyer is attributesing to a product or good (see also the application example for enterprise valuation on page 17).

 

 

Vector Aaggregation and dDrill down aAnalysis

 

The vector-based concept for performance measurement & visualization of total performance also allows users also to easily aggregate performance of various sub-entities (such as groups of customers of a company, of market segments, business units, or corporate functions or of others) into a “sum” of performance for the whole entity (such as a company). Analysis and assessment of quantitative and qualitative values is startsing on the sub-category level per sub-category. The concept of vector-based performance measurement & visualization allows users to aggregate objective and subjective values of these sub-entities into the total performance of the whole entity. We are calling this the bottom-up approach. One example is the separate valuation of the different business units of a company according to the profit (x -axis) and customer use value (y- axis) they have generated. The results of the single business unitis would then add up to the total performance of the company (see diagram 4)[3].

 

The top-down approach starts first with a vector representation of the performance of an entire entity – e.gsuch as . of a company, a bank, a business unit,  or a region. This total performance is then de-aggregated into the contributions of the various sub-entities (e.g. business units, branche offices, product groups,  or countries, and so on) creating a specific vector profile for each sub-entity (see diagram 4). Through a drill-down analysis of the performance of an entity, the components of its total performance become visible on a sub-entity level and can be targeted with managerial interventions. 

 

 

diagram Diagram 4

 

 

Benefits of the concept:

 

Helps managers to keep tabs on the overview over all relevant aspects (subjective and objective) ofin the decisions making process:

In the decision making process, managers have to take into account objective, quantitative information – usually financial information, such as price, cost, revenue or profit, but also subjective, qualitative criteria  -– that is, i.e. information about the likely qualitative effect of their decissions for customers, investors, or other company stakeholders. They need to structure these different types of information and make valuations and weightings in order to take a rational decision that takes all relevant aspects into account. Because people cannot keep all these different parameters in their mindhead, they need instruments that support them in structuring decision relevant information and to maintain an keep the overview. In traditional managerial decision making, often the only instrument available are financial / accounting instruments that structure and visualize financial information – representing just the cost, price, profit or revenue dimension of a decision. The concept for vector-based performance measurement & visualization represents an instrument that allows companies or non-profit organizations to do that also with subjective, qualitative information as well (such as e.g. focusing on effectiveness from a stakeholder perspective) and to combine it with objective, quantitative measurement (focusing for example e.g. on economic/financial efficiency) for performance reporting and decision support.

 

Makes subjective and objective views comparable and communicable – independent of time and location (= increased transparency across the entire organization)

The vector-based concept for performance measurement and visualization provides a value logic that allows managers to include subjective views, experiences, and values and to link them with to objective measures in decision making processes - even when the holders of these subjective views, experiences, and values are not personally present or /involved in the decision making process (which is a normal situation in larger organizations, where decisions and decision -relevant information have to be passed on in written or electronic form to the next hierarchical level in written or electronic form).

 

Due to its mathematical foundation, aggregations and de-aggregations are easily possible (linking the strategic overview with the operational view):

Compared with other techniques that are used to present qualitative, subjective values for decision making for instanc, the vector-based concept provides the benefit that calculations (aggregations and de-aggregations) are easily possible so that the whole picture across different sub-entities /and sub-domains remains visible at any point in time. It can show the objective and subjective aspects of results for single sub-entities (such as projects or business units) and for the whole entity (such as a company). Prioritization in managerial decision making, such as e.g. for optimizing resource allocation across R&D projects or  business units, can be done with the whole picture in mind so that not only total efficiency (resource perspective) but also total effectiveness (customer or market value generated by investment) will be increased.

 

Represents an efficient and effective management information management concept / it is easy to understand from a managerial perspective:

Today's The knowledge economy of today is confronting managers with difficult trade-off decisions under increasing time pressure. The vector-based concept for performance measurement and visualization provides them with a decision support and management information management concept that presents management / decision- relevant information in very concentrated form and in an easy -to -understand and easy -to -digest way – far beyond the possibilities of the classical concepts: requiring fewer paper, fewer pages, and works with more graphics/charts that help to establish a common understanding in a management team of a situation and its various subjective and objective aspects. The result: less interpretation uncertainty, better and more consistent decisions.  

 

Assumptions behind decisions and the history of the decision making process become transparent:

Managerial decision making always involves sSubjective ratings, valuations, and experiences are always involved in managerial decision making. Because the vector-based approach is offersing a systematic way to for the rateing and measurement of qualitative, subjective criteria, it makes the subjective criteria behind a decision transparent and allows also to track the development of the values of these assumptions to be tracked over time in order to modify decisions and optimize the intended effect at a later point in time without the need to communicate again all the details to people that are involved in the decision process.

 

 

Practical Aapplication c