Strategic Management and

Business Policy 15e, Global Edition

Chapter 12

Evaluation and
Control

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Learning Objectives (1 of 2)
12-1 Explain how various types of measures
and controls are utilized to properly
assess performance including activity-based
costing, ERM, ROI, and EVA
12-2 Develop a balanced scorecard to examine key
performance measures of a company
12-3 Apply the benchmarking process to a function or an
activity

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12-2
Learning Objectives (2 of 2)
12-4 Explain how strategic information systems
are being utilized to support specific
strategies
12-5 Discuss the issues with measuring
organizational performance and how
organizations can establish proper controls
to achieve objectives

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12-3
12-1. Explain how various types of measures and controls
are utilized to properly assess performance including
activity-based costing, ERM, ROI, and EVA

• Evaluation and control information consists of performance data and

activity reports (gathered in Step 3 in Figure 12–1).
• If undesired performance results because the strategic management
processes were inappropriately used, operational managers must know
about it so they can correct the employee activity. Top management
need not be involved.
• If, however, undesired performance results from the processes
themselves, top managers, as well as operational managers, must
know about it so they can develop new implementation programs or
procedures.
• Evaluation and control information must be relevant to what is being
monitored.

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4
 Figure 12-1: Evaluation and Control Process

• Evaluation and control process:

1. Determine what to measure.
2. Establish predetermined standards.
3. Measure performance.
4. Does performance match standards? If yes, Stop.
5. If no, Take corrective action, go back to step 3 and continue.
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12-5
 Measuring Performance
• Performance: Is the end result of activity
• Select measures to assess performance based on:
– The organizational unit to be appraised, and
– The objectives to be achieved.
• The objectives that were established earlier in the
strategy formulation part of the strategic management
process (dealing with profitability, market share, and
cost reduction, among others) should certainly be
used to measure corporate performance once the
strategies have been implemented.

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12-6
 Appropriate Measures
• Since one of the obstacles to effective control is the difficulty in developing
appropriate measures of important activities and outputs, a firm needs to
develop measures that predict likely profitability.
• These are referred to as steering controls because they measure variables
that influence future profitability.

• Every industry has its set of key metrics (measures) that tend
to predict profits. Examples:
1. Cost per available seat mile (airlines): Airlines, for example,
closely monitor cost per available seat mile (ASM).

2. Inventory turnover ratio (retail): An example of a steering control

used by retail stores is the inventory turnover ratio, in which a retailer’s
cost of goods sold is divided by the average value of its inventories.

