P5 APM ALL in One Technical Articles

ALL P5 (APM) TECHNICAL ARTICLES
(2021)
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Technical articles
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Advanced Performance Management (APM) was previously
known as P5 Advanced Performance Management. All exam
resources listed as P5 can be used for studying APM.
Advanced Performance Management (APM)
Study support videos
Exam technique
Advanced Performance Management (APM)
Changes to Advanced Performance Management question requirements
From September 2019 onwards, the format of the question requirements in Section A of the APM exam will change.
Advanced Performance Management examiner approach
Advice on how to prepare for the exam, and the best ways to achieve success.
Making the most of ACCA’s Advanced Performance Management resources
ACCA produces a wealth of resources designed specifically to support students taking Advanced Performance Management. Here,
we outline the specific Advanced Performance Management resources on the ACCA website, explaining how they should be used
and what issues they specifically address.
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Improving your Advanced Performance Management answers – Part 1
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Improving your Advanced Performance Management answers – Part 2
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This two-part article aims to give a marker’s perspective on the level of response that is required in a Advanced Performance
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Management answer. It addresses a specific past paper question that caused considerable difficulty in the June 2014 session.
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Bringing forward Performance Management knowledge and skills into Advanced Performance Management
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A member of the Advanced Performance Management examining team provides candidates with some insight into the ways in which
knowledge and skills gained at previous levels can be examined at the final professional level.
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Reading the question requirements of Advanced Performance Management
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An insight into some common problems and misconceptions surrounding Advanced Performance Management. The article considers
how to carefully understand the question requirement with use of selected examples from the past three Advanced Performance
Management exams.
Value for Money (VFM) and performance measurement in not-for-profit organisations
This article discusses the concept of value for money, and how it can be used to measure performance in not-for-profit
organisations.
Sustainability and performance management
Sustainability is becoming an increasingly important issue for business, government and society. This article describes the
importance of measuring sustainability performance, issues organisations need to consider when measuring sustainability
performance and some of the metrics that could be used for doing so
Demystifying value-based management
This article aims to demystify the topic of value-based management by looking into its background, key ideas, problems, and steps
for implementation. Finally, this article will give advice on how to tackle VBM requirements.
Developments in IT and the impact on performance management – part 1
This two-part article looks at some important IT developments and discusses how they have impacted on management information
and measuring performance.
Big data 1: What is big data?
Big data is part of the Performance Management syllabus. But what exactly is big data?
Big data 2: How companies use big data
This article will describe some real life examples of the use of big data for performance management and measurement purposes.
Data analytics and the role of the management accountant
This article describes performance metrics that are used by internet-based businesses and, in particular, looks at some of the metrics
available in Google Analytics, the most widely used analytics tools for website traffic.
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Common mistakes and misconceptions in the use of numerical data used for performance measurement
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This article considers the following learning outcome of the Advanced Performance Management syllabus: ‘Advise on the common
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mistakes and misconceptions in the use of numerical data used for performance measurement’.
Integrated reporting
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Integrated reporting is included in the syllabus of many Strategic Professional exams. This article aims to show how the idea of
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integrated reporting is relevant to the APM syllabus.
Performance reports
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The design of performance reports is regularly examined in the APM exam. This article aims to provide guidance on how to tackle
this type of question.
Lean enterprises and lean information systems
Also available as a podcast on iTunes
This article considers Toyota’s lean principles that have led to a new approach to management in many industries, with a focus on
satisfying the needs of the customer, and not wasting time and money on activities that do not ultimately add value to the customer.
Complex business structures
This article focuses on complex business structures, where a core enterprise needs to manage the performance not only of its own
activities, but also those of its partners to some extent.
Performance indicators
Both SBL and APM require candidates to be able to establish key performance indicators and critical success factors. This article
explains and illustrates these concepts.
Critical success factors
How critical success factors are used.
The risks of uncertainty – part 1
This article considers the concepts of risk and uncertainty will be introduced together with the use of probabilities in calculating both
expected values and measures of dispersion.
The risks of uncertainty – part 2
In this article on the risks of uncertainty, we build upon the basics of risk and uncertainty addressed in the first article published in the
first part to examine more advanced aspects of incorporating risk into decision making.
Economic value added versus profit-based measures of performance – part 1
In the first part of two articles, we look at an alternative performance measurement system, Economic Value Added – or EVA – which
has gained widespread use among companies such as Siemens, Coca Cola and Herman Miller.
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Economic value added versus profit-based measures of performance – part 2
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The second part of an article on Economic Value Added (EVA focuses on how to interpret the calculated EVA and its use as both an
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organisational and divisional performance measure.
Transfer pricing
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Transfer prices are almost inevitably needed whenever a business is divided into more than one department or division.
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Performance management in public sector organisations
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Many governments around the world have undertaken reforms aimed at making public sector organisations more accountable. One
of the key features of these reform programmes has been the increasing use of performance measures like benchmarking, where
one organisation compares its performance in a specific area with another – the benchmark – to identify areas for improvement.
Not-for-profit organisations – part 1
The first part of the article broadly describes the generic characteristics of not-for-profit organisations.
The second part of the article takes a specific and deeper look at charities, which are one of the more important types of not-for-profit
organisations.
Performance management models
This article provides a brief overview of two models which can assist accountants, not only in the determination of business strategy,
but also in the appraisal of business performance.
The pyramids and pitfalls of performance measurement
This article outlines the issues which are central to the understanding and assessment of performance measurement.
Performance measures to support competitive advantage
A focus on the success of airlines such as EasyJet and Ryanair and how the balanced scorecard might be utilised to maintain the
low-cost carriers' competitive edge.
Management control – a pre-requisite for survival
This article explains why increasing recognition is given to satisfying the needs of different stakeholders.
Business failure
The various failure prediction models.
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Environmental management accounting
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This article provides an insight into environmental management accounting, its increasing importance, and new developments.
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Activity-based management
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Activity-based management (ABM) can be defined as the entire set of actions that can be taken on a better informed basis using
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ABC information. The aim is to achieve the same level of output with lower costs.
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Human resource management and the appraisal system
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This article looks at the nature of human resource management, and at the link between human resource management and
performance management. It then examines aspects of the staff appraisal system, and considers the impact of these on the
performance of an organisation.
Reward schemes for employees and management
A major part of performance management involves managing employees and managers, as their performance will have a major
effect on the performance of the organisation as a whole. This article looks at how reward schemes can be used to influence the
behaviour of employees.
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Changes to APM question

requirements
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Changes to APM question requirements
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From September 2019 onwards, the format of the question
requirements in Section A of the Advanced Performance
Management (APM) exam will change.
Throughout this brief article, examples from the APM Specimen exam applicable from September 2019 are used.
As can be seen in Figure 1, there will still be a need for candidates to produce a report for the board or chief executive officer (CEO)
of the company in the question but it will direct candidates to respond to instructions for work on a number of specific areas. In this
illustration the areas of work are the four question parts (denoted by roman numerals), which have a corresponding number of marks
allocated to them.
In order to determine what the instructions are for each of these areas, candidates will need to engage with the question scenario.
Each question part will relate to one or more headed paragraphs/appendices in the question scenario. It will be clear from the
question scenario which paragraphs are relevant to the question part, as the paragraph heading will include corresponding key
phrases. In Figure 2 the question scenario is headed up ‘Economic value added (EVA™)’ which clearly relates to question part (i).
Question part (i) asks for a response to the CEO’s instruction for work on ‘the use of economic value added (EVA™) as the key
performance metric at IC’. So what are the instructions?
The vital information for this part of the question has been highlighted in Figure 3. In summary, an EVA™ calculation has been done
but the CEO wants an evaluation of the accuracy of the calculation and the assumptions it is based upon. The CEO also wants
advice on the results with revised calculations as needed. This paragraph of information also refers to Appendix 1 which contains the
current EVA™ calculation, so this is also relevant when answering question part (i). This is format is known as embedded
requirements.
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When identifying these embedded requirements it is important to note how many activities are being asked for. In this example, the
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following work is required:
• Evaluation of the accuracy of the calculation with a revised calculation
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• Evaluation of the assumptions which the calculation has been based on
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• Advice on the results of the revised calculation – ie what is the revised EVA™ figure saying about company performance
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Taking another example in Figure 4, it is clear that this paragraph headed up ‘Improvement projects’ clearly relates to question part
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(iii). In this paragraph there is information about three improvement projects and the instructions from the CEO on this area have
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been highlighted. As in the example before, there are several activities required:
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• Explanation of the three improvement projects
• Advice on how the three improvement projects will help to meet the CSFs at IC
• Advice on how the three improvement projects will impact on the existing three KPIs.
When noting these instructions, it can be seen that these three activities need to be done for each of the improvement projects. The
first piece of work is a straightforward knowledge request, but the second and third pieces of work require information located in
another paragraph titled ‘Critical success factors (CSFs) and key performance indicators (KPIs), which contains information relevant
to question part (ii) also.
What to do now
Practise using the question requirements and question scenario in this way to become familiar with the use of embedded
requirements. Ensure that all activities being asked for, by either the board or CEO, are broken down and highlighted. This will
ensure that all aspects of the instructions are being addressed by candidates in their report and will maximise the opportunity to
score marks.
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Advanced Performance Management –

examiner approach
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Advanced Performance Management – examiner approach
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Relevant to candidates sitting Advanced Performance
Management (APM) from September 2019
An outline of the aim of APM, its structure and how the syllabus is tested
This article begins by considering the syllabus and overall aims of the exam, how it relates to previous exams and the format of the
exam. It will then summarise advice about my approach to the exam using suitable example questions from recent exams to illustrate
points.
Syllabus
There are five capabilities and most will feature to some extent in every diet:
• use strategic planning and control models to plan and monitor organisational performance
- This emphasises the need to take a holistic view of the factors, both internal and external, affecting the business and to
consider them when giving strategic advice on performance management and measurement solutions. Good candidates at
APM often distinguish themselves by being able to synthesise disparate detailed points into an overall, strategic approach for
an organisation.
• assess the impact of risk and uncertainty on organisational performance
- This signifies an additional focus on recognition of risk and uncertainty and the need to consider these factors when
determining approaches or making decisions across all levels of an organisation; from strategic level through to tactical and
operational levels.
• identify and evaluate the design features of effective performance management information and monitoring systems
- Candidates will not be required to have detailed technical knowledge of hardware and software but are expected to be
conversant with the broad hardware and software trends and issues and how these interact with the provision of performance
information throughout the organisation. It is the effect of these technologies on the performance management decision-making
processes that is most significant.
• apply appropriate strategic performance measurement techniques in evaluating and improving organisational performance
- This capability requires the application of the performance measurement techniques of APM and its assumed knowledge in
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specific scenarios.
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• advise clients and senior management on strategic business performance evaluation and on recognising vulnerability to
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corporate failure
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- This capability takes the performance measurement information and seeks to turn it into commercially valuable advice for
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strategic decision makers both to improve performance and to improve performance management systems.
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In addition to these capabilities candidates are expected to show the ability to gather new knowledge from the general technical
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press and so the articles in Student Accountant will be sources of topics for exam. These articles will also be the principal route by
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which the students will have new techniques and trends communicated outside of the slower cycle of revisions to the syllabus.
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Candidates should note that unlike in the compliance topics such as financial reporting and tax, changes are not regularly made to
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the syllabus areas so that older articles may well be as relevant to the upcoming exam as the most recent ones. Any additional
reading beyond the ACCA-approved texts and Student Accountant articles should be viewed as advisory and not required. However,
candidates are advised to broaden their general business knowledge by the regular reading of good quality business press. This will
provide additional background and examples of the techniques and issues of performance management.
The syllabus comes with a Study Guide of more detailed guidance about the specific topics to be examined. The syllabus has
undergone a recent review and the changes have been attempts to make explicit certain tools and techniques that are applicable at
APM. Therefore, most past exam questions will be relevant to the current exam.
Links to other exams

Performance management systems are the systems in an organisation by which the performance of an organisation is measured,
controlled and improved. The thrust of the exam will move towards the strategic level of considering different performance
measurement techniques and management systems. APM builds on knowledge gained at other levels; especially from PM,
Performance Management and MA, Management Accounting. Areas covered in the SBL, Strategic Business Leader, are also useful
for APM and vice versa. PM tests the candidate’s ability in application and analysis of core management accounting techniques and
APM develops key aspects introduced at the PM level with a greater focus on the synthesis and evaluation of the key topics and
techniques. It will also introduce more specialised techniques and current issues in performance management. Therefore, candidates
should not expect to be retested in a PM style on topics but need to be aware that all of PM knowledge is assumed to be known and
will now be used in a more critical capacity.
Exam format
The exam is a three-hour 15-minute test. There are two sections in the exam:
Section A (a single compulsory question)
There is only one question in Section A worth 50 marks. The purpose of this is to allow a detailed case study scenario to be given so
that candidates can have the information and time to develop deeper answers to the question requirements. The Section A question
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will focus on a range of issues from across syllabus sections A, C and D.
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Professional marks are a regular feature of the Section A questions (four marks in every exam) and it should be possible for a well-
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prepared student to score most of these easily. Efficient preparation involves the identification of appropriate formats and structures
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to use in answering questions and practising writing answers in order to improve clarity.
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From September 2019, this question will fully utilise the use of embedded requirements and there is an article explaining the changes
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to requirements in APM available on the ACCA website.
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Section B (two compulsory questions)
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Section B consists of two 25-mark questions. One of the Section B questions will focus mainly on syllabus section E but may include
a supporting topic from another syllabus area. The other Section B question can come from any other syllabus section.
Use of dates
ACCA is working towards moving Strategic Professional to computer based exams and dates in the APM exam will be in the format
20XX e.g. 20X5. As this will make the dates for each exam session generic, it has been decided to always apply the same dates in
each exam irrespective of the exam session.
Approaching the APM exam

The best approach to the exam can be summarised as:
• cover the whole syllabus
• be prepared to apply all of this knowledge to a business scenario
• read and answer the question asked
• add value to the organisation that is being advised.
Cover the whole syllabus

Remember that, broadly, the exam tests the capabilities that are required of a candidate (listed above). The exam aims to address
issues at the strategic, tactical and operational levels and often requires a candidate to understand the connections between these
levels. For example, the question evaluating the links between the current key performance indicators (KPIs) and the company’s
mission in Question 1 of the March/June 2017 sample questions or evaluating whether a specific critical success factor (CSF) and a
specific KPI will help an organisation achieve it strategic objectives as in Question 4 of the September/December 2016 exam.
Another example of the type of question that arises is how does the choice of operational performance measures impact on the
strategic performance of the organisation? A phrase that rings true in many situations is Drucker’s dictum ‘What gets measured gets
done’. This phrase succinctly points to the impact that the choice of performance metrics have on the management activity of the
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firm.
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Now these points should illustrate why it is a misapprehension that the exam is predominantly about performance measurement, it is
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a performance management exam. This error often manifests in a candidate’s over-concentration on detailed elements of Section D
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(Strategic Performance Measurement) of the syllabus. As indicated above, it is important to remember that the ideas contained in the
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various metrics need to be coherently applied to meet the strategic needs of an organisation and this is where other sections of the
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syllabus will connect to a question – for example, the choice of performance measures needs to fit with the planning and control
structures (Section A) or whether chosen measures will impact the information systems employed (Section C).
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Finally, in thinking about syllabus issues remember that APM builds on PM knowledge applying it in more complex scenarios so you
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should ensure that this PM knowledge is available in the exam.
Apply your knowledge to the question scenario

The exam tests a candidate’s ability to assess different approaches to performance management from a variety of perspectives. This
will entail the candidate knowing what the approaches are and more importantly being able to compare one with another in the
context of a scenario – for example, profit and value approaches, financial and non-financial perspectives, short-term and long-term
issues.
A good candidate will be able to tailor the approaches suitable to the organisation described in the scenario and justify this advice
using the evidence given in the scenario.
The scenario describes the organisation, its objectives and its business environment. A good candidate will show how they have
taken in this information and then applied it to the performance management of that organisation. For example, when assessing
different performance management approaches, a useful question to ask is ‘Does this meet the objectives/needs of the
organisation?’ so obviously, the candidate must have identified these from the scenario.
Candidates must make sure that they can:
• assess the current situation of the organisation (for example, its existing performance management systems) and then
• consider how to apply a new approach to performance management (for example, value-based or based on one of the many
models mentioned in the syllabus such as the performance pyramid or the building block model) and
• assess whether this new approach will be an improvement (for example, by helping to meet the corporate objectives).
Lists of rote-learned advantages and disadvantages for different approaches will not produce a complete answer as a candidate will
be expected to tailor this knowledge to the situation given in the question. Also, simply writing the appropriate jargon words or
phrases associated with a model or method will not score heavily. It is essential that candidates demonstrate that they know how
to apply these appropriately to the scenario. So for example, Question 3 of the March/June 2018 questions asked for an evaluation of
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a value-based management approach within a company which hired machinery out to the construction industry. A good answer
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considered the advantages and disadvantages of the value-based management approach for that organisation and also considered
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alternative approaches which could have been taken.
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Answer the question asked
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The question requirement usually gets a great deal of attention from the examiner who first writes it and the team of reviewers who
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perform more than five layers of review before the exam is finalised. My approach to this point is that candidates should be given
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credit where their answer is technically correct and relevant to the question asked. There has been a tendency by candidates to write
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good answers to questions that they wish had been asked by the examiner rather than the one actually set in the exam. This
approach scores little if no credit. There is a longer article entitled ‘Reading the Question Requirements of APM’ (see ‘Related links’)
that illustrates the common misinterpretations seen in previous sessions. In addition, there is a two-part article entitled ‘Improving
Your APM Answers’ that is very useful reading (see ‘Related links’).
Create information from data

As the business environment has been profoundly affected by the increased use of technology, there is less need at a strategic level
to manually perform calculations. This is already tested heavily in earlier exams; therefore, there has been a reduction in the volume
of computational work required for this exam compared to the lower levels. Occasionally, longer computations may appear but these
will be used as a way of allowing the student to absorb the data in a question and become comfortable with the scenario. Large
repetitious calculations are avoided but it should be noted that some repetition is inevitable as, for example, a trend can only be
identified with at least two, or more realistically three data points.
However, computational work has not totally disappeared from APM but features more in the interpretation and further analysis of
data provided in the question. Candidates have to demonstrate the ability to add value to their advice by taking information already
produced and identifying the important features. At Strategic Professional, comments should be helpfully quantified where possible
and the commercial implications discussed. Candidates should be constantly on the lookout for ways to make their numbers more
understandable, for example, by comparing them to increased activity of the business or to competitor performance.
A valuable management accountant will create information from the detailed data given in a question. It is often best to begin by
considering the ‘big picture’ (what is the overall objective); next, break down the data into smaller but meaningful (and manageable)
chunks; finally, discuss the individual lines of the data table and even then, a candidate should focus on the data that explains the
overall picture of changes.
A good example of this was Question 1 Part (ii) from the March/June 2017 questions.
1. Consider the ‘big picture’ – when assessing the definitions and assumptions in the calculation of the KPIs consider whether they
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are giving a misleading impression to stakeholders which is what has driven this request from the CEO.
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2. Break down the data into smaller but meaningful (and manageable) chunks – the individual KPIs
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3. Discuss the individual lines of the data table focusing on the data and the notes provided about the financial data.
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It is important to realise that, at the APM level, it is not enough to throw down all the ratios and measures that can be imagined. In
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doing this, the candidate is probably going to overload the report reader with unnecessary data. It is essential that candidates try to
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be selective in their choice of what to calculate. This is an important testing area in the exam as it shows that the candidate has
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appreciated the strategic goals or key drivers of performance and can focus on them. (Further examples of applying this skill are in
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Question 3 of the September/December 2017 questions and Question 1 of the March/June 2018 questions).
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Note specifically that in handling data heavy questions, the level required for APM is for answers to go beyond repeating, in sentence
form, the data given in (say) a table in that question. In Question 1 of the March/June 2017 questions, many candidates wasted their
time by limiting their comments to only writing out statements such as ‘Operating profit is a regularly used performance measure and
all parts of the organisation have a comparable result’. This does not address the question which wanted a focus on how that
measure had been calculated and what costs should be included, in particular what the impact on the operating profit figure would be
for the catering business if exceptional costs were treated differently.
Candidates will be expected to analyse not merely calculate numerical data given from a scenario.
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A candidate would be advised to ask him/herself if the answer they have produced would help the organisation to answer the
question requirement.
Remember, try to add value with your answers by way of comments relevant to the issue at hand.
Written by a member of the APM examining team
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Making the most of ACCA's Advanced

Performance Management resources
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Making the most of ACCA's Advanced Performance Management resources
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ACCA produces a wealth of resources designed specifically to
support candidates sitting the Advanced Performance
Management exam. These resources have been developed to
address areas which candidates typically find challenging based
on a review of previous exam sittings.
Here, we help to ensure you don’t make the same mistakes made
by candidates in past exams by directing you to specific
resources on the ACCA website, explaining how they should be
used and what issues they specifically address
Using the examiner's reports

• An examiner’s report is produced after every exam sitting and focuses on areas that candidates did well in and where they
could have done better. They refer to specific exam questions and provide guidance on how you can avoid making the same
mistakes.
• Ideally you should look at the last four reports – noting specific knowledge areas which caused difficulties as well as specific
areas around exam technique.
• Review the examples below for guidance on how the reports link to specific exam questions
Example 1: (Taken from Q1, December 2014)

Q1(ii) Briefly justify appropriate management approaches to each of the stakeholders and, based on
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this analysis, evaluate the appropriateness of the performance measures suggested in Appendix 1. (14
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marks)
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Extract from examiner’s report: Many candidates chose to rework the analysis of interest and power stating
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whether or not they agreed with it, which wasted time when the focus of the answer needed to be on suitable
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management approaches. The discussions of the five performance measures tended to be general rather than
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specific to the issues at Boltzman and the stakeholder analysis.
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Further comment: The stakeholder analysis had already been done in the scenario and so candidates were
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expected to use this analysis to justify a management approach for each stakeholder. An evaluation of the
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performance measures required the candidate to then say what was good and what was bad about those
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measures in relation to the stakeholder analysis.
What a lot of candidates actually did was re-do the stakeholder analysis which was not asked for and instead
of evaluating the performance measures in Appendix 1 they produced a list of new ones. Candidates may think
that they have answered the question as they have recognised the application of Mendelow’s matrix when in
fact they have not. If you had practised this question during your revision and answered the question in this
way then without using the examiner report you may not identify that this was the incorrect approach. This
illustrates why the examiner reports should be an essential part of your revision.
Example 2: (Taken from Q1, June 2014)
Q1(i) Evaluate the current performance report in Appendix 1. (15 marks)
Extract from examiner’s report: There were a number of candidates who provided an irrelevant evaluation of
the performance of Cantor. Those that attempted the question asked scored most of the marks associated with
such reports in general (e.g. data overload, rounding numbers, lack of narrative). However, fewer scored the
marks that were available for appreciating the scenario surrounding Cantor. It was especially surprising that
despite comments in previous examiner’s reports, candidates still seem reluctant to use the mission/strategy of
the business to evaluate the report.
Further comment: This requirement was asking for an evaluation of what was good and what was poor about
the performance report for the company (Cantor) in the question. It was not asking for an evaluation of
performance. The examiner’s report identified this issue and also gave other important advice which could be
missed if these reports are not used in your examination preparation.
In addition to the examples given here, the technical article 'Improving your Advanced Performance Management answers – part 1'
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(see 'Related links') gives a more detailed analysis relating to example 2 above, as well as an example of a weak answer to this
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question, which further illustrates what not to do in the exam.
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A second article, 'Improving your Advanced Performance Management answers – part 2' (see 'Related links') provides an example of
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a candidate answer which would pass this question, demonstrating the key points needed to gain sufficient marks to pass, along with
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a model answer.
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All of the Advanced Performance Management examiner’s reports are available on the ACCA website (see 'Related links').
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Reading the question requirements
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• Close reading of the exam question requirements is an essential skill.
• You should aim to identify the verb, which area of the syllabus is being examined (the key theory) and how you are expected to
apply the syllabus area.
• The structure of the requirement can also help you to identify how you should structure your answer.
• Look at the marks available also as this should give an indication of how much you are expected to write
Example 3: (Taken from Q1 from the sample questions from September 2015/December 2015)

Q1(ii) For each of the three critical success factors at IC, briefly explain a weakness of the current KPI associated with
that CSF and then provide a justified KPI. (6 marks)
Verb – explain/justify
Syllabus area – the relationship between CSFs and KPIs
Application – from the scenario identify IC’s three CSFs and their current KPI
Structure – there are three CSFs so your answer should have a heading for each one. Under each heading
explain a weakness the current KPI and then justify an alternative KPI.

Q3(b) Justify one performance measure for each of the components of the value for money framework
used at TRH and, using that measure evaluate whether TRH is delivering value for money. (10 marks)
Verb – justify/evaluate
Syllabus area – VFM and 3Es
Application – use data in Appendix 1 to justify and calculate a performance measure and then evaluate
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whether the measure indicates value for money is being delivered.
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Structure – there are 3Es so your answer should have a main heading for each one. Under each main
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heading there should be a justification of a measure, the calculation of said measure and then an evaluation of
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what the measure is telling you about TRH’s value for money delivery.
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The technical article, 'Reading the question requirements of APM' (see 'Related links') gives several more examples of how to read
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the requirements of APM exam questions – providing valuable insight into what is expected of you in your exam.
Application ofCC
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models
• Many APM exam questions require the application of a performance management model. Candidates are particularly good at
learning the theory of the models and are able to explain a model’s purpose and structure very well. Issues arise however when
the model has to be put into context with the scenario.
• If a requirement asks for a model to be used then the examining team are expecting that to be the approach to the answer. It is
frustrating to have a candidate explain a model in detail and then subsequently not use it in the rest of their answer.
Example 5: (Taken from Q1 from the sample questions from March 2018/
June 2018)
Q1(iii) Advise on appropriate performance measures and systems for Chiven when using the value
chain approach to simplify the supply chain. (7 marks)
Credit was given for a brief description of the purpose of the value chain but then candidates were expected to
consider how to use the value chain to simplify the supply chain. Lengthy discussion about every section of the
value chain score very little and wasted time, especially as the model diagram had been given in the scenario.
Q3(a) Advise the board how the six sigma project at Posie to reduce returns from customers could be
implemented using DMAIC methodology. (15 marks)
Candidates were able to explain the DMAIC methodology which is an appropriate way to begin answering this
requirement. The DMAIC method should then have been used to structure the answer otherwise the
methodology is not being used to advise the board.
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This application of key theories is a crucial skill to passing Advanced Performance Management. It is not enough just to know the
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theory; you need to be able to practically apply it.
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Assumed knowledge
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APM draws on knowledge from FM. There is a key article which you should read.
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• 'Moving up from PM to APM’ (see 'Related links') identifies key areas for you to refresh from PM in preparation for APM
And finally...
Four professional marks are awarded in APM and the short video 'Professional marks – the difference between a pass and a
fail' gives some pointers to ensure you are awarded these crucial marks.
It is also recommended that you watch the 'APM effective study and exam technique' video (watch the streaming video if you
don't have access to YouTube) all the way through. This covers all of the advice given, as well as further pointers to help you pass
APM – for example, in terms of how best to approach this exam.
Written by a member of the Advanced Performance Management examining team
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Improving your Advanced Performance

Management answers – part 1
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Improving your Advanced Performance Management answers – part 1
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This article aims to give a marker’s perspective on the level of response that is required in a APM answer. It will address a specific
past exam question that caused considerable difficulty in the June 2014 session. The article will present and discuss two possible
poor solutions to this question. Reading through the answer and the marker’s comments should help candidates to avoid basic
mistakes and gain a better understanding of the breadth and depth of solution that a marker is expecting. Comments are made in [
] after each paragraph, where appropriate.
Before reading this article, it is essential to have read the scenario and requirement for Question 1 part (i) of the June 2014 APM
exam and it will be helpful to keep these to hand. The requirement is repeated here for clarity.
Requirement:
Write a report to the CEO of Cantor to:
(i) Evaluate the current performance report in Appendix 1. (15 marks)
Example solution 1: An assessment of the performance of
Cantor Group
This solution has not been written out in full here since it is not an answer to the question, however, an explanation of why this is the
case may help to clarify your understanding of the requirement. There are also some examples of this kind of mistaken thinking in
example solution 2.
This was a common mistake in the actual examination and so, it is worth noting some of the ways in which a candidate could have
realised that ‘an assessment of the performance’ was not what was required.
1. An evaluation of the ‘report’ not the ‘performance’ is requested in the question.
2. The scenario contained the instruction, ‘The CEO has advised you that the board does not require an evaluation of Cantor’s
performance.’ Candidates who are in doubt about the importance of this comment need only check who the solution is being
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addressed to in order to appreciate its significance.
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3. This type of question has appeared in other past exams.
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4. This issue of interpretation of the requirement was commented on in the examiner’s report to these previous exams.
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The most plausible explanations for this error are either a lack of preparation (practising past exams, reading examiner’s reports and
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articles) and/or entering the examination room with an expectation of the questions in the exam – ie that it would begin with a
performance evaluation, which was then followed regardless of the question asked. It is wise to remember that proper preparation
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and then careful reading of the question are pre-requisites for success in the exam.
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The remainder of this article will look at a detailed commentary on a weak solution in order to give advice about how it could be
improved. This solution represents a single answer of roughly the length often seen in the actual examination but it is made up of
common mistakes. A good way to approach this solution is to read it as if you are the marker and see if you can spot the mistake.
Then when you do see something wrong try to think about how you would rewrite that paragraph in order to improve it. The marker’s
comments are at the end of each paragraph.
Example solution 2: A weak answer on evaluation of the

current performance report
Cantor Group operates in a highly competitive market and has reached the limit of its expansion. This will have an impact on their
profit. The company needs to find new ways to expand their market in order for their profits not to decrease.
[Comment: The group has a clear expansion plan for Juicey that contradicts this first sentence. Revenue growth is
confused with profit growth and does not reflect the company strategy of maximising shareholder wealth which need not
be done through revenue growth.]
[Comment: As a starting paragraph, this is not impressive since it does not appear to address the performance report. It
seems to be a discussion of Cantor’s business environment, its strategy and suggested improvements. This is meant to be
an answer to an APM question and so is already straying from the point.]
The current performance report is very informative containing a mix of financial and non-financial information.
[Comment: For a marker reading such a comment it shows that the scenario has not been read carefully. The report is
exclusively financial. This mistake may arise from ignoring the requirement to address Appendix 1 and incorrectly starting
to use the other appendices.]
o x
The report compares actual results with budgeted which is a good comparison as it gives the company an indication how it has
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performed compared to what it has budgeted.
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[Comment: This could be more effectively explained by saying; ‘The report compares actual results with budgeted, which is
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a good comparison as it gives the company an indication how it has performed compared to its plans and will assist in
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controlling the organisation.’ This is better as it begins to show the purpose of budget information.]
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A

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It splits its revenue income into products offered which are food and drink, which is good as the company can see where most of its
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income comes from and can try and focus on these areas to try to increase revenue.
[Comment: An appropriate point but fewer words are often better so an improvement would have been to say, ‘It splits its
revenue between food and drink, which is good as the company can then prioritise the key area for revenue growth.’]
Currently, most of the revenue from the Cantor Cafes (Cafes) comes from drinks, 75% of it (46.5/62.4), which is unusual as you
would expect that the majority of the income would come from food.
[Comment: This needs justification in two ways. Firstly what has this to do with the quality of the report and secondly, why
expect more revenue from food? A marker would often look at this sort of comment as tangential to the question and an
unjustified speculation on the scenario. Without evidence from the scenario this is simply an irrelevant statement.]
Food income is only 25% of the income (15.9/62.4), Cantor Group needs to explain why the revenue from food in Cafes is low
compared to drinks and to try to improve this. They can do customers surveys and see if their menu can be improved or alternatively
expand on the drinks variety and focus only on the revenue from drinks.
[Comment: Again, this paragraph is making points that would be more relevant to a question that asked how to improve the
performance of Cantor. This point could be improved by stating that the report would benefit from the inclusion of a
narrative commentary which could include an explanation of the split of food and drink revenues. However, the need for
this explanation would also need to be justified, possibly by reference to the mission statement.]
The revenue from Juicey mostly comes from drinks (90% of its revenue comes from drinks (5.4/6) compared to 10% of its revenue
from food (5.9/6)). This was expected as the company focus on drinks and only offers food as a compliment.
o x
[Comment: This is the fourth paragraph on revenues and their split. For the candidate to have spent so long on this area,
B
they must think it vital and yet there has been no justification of this. If the mission had indicated that the company’s aim
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was revenue growth then that would have provided such a reason, however, it does not.]
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The report itself is good as it breaks down the revenue and cost by categories and it can clearly see where the revenue or cost is
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being spent.
CC
[Comment: This comment is too vague. A reason must be given that justifies the value in this specific categorisation of
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revenue and costs.]
What it does not do is compare the revenue of food and drink to cost spent.
[Comment: This comment is vague and arguably wrong as gross margin is given. An explanation of the value of reporting
on gross margin for Cantor could score.]
The revenue of drink in Cafes compared to the cost is 27% (12/46.5) which is quite high. The company should try to decrease this
cost via finding cheaper alternatives such as implementing better supply chain or decrease wastage.
[Comment: Revenue compared to cost would normally be interpreted as revenue/cost not cost/revenue; 12/46.5 is 26% and
there is inconsistent rounding in using one decimal place for revenue but not for cost. It is concerning for markers to see
errors in simple number work. A vague suggestion of ‘implement a better supply chain’ isn’t relevant but ‘decrease
wastage’ might be helpful if it could be tied to the scenario by pointing to its importance in a trade serving fresh food.]
The cost of sales in Cafes of food compared to revenue is 4.5% (15.9/3.5) which is acceptable. This concludes that even though the
revenue from drinks is high the cost of sales is also high therefore decreasing profit.
[Comment: Again, there are inaccuracies in simple number work (15.9/3.5 = 454%) and also, there should be a comment that
a gross margin of 4.5% sounds very strange (not ‘acceptable’).]
x

B o
The report shows the Cafes staff cost and compares with actuals vs budget. This indicates that the company budget 1.24% more
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than it actually spent ((16.1-15.9)/16.1)
b a
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[Comment: At this point about half way through, it is often a good idea for the candidate to check that they were answering
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the question asked. This comment clearly is not about the performance report but about the performance of Cantor. Even if
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it were relevant, the comment is empty as no use is made of the 1.24% variance identified. This is most likely because it is
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immaterial.]
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In the Juicey budget, the cost for staff was less than it actually spent by 4.8% more, …
[Comment: This comment has been left in to show just how confused an answer can become. The way to avoid this is to
think before writing. (The probable meaning is that this cost heading was 4.8% over budget.)]
… this indicates that the company needs to focus on the staff cost and try to decrease by either implementing new shift procedures
or monitor its staff turnover.
[Comment: The need for action on Juicey’s staff costs has not been properly justified. In fact, if the candidate had checked
then they would have seen that Juicey’s revenue was over budget by 4.9%, which may have explained much of the need for
higher staff cost.]

The report should compare the staff cost per number of staff in each subsidiary then the CEO could see where the majority of cost
goes.
[Comment: Assuming that what is intended is that a metric of average wage per staff member be included then this is
answering the question but only in a vague way. This recommendation leaves unanswered questions and it could be
improved by stating the reason for measuring this quantity – ie how it fits with the strategy of the business and whether
this metric is appropriate for the group or the subsidiary boards or for all three?]
The report should also try to show the staff cost between Cafes/Juicey and head office staff as it’s not fair to include the head office
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cost in the performance of the two subs.
B o
[Comment: There needs to be a lead in to this discussion that talks about the main measures of performance of the group
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and the subs. For example, it could be argued that this point is incorrect since the report gives the operating profit of the
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subs individually and so has excluded the head office costs. This can be easily checked by seeing that the group staff cost
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is not simply the sum of the staff costs of the two subs.]
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The operating cost shows of breakdown of fixed and variable costs. It should try to focus on variable costs as this will indicate where
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the company is spending most.
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[Comment: The candidate seems to be rushing their answer now and is gaining no benefit by doing so. The operating costs
do not show which are fixed and which are variable – indeed, that is the subject of a later piece of analysis in part (ii) of this
question. Also, there is no justification offered as to why the variable costs are the key costs.]
Including cost such as depreciation and tax will not benefit the performance of the company and will not add any value.
[Comment: This type of comment needs to distinguish which company is being discussed – the group or one of the subs.
As shareholder value is the key metric in the mission, tax and some measure of the use of assets seem significant in
measuring performance.]
It should display the other operating cost on things such as electricity, water, wastage bills as these will add value to the report.
[Comment: No justification is offered for the additional cost of preparing these metrics, nor consideration of the impact of
further confusing a detailed financial report with more financial metrics.]
The report states the number of leavers and new joiners but does not say the cost of these. By showing a breakdown on the cost of
training and employee agency costs the company could try to improve employee satisfaction and maybe decrease the numbers of
employee leavers.
[Comment: The report is in Appendix 1 and it does not give detail about leavers and joiners. If the suggestion here is that
the report should give these measures, then again, this needs to be justified. An acceptable justification would be to point
x
to the need for new metrics if the mission statement is changed.]
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The report also shows a number of ratios and profitability analysis but shows how well the company is doing but without
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benchmarking. We do not know if these are any good compared to competitors.
G l
[Comment: This statement ignores the industry averages given. The answer needs to make specific points such as, ‘It
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would benefit the subsidiary boards to have operating margins and other profitability ratios in their own sub-sectors in
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order to benchmark performance.’ Candidates were expected to comment on how to use the figures given and on the
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possibility of internal benchmarking between the cafes and juice bars.]

