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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 cCases of the cConcept

 

Application in public services: How the vector-based concept for performance measurement can support the “New Public Management” in Switzerland

 

Governmental authorities are facing a major challenge in administrating or managing their public service operations. Different In contrast to from the commercial sector, public service organizations usually do not generate revenues through their operations. Their customers, the citizens, do not pay directly for public services, such as education, infrastructure maintenance, police and &justice, defense, and so on etc.. Revenues of public service organizations arise instead from fund allocation: the government or governmental agencies allocate funds (i.e. a part of their tax income) according to their current policies to the various public service departments. Because there are no revenues from customers (that can serve as a proxy for success) are missing, the traditional public service management regime makes it is very difficult or if not impossible under the traditional public service management regime to determine, the how efficiencyt and effectiveness of a public service operation is and how well or bad it is performing.

 

To oOvercominge this problem and to establishing public services as a modern, customer- focused and efficient service organizations is the objective of the “New Public Management” (NPM) initiative in Switzerland. The Swiss NPM -concept is attempting to shift the is trying to set focus on the effects of governmental activities on society, such as for example in healthcare or education, by centering public service management on these key questions:

 

 

 

Thus, the main intention of the Swiss NPM -concept is to show the relationship between effects, performance, and costs and to use the resulting insights for optimizing public service management. NPM will adapt public service management in Switzerland to today’s citizen demands of citizens while balancing this with today’s financial possibilities. It is expected that NPM will lead to more efficient use of available funds and resources and that they will are be invested or /deployed there, where they are needed to create specifically desired effects for society. With that approach, effects and performance will move to the center of attention – not just the costs (funds) that a public service organization is spending.

 

The basic assumption is, that optimal results will become possible when effects, activities, and their performance and costs are all taken into account together, optimal results will become possible. If one of these three parameters is changed, the change will affect the entire system of the NPM’s “magic triangle” (see diagram 5). If the budget, a specific fund, will be is reduced, then certain activities can no longer not be performed any more: performance will decline. If the government or the Kanton-Verwaltung is changesing the effect-goals, then activities and performance levels of public services need to be changed as well.

 

Because NPM takes into consideration not just costs and funds, but also effects and performance, it enables qualitative targets (effects to be achieved, performance targets) to be defined along with traditional not only financial targets (budgets or funds available to be spentd) can be defined, but also qualitative targets (effects to achieve, performance targets). This creates the foundation for a more “customer-centric”, i.e. citizen-centric public service management and makes it possible to for the possibility to delegate tasks and responsibility to the level, at which where the corresponding competence is available. This principle of devolution is an important building block of the Swiss NPM concept. The expectation is, that the integration of tasks, competencies, and responsibilities on each level will is leading to more clarity, productivity (efficiciency and effectiveness), and flexibility. Therefore Tthe Swiss Regierungsrat has therefore defined as a major objective of the NPM initiative: “Flexibility in resource allocation and responsibility will be delegated as far as possible down to the expert basis” (Kanton Basel-Stadt, 2003).

 

To control and manage a large public service organization under these conditions (three dimensions instead of one financial dimension, and that across many organizational levels) requires something other else than the traditional budget-based or fund-based management instruments public service organizations have been used to for centuries. We believe that the vector-based concept for performance measurement and representation is providesing appropriate instruments for executing the new policies in Switzerland, as they have been outlined in the NPM concept.  

 

For instance, according to the NPM concept structures the activities of a Kantons-Verwaltung are structured into 140 “product groups” for and for each which product group effect goals, performance targets, and financial budget have to be defined and need to be controlled. The vector-based approach combines information from cost accounting with non-financial performance and effects into a multidimensional coherent performance measurement system that links all organizational levels into one system of measurement. This makes the complexity manageable and puts every product group and every public service department into the context of the whole system/organization. 

 

The basic principle for applying the concept for vector-based performance measurement and visualization to e.g. a Swiss Kantonalverwaltung is very simple: achieved effects and effect-goals (“Wirkung”) are presented on the y -axis, cost-budgets and actual costs (“Kosten”) are presented on the x -axis, and performance targets and actual performance (“Leistung”) is presented through the vector (see diagram 5).  With that approach it is possible to measure and present the performance of one product group in all three performance dimensions.