3. Customer satisfaction: Is another example of steering

control (Surveys for example).
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12-7
 Types of Controls (1 of 2)
• Controls can be established to focus on actual performance results
(output), the activities that generate the performance (behaviour), or on
resources that are used in performance (input).
• Output controls
– Specify what is to be accomplished by focusing on the end result
through the use of objectives and performance targets or milestones,
(such as sales quotas, specific cost-reduction or profit objectives, and
surveys of customer satisfaction)
• Behavior controls
– Specify how something is done through policies, rules, standard
operating procedures and orders from supervisors, (such as following
company procedures, making sales calls to potential customers, and
getting to work on time)
• Input controls
– Emphasize resources, such as knowledge, skills, abilities, values, and
motives of employees.
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12-8
 Types of Controls (2 of 2)
• Examples of increasingly popular behavior controls are the ISO 9000 and
14000 Standards Series on quality and environmental assurance, developed
by the International Standards Association of Geneva, Switzerland.
• ISO 9000 Series of Quality Standards
– A way of objectively documenting a company’s high-level of quality
operations.
– A company wanting ISO 9000 certification would document its process
for product introductions, among other things.
• ISO 14000 Series of Quality Standards
– Establishes how to document the company’s impact on the environment.
• The benefits from ISO certification are partially in cost savings, but primarily
they are a signal to suppliers and buyers about the focus of the company.
• Many corporations view ISO 9000 certification as assurance that a supplier
sells quality products.
• Companies in more than 119 countries require ISO 9000 and/or ISO 14000
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12-9
 Activity-based Costing
• Activity-based costing
– Is a recently developed accounting method that allocates indirect and
direct (fixed) costs to individual products or product lines based on
value-added activities going into that product.
– This accounting method is very useful in constructing a value-chain
analysis of a firm’s activities for making outsourcing decisions.
– Traditional cost accounting, in contrast, focuses on valuing a
company’s inventory for financial reporting purposes.
• ABC accounting allows accountants to charge costs more accurately than
the traditional method because it allocates overhead far more precisely.
• Example, imagine a production line in a pen factory where black pens are
made in high volume and blue pens in low volume.
• H.W. :(Read the example from the book for a contrast between ABC
accounting method and the traditional accounting method).
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12-10
 Enterprise Risk Management (1 of 2)
• Enterprise risk management
– Corporatewide, integrated process for managing uncertainties that
could negatively or positively influence the achievement of corporation’s
objectives.
– In the past, managing risk was done in a fragmented manner within
functions or business units.
– Individuals would manage process risk; safety risk; and insurance,
financial, and other assorted risks.
– As a result of this fragmented approach, companies would take huge
risks in some areas of the business while overmanaging substantially
smaller risks in other areas.
– ERM is being adopted because of the increasing amount of
environmental uncertainty that can affect an entire corporation.
– As a result, the position Chief Risk Officer (CRO) is one of the fastest
growing executive positions in U.S. corporations.

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12-11
 Enterprise Risk Management (2 of 2)

The process of rating risks involves three steps:

1. Identify the risks using scenario analysis, or
brainstorming, or by performing risk assessments.
2. Rank the risks, using some scale of impact and
likelihood.
3. Measure the risks using some agreed-upon
standard.

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PRIMARY MEASURES Of CORPORATE
PERFORMANCE
o The days when simple financial measures such as ROI or
EPS were used alone to assess overall corporate
performance have generally come to an end.
o Analysts recommend a broad range of methods to evaluate
the success or failure of a strategy.

o Some of these methods are stakeholder measures,

shareholder value, and the balanced scorecard approach

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 Traditional Financial Measures (1 of 2)
• Return on investment (ROI)
– The most commonly used measure of corporate
performance (in terms of profits) is return on investment.
– It is simply the result of dividing net income before taxes by the total
amount invested in the company (typically measured by total assets).
– Disadvantage: While ROI gives the impression of objectivity
and precision, it can be easily manipulated.
• Earnings per share (EPS)
– Dividing net earnings by the amount of common stock.
– Disadvantage: EPS does not consider the time value of
money.

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12-14
 Traditional Financial Measures (2 of 2)
• Return on equity (ROE)
– Involves dividing net income by total equity.
• Operating cash flow
– The amount of money generated by a company before the
cost of financing and taxes, is a broad measure of a
company’s funds.
• Free cash flow
– The amount of money a new owner can take out of the firm
without harming the business.

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12-15
 Non–financial Performance Measures Used by Internet
Business Ventures
▪ Because of these and other limitations, ROI, EPS, ROE, and
operating cash flow are not by themselves adequate measures
of corporate performance.
▪ At the same time, these traditional financial measures are very
appropriate when used with complementary financial and
non-financial measures.
▪ For example, some non-financial performance measures used
by Internet business ventures are:
– Stickiness: Length of website visit
– Eyeballs: Number of people who visit a website
– Mindshare: Brand awareness
• Mergers and acquisitions may be priced on multiples of MUUs (monthly
unique users) or even on registered users.