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The report is also very number based and contains a lot of financial information. This would not be good for non-financial user to
read.
[Comment: Again, it is helpful to give examples of what is meant and maybe suggest broad improvements such as the
inclusion of a narrative commentary.]
Also, it only contains one year’s worth of information. It does not show the last year’s results and so we do not know if the
performance is getting better or worse.
Cantors’ mission statement is to maximise shareholders wealth but the report does not give any indicators on how this is happening,
it should show EPS ratios or information on how it is targeting to improve their wealth.
[Comment: This is right on the mark but sadly not given the priority it deserves – ie it should be at the beginning of the
answer. If the answer had started with this comment, it may have prompted many more helpful comments as the detail of
the report was discussed.]
The report should contain a mix of financial and non-financial information and it should compare both, such as number of returning
customers or staff cost per restaurant.
[Comment: Again, this is unjustified. The candidate is leaving it to the marker to work out if it’s a reasonable idea or not. An
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improvement would be for the answer to point to the mission statement and the role of customers in order to justify such a
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new metric.]
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This would target specific areas and give a better indicator on how both companies are doing.
[Comment: This is an unnecessary comment.]
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Summary
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The answer tries hard but consistently fails to make its points relevant and justified in assessing the performance report of Cantor
Group using the information in the scenario.
It shows how not to answer this question. Before reading the improved solutions (the next article), it would be an excellent exercise
for you to now write your own solution. This should only take about 20–25 minutes as you have done the preparation!
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Improving your Advanced Performance

Management answers – part 2
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Improving your Advanced Performance Management answers – part 2
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This article aims to give clarity on the level of response that is required in an APM answer. It will address a specific past exam
question that caused considerable difficulty in the June 2014 session. The article follows on from the first part (see 'Related links')
giving examples of weak answers, and will discuss two possible passing solutions to this question. Then it will consider a marker’s
view of each one.
In reading through these solutions and the marker’s comments, candidates should gain a better understanding of the breadth and
depth of solution that a marker is expecting. Comments are made in [ ] after each paragraph, where appropriate.
Before reading this article, it is essential to have read the scenario and requirement for Question 1, part (i) of the June 2014 APM
exam and it will be helpful to keep these to hand. The requirement is repeated here for clarity.
Requirement:
Write a report to the CEO of Cantor to:
(i) Evaluate the current performance report in Appendix 1. (15 marks)
The first example (numbered 3 to be consistent with the earlier article) is based on several, very good solutions seen. The spelling
and grammar has been slightly tidied up but not perfected so that this solution is understandable but not overly polished. This
solution’s length reflects real exam efforts.
Example solution 3 – an excellent, passing solution

The current performance report has the following merits to it:
It represents the results of the two subsidiaries separately along with total group results, thus enabling for specific management and
measurement of the subsidiaries, which represents different types of business and also allowing for internal benchmarking.
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[Comment: Valuable here are the implicit identification of the different users of the report, different businesses (though,
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more accurately, it is their different stage of development) and the appropriate use of the jargon term ‘internal
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benchmarking’.]
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The report also shows comparisons of budgeted and actual results, allowing for analysis and continuous improvement of planning
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and budgeting processes.
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The report also provides a list of margins on the group level, so allowing for efficiency and profitability analysis and conclusions.
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[Comment: Notice how, in the second and third points, the author has not just identified what the report does, but has then
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said why it is helpful (‘allowing for analysis and continuous improvement of planning and budgeting processes’).]
The report shows industry averages, thus allowing for external benchmarking and preventing company from internal focus, smugness
and putting company’s performance into perspective.
[Comment: The language strays here a little from the professional (‘smugness’) but a marker would allow some latitude as
the general point is well made.]
The report also shows detailisation for food and drink sales within the group and subsidiary, enabling detailed analysis of product mix
and product margins.
[Comment: ‘Detailisation’ is an overly complicated way of saying ‘a breakdown’. Markers prefer simple, clear language.
Also, the breakdown is not at a product level so this comment is not entirely accurate. Better would have been to mention
what detail is given and then to say what detail would be helpful for the boards.]
Operational costs are very detailed allowing for deep evaluation which is in line with the idea of cost control and cost reduction, which
is a vital part of most business management processes.
[Comment: A prime reason why this is a good answer is that most of the points are structured to state what the report does
and then why (and often, how) this is beneficial. Notice that the answer does not just declare that the point at issue in the
report is ‘good’, it explains why this is so.]
However, there are some drawbacks to the report:
The report is obviously overloaded with information. It’s difficult (almost impossible) to understand for non-financial people and
members of the board. This is helpful information for the financial managers but it will prove of little use for the top level of the
company.
x
[Comment: This point is a little confused. It actually appears to be making two points. First, that there is information
o
overload and secondly the use of excessive financial jargon. It might also be considered insulting to the board to imply
B
they cannot read a basic set of accounts. It would be improved by a specific example of how the report goes wrong – for
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example, poor rounding choice or how to improve the report – eg which margins should be highlighted.]
b a
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The report consists only of financial information, lacking some non-financial aspects which are very important for the business of
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Cantor, such as customers’ satisfaction, brand awareness and brand loyalty, staff turnover (especially in the light of new staff angle of
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the mission statement).
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[Comment: This may not be perfectly put, but is an excellent point as it is justified by using the mission of the company.]
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Some vital financial information is missing as well. Cantor is a listed company stating maximisation of shareholders’ wealth as its
primary objective – but there are no measures of shareholders’ wealth on the report. It could be useful to include such traditional
measures as total shareholders return (TSR), price to earnings (P/E), earnings and dividend yields, earnings per share (EPS) and
such. However, this matter is expected to be addressed after the introduction of VBM and EVA as its main part.
[Comment: Again, this is well justified by reference to the mission though a logical approach would have put point 3 ahead
of point 2. Also, a marker will like the fact that the solution links the point about VBM to this area as it shows that the
candidate is grasping an overall view of the problems faced by Cantor.]
As we know, Cafes and Juicey are very different types of business, Cafes is a mature business with a saturated market and low
expected growth, whereas Juicey is a young, rapidly developing business. According to the BCG matrix, they can be classified as
cash cow and star respectively, so it would be logical to introduce different measures for them. For Cafes – cash flows, cost
measures (cost margins, cost variances, cost trends) and for Juicey – profitability, market share, number of new Cafes launched and
such.
[Comment: Here is a good illustration of how to use the models that the APM syllabus contains in a suitable context. It is a
common mistake here to realise the BCG matrix may help but then to wander away into a lengthy (and unnecessary)
definition and description of the BCG matrix. The solution has used the jargon correctly in context and demonstrated this in
the specific advice given. A very good approach.]
Properties are very important for restaurant business in general and so for Cafes and Juicey as well. This part of activities needs
special control and attention. Cafes are renting on the open market and use standard lease terms (here we should control lease
payments to ensure they don’t exceed market levels). Juicey is experiencing the monopoly of one supplier (strong bargaining power
according to Porter’s Five Forces model). So the calculation of rentals which is a percentage of revenue should be controlled.
[Comment: These are useful performance management points but they are in danger of not being relevant to the question
asked. They can be made clearly relevant to the report (and so the question) by explaining what metrics should be
appearing in the report (for example, benchmark of open market fixed and variable rental charges or alternatively, the
market inflation rate of these amounts). It would not be wise, however, to take this advice as implying that it would be better
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to add to the report many new metrics since this contradicts point 1 above. However, given that the solution has justified
o
this specific point as of particular importance to Cantor, it would seem reasonable to make such a suggestion here. A
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further improvement might be to suggest what data in the existing report should be dropped to allow for this inclusion.]
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It’s also not recommended that Cantor use one report for the purposes of all three boards. Cantor should customise its reports,
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issuing three different reports which would address special strategies and factors of both Cafes and Juicey and would be more
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aggregated for Cantor as a parent company.
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[Comment: Much more could be said about this; however, the answer has at least shown how this improvement could be
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done (‘more aggregated for Cantor’).]
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I’d also recommend the rounding up of figures to represent them in thousands (‘000), not in dollars – it adds little but excessively
clogs the report.
[Comment: A marker would be happy to see this minor point towards the end of the list.]
It also would assist managerial decision making and appraisal if previous year’s comparative figures would appear on the report
allowing for year on year comparison.
[Comment: Again note that this solution does not just say include historic comparatives, it states why, although it might be
better put as ‘allowing for historic trends to be shown’.]
Summary
Overall, the answer has a good logical structure – merits then drawbacks which is what is expected when the verb ‘evaluate’ is used.
Within the lists of points, there is some effort to prioritise but this could be improved – see third drawback.
More and different points could be made, but in a time-limited examination this is an excellent effort. It may be worth noting that this
answer contains c.600 words while the poor answer example for the same question (in the earlier article) had c.800 words and would
have scored less than half as many marks! Quality not quantity is what markers and your future employers seek.
Example solution 4 – the model solution

A detailed commentary on this solution is provided at the end.
Current performance report
x
The current report has a number of strengths and weaknesses. These will be discussed according to whether the report:
• addresses the overall aims of the group
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• assists the individual subsidiaries
b a
• is well presented
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• contains appropriate information for decision-making.
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The current mission of the group can be broken down into three parts:
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• to maximise shareholder value
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• supplying good value food and drink, and
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• providing appealing environments for our customers.
The report does not directly measure shareholder value which could be done through considering net present value or economic
value added (EVA™) or share price and dividends. This problem has been recognised and is addressed in a later section of this
report. The current report uses period profits as its main measure of performance. This can suffer from being short term unlike the
shareholder value measures mentioned. The report does compare budget and actual performance which gives an indication of
whether plans are being followed and is helpful in controlling the organisation.
There is an indirect measure of the customer value being offered by the group through the gross profit which, when compared to the
industry average, gives a partial measure of value but without data on the price/quality mix compared to competitors, it is difficult to
be conclusive about this. Revenue growth compared to industry growth would aid in giving an impression of the attractiveness of our
offering to the customer. However, no historic information is given which would allow trends to be calculated.
Measuring the appeal of the sites to customers will be difficult and involve subjective non-financial measurements. Customer loyalty
and price elasticity of demand will give some indication of the appeal but it will be difficult without directly surveying customers to
untie this from the issues of price/quality mentioned above.
The main board would probably find it easier if less detailed figures were given and a clear statement of the key measures of
subsidiary performance provided.
The report seems to treat the subsidiaries in the same way as the group, using profit and comparison to industry average margins
and budgets as the main assessment tools. As already mentioned, the reporting of performance against budget is a helpful control
tool. However, as the subsidiaries will have more detailed issues than the group, it does not seem appropriate to be using the same
high-level overview as for the group board. For the subsidiaries, it would be expected that there would be a more detailed breakdown
of revenues and gross margins by product line. Marketing, which is a significant cost, is not attributed to specific sites/products which
would help to explain the changes in these categories. The subsidiary managers would probably benefit from the inclusion of a
breakdown of profit by geographical region as well. It would seem that the measure being used to assess subsidiary performance
would be the operating profit, which is appropriate as it contains the elements of performance controllable by the subsidiaries’
managers. The annual reporting period would also appear to be too lengthy to allow the detailed control of operations required by the
subsidiary boards.
x
In terms of presentation, the data is clear and in a form which would be easily recognisable to those used to reading accounts.
o
However, it is common to provide a narrative commentary with such a report in order to highlight the key features in the report, such
l B
as major deviations from the budget or performance well outside industry norms. The report could be made easier to read by
a
rounding all figures to thousands and thus removing unnecessary detail.
lo b
To summarise, additional information which could be supplied in the report also includes:
G
A
• historic information to demonstrate trends (especially important at Juicey with its fast growth)
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• greater detail by product or site to aid the managers of the subsidiaries
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• competitor information relating to their performance in the three areas of Cantor’s mission (shareholder value, product value,
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site appeal)
[Overall commentary:
As with all model solutions, this is longer than a marker would expect to see produced in the time limits of the exam. This
model solution has more than 15 marks within it (probably about 20 marks).
However, this is the top of the standard expected in terms of the depth of points made – not beyond that standard! It would
be wise to study how each point is supported by evidence or argument from the scenario or else is developed. The answer
tries to avoid making unsupported judgements. As an example, in the second last paragraph, the solution does not only
say ‘However, a narrative commentary should always be provided in such a report.’ Instead, it says ‘However, it is common
to provide a narrative commentary with such a report in order to highlight the key features in the report,’ (reason/benefit)
‘such as major deviations from the budget or performance well outside industry norms’ (specific example). It is
the italicised clauses that the marker is looking for.
Another feature of the model solution is its logical structure. The model solution begins with the most important point of
view: the group board’s perspective. It lays out the group strategy and then assesses whether the report is measuring the
achievement of the strategy. Then, it goes deeper by considering the needs of the subsidiaries’ boards. Finally, it finishes
with probably, the least important points about general presentation and provides a short summary.
Having read this article, prepare (or if already done)/review your own solution to this question so that you can see where
improvements can be made.]
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Moving up from Performance

Management to Advanced
Performance Management
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Moving up from Performance Management to Advanced Performance Management
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The Advanced Performance Management (APM) exam looks at different types of performance management systems which can be
employed by organisations. By performance management systems, we include techniques such as budgeting, variance analysis,
balanced scorecards and other such techniques used by organisations to manage their performance so they can plan and control
their activities better. It also covers areas such as remuneration schemes for management and employees which attempt to motivate
them to work towards the objectives of the organisation.
While performance management systems are covered in PM, at APM additional models of performance management are included
such as value based models, corporate failure models and other strategic performance models like the performance pyramid. In
addition, candidates must be able to advise on what type of systems are relevant to a particular organisation. Different organisations
have different needs, and candidates must be able to understand these, and be aware of the factors that determine what type of
management accounting information is needed.
Finally, in APM, there is more detailed discussion of qualitative factors surrounding performance management.
Candidates need to have much more depth of knowledge than at PM. So rather than just knowing the rationale of the Balanced
Scorecard and being able to recommend goals and measures under the perspectives; in APM, candidates might be asked to
evaluate the use of a balanced scorecard in the context of a specific scenario.
What do I need to know?

Since APM builds on PM, the examiner could assume you know all of the PM topics. In practice, the examiner is unlikely to examine
PM topics in a lot of detail unless they are also specifically included within the syllabus for APM too. It is advisable however to have a
good knowledge of certain areas of the PM syllabus before starting to study APM. The areas of particular importance are as follows:
• activity-based costing
• budgeting and variance analysis
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• decision making
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• performance measurement.
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Activity-based costing, which is in Section B1 of the PM syllabus, feeds into activity-based management in the APM syllabus (Section
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E). Some activity‑based management questions in APM exams have required candidates to perform calculations using activity‑based
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costing principles, so it is important to have a good knowledge of this area.
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The other specialist cost and management accounting techniques included in the PM syllabus which are also relevant to APM are
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target costing, lifecycle costing and environmental management accounting. However, as these are specifically included within the
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APM syllabus, candidates should be able to refresh and increase their knowledge of these from their APM materials.
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Budgeting and variance analysis are important areas. In APM, the focus is on whether budgets are a useful tool or not, and which
types of budget are useful in what situations. It is useful, therefore, to be familiar with the following budgeting sections from PM
syllabus:
• D1 – Budgetary systems and types of budget
• D6 – Planning and operating variances
• D7 – Performance analysis
While quantitative aspects of budgeting have been excluded from this list, candidates would have to have to deal with some maths –
for example to reforecast a rolling budget, perform some activity based budget calculations or produce a flexed budget. Candidates
would not be required to do detailed calculations involving techniques such as regression and time series analysis.
Standard costing and variance analysis (Sections D3-D6) are core management accounting tools, so you do need to be aware of
them, and be able to discuss whether they are useful techniques in a specific scenario and whether they provide useful information to
management. Candidates may also be required to calculate variances at APM, so it is important to understand how to do these –
particularly those variances with strategic implications.
Decision making is an area that sometimes gets examined in APM. Candidates may be asked to evaluate a decision, so some
calculation may be required in such questions. It is important, therefore, to be familiar with relevant costing principles, which are in
Section C1 of the PM syllabus. An awareness of CVP analysis (Section C2) is also useful, especially the ability to calculate break-
even, although it is extremely unlikely that you would be required to draw any of the charts in APM. In addition, a practical
understanding of cost structures and cost behaviour (fixed and variable) will often be useful in analysing and giving advice in a
scenario.
Knowledge of limiting factors (Section C3) is required, not just for decision making, but also because it feeds into transfer pricing. You
should know how to solve basic limited factor decisions. It would not be necessary to go into solving linear programming problems for
APM.
Pricing (Section C4) is not specifically in the syllabus for APM, but the examiner has indicated that he would expect candidates to be
able to calculate a simple cost plus price. Pricing is also relevant in the context of transfer pricing. An awareness of practical pricing
strategies employed by companies would also be useful.
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Risk and uncertainly is an important factor in control of an organisation so the PM topics on risk and uncertainty should also be
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known. Particularly important areas are expected values, maximax, maximin, minimax regret and the use of sensitivity analysis, and
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these have all been examined in APM. It is unlikely that you would be asked to produce a decision tree in APM but knowledge the
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underlying principles of probability and joint probabilities would be useful.
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Performance measurement and control (Sections E1-E4) is introduced at PM, and is a core topic at APM. However, many of the
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relevant learning outcomes from PM are also included within the APM syllabus too, so you should be able to pick up the required
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knowledge of this area from your APM study material rather than needing to go back and review your PM notes. The performance
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measurement topics are developed further at APM with the introduction of new techniques such as value-based management,
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economic value added (EVA™), the performance pyramid and the corporate failure models.
Studying APM
The core part of your APM preparation will be your APM study materials. When studying for APM, it is not necessary or desirable to
learn everything in your study materials parrot fashion. Simply repeating what you have seen in your study manuals in an exam is
never likely to satisfy the examiner’s requirements. What is important is to read the materials, understand and appreciate the issues,
and think about them. Then practise past exam questions dealing with these areas. This will help you to develop the skills of critical
analysis that you will need both in the exam, and in your professional work.
Have a broad knowledge of the syllabus. It is better to have a reasonable knowledge of the entire syllabus, than a perfect knowledge
of say 60% of it, and not to know anything about the rest.
Being a Strategic Professional exam, it is important to read around the subject too. There are plenty of technical articles on the ACCA
website relating to APM, and these are essential reading. These articles have a long shelf-life so the older articles are equally as
important as the articles from the past few years.
As an APM tutor, I find that using real-life examples helps my students to understand the concepts covered during the courses and
makes the materials come alive. These examples can be found in quality newspapers and news websites, so try to read a good
quality newspaper/website, if not every day, at least once a week.
Practising past exam questions under timed conditions is essential. A big part of the challenge in APM (and indeed all the Strategic
Professional exams) is being able to analyse a detailed scenario, and provide relevant answers to the questions asked. Unless you
practise this in advance, you are at a big disadvantage in the exam hall. Many students get into the terrible habit of reading the
question and then auditing the answer. This is a waste of time. You only learn from a question if you really try it yourself.
Finally, you should also read the examiner’s reports from the last sittings. These provide a useful insight into where students have
done well or badly in previous exams. You can learn from their mistakes. It also gives an insight into what the examiner likes and
dislikes.
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Skills required for APM
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APM is a Strategic Professional exam, and the examiner expects candidates to demonstrate the skills that they would need when
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working in a professional environment as an advisor or consultant. This is more than is required at PM.
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In PM, you are required to be able to apply given techniques to the short scenarios in the exam. For example, a question may ask
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you to calculate materials mix and yield variances for the last month. You are also required to be able to interpret numbers at PM, for
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example, using pre-calculated variances to assess the performance of the sales manager. The scenarios in PM are usually fairly
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short, and the questions specify very clearly what is required of you.
In APM questions, particularly in Section A, you will need to be able to deal with much longer scenarios. The examiner is seeing if
you can apply your knowledge to real, life like situations. This tests your ability to deal with a larger amount of data and identify the
most important issues. Can you see the big picture when presented with a lot of detail?
One APM question may well focus on several different parts of the syllabus, so at this level you can’t just view each topic as being in
a separate box, you have to appreciate how they are all linked. This is much more like real life.
Conclusion
The APM syllabus builds on the knowledge covered in PM, and there are certain PM topics that you should know well before
embarking on APM. Much higher skills are required at APM, and there is much greater application of your knowledge to life like
scenarios. In order to improve your chance of success, it is good to read around the subject and practise past exam questions.
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Reading the question requirements of

Advanced Performance Management
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Reading the question requirements of Advanced Performance Management
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The article considers how to carefully understand the question
requirement with use of selected examples from the past
Advanced Performance Management exams
The aim of this article is to try to provide an insight into some common problems and misconceptions surrounding the Advanced
Performance Management (APM) exam to improve your chances of success. These comments are probably going to be most
relevant when you are attempting past exam questions during revision.
The main activity that this article will consider is how to read the question requirement. The points made here will be illustrated with
examples from previous APM exam sessions. In order to keep the article to a sensible length, only the actual requirements will be
reproduced here; it will be useful to read this article in conjunction with the past exams that are referred to and which are available on
the ACCA website (see 'Related links').
The question requirement usually gets a great deal of attention from the examiner who first writes it and the team of reviewers who
perform more than five layers of review before the exam is finalised. It is written carefully and should also be read carefully. So my
first recommendation is take time to read the requirement because every word and phrase will have significance.
Key aspects of requirements to note

1. The verb used: APM mainly focuses on the higher level verbs in Bloom’s taxonomy – eg evaluate, assess, advise…
To illustrate the importance of the verb let us look at evaluate. To ‘evaluate’ means to judge or determine the value, worth or
quality of an object. If that object is the performance of a company, then the answer can be expected to be descriptive but based
on numerical measures (such as profit, present value or EVA). But if that object is a performance system, or a costing method, or
a remuneration package, or a performance management model, then a candidate is expected to weigh up the advantages and
disadvantages of that method – possibly in comparison to other appropriate ways of doing things. It should also be noted that
weighing up the advantages and disadvantages means more than simply listing them – it requires a final application of judgment
as to what is appropriate in the given scenario. NOTE: (When the verb ‘assess’ is used, it is a very similar exercise in most
circumstances).
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2. Application to the scenario:
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Another point about APM is that management accounting is always context based. Therefore if a requirement is asking for
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application to the company named in the scenario or asking for illustrative examples from the scenario, then you should be aware
that referring the scenario and providing relevant examples will hold the bulk of the marks in the question. Answers that focus
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mainly on describing theory and technical terms will not score highly.
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3. If an opinion/recommendation is sought:
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Any offer of opinion or recommendation should be justified in the context of the scenario. Support your recommendation/advice
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with key information and try not to sit of the fence.
4. Use of model, method, system, data:
If a requirement asks you to use a certain model, method, system or source of data then your answer should reflect that.
Following the instruction will give you the approach you should take to your answer. Marks are available for appropriate use of
the model, method etc.
Example:
(1) March/June 2018 Sample Questions, Question 4
Required:
(a) Using Argenti’s A Score model, evaluate whether LP is at risk of corporate failure.
(b) Advise LP what performance management systems are needed in order to improve performance in respect of each of the
mistakes and symptoms you have identified in part (a).
(c) Evaluate the usefulness of using qualitative models such as the Argenti A Score in predicting corporate failure.
Part (a) asks for an evaluation of whether LP is at risk of corporate failure using a specific model; the Argenti A Score. Note the
requirement did not ask for a list of problems which the company was experiencing; the requirement expected the issues to be
structured within the context of the model. The A Score model was even provided in the question to indicate to candidates that this
should be the approach to use to structure answers. Check that you can see how the requirement was guiding you to approach your
answer. The nature of the requirement would also expect an overall conclusion to be drawn based on your use of the model.
Part (b) asks what performance management systems are needed to improve performance in respect of the mistakes and symptoms
identified in part (a). This also indicates the importance of using the model in part (a) as mistakes and symptoms are two of the
headings in the Argenti A Score model. Note the requirement does not ask about performance management systems to deal with
defects and this was an important distinction. Discussing methods to deal with defects was not answering the requirement and
wasted valuable exam time. The requirement also wanted a clear relationship to be drawn between the performance management
system and the mistake or symptom it was trying to address. A list of general performance management systems with no relation
made to the issues at hand in the scenario would score very little.
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Part (c) asks you evaluate the usefulness of using qualitative models such as the Argenti A Score in predicting corporate failure.
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Evaluating a model means considering their advantages and disadvantages in particular. It is also an opportunity to further illustrate
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your points by using other models to support them i.e. the use of quantitative models versus qualitative models. The requirement is
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not asking for a description of the model.
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(2) September/December 2016 Sample Questions Q1
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(i) Assess the problems of using a balanced scorecard at Monza.
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This requirement is not asking for a description of the balanced scorecard or its benefits. It is very specifically asking for the problems
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of using this method at the company in the scenario. This means that any discussion of the limitations of the balanced scorecard
model should be made in the context of the company. Generic comments about problems of this model would not score highly; the
examining team want you to explain why these problems are relevant in this scenario.
(3) September/December 2017 Sample Questions Q3
(b) Justify one performance measure for each of the components of the value for money framework used at TRH and, using that
measure evaluate whether TRH is delivering value for money.
Here candidates were expected to use the 3E’s framework to structure their answer (the framework was given in the scenario).
Under each heading in the framework the examining team expected to see a justification for the performance measure chosen for the
‘E’, then a calculation of the said measure (there was limited numerical information available in an appendix in the question) and then
an assessment of the result of that measure as to whether it indicated whether TRH was delivering value for money. A discussion of
value for money and how it is measured generally would not have scored highly here. In addition, not using the framework would
have limited the marks available as the requirement clearly asked for it.
(4) March/June 2017 Sample Questions Q4
(b) Recommend, using appropriate calculations, whether the manager of Export division should receive her bonus for the year.
This is a good example of requirement which asked candidates to make a recommendation and as you can see asked for supporting
facts through the use of appropriate calculations.
Finally, I want to mention two other small points:
• While I would encourage you to demonstrate a professional approach to presentation, you only need to do report headings
where there are professional marks and a report has been specifically requested. The exam is time-limited, as are the
professional marks, and you cannot be awarded professional marks that are not noted in the original question requirement.
Please note however, this does not mean that a logical, structured answer is not required.
• There is a common misconception – evident from thousands of candidate answers – that financial performance indicators are
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always being manipulated and non-financial performance indicators are less open to manipulation. Stop and think about what
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this implies: (a) that the people that prepare financial reports are generally unethical; and (b) that the controls over financial
information systems are less severe than non-financial information systems. Your studies so far of professional ethics and the
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controls surrounding financial reporting systems should immediately indicate that these implications are false. However, you
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would be correct to state that there is a danger of manipulation and that this is exacerbated by inappropriate reward systems (a
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‘bonus culture’).
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I hope that these comments will be helpful to you in your preparation for the APM exam.
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Value for Money (VFM) and

performance measurement in not-for-
profit organisations
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Value for Money (VFM) and performance measurement in not-for-profit organisations
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In the Advanced Performance Management exam, you could be asked to evaluate the performance of not-for-profit organisations (for
example, public sector organisations) as well as profit-seeking ones.
This article discusses the concept of value for money, and how it can be used to measure performance in not-for-profit organisations.
The article uses a past exam question (from the September/December published sample questions) to illustrate this. The scenario
from the exam question is summarised in the article, but it is essential to read the scenario and requirement in full and keep these to
hand while reading the article.
The importance of value for money (VFM)
A key theme in contemporary performance management is that organisations need to measure, and manage, non-financial aspects
of performance, rather than focusing solely on financial aspects. However, in profit-seeking organisations, there remains an
underlying financial objective: typically, to maximise profit in order to maximise value for shareholders.
By definition though not-for-profit organisations do not have this underlying objective. Nonetheless, financial performance remains
important in not-for-profit organisations (for example, comparing actual expenditure against budget, or comparing the surplus (or
deficit) of income over expenditure.
However, these organisations also need to monitor how efficiently they are using the resources available to them, and how well they
are performing in relation to their key objectives. For example, for hospitals and medical centres, how effectively they are providing
health care to their patients; for schools and universities, the quality of education they are providing to their students.
In this respect, three important aspects of performance to measure are: economy, efficiency and effectiveness; the so-called
‘three Es’. Achieving these three Es will help an organisation to ensure it is delivering good value for money.
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Value for money is seen as an appropriate framework for measuring performance in not-for-profit organisations, because value for
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money reflects not only the cost of providing a service but also the benefits achieved by providing it. In the absence of an underlying
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profit motive, assessing the benefits provided by a service is a particularly important part of evaluating its performance: for example,
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the benefits received by patients from hospital treatment they receive; the quality of education that students receive at their school or
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college.
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Importantly also, value for money is not simply about minimising cost. To use the UK National Audit Office’s definition: “Good value
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for money is the optimal use of resources to achieve the intended outcomes” where ‘optimal’ means “the most desirable possible
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given expressed or implied restrictions or constraints”.1
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Value for money – the three Es
The key to achieving good value for money is finding an appropriate balance between the three Es (as summarised in Figure 1).
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Figure 1: Drivers of value for money
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Economy: obtaining the appropriate quantity and quality of resources at the lowest cost possible; optimising the resources (inputs)
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which an organisation has.
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Efficiency: maximising the output generated from units of resource used; optimising the process by which inputs are turned into
outputs.
Efficiency can often be measured in terms of the cost of providing a service per unit of resource used, per unit of output, or per
beneficiary served (in the context of a service).
For example, if the number of teachers employed by two schools is the same, but the first school has twice as many pupils as the
second, we could say the first school is more efficient, because the staff costs per pupil will be lower.
Effectiveness: the relationship between the organisation’s intended and actual results (outputs); the extent to which it achieves its
objectives.
For example, one of the indicators which is often used to measure schools’ performance is exam results, and this provides a
measure of effectiveness. Is the tuition which pupils receive building their knowledge and, in turn, helping them to pass their exams?
Potential conflicts between the three Es
Although the aim of value for money is to achieve an appropriate balance between the three Es, this can often be difficult to achieve.
Each of the Es aims to achieve different – potentially conflicting – outcomes in an organisation.
For example, increasing the number of pupils in each class at a school could help to improve efficiency (by reducing staff costs per
pupil), but the quality of the pupils’ learning experience might suffer as a result. So, in effect, increasing efficiency could be
detrimental to effectiveness.
In recent years, there have been many stories in the news about cost savings or budget cuts in public sector services (health care;
education; police forces). These suggest an emphasis on ‘economy’ – and potentially ‘efficiency’ – rather than the ‘effectiveness’ of
the services.
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However, it is very important to remember that the value for money framework highlights the importance of measuring (and
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managing) all three Es, rather than focusing just on one aspect of performance.
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This also has implications in relation to choosing performance measures. Organisations will need data to assess how well they are
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achieving value for money, and therefore in order to assess value for money appropriately, the range of performance measures used
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will need to address all three Es, rather than, for example, focusing primarily on cost (economy) or efficiency.
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Equity
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Sometimes a fourth ‘E’ is also included when measuring value for money performance: equity.
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This reflects the extent to which services are available to, and reach, the people they are intended for, and whether the benefits from
the services are distributed fairly.
For example, if an advice service provided to residents by a local authority is provided in a language that some residents do not
speak, those residents will not be able to benefit from the service.
Evaluation of VFM from the Section A question published in the

September/December 2020 sample questions.
The case study scenario identified that, following a recent change of government, the new minister in charge of policing in the
country of Deeland has been instructed to improve the performance of the Deeland Police (DP).
The scenario identified DP’s mission statement – ‘to protect the community and prevent crime while providing a value for money
service’ – and four critical success factors (CSFs) which had been proposed to support this:
1. Greater protection and more support for those at risk of harm
2. Be better at catching criminals
3. Reducing the causes of crime by increased involvement with local communities
4. Create a task force to develop skills in detection and prosecution of virtual crime.
A table of data was also provided – as replicated below.
Deeland Police data for each year ending 30 June
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Population of Deeland (‘000s) 11,880 11,761 11,644
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Number of police officers 37,930 38,005 38,400
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Number of administrative staff 12,320 12,197 12,075
Number of crimes reported in the year 541,735 530,900 520,282
Number of violent crimes reported in the year 108,347 106,180 104,056
Number of crimes solved in the year 297,954 300,934 303,943
Number of complaints 7,624 7,512 7,483
Response to an incident within the allocated time limit 84% 86% 87%

Cost of police force for the year ($m) 2,248 2,226 2,203
Staff costs (all staff, including police officers) ($m) 2,026 2,103 2,141
Requirement
The first part of the question focused on CSFs and key performance indicators (KPIs) and included a requirement to provide up to
two justified KPIs for each CSF.
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Then, the second part – which is the one we will focus on here – asked candidates for an explanation of the 3Es (economy, efficiency
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and effectiveness) and how this links to the work on CSFs and KPIs. Candidates were also asked to use the data provided to
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evaluate whether DP provides a value for money service.
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The requirement was worth 13 marks.
Tackling the question

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As the question asks for an explanation of the 3Es, a sensible starting point would be to give brief definitions of each of economy,
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efficiency and effectiveness.
As we mentioned earlier, effectiveness relates to the extent to which an organisation achieves its objectives and intended results.
So, this is an important link to CSFs and KPIs. Having identified its key performance indicators (eg the percentage of crimes solved;
reducing the total number of crimes), how effectively has DP achieved these? How has its performance in these areas changed over
time?
In this scenario, we are only given data for DP, so we can only assess its own performance over the three years. However, if the data
were available, it would also be useful to compare actual performance against targets, and to benchmark DP’s performance against
that of other police forces. (Although we don’t discuss league tables in this article, these are often used to benchmark performance in
public sector organisations; and another requirement in this exam question looked at the potential introduction of league tables).
Is DP providing a value for money service?
The key part of this question, though, is analysing the data provided and evaluating what this shows about the economy, efficiency
and effectiveness of the service DP provides.
Economy
Cost is the key issue here – is DP obtaining appropriate resources at the lowest costs possible? – so the final two rows of data are
important.
The overall costs of the police have increased slightly each year. However, staff costs, which make up most DP’s costs, are falling. A
positive factor in terms of economy?
The data also gives information about the numbers of police officers and administrative staff, and this shows that the number of
police officers has been falling while the number of administrative staff has increased.
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Number of police officers
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Number of administrative staff 12,320 12,197 12,075
Total number of staffA 50,250 50,202 50,475
% of staff who are officers 75.5% 75.7% 76.1%

Staff costs ($m) 2,026 2,103 2,141
Cost per employee 40,318 41,891 42,417
Again, this could be a positive factor in terms of economy, if DP is recruiting cheaper administrative staff to do jobs previously carried
out by police officers. Remember our definition of economy: “obtaining the appropriate quantity and quality of resources at the
lowest cost possible”. If certain aspects of the work can be done by administrative staff, why pay more to have them done by a police
officer?
Efficiency
As we have mentioned earlier, a key aspect of efficiency is output per unit of resource.
We have looked at staff costs in the context of economy, but as a measure of efficiency we could look at the number of police officers
relative to the population of Deeland. (The logic here being the more people served per police officer, the more efficient the police
officers are.)
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Population of Deeland ('000) 11,880 11,761 11,644
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Number of police officers 37,930 38,005 38,400

People per police office 313.2 309.5 303.2
Number of police officers per '000 people 3.19 3.23 3.30
So, on this basis, it might seem that reducing the number of police officers has helped to improve efficiency as well as economy.
But what about DP’s efficiency in terms of solving crimes? We know the number of crimes solved each year, and we know the
numbers of staff, so we can calculate the number of crimes solved per police officer or per employee as a key measure of efficiency.