 

diagram Diagram 5

 

It is also possible to break down the total performance of the product group down into performance contributions of sub-entities (such as , e.g. organizational units), or to add performance of all product groups up to the overall performance of a department or an entire Kanton. This enables thea Kantonalverwaltung to keep tabs on always the overview over the effects, performance, and costs of the various product groups and departments and to make better trade-off decisions between effects and costs and thus to optimize the portfolio of its services from a holistic perspective (see diagram 6).

 

diagram Diagram 6

 

Benefits for the Kanton-Verwaltung include:

 

 

 

Application in the software industry: How the vector-based concept for performance measurement & visualization can support the management of an R&D operation:

 

While R&D investments and activities are major value generators in companies today[4], they are also among one of the most risky ones. The time span from investment decision to return is quite long (in the pharmaceuticals industry for instance up to 15 years, in the software industry 5-8 years). During this long period, the investment is subject to many risks: that the market may change is changing in the meantime, so that new products, once they come finally to market, are not in demand anymore (market risk), ); that the engineers may are not meeting customer requirements or that may they produce a defective product (engineering risks), ); that the technology, on which the product is based, is may become outdated at a certain point in time (technology risk) etc.. Therefore it is considered as best practice in the software industry, as in other R&D intensive industries, to manage R&D projects as investment projects on a rolling basis through a continuous investment management approach that allows corrections during the development process.

 

Rather than making only one (investment) decision at the start of the development project, decisions are made aAt clearly and predefined check-points, it is again and again decided, whether to continue the if a development project will be continued, modify itied (changeing e.g.the specifications of the final product, underlying technology or the general scope, for example), or abandon ited, rather than to make only one (investment) decision at the start of the project. Typically this rolling investment management procedure is applied to several project in common – , that is, to a portfolio of products that are targeted for instance to one market segment or for all R&D projects of a company.

 

The major challenge in the decision making process of the product technology board of a software company (sometimes also called R&D portfolio board) is to maintain an keep the overview over all portfolios and/ development projects and to make good trade-off decisions between costs and effects for customers (customer value, i.e. created revenue potential). But they must also have to judge the performance of a development manager or development teams (for instance to make a decision, which is based on clear criteria, about which team or which manager is best suited to lead a new important development project). And that is not an easy tasks.

 

Should the performance be measured based on the number of lines of codeing lines produced in a certain period of time? While this indicator does show provides an insight, how efficient a development team is in utilizing its resources to produce output, it certainly is tellsing us nothing about the effectiveness of  its output – , that is, whether if the final software product will meet customer demand and will be attractive enough for potential new customers. It is obvious that additional, qualitative information is required, such as e.g. subjective ratings by a set of pilot customers, is required. Only when both dimensions are taken into account can , a sound judgment can be made about the performance of a software development team. The problem so far in many software companies is, that no concept exists, that allows to measure and visualize in detail these qualitative aspects to be measured and visualized in detail, connected them with the quantitative, financial information, and to linked it into the performance measurement system of the entire organization. Also Hhere too we consider the concept of vector-based performance measurement & visualization as a solution:

 

The vector-based concept allows a software development department to measure efficiency (x -axis: e.g. number of coding lines per headcount) and effectiveness (y -axis: e.g. relative rating of customer satisfaction or, if the intended result of the project is a “semi-finished” product that will be used by other development projects, rating of the usefulness of the tool buy other software development teams) in a way that allows an easy to understand visualization of the compound result (the vector).

 

Because the vector-based concept of performance measurement is introducesing (often for the first time) a standardized way of rating of qualitative effectiveness based on a standard rating scale, performance of development projects, portfolios, single individual teams, departments, or entire business units can be easily aggregated and disaggregated. This enables a software company to manage and optimize its entire development organization based on clear criteria oriented on to customers, markets, costs, and the individual performance of individual development teams or even individual single developers.