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12-16
 Shareholder Value (1 of 3)
• Because of the belief that accounting-based numbers such as
ROI, ROE, and EPS are not reliable indicators of a
corporation’s economic value, many corporations are using
shareholder value as a better measure of corporate
performance and strategic management effectiveness.
• Shareholder value
– It is the present value of the anticipated future streams of cash flows
from the business plus the value of the company if liquidated.
– Arguing that the purpose of a company is to increase
shareholder wealth, shareholder value analysis
concentrates on cash flow as the key measure of
performance.
– As long as the returns from a business exceed its cost of capital, the
business will create value and be worth more than the capital invested
in it.
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12-17
 Shareholder Value (2 of 3)
• Economic value-added (EVA)
– EVA has become an extremely popular shareholder value
method of measuring corporate and divisional performance
and may be on its way to replacing ROI as the standard
performance measure.
– It measures the difference between the pre-strategy and
post-strategy values for the business.
– Simply put, EVA is after-tax operating income minus the
total annual cost of capital.

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12-18
 Shareholder Value (3 of 3)
• Market value-added (MVA)
– MVA measures difference between market value of a
corporation and capital contributed by shareholders and
lenders.
– Like net present value (NPV), it measures the stock
market’s estimate of the net present value (NPV) of a firm’s
past and expected capital investment projects.
– As such, MVA is the present value of future EVA.

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12-19
12-2. Develop a balanced
scorecard to examine key
performance measures of a
company

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 Balanced Scorecard (1 of 3)
• Rather than evaluate a corporation using a few financial
measures, Kaplan and Norton suggested a “balanced
scorecard” that includes non-financial as well as financial
measures.
• This approach is especially useful given that research indicates
that non-financial assets explain 50% to 80% of a firm’s value.
• Balanced scorecard
– Combines financial measures that tell results of actions
already taken with operational measures on customer
satisfaction, internal processes, and corporation’s
innovation and improvement activities—the drivers of future
financial performance.
– Thus, steering controls are combined with output controls.
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12-21
 Balanced Scorecard (2 of 3)
In the balanced scorecard, management develops goals or
objectives in each of four areas:
1. Financial: How do we appear to shareholders?
2. Customer: How do customers view us?
3. Internal business perspective: What must we excel at?
4. Innovation and learning: Can we continue to improve and
create value?
• Each goal in each area (for example, avoiding bankruptcy in
the financial area) is then assigned one or more measures, as
well as a target and an initiative.
• These measures can be thought of as key performance
measures. (next slide)
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12-22
 Balanced Scorecard (3 of 3)
• Key performance measures
– They are measures that are essential for achieving a desired
strategic option.
– For example, a company could include cash flow, quarterly
sales growth, and ROE as measures for success in the
financial area (1).
– It could include market share (competitive position goal),
customer satisfaction, and percentage of new sales coming
from new products (customer acceptance goal) as
measures under the customer perspective (2).
– It could include cycle time and unit cost (manufacturing
excellence goal) as measures under the internal business
perspective (3).
– It could include time to develop next-generation products
(technology leadership objective) under the innovation and
learning perspectiveCopyright
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12-23
Evaluating Top Management and the Board of
Directors
o Through its strategy, audit, and compensation committees, a
board of directors is charged with closely evaluating the job
performance of the CEO and the top management team.

o Members of the compensation committees of today’s boards

of directors generally agree that a CEO’s ability to:
A. Establish strategic direction,
B. Build a management team, and
C. Provide leadership,
are more critical in the long run than are a few quantitative
measures.
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 Chairman-CEO Feedback Instrument
• Many companies evaluate their CEO by using a
17-item questionnaire developed by Ram Charon, an
authority on corporate governance.
• The questionnaire focuses on four key areas:
1. Company performance
2. Leadership of the organization
3. Team-building and management succession
4. Leadership of external constituencies

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12-25
 Management Audits
• Management audits
– They are very useful to boards of directors in evaluating
management’s handling of various corporate activities.
– Management audits have been developed to evaluate
activities such as:
1. Corporate social responsibility (CSR),
2. Functional areas like the marketing department, and
3. Divisions such as the international division.
– These can be helpful if the board has selected particular
functional areas or activities for improvement.