20X5 20X4 20X3

Number of police officers 37,930
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Total number of staff (officers + administrative staff)
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Crimes solved per police officer 7.86 7.92 7.92
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Crimes solved per employee 5.93 5.99 6.02
Whichever measure is used (crimes solved per police officer, or per employee) the number of crimes solved is falling, and therefore
DP’s performance in this respect is worsening.
So, this raises the possible concern that although reducing the numbers of police officers and changing the mix of staff has reduced
costs (and improved ‘economy’) it has reduced efficiency. This concern is also reinforced by the fall in the percentage of incidents
which DP responds to within the allocated time limit.
And what impact has the reduction in the number of police officers had on DP’s effectiveness?
Effectiveness
As we have already mentioned, effectiveness relates to how well an organisation is performing in relation to its objectives or goals.
So, in this scenario, the issue is: how well is DP performing against its CSFs (and the related KPIs)?
The data provided doesn’t allow us to assess DP’s performance against all its CSFs (for example, there is no data about virtual (or
cyber) crimes), but there are still some useful measures we can calculate:
Protecting those at risk
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Number of violent crimes 108,347 106,180 104,056
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% change year on year 2.04% 2.04%
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Number of violent crimes per 1,000 population 9.12 9.03 8.94
% change year on year 1.02% 1.03%
Be better at catching criminals
20X5 20X4 20X3
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Number of crimes reported in the year 541,735 530,900 520,282

% clear-up rate in solving reported crimes 55.0% 56.7% 58.4%
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These figures are particularly stark in showing the DP is becoming less effective, because while the number of crimes reported is
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increasing each year, the number of crimes solved has fallen.
Reduce the causes of crime
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Number of crimes reported 541,735 530,900 520,282
% change 2.04% 2.04%
The logic behind the CSF here would appear to be ‘prevention rather than cure’. If DP can reduce the causes of crime, this should
lead to a reduction in the number of crimes. However, the numbers of reported crimes are increasing.
In each case, the indicators suggest that DP is not performing effectively; with the numbers of crimes increasing, and DP’s rate in
solving them falling.
Although we need to be careful not to assume that correlation implies causality, it is nonetheless likely that the reduction in police
officer numbers, and the apparent restrictions on staffing costs, have contributed to a decline in DP’s effectiveness.
Conclusion
This question from the September/December published sample questions provides an excellent illustration of the issues which
organisations face when trying to achieve value for money; in particular, the potential relationships between the three Es, and the
impact that changing of the Es could have on the others.
More generally, an organisation which fails to achieve its principal objectives will not be successful. As such, organisations (and wider
stakeholders, such as governments and funding agencies) need to be aware of the danger of becoming too focused on economy or
efficiency (or both) to the detriment of effectiveness.
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Focusing on the wrong measures – or focusing on one ‘E’ at the expense of the others – can be very damaging to an organisation.
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So, the challenge in achieving good value for money is how to balance and manage all three Es: being effective in achieving your
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objectives yet doing so in an economic and efficient manner.
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Reference:
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(1). National Audit Office (n.d.) Value for money, Online.
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Available from: https://www.nao.org.uk/successful-commissioning/general-principles/value-for-money/
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Sustainability and performance

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The importance of sustainability
Since the 1990s, there has been increasing recognition amongst governments, businesses, consumers, investors and other
stakeholders of the importance of sustainability and the impacts of businesses on society and environment. They have recognised
that focusing solely on profit maximisation, without considering the interaction of a business with its operating environment, will not
be a sustainable approach.
At the same time, there has been increasing demand for environmentally friendly products and processes, for example, hybrid – and
more recently – electric vehicles in place of conventional petrol or diesel ones. As such, adopting a sustainable business model could
be not only a challenge but also an opportunity for organisations.
There are many different definitions of sustainability, but a commonly used one is that in the Brundtland Report (1987): meeting the
needs of the present without compromising the ability of future generations to meet their own needs.
Most discussions of sustainability also highlight the need for organisations to contribute to economic prosperity, environmental quality
and social justice. We will focus on these three strands (economic, environmental, social) as the basis of our discussion in this
article.
Sustainability and performance
In addition to the overall importance of sustainability, there could also be a direct link between environmental behaviour and
performance.
There are a number of ways poor environmental behaviour could affect a business:
• fines (for pollution, or other breaches of regulations)
• increased liability to environmental taxes (for example, carbon taxes)
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• damage to corporate reputation
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• loss of sales or consumer boycotts
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• inability to secure finance
• loss of insurance cover
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Conversely, reducing material, energy and water usage should not only reduce environmental impact, it could also reduce operating
costs. Similarly, a focus on reducing waste could, in turn, improve process efficiency, and reduce the amount (and therefore the cost)
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of materials used.
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Equally, although health and safety measures might not add value to a business by themselves, they can help to protect a business
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from the cost of accidents which might otherwise occur. If a business has poor health and safety controls, this might result in –
amongst other things – increased staff absence from injury or illness, and possible compensation claims for any work-related injuries.
Triple bottom line
The increased focus on sustainability has important implications for performance management, and for accountants producing and
reviewing management information. In addition to the financial information which they have traditionally measured, businesses now
also need to consider the environmental and social aspects of performance, and they need the information on these areas to be
relevant and reliable, and to be provided in a meaningful and comparable way.
The triple bottom line approach (Elkington, 1998) has emerged as a potential way to define a business’s sustainable performance:
measuring performance not only in the economic value businesses add, but also on the environmental and social value they add – or
destroy.
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It is important to note that the third element here – economic – does not simply mean the financial profit a business makes. Economic
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impact is wider than just financial impact. Financial profit focuses on the business itself, but the economic impact of a business is on
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society as a whole, for example, through creating jobs and paying taxes.
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It is also important to recognise that social and environmental issues are not confined within a business’ normal financial reporting
boundaries, but businesses also needed to consider sustainability issues across their supply chain, and the social and environmental
practices of their suppliers (for example, supermarkets requiring suppliers to manufacture products from sustainable sources or eco-
friendly materials, or to supply ‘organic’ produce).
Triple bottom line and different types of capital
We are all familiar with the logic that companies’ underlying objective is to deliver value for their shareholders. However, there is now
an increasing recognition that the long-term pursuit of shareholder value is linked to the preservation and enhancement of different
types of capital – natural, human, social, manufactured and financial – which can be broadly related to the three aspects of the triple
bottom line:
Aspect of triple bottom line Type of capital affected
Environmental - Natural capital: natural resources (eg air, water, land) and
processes used by a business in delivering its products and services
Social - Human capital: health, skills, motivation of employees.
- Social capital: relationships, partnerships and co-operation (eg

with suppliers)
Economic - Manufactured capital: buildings, equipment and infrastructure

used by the business
- Financial capital: funds available to enable the business to
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operate. Reflects the value generated from the other types of capital.
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The recognition that businesses depend on different forms of capital for their success is also an important part of the rationale for
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integrated reporting (IR). However, IR also encourages a focus on business sustainability and organisation’s long-term success. By
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encouraging businesses to focus on their ability to create and sustain value over the longer term, IR should help them take decisions
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which are sustainable, and which ensure a more effective allocation of scarce resources.
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Integrated Reporting is discussed in more detail in a separate article.
Sustainability and performance information
The argument that it is insufficient for businesses to consider only financial information alone is not new. There are echoes here to
discussions around the need for multi-dimensional performance measurement systems (such as the balanced scorecard (Kaplan and
Norton, 1996)) – which emphasise the need for financial and non-financial measures to be part of a business’ information systems.
Equally, one of the criticisms sometimes made of the way businesses use balanced scorecards is that they are linked to delivering
traditional economic value (eg shareholder wealth), rather than considering the importance of corporate social responsibility (CSR)
and sustainability. As such, some commentators have suggested the need to add social and environmental perspectives to the
balanced scorecard.
However, others have argued that sustainability could be incorporated into the existing four perspectives. The logic of the scorecard
is to link a business’ objectives and strategy to its performance measures, and the argument here is that businesses should include
sustainability goals within their strategy.
As such, when selecting goals for the perspectives, a business should consider requirements for sustainability. For example:
• Customer perspective: Have the interests of sustainability stakeholders been taken into account eg green consumers; local
communities; government regulators?
• Internal process perspective:

• Have the environmental impacts of processes eg resource usage; waste and recycling; impact on water and air been
considered?
• Do HR processes take into account labour best practices around health and safety, diversity, equal opportunity etc?
• Learning and growth:

• How are training and development programmes helping to promote sustainability values and culture?
• How are innovations leading to more efficient use of resources and the reduction of waste, or leading to the introduction of
more environmentally friendly products?
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More generally, regardless of the performance measurement system it uses, in order to improve sustainability performance, a
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business needs to translate its overall objectives into specific practices, linked to sustainability, in each key area of performance. It
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then needs to identify specific measurement indicators, so it can assess how well it is achieving its objectives in each key area.
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Key performance indicators (KPIs)
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Monitoring key performance indicators (KPIs) is recognised as a crucial part of performance management for any business. However,
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many businesses don’t measure sustainability KPIs in the way that they would financial KPIs, for example. One of the key challenges
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with introducing sustainability KPIs is that the list of potential indicators is very large, so determining which are the most important to
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monitor (ie the key indicators) can be a complex task.
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However, the following are some potential indicators a business could track in relation to sustainability:
Energy Materials
- Energy consumption
- Raw material usage
- Energy saved due to implemented improvements - % of non-renewable materials used
- % of recycled materials used
- Product recycling rate %
Water Supply chain
- Water consumption/ Water footprint

- % of suppliers that comply with established
- % of water reused or recycled sustainability strategy
- Supply chain miles
Waste Social
- Waste generated
- Number of health and safety incidents (workplace
- Waste by type and disposal method
safety)
- Waste production rate - Number of sick days (employees’ health and well-
being)
Emissions
- Toxic emissions
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- CO2 emissions
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- Greenhouse gas emissions
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- Carbon footprint
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As we have mentioned before, in addition to encouraging sustainability, monitoring these indicators could also help business
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performance more generally. For example, monitoring and trying to reduce energy consumption could help to lower energy costs as
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well as reducing environmental impact. Similarly, supply chain miles provide an indicator of how far a product is travelling before
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reaching its destination. If products are travelling large distances, this could mean they incur heavy costs along the way. Therefore,
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looking to reduce supply chain miles could influence a business’s choice of suppliers; not just to reduce carbon footprint, but
potentially costs as well.
Evaluating measurement of sustainability performance
Having established the need to embed ‘sustainability’ into an organisation’s performance measurement systems, a key question to
ask will be: how well are businesses actually doing this?
By definition, performance measurement is always selective. Businesses cannot measure every aspect of performance, so they must
decide the most important metrics and indicators to focus on. When evaluating an organisation’s performance measurement systems
(in relation to sustainability) key questions to ask will be:
• What is being measured? What measures are chosen?
• To what extent are aspects of sustainability covered in an organisation’s performance measurement system? Are measures of
sustainability included?
• To what extent do the chosen performance indicators enable management to measure performance from a sustainability
perspective?
• Are the measures chosen the most appropriate ones for the organisation to be using?
• Do the chosen measures provide a balanced picture of the organisation’s performance (rather than, for example, just focusing
on areas which the organisation is doing well)?
One potential approach here when selecting areas to measure could be to analyse a business’s organisation’s value chain to identify
the areas which have the greatest potential impact on sustainability. These should then be the priority areas to measure, so the
business should select indicators which show well it is performing in these priority areas.
Reliability of measures
As well as the areas being measured, another important consideration is the extent to which the data being gathered is reliable and
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meaningful.
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• How is performance measured (eg inputs; activities; outputs), and can the data be reliably captured?
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• Are there benchmarks or comparators against which performance can be assessed?
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• Are performance me
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• Is information presented in a way which maximises its usefulness to its audience?
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As with other performance indicators, it is important to monitors trends in indicators of sustainability performance to measure
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progress. However, for any trend to be meaningful, the indicators need to be measured consistently – over time, and across different
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parts of a business (and potentially between businesses).
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One of the particular challenges in comparing sustainability performance between businesses is that, whereas financial performance
can be monitored using a number of widely accepted indicators derived from the financial statements, the indicators of social and
environmental impacts are less clearly established, and the information used to calculate them is often not part of mainstream
information flows.
In addition, the perception of sustainability can vary across countries, communities and individuals. Some initiatives promoted by an
organisation as environmentally friendly might not be perceived as by relevant or beneficial by green consumers.
Reporting Sustainability: Global Reporting Initiative and the UN

Sustainable Development Goals
Given the increasing importance of sustainability as a major global issue, there has been increasing recognition for a globally
accepted framework within which organisations can frame their sustainability strategy.
The Global Reporting Initiative (GRI) Standards provide best practice for reporting on a range of economic, environmental and social
impacts, and give companies specific guidance on what information they should report on. However, the GRI Standards are not
mandatory. And while there is an increasing recognition of the need to set a sustainability equivalent of the International Financial
Reporting Standards (IFRS), to put financial and non-financial information on the same footing, this has not been achieved yet.
The United Nations’ Sustainable Development Goals (SDGs) could be more relevant at a strategic level, encouraging companies to
embed sustainability measures into their ‘core’ performance reporting.
The SDGs are part of the United Nations (UN) 2030 Agenda for Sustainable Development. The Agenda, formally adopted by the UN
in 2015, is a 15-year plan with the aim of ending poverty, combatting climate change, and fighting injustice and inequality. The SDGs
are 17 high level goals for sustainable development, with each goal supported by a number of specific objectives. In turn, indicators
are recommended for each objective to enable performance against it to be measured.
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1: No poverty 10: Reduced inequalities
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2: Zero hunger 11: Sustainable cities and communities
3: Good health and well being
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12: Responsible consumption and production
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4: Quality education
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5: Gender equality
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6: Clean water and sanitation 15: Life on land
7: Affordable and clean energy 16: Peace, justice and strong institutions
8: Decent work and economic growth 17: Partnerships for the goals
9: Industry, innovation and infrastructure
Sustainable Development Goals – United Nations General Assembly (2015)
The overall goals are broad and aspirational. However, they are supported by a range of associated targets (169 in total) and
indicators, which provide a quantifiable framework for assessing whether the goals are being achieved.
For example, Goal 8 'Decent work and economic growth' aims to 'Promote sustained, inclusive and sustainable economic growth, full
and productive employment and decent work for all.' One of the targets linked to this goal is to “Improve … global resource efficiency
in consumption and production and endeavour to decouple economic growth from environmental degradation”. In turn, performance
against this target is measured using the indicators:
• Material footprint, material footprint per capita and material footprint per GDP
• Domestic material consumption, domestic material consumption per capita, and domestic material consumption per GDP.
Implications of the SDGs on organisations and performance

management
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The principal responsibility for achieving the SDGs lies with national governments, but governments cannot tackle the issues on their
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own. Success in achieving the SDGs also depends on the active participation of businesses and non-governmental organisations
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(NGOs) across the world.
In this respect, two key challenges are:
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• encouraging senior managers to evaluate the extent to which their business objectives create societal value and
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• demonstrating the link between 'sustainability' and business.
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One possible way to do this is to translate the language of sustainability into the language of everyday business and operations. For
example, instead of asking a construction company 'How does climate change affect your business?', the issues could be identified
more pertinently by looking at the risks that flooding or changes in water level might have on the company's projects and site
operations.
More generally, the SDGs encourage businesses to adopt sustainable practices and integrate sustainability information into their
reporting. As we mentioned earlier, in relation to the balanced scorecard, the challenge here is not so much adding additional
perspectives for measuring performance, but embedding ‘sustainability’ into the existing perspectives, as an integral factor to
consider in business decisions and business performance measurement.
Accordingly, in the APM exam, you should be prepared to evaluate how effectively a business measuring sustainability within its
performance measurement system.
References:
Brundtland, G. (1987) Report of the World Commission on Environment and Development: Our Common Future, United Nations
General Assembly document 4/42/427
Elkington, J. (1998) Cannibals with Forks: The Triple Bottom Line of 21st Century Business (2nd edition), Oxford: Capstone Publishing
Ltd.
Kaplan R. and Norton, D. (1996) Strategic learning and the balanced scorecard, Strategy & Leadership, Vol 25, No. 5, pp 18-24
United Nations General Assembly (2015) Transforming our world: the 2030 Agenda for Sustainable Development, 21 October,
A/RES/70/1
Available at: https://sustainabledevelopment.un.org/post2015/transformingourworld/publication
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Being able to evaluate and improve a company’s performance using new performance management systems is an important
capability that you should develop during your APM studies and is also an often-examined topic. Value-based management (or VBM)
is one such system in the syllabus which often creates trouble for APM candidates.
This article aims to demystify the topic of VBM by looking into its background, key ideas, problems, and steps for implementation.
Finally, this article will give advice on how to tackle VBM requirements.
Problems of profit-based performance measurement

If we go back in time to the 1970s and earlier, companies usually measured performance with profit-based metrics, such as Earnings
per Share ('earnings' is a synonym for profit), Return on Capital Employed (ROCE), or Net Profit Margin. The source of information
for these metrics was the company’s financial statements. These metrics are referred to as 'traditional performance metrics' in your
APM syllabus.
Then, in the 1980s, leaders in business strategy and performance management began to challenge this approach. While recognising
that increasing shareholder wealth is the ultimate goal of a company, a paradox was observed: a company's profits could be
increasing, while at the same time, total shareholder return could be decreasing. They concluded that the link between the objectives
of ‘maximising profit’ and ‘maximising shareholder value’ is actually tenuous. Other problems with profit-based measures were also
highlighted at this time:
• Profit-based metrics ignore the required return of the company’s capital providers.
• Profit-based metrics can give a distorted view of performance: accounting standards and policies mean significant non-cash
expenses, like provisions, can negatively impact a company’s reported profit but don’t decrease cash.
• Profit-based metrics are often based on annual results, so managers may be inclined to focus on increasing annual profit while
ignoring long-term company growth. For example, a manager who is not on track to make their profit target might cut back on
R&D expenditure or marketing, which will likely harm the long-term profits and competitive position of the company.
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It was in this period that alternative approaches to performance management were developed (which you will be familiar with as
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many are covered in APM), ideas such as the Balanced Scorecard, Total Quality Management, and Value-Based Management, the
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subject of this article.
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Example of poor decision-making using profit-based
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To illustrate the problem described above, imagine we have a fictitious, listed company Omega Co. Omega Co has numerous
divisions, including Alpha and Beta, which are treated by management as autonomous investment centres. Omega’s weighted
average cost of capital is 13%.
Division Alpha
Division Alpha is an underperforming division in a declining market—a ‘Dog’ according to the BCG Matrix model. The manager of
Alpha is assessed on ROCE, which is currently 5%. She has the option to invest shareholder funds in a project that will improve her
division’s ROCE to 7%. She accepts the project.
Division Beta
Division Beta is the leader in its fastest-growing market. This is a ‘Star,’ according to the BCG model. The manager of Division Beta is
currently achieving a ROCE of 21%. She has the opportunity to invest in a new project. However, when the profits and investment of
this new project are added to her divisional ROCE, she calculated that it would fall to 19%. Hence, she rejects this investment.
The problem
Both managers made decisions based on accounting profit measures rather than value-based measures. If a manager uses ROCE
to make decisions, they are ignoring cash flows, the impact of tax, and the effect their actions have on the value of the company.
Division Alpha’s project, while delivering increased profits to XYZ Co, most likely did not exceed the company’s cost of capital.
Division Beta’s potential project might have exceeded the cost of capital, however, she rejected it.
This problem is also known as ‘goal incongruence,’ which you first encountered on your Performance Management studies. How
could we know if the two divisions are growing or eroding shareholder wealth? Is there a better way? Yes, adopt the principles of
Value-Based Management (VBM).
Introducing VBM
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As you learned in Financial Management, it is a company’s discounted future cashflows that determine its value. And, value is
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created when the cash flows returned from invested capital exceed the expected returns of the company’s capital providers,
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measured by the weighted average cost of capital. This is the idea of ‘value’ in VBM, and the VBM approach puts maximising
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shareholder value (as opposed to maximising profit) as the high-level objective of a company.
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In order to achieve this, the company’s strategy, objectives, and processes should be aligned with the generation of shareholder
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wealth.
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To measure performance under VBM, a single, over-arching organisational performance metric is established, such as Economic
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Value Added (EVA). Then, ‘value drivers’ are identified: these are activities linked to shareholder value which managers in the
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company can influence. This system of value drivers cascades throughout all levels of the company, linking to objectives for
managers and staff. VBM is a hierarchical system that connects all levels of a company to shareholder value, not just a framework for
board-level evaluation. Under an effective VBM system, individual employee objectives should be connected with the high-level
company objective of increasing shareholder value. This is the core idea behind VBM.
It is important to emphasise that this system of value drivers is matched to the specific activities that management can control at each
level of the company. Value drivers often cascade in a ‘tree’ diagram and cover both financial and non-financial performance areas of
performance.
For example, employee satisfaction and employee training are value drivers that have a direct impact on customer satisfaction.
Customer satisfaction, in turn, directly impacts customer retention. Improved customer retention will then (combined with revenue per
customer) positively affect revenue, which will directly impact operating profit. These value drivers move up from operational to
strategic level and cover financial and non-financial areas of operation.
VBM vs. EVA: they are not the same thing

Make sure you understand the difference between VBM and EVA: VBM is an approach to performance management that improves
shareholder value, while EVA is one performance metric that measures shareholder value. While EVA is an often-used metric and
covered by the APM syllabus, there are others as well, for example, Net Present Value, Market Value Added and Shareholder Value
Analysis (the last two won’t be specifically examined in APM). In other words, EVA is a high-level performance metric appropriate to
use under the VBM approach.
Implementing VBM
VBM can be implemented using a four-step approach:
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Step 1: Strategy development
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At the corporate level, a strategy is developed with the high-level objective of maximising shareholder value. This strategy can span
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operations, financial management, and buying and selling of business units.
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Value drivers are then created for business units and all levels of the company. For example, a telecom company could have a
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business unit objective, ‘reduce call centre costs.’ Value drivers linked to this could be ‘personnel costs’ and ‘premises costs,’ which
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cascade down the organisational pyramid to operational drivers such as ‘average time per call’ (for personnel costs) and ‘equipment
maintenance costs’ (for facilities costs). Similar value drivers would be defined for all business units and at all organisation levels.
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Step 2: performance targets are created
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After value drivers are defined, they should be translated into specific targets. Following on from the example above, a target for
‘personnel costs’ could be ‘personnel cost reduction of 18% over three years.’ For ‘average time per call,’ a target could be, ‘maintain
six minutes per call’ for the current year. Note that VBM promotes linking short term targets to long-term ones, and all the targets
should be connected to say the EVA metric at the top of the organisational pyramid.
Step 3: Operational plans
Next, the performance targets defined above should be assigned to and ‘owned’ by specific employees. For example, the business
unit manager might be responsible for reducing personnel costs, and a customer service team leader might be responsible for
maintaining six minutes per call. Specific operational plans are then defined that will help employees take actions that will help them
achieve their individual targets.
Step 4: Performance measurement
As with all modern performance management systems, VBM promotes the creation of key performance indicators for all members of
staff, and a shift will be required from financial metrics to the inclusion of management-driven, non-financial metrics (yes, this idea
overlaps with the Balanced Scorecard). Under VBM, ‘economic profit’ will be a short-term financial measure used to measure
performance over a single year, but other metrics should be tailored to specific business units and the activities of individual
managers. Depending on the value driver being measured, the metric may be non-financial in nature (for example, customer
satisfaction level), and focused on the long-term, rather than short-term (for example, customer lifetime value).
VBM overlaps with HR Management Issues (also in your APM syllabus). Successful VBM implementation will require linking
management remuneration to key value drivers and objectives, ideas covered by the Building Block Model.
Spreadsheet modelling
Spreadsheet modelling is a critical tool for the management accountant in VBM as there will be many forecast variables involved in
calculating EVA (or other value-based metrics), such as growth in revenue, forecast capital expenditure and depreciation, corporate
tax rate, interest rate on issued debt, etc. With a spreadsheet it will be possible to conduct scenario analysis and see how different
economic assumptions impact different value drivers, and in turn, impact the value of the company.
Also, a spreadsheet will help the management accountant combine performance metrics from many business units and management
processes into a unified financial model and this can drive a dashboard to monitor performance. For example, a dashboard could be
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designed to present operational-level metrics such as receivables and payables timing, percentage of billable hours to total hours, or
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percentage of capacity utilised. Managers at different levels of the company can use this information for improved decision making
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and performance management.
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Potential Problems of VBM
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• For a VBM initiative to be successful, it may involve culture shift. The new objectives, performance metrics, and reward
schemes associated with VBM may be a big change for staff. All managers and employees will need to understand how their
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individual role adds value.
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• Management information systems will need to be updated to take account of new, non-financial information that will need to be
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captured. This has the potential to be a big, expensive project.
• ‘Value Veneering’ as opposed to value-based management. A thought leader on VBM, Timothy Koller, observed that a company
may go to great efforts calculating cash flow forecasts, business unit valuations, and cost of capital (for example), but then fail
to involve decision makers at group or business level in any new management processes, thus failing to use VBM as a true
management tool.
Exam technique
Now that you understand the concepts of VBM, you need to be able to apply these ideas to your upcoming APM exam, and this topic
often causes trouble for APM candidates. One examiner’s report said the problem for most candidates was a lack of knowledge
about the subject. Next, many candidates talked about VBM in general terms without showing an understanding of it in the context of
the scenario.
If VBM comes up on your exam, you might be asked to ‘evaluate whether the VBM approach is an appropriate approach.’ To avoid
the problems mentioned above, ensure your answer is linked to evidence from the scenario. Without doing this, you will certainly not
gain passing marks. Next, if you are ‘evaluating’ or ‘assessing,’ make sure you are stating whether VBM will help or hurt the company
for specific reasons. To generate ideas that are linked to the particular company given, you can ask yourself these questions:
• Is there any indication that shareholder value is dropping? If the scenario mentions that total shareholder return or the
company’s share price is dropping, or that ‘shareholders are unhappy with their returns,’ then VBM might help turn the situation
around as VBM will put the focus on shareholder value.
• Does the scenario mention the company’s current primary performance metric? If the scenario states something similar
to, ‘The company currently measures performance with ROCE,’ then you know shareholder value is not aligned with the main
company objective. The company is using a profit-based, rather than a value-based, high-level metric.
• Does the scenario mention the company’s business unit objectives? If the scenario states that business unit managers
are given net profit margin (or another profit-based metric) as their primary objective, we might see a follow-on problem:
managers will be focused on generating short-term profit rather than long-term value creation. There may be examples of short-
termism, or dysfunctional decisions being made that you can reference in your answer.
Another requirement you might be asked is, ‘what changes to the business will be required to adopt VBM?’ Again, to gain passing
marks, your ideas need to be linked to the scenario. Here are some ideas you could develop (of course, related to the scenario):
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• The company will need to change its performance metrics. Suggest EVA as a new high-level metric and state why it
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measures value while other metrics do not.
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• The company will need to create a framework of value drivers. Give an example or two of value drivers that could be linked
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to the company in question.
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• The company will need to assign new targets and KPIs to managers and staff. Suggest a new target and KPI, linked to
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the value drivers you suggested above. This may be a challenging change initiative for the company to move to a new system
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of objectives.
• The company will need new information. If the company is currently using profit-based metrics, its information systems may
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be primarily based on financial data. To implement VBM, the company will need new management information systems that
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provide timely, accurate, and reliable information, derived from both financial and non-financial sources. If there is no
information provided about this in the scenario, simply state this and develop the ideas above as recommendations.
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This article has examined the topic of VBM and its links with other syllabus areas. With a practical approach that answers the
question asked, further question practice, and an answer this is linked to the scenario, you should be able to successfully tackle any
VBM requirement on your upcoming exam.
To see how VBM has been examined in the past, please see Question 2 of the March 2020 exam.
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Developments in IT and the impact on

performance management – part 1
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The impact of information technology on the work of the management accountant has been an area of discussion since Burns and
Scapens published their famous article ‘Accounting change project’ which describes the way the work of the management accountant
has changed. This article looks at some important IT developments and discusses how they have impacted on management
information and measuring performance.
Enterprise resource planning systems

‘Enterprise Resource Planning (ERP) Systems are groups of software applications integrated to form enterprise wide information
systems.’ (1)
Before ERP systems, departments would develop their own separate applications. The warehouse might have a perpetual inventory
recording system while the manufacturing planning department would have a planning system, and the finance department would
have an accounting programme system. These systems were not linked, which meant that sharing of information between
departments relied on traditional communication methods. A lot of information was entered into two or more systems manually and
often it was necessary to spend time reconciling information from one system with another.
In multi-national companies, subsidiaries around the world may have had their own systems which were not linked into head office.
Head office had to wait for the monthly management accounts to find out what was happening in the subsidiaries, and the
consolidated position might then not be known for another month.
The 1990s was the advent of the ERP system. The aim was that one system would serve the whole organisation. Typically ERP
systems have a modular structure, such as a general ledger module for accounting, an inventory control module, manufacturing
resource planning (MRP), sales ledger, purchase ledger, payroll, customer relationship management and sales and marketing
modules. The best known providers of ERP systems are SAP, Oracle, PeopleSoft and Baan.
There are several advantages of ERP systems. Firstly, senior managers now have access to all the data in one place, rather than
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information being spread among separate systems. This enables managers to have a clearer knowledge of what is happening. It also
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leads to less duplication of data, which means less time is wasted entering information into two or more systems and reconciling
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information from different systems. The departments are aware of what other departments are doing – so the MRP system will be
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linked into the purchase system and inventory control system, for example, to ensure that inventory levels are sufficient to support
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planned production.
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Scapens and Jazayeri (2) studied the impact that a global implementation of SAP had on management accounting practices at a
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multinational building company. What they concluded was that the management accounting data itself did not change, but the role of
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the management accountant did. Much of the management accounting data could be produced automatically by the system (eg once
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the standard costs were entered into the system, variances were calculated automatically, based on actual costs). This removed
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many of the routine tasks traditionally performed by management accountants. Non-financial managers also increased their own
accounting knowledge, and with the help of the SAP system, could often get their own accounting reports.
While many of the routine tasks of the management accountant were no longer required, the management accountant was needed to
help to interpret operating performance and financial results. Thus the management accountant had become an ‘internal consultant’
rather than a scorekeeper.
Unified corporate databases

Some of the early ERP systems did not share a common database, but were linked together by interfaces, so that data from one
system would flow through to another. Information about purchases, for example, would flow from the inventory control system to the
general ledger system so that the accounting records could reflect the correct inventory balances. The lack of a common database
meant that each department’s data was still inaccessible by other departments.
Truly integrated ERP systems work on a unified corporate database. What this means is that all the data from the organisation can
be stored in one place, and accessed by the different modules of the ERP system. This allows management to interrogate the data
more effectively to make use of the information available to gain additional insights into the business.
Integrated ERP systems support businesses that wish to move away from a functional structure to a more process based structure.
This involves breaking down the barriers between the different departments, and focussing on the processes rather than the roles of
each department. Many organisations have performed some business process reengineering at the same time as implementing new
ERP systems. In terms of performance management, this supports initiatives such as activity based management and business
process reengineering.
Data warehouses
A data warehouse is essentially a very large database that stores all the information from the different systems in one place.
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Assuming that the organisation does not have a unified corporate database, or that there is data stored in older systems that the
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company wishes to retain, data is fed from the various systems into one place. The data is often ‘cleaned’ before being put into the
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warehouse, to remove duplicate or corrupted data.
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The data in the warehouse can then be used by management to provide useful information. Big Data analysis such as data mining
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can be used to identify interesting trends that could provide insights into the business. This might include relationships, such as
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relationships between sales and marketing segments, which might help businesses to focus their products better.
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Knowledge management systems
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For many organisations, knowledge is one of the key resources that they have. In a company that makes high technology products,
for example, the technical knowledge of its engineers, programmers and designers will have a significant impact on how good the
organisation’s products are. Knowledge is difficult to manage, because it exists in the brains of staff.
Knowledge management systems (KMS) aim to manage the knowledge that the organisation has. The aim of the systems is to store
the information and share it, so it is available to other members of staff when they need it.
KMS can be broadly categorised as codified based systems and personalisation based. Codified based systems tend to include
formal technical knowledge, such as laws or tax rules. A tax practitioner may use such a system to look up tax regulations, for
example. Personalisation based systems are where staff within the business are asked to share their knowledge. The system will let
staff input any information they think is necessary for others to know about. This information can be input using various formats –
social media type pages, where information is posted, blogs, forums and wikis. (A wiki is a website on which users collaborate to
input and update information.) Popular packages include Zoho.
An important aspect of performance management is ensuring that staff have the knowledge they need. Designing an appropriate
KMS is therefore a good way of ensuring that the organisations knowledge can be maintained and shared. Some organisations have
set up KMS for new staff, and discovered that it can reduce the time taken to learn the job. Customer service centres also use KMS
to help them answer customers’ questions, and often customers are given access to such systems to help them find solutions in
order to avoid having to call the call centre.
Customer relationship management

Customer relationship management (CRM) is the process of managing the relationship with a customer from the point where they are
a potential customer, throughout their life as a customer. It starts with customer acquisition, which involves campaigns to find new
customers, and continues with retention of customers, since retaining customers is easier than finding new customers.
CRM IT systems have become popular since the start of the millennium. Some of these are included as modules within an ERP
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system such as SAP, while others are stand alone, such as Salesforce. The systems support CRM activity by providing and storing
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data about customers, for example, information about conversations or interactions with the customer, pipeline management, and
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managing e-mail communications with the customer.
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Networking
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Historically, the first computerised information systems were held on large mainframe computers. Users would access the system
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using terminals that look like PCs, but did not have their own CPU so could only operate when connected to the mainframe. Access
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to the system was the preserve of a few privileged individuals such as the accounting staff and IT staff, and access was strictly
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limited.
Mainframes gave way to PCs in the 1980s, where staff had PCs on their desk. This supported ‘distributed’ processing, where data
would be processed separately on PCs, for example accountants preparing spreadsheets.
The growth of client server computing gained popularity, whereby the PCs (the clients) would be linked up to a bigger PC called a
server, which would provide services such as printing, file storage, and access to the internet. Systems such as ERPS could also be
loaded onto the servers which allowed centralised processing. Local area networks enabled information to be shared within one
location, while wide area networks allowed local area networks to interconnect, often using a devoted telephone line.
With the advent of the internet in the 1990s, organisations can now interlink over the internet. Intranets can also be set up. An
intranet is a private network which is based on the internet, but only allows access to members of the organisation. The internet and
intranet have clearly revolutionised the way people within organisation can communicate with each other. They have also lead to an
increase in teleworking, where staff often work at home, and connect to their workplace via the intranet. The internet has also opened
up the opportunity for cloud computing.
Cloud computing
Traditionally, setting up a computerised information system involved buying hardware, such as servers and PCs, buying software
licenses for all the applications, and loading these onto the servers or PCs that needed them. An IT department managed the
organisation’s hardware, software and data, and was responsible for security.
Cloud computing involves buying the right to use computer applications which are held in a remote location, and accessed via the
internet. The most basic cloud services include storage spaces such as Dropbox or Google Drive. Software as a service (SaaS) is
another trend, where the user buys the right to use an application held on the cloud provider’s hardware, for example, many
accounting products such as Xero and Quickbooks are cloud based. It is even possible to have complete system infrastructure via
the cloud – the cloud service provider sets up the hardware and software architecture, and users access it via the web.
The advantage of cloud computing is that it changes what is normally a fixed cost into a variable cost. Users are generally charged
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for the amount they use, rather than having to make large upfront investments. This makes systems very ‘scalable’ which means that
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organisations buy exactly the amount of IT they need, rather than having to invest in steps. It also saves time – large, dispersed
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organisations can get access to a global centrally managed system via the internet in a fraction of the time it would have taken to set
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up local, interconnected networks at each location.
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Cloud computing allows organisations to standardise their information systems globally, very much reinforcing the approach of ERP
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systems. Senior management can access the global data remotely, and there is more ability to share information among all
employees as they will all be able to access data from wherever they are located.
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One possible disadvantage of cloud computing is security. Having your information system or data on somebody else’s hardware
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means that you lose control of it. However, the providers of cloud services generally have excellent security measures in place, so
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the data is probably safer than it would be if it were held in house.
Implications for managing and measuring performance

There are many implications of the IT developments describe above, both for organisations and for performance management and
measurement. The role of the management accountant has always been to provide information to organisations to help them plan
and control their organisations, and make decisions. Traditionally much of this information was financial.
The first, and perhaps most obvious implication of the developments described above is that there is a huge amount of information
that is now available to organisations, which is very easily accessed, and shared. This means that traditional financial information
perhaps becomes less important.
A second implication is that managers and employees can now find much of the information that they need for themselves.
Historically, the management accountant was the provider of information for performance management, but often finds that his role
has been usurped by the systems above.
A third implication is better collaboration and sharing, which should lead to better team working within organisations. This supports
the process view of the organisation, where staff recognise that they are working together to meet the needs of the customer, rather
than doing a task that relates only to their internal department.
A possible weakness is that with so much information around, managers may not be able to see the big picture. This is where the
management accountant can help. There is a greater role in terms of interpreting the information, and pointing senior management to
the data that is really important. It also includes explaining how the financial and non-financial data interlink.
References
1. ‘Enterprise information systems, a pattern based approach’, Dunn CL
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2. ‘ERP systems and management accounting change. Opportunities or impacts?’ by Scapens and Jazayeri, published in European
Accounting Review, 2003
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Nick Ryan is a subject matter expert for BPP
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Developments in IT and the impact on

performance management – part 2
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Following on from 'Developments in IT and the impact on performance management – part 1' (see 'related links'), this article looks at
some more recent developments in IT; specifically process automation, artificial intelligence (AI), data visualisation and the internet of
things.
Process automation
Process automation is the concept of processes being performed by machines rather than by humans. Machines can perform some
repetitive processes, to a consistent standard, quickly and without errors, so are often better at performing these tasks than the
human. Robotic process automation implies the use of computer software in the automation.
In manufacturing industries, robots are common, for example in car production lines, where they perform many of the assembly
tasks. In services industries too, many processes are being automated, such as bank transactions being processed entirely without
human involvement. Robots are even assisting in surgical procedures in hospitals.
Automation is not a new concept. The first completely automated industrial process was a flour mill, developed by Oliver Evans in
1785. Recent developments in computer technology are providing scope for greater automation. These developments include better
hardware and software, and developments such as artificial intelligence described below.
A report by the Mckinsey Global Institute 1 published in 2017 claims that in the global economy, 49% of the tasks that are currently
performed by humans could be automated using technology that already exists. Only 5% of occupations could be fully automated,
but at least 30% of the activities performed could be automated in 60% of jobs.
From a global perspective, Mckinsey see automation as leading to greater productivity and higher economic growth. They predict that
since the jobs that are automated would be replaced by new types of employment, automation would not lead to higher
unemployment. For businesses, the benefits of automation are not limited to labour savings. Benefits include 'greater throughput,
higher quality, improved safety, reduced variability, a reduction in waste and higher customer satisfaction'.
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How will automation impact on the work of the management accountant? The tasks most likely to be automated include the more
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basic accounting work such as the collection and processing of data. Many accounting software packages upload bank transactions
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from the bank’s systems, and supplier invoices scanned by smart phones can be automatically booked. The work of the management
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accountant which can’t be automated are the more advisory aspects of accounting – interpreting and analysing information and
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providing recommendations. This reinforces the role of the management accountant as a consultant and advisor to organisations, in
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relation to strategy development, decision-making and value creation.
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Artificial intelligence (AI) and machine learning
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Artificial intelligence (AI) can be defined as 'The ability of machines to exhibit human like capabilities in areas related to thinking,
understanding, reasoning, learning or perception'. 2 What this essentially means is machines that can think for themselves, like
humans. Science fiction films provide many exciting examples of intelligent machines, such as C-3PO in the Star Wars films, but
these do not yet exist in the real world.
Computer scientists talk about two levels of AI – weak and strong. Weak AI means that machines can think for themselves, but only
to the extent of doing specific tasks, for example cars that can drive themselves. Strong AI means that machines have a general level
of intelligence and can think like humans. Strong AI currently only exists in sci-fi fantasy, but weak AI is an area that is developing
very quickly and has innumerable applications to business and society in general.
Early applications of AI included expert systems. Computers were programmed to make decisions that previously experts had made,
such as giving quotations for car insurance. Relevant information about applicants, such as their age, gender and driving experience
could be entered into a system, which would then evaluate their risk category and quote an appropriate premium, thus performing the
role of an actuary. Other examples include systems which support doctors, whereby the doctor can enter information about the
patient’s symptoms, and the system will help to provide a diagnosis.
Expert systems can only make decisions based on rules that have been hard programmed into them by experts. Over time, their
output for a given set of circumstances does not change, unless they are reprogrammed. With the advent of 'machine learning'
machines can 'learn' from their experience, rather like humans do, and therefore provide more accurate output. Some accounting
systems 'guess' where the debit side of a payment or the credit side of a receipt should be booked, based on what the bookkeeper
did last time a similar receipt or payment arose.
Machine learning is used extensively in data analytics where computers performing the analysis learn more about the data
population with experience. To take a simple example, imagine that we wanted to analyse all the companies on the stock exchange
to predict which might go bankrupt within 12 months. We might programme a computer to calculate a score, such as Altman’s Z-
score model, and use this as the basis of our predictions. This is not AI as the computer is just doing what it is programmed to do.
Unfortunately, the Altman Z-score model does not predict perfectly, sometimes classifying companies that are at risk of bankruptcy
when they subsequently survive or failing to predict the bankruptcy of others. These errors are referred to as classification errors.
Without machine learning, programming the computer to simply calculate z-scores would not reduce the probability of these errors.
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Alternatively, we could programme a machine to analyse a sample of historic data and come up with its own version of the Z-score
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model. Machines can analyse much larger volumes of data than humans, so the machine would come up with a much more reliable
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version of the z-score, possibly incorporating many more variables than the five used in Altman’s model. Here the machine is learning
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from the data, so this is AI. There would still be a probability of classification errors, but it is likely that this would be much lower than
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in the Altman model. What is more, the machine would continuously update its model as it analysed more and more companies. This
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demonstrates one use of AI, in classification of data.
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There are several areas where artificial intelligence and machine learning are relevant to management accountants. Firstly, within
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data analytics, analysis that incorporates machine learning techniques can provide new insights to management. One of the roles of
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the management accountant has been to analyse data for the purposes of planning, decision making and cost control. For
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management accountants to remain relevant in this brave new world it is essential that they understand, and input into the AI which is
being used in analysis.
AI can also be used for identifying unusual transactions that may help accountants to become better at detecting fraud. As fraudsters
are continually developing new methods to practice their trade, machine learning provides an opportunity for accountants to keep up
with them.
AI can also help accountants provide much more accurate forecasts, based on a more thorough analysis of the external
environment, using machine learning to identify with greater accuracy the factors that will affect a business’s revenues and costs.
Data visualisation techniques