 

The software industry is under considerable pressure to become commoditized. A counter-strategy that for example e.g. suppliers of business software are applying is, to transform their business model from the one of a software supplier (shipment of code) to the one of  a service provider. T: the objective is to support customers end-to-end in the process of optimizing their business processes through information systems. Critical in the customer engagement process for management is to keep maintain an the overview over all activities in the customer -oriented value chain – not only from a cost and (short term) revenue perspective, but also from a qualitative perspective that is shedsding lights on the most critical potential the company needs to create customer value and competitive advantage. The vector-based approach, especially the vector aggregation technique described above, is providesing these software companies also with a powerful strategic tool to maintain an keep the overview over their entire customer oriented value chain across all functions and process steps, both form a financial and intangible/qualitative perspective. This helps management to determine, where investments to enhance capabilities (i.e. value potential for the future) are required / or where investments will create maximum value (see diagram 7). 

 

diagram Diagram 7

 

Other possible applications

 

Also oOrganizations in other sectors, especially companies in service industries, are facing similar challenges in performance measurement and management like to those faced by public services organizations or software companies. We are convinced that the vector-based concept of performance measurement and visualization is providesing all these companies and organizations with an instrument that can bring more clarity, transparency, and speed into the decision making and reporting process by combining subjective, qualitative information, with objective, quantitative information. One of the industries that is actually going through a major transformation that is confronting facing its players with the challenge to focus much more on effectiveness from a customer perspective is the banking industry.

 

Application in a bank:

In a bank, the concept can be used to optimize trade-offs between financial efficiency and customer satisfaction throughout the entire organization -– something that is regarded in the banking sector as one of the major challenges and success factors at the same time. The vector-based concept would introduce for example in e.g. a retail bank an additional performance management dimension, additional to the usual financial performance metrics. Branch performance, for instance, can be visualized easily with the vector-based concept as the compound result (represented through the vector) of effectiveness, which is measured through customer satisfaction (value on the y -axis, e.g. based on a yearly general survey or by quarterly surveys of randomly selected customers) and efficiency, which is measured for instance through the cost/income ratio (value on the x -axis, based on accounting data). Through vector aggregation and/or de-aggregation of the contribution of branches, areas, and regions to the total compound (qualitative and quantitative), the performance of the entire bank organization can be visualized. It could be also be used to break down total performance into the contributions of product groups or functional departments.   

 

Many other possible applications of the vector-based concept for performance measurement and visualization exist, where the concept provides powerful tools for optimizing trade-offs between qualitative subjective parameters and quantitative, objective (financial) parameters and for improving the productivity of an organization, whether commercial or non-profit.

 

One of these other applications that we have already briefly mentioned is the following.

 

Application of the concept for valuing an enterprise:

Continuing with the example for applying the vector-based concept to the area of enterprise valuation from page 7, an additional perspective the vector-based approach could provide is the perspective on intangible asset levels a possible acquirer of an enterprise would require in order to create a “leverage effect” and to generate create a positive return. To explain thatthis, let us take the example of an acquisition of Cisco and the leverage effect Cisco had been able to realize by leveraging two important intangible assets: its customer base and the capability of the company to integrate the products and employees of an acquired company quickly very fast and successfully into its own value creation system:

 

Cisco, the network equipment vendor, acquired Crescendo, a small company specialized in so -called network switches, in 1995 (Bunnell, 2000). Cisco paid $97 million dollars for Crescendo, an enterprise that had an annual turnover of only $10 million dollars. Wall Street analysts found this to be hopelessly overpriced. However, Cisco went on to gain a $500 million dollar turnover a year later with the Crescendo products. In the light of this new figure ($500 million instead of $10 million) Cisco's acquisition of Crescendo was cheap. The analysts had overlooked the fact that the combination of Crescendo technology and Cisco sales potential (the Cisco customer base) meant that Cisco was able to immediately gain a much higher sales volume than Crescendo would ever have had in the foreseeable future. The subjective perception of Wall Street analysts differed greatly extremely from the subjective perception of the Cisco management. EachBoth  saw Cisco very differently: in sharp contrast to the financial analysts, who saw Cisco only from the perspective of a financial investor, who can only apply portfolio techniques and financial market information to “leverage” an investement, the Cisco management saw the investment opportunity Crescendo represented from the perspective of an entrepreneur, who is able to leverage the investment with a strategic enterprise asset a financial investor cannot dispose of: Cisco’s customer base and the ability of the organization to integrate a new companies products and employees quickly very fast and successfully. 