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12-26
 Strategic Audits
• Strategic audits
– The strategic audit, presented in the Chapter 1 Appendix 1.A, is a type
of management audit.
– It provides checklist of questions, by area or issue,
enabling systematic analysis of various corporate functions
and activities to be made.
– It is a type of management audit and is extremely useful as
diagnostic tool to pinpoint corporate-wide problem areas
and to highlight organizational strengths and weaknesses.
– A strategic audit can help determine why a certain area is
creating problems for a corporation and help generate
solutions to the problem.
– As such, it can be very useful in evaluating the
performance of top management.
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12-27
PRIMARY MEASURES Of DIVISIONAL AND
FUNCTIONAL PERFORMANCE
o Companies use a variety of techniques to evaluate and control
performance in divisions, strategic business units (SBUs), and functional
areas.
o If a corporation is composed of SBUs or divisions, it will use many of the
same performance measures (ROI or EVA, for instance) that it uses to
assess overall corporate performance.
o To the extent that it can isolate specific functional units such as R&D, the
corporation may develop responsibility centres.
o It will also use typical functional measures, such as:
• Market share and sales per employee (marketing),
• Unit costs and percentage of defects (operations),
• percentage of sales from new products and number of patents (R&D)
• Turnover and job satisfaction (HRM).
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 Responsibility Centers (1 of 2)
• Responsibility centers
– Control systems can be established to monitor specific functions,
projects, or divisions.
• Budgets are one type of control system that is typically used
to control the financial indicators of performance.
– They are used to isolate a unit so it can be evaluated separately
from the rest of the corporation.
– Each responsibility center, therefore, has its own budget and is
evaluated on its use of budgeted resources.
– It is headed by the manager responsible for the center’s
performance.
– There are five major types of responsibility centers.
– The type is determined by the way the corporation’s control
system measures these resources and services or products.
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12-29
 Responsibility Centers (2 of 2)
1. Standard cost centers: are primarily used in manufacturing
facilities.
2. Revenue centers: With revenue centers, production, usually
in terms of unit or dollar sales, is measured without
consideration of resource costs (for example, salaries).
3. Expense centers: Typical expense centers are
administrative, service, and research departments
4. Profit centers: A profit center is typically established
whenever an organizational unit has control over both its
resources and its products or services.
5. Investment centers: An investment center’s performance is
measured in terms of the difference between its resources
and its services or products.
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12-30
12-3. Apply the benchmarking
process to a function or an
activity

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 Using Benchmarking To Evaluate Performance

• Benchmarking
– Is the continual process of measuring products, services
and practices against the toughest competitors or those
companies recognized as industry leaders.
– Benchmarking, an increasingly popular program, is based
on the concept that it makes no sense to reinvent
something that someone else is already using.
– It involves openly learning how others do something better
than one’s own company so that the company not only can
imitate, but perhaps even improve upon its techniques.

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 Benchmarking
The benchmarking process usually involves the following steps:
1. Identify area or process to be examined.
2. Find behavioral (how something is done) and output (what is
to be accomplished) measures (controls) of the area or
process and obtain measurements.
3. Select accessible set of competitors of best practices
(best-in-class) companies against which to benchmark.
4. Calculate differences among company’s performance
measurements and competitors (those of the best-in-class);
determine why differences exist.
5. Develop tactical programs for closing performance gaps.
6. Implement the programs and then compare the resulting new
measurements with those of the best-in-class companies.
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12-33
12-4. Explain how strategic information
systems are being utilized to support specific
strategies

o Before performance measures can have any

impact on strategic management, they must first be
communicated to the people responsible for
formulating and implementing strategic plans.
o Strategic information systems can perform this
function (i.e. communicating performance measures to the
people responsible for …..)
o They can be computer-based or manual, formal or
informal.
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34
 Strategic Information Systems 1 of 2
• Enterprise resource planning (ERP)
– Many corporations around the world have adopted enterprise
resource planning (ERP) software.
– ERP unites all of a company’s major business activities, from
order processing to production, within a single family of software
modules.
– The system provides instant access to critical information to
everyone in the organization, from the CEO to the factory floor
worker.
– Because of the ability of ERP software to use a common
information system throughout a company’s many operations
around the world, it is becoming the business information
systems’ global standard.
– The major providers of this software are SAP, Oracle, and Infor.
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12-35
 Strategic Information Systems 2 of 2
• Radio frequency identification (RFID) and near field communication
(NFC)

– It is an electronic tagging technology used to improve supply-chain

efficiency, while near field communication (NFC) stands for contactless
communication between devices like smartphones or tablets.