Data visualisation refers to presenting data using visual techniques such as charts and diagrams so the story behind the data can be
seen easily. As the old saying goes, a picture is worth 1,000 words. Providing information visually can assist decision makers to
understand data much more quickly, providing that it is presented in a way that helps their understanding.
Charts and diagrams have been with us for hundreds of years, so there is nothing new in the concept of data visualisation. A classic
example is the map of the London Underground that was designed by Harry Beck in 1931. What has changed in recent years is the
volume of data that is available for use by businesses, from devices such as smart phones, smart devices on the 'internet of things',
the explosion of social media, and the use of sophisticated data analytic techniques to assist in analysing all of this data. There is
also increased demand from management for analysis of this data.
New technology has also become available to help perform data visualisation. Market leaders are Microsoft Power BI, Tableau and
Qlik. Such packages enable users to access data from many different platforms and provide reports that update in real time. They
help users provide many different types of visualisation using built in templates with high quality graphics.
From a practical point of view, businesses need to consider where the data for the reports comes from. It is important that the data
can be extracted easily, particularly where it comes from several sources. It may be necessary to have a data warehouse where the
data from different sources is deposited. The data can then be cleaned if necessary. The reports would extract the data from the data
warehouse rather than from the original sources.
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Common types of data visualisation techniques are as follows:
Dashboards
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Dashboards contain summarised information, typically by showing a small number of key performance indicators. They allow
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managers to see the big picture quickly, focussing on the critical success factors. They may also include drill down facilities whereby
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managers can click on the number in the dashboard to see more detailed analysis. This can give managers the ability to answer
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some of their own questions.
Waterfall charts
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Waterfall charts, also referred to as bridges, can be used to show the components that make up a total. The components are shown
as bars, where the length of the bars represents the value of the component. It will also show whether the components increase or
decrease the total. A simple waterfall chart showing variances for the month is shown below:
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Mapping charts
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These present data geographically, for example, countries or regions can be clicked on and drilled into to find information specific to
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those areas.
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Traditional methods of presenting information, such as tables, heatmaps, line, bar and pie charts are also ways to visualise
information.
When users have information presented visually it can focus attention and allow outliers and trends to be identified more easily than
if someone was looking a large spreadsheet of data.
The internet of things

The internet of things refers to the devices that are connected to the internet and which continuously send information. Examples
include smart phones, smart speakers, exercise watches and machine control devices. Many homes have smart switches than
enable homeowners to control the lighting and heating in their homes remotely.
Machinery can be fitted with sensors that enable maintenance departments to monitor their performance, which can enable faults to
be identified earlier, before they become more serious. Other useful information such as the temperature of fridges in supermarkets
can also be monitored in this way.
The relevance of the internet of things to management accountants is that it provides huge amounts of data that can be analysed and
is therefore another source of potentially useful information to management. Businesses can collect information about the behaviour
of their customers from devices such as smart phones and analyse this information to provide additional insights that can be used in
many ways (see the articles on Big Data).
Ethical issues
There are ethical issues related to these developments. In particular, these developments enable businesses to find out more
information about individuals and this threatens privacy and can even lead to harm. Governments and policymakers are trying to
regulate this with laws such as the Data Protection Regulation (GDPR) issued by the EU in 2018 that updated existing laws in
member states.
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Keeping up to date
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Technology is a fast-moving industry, and it is important that you are aware of new developments and trends. Good sources of
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information are reports and briefings issued by Accounting Institutes such as ACCA, and accounting and consulting firms. There are
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also some interesting channels on YouTube, such as 'Crash Course Computer Science' that provide a layman’s guide to complex
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technology developments.
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References
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1. 'A future that works: Automation, Employment, and Productivity' (executive summary), Mckinsey Global Institute, January 2017
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2. 'Machine learning: more science than fiction', ACCA, 2019
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What is big data?
There are many definitions of the term ‘big data’ but most suggest something like the following:
'Extremely large collections of data (data sets) that may be analysed to reveal patterns, trends, and associations, especially relating
to human behaviour and interactions.'
In addition, many definitions also state that the data sets are so large that conventional methods of storing and processing the data
will not work.
Sources of big data
Main sources of big data can be grouped under the headings of social (human), machine (sensor) and transactional.
Social (human) – this source is becoming more and more relevant to organisations. This source includes all social media posts,
videos posted etc.
Machine (sensor) – this data comes from what can be measured by the equipment used.
Transactional – this comes from the transactions which are undertaken by the organisation. This is perhaps the most traditional of the
sources.
Characteristics of big data
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The characteristics of big data, known as the 5Vs, are:
• Volume
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• Variety
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• Veracity
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• Value
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These characteristics have been generally adopted as the essential qualities of big data.
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Volume
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The volume of big data held by large companies such as Walmart (supermarkets), Apple and EBay is measured in multiple
petabytes. A typical disc on a personal computer (PC) holds a gigabyte, so the big data depositories of these companies hold at least
the data that could typically be held on 1 million PCs, perhaps even 10 to 20 million PCs.
The scale of this is difficult to comprehend. It is probably more useful to consider the types of data that large companies will typically
store.
Retailers
Via loyalty cards being swiped at checkouts: details of all purchases you make, when, where, how you pay, use of coupons.
Via websites: every product you have every looked at, every page you have visited, every product you have ever bought.
Social media (such as Facebook and Twitter)
Friends and contacts, postings made, your location when postings are made, photographs (that can be scanned for identification),
any other data you might choose to reveal to the universe.
Mobile phone companies
Numbers you ring, texts you send (which can be automatically scanned for key words), every location your phone has ever been
whilst switched on (to an accuracy of a few metres), your browsing habits and voice mails.
Internet providers and browser providers
Every site and every page you visit. Information about all downloads and all emails (again these are routinely scanned to provide
insights into your interests). Search terms which you enter.
Banking systems
Every receipt, payment, credit card information (amount, date, retailer, location), location of ATM machines used.
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Variety
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Some of the variety of information can be seen from the examples listed above. In particular, the following types of information are
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held:
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• Browsing activities: sites, pages visited, membership of sites, downloads, searches
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• Financial transactions
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• Interests
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• Buying habits
• Reaction to advertisements on the internet or to advertising emails
• Geographical information
• Information about social and business contacts
• Text
• Numerical information
• Graphical information (such as photographs)
• Oral information (such as voice mails)
• Technical information, such as jet engine vibration and temperature analysis
This data can be both structured and unstructured:
Structured data: this data is stored within defined fields (numerical, text, date etc) often with defined lengths, within a defined record,
in a file of similar records. Structured data requires a model of the types and format of business data that will be recorded and how
the data will be stored, processed and accessed. This is called a data model. Designing the model defines and limits the data which
can be collected and stored, and the processing that can be performed on it.
An example of structured data is found in banking systems, which record the receipts and payments from your current account: date,
amount, receipt/payment, short explanations such as payee or source of the money.
Structured data is easily accessible by well-established database structured query languages.
Unstructured data: refers to information that does not have a pre-defined data-model. It comes in all shapes and sizes and it is this
variety and irregularity which makes it difficult to store in a way that will allow it to be analysed, searched or otherwise used. An often
quoted statistic is that 80% of business data is unstructured, residing it in word processor documents, spreadsheets, PowerPoint
files, audio, video, social media interactions and map data.
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Here is an example of unstructured data and an example of its use in a retail environment:
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You enter a large store and have your mobile phone with you. That allows your movement round the store to be tracked. The store
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might or might not know who you are (depending on whether it knows your mobile phone number). The store can record what
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departments you visit, and how long you spend in each. Security cameras in the ceiling match up your image with the phone, so now
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they know what you look like and would be able to recognise you on future visits. You pass near a particular product and previous
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records show that you had looked at that product before, so a text message can be sent perhaps reminding you about it, or
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advertising a 10% price reduction. Perhaps the store has a marketing campaign that states that it will never be undersold, so when
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you pass near products you might be making a price comparison and the store has to check prices on other stores websites and
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message you with a new price. If you buy the product then the store might have further marketing opportunities for related products
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and consumables and this data has to be recorded also. You pay with an affinity credit card (a card with associations with another
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organisations such as a charity or an airline), so now the store has some insight into your interests. Perhaps you buy several
products and the store will want to discover if these items are generally bought together.
So just walking round a store can generate a vast quantity of data which will be very different in size and nature for every individual.
Velocity
Information must be provided quickly enough to be of use in decision-making and performance management. For example, in the
above store scenario, there would be little use in obtaining the price-comparison information and texting customers once they had left
the store. If facial recognition is going to be used by shops and hotels, it has to be more or less instant so that guests can be
welcomed by name.
You will understand that the volume and variety conspire against velocity and, so, methods have to be found to process huge
quantities of non-uniform, awkward data in real-time.
Veracity
Veracity means accuracy and truthfulness and relates to the quality of the data. In the context of big data, for any analysis to provide
useful findings for decision making, the data collected must be true. To assess how true the data collected is, companies must
consider not only how accurate or reliable a data set might be but also how trusted is the source of the data. Companies must be
able to trust the source of the data being collected and be confident that the data is reliable and accurate if they are to base
important, and often costly decisions on the findings of its analysis.
The difficulty that companies face here is that by its very nature, the data collected comes from many different sources. Some will be
more trustworthy that others. For example machine and transactional sourced data would be seen as more reliable than human
sourced data. Data from transactional and machine sources would be easier to verify and less easy to manipulate. Human data, for
example from social media, however can be more easily manipulated and care must be taken when using this type of data,
particularly given the recent increase in so called ‘fake news’ and growing reports of deliberately manipulated customer reviews on
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retail sites.
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Veracity also ties in to velocity. To be useful in decision making, data needs to be analysed as soon as possible. Velocity shows that
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the data being collected changes quickly. Analysing out of date data could lead to poor decision making.
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Value
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The last V of big data (although some models have added more) is Value. There is little point in going to the effort and expense of
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gathering and analysing the data if this does not ultimately result in adding value to the company. It is important for companies to
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consider the potential of big data analytics and the value it could create if gathered, analysed and used wisely.
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An example of how data analysis was used by British supermarket group Tesco to add value:
Tesco has operations in several countries around the world. In Ireland, the company developed a system to analyse the temperature
of its in-store refrigerators. Sensors were placed in the fridges that measured the temperature every three seconds and sent the
information over the internet to a central data warehouse. Analysis of this data allowed the company to identify units that were
operating at incorrect temperatures. The company discovered that a number of fridges were operating at temperatures below the
-21◦C to -23◦C recommended. This was clearly costing the company in terms of wasted energy. Having this information allowed the
company to correct the temperature of the fridges. Given that the company was spending €10 million per year on fridge cooling costs
in Ireland, an expected 20% reduction in these costs was a significant saving.
The system also allowed the engineers to monitor the performance of the fridges remotely. When they identified that a particular unit
was malfunctioning, they could analyse the problem then visit the store with the right parts and replace them. Previously the fridges
would only be fixed when a problem had been discovered by the store manager, which would usually be when the problem had
developed into something more major. The engineers would have to visit the store, identify the problem, and then make a second
visit to the store with the required parts.
Processing and analysing big data

The processing of big data is generally known as big data analytics and includes:
• Data mining: analysing data to identify patterns and establish relationships such as associations (where several events are
connected), sequences (where one event leads to another) and correlations.
• Predictive analytics: a type of data mining which aims to predict future events. For example, the chance of someone being
persuaded to upgrade a flight.
• Text analytics: scanning text such as emails and word processing documents to extract useful information. It could simply be
looking for key-words that indicate an interest in a product or place.
• Voice analytics: as above but with audio.
• Statistical analytics: used to identify trends, correlations and changes in behaviour.
Google provides website owners with Google Analytics that will track many features of website traffic. For example, the website
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OpenTuition.com provides free ACCA study resources. Google analytics reports statistics such as the following:
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GEOGRAPHICAL DISTRIBUTION OF USERS
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AGE OF USER
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The final table is instructive. OpenTuition.com does not ask for users’ ages, so this data has been pieced together from other
information available to Google. It has been able to do this for only about 58% of users.
These analytical findings can lead to:
• Better marketing
• Better customer service and relationship management
• Increased customer loyalty
• Increased competitive strength
• Increased operational efficiency
• The discovery of new sources of revenue.
The Big Data (DIKW) pyramid
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The DIKW pyramid, also known as the knowledge pyramid became well known in 1989 from the work of Askoff. With the emergence
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of big data, the pyramid has also become known as the big data pyramid. The work of Jennifer Rowley in 2007 explained the
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relationships between data, information, knowledge and wisdom.
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Rowley explained the pyramid: 'Typically information is defined in terms of data, knowledge in terms of information, and wisdom in
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terms of knowledge.'
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Data: a range of data can be collected from various sources – this is raw data and not particularly useful in this form.
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Information: The raw data can be analysed to look for trends or patterns, for example it may appear that there is a link between the
purchase of a particular product and a particular group of customers. This is information.
Knowledge: The information can be analysed further to establish how the identified links are connected. Knowing the details of
exactly what types of customers buy a particular product or favour particular product features is knowledge.
Wisdom: The knowledge gathered can be used to make informed business decisions.
Example of how the pyramid could be used:
A soft drink manufacturer makes a range of fruity soft drinks in four different flavours (orange, apple, lime and pear). It has
traditionally used plastic bottles but has recently run a trial whereby two flavours were also made available in glass bottles. It is
making its plan for next year’s production and is considering if it should expand the use of glass bottles.
Data: The company has collected a range of data from previous purchases, customer questionnaires, social media posts etc.
Information: The raw data was analysed to look for trends or patterns. The company finds that there appears to be a link between
the types of bottles purchased by different age groups.
Knowledge: Further analysis has shown that younger customers prefer the glass bottles while customers from the older age range
prefer plastic bottles. Previous analysis also showed that lime flavour is almost exclusively only purchased by older customers and
pear is almost exclusively only purchased by younger customers.
Wisdom: How can this knowledge be used? The company should only produce lime flavour in plastic bottles and only produce pear
flavour in glass bottles. Here, the company is using the insights gained in order to make a decision and therefore this is classed as
wisdom.
Dangers/risks of big data
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are some potential dangers and drawbacks.
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Cost: It is expensive to establish the hardware and analytical software needed, though these costs are continually falling.
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Regulation: Some countries and cultures worry about the amount of information that is being collected and have passed laws
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governing its collection, storage and use. Breaking a law can have serious reputational and punitive consequences.
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Loss and theft of data: Apart from the consequences arising from regulatory breaches as mentioned above, companies might find
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themselves open to civil legal action if data were stolen and individuals suffered as a consequence.
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Incorrect data: If the data held is incorrect or out of date incorrect conclusions are likely. Even if the data is correct, some
correlations might be spurious leading to false positive results.
Updated article extracted from articles by Ken Garrett, a freelance lecturer and writer, and Nick Ryan, a lead tutor for
performance management subjects
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Big data 2: How companies use big

data
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Big data 2: How companies use big data
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Big data refers to the large collections of data that may be analysed to reveal patterns, trends and associations, especially relating to
human behaviour and interactions. Big data has already been explained in another article (Big data 1: What is big data?). This
article will describe some real life examples of the use of big data for performance management and measurement purposes.
Performance management involves managing the organisation in order to ensure that it meets its objectives. Broadly, big data is
relevant to performance management in the following ways:
• Gaining insights (eg about customers’ preferences) which can then be used to improve marketing and sales, thus increasing
profits and shareholders’ wealth.
• Forecasting better (eg customer’s future spending patterns, when machines will need replacing) so that more appropriate
decisions can be made.
• Automating of high level business processes (eg lawyers scanning documents) which can lead to organisations becoming more
efficient.
• Providing more detailed and up to date performance measurement.
Examples of companies using big data
Netflix
Netflix began as a DVD mailing service and developed algorithms to help it to predict viewers’ preferences and habits. Now it delivers
films over the internet and can easily collect information about when movies are watched, how often films might be stopped and
restarted, where they might be abandoned, and how users rate films. This allows Netflix to predict which films will be popular with
which customers. It is also being used by Netflix to produce its own TV series, with much greater assurance that these will be hits.
Amazon
The world’s leading e-retailer collects huge amounts of information about customers’ preferences and habits which allow it to market
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very accurately to each customer. For example, it routinely makes recommendations to customers based on products previously
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Airlines
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Airlines know where you’ve flown, preferred seats, cabin class, when you fly, how often you search for a flight before booking, how
susceptible you are to price reductions, probably which airline you might book with instead, whether you are returning with them but
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didn’t fly out with them, whether car hire was purchased last time, what class of hotel you might book through their site, which routes
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are growing in popularity, seasonality of routes. They also know the profitability of each customer so that, for example, if a flight is
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cancelled they can help the most valuable customers first.
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This information allows airlines to design new routes and timings, match routes to planes and also to make individualised offers to
each potential passenger.
Target
Target is a large discount retailer in the USA. There is an often quoted story about their ability to predict when a customer is pregnant
– frequently before the customer has informed her family. By looking at about 25 products it is claimed that they can create a
pregnancy predictor. For example, early pregnancy often causes morning sickness so consumers would perhaps change to blander
food and less perfumed shower gel. Why would Target be interested in knowing whether a consumer is pregnant? Well that person
will require different products during the pregnancy then in a few months the baby will have its own product needs: nappies, baby
shampoo and clothes. Early identification of pregnancy can allow Target to establish the shopping habits of the mother and perhaps
even the preferences of the child.
Walmart’s Polaris search engine
Walmart is an American retailer that operates in 28 countries around the world. It is the world’s largest company based on revenues.
Many of Walmart’s customers buy online through the company’s website. Walmart wanted to make sure that customers can find what
they are looking for on its website, so it developed its Polaris search engine. If customers are looking for a particular product, they
enter the description in a search box, and the website displays products which meet that description.
What is unusual about Polaris is the way it ranks the search results. It attempts to show the products that the customer is most likely
to buy towards the top of the list. The algorithm takes into account many factors, including the number of likes that the product has on
social media networks and how many favourable reviews it has.
The system also uses artificial intelligence to learn so that it can continually provide better search results. If a phrase has been
entered that the engine did not initially understand, for example, the engine can ‘learn’ what that phrase meant based on what the
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customer actually bought. Thus the system was soon able to figure out that when a user entered ‘House’ into the search box, they
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were probably looking for merchandise connected with the TV series of that name, not furniture or other items for their house. If
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someone searches for ‘Flats’, the engine has learned that they probably want to buy shoes, not apartments or flat screen TVs.
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The metric that is used to measure the success of the website is customer conversion rate – the number of customers that actually
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buy a product after a search. It is estimated that the Polaris search engine has increased the conversion rate by between 10% and
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15%. That is worth billions of dollars in extra revenue.
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Beredynamic
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Beredynamic is a manufacturer of high quality audio products such as microphones and headphones. The company is based in
Germany, but has a wide international sales and distribution network. The company wanted to improve its analysis of sales. Most ad
hoc reports required data to be extracted from its legacy systems into a spreadsheet where the reports would then be manually
compiled. This was time consuming, leading to delays in producing the reports. The reports themselves were not always accurate
either.
The company developed a data warehouse that automatically extracts transactions from its existing ERP and financial accounting
systems. The structure of this warehouse was carefully designed so that standard information is stored for each transaction such as
product codes, country code, customer and region. This is supplemented by a web based reporting solution that enables managers
to create their own reports, both standard and ad hoc, based on the data held in the warehouse.
The system allows the company to perform detailed analysis of sales, which helps it to identify trends in different products or
markets. This leads to two business advantages. The first is that the sales and distribution strategy can be changed when demand
changes in certain markets – for example, when sales of gaming headphones began to increase in Japan, the company introduced
promotions for all its gaming products in that country, including a large advertising campaign and introduction of product bundles
specially for the Japanese market. The second advantage is that production plans can quickly be changed as demand changes. If
demand is falling, production is slowed to ensure that the company is not left with excessive inventory. If demand is expanding,
production is increased to take advantage of higher sales.
The ability to provide more detailed analysis quickly can also be used for performance measurement and appraisal, for example,
comparing actual sales with targets by region, assessing whether a promotion achieved the expected increase in profits. Such
reports can be produced quickly based on real time data, meaning that management can respond quickly to any adverse variances.
The success of the new system is measured in terms of the growth in revenues and profits. While this seems simple, it has to be
recognised that some growth would have been expected even if the system had not been implemented, so determining how much
revenue growth has resulted from the greater analysis can be difficult. Assumptions need to be made.
Morton’s Steak House
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A customer jokingly tweeted US chain Morton’s and requested that dinner be sent to the Newark airport where he was due to arrive
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late. Morton’s saw the tweet, realised he was a regular customer, pulled up information on what he typically ordered, figured out
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which flight he was on and then sent a waiter to meet him at the airport and serve him dinner.
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was. It also shows how companies like to influence social media users who have a large following as a means of increasing their own
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publicity.
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It is difficult to measure the impact of interventions into social media. No doubt the happy customer would have communicated this
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story, and this may have improved the reputation of the restaurant, but it is very difficult to measure the impact of this on sales.
Conclusion
The cases above have shown how detailed analysis of data can be used in a number of different ways to improve the performance of
an organisation. Big data can be used to understand customers and trends better, to provide insights into costs, and to make it easier
for customers to find what they want on the website. Companies are likely to continue to identify innovative uses of the increasing
volumes of data available to them, and analysis of big data is likely to grow in importance as an important strategic tool for many
businesses.
Updated article extracted from articles by Ken Garrett, a freelance lecturer and writer, and Nick Ryan, a lead tutor for
performance management subjects
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Data analytics and the role of the

management accountant
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Data analytics and the role of the management accountant
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We are living through the digital revolution where the traditional business landscape is being pushed aside by internet based
companies. Large well established retail businesses are going into bankruptcy as consumers switch to buying online. Businesses
use the internet to connect with new suppliers offering better prices and quicker delivery times. Many service businesses no longer
have a physical high street presence but use their websites as their shop window.
This article describes performance metrics that are used by internet-based businesses and, in particular, looks at some of the metrics
available in Google Analytics, the most widely used analytics tools for website traffic.
Performance management in e-commerce

In the world of e-commerce, the focus of performance management is on measuring the online experience, and focuses on the
following facets:
• Customer acquisition: getting visitors to the company’s website and converting those visits into sales.
• Customer retention: persuading first time customers return again. According to Reicheld and Schefter, retaining 5% more
customers can increase profits by between 25% and 95%. This is due to the fact that better established customers usually buy
more, and are a valuable source of referrals.
• Customer extension: Selling additional goods or services to existing customers.
Much of the information needed to evaluate performance in these areas can be gained by recording data about visitors to the
businesses website.
Google Analytics
Google analytics provides website owners with a range of information and analysis about website visitors. Users of Google Analytics
install a tracking code on their website. When users visit the website, the tracking code is activated on the visitors’ browser. This
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collects information about the visitor and their visit, which is collected by Google Analytics and used as a basis of the analysis. A
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weakness of this process is that visitors may use Ad blockers in their web browser that stop the tracking code from working, so
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information is not collected about all visitors.
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The programme provides a large amount of standard data and analyses, and users can also customise it to provide their own reports
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or metrics. This article looks at the highlights of Google Analytics. Readers are encouraged to visit the Google Analytics website (2)
and view the demonstration reports.
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Audience reports
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Audience reports provide information about the visitors to the site. The high level overview report includes the percentage of visitors
that are new, their location and language. This can be useful marketing information, for example to identify whether a marketing
campaign in a particular territory was useful, or identifying territories where interest in the company’s products appears to be growing.
Analysis of visitors as new or returning enables businesses to measure customer retention rates.
In addition to this a host of demographic information, such as age of users, gender and even their interests is produced. This
information is most useful when combined with other information such as visitor behaviour (see below). Marketers may be interested
for example not only about what percentage of their visitors fall into a particular demographic group, but also what percentage of that
group actually make a transaction (the conversion rate) when they visit the website. Google Analytics allows data from these different
'dimensions' to be combined in reports.
Such marketing data is invaluable as it enables the company to identify much more accurately what their target market segments are,
and to monitor the success of new products or marketing campaigns aimed at such groups.
Acquisition reports
Acquisition reports show how visitors arrived at the website, and provide information about the effectiveness of the different channels
that the company uses to attract visitors. Organic visitors are those who came to the website via a web search engine, such as
Google, Bing or Ask.com. An important element of e-marketing is search engine optimisation (SEO), which involves strategies to
ensure that the businesses website comes near the top of the list when users do a particular search. A small accounting practice for
example, would want its website to be visible in search results for 'accountants near me' or 'tax advice' or any other key words that
are appropriate to that business. The number of organic users gives an indication of how effective SEO strategies are.
Other visitor types includes direct, which refers to visitors who simply typed the website address into their browser. Referrals and
affiliates are visitors who arrived at the website by clicking on an advert on another website. When viewing the high level reports,
users can drill down to more detailed analysis of each of these, such as an analysis of visitors by search engine or by advert type.
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While the acquisition reports show how many visitors each channel has attracted to the website, they do not provide information
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about the quality of the visitors. Visitors who are simply surfing the web with no intention of buying are obviously much less useful
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than visitors who place regular orders for the websites products.
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Statistics about visitors numbers may also be distorted by bots and spider programmes. These are programmes that scan web
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pages, 'reading' websites to find out what the content is of the web pages. The Google search engine uses bots to identify content in
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web pages which is then used by the search engine to help users find relevant pages.
Behaviour reports
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Behaviour reports analyse what visitors actually do while on the website. This provides feedback to the designers of the site about
how well it encourages users to engage with the site, and ultimately to achieve a goal, such as contacting the company or buying a
product or service from the website.
A prominent statistic in behaviour reports is the 'bounce rate'. This is the portion of users who land on the website, but do not interact
further. They may move onto another website, or remain inactive. A high bounce rate is often seen as a sign of poor performance, as
it means that the website has failed to engage users. However, some information websites may not require users to interact – users
may open the home page and see the information they need straight away, and not interact further, in which case they would be
included as a bounce, but the business would be happy with the visit.
The conversion rate is a key statistic on an e-commerce website, and measures the portion of visitors that buy something from the
site during their visit. A low conversion rate might suggest, among other things, that the prices are too high, the selection of products
available is poor, or that the presentation on the website is poor, meaning that visitors are not tempted to transact.
Behaviour flow shows how visitors progressed through the website. Which page was the landing page? What pages did users
progress to from the landing page? How many people 'dropped off' after the landing page, or each subsequent page? The drop off
rate indicates how good a particular page is at maintaining the interest of the visitors. A high drop off rate might suggest that visitors’
interest was not maintained, or perhaps links to other pages were not displayed prominently enough, or did not actually work.
Impact on the role of the management accountant

Traditionally, business managers relied on management accounts to enable them to monitor the performance of their business and
plan for the future. Much of the information provided by management accountants was financial in nature, and focused on improving
efficiency so that costs could be reduced. For an online business, the focus of management attention is on customer acquisition and
costs. Information provided by the likes of Google Analytics is likely to be considered far more relevant than tools such as variance
analysis. Data analytics are usually updated in real time – all a manager needs to do is log in and see up to the minute information.
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Large organisations will utilise the services of data experts; data scientists who have advanced data mining skills and the ability to
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create predictive algorithms. This is a highly specialised field and the determination of the inputs and the translation of the outputs
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from this area are vital. Management accountants are in the ideal position to determine the data needs to support an organisation as
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they have a holistic view of the organisation and its existing information systems. It is essential to establish what areas an
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organisation should be monitoring to direct the focus of the data experts.
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The first implication for management accountants is that they must be aware of metrics such as those included in Google Analytics
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and be able to explain and interpret them. Knowledge of big data analytics and website analytics should be considered a key skill for
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any accountant.
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One traditional role of management accountants has been to interpret and explain data, having the ability to see the big picture, and
communicate this to senior managers. This role is just as relevant today as it was in the past, so management accountants have to
be able to understand the data analytics, and be able to communicate that. Management accountants should have the business
knowledge and commercial acumen to interpret the results of data analytics in order to provide meaningful commercial analysis and
supply recommendations.
While managers may wish to focus on acquisition and retention of customers, ultimately those customers must lead to profits, so
management accountants will still have a role in evaluating the overall financial performance of the business. Controlling costs is also
as important today as it has always been. Management accountants will have a role in calculating profits per product, or profits per
customer, controlling the marketing spend and looking for evidence of return on marketing expenditure.
Management accountants will use data analytics to support value creation, which can be through increasing efficiency, improving
profitability and cash flow but also through customer management, innovation and intellectual property. All of this data is not just
about focusing on new opportunities which can be targeted but also about internal drivers of value. Examples of activities where
management accountants can utilise data analytics (depending on the size and scope of the organisation, could be inventory
management, production planning, error rates, quality assurance, logistics, market segmentation, price optimisation, resource
management and so on.
Nick Ryan is a freelance tutor and technical author
References
1. E-loyalty: Your Secret Weapon on the Web by Frederick F Reichheld and Phil Schefter, Harvard Business Review, July August
2000.
2. https://analytics.google.com
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Common mistakes and misconceptions

in the use of numerical data used for
performance measurement
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Common mistakes and misconceptions in the use of numerical data used for performance
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measurement
The APM syllabus contains the learning outcome:
‘Advise on the common mistakes and misconceptions in the use of numerical data used for performance measurement’.
The mistakes and misconceptions can be divided into two causes:
• The quality of the data: what measures have been chosen and how has the data been collected?
• How has the data been processed and presented to allow valid conclusions to be drawn?
Inevitably, these two causes overlap because the nature of the data collected will influence both processing and presentation.
The collection and choice of data
What to measure?
What data to measure is the first decision and the first place where wrong conclusions can be either innocently or deliberately
generated. For example:
• A company boasts about impressive revenue increases but downplays or ignores disappointing profits.
• A manager wishing to promote one of two mutually exclusive projects might concentrate on its impressive IRR whilst glossing
over which project has the higher NPV.
• An investment company with 20 different funds advertises only the five most successful ones.
Not only might inappropriate amounts be measured, but they might be deliberately undefined. For example, a marketing manager in
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a consumer products company might report that the company’s new toothbrush is reported by users to be 20% better.
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But what’s meant by that statement? What is ‘better’? Even if that quality could be defined, is the toothbrush 20% better than, for
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example, using nothing, competitors’ products, the company’s previous products, or better than using a tree twig?
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Another potential ruse is to confuse readers is with relative and absolute changes. For example, you will occasionally read reports
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claiming something like eating a particular type of food will double your risk of getting a disease. Doubling sounds serious but what if
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you were told that consumption would change your risk from 1 in 10m to 1 in 5m? For most people doubling the risk does not look
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quite so serious now. The event is still rare and the risk very low.
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Similarly, if you were told that using a new material would halve the number of units rejected by quality control, you might be tempted
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to switch to using it. But if the rate of rejections is falling from 1 in 10,000 to 1 in 20,000, the switch does not look so convincing –
although it would depend on the consequences of failure.
Sampling
Many statistical results depend on sampling. The characteristics of a sample of the population are measured and, based on those
measurements, conclusions are drawn about the characteristics of the population. There are two potential problems:
1. For the conclusions to be valid, the sample must be representative of the population. This means that random sampling must to
be used so that every member of the population has an equal chance of being selected for the sample. Other sorts of sampling
are liable to introduce bias so that some elements of the population are over or under represented so that false conclusions are
drawn. For example, a marketing manager could sample customer satisfaction only at outlets known to be successful.
2. Complete certainty can only be obtained by looking at the whole population and there are dangers in relying on samples which
are too small. It is possible to quantify these dangers and, in particular, you need to know information like to a 95% confidence
level, average salaries are $20,000 ± 2,300. This means that, based on the sample, you are 95% confident (the confidence
level) that the population’s average salary is between $17,700 and $22,300 (the confidence interval). Of course, there is a 5%
chance that the true average salary lies outside this range. Conclusions based on samples are meaningless if confidence
intervals and confidence levels are not supplied.
The larger the sample the greater the reliance that can be placed on conclusions drawn. In general, the confidence interval is
inversely proportional to the square size of the sample. So, to halve the confidence interval the sample size has to be increased four
times – often a significant amount of work and expense.
More on small samples
Consider a company that has launched a new advert on television. The company knows that before the advert 50% of the population
recognises its brand name. The marketing director is keen to show to the board that the advert has been effective in raising brand
recognition to at least 60%. To support this contention a small survey has been quickly conducted by stopping 20 people at ‘random’
in the street and their brand recognition was tested. (Note that this methodology can introduce bias: which members of the population
are out and about during the survey period? Which street was used? What are the views of people who refuse to be questioned?)
Even if the advert were completely ineffective, it can be shown that there is a 25% chance that at least 12 out of the 20 selected will
recognise the brand. So, if the director didn’t get a favourable answer in the first sample of 20, another small sample could be quickly
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organised. There is a good chance that by the time about four surveys have been carried out one of the results will show the
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improved recognition that the marketing director wants. It’s rather like flipping a coin 20 times – you intuitively know that there is a
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good chance of getting an 8:12 split in the results. If instead of just 20 people being surveyed, 100 were asked, then the chance of
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getting a recognition rate of at least 60% would be only 1.8%. (Note: these results make use of the binomial distribution, which you
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In general, small samples:
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• Increase the chance that results are false positives
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• Increase chance that important effects will be missed.
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Always be suspicious of survey results that do not tell you how many items were in the sample.
Another example of a danger arising from small samples is that of seeing a pattern where there is none of any significance.
Imagine a small country of 100km x 100km. The population is evenly distributed and that four people will suffer from a specific
disease. In the graphs below, the locations of the sufferers have been generated randomly using Excel and plotted on the 100 x 100
grid. These are actual results from six consecutive recalculations on the spreadsheet data and represent the six possible scenarios
Now imagine you are a researcher who believes that the disease might be caused high-speed trains. The dark diagonal line
represents the railway track going through the country.
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Have a look at the position of the dots (sick people) compared to the rail-tracks. If you wanted to see a clustering of disease close to
the railway tracks you could probably do so in several of the charts. Yet the data has been generated randomly.
I didn’t have to do many more recalculations before the following pattern emerged:
For people predisposed to believing what they want to believe, this graph is presenting them with a pattern they will interpret as
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conclusive evidence of the effect.
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The problem is that if you are dealing with only four pieces of data then there is a good chance that they will often cluster around any
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given shape. The negative results such as seen in Graph C are easily dismissed and researchers concentrate on the patterns they
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want to see.
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Now think about the following business propositions:
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• A business receives very few complaints about its level of service, but in one year all complaints relate to one branch. Does that
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indicate that the branch is performing poorly or is it just an artefact of chance?
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• In a year a business tenders for 1000 contracts but only three are won – all by the same sales team. Does that really mean that
that sales team is fantastic or is it again simply the result of chance?
The processing and presentation of data

Averages
Almost certainly when you use the term ‘average’ you are referring to the arithmetic mean. This is calculated by adding up all results
and dividing by the number of results. So, for example:
Person Height (cm)
Person Height (cm)
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B 179
C 185
D 179
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Total 894
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So the arithmetic mean of these 5 people is 894/5 = 178.8 and this feels as though it is a natural way to describe an important
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measurement about the data. However, as we will see below, it can lead you astray.
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The arithmetic mean is one measure of the data’s location. The other common measures are:
Mode: the most commonly occurring value. In the table above, the mode is 179. This measure would be more useful to you than the
mean if you were a mobile phone manufacturer and needed to know customer preferences for phones of 8, 16, 32 or 64GB. You
need to know the most popular.
Median: this is the value of the middle ranking item. So, for the data above arrange it in ascending order of height and find the height
of the person at the mid-point.
Person Height (cm)
Person Height (cm)
A 175
E 176
B 179
D 179
x
C 185
B o
al
lo
So, the height of the mid-ranking person is 179 and this is the median
b
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Unless the distribution of the data is completely symmetrical, the mean, mode and median will generally not have the same values. In
C
particular, the arithmetic mean can be distorted by extreme values that give rise to its misinterpretation.
A C
To demonstrate this we will initially set up a theoretical symmetrical distribution of the annual income of a population:
Number of people (000) 10 20 30 40 50 40 30 20 10
Annual income $ 000 15 25 35 45 55 65 75 85 95
The mean, median and mode are all $55,000. If you earned that you would feel that you were on ‘average’ pay with as many people
earning more than you as less than you.
Now let’s say that into this population comes the founder of a hi-tech internet company called Martin Gutenburg who invented a
social medium service. Mr Gutenburg has a very high income – $10m/year. The salary distribution now looks like:
Number
10 20 30 40 50 40 30 20 10 M Gutenburg 1
of people
(000)
Annual
15 25 35 45 55 65 75 85 95 10000
income