 

From such a perspective, the ratings on the y -axis in diagram 3 wouldn’t just represent the subjective value different investors with different strategies would attribute to an investment opportunity like the acquisition of a company like Crescendo. It would also define the level of intangible assets an investor has to dispose of, if this the investor wants to be able to “leverage” an investment for a given price. The concept of vector-based performance measurement & visualization helps to visualize make this different value concepts visible and is setting the focus on the difference between price and value that was has been described already on page 7. 

 

 

Implementation steps

 

For organizations that want to apply the concept, we recommend the following implementation steps:

  1. Awareness & Scope Workshop: workshop with the key -personnels (sponsor, owner, experts) of the area that has been selected to serve as a “prototype” to test the concept (these persons usually will become members of the project team or steering committee later). The objective of this workshop is to broaden the understanding of the concept, create awareness for its opportunities and for its limitations, to determine the scope of the prototype, and to make a final decision about the members of the project team and the governingment structure of the project (project plan and miles stones, formation of steering committee, etc.). The members of the project team, who might collaborate for certain tasks with other people in the organization, perform the following steps:

  2. Object definition: define the objects of performance measurement (projects, departments, process steps …  -> what do we want to measure?) and their relationship between each other and the “whole picture” (company, business unit etc.).

  3. Definition ofing measures, metrics, and visualization: define measures and metrics for qualitative, quantitative and compound measurement (->how do we want to measure in a multidimensional way? What are the relevant/critical dimensions?), define the framework for 2D or 3D visualization.

  4. Parameterization: Define rules for quantifying qualitative metrics (-> how do we quantify subjective ratings in such a way, that we can later perform later mathematical operations with these measures?) for example e.g. by introducing a qualitative scale such as 1-5 for qualitative ratings in a survey.

  5. Clustering: define clusters for objects that have been selected in step 2 (-> how can we group the most detailed objects into clusters so that we can maintain an keep the overview?) An example would be to group the 140 product groups of a Kantonalverwaltung into a number of clusters that can be handled from a managerial perspective and / can be used for aggregation and de-aggregation.

  6. Weighting: define weights for each object and/ cluster to be analyzed from the perspective of the whole picture of the organizational entity involved (-> how important is each object within the framework of the whole entity from the perspective of the customer or another major stakeholder?) For instance, in a public service organization like a Kantonalverwaltung in Switzerland one would weight the importance of the services of the different dDepartments from the perspective of the citizens or from the perspective of the governing party – see diagram 6.

  7. Defining the charts / visuals: define the charts/visuals for each application area on the various levels of the organization / in the areas involved (-> which charts do we need to support planning processes, performance reviews, or specific decisions? How are they connected with each other –  / what is their logical link?).

  8. Test and revision: Test the new measurement and the visualizations system (-> are the assumptions we made in line with reality? Does the system work in practice?) and revise it where necessary (iterative process).

 

 

Conclusion and outlookOutlook

 

In today's the demand -dominated global knowledge economy of today, customers or other important stakeholders of businesses and or non-profit organizations want require from these organizations to act according to their stakeholder’s subjective, qualitative values and criteria. Therefore, in managing their operations, organizations have to take into account increasingly qualitative, subjective ratings, experiences, and values of customers, and external stakeholders, but also of their managers and experts into account, in order to create value added, i.e. to create positive effects for customers and stakeholders with minimal resource consumption.

 

The Pperformance of an organization can therefore 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, their bandwidth is too small so that they ignore vital performance information for successful enterprise management today: information about the external effectiveness of an organization.

 

We therefore 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 traditional quantitative, i.e. financial information. In addition, the result has to be easy to understand and “handablemanageable” from a managerial perspective, meaning that it is scalable (i.e. independent form of time and location), that it can be aggregated and de-aggregated, and 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 & visualization is offersing a practical solution for this problem. Discussions with and investigations of various organizations of different sectors – business and non-profit – about the application of the concept in areas such as internal audit, R&D, strategic planning, performance management in public services, customer service management, and many others have already demonstrated its practical relevance. We expect After from in-depth tests and experiences from the broader applications in different organizations in the near future, we expect  further insights into its practicality and where improvements and/ enhancements are required. 