– By tagging containers and items with tiny chips, companies use the
tags as wireless barcodes to track inventory more efficiently.

• Divisional and functional strategic information support

– At the divisional or SBU level of a corporation, the information system

should be used to support, reinforce, or enlarge its business-level
strategy through its decision-support system.

– Example: An SBU pursuing a strategy of overall cost leadership could

use its information system to reduce costs either by improving labor
productivity or improving the use of other resources such as inventory
or machinery.
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12-36
12-5. Discuss the issues with
measuring organizational
performance and how organizations
can establish proper controls to
achieve objectives

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37
 Problems in Measuring Performance
• The measurement of performance is a crucial part of
evaluation and control.
• Two obvious control problems:
1. The lack of quantifiable objectives or performance
standards.
2. The inability to use information systems to provide timely
and valid information.
• Without objective and timely measurements, it would be
extremely difficult to make operational, let alone strategic,
decisions.
• The very act of monitoring and measuring performance can
cause side effects that interfere with overall corporate
performance.
• Among the most frequent negative side effects are a
short-term orientation and goal displacement.
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12-38
 Short-Term Orientation
• Long-term evaluations may not be conducted because
executives:
1. Don’t realize their importance.
2. Believe that short-term considerations are more
important than long-term considerations.
3. Aren’t personally evaluated on a long-term basis.
4. Don’t have the time to make a long-term analysis.
• There is no real justification for the first and last reasons.
• If executives realize the importance of long-term evaluations,
they make the time needed to conduct them.
• Read the example in the next slide..

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12-39
EXAMPLE:
• At one international heavy-equipment manufacturer,
managers were so strongly motivated to achieve their
quarterly revenue target that they shipped unfinished
products from their plant in England to a warehouse in the
Netherlands for final assembly.
• By shipping the incomplete products, they were able to
realize the sales before the end of the quarter—thus fulfilling
their budgeted objective and making their bonuses.
• Unfortunately, the high cost of assembling the goods at a
distant location (requiring not only renting the warehouse but
also paying additional labor) ended up reducing the
company’s overall profit.

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40
 Goal Displacement (1 of 3)
• If not carefully done, monitoring and measuring of performance
can actually result in a decline in overall corporate performance.
• Goal displacement
– It is the confusion of means with ends.
– It occurs when activities originally intended to help
managers attain corporate objectives become ends in
themselves—or are adapted to meet ends other than those
for which they were intended.
– Types of goal displacement are:
▪ Behavior substitution
▪ Sub-optimization

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12-41
 Goal Displacement (2 of 3)
• Behavior substitution
– Refers to the phenomenon of pursuing substitute activities that do not
lead to goal accomplishment instead of activities that do lead to goal
accomplishment because the wrong activities are being rewarded.
– Managers, like most other people, tend to focus more of their attention
on behaviours that are clearly measurable than on those that are not.
– Employees often receive little or no reward for engaging in
hard-to-measure activities such as cooperation and initiative.
– However, easy-to-measure activities might have little or no relationship
to the desired good performance.
– Rational people, nevertheless, tend to work for the rewards that the
system has to offer.
– Therefore, people tend to substitute behaviors that are recognized and
rewarded for behaviors that are ignored, without regard to their
contribution to goal accomplishment.