$000
The arithmetic mean of this distribution is $55,400, so now earning only $55,000 you feel that you are earning less than average. In
fact over 50% of the population is earning less than ‘average’ – something that at first glance would seem impossible.
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This distortion could allow a government to claim that people are now better off because average earnings are higher. In fact, even if
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all the salary bands were reduced by 5%, the arithmetic mean including Gutenburg would be around $55,380. So the government
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could claim that on average the population is better off when, in fact, almost everyone is worse off.
al
b
In situations where the data is not symmetrical, the median value will often provide a more useful measure. The inclusion of
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Gutenburg does not change the median value and if everyone’s income fell by 5%, so would the median.
False positives and false negatives: Bayes’ theorem
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A
This will first be demonstrated using a medical example, then it will be applied to a more business-related area.
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A
Assume there is a serious medical condition called ‘lurgy’ suffered by 5% of the population. There is a diagnostic test available, but
this is not perfect. If the test result is positive there is a 90% chance that it is correct, and a 10% chance that it is wrong (false
positive). If the test is negative, there is an 80% chance that the result is correct, but a 20% chance that the disease was missed
(false negative).
You are tested and the result is positive, so what is the probability that you have lurgy? You might assume the answer is 90%, but
that is far from the truth.
The easiest way to solve this is to construct a table, based (say) on 10,000 people.
Suffers from lurgy Does not suffer from lurgy Total
Suffers from lurgy Does not suffer from lurgy Total
Positive test result
Negative test result
Total 500 9,500 10,000
x
First, put in the true number of the 10,000 who suffer from the disease: 5% and 95% of 10,000.
B o
l
So, of the 500 who have the disease, the test will report correctly on 90% of them and incorrectly on 10%. In numbers this will be
a
90% x 500 = 450 who have the disease and who are correctly reported on, and 10% x 500 = 50 who have the disease but are not
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reported on.
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Similarly, of the 9,500 non-sufferers, the test will correctly report on 80% of them. The numbers are 80% x 9,500 = 7,600. The
A
remainder will be reported as having the disease, 20% x 9,500 = 1,900.
CC
The table can now be shown as:
A
Suffers from Does not suffer Total
lurgy from lurgy
Positive test result 450 1,900 2,350
Negative test result 50 7,600 7,650
Total 500 9,500 10,000
So, you go to your doctor for your test results and find they are positive. You are obviously in the top line of this table (where the
positive results are). From the population of 10,000 there are 2,350 positive results, but only 450 are true positives. Therefore your
chance of actually having the disease is 450/2,350 = 19% - a far cry from the 90% you might have thought at the start.
Now let’s look at a business-orientated example.
Maxter Software Co creates software and web-sites for clients. They prefer to recruit employees with no programming experience
and train them. It is believed that 1% of the 10,000 population has the aptitude to become a programmer. The company asks each
applicant to undergo an aptitude test. If someone has the proper aptitude the test will identify them correctly on 80% of occasions,
but 20% are missed. If a recruit does not have aptitude there is a 5% chance that they will pass the test.
If someone is identified as having aptitude, what is the chance that they actually do?
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Has aptitude
l B Does not have Total
a
aptitude
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Passes test 80 495 575
Does not pass test
CA 20 9,405 9,425
Total
A C 100 9,900 10,000
So the chance that a person who passes the test actually has aptitude is 80/575 = 13.9: not a great way to recruit successful staff.
Correlation
One of the most common misuses of data is to assume that good correlation between two sets of data (ie they move closely
together) implies causation (that one causes the other). This is an immensely seductive fallacy and one that needs to be constantly
fought against.
For example, consider this data set:
Diabetes in UK1 (m) Sales of smartphones in UK2 (m)
2012 3.04 26.4
2013 3.21 33.2
2014 3.33 36.4
2015 3.45 39.4
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b a
1 Diabetes UK
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2 Statista/eMarketer
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On a graph the data looks like:
A C
The two sets of data follow one another closely and indeed the coefficient of correlation between the variables is 0.99, meaning very
close association.
It is unlikely that any of you believe that owning a smart phone causes diabetes or vice versa and you will easily prefer to believe that
the high correlation is spurious. However, with other sets of data showing with high correlation it is easier to assume that there is
causation. For example:
• Use of MMR vaccines and incidence of autism. Almost no doctors now accept there is any causal connection. In addition the
whole study was later discredited and the doctor responsible was struck off the UK medical resister.
• Cigarette smoking and lung cancer. A causal effect is well-established, but it took more than correlation to do so.
• Concentration of CO₂ in the atmosphere and average global temperatures. Not universally accepted (but increasingly
accepted).
Graphs and pictograms
Here’s a graph of the £/€ exchange rate for September to October 2015. It seems to be quite a rollercoaster:
o x
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b a
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A C
However, the effect has been magnified because the y axis starts at 1.3, not 0. The whole graph only stretches from 1.3 to 1.44. If the
graph is redrawn starting the y axis at 0, then the graph will look a follows:
Not nearly so dramatic.
o x
Note that a board of directors that wants to accentuate profit changes could easily make small increases look dramatic, simply by
B
starting the y axis at a high value.
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b
Pictograms are often used to make numerical results more striking and interesting. Look at the following set of results:
lo
G
Year
CA Profit ($m)
A
2013 C 100
2014 110
2015 120
The increase has been a relatively modest 10% per year and on a bar chart would appear as:
A pictogram could show this as:
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b a
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Look at the first and last bag of money and think about how much you could fit into each. I would suggest the capacity of the third
A
one looks at least 50% greater than the first one. That’s because the linear dimensions have increased by 20%, but that means that
C
the capacity has increased by 1.23 = 1.73, flattering the results.
A C
So it is important to consider how data is collected, processed and presented as it can be used to indicate that performance of an
organisation is better or worse than it actually is.
Ken Garrett is a freelance lecturer and writer
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Integrated reporting (IR) has been developed and promoted by the International Integrated Reporting Council (IIRC), a global
coalition of regulators, investors, companies, standard setters, the accounting profession and non-governmental organisations. IR
has been introduced to the syllabuses of many of the Professional level exams. This article aims to show how the idea of integrated
reporting is relevant to the APM syllabus.
Relevance to APM
IR is focused on showing the connectivity of strategic objectives, risk and performance to demonstrate how organisations create
value. This means that organisations need to understand and report on all areas of performance and not just focus on short-term
financial results.
You will see that IR has many elements which easily relate to APM. The definitions of IR are:
• A concise communication of an organisation’s strategy, governance and performance.
• Demonstrates the links between its financial performance and its wider social, environmental and economic context.
• Show how organisations create value over the short, medium and long term.
It is useful to imagine yourself investigating a company about which you know nothing to decide whether or not you want to invest in
it. Going to the latest annual report and financial statements would probably be your starting point, but you will be left with many
unanswered questions – certainly if the company shows the minimum information required by law and the accounting and financial
reporting standards. You will learn relatively little about the company’s business activities (though segmental reporting helps), their
competitors, their future plans or how they intend to achieve sustainable competitive advantage. IR aims to fill the gaps so that
existing or prospective investors better understand the company.
Think about the evolution of modern management accounting. A few decades ago management accounting was being criticised for
being too internally and operationally focused. It was recognised that there was a need for management accounting to be useful for
strategic decision-making and that management accountants should act essentially as business partners in organisations. The role of
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management accounting now is to assist in the analysis, formulation and monitoring and evaluation of strategy. It has a significant
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contribution to make in the validation of strategic plans and decisions.
l B
a
APM is focused on how strategic objectives are linked to critical success factors and key performance indicators and how this is
b
translated throughout an organisation. It encompasses the need to address risk, external influences, stakeholders, non-financial
lo
results, brand, etc. It addresses the importance of selecting the right performance management techniques, information systems,
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reporting functions to ensure performance is delivered at all levels and over the short and long-term.
CA
The following IR Content Elements are particularly relevant to APM:
A C
• Organisational overview and the external environment
• Opportunities and risks
• Strategy and resource allocation
• Business model
• Performance
• Future outlook
Let's add some detail and examples to these elements:
Organisational overview and the external environment
What does the organisation aim to do? Who are the major stakeholders? Where is it located? How is it structured? What external
events will affect if most?
Fairly obviously the organisation’s mission and objectives, stakeholder analysis, organisation chart and a PEST analysis would be
relevant to this section of the IR.
Opportunities and risks
These must cover both internal and external matters. The traditional SWOT analysis usually categorises opportunities and threats
(risks) as external, but it is essential to also look internally. A weakness (for example arising from gaps in new product development)
is a risk to future revenues.
Similarly a strong brand name creates greater opportunities for future revenue streams. Historically, the board of companies would
tend to emphasise a company’s opportunities, but investors cannot make an informed decision about an investment without an
appreciation of the associated risk. Some risks can be quantified (for example, by expected values and sensitivity analysis) but it is
unlikely that quantified amounts would appear in an IR. A qualitative indication should be provided about both internal and external
risks. The report should also mention how the risks are being managed and mitigated.
Strategy and resource allocation
Does the organisation intend to develop new products, set up new factories or expand to new markets? This section of the IR can
make extensive use of Porter’s models, BCG matrix and the value chain. It would be valuable to investors to be told how their
x
company is going to respond to these changes in the market, how much it might cost to achieve the new strategies and how this
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change will be managed effectively.
l B
a
Business model
b
An organisation’s business model is 'its system of transforming inputs, through its business activities, into outputs and outcomes that
lo
aims to fulfil the organisation’s strategic purposes and create value over the short, medium and long term' (IIRC). Many of the
G
performance management models are particularly relevant here: for example, the value chain explicitly sets out inputs, processes
A
and outputs and requires organisations to understand how value is added so that profits can be made. If a company does not
C
understand where it adds value then the company is existing in a temporary state of good fortune. It is making profits now, but does
C
not understand why, so chance of continued success must low.
A
Inputs are the major inputs such as raw material or human resources. Outputs are the key products and services. The business
activities include not just the manufacturing process, but also how the company innovates, carries out its marketing, what its after-
sales services are, how it delivers its goods and how it acquires, trains and retains staff.
Business process re-engineering, value-based management, activity-based management are also all methods that can influence an
organisation’s business model.
Performance
This area of IR addresses how an organisation has performed against its strategy and what are its key outcomes. These outcomes
can be internal or external – for example, revenue, cash flow, customer satisfaction, brand loyalty, environmental impacts, etc.
It is vital that the most appropriate performance indicators are chosen so that measurement of strategic goals is meaningful and that
the value-adding activities of an organisation are identified and managed. It is also recognises the importance of reporting on non-
financial, qualitative results.
Future outlook
An integrated report should answer the question: What challenges and uncertainties is the organisation likely to encounter in
pursuing its strategy, and what are the potential implications for its business model and future performance? (IIRC)
PEST and a five forces analysis are likely to be particularly relevant here. For example, if you were a stakeholder in a conventional
television company you should want to know how the company will address challenges from internet-based companies such as
Netflix.
Examples from ACCA’s integrated report

Here are some relevant extracts from ACCA's Integrated Report 2013–14 (see 'Related links') demonstrating some of the reporting of
the elements set out above. Remember, the IIRC guidelines are principles based and organisations can change element headings
and groupings.
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External environment
l B
b a
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• We are seeing new economies and sectors emerging and developing at faster rates
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• In the post-recession world, there is a greater demand for and understanding of the importance of financial stability as an
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underpinning for economic stability
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• Consumers are more sophisticated and demanding, with an increasingly tech-savvy audience expecting a personalised and
tailored experience
CC
• The competitive environment is much broader, with more and different players and with technology enabling greater
international competition
Risks [include]:
A
• Market risks: trade protectionism, global economic stagnation, loss of UK audit recognition.
• Operational: exam process issues, worldwide legislative complexity, pricing decisions, cybercrime and data protection.
The impact of each risk is assessed and mitigation measures are explained. For example, on cybercrime and data protection:
• Impact: Potential corruption or loss of organisational data which could lead to legal liability and reputational damage as more
ACCA services are provided on-line
• Mitigation: ACCA’s Information Security Officer monitors and advises on data security. Policies in place to address data
security risks which are regularly reviewed, monitored and tested.
Business model
• Key resources [include]: market offices supported by global headquarters, people, partners, intellectual property and brand,
suppliers, IT infrastructure, financial capital.
• Key value-adding activities: creating global networks, qualifying and regulating professional accountants to high standards,
maintaining and developing a global brand that attracts students around the world, generating globally-relevant technical insight
with public interest at its heats, digitally-enabled developments for an online, self-service world.
• Key outputs [include]: professional, ethical accountants, widespread recognition, best-in-class products and services.
• Key outcomes [include]: support and opportunities for members, joint initiatives, global mobility for our members, customer
satisfaction.
• Societal benefit: Businesses in all sectors that are run efficiently and responsibly, that help grow economies sustainably and
safeguard the interests of the public and society.
Conclusion
The inclusion of IR in the APM syllabus should not cause major difficulties for students. In many ways, it is corporate reporting
x
catching up with the aspects of analysis and reporting which management accountants have been already been performing for
o
internal, organisational use. Management accounting has, for many years, recognised that there’s much more to appraising
B
organisations than simply looking at their financial results.
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Performance reports
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Performance reports
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The design of performance reports is regularly examined in the Advanced Performance Management (APM) exam. This article aims
to provide guidance on how to tackle this type of question.
Examples of recent exam questions:
• December 2018, Q1(a): Evaluate the performance reporting system as requested. (13 marks)
• March/June 2018, Q1(i): Evaluate the performance report in Appendix 1 as requested. (20 marks)
• September/December 2017 Q1(i): Evaluate why the dashboard in Appendix 1 was award winning, as requested by the
CEO. (8 marks)
Of course, performance means different things to different organisations, so there is certainly no single correct way of measuring or
presenting performance. For example, profit-seeking organisations will certainly be interested in sales and profits, but charitable
organisations have neither sales nor profit. Furthermore, even within a single organisation different aspects of performance may have
to be examined in more detail at different times and for different audiences.
Mission and objectives

An organisation’s mission and subsidiary aims/objectives should define its purpose, and any evaluation of a performance report must
address the extent to which these are being measured and allow the organisation’s executive to see if its mission etc. is being
achieved.
March/June 2018 Q1 (Chiven) contained the following:
• Its overall aim is: ‘to become the largest clothing retailer in Beeland and deliver exceptional value to its shareholders.’
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• The CEO says she plans to achieve this overall aim by ‘maximising our opportunities from new technology and increasing our
currently small web presence,’ She also has two other aims which relate to the use of Big Data and simplifying the supply
o
chain.
l B
a
Using the March/June 2018 Q1 as an example, the first matter to consider is whether the performance report addresses the mission.
b
It is useful here to determine if the mission has multiple parts, which is the case with Chiven. Its mission has two parts – to be the
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largest clothing retailer and to deliver exceptional value to shareholders. Once the structure of the mission has been determined, it is
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essential that each of the component parts is considered in turn, in terms of whether the performance report adequately measures
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them.
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Once the mission has been addressed, then each of the subsidiary aims need to be assessed. Once more the focus should be on
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whether the report measures each of these key areas.
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General considerations and layout
The audience for performance reports will normally be the board of directors, managers, owners, government or, more generally,
those charged with governance.
Care has to be taken to assess the appropriate level of detail, layout and terminology used in reports so that users will properly
understand the information that is provided. It should be considered whether the report has too much or too little information. One of
the most common criticisms of reports is that they present too much information and are much too cluttered. There might be valuable
information there but it is almost impossible to find and interpret it. There is always the suspicion that large volumes of information
have been deliberately provided to obfuscate the facts and to blunt the message.
In addition, the level of the information being reported should be considered i.e. lots of operational details should not be necessary in
a report which is for the board and ought to focus on strategic performance indicators.
Layout must help users to understand the information presented and to see quickly the important amounts, trends, results and
explanations. Graphical displays can be used to greatly enhance performance information.
The inclusion of a narrative explaining the information is also needed for drawing attention to important matters and explaining their
significance or causes. For example, even something as simple as an adverse material price variance needs an explanation about
what caused it. If no explanation is given it will simply mean that questions will be raised later. Explanations might be accepted or
might be challenged, but simply to report a variance without stating how it might have arisen is rather useless.
As well as the evaluation of whether the report measures the mission and objectives, consideration should be given to whether any
other important information is missing, for example, external benchmarks like competitor information.
Types of information
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Information can be classified as follows:
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b a
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A C
Examples are:
• financial: sales, profits, costs, GP%, return on capital employed.
• non-financial quantitative: percentage of product rejects, volume of sales, number of complaints.
• non-financial qualitative: reputation, effectiveness, customer satisfaction, staff morale, innovation.
The information provided must match the purpose of the performance report. In particular, non-financial performance is a very
important determinant of the long term success of any enterprise. For a business, short-term financial performance can often be
improved by reducing quality, innovation and training. However, a business pursuing these approaches is likely to suffer financially in
the long term. It is not so much that a business is interested in making high quality products for their own sake, but if the business
positions itself as a high quality manufacturer it must deliver high quality and, therefore, quality needs to be monitored. If the
business were known as a ‘cheap and cheerful’ supplier, the measurement of quality would be much less important but costs per unit
would become more important.
The need for non-financial information is more obvious in not-for profit organisations and, indeed, in those organisations non-financial
performance is often an end in itself, rather than an enabler of profitability.
Non-financial qualitative information is likely to be as important as quantitative information, but is harder to pin-down. Technically,
qualitative information is known as a ‘construct’, an attribute that cannot be measured directly. Examples of constructs are
enthusiasm and empathy. Both are very important in business, but there is no direct way in which they can be measured. Usually, for
communication, assessment and comparative purposes an effort has to be made to try to turn qualitative information into quantified
information. For example, in a hospital it would be important for patients to feel that they were treated sensitively and with dignity.
Assuming management feels that these are important qualities, targets need to be set for them and performance assessed.
Inevitably this will be done by setting up some type of numerical assessment system so that qualitative information becomes
quantitative.
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The transition from qualitative to quantitative can introduce distortions to the information. For example, does what is measured truly
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reflect what the undertaking wants to assess? For example, in an effort to measure enthusiasm an organisation might measure when
a
staff arrive in the morning. However, the person who always arrives early might simply be a victim of an hourly train service: arrive 40
b
minutes early or 20 minutes late.
lo
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Question 1(b) in the December 2018 exam is an excellent example of how a performance measurement information can be distorted.
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This is directly connected to learning outcome C5b in the APM syllabus.
CC
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Conclusion
When evaluating a performance report remember to:
• assess whether it measures the components of the organisation’s mission
• assess whether it measures the subsidiary aims and objectives of the organisation
• review its general content, level of detail and layout
As part of the evaluation do not be afraid to recommend changes or alternatives but remember these recommendations should be
justified as to why they should be considered.
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Lean enterprises and lean information

systems
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Lean enterprises and lean information systems
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History of Lean
The term lean was first used by Womack, Jones and Roos to describe the Toyota Production system. It means far more than simply
cutting costs, as the history of lean production shows.
In the early 20th century, American car manufacturers such as Ford and General Motors developed mass production systems. These
allowed car manufacturers to produce thousands of identical cars, using standardised parts and components. The moving production
line was introduced, where the car body moved along a conveyor belt, and at each stage, factory workers added components to it
until the finished product came off the production line. The resulting economies of scale meant that the motor car became much more
affordable to the average family.
In 1950, Eiji Toyoda, an engineer, and member of the family that started the Toyota Company, visited the Ford Rouge plant in Detroit.
He studied the production techniques being used at Ford closely and on return to Japan discussed them with his production manager
Taiichi Ohno. The two of them came to the conclusion that the methods used at Ford could not be copied directly at Toyota. Over the
years, they made several innovations that we now refer to as lean:
1. More flexible production lines allowing smaller batch sizes
2. Greater involvement of employees
3. Elimination of non-value adding functions
4. Identifying the root causes of problems
5. Constructive relations with suppliers
6. Greater contact with customers
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1. More flexible production lines
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One feature of mass production was the difficult set up processes for the machinery. A particular machine might be used to make
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parts for several different cars. Setting up the machine to make a particular part was a difficult process requiring precision. If the set-
l
up was not correct the parts being made would be useless. It often took two days to set up a machine, and skilled engineers were
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required to perform the task.
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In the mass production factories, the solution to the long set-up process was to have long production runs, making hundreds or even
C
thousands of a particular part before resetting the machine to make parts for a different model. Alternatively, a dedicated set of
A
machines might be used for one particular car, meaning that once the initial set up had taken place, no further set ups were required.
In the early post-war years, Toyota was a small company producing for the domestic market. Demand was insufficient to allow the
company the luxury of having long production runs when only a small number of units of each part were required. Toyota spent time
investigating a quicker way of setting up the machines so that production could feasibly take place in small batch sizes. In some
cases, such as the stamping machine, they managed to reduce set up times from typically one day to three minutes. What’s more,
the production line staff were trained to do the set-ups, so it was not necessary to employ engineers.
The small batch sizes meant that the volume of work in progress and the associated inventory holding costs were much lower; as
soon as a part was made in one process, it was used in the next. An unintended advantage was also discovered; because parts from
one process were used almost straightaway in the next, any defects were noticed very quickly. Thus, any faulty machine set-ups
would be corrected before many bad units had been made.
A further advantage was that the factories became much more flexible, allowing a wider variety of products to be made. Having
shorter set-up times allowed machines to be used to produce a greater variety of parts and, therefore, cars.
2. Greater involvement of employees
The motor industry is very cyclical. Workers in the mass production plants were well aware that their job might be lost in the next
economic downturn. Not surprisingly staff had little motivation to do more than the minimum.
Staff at Toyota on the other hand were offered jobs for life – a guarantee that they would not be laid off during the next downturn.
They were also provided with a steep career path, where promotion led to a high increase in salary. In return, employees at all levels
would be expected to become involved in helping to continuously improve the operations.
The teams would be expected to have meetings periodically with the industrial engineers, to discuss ways to improve the production
process. Toyota recognised that the assembly workers on the floor, far from being replaceable, were a great source of knowledge.
3. Elimination of non-value adding functions
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In the mass production factories, the assembly workers were given very basic monotonous tasks to perform. The foremen who
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supervised the workers did not perform any assembly tasks. Engineers reset the machines, housekeepers cleaned the factory area,
o b
and so on. The assembly workers were treated with little respect and considered to be easily replaceable.
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In Toyota, production was based on teams. All members of a team were highly trained, and could do all tasks – assembly, machine
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sets-ups, and cleaning the factory area. The team leader replaced the foreman, but unlike the foreman the team leader would
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perform assembly tasks as well as coordinating the team. This led to more motivated teams and ensured that no wages were wasted
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on indirect labour that did not add value to the final product.
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4. Identifying the root cause of problems
In the production lines of Ford and General Motors, workers were required to perform their tasks at the right speed to avoid slowing
the production line. Defects inevitably did occur, such as the discovery that a part was defective after it had been assembled. The
production line could not be stopped, however, and so the defective unit would continue its journey through the rest of the production
line, with the defect becoming compounded. At the end of the line was a rectification department where faulty cars would be
investigated and fixed. It was fairly typical that 20% to 25% of all cars produced would end up here.
In the Toyota factory, if a worker spotted a defect, he would pull a cord that would stop the production line, so the error could be fixed.
Workers were then required to identify the cause of the error using a technique called 'the five whys'. The five whys approach
involved firstly asking why the defect arose. Having identified the cause, then it was asking why the cause arose, and so on, thus
drilling down to find the root cause that would then be fixed. Such errors were unlikely to arise again. These days, virtually no Toyota
cars require reworking when they come off the production line.
5. Constructive relations with suppliers
The mass production approach to sourcing the various parts for the vehicles was to design the parts in-house. The majority of the
parts would also be made in-house, while various suppliers who would be asked to bid to make the parts that could not be. Often, the
lowest price suppliers would win the business. Suppliers would therefore be more interested in keeping their costs down than in
helping the manufacturers to improve their products by offering the latest innovations.
Toyota did not design the parts, but would tell the suppliers what was needed – for example, a braking system that would stop a
1,000kg car that was moving at 100 kilometres per hour within 60 metres. The supplier would then be required to use their own
expertise to design and produce such a system. Thus, Toyota could benefit from the expertise of their suppliers and save time on
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detailed design of all components needed.
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Toyota would pay their suppliers a price that would enable them to make a fair profit, but would work with the suppliers to reduce
a
costs using techniques such as target costing. Cost savings would then be shared by the two organisations.
lo b
In order to overcome the problem of coordinating the supply of parts from suppliers and avoiding over or under production, Ohno had
G
the idea of the famous ‘just in time’ or ‘pull’ system. The idea of this was that a part would only be produced when an instruction was
A
received from the next link in the supply chain. There would be no producing for inventory and no need for buffer inventory. The point
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of this was not only to reduce inventory levels and associated costs, but to put pressure on all parts of the supply chain to become
C
more responsive to changes in demand.
A
Zero inventory is an ideal that has not been achieved in practice, even at Toyota. A small amount of inventory is still maintained,
particularly in the final processes of the production line. This is to avoid failing to meet demand when there is a sudden spike. In spite
of this, the principle of just in time leads to a more responsive supply chain focused on meeting the changing demands of customers
quickly.
6. Contact with customers
The Western car manufacturers tended to sell through dealers, who would be pressured to buy a certain number of cars from the
factory with their own finance. Toyota, on the other hand, had sales teams that sold directly to customers. Contact was maintained
with customers with the object of ensuring product loyalty when the customer replaced their existing cars. Customer feedback was
also fed back into the design process much more thoroughly than the Western manufacturers who typically relied on a small number
of focus groups to establish what customers wanted.
Toyota’s flexible approach to manufacturing enabled the company to produce a wider product range, and to design new models much
quicker than the western car manufacturers. Womack et al reported that, in 1990, Toyota was producing as many different products
as General Motors, even though at the time the company was half the size of GM.
In 2001, Toyota launched 'The Toyota Way', which aimed to take lean beyond its manufacturing and product development into all
other areas of the business. Even after 60 years, lean is still evolving within Toyota.
Adoption of lean outside of Toyota

Thanks to the success of Toyota, many organisations in various industries have aimed to copy the lean principles, and a variety of
lean methodologies have evolved to help organisations become lean such as The Flow Framework, developed by Kate Mackle,
described by Bicheno and Holweg in The Lean Toolbox. The Flow Framework is a methodology that focuses the attention of
organisations on the flow of goods or services through the system and aims to eliminate lead time and bottlenecks.
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Plenty of lean implementations have not been successful. Bicheno and Holweg believe the reason for this is that many organisations
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think lean is a one off programme. It is actually a culture of continuous improvement, and its success relies on the continued support
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of management. Predictably, managers in many businesses lose interest in initiatives that do not produce immediate improvements
o b
to the bottom line.
Lean information systems

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C A
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Lean principles can be applied to information systems. Features of a lean information system are:
makersA
• reports and other outputs from the system should only be produced if they add value – that is if they are useful to the decision
• reports should only be sent to those who need them
• information should be processed quickly so that users do not have to wait for it. Generally, real-time processing is preferred to
batch processing as batch processing introduces delays
• waste should be avoided. Duplication of data should be eliminated so data is only entered into the system once
• continuous improvement – the providers and users of information should meet regularly to review the usefulness of existing
information and identify improvements
• adaptability – information systems should be flexible enough to meet special ad hoc needs or changing needs of managers
over time. An information system that can only produce a standard set of reports is not lean. A system that allows managers to
create their own customised reports from databases is more likely to be lean.
The Five S Model
The Five S model is a popular tool that has been used by many organisations as part of a lean methodology. The Five S model lends
itself neatly to information systems. The objectives of the model are to reduce waste, improve productivity and remove variation.
Variation means variation in production or output. It is variations that lead to stress at peak times, and that leads to errors.
The Fives Ss are:
• sort (structurise)
• simplify (systemise)
• scan (sanitise)
• standardise
• sustain (self-discipline)
x
Sort means sort out the items in the workplace. Items that are not used should be thrown out as they are just taking up space and
o
getting in the way. Those items that are used less frequently should be kept away from the workplace, in cupboards or in store
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rooms. Sorting should be repeated regularly – for example, every six months.
al
b
Simplify involves putting items in the best place, where they will easily be found when needed (eg a carpenter might keep the tools
lo
that he uses every day on shelves or in cupboards close to his work bench, while those tools that are used less often will be located
further from the bench).
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A
Scan refers to continuously scanning the workplace for things that are out of place and need tidying away. It also involves performing
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routine maintenance tasks, such as lubricating the machines.
A C
Standardise means setting standards or procedures once the sort and simplify processes have been performed to make it easier to
keep the workplace sorted and simplified. Colour coded stickers could be introduced – for example, indicating which locations items
should be stored in.
Sustain – the use of the Five S Model should not be a one-off exercise, but should continue to be used after its introduction, and
become part of the routine in the workplace.
The Five S Model can be applied to information systems as follows:
Sort the information transactions that flow around the organisation. Questions should be asked about what is the minimum
information that is required for planning, controlling and decision making, and operating the various business processes. The time
accuracy trade-off can also be applied here, where 90% accurate in half the time may be preferred.
Simplify means identifying the best methods of communicating the information. At Toyota, key information was communicated to all
employees on the factory floor using large TV screens. Simplify also considers the way the information is stored in the system, such
as the file structures to avoid duplications.
Scan involves regularly auditing the reports and who is actually using them. It also involves removing obsolete data such as old
customers or inventory items that are no longer used.
Stabilise includes coming up with standards such as standards for reports and rules about who should be copied in on emails.
Sustain involves continuously performing the above four steps and therefore continuously improving the information systems.
Conclusion
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The lean principles that evolved in the Toyota car factories have led to a new approach to management in many industries. They
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attempt to focus on satisfying the needs of the customer, and not wasting time and money on activities that do not ultimately add
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value to the customer. Lean principles can also be applied to information systems to ensure that only useful information is produced
b a
on a timely basis.
lo
Nick Ryan is lead tutor for performance management subjects.
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A
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Bibliography
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(1) Womack, Jones and Roos, The Machine that Changed the World, published by Simon & Schuster, 2007
(2) Bicheno and Holweg, The Lean Toolbox 4th edition, published by PICSIE Books, 2009
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Businesses increasingly rely on relationships with external partners to perform critical business processes. Relationships such as
outsourcing and collaboration allow business processes to be performed better or more cost effectively, or without the need for
investment in expensive production capacity. Various terms have been used to describe the complex relationships that have
developed, such as virtual organisations, hollow organisation and network organisations.
In Virtual Organisations and Beyond (1), Hedberg, Dahlgren, Hansson and Olve describe how the Swedish clothes retailer GANT
operates. The centre of operations is a Swedish company, Pyramid Sportswear AB, which has eight employees. Pyramid Sportswear
owns the rights to use the brand name, selects the designers, performs quality control of production, arranges advertising, and
organises the shipping of clothes from the factories to the retailers. Design and production of the clothes are outsourced, and the
clothes are sold through independent retailers. To the customer it appears that there is one organisation, the GANT Company, which
performs all these activities but in reality no such organisation exists. This group of independent companies, working together,
coordinated by Pyramid Sportswear is described as an ‘imaginary organisation’ by Hedberg et al although the term ‘hollow
organisation’ has been used by others to describe similar arrangements. Pyramid Sportswear is the core of this imaginary
organisation, and it coordinates the other organisations; the partners.
A virtual organisation is one that has little or no physical premises, but where employees and managers work remotely (typically from
home) and are connected using IT, such as emails, video conferencing, extranet and intranets. The organisation appears to the
outside world to be just like any traditional style organisation. Customers and suppliers are linked using IT systems which adds to the
impression that they are all part of the organisation. The classic example is Amazon, the online retailer. Most orders placed on
Amazon’s web site are forwarded to suppliers, who then send the goods directly to the customer.
Collaboration is also an important element in many business chains. Organisations such as Apple rely on a network of independent
programmers who develop apps for their products. While these programmers work independently, they rely on Apple sharing
technical information with them about its operating systems, and through Apple’s developer conference, they become part of the
Apple family.
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For the rest of this article, all these different arrangements will be referred to as complex business structures. They include a core
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enterprise (such as Pyramid Sportswear) that coordinates the activities of the partners in the structure.
al
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Performance Management
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In complex business structures the core enterprise needs to manage the performance not only of its own activities, but also those of
A
the partners to some extent. The obvious problem is that the core enterprise does not usually own the partners, so has no legal right
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to try to manage them. Performance management issues must therefore be agreed with each partner as part of the terms of
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business.
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Typically a contract or service level agreement will specify what activities are expected of each partner, what the minimum standards
are in terms of quality, and the price that will be paid. These agreements may also describe reporting requirements, whereby partners
are required to report their own performance using agreed metrics, such as % of late deliveries, and number of customer complaints.
There may also be fines for repeated failure to achieve some of the standards.
Planning
In traditional organisations, planning and control is based on the budget. The process of preparing the budget requires the different
parts of the organisation to coordinate their activities for the following year, and this requires some central coordination. Budgets also
aim to ensure that costs of production are controlled. At the end of each accounting period, actual results are compared with budgets
and action taken to remedy any significant variances.
In a complex business structure, the core organisation does not need to have a detailed analysis of costs incurred by the business
partners. From a financial point of view, the core is only interested the prices that partners will charge, and these will already have
been agreed in the service level agreement. The core does need to be sure that suppliers will have the capacity to meet its demand
on time, even though it may not be possible to specify how much that demand will be at the start of the year. Some type of planning
will therefore be required to ensure that all parts of the structure have the flexibility and capacity to meet the potential demand from
the core organisation.
Control
The core is mainly interested in non-financial aspects of the performance of the partners. Quality of goods or services are obvious
areas. Other aspects may include delivery times, quality of customer service and ethical behaviour. Several large multinational
companies have had their reputations damaged by the behaviour of partners in third world countries who employ child labour for
example, or operate sweat shop style operations where employees are paid subsistence wages, and made to work long hours. Poor
ethical behaviour of such partners can harm the reputation of the whole structure.
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Expected standards must be specified in service level agreements. If a partner is required to fulfil sales orders to customers for
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example, there may be requirements about the minimum period within which such orders must be completed. The service level
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agreement may also require compliance with a corporate code of ethics. Partners will be expected to provide performance reports
a
showing appropriate measures of performance and must allow inspections and audits to be performed by the core organisation.
lo b
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Monitoring the workforce
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Where the structure makes use of freelance workers and employees who work from home, traditional methods of control over the
C
work force become less useful. It is not possible to clock employees in each morning when they work from home, for example, and
A
they cannot be watched to ensure that they are working diligently. One solution is to simply pay by results. Remuneration may be
based on quantitative measures of the output such as number of customer queries dealt with. Trust is likely to be a key factor in any
such relationship, and the use of cultural controls, which involves employing people who are self-motivated.
Information technology can also be used to keep tabs on employees. System logs can record what time employees log onto and off
the system, although there is of course no guarantee that they are being productive all of the time they are logged in.
Performance management problems

While performance measures and expected targets will be specified in the service level agreements, there can still be disagreements
when things go wrong. Disagreements can arise about the value of metrics calculated. In the exam question Callisto Retail (June
2012 – see 'Related links'), there was disagreement about the amount of days inventory held by one of the wholesalers, and this
required detailed reconciliation to be performed. Disagreement may also arise over who is to blame when things go wrong. If
customers are not happy about the service they receive, there could be a number of partners who are potentially to blame.
Confidentiality of information becomes a risk, due to the fact that the core organisation is sharing key information with its partners.
This may include commercially sensitive information such as production methods, or names and addresses of customers.
Procedures need to be in place to ensure that such information is secure. This would include requirements relating to the security
surrounding the information systems.
Motivation can also be an issue. Where all business processes are carried out in house, it can be easier to motivate employees using
reward systems. Where the processes are carried out by an outside partner, it may not be so easy to motivate them. It is essential
therefore that all partners share the same objectives and understand how they contribute to the success of the whole organisation. In
some relationships, there is an element of profit share or bonus paid to the partners to motivate them to perform well.
Role of IT
Information systems often play a crucial role in complex business structures. The core organisation may invest in the development of
o x
an information system that it requires all partners to use. This can mitigate many of the challenges relating to performance
B
management discussed above. Its role in monitoring the work of employees has already been noted above. Having one system used
l
by all partners means that everyone is using the same data. There should be less difficulty collecting information about the
a
performance of partners since the information will all be stored on one system. The core party has greater control over the security of
b
data, and communication between the parties will be much more fluid allowing greater coordination.
lo
Conclusion
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CA
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The greater use of business partners to perform crucial business processes may lead to lower costs and greater specialisation.
A
However, the reliance on external partners can lead to additional challenges for performance management. These must be
considered in drafting of contracts with the partners. The use of shared IT systems can also assist in many of the challenges.
Reference
(1) Hedberg, Dahlgren, Hansson and Olve, Virtual Organisations and Beyond, Chapters 1 & 9, Wiley, 2000.
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Home / Students / Study support resources / Strategic Business Leader (SBL) / Technical articles
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Passing Strategic Professional exams
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Strategic Business Leader – 10 things to learn from the September 2018 sitting
How to approach Strategic Business Leader
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Performance indicators G
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This article explains and illustrates key performance
indicators and critical success factors.
Introduction
Objectives
Performance indicators and key performance indicators
Performance measures – a practical framework
Use of performance indicators in the SBL and APM syllabi
Introduction
Both Strategic Business Leader (SBL) and Advanced Performance Management (APM)
require candidates to be able to establish key performance indicators and critical success
factors. For example, Question 1 of December 2013 APM illustrates this.
A surprising number of candidates do not feel comfortable with these terms, and this article
is aimed at explaining and illustrating these concepts. In particular it will explain what is
meant by:
Performance
Objectives
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Key performance indicators.
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Back to top

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Performance
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This can be defined as:
‘A task or operation seen in terms of how successfully it is performed’

(www.oxforddictionaries.com).
Organisations differ greatly in which aspects of their behaviour and results constitute good
performance. For example their aim could be to make profits, to increase the share price, to
cure patients in a hospital, or to clear household rubbish. The concept of ‘performance’ is
very relevant to both SBL and APM. SBL looks at how organisations can make decisions
that improve their strategic performance and APM is focused on how organisations evaluate
their performance.
The primary required tasks are often found in the organisation’s mission statement as it is
there that the organisation’s purpose should be defined. These are called ‘primary required
tasks’ because although the primary task of a profit-seeking business is to make profits, this
rests on other subsidiary tasks such as good design, low cost per unit, quality, flexibility,
successful marketing and so on. Many of these are non-financial achievements.
Some aspects of performance are ‘nice to have’ but others will be critical success factors.
For example, the standard of an airline’s meals and entertainment systems will rank after
punctuality, reliability and safety, all of which are likely to be critical to the airline’s success.
Back to top