 

We are convinced that in the future, organizations will need and will use in the future instruments that can handle intangible, qualitative, subjective values in a similar way thatthan  financial accounting and financial statements can handle today's financial information. In addition to the financial balance sheet, oOrganizations will need in addition to the financial balance sheet an intangible balance sheet that accounts for intangible values (potential for the future) that has been created or destroyed during the reporting period. And they will need in addition to the financial income statement they will need an intangible income statement that accounts for how efficiently (intangible costs) and effectively (intangible revenues) an organization is utilizing its intangible values and/ potential.

 

The concept of vector-based of performance measurement & visualization brings an unprecedented degree of rigoridity and discipline into the rating, measurement, and handling of qualitative performance measurement in organizations that usually does not exist so far. We therefore regard the concept of vector-based performance measurement & visualization as an first important first step in developing systems for the systematic recording, reporting, and visualization of intangible, qualitative, subjective values that set the qualitative and subjective (intangible) dimension into the context of the quantitative and objective (tangible) dimension. This is important because intangible, qualitative aspects can only create only value, when they are connected to the physical, tangible, and financial world of our economies. 

 

References

 

Aboody, D. / Lev. B. (2001). “R&D Productivity in the Chemical Industry”, (this paper is available on Baruch Lev’s website: http://www.baruch-lev.com/)

 

Bretscher, P. (1996,1998). “Re-Inventing Business Administration, der Grundlagenartikel“ (this paper is available at http://www.bengin.com/)

 

Bunnell, D. (2000). “Making the Cisco Connection”, John Wiley & Sons, New York, p. 35 ff.

 

Daum, J.H. (2002). “Intangible Assets and Value Creation”, John Wiley, Chichester 

 

Kanton Basel-Stadt (2003). “New Public Management im Kanton Basel-Stadt“, Basel (Brochure of the Kantonalverwaltung Basel-Stadt), p. 6

 

Lev. B. (2001). Intangibles: “Management, Measurement, and Reporting”, Brookings Institution Press, Washington D.C.

 

Sloan, A.P. (1963). “My Years With General Motors”, Currency Doubleday, New York, p.116-148

 

 

About the authors

 

1Juergen H. Daum is an internationally recognized expert, author, speaker, and consultant in enterprise management. He currently acts as the Chief Solution Architect of the Business Solutions Architect Group at SAP AG and advises senior executives, CFOs and finance professionals in finance transformation and enterprise performance management best practice. He is a frequent speaker on enterprise and performance management topics and a frequent contributor of articles for leading journals. He is the author of the book Intangible Assets and Value Creation (John Wiley & Sons, 2002). Website: http://www.juergendaum.com/

 

2Peter Bretscher is the founder of the Ing. Büro für Wirtschaftsentwicklung (founded in 1988) Its mission is to advise organizations in the design of economic steering and management systems that integrate the intangible perspective. He also is engaged in supporting companies, consultants, and other organizations in innovation and project management, in intellectual property and patent management, and in setting up business plans and defining enterprise strategy. Since 1994 he has also taught business engineering und business planning at the Hochschule für Wirtschaft, Technik und soziale Arbeit in St. Gallen, Switzerland.Website: http://www.bengin.com/

 

 

Footnotes

 

[1] A good description of the basics of the financial control concept and the development of the financial control based management system at General Motors in the 1920s can be found in (Sloan, 1963), chapter 8.  

[2] According to the experiences of the authors still 70-90 percent of the information found in performance management systems and management reports are financial information

[3] For simplification, the cost/use value of the center is neglected here. 

[4] Lev and Aboody (Lev and Aboody, 2000) report for example that a study in the chemical industry has revealed, that while traditional capital investments (in tangible assets) return after tax just the cost of capital of 7 percent, in contrast to that investment in R&D return 17 percent – thus representing one if not the major source of the added value created by chemical companies. For value creation through R&D and other intangibles see also (Lev, 2001).

