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The new New Economy Analyst
Report – Aug 05, 2004
Juergen Daum’s new New
Economy Best Practice service
©2004 Juergen Daum. All rights reserved.
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:
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
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”.
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.
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 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):
one dimension
(the x -axis)
represents the objective, quantitative dimension of performance
the second dimension (the y- axis) represents the
subjective, qualitative dimension of performance
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):
The x- axis displays
financial results achieved (explicit
values measured in monetary units representing e.g. profit or return
on investment). It gives an indication about of how efficiently an
organization is using its resources from an
economic/financial
perspective.
The y- axis displays value created from a customer
perspective (implicit values measured e.g. according to a relative
customer satisfaction scale or based on regular surveys and industry
benchmarks). It gives an indication about of how effective an
organization is in satisfying customer
demand.
The vector
represents management’s total performance (measured according to a relative scale that includes
length and gradient angle). The length of the vector gives an indication of the total performance
achieved (including qualitative, subjective customer value and
financial results). The gradient
angle of the vector can give a relative indication about created or destroyed
potential for financial performance for the future (“sustainability/potential
indicator”): the steeper the vector’s gradient, the larger is the
value-added created from a customer perspective compared with financial results
achieved. This could be a sign that the company or the business unit has
created significant customer value, but has not yet been able to
leverage it from a financial perspective. The opposite case (the vector’s
gradient is low) would signal that, while the company or business unit
is still producing good financial performance, it has created
not very much true customer value or has somehow destroyed customer value
(which could mean that its products offerings are
overpriced) – a fact that might result in the future also in
declining financial results in the future.

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).
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
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.