Objectives
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Objectives are simply targets that an organisation sets out to achieve. They are elements of
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the mission that have been quantified and are the basis for deciding appropriate
a
performance measures and indicators. There is little point measuring something if you do
b
not know whether the result is satisfactory and cannot decide if performance needs to
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change. Organisations will create a hierarchy of objectives which will include corporate
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objectives which affect the organisation as a whole and unit objectives which will affect
A
individual business units within the organisation. Even here objectives will be categorised
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as primary and secondary, for example an organisation might set itself a primary objective
C
of growth in profits but will then need to develop strategies to ensure this primary objective
A
is achieved. This is where secondary objectives are needed, for example to improve
product quality or to make more efficient use of resources.
Objectives often follow the SMART rule. They should be:
Specific: there is little point in setting an objective for a company to improve its inventory.
What does that mean? It could mean that stock-outs should be less frequent, or average
stock holdings should be lower, or the inventory will be held in better conditions to reduce
wastage.
Measurable: if you can’t measure something you will be at a loss as to how to control it.
Some aspects of performance might be difficult to measure, but efforts must be made.
Customer satisfaction is important to most businesses and indications could be obtained by
arranging customer surveys, repeat business and so on.
Achievable/agreed/accepted: objectives are achieved by people and those people must
accept and agree that the objectives are achievable and important.
Relevant: relevant to the organisation and the person to whom the objectives are given. It is
important that people understand how achieving an objective will help organisational
success. If this connection isn’t clear, employees will begin to feel that the objective is
simply a cynical exercise of management power. The person to whom the objective is given
must also feel that they can affect its achievement.
Time-limited: all objectives have to be achieved within a specified time period otherwise
procrastination will rule.
Back to top

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b a
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A critical success factor (CSF) can be defined as:
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‘An area where an organisation must perform well if it is to succeed.’
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Alternatively, Johnson, Scholes & Whittington defined CSFs as:
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'Those product features that are particularly valued by a group of customers, and, therefore,
where the organisation must excel to outperform the competition.’
This definition is more complex than the first, but it is more useful because it makes the
organisation look towards its customers (or users) and recognises that their opinion of
excellence is more important and reliable than internally generated opinions. If an
organisation doesn’t deliver what its customers, clients, patients, citizens or students value,
it is failing.
Back to top

Performance indicators and key performance

indicators
Performance indicators (or performance measures) are methods used to assess

performance. For example:
In profit-seeking organisations:
Profit
Earnings per share
Return on capital employed
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In not-for-profit organisations:
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b
Exam grades (a school)
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Waiting times for hospital admission (a health service)
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Condition of roads (a local government highways department)
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A
Particularly in profit-seeking organisations, the prime financial performance indicators allow
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performance to be measured but they say little about how that performance has been
C
achieved. So, high profits will depend on a combination of good sales volumes, adequate
A
prices and sufficiently low costs. If high profits can only be achieved by a satisfactory
combination of volume, price and cost, then those factors should be measured also and will
need to be compared to standards and budgets.
Similar effects are found in not-for-profit organisations. For example, in a school, a CSF
might be that a pupil leaves with good standards of literacy. But that might depend on pupil-
teacher ratios, pupils’ attendance and the experience of the teachers. If these factors
contribute to good performance, they need to be measured and monitored.
Just as CSFs are more important than other aspects of performance, not all performance
indicators are created equal. The performance indicators that measure the most important
aspects of performance are the key performance indicators (KPIs). To a large extent,
KPIs measure how well CSFs are achieved; other performance indicators measure how
well other aspects of performance are achieved
There are a number of potential pitfalls in the design of performance indicators and
measurement systems:
Not enough performance measures are set
Often, directors and employees will be judged on the results of performance

measures. It has been said that ‘Whatever gets measured gets done’ and employees
will tend to concentrate on achieving the required performance where it is measured.
The corollary is that ‘Whatever doesn't get measured doesn't get done’ and the
danger is that employees will ignore areas of behaviour and performance which are
not assessed.
Too many performance indicators
This occurs especially where performance measures are not ranked by importance
and none have been identified as KPIs. Performance indicators have to be
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measured, calculated and reported to management, and discrepancies must be
B
explained or excuses invented. Too many measures can divert time from more
l
important tasks and there is a danger that employees concentrate on the easier but
a
more trivial measures than on the more difficult but vital targets.
The wrong performance measures
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An example of this would be applying strict cost measures in an organisation where
A
luxury products and services are sold (a differentiation strategy). This is likely to
C
detract from the organisation’s strategic success.
A C
Too tight/too loose performance measures
Performance indicators that are too difficult to attain can lead to a loss of employee
motivation and promote dysfunctional behaviours such as gaming and the
misrepresentation of data. Performance measures that are too loose can pull down
performance. Benchmarking can help to avoid this. Internal benchmarking generally
sets measures based on previous period’s measures or set measures with respect to
other branches or divisions. However these internal benchmarks can lead to
complacency as many organisations have to compete with others and benchmarks
should be aligned to competitors’ performance.
‘Hit and run’ performance indicators
This means that a performance indicator is set and then it is assumed that things will
look after themselves. Performance indicators need a management framework they
are to be at all effective.
Back to top

Performance measures – a practical framework
Expanding on the last point, above, to establish a performance measurement system,

something like the following is needed for each measure:
1. A meaningful title of the measure

2. What is its purpose and how does that purpose relate to strategic success?
x
3. What other performance measures might be affected by this one, how are they
o
affected and how are conflicts to be resolved?
B
4. Who will be held responsible for it?
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5. What is the source data, who is responsible for its supply, how is it measured and
b a
how is the measure calculated?
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6. What investigations and explanations are required and who is responsible?
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7. What target is set and how has that target been determined?
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8. How often should the target be updated?
A
9. How often is the measure reported on?
C
10. Reporting and action?
A C
For example, consider a passenger train company called TTTE:
1. Title of Punctuality (the percentage of trains arriving at their destination on time)

performance
measure
2. Purpose of TTTE’s strategic objective is to provide comfortable, reliable and punctual

performance services to passengers. TTTE competes with other train companies, cars, buses
measure and airlines. Punctuality is seen as a key competitive lever and therefore must be
measured
3. Other Safety – safety checks and speed limits will take priority over punctuality
performance
measures Cleanliness – it might be necessary to occasionally reduce cleaning to keep to
affected the timetable
Energy consumption running a train faster than normal (though within speed
limits) will cause higher fuel consumption but punctuality takes precedence
4. Who is Operations director

held
x
responsible?
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b
5. Source The duty manager at each station is responsible for logging the arrivals time of
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data, each train. A five-minute margin is allowed ie a train is logged ‘on time’ if it is no
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measurement later than 5 minutes after the advertised time. Beyond five minutes the actual
and time by which the train is late is logged. Results will be calculated in percentage
A
calculation of bands: on time, up to 15 minutes late, >15–30 minutes late, >30 minutes – one
C
the measure. hour late, >one hour late, and so on
A C
6. While logging late arrivals, station duty managers should also note the cause
Investigations where possible. The operations director must collate this information using
and statistical analysis which highlights persistent problems such as particular times
explanations of the day, routes or days of the week
7. Target and The target is dictated by the railway timetable. The timetable should be reviewed
how it is twice a year to look for ways of reducing journey times to keep TTTE competitive
determined with improvements in competing transport
8. Update of The banding and any tolerances will be updated annually

target
9. How often Weekly

should the
measure be
reported
10. Reporting The operations director will report performance on a monthly basis to the board
x
and action together with plans for service improvement
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Use of performance indicators in the SBL and APM
syllabi
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Performance indicators are relevant to the following models and theories:
Mission statements: these define the important aspects of performance that sum up the
purpose of the organisation. See the article ‘Reports for performance management’ (see
'Related links').
Stakeholder analysis: recognises that different stakeholders have different views on what

constitutes good performance. Sometimes what stakeholders want is different to what the
mission statement suggests as the purpose of the organisation. This can be a particular
problem when the stakeholders are key-players.
Generic strategies: the main generic strategies to achieve competitive advantage are cost
leadership and differentiation. If a company’s success depends on being a cost leader (a
CSF) then it must carefully monitor all its costs to achieve the leadership position. The
company will therefore make use of performance indicators relating to cost and efficiency. If
a company that has chosen differentiation as its path to success then it must ensure that it
is offering enhanced products and services and must establish measures of these.
Value chain: a value chain sets out an organisation’s activities and enquires as to how the
organisation can make profits: where is value added? For example, value might be added
by promising fantastic quality. If so, that would be a CSF and a key performance indicator
would the rate occurrence of bad units.
Boston consulting group grid: this model uses relative market share and market growth
to suggest what should be done with products or subsidiaries. In SBL if a company
identifies a product as a ‘problem child’ BCG says that the appropriate action for the
company is either to divest itself of that product or to invest to grow the product towards a
x
‘star’ position on the grid. This requires money to be spent on promotion, product
o
enhancement, especially attractive pricing and perhaps investment in new, efficient
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equipment. In APM the model would be used to establish how to manage the performance
a
of the products and what measures should be used depending on their position in the grid.
b
For example, good performance for a star would be measured by market share growth
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rather than profits. Return on investment could be low until full use is made of the new
G
equipment. Once a product reaches its ‘cash cow’ stage performance measures will focus
A
on revenues, costs and profits.
CC
PESTEL and Porter’s five forces: both the macro-environment and competitive
A
environment change continuously. Organisations have to keep these under review and
react to the changes so that performance is sustained or improved. For example, if laws
were introduced which stated that suppliers should be paid within a maximum of 60 days,
then a performance measure will be needed to encourage and monitor the attainment of
this target.
Product life cycle: different performance measures are required at different stages of the
life cycle. In the early days of a product’s life, it is important to reach a successful growth
trajectory and to stay ahead of would-be copycats. At the maturity stage, where there is
great competition and the market is no longer growing, performance will depend on low
costs per unit and maintaining market share to enjoy economies of scale.
Company structure: different structures inevitably affect both performance and its

management. For example as businesses become larger many choose a divisionalised
structure to allow specialisation in different parts of the business: manufacturing/selling,
European market/Asian market/North American market, product type A/product type B.
Divisional performance measures, such as return on investment and residual income, then
become relevant.
Information technology (IT): new technologies will influence performance and could help
to more effectively measure performance. However, remember that sophisticated new
technology does not guarantee better performance as costs can easily outweigh benefits. If
IT is vital to a business then downtime and query response time become relevant as might
a measure of system usability.
Human resource management: what type of people should be recruited, and how are
they to be motivated, appraised and rewarded to maximise the chance of good
organisational performance? Performance measures are needed, for example, to monitor
the effectiveness of training, job performance, job satisfaction, recruitment and retention. In
addition, considerable effort has to be given to considering how employees’ remuneration
x
should be linked to performance.
B o
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Fitzgerald and Moon building blocks
b a
Section E(1) of the APM Study Guide mentions three specific approaches or models:
lo
G
Balanced scorecard
A
Performance pyramid
C
Fitzgerald’s and Moon’s building blocks
A C
The balanced scorecard approach is probably the best known but all seek to ensure that
the net is thrown wide when designing performance measures for organisations so that
factors such as quality, innovation, flexibility, stakeholder performance, and delivery and
cycle time are listed as being important aspects of performance. Whenever an aspect of
performance is important then a performance measure should be designed and used.
The Fitzgerald and Moon model is worth a specific mention here as it is the only model
which explicitly links performance measures to the individuals responsible for the
performance.
The model first sets out the dimensions (split into results and determinants) where key
performance indicators should be established. You will see there is a mix of financial and
non-financial, and both quantitative and qualitative:
Results
Financial performance
Competitive performance
Determinants
Quality
Flexibility
Resource utilisation
Innovation
The model then suggests standards for KPIs:
Ownership: refers to the idea that KPIs will be taken more seriously if staff have a say
in setting targets. Staff will be more committed and will better understand why that
KPI is needed.
x
Achievability: if KPIs are frequently and obviously not achievable then motivation is
o
harmed. Why would staff put in extra effort to try to achieve a target (and bonus) if
B
they believe failure is inevitable.
l
Fairness: everyone should be set similarly challenging objectives and it is essential
b a
that allowance should be made for uncontrollable events. Managers should not be
o
penalised for events that are completely outside everyone’s control (for example, a
l
natural disaster) or which is someone else’s fault.
G
A
The model then suggests how employee rewards should be set up to encourage
C
employees to achieve the KPI targets:
A C
Clarity: exactly how does performance translate into a reward?
Motivation: the reward must be both desirable and must be perceived as achievable if
it is to be motivating.
Controllable: achievement of the KPI giving rise to the reward should be something
the manager can influence and control.
Adapted from an article originally written by Ken Garrett (a freelance lecturer and
writer)
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Relevant to ACCA Qualification Papers P3 and P5
Critical success factors (CSFs) are often quoted in management literature as those areas in which an organisation needs to
perform best if it is to achieve overall success. CSFs have frequently been used to help determine the requirements for
executive information systems (EIS), supporting the ‘key indicator’ approach to management control. A number of methods
have been developed to identify these key indicators, and the CSF approach is one of the most widely used, which should
be measured and monitored using EIS to help manage the strategic direction of an organisation.
It is difficult and expensive to gather, store, validate and make available the various types of management information required for
decision making. As such, it is important for managers and providers of information support systems to determine, in advance, what
is most relevant to them.
It is necessary to identify the ‘key indicators’ that will help a manager to plan, manage, and control an area of responsibility. This
method is based on the need for managers to focus, at any point in time, on the most significant aspects of their responsibilities. The
development of an EIS, designed to support management control, is based on two main concepts:
• The selection of a set of key indicators of the health of the functional business area. Information will then be collected for each
of these indicators.
• Exception reporting – the ability to make available to a manager, as required, information on only those indicators where
performance differs significantly from expectations.
The underlying belief is that an effective control system must be tailored to the specific industry in which the organisation operates,
and to the specific strategies that it has adopted. It must identify the CSFs that should receive careful and continuous management
attention if the organisation is to be successful, and it must highlight performance with respect to these key variables in reports
x
available to all levels of management.
l B
The first concept is frequently approached from the viewpoint of CSFs in that a limited number of areas are identified in which results,
a
if they are satisfactory, will ensure successful performance. They are the few key areas, it is believed, where ‘things must go right’ if
b
the organisation is to flourish. In turn, each manager must identify the key areas that apply to them, in which results are identified as
lo
being absolutely necessary to achieve specific goals. The goals, in turn, support overall organisational goals. The genesis of this
G
approach goes back to the history of warfare, where writers on battles have identified the successful leader as the one who
concentrated his forces on the most significant areas.
C
The current state of performance in these areas should be continually measured. Because these areas are identified as being critical,
C
each manager should have the appropriate information that indicates whether events are proceeding sufficiently well in each area.
A
CSFs and associated performance indicators (PIs) can play a central role in this.
BACKGROUND TO THE APPROACH
The concept of CSFs was first introduced in 1962 by D Ronald Daniel, later managing director of the management consultancy
McKinsey and Co. Introducing the concept, Daniel cited examples where major corporations had introduced computerised
information systems, processed extensive amounts of data, and claimed to produce meaningful information. However, this
information, on closer examination, appeared to be of little use in assisting managers to better perform their jobs, especially in terms
of direction, planning, management of operations, and control. To draw attention to the type of information required, Daniel coined the
phrase ‘critical success factors’. Further, he provided examples of CSFs that he had identified for contemporary major industries.
These included:
• In the automobile industry – styling, an efficient dealer network organisation, tight control of management costs.
• In the food processing industry – new product development, good distribution channels, effective advertising.
• In the life insurance industry – the development of agency management personnel, effective control of clerical personnel,
innovative new policies.
• In the supermarket industry – the right product mix available in each store, having it actually available on the shelves,
advertising it effectively to pull shoppers in, pricing it correctly (since profit margins were low in this industry).
Daniel identified CSFs as being necessary to support the attainment of organisational goals. Goals represent the end points that an
organisation hopes to reach. CSFs, however, are the areas in which good performance is necessary to ensure attainment of these
goals. Daniel focused on those CSFs that are relevant for any company in a particular industry.
REFINING THE APPROACH
Early research in to the uses and usefulness of CSFs took place at the Massachusetts Institute of Technology (MIT) in the early
1970s, which took Daniel’s work further (see Rockart, John F, Chief executives define their own information needs, Harvard Business
Review, March–April 1979, Vol 57, pp 81–93 and John F Rockart and Christine Bullen, 1986, The Rise of Managerial Computing,
Sloan School of Management and IT).
Daniel’s initial thinking had been that CSFs are those that are common to organisations operating in a particular industry. However,
x
MIT identified five prime sources of CSFs:
B o
l
• the structure of the particular industry
a
• competitive strategy, industry position, and geographic location
b
• environmental factors
• temporary factors
lo
G
• functional managerial position.
CC
The structure of the particular industry
A
As first identified by Daniel, any industry has a set of CSFs that are determined by the characteristics of the industry itself. Each
company in the industry must pay attention to these factors. For example, the manager of any supermarket would ignore at his peril
the CSFs listed above.
Competitive strategy, industry position, and geographic location
Every company in an industry is in a unique situation determined by its history and current competitive strategy. For smaller
organisations within an industry dominated by one or two large companies, the actions of the major companies will often produce
new and significant problems for their smaller competitors. The competitive strategy for the smaller companies may involve
establishing a new market niche, getting out of a product line completely, or redistributing resources among various product lines.
Their strategy is mainly a reaction to the larger companies’ strategies.
In this way a major competitor’s strategy can produce a CSF for a small company. For example, Dell’s competitive approach to the
marketing of small, inexpensive computers informs the CSF identification for all computer manufacturers. The smaller companies
must identify what they will do in response, and how they measure the effectiveness of their response. Just as differences in industry
position can dictate CSFs, differences in geographic location (eg distribution costs) and in strategic positioning (differentiation or
focus strategies for smaller companies) can lead to different CSFs in companies within the same industry.
Environmental factors
As the Gross National Product of an economy can fluctuate with changes in political and demographic factors, CSFs can also
change for an organisation. In the early 1970s, virtually no chief executive in the US would have listed ‘energy supply availability’ as a
CSF. However, following the organisation of OPEC and its oil embargo, this factor is now closely monitored by most executives,
because adequate availability of energy, and its price stability, is vital to organisational planning and bottom-line performance in
manufacturing and distribution.
Temporary factors
Internal organisational considerations often lead to the monitoring of temporary CSFs. These are areas of activity that are deemed
significant to the success of the organisation for a particular period of time because they are considered below the threshold of
acceptability, even though they may generally appear to be in good shape and not apparently in need of special attention. For
instance, an insurance company that had just been fined by the industry regulator for miss-selling would probably generate a short-
term CSF of ensuring that such miss-selling, and consequent financial penalties, would not happen again in the near future.
x
Functional managerial position
o
Each functional managerial position has a generic set of CSFs associated with it. For example, almost all manufacturing managers
l B
are concerned with product quality, inventory control, and cost control.
b
Two further dimensions
lo
These five sources of CSFs are one form of classification. CSFs can also be classified as follows:
Internal versus external sources of CSFs
A
Every manager will have internal CSFs relating to the department and the people they manage. These CSFs can range across such
C
diverse interests as human resource development or inventory control. The primary characteristic of such internal CSFs is that they
C
deal with issues that are entirely within the manager’s sphere of influence and control. External CSFs relate to issues that are
A
generally less under the manager’s direct control such as the availability or price of a particular critical raw material or source of
energy.
Monitoring versus building/adapting CSFs
Managers who are geared to producing short-term operating results invest considerable effort in tracking and guiding their
organisation’s performance, and therefore employ monitoring CSFs to continuously scrutinise existing situations. Almost all
managers have some monitoring CSFs, which often include financially-oriented CSFs such as actual performance versus budget or
the current status of product or service transaction cost. Another monitoring CSF might be personnel turnover rates.
Managers who are either in reasonable control of day-to-day operations, or who are insulated from such concerns, spend more time
in a building or adapting mode. These people can be classified as future-oriented planners whose primary purpose is to implement
major change programmes aimed at adapting the organisation to the perceived emerging environment. Typical CSFs in this area
might include the successful implementation of major recruitment and training efforts, or new product or service development
programmes.
RESEARCH CONCLUSIONS – CSFs IN PRACTICE
Research has shown that, in general, individual managers focus on a mix of CSFs drawn from the above sources. From an
organisational perspective, however, CSFs also have a number of hierarchical levels:
• industry CSFs
• corporate CSFs
• functional CSFs
• individual CSFs.
As mentioned at the beginning of this article, industry CSFs affect an organisation in the development of its strategy, objectives, and
goals. No organisation can afford to develop a strategy that does not pay adequate attention to the principal factors that underlie
success in its industry. In turn, the strategy, objectives, and goals developed by an organisation lead to the development of a
particular set of CSFs for the whole organisation (corporate CSFs) unique to its own circumstances. In turn, corporate CSFs become
an input into a similar CSF determination process for each sub-organisation or division in the corporation. Managers at each
x
organisational level will have an individual set of CSFs that will depend heavily on their perspective of their role and on temporary
o
factors.
l B
a
It is at this point that we should discuss the concept that organisations are ‘human activity systems’, and that individuals within these
b
systems bring their own ‘world view’ to their roles – encompassing their whole belief system – based on their training and previous
lo
experience. This world view will influence their perception of what they consider to be important in achieving their own organisational
G
objectives. Thus a new incumbent to a role may identify a number of new CSFs that may augment or replace the CSFs identified by
the previous incumbent.
C
STEPS TOWARDS IMPLEMENTATION – MEASUREMENT
C
The main use of the CSF concept is as a focus for implementing organisational transformation by supporting beneficial change. This
A
is achieved by:
• helping individual managers determine their priorities and their supporting information requirements
• aiding an organisation in its general planning processes, for strategic and annual planning, and for budgeting purposes
• aiding an organisation in its information systems planning processes.
A key driver for strategic and tactical information systems development is the provision of better performance management
information, in order to match achievement against critical organisational goals. To achieve any benefit from using the CSF concept it
is also important to remember that choosing what to measure and report on will markedly influence behaviour at every level. So care
needs to be taken in human activity systems to recognise that an unbalanced set of indicators, while valid for the short-term needs of
an individual in the hierarchy, may have unintended consequences in influencing the behaviour of subordinates. Therefore there is a
need to produce a Balanced Scorecard of indicators and measures.
As a starting point in a typical command and control organisation, the following implementation tactics may help:
• Concentrate on measurement, not on counting. For example, focus on what the organisation is trying to achieve, set targets,
and measure progress towards achieving those targets.
• Make it a priority to establish measures for the main core processes (core being defined as those that touch the customer or
client).
• Ensure that the chosen measures reflect what matters to the customer or client.
• Use historic data to establish existing capability – identify targets and have a plan to close the gap.
• Continually review measures in use and their impact – look at ‘what’ is being measured and ‘why’, and publicly discard those
measures no longer most relevant.
As a starting point, four areas for measurement should be considered when managing for improvement: customers, response,
process, and system.
Customers
What matters to customers? Can these things be measured (simply and efficiently)? Do we have any systematic methods for
x
understanding what matters to customers? Do we translate what matters into measures for managing and improving performance?
l B
Response
a
Can ‘what matters to customers’ be turned into response measures? Are there other ‘end to end’ measures that will help the
b
organisation learn about, for example, customer acquisition and the efficiency of services delivered? What processes must be
lo
measured end to end? Consider risk management – what events in the outside environment do we need to watch out for? What do
G
we need to know about competitor activity?
A
Process
CC
What measures might be useful in the processes? Some measures should be permanent and some should be temporary. For
A
example, ‘throughput’ might be an important permanent measure, and ‘waste’ a useful temporary measure.
System
How should the above measures fit together to tell managers how they are performing, and how they will perform? Are other whole
system measures needed? How well is the organisation integrated into, and monitoring, its external environment?
Finally, CSF measures chosen should be SMART, that is:
• specific – in the context of developing CSF objectives this means that the action, behaviour, or achievement described is
always linked to a rate, number percentage, or frequency
• measurable – a system, method, or procedure exists that allows the tracking and recording of the behaviour or action on which
the CSF objective is focused
• agreed – there should be an agreement with those involved in achieving the objective that it is relevant and necessary
• realistic – that the objectives set are capable of being achieved
• time-based – the objective set should be linked to a date by which it is to be achieved.
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The risks of uncertainty - part 1
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Clearly, risk permeates most aspects of corporate decision making (and life in general), and few can predict with any
precision what the future holds in store
Risk can take myriad forms – ranging from the specific risks faced by individual companies (such as financial risk, or the risk of a
strike among the workforce), through the current risks faced by particular industry sectors (such as banking, car manufacturing, or
construction), to more general economic risks resulting from interest rate or currency fluctuations, and, ultimately, the looming risk of
recession. Risk often has negative connotations, in terms of potential loss, but the potential for greater than expected returns also
often exists.
Clearly, risk is almost always a major variable in real-world corporate decision-making, and managers ignore its vagaries at their
peril. Similarly, trainee accountants require an ability to identify the presence of risk and incorporate appropriate adjustments into the
problem-solving and decision‑making scenarios encountered in the exam hall. While it is unlikely that the precise probabilities and
perfect information which feature in exam questions can be transferred to real-world scenarios, a knowledge of the relevance and
applicability of such concepts is necessary.
In this first article, the concepts of risk and uncertainty will be introduced together with the use of probabilities in calculating both
expected values and measures of dispersion. In addition, the attitude to risk of the decision maker will be examined by considering
various decision‑making criteria, and the usefulness of decision trees will also be discussed. In the second article, more advanced
aspects of risk assessment will be addressed, namely the value of additional information when making decisions, further probability
concepts, the use of data tables, and the concept of value-at-risk.
The basic definition of risk is that the final outcome of a decision, such as an investment, may differ from that which was expected
when the decision was taken. We tend to distinguish between risk and uncertainty in terms of the availability of probabilities. Risk is
when the probabilities of the possible outcomes are known (such as when tossing a coin or throwing a dice); uncertainty is where the
randomness of outcomes cannot be expressed in terms of specific probabilities. However, it has been suggested that in the real
world, it is generally not possible to allocate probabilities to potential outcomes, and therefore the concept of risk is largely redundant.
x
In the artificial scenarios of exam questions, potential outcomes and probabilities will generally be provided, therefore a knowledge of
o
the basic concepts of probability and their use will be expected.
l B
Probability
b a
lo
G
The term ‘probability’ refers to the likelihood or chance that a certain event will occur, with potential values ranging from 0 (the event
A
will not occur) to 1 (the event will definitely occur). For example, the probability of a tail occurring when tossing a coin is 0.5, and the
C
probability when rolling a dice that it will show a four is 1/6 (0.166). The total of all the probabilities from all the possible outcomes
C
must equal 1, ie some outcome must occur.
A
A real world example could be that of a company forecasting potential future sales from the introduction of a new product in year one
(Table 1).
From Table 1, it is clear that the most likely outcome is that the new product generates sales of £1,000,000, as that value has the
highest probability.
Independent and conditional events
An independent event occurs when the outcome does not depend on the outcome of a previous event. For example, assuming that a
dice is unbiased, then the probability of throwing a five on the second throw does not depend on the outcome of the first throw.
In contrast, with a conditional event, the outcomes of two or more events are related, ie the outcome of the second event depends on
the outcome of the first event. For example, in Table 1, the company is forecasting sales for the first year of the new product. If,
subsequently, the company attempted to predict the sales revenue for the second year, then it is likely that the predictions made will
depend on the outcome for year one. If the outcome for year one was sales of $1,500,000, then the predictions for year two are likely
to be more optimistic than if the sales in year one were $500,000.
The availability of information regarding the probabilities of potential outcomes allows the calculation of both an expected value for
the outcome, and a measure of the variability (or dispersion) of the potential outcomes around the expected value (most typically
standard deviation). This provides us with a measure of risk which can be used to assess the likely outcome.
Expected values and dispersion
Using the information regarding the potential outcomes and their associated probabilities, the expected value of the outcome can be
x
calculated simply by multiplying the value associated with each potential outcome by its probability. Referring back to Table 1,
o
regarding the sales forecast, then the expected value of the sales for year one is given by:
l B
a
Expected value
lo b
= ($500,000)(0.1) + ($700,000)(0.2) + ($1,000,000)(0.4) + ($1,250,000)(0.2) + ($1,500,000)(0.1)
G
= $50,000 + $140,000 + $400,000 + $250,000 + $150,000
A
= $990,000
CC
In this example, the expected value is very close to the most likely outcome, but this is not necessarily always the case. Moreover, it
A
is likely that the expected value does not correspond to any of the individual potential outcomes. For example, the average score
from throwing a dice is (1 + 2 + 3 + 4 + 5 + 6) / 6 or 3.5, and the average family (in the UK) supposedly has 2.4 children. A further
point regarding the use of expected values is that the probabilities are based upon the event occurring repeatedly, whereas, in reality,
most events only occur once.
In addition to the expected value, it is also informative to have an idea of the risk or dispersion of the potential actual outcomes
around the expected value. The most common measure of dispersion is standard deviation (the square root of the variance), which
can be illustrated by the example given in Table 2 above, concerning the potential returns from two investments.
To estimate the standard deviation, we must first calculate the expected values of each investment:
Investment A
Expected value = (8%)(0.25) + (10%)(0.5) + (12%)(0.25) = 10%
Investment B
Expected value = (5%)(0.25) + (10%)(0.5) + (15%)(0.25) = 10%
The calculation of standard deviation proceeds by subtracting the expected value from each of the potential outcomes, then squaring
the result and multiplying by the probability. The results are then totalled to yield the variance and, finally, the square root is taken to
give the standard deviation, as shown in Table 3.
o x
l B
b a