 

 

 

Additional Resources:

 

 

 

The panel discussion on performance management at the at the PMA 2004 Conference in Edinburgh, UK (29-30 July 2004). Speakers on the panel (from left to right):

 

Liviu Cotora, Integrator, France

Ian Reeves, Gartner Group, UK

Nicolas Millman, Accenture, UK

Professor Sir Andrew Likiermann, London Business School, UK

Juergen H. Daum, SAP AG, Germany

Professor Andy Neely, Cranfield Business School, UK

 

What is Enterprise Performance Management? - Definition from Juergen H. Daum at the panel discussion:

 

"Enterprise Performance Management is the process of creating sustainable value* in an enterprise through: systematic planning, target setting, incentive/bonus schemes, performance monitoring & forecasting and a structured approach to define and manage corrective actions in order to still achieve targets, when business conditions are changing (taking into account both the need to create value added from existing resources and the need to create new capabilities in order to adapt to future market/customer requirements).

 

*Creating value means creating value added = generate output value that exceeds the value of input resources
(-> performance has to be measured as input performance - such as low costs, and as output performance - such as customer value or shareholder value created. Output performance has to be defined from the perspective of the receiver, i.e. customer / stakeholder)

 

 

 

J.D.s presentation at the conference (PPT slides as PDF winziped)

 

Juergen H. Daum's and Peter Bretscher's article/paper they have written for the symposum (PDF)

 

Link to the conference website              

 

Why a new Management System ? –article by Juergen H. Daum

 

Juergen H. Daum's groundbraking book: Intangible Assets and Value Creation, Wiley 2002

 

J.D.’s Best Practice Channel – Finance

 

 

 

“Fixed budgets don’t work today. A budget is a too static instrument and locks managers into the past - into something they thought last year that it was right. To be effective in a global economy with rapidly shifting market conditions and quick and nimble competitors, organization have to be able to adapt constantly their priorities and have to put their resources where they can create most value for customers and shareholders. In order to do that, they need the right concepts, management processes and tools – concepts such as the Beyond Budgeting Management Model. The introduction of new management instruments such as the Balanced Scorecard, which help to better align the entire organization with corporate strategic objectives and to focus it on the essentials, has created the right foundation. Because if corporate strategy and the objectives are clear for all people in an organization, one can principally react faster to changing market conditions.  But then the fixed budget comes into their way and prevents them from really doing the right things. Though what is often missing is a more flexible operational planning and control model. The Beyond Budgeting model wants to fill exactly this gap.”   
                                                     Juergen H. Daum  


New! - visit J.H.D.'s Beyond Budgeting Info Center 
- including latest BB insight materials, interviews with BB pioneers etc. - here an extract:
| J.D.'s insight article "Beyond Budgeting" | Interview with Lennart Francke, CFO of Svenska Handelsbanken | Panel Discussion with Borealis, Nestlé, and Unilever | Interview with Jeremy Hope – co-founder of the Beyond Budgeting Round Table | Interview with J.D. on finance and IT | 

 

 

Related articles from earlier new New Economy Analyst Reports:

 

Report from the First PMA Intellectual Capital Research Symposium held in Cranfield, UK, 1-2 October 2003,

 

A European Peer Discussion: “Measuring and Managing Intangible Values in Today’s Economy”

 

Intangible Assets: a central topic at the mySAP Financials conference in Strasbourg

 

Interview with Baruch Lev: Accounting, Reporting and Intangible Assets

 

Corporate Performance Management: Managing profitability and growth in the new environment

 

How to create value with Real Options based innovation management

 

Interview with Leif Edvinsson: Intellectual Capital: the new wealth of corporations

 

The new FASB rules for reporting on Intangible Asset - The U.S. versus the European way

 

The book of the month: “Intangibles: Management, Measurement, and Reporting” by Baruch Lev

 

How Systems Thinking / Systems Dynamics helps to identify limits to growth to boost innovation value

 

How accounting gets more radical in measuring what really matters to investors

 

Interview with David P. Norton: "Intangible Assets and the Balanced Scorecard"  

 

 

More about Enterprise Management Best Practice and related topics to this report will be continued here in this new New Economy Analyst reports. To subscribe for Juergen Daum’s free-of-charge e-mail newsletter (a regular summary of the recent reports published here) click here. 

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