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12-42
 Goal Displacement (3 of 3)
• Suboptimization
– Refers to phenomenon of a unit optimizing its goal
accomplishment to the detriment of the organization as a
whole.
– The emphasis in large corporations on developing separate
responsibility centers can create some problems for the
corporation as a whole.
– To the extent that a division or functional unit views itself as
a separate entity, it might refuse to cooperate with other
units or divisions in the same corporation if cooperation
could in some way negatively affect its performance
evaluation. Example:
– The competition between divisions to achieve a high ROI can result in
one division’s refusal to share its new technology or work process
improvements.
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12-43
 Guidelines for Proper Control (1 of 2)
• In designing a control system, top management should remember that
controls should follow strategy.
• Unless controls ensure the use of the proper strategy to achieve objectives,
there is a strong likelihood that dysfunctional side effects will completely
undermine the implementation of the objectives.

The following guidelines are recommended:

1. Controls should involve only the minimum amount of
information needed to give a reliable picture of events:
Too many controls create confusion. Focus on the strategic factors
by following the 80/20 rule: Monitor those 20% of the factors that
determine 80% of the results.
2. Controls should monitor only meaningful activities and
results, regardless of measurement difficulty.

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12-44
 Guidelines for Proper Control (2 of 2)
3. Controls should be timely so that corrective action can
be taken before it is too late: Steering controls, (controls that
monitor or measure the factors influencing performance), should be
stressed so that advance notice of problems is given.

4. Long-term and short-term goals should be used: If only

short-term measures are emphasized, a short-term managerial orientation
is likely.

5. Controls should aim at pinpointing exceptions.

6. Emphasize the reward of meeting or exceeding
standards rather than punishment for failing to meet
standards: Heavy punishment of failure typically results in goal
displacement. Managers will “fudge” reports and lobby for lower
standards.

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12-45
ALIGNING INCENTIVES
o To ensure congruence between the needs of a corporation
as a whole and the needs of the employees as individuals,
management and the board of directors should develop an
incentive program that rewards desired performance.
o This reduces the likelihood of the agency problems (when
employees act to feather their own nests instead of building
shareholder value).
o Incentive plans should be linked in some way to corporate
and divisional strategy.
o The following three approaches are tailored to help match
measurements and rewards with explicit strategic objectives
and time frames:

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 Approaches to Strategic Incentive Management (1 of 2)
• Weighted-factor method: The weighted-factor method is
particularly appropriate for measuring and rewarding the
performance of top SBU managers and group-level executives
when performance factors and their importance vary from one
SBU to another.
• Long-term evaluation method: The long-term evaluation
method compensates managers for achieving objectives set
over a multiyear period. An executive is promised some
compensation based on long-term performance.
• Strategic funds method: The strategic-funds method
encourages executives to look at developmental expenses as
being different from expenses required for current operations.
The accounting statement for a corporate unit enters strategic
funds as a separate entry below the current ROI.
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12-47
 Approaches to Strategic Incentive Management (2 of 2)
• An effective way to achieve the desired strategic results
through a reward system is to combine the three approaches:
1. Segregate strategic funds from short-term funds, as is
done in the strategic-funds method.
2. Develop a weighted factor chart for each SBU.
3. Measure performance based on three things:
▪ The pre-tax profit indicated by the strategic-funds
approach,
▪ The weighted factors, and
▪ The long-term evaluation of the SBU’s performance.

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12-48
Figure12-2: Business Strength/Competitive position

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12-49
• Figure 12-2: Using portfolio analysis, one corporation’s
measurements might contain the following variations:
• The performance of high-performing (Star) SBUs is
measured equally in terms of ROI, cash flow, market share,
and progress on several future-oriented strategic projects
(funds);
• The performance of low-growth, but strong (Cash Cow)
SBUs, in contrast, is measured in terms of ROI, market
share, and cash generation;
• The performance of developing (Question Mark) SBUs is
measured in terms of development and market share growth
with no weight on ROI or cash flow.
• The performance of low growth and low competitive position
(Dog) is measured in terms of ROI and cash flow only.
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