lo
G
A
In Table 3, although investments A and B have the same expected return, investment B is shown to be more risky by exhibiting a
C
higher standard deviation. More commonly, the expected returns and standard deviations from investments and projects are both
C
different, but they can still be compared by using the coefficient of variation, which combines the expected return and standard
A
deviation into a single figure.
Coefficient of variation and standard error
The coefficient of variation is calculated simply by dividing the standard deviation by the expected return (or mean):
Coefficient of variation = standard deviation / expected return
For example, assume that investment X has an expected return of 20% and a standard deviation of 15%, whereas investment Y has
an expected return of 25% and a standard deviation of 20%. The coefficients of variation for the two investments will be:
Investment X = 15% / 20% = 0.75
Investment Y = 20% / 25% = 0.80
The interpretation of these results would be that investment X is less risky, on the basis of its lower coefficient of variation. A final
statistic relating to dispersion is the standard error, which is a measure often confused with standard deviation. Standard deviation is
a measure of variability of a sample, used as an estimate of the variability of the population from which the sample was drawn. When
we calculate the sample mean, we are usually interested not in the mean of this particular sample, but in the mean of the population
from which the sample comes. The sample mean will vary from sample to sample and the way this variation occurs is described by
the ‘sampling distribution’ of the mean. We can estimate how much a sample mean will vary from the standard deviation of the
sampling distribution. This is called the standard error (SE) of the estimate of the mean.
The standard error of the sample mean depends on both the standard deviation and the sample size:
SE = SD/√(sample size)
The standard error decreases as the sample size increases, because the extent of chance variation is reduced. However, a fourfold
increase in sample size is necessary to reduce the standard error by 50%, due to the square root of the sample size being used. By
o x
contrast, standard deviation tends not to change as the sample size increases.
l B
a
Decision-making criteria
lo b
The decision outcome resulting from the same information may vary from manager to manager as a result of their individual attitude
G
to risk. We generally distinguish between individuals who are risk averse (dislike risk) and individuals who are risk seeking (content
A
with risk). Similarly, the appropriate decision-making criteria used to make decisions are often determined by the individual’s attitude
C
to risk.
A C
To illustrate this, we shall discuss and illustrate the following criteria:
1. Maximin
2. Maximax
3. Minimax regret
An ice cream seller, when deciding how much ice cream to order (a small, medium, or large order), takes into consideration the
weather forecast (cold, warm, or hot). There are nine possible combinations of order size and weather, and the payoffs for each are
shown in Table 4.
The highest payoffs for each order size occur when the order size is most appropriate for the weather, ie small order/cold weather,
medium order/warm weather, large order/hot weather. Otherwise, profits are lost from either unsold ice cream or lost potential sales.
We shall consider the decisions the ice cream seller has to make using each of the decision criteria previously noted (note the
absence of probabilities regarding the weather outcomes).
1. Maximin
x
This criteria is based upon a risk-averse (cautious) approach and bases the order decision upon maximising the minimum payoff.
o
The ice cream seller will therefore decide upon a medium order, as the lowest payoff is £200, whereas the lowest payoffs for the
B
small and large orders are £150 and $100 respectively.
l
2. Maximax
a
This criteria is based upon a risk-seeking (optimistic) approach and bases the order decision upon maximising the maximum
b
payoff. The ice cream seller will therefore decide upon a large order, as the highest payoff is $750, whereas the highest payoffs
o
for the small and medium orders are $250 and $500 respectively.
l
3. Minimax regret
G
This approach attempts to minimise the regret from making the wrong decision and is based upon first identifying the optimal
decision for each of the weather outcomes. If the weather is cold, then the small order yields the highest payoff, and the regret
A
from the medium and large orders is $50 and $150 respectively. The same calculations are then performed for warm and hot
C
weather and a table of regrets constructed (Table 5).
A C
The decision is then made on the basis of the lowest regret, which in this case is the large order with the maximum regret of $200, as
opposed to $600 and $450 for the small and medium orders.
Decision trees
The final topic to be discussed in this first article is the use of decision trees to represent a decision problem. Decision trees provide
an effective method of decision-making because they:
• clearly lay out the problem so that all options can be challenged
• allow us to fully analyse the possible consequences of a decision
• provide a framework in which to quantify the values of outcomes and the probabilities of achieving them
• help us to make the best decisions on the basis of existing information and best guesses.
A comprehensive example of a decision tree is shown in Figures 1 to 4, where a company is trying to decide whether to introduce a
new product or consolidate existing products. If the company decides on a new product, then it can be developed thoroughly or
rapidly. Similarly, if the consolidation decision is made then the existing products can be strengthened or reaped. In a decision tree,
each decision (new product or consolidate) is represented by a square box, and each outcome (good, moderate, poor market
response) by circular boxes.
The first step is to simply represent the decision to be made and the potential outcomes, without any indication of probabilities or
potential payoffs, as shown in Figure 1 below.
The next stage is to estimate the payoffs associated with each market response and then to allocate probabilities. The payoffs and
o x
probabilities can then be added to the decision tree, as shown in Figure 2 below.
l B
The expected values along each branch of the decision tree are calculated by starting at the right hand side and working back
a
towards the left recording the relevant value at each node of the tree. These expected values are calculated using the probabilities
o b
and payoffs. For example, at the first node, when a new product is thoroughly developed, the expected payoff is:
G l
Expected payoff = (0.4)($1,000,000) + (0.4)($50,000) + (0.2)($2,000) = $420,400
CA
The calculations are then completed at the other nodes, as shown in Figure 3 below.
A C
We have now completed the relevant calculations at the uncertain outcome modes. We now need to include the relevant costs at
each of the decision nodes for the two new product development decisions and the two consolidation decisions, as shown in Figure
4 below.
The payoff we previously calculated for ‘new product, thorough development’ was $420,400, and we have now estimated the future
cost of this approach to be $150,000. This gives a net payoff of $270,400.
The net benefit of ‘new product, rapid development’ is $31,400. On this branch, we therefore choose the most valuable option, ‘new
product, thorough development’, and allocate this value to the decision node.
The outcomes from the consolidation decision are $99,800 from strengthening the products, at a cost of $30,000, and $12,800 from
reaping the products without any additional expenditure.
By applying this technique, we can see that the best option is to develop a new product. It is worth much more to us to take our time
and get the product right, than to rush the product to market. And it’s better just to improve our existing products than to botch a new
product, even though it costs us less.
In the next article, we will examine the value of information in making decisions, the use of data tables, and the concept of value-at-
risk.
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In this second article on the risks of uncertainty, we build upon the basics of risk and uncertainty addressed in the first
article published in April 2009 to examine more advanced aspects of incorporating risk into decision making
In particular, we return to the use of expected values and examine the potential impact of the availability of additional information
regarding the decision under consideration. Initially, we examine a somewhat artificial scenario, where it is possible to obtain perfect
information regarding the future outcome of an uncertain variable (such as the state of the economy or the weather), and calculate
the potential value of such information. Subsequently, the analysis is revisited and the more realistic case of imperfect information is
assumed, and the initial probabilities are adjusted using Bayesian analysis.
Some decision scenarios may involve two uncertain variables, each with their own associated probabilities. In such cases, the use of
data/decision tables may prove helpful where joint probabilities are calculated involving possible combinations of the two uncertain
variables. These joint probabilities, along with the payoffs, can then be used to answer pertinent questions such as what is the
probability of a profit/(loss) occurring?
The other main topic covered in the article is that of Value-at-Risk (VaR), which has been referred to as 'the new science of risk
management'. The principles underlying VaR will be discussed along with an illustration of its potential uses.
Expected values and information
To illustrate the potential value of additional information regarding the likely outcomes resulting from a decision, we return to the
example given in the first article, of the ice cream seller who is deciding how much ice cream to order but is unsure about the
weather. We now add probabilities to the original information regarding whether the weather will be cold, warm or hot, as shown in
Table 1.
Table 1: Assigning probabilities to weather
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Order/weather
Cold
l B Warm
Hot
Probability 0.2
b a 0.5 0.3
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Small $250 $200 $150
Medium
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Large
A C $100 $300 $750
We are now in a position to be able to calculate the expected values associated with the three sizes of order, as follows:
• Expected value (small) = 0.2 ($250) + 0.5 ($200) + 0.3 ($150) = $195
• Expected value (medium) = 0.2 ($200) + 0.5 ($500) + 0.3 ($300) = $380
• Expected value (large) = 0.2 ($100) + 0.5 ($300) + 0.3 ($750) = $395
On the basis of these expected values, the optimal decision would be to order a large amount of ice cream with an expected value of
$395. However, it may be possible to improve upon this value if better information regarding the weather could be obtained. Exam
questions often make the assumption that it is possible to obtain perfect information, ie to predict exactly what the outcome of the
uncertain variable will be.
The value of perfect information
In the case of the ice cream seller, perfect information would be certainty regarding the outcome of the weather.
If this was the case, then the ice cream seller would purchase the size of order which gave the highest payoff for each weather
outcome - in other words, purchasing a small order if the weather was forecast to be cold, a medium order if it was forecast to be
warm, and a large order if the forecast was for hot weather. The resulting expected value would then be:
Expected value =; 0.2 ($250) + 0.5 ($500) + 0.3 ($750) = $525
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The value of the perfect information is the difference between the expected values with and without the information, ie
Value of information = $525 - $395 = $130
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Exam questions are often phrased in terms of the maximum amount that the decision maker would be prepared to pay for the
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information, which again is the difference between the expected values with and without the information.
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However, the concept of perfect information is somewhat artificial since, in the real world, such perfect certainty rarely, if ever, exists.
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Future outcomes, irrespective of the variable in question, are not perfectly predictable. Weather forecasts or economic predictions
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may exhibit varying degrees of accuracy, which leads us to the concept of imperfect information.
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The value of imperfect information
With imperfect information we do not enjoy the benefit of perfect foresight. Nevertheless, such information can be used to enhance
the accuracy of the probabilities of the possible outcomes and therefore has value. The ice cream seller may examine previous
weather forecasts and, on that basis, estimate probabilities of future forecasts being accurate. For example, it could be that when hot
weather is forecast past experience has suggested the following probabilities:
• P (forecast hot but weather cold)- 0.3
• P (forecast hot but weather warm);- 0.4
• P (forecast hot and weather hot)- 0.7
The probabilities given do not add up to 1 and so, for example, P (forecast hot but weather cold) cannot mean P (weather cold given
that forecast was hot), but must mean P (forecast was hot given that weather turned out to be cold).
We can use a table to determine the required probabilities. Suppose that the weather was recorded on 100 days. Using our original
probabilities, we would expect 20 days to be cold, 50 days to be warm, and 30 days to be hot. The information from our forecast is
then used to estimate the number of days that each of the outcomes is likely to occur given the forecast (see Table 2).
Table 2: Likely weather outcomes
Outcome/forecast Cold Warm Hot Total
Hot 6** 20 21 47
Other 14 30
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20*
b a 50 30 100
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* From past data, cold weather occurs with probability of 0.2 ie on 0.2 of the 100 days in the sample = 20 days. Other percentages
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are also derived from past data.
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** If the actual weather is cold, there is a 0.3 probability that hot weather had been forecast. This will occur on 0.3 of the 20 days on
which the weather was poor = 6 days (0.3 x 20). Similarly, 20 = 0.5 x 40 and 21 = 0.7 x 30.
The revised probabilities, if the forecast is hot, are therefore:
• P (Cold)=6/47=0.128
• P (Warm) = 20/47 = 0.425
• P (Hot) = 21/47 = 0.447
The expected values can then be recalculated as:
• Expected value (small) = 0.128 ($250) + 0.425 ($200) + 0.447 ($150) = $184
• Expected value (medium) = 0.128 ($200) + 0.425 ($500) + 0.447 ($300) = $372
• Expected value (large) = 0.128 ($100) + 0.425 ($300) + 0.447 ($750) = $476
• Value of imperfect information = $476 - $395 = 81
The estimated value for imperfect information appears reasonable, given that the value we had previously calculated for perfect
information was $130.
Bayes' rule
Bayes' rule is perhaps the preferred method for estimating revised (posterior) probabilities when imperfect information is available. An
intuitive introduction to Bayes' rule was provided in The Economist, 30 September 2000:
'The essence of the Bayesian approach is to provide a mathematical rule explaining how you should change your existing beliefs in
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the light of new evidence. In other words, it allows scientists to combine new data with their existing knowledge or expertise. The
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canonical example is to imagine that a precocious newborn observes his first sunset, and wonders whether the sun will rise again or
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not. He assigns equal prior probabilities to both possible outcomes, and represents this by placing one white and one black marble
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into a bag. The following day, when the sun rises, the child places another white marble in the bag. The probability that a marble
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plucked randomly from the bag will be white (ie the child's degree of belief in future sunrises) has thus gone from a half to two-thirds.
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After sunrise the next day, the child adds another white marble, and the probability (and thus the degree of belief) goes from two-
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thirds to three-quarters. And so on. Gradually, the initial belief that the sun is just as likely as not to rise each morning is modified to
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become a near-certainty that the sun will always rise.'
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In mathematical terms, Bayes' rule can be stated as:
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Posterior probability =likelihood x prior probability
marginal likelihood
For example, consider a medical test for a particular disease which is 90% accurate, ie if you test positive then there is a 90%
probability that you have the disease and a 10% probability that you have been misdiagnosed. If we further assume that 3% of the
population actually have this disease, then the probability of having the disease (given that you have tested positive) is shown by:
P(Disease|Test = +) =
P(Test = +|Disease) x P(Disease)
P(Test = +|Dis) x P(Dis) + P(Test= +|No Dis) x P(No Dis)
= 0.90 0.03; 0.027;
0.90 x 0.03 + 0.10 x 0.97 0.027 + 0.097
= 0.218
This result suggests that you have a 22% probability of having the disease, given that you tested positive. This may seem a low
probability but only 3% of the population have the disease and we would expect them to test positive. However, 10% of tests will
prove positive for people who do not have the disease. Therefore, if 100 people are tested, approximately three out of the 13 positive
tests will actually have the disease.
Bayes' rule has been used in a practical context for classifying email as spam on the basis of certain key words appearing in the text.
Data tables
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Data tables show the expected values resulting from combinations of uncertain variables, along with their associated joint
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probabilities. These expected values and probabilities can then be used to estimate, for example, the probability of a profit or a loss.
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To illustrate, assume that a concert promoter is trying to predict the outcome of two uncertain variables, namely:
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1. The number of people attending the concert, which could be 300, 400, or 600 with estimated probabilities of 0.4, 0.4, and 0.2
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respectively.
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2. From each person attending, the profit on drinks and confectionary, which could be $2, $4, or $6 with estimated probabilities of
0.3, 0.4 and 0.3 respectively.
As each of the two uncertain variables can take three values, a 3 x 3 data table can be constructed. We shall assume that the
expected values have already been calculated as follows:
Number/spend 300 400 600
$2 (2,000) (1,000) 3,000
$4 (750) 3,000 4,000
$6 1,000 5,000 7,000
The probabilities can be used to calculate joint probabilities as follows:
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$2 0.12 0.12 0.06
$4
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$6
A C 0.12 0.12 0.06
The two tables could then be used to answer questions such as:
1. The probability of making a loss? = 0.12 + 0.12 + 0.16 = 0.40
2. The probability of making a profit of more than $3,500? = 0.08 + 0.12 + 0.06 = 0.26
Value-at-Risk (VaR)
Although financial risk management has been a concern of regulators and financial executives for a long time, Value-at-Risk (VaR)
did not emerge as a distinct concept until the late 1980s. The triggering event was the stock market crash of 1987 which was so
unlikely, given standard statistical models, that it called the entire basis of quantitative finance into account.
VaR is a widely used measure of the risk of loss on a specific portfolio of financial assets. For a given portfolio, probability, and time
horizon, VaR is defined as a threshold value such that the probability that the mark-to-market loss on the portfolio over the given time
horizon exceeds this value (assuming normal markets and no trading) is the given probability level. Such information can be used to
answer questions such as 'What is the maximum amount that I can expect to lose over the next month with 95%/99% probability?'
For example, large investors, interested in the risk associated with the FT100 index, may have gathered information regarding actual
returns for the past 100 trading days. VaR can then be calculated in three different ways:
1. The historical method
This method simply ranks the actual historical returns in order from worst to best, and relies on the assumption that history will repeat
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itself. The largest five (one) losses can then be identified as the threshold values when identifying the maximum loss with 5% (1%)
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probability.
2. The variance-covariance method
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This relies upon the assumption that the index returns are normally distributed, and uses historical data to estimate an expected
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value and a standard deviation. It is then a straightforward task to identify the worst 5 or 1% as required, using the standard deviation
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and known confidence intervals of the normal distribution - ie -1.65 and -2.33 standard deviations respectively.
3. Monte Carlo simulation
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While the historical and variance-covariance methods rely primarily upon historical data, the simulation method develops a model for
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future returns based on randomly generated trials.
Admittedly, historical data is utilised in identifying possible returns but hypothetical, rather than actual, returns provide the data for the
confidence levels.
Of these three methods, the variance-covariance is probably the easiest as the historical method involves crunching historical data
and the Monte Carlo simulation is more complex to use.
VaR can also be adjusted for different time periods, since some users may be concerned about daily risk whereas others may be
more interested in weekly, monthly, or even annual risk. We can rely on the idea that the standard deviation of returns tends to
increase with the square root of time to convert from one time period to another. For example, if we wished to convert a daily
standard deviation to a monthly equivalent then the adjustment would be :
σ monthly = σ daily x √ T where T = 20 trading days
For example, assume that after applying the variance-covariance method we estimate that the daily standard deviation of the FT100
index is 2.5%, and we wish to estimate the maximum loss for 95 and 99% confidence intervals for daily, weekly, and monthly periods
assuming five trading days each week and four trading weeks each month:
95% confidence
Daily = -1.65 x 2.5% = -4.125%
Weekly = -1.65 x 2.5% x √ 5 = -9.22%
Monthly = -1.65 x 2.5% x √ 20 = -18.45%
99% confidence
Daily = -2.33 x 2.5% = -5.825%
Weekly = -2.33 x 2.5% x √ 5 = -13.03%
Monthly = -2.33 x 2.5% x √ 20 = -26.05%
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Therefore we could say with 95% confidence that we would not lose more than 9.22% per week, or with 99% confidence that we
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would not lose more than 26.05% per month.
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On a cautionary note, New York Times reporter Joe Nocera published an extensive piece entitled Risk Mismanagement on 4 January
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2009, discussing the role VaR played in the ongoing financial crisis. After interviewing risk managers, the author suggests that VaR
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was very useful to risk experts, but nevertheless exacerbated the crisis by giving false security to bank executives and regulators. A
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powerful tool for professional risk managers, VaR is portrayed as both easy to misunderstand, and dangerous when misunderstood.
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Conclusion
These two articles have provided an introduction to the topic of risk present in decision making, and the available techniques used to
attempt to make appropriate adjustments to the information provided. Adjustments and allowances for risk also appear elsewhere in
the ACCA syllabus, such as sensitivity analysis, and risk-adjusted discount rates in investment appraisal decisions where risk is
probably at its most obvious. Moreover in the current economic climate, discussion of risk management, stress testing and so on is
an everyday occurrence.
References
• Jorion, P (2006), Value at Risk: The New Benchmark for Managing Financial Risk, 3rd edition, McGraw Hill
• Nocera, J (2009), Risk Management, New York Times
• Taleb, N (2007), Black Swan, Random House Publishing
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Economic value added versus profit-

based measures of performance - part 1
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Relevant to ACCA Qualification Paper P5
A successful performance measure evaluates how well an organisation performs in relation to its objectives. Since the primary
objective of commercial organisations is normally assumed to be the maximisation of the wealth of its shareholders, it follows that
performance measures should evaluate this. In practice, many organisations use profit-based measures as the primary measure of
their financial performance. Two problems relating to profit in this area are:
• Profit ignores the cost of equity capital. Companies only generate wealth when they generate a return in excess of the return
required by providers of capital – both equity and debt. In financial statements, the calculation of profit does take into account
the cost of debt finance, but ignores the cost of equity finance.
• Profits calculated in accordance with accounting standards do not truly reflect the wealth that has been created, and are subject
to manipulation by accountants.
Economic Value Added – or EVA – is a performance measurement system that aims to overcome these two weaknesses. EVA was
developed by the US consulting firm Stern Stewart & Co, and it has gained widespread use among many well-known companies
such as Siemens, Coca Cola and Herman Miller.
Residual income
EVA is based on the residual income technique that has been used since the early 20th century. Residual income is a performance
measure normally used for assessing the performance of divisions, in which a finance charge is deducted from the profits of the
division. The finance charge is calculated as the net assets of the division, multiplied by an interest rate – normally the company’s
weighted average cost of capital.
Example 1
Division A made a profit of $10,000 during the most recent financial year. The capital used by the division (equity plus long-term debt)
was $70,000. The weighted average cost of capital of the company is 13%, and this is used when calculating the finance charge. The
residual income of Division A was therefore:
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$
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Profit 10,000
a
Finance charge 9,100 (70,000 x 13%)
b
Residual income 900
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The finance charge of $9,100 represents the minimum return required by the providers of finance on the $70,000 capital they
provided. Since the actual profit of the division exceeds this, the division has recorded residual income of $900.
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EVA is similar in structure to residual income. It can be stated as:
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EVA = NOPAT – (k x capital)
Where: NOPAT = Net operating profits after tax.
(k x capital) is the finance charge, where k = the firms weighted average cost of capital
and
capital = equity plus long-term debt of the company at the start of the period.
This formula will not necessarily be given in the exam, so you need to learn it.
NOPAT
NOPAT means net operating profit after tax. This profit figure shows profits before taking out the cost of interest. The cost of interest
is included in the finance charge that is deducted from NOPAT when calculating EVA. Two approaches to adjusting for interest are
taken. Either:
• start with operating profit. Then deduct the adjusted tax charge. The tax charge should be adjusted because it includes the tax
benefit of interest. Since interest is a tax-deductible item, having interest in the income statement means that the tax charge is
lower. Since we are taking the cost of interest out of the income statement, it is also necessary to remove the tax benefit of it
from the tax charge. To do this, multiply the interest by the tax rate, and add this to the tax charge, or
• start with profit after tax, and add back the net cost of interest. This is the interest charge multiplied by (1 – rate of corporate
tax).
Example 2
An extract from the income statement of Alpha Inc shows the following:
$
Operating profit 1,000
Interest charge (100)
Profit before tax 900
Tax at 25% (225)
Profit after tax 675
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NOPAT is either:
Profit after tax 675
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Add after tax interest (100 x 75%) 75
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NOPAT 750
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or:
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Operating profit 1,000
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Less tax charge adjusted to exclude
tax relief on interest (225 + (100 x 25%)) 250
NOPAT 750
Accounting adjustments
The major departure from residual income is the adjustments made to reported financial profits and capital. Proponents of EVA argue
that profits calculated in accordance with financial reporting principles do not reflect the economic value generated by the company.
There are three main reasons for these adjustments:
1. To convert from accrual to cash accounting. Investors are interested in cash flows, so many of the accounting adjustments made,
such as allowances for doubtful debt, should be eliminated.
2. Spending on ‘market building’ items such as research, staff training and advertising costs should be capitalised to the extent that
they have not been in the financial statements. This may contradict IAS 38, but Stern Stewart believes that financial reporting
standards are too strict in this regard, and discourage managers from investing in items that bring long-term benefits.
3. Unusual items of profit or expenditure should be ignored.

Stern Stewart famously remarked that, for some companies, 160 adjustments were made to the accounting profits in calculating
NOPAT. The Paper P5 exam will test only the most common adjustments, which are as follows:
1. Expenditure on promotional activities, research and development and employee training should be capitalised. If they have been
treated as an expense in the income statement, they should be added back to profit, and added to capital employed in the year in
which the expenses were incurred.
2. The depreciation charge is added back to profit, and instead a charge for economic depreciation is made. Economic depreciation
reflects the true change in value of assets during the period, unlike accounting depreciation. If no detail is given on economic
depreciation then candidates should assume that accounting depreciation represents a reasonable approximation for it.
3. Items such as provisions, allowances for doubtful debts, deferred tax provisions and allowances for inventory should be added
back to capital employed, since these represent over-prudence on the part of financial accountants, and this understates the true
value of capital employed. Any expenses or income recognised in the income statement in respect of movements in such items
should also be removed from NOPAT.
4. Non-cash expenses are treated with suspicion, as these are likely to reflect the finance director manipulating the profits rather
than any real costs. If the costs were real, then cash would have been paid for them. Therefore, non-cash expenses should be
added back to profits, and to capital employed.
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5. The treatment of operating leases is inconsistent with the treatment of finance leases, with finance leases being capitalised and
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operating leases being excluded from the statement of financial position. This inconsistency means that firms can take advantage
of operating leases to reduce the reported capital employed and , therefore , increase the calculated EVA. When calculating EVA
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therefore, operating leases should be capitalised and added to capital employed.
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On the income statement side, operating lease charges should be added back. In principle, interest and depreciation should then
a
be charged on the assets acquired under finance leases. However, any interest would then be added back to profit in calculating
b
NOPAT, and accounting depreciation would be replaced with economic depreciation.
The lease adjustments may soon become irrelevant as the International Accounting Standards Board (IASB) is currently revising
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IAS 17 and the revised standard may require the same treatment for both finance and operating leases.
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6. The tax charge. This is based on ‘ cash taxes ’ rather than the accruals based methods used in financial reporting. The cash
taxes are calculated as follows:
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$
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Tax charge per income statement X
Less increase (add reduction) in deferred tax provision (X)/X
Add tax benefit of interest X
Cash taxes X
Note: no further adjustments are made in respect of the tax on the other items adjusted for during the calculation of NOPAT.
The adjustments can be summarised by the following table:
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a
The finance charge
b
The finance charge is calculated by multiplying the capital employed by the weighted average cost of capital (WACC). Capital
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employed is taken to mean equity plus long-term debt, and it is normal to take capital employed at the start of the year. In practice,
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the best approach is to start with capital employed from the published statement of financial position, and then to make the
adjustments mentioned in the section above.
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Further information is as follows:
1. The allowance f or doubtful debts was $300,000 at 1 January 2009, $250,000 at 31 December 2009 and $350,000 at 31
December 2010.
2. Research and development costs of $500,000 were incurred during each of the years 2009 and 2010 on Project Z. These costs
were expensed in the income statement, as they did not meet the requirements of financial reporting standards for capitalisation.
Project Z is not complete yet.
3. At the end of 2008, the company had completed another research and development project, Project X. Total expenditure on this
project had been $1,500,000, none of which had been capitalised in the financial statements. The product developed by Project X
went on sale on 1 January 2009, and the product was a great success. The product ’s life cycle was only two years, so no further
sales of the product are expected after 31 December 2010.
4. The company incurred non-cash expenses of $15,000 in both years.
5. Capital employed (equity plus debt) per the statement of financial position was $33,500 at 1 January 2009, and $37,000 at 1
January 2010 .
6. The pre - tax cost of debt was 5% in each year. The estimated cost of equity was 12% in 2009 and 14% in 2010. The rate of
corporate income tax was 25% during both years.
7. The company’s capital structure was 60% equity and 40% debt.
8. There was no provision for deferred tax.
Required
Calculate Economic Value Added (EVA).
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Note: The research and development expenditure on both Project X and Project Z was expensed in the income statement in
accordance with financial reporting standards. Since it is considered to be market building expenditure, however, it is added back to
profits in the year it was incurred, and added back to capital employed at the end of the year in which it was incurred, when
calculating EVA.
Such capitalisation should also be amortised over the period that it brings benefits. Therefore, in the case of Project X, this has been
amortised over the two years during which the company sold products based on it. Project Z has not been completed yet, so no
amortisation has taken place.
A reconciliation of the balance can be shown as follows:
Project Z Project X Total
$000 $000 $000
Balance at 1 January 2009 0 1,500 1,500
Expenditure incurred during 2009 500 0 500
Less amortisation during 2009 0 (750) (750)
Balance at 1 Jan 2010 500 750 1,250
In the second part of this article, to be published in the next issue of Student Accountant, we will focus on interpreting the calculated
EVA , and its use as both an organisational performance measure and divisional performance measure.
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References
• John D Martin and J William Petty, Value Based Management, Harvard Business School Press 2000.
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• Shane Johnson and Matt Bamber, ‘Economic Value Added’, Student Accountant (2007), ACCA
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• Erik Stern, EVA Has Potential to Boost Employees’ Motivation, www.SternStewart.com/2011/04/erik-stern-eva/
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Economic value added versus profit-

based measures of performance - part 2
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Economic value added versus profit-based measures of performance - part 2
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Relevant to ACCA Qualification Paper P5
In the first part of this article, we considered the rise in popularity of Economic Value Added – or EVA – as an alternative to traditional
performance measurement systems. This second part focuses on interpreting the calculated EVA, and its use as both an
organisational and divisional performance measure.
Interpreting the calculated EVA
When using EVA to assess the performance of an organisation or a division, the following should be considered:
1. Is it positive? If so, that is favourable, as it means that the organisation is providing a return that is greater than that required by
providers of finance. It is creating wealth.
2. What is the trend over time? Is the calculated EVA increasing or not? Even if the trend is down, the organisation has still
performed favourably if the calculated EVA is positive.
3. Reasons for changes in EVA also need to be investigated. For individual projects, EVA is only really meaningful when looking at
the whole lifespan of a project. In the early years of a project’s life, when the net book value of the assets is higher, the finance
charge may also be higher, leading to a lower value of EVA , whereas in later years the reverse is true.
Use of EVA as an organisational performance measure
EVA is a performance measure that can be used to assess the performance of the directors of a company. The idea is that directors
will be motivated to improve EVA in one of four ways:
1. Invest in divisions where the returns on those divisions exceed the costs of capital.
2. Increase the operating performance of its existing divisions – thus increasing the net operating profits after tax (NOPAT) without
increasing the finance charge.
3. The firm can ‘harvest assets’ by closing down divisions where the return is less than the costs of capital, and either re-invest the
proceeds in other divisions, or return the cash to share holders as a dividend.
4. The firm can increase its debt to equity ratio, and thus reduce the weighted average cost of capital (as the cost of debt is less
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than the cost of equity). Clearly this must be done within the bounds of prudence, and the company should not become over-
geared.
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As such, EVA is a useful tool for assessing the performance of the directors of a company and should motivate them to maximise the
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wealth of the shareholders.
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Use of EVA as a divisional performance measure
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EVA can also be used as a performance evaluation tool for divisional managers. In decentralised organisations, divisions are
effectively companies in their own right, with the head office acting as a holding company. As such, using EVA encourages divisional
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managers to maximise the wealth of the division. Divisional managers may not have sufficient autonomy to make decisions about
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financing or gearing, so will not be able to change the weighted average cost of capital (WACC). However, using EVA should ensure
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that divisional managers only invest in projects where the return on the projects exceed the costs of the company’s capital.
Consistency with net present value
The ultimate measure of how much value an organisation creates is the net present value of the projects it invests in. Net present
value shows the return on projects in excess of the cost of financing them. If the financial markets are functioning efficiently, it should
be the case that the market value of an organisation is the same as the book value of the net assets of the organisation, plus the
present value of future cash flows. Maximising shareholders’ wealth therefore means maximising the net present value of future cash
flows.
It can be shown that residual income – and therefore EVA – is consistent with net present value. Consider the following example:
Example 1
A company will invest $10,000 in a new project. The $10,000 represents investments in non-current assets. The project will last for
three years, and will generate cash inflows of $5,000 in year one, and $7,000 in years 2 and 3. The assets will have no residual value
at the end of the life of the project. The relevant discount rate is 10%.
The net present value of the project can be calculated as follows:

Sum of discounted residual income (606 + 2,478 + 2,502) = $5,586. This is the same as the net present value calculated using the
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cash flow method above. The small difference of $2 is due to rounding.
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Note 1: Straight-line depreciation has been used, so annual depreciation is $10,000/3.
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Note 2:
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The finance charge is 10% of the net book value of the assets of the project at the start of each year:
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Year 1 Year 2 Year 3
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Opening net book value 10,000 6,667 3,334
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Less depreciation (note 1) (3,333) (3,333) (3,334)
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Closing net book value 6,667 3,334 0
Finance charge 1,000 667 334
This relationship between residual income – and therefore EVA – and net present value is important.
Return on capital employed and return on investment
So what of those well-known, traditional profit-based measures, return on capital employed and return on investment? We normally
use the former description when discussing organisations, and the latter when describing divisions of organisations. A commonly
used version of these calculations is as follows:
Return on capital employed (ROCE) = profit BEFORE interest and tax x 100
shares + reserves + long-term liabilities
Return on investment (ROI) = controllable profit x 100
capital employed
In principle, using these measures to assess the performance of the managers of an organisation should not conflict with the goal of
maximising shareholder value. However, the following problems may exist:
1. Profit can be manipulated – for example, by changing accounting policies or using different judgments. As one commentator
noted: ‘Profit is a matter of opinion, cash flow is a matter of fact.’
2. Managers may take decisions that improve profits in the short term, but may harm the business in the long term – such as cutting
back on staff training or research expenditure.
3. Using ROI as a performance measure for a divisional manager may lead to ‘goal incongruence’, where a manager rejects a
potential project that may generate a positive net present value, if the project would reduce the manager’s measured return on
investment.
These three potential problems should not exist when using EVA because:
• the adjustments made to profits in calculating NOPAT are designed to remove such accounting manipulations
• the fact that long-term value-adding expenditure can be capitalised when calculating EVA should remove any incentive that
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managers may have to take such short-term views
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• any project that will generate a positive net present value will also increase EVA .
Disadvantages of EVA
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EVA suffers from several disadvantages, such as:
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• the adjustments to profits and capital can become cumbersome, especially if performed every year
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• estimating the WACC can be difficult. While many organisations use models such as the CAPM, this is not a universally
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accepted method of determining the cost of equity
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• the calculation of WACC is based on market values of equity and debt, while the finance charge applies this WACC to adjusted
book values of equity and debt – so there is some inconsistency
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• EVA is an absolute measure, so it cannot be used to compare companies of different sizes, unlike return on investment.
In spite of these disadvantages, EVA as a performance measure does assess the value created by managers, so is a more
appropriate tool for measuring the performance of commercial organisations than profit-based ones.
References
• John D Martin and J William Petty, Value Based Management, Harvard Business School Press 2000.
• Shane Johnson and Matt Bamber, ‘Economic Value Added’, Student Accountant (2007), ACCA
• Erik Stern, EVA Has Potential to Boost Employees’ Motivation, www.SternStewart.com/ 2011/04/erik-stern-eva/
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Transfer pricing
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Transfer pricing
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Transfer prices are almost inevitably needed whenever a business is divided into more than one department or division
In accounting, many amounts can be legitimately calculated in a number of different ways and can be correctly represented by a
number of different values. For example, both marginal and total absorption cost can simultaneously give the correct cost of
production, but which version of cost you should use depends on what you are trying to do.
Similarly, the basis on which fixed overheads are apportioned and absorbed into production can radically change perceived
profitability. The danger is that decisions are often based on accounting figures, and if the figures themselves are somewhat arbitrary,
so too will be the decisions based on them. You should, therefore, always be careful when using accounting information, not just
because information could have been deliberately manipulated and presented in a way which misleads, but also because the
information depends on the assumptions and the methodology used to create it. Transfer pricing provides excellent examples of the
coexistence of alternative legitimate views, and illustrates how the use of inappropriate figures can create misconceptions and can
lead to wrong decisions.
When transfer prices are needed
Transfer prices are almost inevitably needed whenever a business is divided into more than one department or division. Usually,
goods or services will flow between the divisions and each will report its performance separately. The accounting system will usually
record goods or services leaving one department and entering the next, and some monetary value must be used to record this. That
monetary value is the transfer price. The transfer price negotiated between the divisions, or imposed by head office, can have a
profound, but perhaps arbitrary, effect on the reported performance and subsequent decisions made.
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Example 1
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Take the following scenario shown in Table 1, in which Division A makes components for a cost of $30, and these are transferred to
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Division B for $50. Division B buys the components in at $50, incurs own costs of $20, and then sells to outside customers for $90.
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As things stand, each division makes a profit of $20/unit, and it should be easy to see that the group will make a profit of $40/unit.
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You can calculate this either by simply adding the two divisional profits together ($20 + $20 = $40) or subtracting both own costs from
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final revenue ($90 – $30 – $20 = $40).
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You will appreciate that for every $1 increase in the transfer price, Division A will make $1 more profit, and Division B will make $1
less. Mathematically, the group will make the same profit, but these changing profits can result in each division making different
decisions, and as a result of those decisions, group profits might be affected.
Consider the knock-on effects that different transfer prices and different profits might have on the divisions:
Performance evaluation. The success of each division, whether measured by return on investment (ROI) or residual income (RI)
will be changed. These measures might be interpreted as indicating that a division’s performance was unsatisfactory and could tempt
management at head office to close it down.
Performance-related pay. If there is a system of performance-related pay, the remuneration of employees in each division will be
affected as profits change. If they feel that their remuneration is affected unfairly, employees’ morale will be damaged.
Make/abandon/buy-in decisions. If the transfer price is very high, the receiving division might decide not to buy any components
from the transferring division because it becomes impossible for it to make a positive contribution. That division might decide to
abandon the product line or buy-in cheaper components from outside suppliers.
Motivation. Everyone likes to make a profit and this ambition certainly applies to the divisional managers. If a transfer price was such
that one division found it impossible to make a profit, then the employees in that division would probably be demotivated. In contrast,
the other division would have an easy ride as it would make profits easily, and it would not be motivated to work more efficiently.
Investment appraisal. New investment should typically be evaluated using a method such as net present value. However, the cash
inflows arising from an investment are almost certainly going to be affected by the transfer price, so capital investment decisions can
depend on the transfer price.
Taxation and profit remittance. If the divisions are in different countries, the profits earned in each country will depend on transfer
prices. This could affect the overall tax burden of the group and could also affect the amount of profits that need to be remitted to
head office.
As you can see, therefore, transfer prices can have a profound effect on group performance because they affect divisional
performance, motivation and decision making.
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The characteristics of a good transfer price
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Although not easy to attain simultaneously, a good transfer price should:
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Preserve divisional autonomy: almost inevitably, divisionalisation is accompanied by a degree of decentralisation in decision
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making so that specific managers and teams are put in charge of each division and must run it to the best of their ability. Divisional
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managers are therefore likely to resent being told by head office which products they should make and sell. Ideally, divisions should
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be given a simple, understandable objective such as maximising divisional profit.
Be perceived as being fair for the purposes of performance evaluation and investment decisions.
Permit each division to make a profit: profits are motivating and allow divisional performance to be measured using positive ROI or
positive RI.
Encourage divisions to make decisions which maximise group profits: the transfer price will achieve this if the decisions which
maximise divisional profit also happen to maximise group profit – this is known as goal congruence. Furthermore, all divisions must
want to do the same thing. There’s no point in transferring divisions being very keen on transferring out if the next division doesn’t
want to transfer in.
Possible transfer prices
In the following examples, assume that Division A can sell only to Division B, and that Division B’s only source of components is
Division A. Example 1 has been reproduced but with costs split between variable and fixed. A somewhat arbitrary transfer price of
$50 has been used initially and this allows each division to make a profit of $20.
Example 2
See Table 2. The following rules on transfer prices are necessary to get both parties to trade with one another:
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For the transfer-out division, the transfer price must be greater than (or equal to) the marginal cost of production. This allows the
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transfer-out division to make a contribution (or at least not make a negative one). In Example 2, the transfer price must be no lower
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than $18. A transfer price of $19, for example, would not be as popular with Division A as would a transfer price of $50, but at least it
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offers the prospect of contribution, eventual break-even and profit.
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For the transfer-in division, the transfer in price plus its own marginal costs must be no greater than the marginal revenue earned
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from outside sales. This allows that division to make a contribution (or at least not make a negative one). In Example 2, the transfer
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price must be no higher than $80 as:
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$80 (transfer-in price) + $10 (own variable cost) = $90 (marginal revenue)
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Usually, this rule is restated to say that the transfer price should be no greater than the net marginal revenue of the receiving division,
where the net marginal revenue is marginal revenue less own marginal costs. Here, net marginal revenues = $80 = $90 – $10.
So, a transfer price of $50 (transfer price ≥ $18, ≤ $80), as set above, will work insofar as both parties will find it worth trading at that
price.
The economic transfer price rule
The economic transfer price rule is as follows:
Minimum (fixed by transferring division)
Transfer price ≥ marginal cost of transfer‑out division
And
Maximum (fixed by receiving division)
Transfer price ≤ net marginal revenue of transfer‑in division
As well as permitting interdivisional trade to happen at all, this rule will also give the correct economic decision because if the final
selling price is too low for the group to make a positive contribution, no operative transfer price is available.
So, in Example 2, if the final selling price were to fall to $25, the group could not make a contribution because $25 is less than the
group’s total variable costs of $18 + $10. The transfer price that would make both divisions trade must be no less than $18 (for
Division A) but no greater than $15 (net marginal revenue for Division B = $25 – $10), so clearly no workable transfer price is
available.
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If, however, the final selling price were to fall to $29, the group could make a $1 contribution per unit. A viable transfer price has to be
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at least $18 (for Division A) and no greater than $19 (net marginal revenue for Division B = $29 – $10). A transfer price of $18.50,
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say, would work fine.
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Therefore, all that head office needs to do is to impose a transfer price within the appropriate range, confident that both divisions will
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choose to act in a way that maximises group profit. Head office therefore gives each division the impression of making autonomous
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decisions, but in reality each division has been manipulated into making the choices head office wants.
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Note, however, that although we have established the range of transfer prices that would work correctly in terms of economic
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decision making, there is still plenty of scope for argument, distortion and dissatisfaction. Example 1 suggested a transfer price
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between $18 and $80, but exactly where the transfer price is set in that range vastly alters the perceived profitability and
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performance of each sub-unit. The higher the transfer price, the better Division A looks and the worse Division B looks (and vice
versa).
In addition, a transfer price range as derived in Example 1 and 2 will often be dynamic. It will keep changing as both variable
production costs and final selling prices change, and this can be difficult to manage. In practice, management would often prefer to
have a simpler transfer price rule and a more stable transfer price – but this simplicity runs the risk of poorer decisions being made.
Practical approaches to transfer price fixing
In order to address these concerns, some common practical approaches to transfer price fixing exist:
1. Variable cost
A transfer price set equal to the variable cost of the transferring division produces very good economic decisions. If the transfer price
is $18, Division B’s marginal costs would be $28 (each unit costs $18 to buy in then incurs another $10 of variable cost). The group’s
marginal costs are also $28, so there will be goal congruence between Division B’s wish to maximise its profits and the group
maximising its profits. If marginal revenue exceeds marginal costs for Division B, it will also do so for the group.
Although good economic decisions are likely to result, a transfer price equal to marginal cost has certain drawbacks:
Division A will make a loss as its fixed costs cannot be covered. This is demotivating.
Performance measurement is distorted. Division A is condemned to making losses while Division B gets an easy ride as it is not
charged enough to cover all costs of manufacture. This effect can also distort investment decisions made in each division. For
example, Division B will enjoy inflated cash inflows.
There is little incentive for Division A to be efficient if all marginal costs are covered by the transfer price. Inefficiencies in Division A
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will be passed up to Division B. Therefore, if marginal cost is going to be used as a transfer price, at least make it standard marginal
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cost, so that efficiencies and inefficiencies stay within the divisions responsible for them.
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2. Full cost/full cost plus/variable cost plus/market price
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Example 3.
See Table 3.
A transfer price set at full cost as shown in Table 3 (or better, full standard cost) is slightly more satisfactory for Division A as it means
that it can aim to break even. Its big drawback, however, is that it can lead to dysfunctional decisions because Division B can make
decisions that maximise its profits but which will not maximise group profits. For example, if the final market price fell to $35, Division
B would not trade because its marginal cost would be $40 (transfer-in price of $30 and own marginal costs of $10). However, from a
group perspective, the marginal cost is only $28 ($18 + $10) and a positive contribution would be made even at a selling price of only
$35. Head office could, of course, instruct Division B to trade but then divisional autonomy is compromised and Division B managers
will resent being instructed to make negative contributions which will impact on their reported performance. Imagine you are Division
B’s manager, trying your best to hit profit targets, make wise decisions, and move your division forward by carefully evaluated capital
investment.
The full cost plus approach would increase the transfer price by adding a mark up. This would now motivate Division A, as profits can
be made there and may also allow profits to be made by Division B. However, again this can lead to dysfunctional decisions as the
final selling price falls.
A transfer price set to the market price of the transferred goods (assuming that there is a market for the intermediate product) should
give both divisions the opportunity to make profits (if they operate at normal industry efficiencies), but again such a transfer price runs
the risk of encouraging dysfunctional decision making as the final selling price falls towards the group marginal cost. However,
market price has the important advantage of providing an objective transfer price not based on arbitrary mark ups. Market prices will
therefore be perceived as being fair to each division, and will also allow important performance evaluation to be carried out by
comparing the performance of each division to outside, stand-alone businesses. More accurate investment decisions will also be
made.
The difficulty with full cost, full cost plus, variable cost plus, and market price is that they all result in fixed costs and profits being
perceived as marginal costs as goods are transferred to Division B. Division B therefore has the wrong data to enable it to make
good economic decisions for the group – even if it wanted to. In fact, once you get away from a transfer price equal to the variable
cost in the transferring division, there is always the risk of dysfunctional decisions being made unless an upper limit – equal to the net
marginal revenue in the receiving division – is also imposed.
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Variations on variable cost
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There are two approaches to transfer pricing which try to preserve the economic information inherent in variable costs while
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permitting the transferring division to make profits, and allowing better performance valuation. However, both methods are somewhat
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complicated.
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Variable cost plus lump sum. In this approach, transfers are made at variable cost. Then, periodically, a transfer is made between
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the two divisions (Credit Division A, Debit Division B) to account for fixed costs and profit. It is argued that Division B has the correct
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cumulative variable cost data to make good decisions, yet the lump sum transfers allow the divisions ultimately to be treated fairly
with respect to performance measurement. The size of the periodic transfer would be linked to the quantity or value of goods
transferred.
Dual pricing. In this approach, Division A transfers out at cost plus a mark up (perhaps market price), and Division B transfers in at
variable cost. Therefore, Division A can make a motivating profit, while Division B has good economic data about cumulative group
variable costs. Obviously, the divisional current accounts won’t agree, and some period-end adjustments will be needed to reconcile
those and to eliminate fictitious interdivisional profits.
Markets for the intermediate product
Consider Example 1 again, but this time assume that the intermediate product can be sold to, or bought from, a market at a price of
either $40 or $60. See Table 4.
(i) Intermediate product bought/sold for $40
Division A would rather transfer to Division B, because receiving $50 is better then receiving $40. Division B would rather buy in at
the cheaper $40, but that would be bad for the group because there is now a marginal cost to the group of $40 instead of only $18,
the variable cost of production in Division A. The transfer price must, therefore, compete with the external supply price and must be
no higher than that. It must also still be no higher than the net marginal revenue of Division B ($90 – $10 = $80) if Division B is to
avoid making negative contributions.
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(ii) Intermediate product bought/sold for $60
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Division B would rather buy from Division A ($50 beats $60), but Division A would sell as much as possible outside at $60 in
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preference to transferring to Division B at $50. Assuming Division A had limited capacity and all output was sold to the outside
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market, that would force Division B to buy outside and this is not good for the group as there is then a marginal cost of $60 when
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obtaining the intermediate product, as opposed to it being made in Division A for $18 only. Therefore, we must encourage Division A
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to supply to Division B and we can do this by setting a transfer price that is high enough to compensate for the lost contribution that
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Division A could have made by selling outside. Therefore, Division A has to receive enough to cover the variable cost of production
plus the lost contribution caused by not selling outside:
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Minimum transfer price = $18 + ($60 – $18) = $60
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Basically, the transfer price must be as good as the outside selling price to get Division B to transfer inside the group.
The new rules can therefore be stated as follows:
Economic transfer price rule
Minimum (fixed by transferring division)
Transfer price ≥ marginal cost of transfer-out division + any lost contribution
And
Maximum (fixed by receiving division)
Transfer price ≤ the lower of net marginal revenue of transfer-in division and the external purchase price

Conclusion
You might have thought that transfer prices were matters of little importance: debits in one division, matching credits in another, but
with no overall effect on group profitability. Mathematically this might be the case, but only at the most elementary level. Transfer
prices are vitally important when motivation, decision making, performance measurement, and investment decisions are taken into
account – and these are the factors which so often separate successful from unsuccessful businesses.
Ken Garrett is a freelance writer and lecturer
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Performance management in public

sector organisations
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Performance management in public sector organisations
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Public sector organisations
Public sector organisations come in many shapes and forms. The most obvious examples are schools and hospitals, police forces
and local transport providers, but there are many less visible organisations such as regulatory bodies. The objectives of public sector
organisations are very different from those of commercial organisations, and this can make performance management more
complicated. The following factors in particular differentiate public sector organisations from commercial:
1. They have a broader group of stakeholders than commercial organisations. This can lead to greater conflicts. Commercial
organisations are likely to be mainly concerned with shareholders, employees, customers and their lenders. Public sector
organisations are likely to be interested in pleasing the providers of funding (the government), the users of the service and the
taxpayer. In the case of schools, for example, parents would be happy to see more money spent on education – but, as
taxpayers, they may not wish to pay more taxes.
2. Customers do not pay directly for the services they receive, and there may be little relationship between the costs of providing the
service and the amount it is used. Consider a subsidised bus service, for example. The daily costs of running the buses are likely
to be largely fixed, and do not depend on the number of passengers using them – at least in the short term. This makes it harder
to decide how much should be spent on the service.
3. Many public sector organisations operate as monopoly providers. Even if customers are not happy with the service they receive,
they cannot switch to an alternative supplier. In commercial organisations, this is generally not the case, and bad performance will
lead to a loss of customers and, therefore, loss of funding.
4. The output of public sector bodies is often difficult to measure. How do you determine how much work a police force has
performed? Statistics such as the number of crimes reported may be used. If the police force is doing a good job however, and
crime is falling, the number of crimes reported may fall. So the lower number of crimes reported would wrongly suggest that the
police force is not working so hard.
There is a perception that performance in public sector organisations is poorer than in the private sector, both in terms of efficiency
and quality of service.
Greater use of targets in public sector organisations
Since the early 1980s the governments of some countries – notably the UK, Sweden, Australia and New Zealand – have undertaken
reforms aimed at making public sector organisations become more accountable. These reforms have been driven by the need to:
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• improve the overall efficiency and effectiveness of public expenditure
• reduce overall levels of expenditure
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• improve accountability and transparency of the public sector
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• enhance the responsiveness of public sector organisations to the needs of citizens.
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Such reforms have been dubbed the ‘new public management’.
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One of the key features of these reform programmes has been the increasing use of performance measures and targets to evaluate
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all aspects of the performance of an organisation’s activities. Typically, objectives are identified based on the mission statement.
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Targets are set for each objective. Managers must explain any variances between actual performance and the targets.
The targets are normally based on some output of the organisation. Typical targets might be the number of patients treated by a
doctor, or the number of passports issued by the passport issuing authority. Qualitative targets may also be used, such as the level of
patient care, which could be measured using surveys of patients.
This highly rational approach to performance management has its roots in the writings of Drucker and Argenti, who emphasised
detailed planning and the use of quantified targets. They argued that this gives greater direction to the management and staff of an
organisation.
The use of and publication of targets also increases accountability. In the public sector, the managers are the agents, who act on
behalf of the principal. The principal would be the general public, although the role of principal is often played by the government on
their behalf. Much discussion of accountability focuses on whether or not managers have acted ethically – ie have not stolen the
funds provided to them, and can account for their use. An equally important aspect of accountability, however, is how well the agent
has performed in terms of efficiency.
Linking reward schemes to targets
Performance-related pay schemes are usually introduced alongside the targets, whereby bonuses are paid if particular targets are
achieved. In the UK , for example, the government introduced an incentive programme for doctors in 2004, whereby bonuses are
awarded based on the achievement of 146 targets. These targets focus on a wide range of areas, including clinical care, practice
organisation and patient satisfaction. The bonuses are on a sliding scale – so even if not all of the targets are achieved, some of the
available bonus would be paid.
Having such reward schemes is designed to improve the motivation of the management and staff, and it is argued that this improves
the overall performance of t he organisation.
Difficulties of using targets in the public sector
The use of targets in the public sector is not without problems, however:
1. The larger number of stakeholders makes it difficult to decide which metrics should be used. Often, governments focus on
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reducing costs. This has led to situations such as hospitals refusing to buy life saving medicines because they are too expensive,
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or police being removed from the beat to save money.
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2. There may be less of a direct link between effort and outcomes in the public sector. In a hospital, for example, mortality rates may
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depend on many factors that are outside of the control of the hospital. Individual targets may not be a fair measure of
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performance in such situations; however, using a range of targets may overcome these problems.
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3. It may be difficult to identify quantifiable outputs in the public sector. How does one measure the output of the local fire brigade,
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for example?
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4. If systems are implemented in a very rigid way, without giving consideration to local issues, or special situations relating to the
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organisations being measured, then this may lead to problems such as manipulation of data, tunnel vision, sub optimisation and
so on.
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5. Many critics of targets in the public sector argue that their use has not resulted in lower costs or better quality of service. They
claim that what has actually happened is that a higher portion of the organisation’s budget is spent on employing managers and
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accountants to set the targets and measure performance, and a lower portion has been spent on frontline services.
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This final criticism does not appear to have been confirmed by the facts. In the UK National Health Service (NHS), for example, the
period from 1999 to 2009 saw a large rise in the use of targets. During this period, the average increase in support staff was 3.6%
per annum, while the average increase in total staff was 3% per annum, according to statistics released by the NHS information
centre (www.ic.nhs.uk). There was clearly some increase in the portion of budgets spent on managers, but hardly a significant
increase.
Empirical evidence
It is extremely difficult to assess the impact of the use of targets in public sector organisations, due to the fact that it is difficult to
assess what would have occurred had they not been introduced. Unlike scientific experiments, where there is a control experiment,
no such control experiment exists in the public sector. In some situations, governments introduce pilot schemes in an attempt to gain
some sort of comparison, but it is often difficult to get precise comparisons.
Another problem is that numerous changes have been made to the practices of setting and monitoring targets over the years, making
the picture even less clear. Debate has largely focused on anecdotal evidence rather than on proper studies of the outcomes.

Studies into the impact of performance-related reward schemes are fairly few and far between, but do appear to show a positive
relationship between the use of performance-related pay and the performance of the staff of the organisation (5). While such studies
have shown that individuals work harder, the impact on the provision of services overall is far from certain.
Use of benchmarking in public sector bodies
Benchmarking has also been used in many countries as a means of reducing the perceived gap between the performance of public
sector organisations and their private sector counterparts, with the aim of improving the quality of service, and ultimately saving the
taxpayer’s money.
Benchmarking is where one organisation compares its performance in a specific area with another organisation, the benchmark, to
identify how much room there is for improvement. It then attempts to implement practices similar to the benchmark in an attempt to
narrow the gap in performance.
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The specific area for benchmarking could be a particular business process – such as inventory control, or it could be a broader area
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such as 'quality of customer service'. The benchmark could be another organisation, or it could be another department within the
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same organisation.
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Seven-step approach to benchmarking
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The consulting firm Kaiser Associates proposes a seven-step approach to benchmarking as follows:
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1. Determine which areas or functions to benchmark. It would probably not be feasible to benchmark all functions at one time, so it
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is necessary to choose those activities where benchmarking can bring the greatest benefits to the organisation. This may be
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based on which activities offer the greatest scope for cost savings, or which are ‘key service differentiators’.
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2. Identify the performance indicators and performance drivers that will be measured during the benchmarking exercise.
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3. Select the organisations that will be used as the benchmark.
4. Measure the performance of the benchmark using the measures identified in step two above.
5. Measure your own performance, and compare it to the benchmark to identify the gaps.
6. Specify actions and programmes to close the gap. This involves analysing how the benchmark achieves superior performance,
and identifying similar practices that could be adopted.
7. Implement and monitor the actions and programmes. Monitoring should not be a one-off process, but should continue for a longer
period after the benchmarking exercise.
Identifying the performance indicators
In public sector benchmarking, the performance indicators used tend to focus on cost and efficiency or differentiation. Cost variables
might include items such as labour efficiency, or total costs for a particular function as a percentage of income.
Regarding differentiation, many of the metrics used would be of a qualitative nature, such as client satisfaction or quality of service. It
is difficult to measure these directly due to their subjectivity. One approach is to use customer surveys for these.
In attempting to find relevant metrics, benchmarking exercise s carried out in the past by similar organisations can be a useful
source. Much information about these is available in accounting and business journals, and online, or by contacting organisations
that have already performed a benchmarking exercise. This is easier in the public sector, as the government – as overseer and
beneficiary of the benchmarking – can often force other organisations to disclose information. This would not be the case in the
private sector.
Selecting the benchmark
When choosing the benchmark, we can talk about different types of benchmarking:
• Internal benchmarking uses another organisation within the same organisation. For example, a comparison of the performance
of the procurement department of one hospital with the procurement department of another hospital.
• External functional benchmarking is where a particular function is compared with that function for the organisation that performs
that function best, regardless of which industry they are in.
• Competitive benchmarking is where a competitor is used as the benchmark. This may not be so common in the public sector.
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When using external functional benchmarking, using a similar organisation in terms of objectives and size can make the process
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easier. It is not necessary then to take into account differences between the two organisations when comparing their performance,
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and it should be easier to adopt the practices of the benchmark if they are similar. For example, if a school uses a similar school in a
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different area as a comparator.
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External functional benchmarking can also be performed successfully using out of category organisations – ie organisations that may
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be have totally different objectives and even different primary activities. Using such benchmarks will make the process more
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complex, but may provide the opportunity for an organisation to overtake, rather than simply to catch up with comparable
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organisations. For example, a public sector logistics department could use one of the private sector international courier companies
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as a benchmark for its logistics.
The most important factor when selecting the benchmark is to identify the ‘best in class’ for the activity or business process being
benchmarked.
Measuring the performance of the benchmark
Prior to starting to perform measurement, the organisation will have identified what it wants to measure (in step two), so it should
already be clear what information is required. The question now is how to obtain it.
Much information is already in the public domain. Many organisations publish information about best practice benchmarks for
particular industries. Financial reports may provide information about cost efficiency. There may be newspaper reports or analysts’
reports available for larger listed companies. Publicly available information is a good place to start, but it is unlikely to provide all the
information required for a successful benchmarking exercise.
Another source of information is ‘data sharing’ where other organisations are contacted, either directly and formally, or through
professional conferences. This can be supplemented by interviewing of staff at the benchmark.
Factors that influence the effectiveness of benchmarking
Based on some empirical research, Sandra Tillema tried to identify what factors determine whether or not a benchmarking exercise
actually leads to improved performance. A study of benchmarking carried by four Dutch water boards concluded that the performance
of those water boards had not improved after the benchmarking.
Tillema claims that one reason for the lack of success of many public sector benchmarking exercises is that they focus only on
measuring performance against the benchmark. They do not attempt to learn from, and adopt the practices of, the benchmark. Thus,
the benchmarking is often a measuring exercise, not a learning exercise.
A second factor is the influence of stakeholders. A benchmarking exercise will only lead to improvement s if pressure is put on the
organisation from its stakeholders to narrow the gap identified between the organisation and the benchmark. This pressure can come
from internal stakeholders, such as supervisory boards, or external stakeholders, such as users of the service. In the case of the
Dutch water boards, no pressure had been exerted on the managements of the board, which is why no improvement was
experienced.
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In some situations, benchmarking may lead to economic pressure on an organisation to improve. If poor benchmarking results are
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published, users of the service may switch to alternative providers. So benchmarking can lead to economic pressure on poorer
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organisations. In the case of state universities, for example, students have a choice which university to go to, and their choice may
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be influenced by published results of benchmarking.
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Such economic pressure only works in situations where users can switch service provider. This is not always the case, and monopoly
providers of services will not feel this economic pressure. Another issue is that users may not always understand the results of
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benchmarking, and their decisions may be based on factors other than the benchmarking exercise – for example, the student that
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chooses a university based on the better nightlife in the city where it is located, rather than the publicly available results of
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benchmarking.
Dysfunctional effects of benchmarking
Tillema notes that in common with all performance measurement, benchmarking may lead to dysfunctional behaviour. Management
may take actions to improve their measured scores without improving underlying performance. A criticism by some of UK schools is
that management focus on improving their performance in the government league tables, not on providing a good education for
pupils. This is part of a general problem in performance management, which is the ‘what gets measured gets done’ concept.
Benchmarking can also be used to defend rather than improve poor performance. In such cases, management focus on explaining
why their organisation performed poorly, citing factors that make their organisation different from its peers. In such cases, the
benchmarking leads to little or no improvement in performance.
One factor that leads to greater levels of dysfunctional behaviour is where stakeholders misinterpret the results. For example, they do
not take account of different operating environments, or different objectives of the organisation and benchmark, and this leads to
unrealistic pressure to close the performance gaps.
Misinterpretation is less common where the results are only made available to expert stakeholders. Because the expert stakeholders
have a better understanding of the performance, and the factors that may differentiate the organisation from its peer s, they will be
more realistic in their assessment of the results. This reduces the incentive for managers to manipulate the results.
League tables
League tables are commonly used in the public sector to present the results of benchmarking. Under league tables, the various
metrics are summarised into a weighted average overall score. A league table is then prepared, showing all organisations ranked
according to their overall score – for example, UK schools are ranked by exam results.
The benefit of league tables is that many different areas of performance are summarised into one final score, showing how well the
organisation has performed over all. League tables are also designed to improve competition among the organisations, giving an
incentive to the poorer performers to improve so that they move up the table.
Common criticisms of league tables are that they apply arbitrary weighting to the various factors that are used in the calculation of
the final score. It is also argued that they do not take into account differences between the organisations being measured. In schools,
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for example, one factor that affects the performance of schools quite strongly is the demographics of the area where the schools are
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located, with schools in poorer areas typically appearing towards the bottom of the table.
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Conclusion
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There has been a move towards making public sector bodies more efficient and effective, using more targets and benchmarking. It is
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not clear whether targets have improved the performance of public sector bodies or not. Benchmarking can lead to improved
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performance in some public organisations. However, it is most successful where stakeholders have the ability to apply pressure to
the organisations to narrow the gap between their actual performance and that of the benchmark. If not, then the benchmarking may
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not lead to improved performance.
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References
1. Bruder Jr, Kenneth A Gray, Edward M, ‘Public sector benchmarking: a practical approach’, published in Public Management,
September 1994
2. Sandra Tillema, ‘Public sector benchmarking and performance improvement: what is the link and can it be improved?’, published
in Public Money and Management, January 2010.
3. Noel Hyndman and Francis McGeough, ‘NPM and performance measurement: a comparative study of the public sectors in
Ireland and the UK’, published in Irish Accounting Review, December 2008
4. NHS Staff overview, published on the web site , www.ic.nhs.uk
5. Graham Prentice, Simon Burgess and Carol Propper, ‘Performance pay in the public sector: A review of the issues and evidence’.
Published for the UK Office of Manpower Economics – www.ome.uk.com
6. Benchmarking Process at www.kaiserassociates.com/capabilities/benchmarking
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Several papers in the ACCA Qualification may feature questions on not-for-profit organisations. Although many of the
principles of management and organisation apply to most business models, not-for-profit organisations have numerous
features that distinguish them from the profit maximising organisations often assumed in conventional economic theory.
This article explains some of these features. The first part of the article broadly describes the generic characteristics of not-for-profit
organisations. The second part of the article takes a specific and deeper look at charities, which are one of the more important types
of not-for-profit organisations.
What is a not-for-profit organisation?

It would be simplistic to assume that any organisation that does not pursue profit as an objective is a not-for-profit organisation. This
is an incorrect assumption, as many such organisations do make a profit every year and overtly include this in their formal plans.
Quite often, they will describe their profit as a ‘surplus’ rather than a profit, but as either term can be defined as an excess of income
over expenditure, the difference may be considered rather semantic.
Not-for-profit organisations are distinguished from profit maximising organisations by three characteristics. First, most not-for-profit
organisations do not have external shareholders providing risk capital for the business. Second, and building on the first point, they
do not distribute dividends, so any profit (or surplus) that is generated is retained by the business as a further source of capital. Third,
their objectives usually include some social, cultural, philanthropic, welfare or environmental dimension, which in their absence,
would not be readily provided efficiently through the workings of the market system.
Types of not-for-profit organisation

Not-for-profit organisations exist in both the public sector and the private sector. Most, but not all, public sector organisations do not
have profit as their primary objective and were established in order to provide what economists refer to as public goods. These are
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mainly services that would not be available at the right price to those who need to use them (such as medical care, museums, art
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galleries and some forms of transportation), or could not be provided at all through the market (such as defence and regulation of
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markets and businesses). Private sector examples include most forms of charity and self-help organisations, such as housing
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associations that provide housing for low income and minority groups, sports associations (many football supporters’ trusts are set up
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as industrial and provident societies), scientific research foundations and environmental groups.
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Corporate form
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Not-for-profit organisations can be established as incorporated or unincorporated bodies. The common business forms include the
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following:
• in the public sector, they may be departments or agents of government
• some public sector bodies are established as private companies limited by guarantee, including the Financial Services Authority
(the UK financial services regulator)
• in the private sector they may be established as cooperatives, industrial or provident societies (a specific type of mutual
organisation, owned by its members), by trust, as limited companies or simply as clubs or associations.
A cooperative is a body owned by its members, and usually governed on the basis of ‘one member, one vote’.
A trust is an entity specifically constituted to achieve certain objectives. The trustees are appointed by the founders to manage the
funds and ensure compliance with the objectives of the trust. Many private foundations (charities that do not solicit funds from the
general public) are set up as trusts.
Formation, constitution, and objectives
Not-for-profit organisations are invariably set up with a purpose or set of purposes in mind, and the organisation will be expected to
pursue such objectives beyond the lifetime of the founders. On establishment, the founders will decide on the type of organisation
and put in place a constitution that will reflect their goals. The constitutional base of the organisation will be dictated by its legal form.
If it is a company, it will have a Memorandum and Articles of Association, with the contents of the latter entrenched to ensure that the
objectives cannot be altered easily in the future. Not-for-profit organisations that are not companies most commonly have a set of
Rules, which are broadly equivalent to Articles of Association.
As with any type of organisation, the objectives of not-for-profit organisations are laid down by the founders and their successors in
management. Unlike profit maximisers, however, the broad strategic objectives of not-for-profit organisations will tend not to change
over time.
The purposes of the latter are most often dictated by the underlying founding principles. Within these broad objectives, however, the
focus of activity may change quite markedly. For example, during the 1990s the British Know-How Fund, which was established by
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the UK government to provide development aid, switched its focus away from the emerging central European nations in favour of
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African nations.
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It is important to recognise that although not-for-profit organisations do not maximise profit as a primary objective, many are expected
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to be self-financing and, therefore, generate profit in order to survive and grow. Even if their activities rely to some extent on external
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grants or subventions, the providers of this finance invariably expect the organisation to be as financially self-reliant as possible.
As the performance of not-for-profit organisations cannot be properly assessed by conventional accounting ratios, such as ROCE,
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ROI, etc, it often has to be assessed with reference to other measures. Most not-for-profit organisations rely on measures that
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estimate the performance of the organisation in relation to:
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• effectiveness – the extent to which the organisation achieves its objectives
• economy – the ability of the organisation to optimise the use of its productive resources (often assessed in relation to cost
containment)
• efficiency – the ‘output’ of the organisation per unit of resource consumed.
Many service-orientated organisations use ‘value for money’ indicators that can be used to assess performance against objectives.
Where the organisation has public accountability, performance measures can also be published to demonstrate that funds have been
used in the most cost-effective manner.
It is important within an exam question to read the clues given by the examiner regarding what is important to the organisation and
what are its guiding principles, and to use these when assessing the performance of the organisation.
Management
The management structure of not-for-profit organisations resembles that of profit maximisers, though the terms used to describe
certain bodies and officers may differ somewhat.
While limited companies have a board of directors comprising executive and non-executive directors, many not-for-profit
organisations are managed by a Council or Board of Management whose role is to ensure adherence to the founding objectives. In
recent times there has been some convergence between how companies and not-for-profit organisations are managed, including
increasing reliance on non-executive officers (notably in respect of the scrutiny or oversight role) and the employment of ‘career’
executives to run the business on a daily basis.
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Not-for-profit organisations - part 2

Charities
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Not-for-profit organisations - part 2 Charities
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The term ‘charity’ refers to the practice of benevolent giving. Charities are established for general or specific philanthropic
purposes.
They are one type of not-for-profit organisation, but with several additional distinguishing features:
• they exist entirely to benefit defined groups in society
• as their purposes are philanthropic, they can usually avail themselves of favourable tax treatment, and for this reason have to
be registered with a regulator
• their activities are restricted or limited by a regulator
• they rely on the financial support of the public or businesses (or both) in order to achieve their objectives
• in order to be financially viable, they rely heavily on voluntary (unpaid) managers and workers.
Charitable activities
In the UK, charities are regulated by the Charities Act 2006, which sets out in very broad terms what may be considered to be
charitable activities, many of which would be considered as such in other jurisdictions within most other countries. These include:
• the prevention or relief of poverty
• the advancement of education
• the advancement of religion
• the advancement of health or the saving of lives
• the advancement of citizenship or community development the advancement of the arts, culture, heritage or science
• the advancement of amateur sport
• the advancement of human rights, conflict resolution or reconciliation or the promotion of religious or racial harmony or equality
and diversity
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• the advancement of environmental protection or improvement
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• the relief of those in need, by reason of youth, age, ill-health, disability, financial hardship or other disadvantage
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• the advancement of animal welfare
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• the promotion of the efficiency of the armed forces of the Crown or of the police, fire and rescue services or ambulance services
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• other purposes currently recognised as charitable and any new charitable purposes which are similar to another charitable
purpose.
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The activities of charities in England and Wales are regulated by the Charity Commission, itself a not-for-profit organisation, located
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in Liverpool. The precise definition of what constitutes charitable activities differs, of course, from country to country. However, most
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of the activities listed above would be considered as charitable, as they would seldom be associated with commercial organisations.
CorporateA
form
Charities differ widely in respect of their size, objectives and activities. For example, Oxfam is a federal international organisation
comprising 13 different bodies across all continents, while many thousands of charities are local organisations managed and staffed
entirely by volunteers.
Unsurprisingly, most of the constituent organisations within Oxfam operate as limited companies, while local charities would find this
form inappropriate and prefer to be established as associations.
A charity is not forbidden from engaging in commercial activities provided that these activities fully serve the objectives of the charity.
For example, charities such as the British Heart Foundation, the British Red Cross, and Age Concern all raise funds by operating
chains of retail shops. These shops are profitable businesses, but if a company is formed to operate the shops, the company would
be expected to formally covenant its entire annual profits to the charity.
Charities with high value non-current assets, such as real estate, usually vest the ownership of such assets to independent guardian
trustees, whose role is to ensure that the assets are deployed in a manner that reflects the objectives of the charity.
The guardian trustees are empowered to lease land, subject to the provisions of the lease satisfying requirements laid down by the
Charity Commission.
Formation, constitution and objectives

Charities are always formed with specific philanthropic purposes in mind. These purposes may be expanded or varied over time,
provided the underlying purpose remains. For example, Oxfam was originally formed as the Oxford Committee for Famine Relief in
1942, and its original purpose was to relieve the famine in Greece brought about by the Allied blockade. Oxfam now provides famine
relief on a worldwide basis.
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The governing constitution of a charity is normally set down in its rules, which expand on the purposes of the business. Quite often,
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the constitution dictates what the organisation cannot do, as well as what it can do.
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Charities plan and control their activities with reference to measures of effectiveness, economy and efficiency. They often publish
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their performance outcomes in order to convince the giving public that the good causes that they support ultimately benefit from
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charitable activities.
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Management
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Most charities are managed by a Council, made up entirely of volunteers. These are broadly equivalent to non-executive directors in
limited companies. It is the responsibility of the Council to chart the medium to long-term strategy of the charity and to ensure that
objectives are met.
Objectives may change over time due to changes in the external environment in which the charity operates. Barnardos is a childrens’
charity that was originally founded as Doctor Barnado’s Homes, to provide for orphans who could not rely on family support.
The development of welfare services after World War II and the increasing willingness of families to adopt and foster children resulted
in less reliance on the provision of residential homes for children but greater reliance on other support services. As a result, the
Barnardos charity had to change the way in which it looked at maximising the welfare of orphaned children.
Local charities are dependent on the support of a more limited population and therefore have to consider whether their supporters
will continue to provide the finance necessary to operate continuously. For example, a local charity supporting disabled sports could
be profoundly affected by the development of facilities funded by central or local government.
Every charity is confronted by distinctive strategic and operational risks, of which the Council must take account in developing and
implementing its plans. International aid charities are vulnerable to country risk and currency risk, so plans have to take account of
local conditions in countries whose populations they serve. Many such countries may, of course, be inherently unstable politically.
Operational risk for charities arises from the high dependence on volunteer workers, including the extent to which they can rely on
continued support, as well as problems of internal control. For example, many charities staff their shops with the help of unpaid
retired people, but there is some debate as to whether future generations of retired people will be as willing to do this for nothing.
As many charities have to contain operating expenses in order to ensure that their objectives can be met, it is often difficult or
impossible for them to employ full time or part time paid staff to replace volunteer workers.
Risks also arise from the social environment, particularly in times of recession, when members of the public may be less disposed to
give to benefit others as their discretionary household income is reduced.
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There is some evidence of ‘charity fatigue’ in the UK. This arises when the public feel pressurised by so many different competing
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charities that they feel ill-disposed to give anything to anyone at all.
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Test how much of this article, and Part 1 of the article, you have understood below.
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This article provides a brief overview of two models which can assist accountants, not only in the determination of
business strategy, but also in the appraisal of business performance.
Porter’s Five Forces Model

The use of Porter’s five forces model (see Figure 1) will help identify the sources of competition in an industry or sector.
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The model has similarities with other tools for environmental audit, such as political, economic, social, and technological (PEST)
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analysis, but should be used at the level of the strategic business unit, rather than the organisation as a whole. A strategic business
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unit (SBU) is a part of an organisation for which there is a distinct external market for goods or services. SBUs are diverse in their
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operations and markets so the impact of competitive forces may be different for each one.
Five forces analysis focuses on five key areas: the threat of entry, the power of buyers, the power of suppliers, the threat of
substitutes, and competitive rivalry.
The threat of entry

This depends on the extent to which there are barriers to entry. These barriers must be overcome by new entrants if they are to
compete successfully. Johnson et al (2005), suggest that the existence of such barriers should be viewed as delaying entry and not
permanently stopping potential entrants. Typical barriers are detailed below.
Economies of scale
For example, the benefits associated with volume manufacturing by organisations operating in the automobile and chemical
industries. Lower unit costs result from increased output, thereby placing potential entrants at a considerable cost disadvantage
unless they can immediately establish operations on a scale that will enable them to derive similar economies.
The capital requirement of entry
These vary according to technology and scale. Certain industries, especially those which are capital intensive and/or require very
large amounts of research and development expenditure, will deter all but the largest of new companies from entering the market.
Access to supply or distribution channels
In many industries, manufacturers enjoy control over supply and/or distribution channels via direct ownership (vertical integration) or,
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quite simply, supplier or customer loyalty. Potential market entrants may be frustrated by not being able to get their products
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accepted by those individuals who decide which products gain shelf or floor space in retailing outlets. Retail space is always at a
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premium and untried products from a new supplier constitute an additional risk for the retailer.
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Supplier and customer loyalty
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A potential entrant will find it difficult to gain entry to an industry where there are one or more established operators with a
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comprehensive knowledge of the industry, and with close links with key suppliers and customers.
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Cost disadvantages independent of scale
Well-established companies may possess cost advantages which are not available to potential entrants irrespective of their size and
cost structure. Critical factors include proprietary product technology, personal contacts, favourable business locations, learning
curve effects, favourable access to sources of raw materials, and government subsidies.
Expected retaliation
In some circumstances, a potential entrant may expect a high level of retaliation from an existing firm, designed to prevent entry – or
make the costs of entry prohibitive.
Government regulation
This may prevent companies from entering into direct competition with nationalised industries. In other scenarios, the existence of
patents and copyrights afford some degree of protection against new entrants.
Differentiation
Differentiated products and services have a higher perceived value than those offered by competitors. Products may be differentiated
in terms of price, quality, brand image, functionality, exclusivity, and so on. However, differentiation may be eroded if competitors can
imitate the product or service being offered and/or reduce customer loyalty.
The power of buyers

The power of the buyer will be high where:
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• there are a few, large players in a market. For example, large supermarket chains can apply a great deal of price pressure on
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their potential suppliers. This is especially the case where there are a large number of undifferentiated, small suppliers, such as
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small farming businesses supplying fresh produce to large supermarket chains
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• the cost of switching between suppliers is low, for example from one haulage contractor to another
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• the buyer’s product is not significantly affected by the quality of the supplier’s product. For example, a manufacturer of foil and
cling film will not be affected too greatly by the quality of the spiral-wound paper tubes on which their products are wrapped
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• buyers earn low profits
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• buyers have the potential for backward integration, for example where the buyer might purchase the supplier and/or set up in
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business and compete with the supplier. This is a strategic option which might be selected by a buyer in circumstances where
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favourable prices and quality levels cannot be obtained
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• buyers are well informed. For example, having full information regarding availability of supplies.
The power of suppliers

The power of the seller will be high where (and this tends to be a reversal of the power of buyers):
• there are a large number of customers, reducing their reliance upon any single customer
• the switching costs are high. For example, switching from one software supplier to another could prove extremely costly
• the brand is powerful (BMW, McDonalds, Microsoft). Where the supplier’s brand is powerful then a retailer might not be able to
operate a particular brand in its range of products
• there is a possibility of the supplier integrating forward, such as a brewery buying restaurants
• customers are fragmented so that they have little bargaining power, such as the customers of a petrol station situated in a
remote location.
The threat of substitutes
The threat of substitutes is higher where:
• there is product-for-product substitution, eg for fax and postal services
• there is substitution of need. For example, better quality domestic appliances reduce the need for maintenance and repair
services. The information technology revolution has made a significant impact in this particular area as it has greatly diminished
the need for providers of printing and secretarial services
• there is generic substitution competing for disposable income, such as the competition between carpet and flooring
manufacturers.
Competitive rivalry
Competitive rivalry is likely to be high where:
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• there are a number of equally balanced competitors of a similar size. Competition is likely to intensify as one competitor strives
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to attain dominance over another
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• the rate of market growth is slow. The concept of the life cycle suggests that in mature markets, market share has to be
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achieved at the expense of competitors
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• there is a lack of differentiation between competitor offerings because, in such situations, there is little disincentive to switch
from one supplier to another
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• the industry has high fixed costs, perhaps as a result of capital intensity, which may precipitate price wars and hence low
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margins. Where capacity can only be increased in large increments, requiring substantial investment, then the competitor who
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takes up this option is likely to create short-term excess capacity and increased competition
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• there are high exit barriers. This can lead to excess capacity and, consequently, increased competition from those firms
effectively ‘locked in’ to a particular marketplace.
In summary, the application of Porter’s five forces model will increase management understanding of an industrial environment which
they may want to enter.
Example 1
Kleen-up plc, which provides factory cleaning services, is considering a strategic decision to set up industrial launderettes in order to
enter the market for cleaning industrial work-wear in the country of Eajland. Map the following eight points onto the five forces model:
1. A government grant, equal to 95% of the start-up costs, will be paid to any organisation setting up an industrial launderette.
2. Disposable work-wear is available on a nationwide basis from a distributor of imported products.
3. A large number of businesses spend large amounts of money on cleaning employees’ work-wear each week.
4. There are very few high quality launderettes capable of cleaning industrial work-wear to a satisfactory standard.
5. Health and Safety legislation in Eajland encourages the use of launderettes by businesses.
6. Other launderettes within the community regularly offer free cleaning, or high discounts on the cleaning of clothing items.
7. The number of industrial firms setting up in Eajland is increasing by 10% per annum.
8. The market in the cleaning of industrial work-wear in Eajland is relatively new, and is projected to grow rapidly.
Answer
1. A government grant, equal to 95% of the start-up costs, will be paid to any organisation setting up an industrial launderette. threat
of entry – low barriers to entry.
2. Disposable work-wear is available on a nationwide basis from a distributor of imported products. product-for-product substitution.
3. A large number of businesses spend large amounts of money on cleaning employees’ work-wear each week. high bargaining
power of buyers.
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4. There are very few high quality industrial launderettes capable of cleaning industrial work-wear to a satisfactory standard. high
bargaining power of suppliers.
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5. Health and Safety legislation in Eajland encourages the use of industrial launderettes by businesses. threat of entry reduced by
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legislation.
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6. Other launderettes within the community regularly offer free cleaning, or high discounts on the cleaning of clothing items. threat of
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entry – differentiation.
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7. The number of industrial firms setting up in Eajland is increasing by 10% per annum. bargaining power of buyers.
8. The market in the cleaning of industrial work-wear is relatively new, and is projected to grow rapidly.
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Factors to consider for performance management
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When conducting a five forces assessment an organisation will need to consider:
• how to measure the strength of the forces and how reliable those measurements are
• how to manage the forces identified to mitigate their influence on the organisation’s future performance
• what performance measures are required to monitor the forces
The Boston Consulting Group Matrix

There is a fundamental need for management to evaluate existing products and services in terms of their market development
potential, and their potential to generate profit. The Boston Consulting Group matrix, which incorporates the concept of the product
life cycle (PLC), is a useful tool which helps management teams to assess existing and developing products and services in terms of
their market potential. More importantly, the model can also be used to assess the strategic position of SBUs, and in this respect it is
particularly useful to those organisations which operate in a number of different markets.
The matrix offers an approach to product portfolio planning. It has two controlling aspects, namely relative market share (meaning
relative to the competition) and market growth. Management must consider each product or service marketed, and then position it on
the matrix. This should be done for every product manufactured or service provided, and management should then plot the position
of competitors’ products and services on the matrix in order to determine relative market share.
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Stars
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Stars are products which have a good market share in a strong and growing market. As a product moves into this category it is
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commonly known as a ‘rising star’. While a market is strong and still growing, competition is not yet fully established. Since demand
is strong, and market saturation and over-supply is not an issue, the pricing of such products is relatively unhindered, and therefore
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these products generate very good margins. At the same time, manufacturing overheads are minimised due to high volumes and
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good economies of scale. These are great products, and worthy of continuing investment for as long as they have the potential to
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achieve good rates of growth. In circumstances where this potential no longer exists, these products are likely to fall vertically in the
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matrix into the ‘cash cow’ quadrant (‘fallen stars’), and their cash characteristics will change. It is therefore vital that a company has
‘rising stars’ developing from its ‘problem children’ in order to fill the void left by the fallen stars.
Problem children
‘Problem children’ have a relatively low market share in a high-growth market, often due to the fact that they are new products, or that
they are yet to receive recognition by prospective purchasers. In order to realise the full potential of problem children, management
needs to develop new business prudently, and apply sound project management principles if it is to avoid costly disasters. Gross
profit margins are likely to be high, but overheads are also high, covering the costs of research, development, advertising, market
education, and low economies of scale. As a result, the development of problem children can be loss-making until the product moves
into the rising star category, which is by no means assured. This is evidenced by the fact that many problem children products remain
as such, while others become tomorrow’s ‘dogs’.
Cash cows
A cash cow has a relatively high market share in a low growth market, and should generate significant cash flows. This somewhat
crude metaphor is based on the idea of ‘milking’ the returns from a previous investment that established good distribution and market
share for the product. Activities to support products in this quadrant should be aimed at maintaining and protecting their existing
position, together with good cost management, rather than aimed at growth. This is because there is little likelihood of additional
growth being achieved.
Dogs
A dog has a relatively low market share in a low growth market, might well be loss making, and therefore have negative cash flow. A
common belief is that there is no point in developing products or services in this quadrant. Many organisations discontinue ‘dogs’, but
businesses that have been denied adequate funding for development may find themselves with a high proportion of their products or
services in this quadrant.
Limitations of the Boston Consulting Group matrix

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The popularity of the matrix has diminished as more comprehensive models have been developed. Management should exercise a
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degree of caution when using the matrix. Some of its limitations are detailed below:
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• The rate of market growth is just one factor in an assessment of industry attractiveness, and relative market share is just one
factor in the assessment of competitive advantage. The matrix ignores many other factors that contribute towards these two
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important determinants of profitability.
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• There can be practical difficulties in determining what exactly ‘high’ and ‘low’ (growth and share) can mean in a particular
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situation.
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• The focus upon high market growth can lead to the profit potential of declining markets being ignored.
• The matrix assumes that each SBU is independent. This is not always the case, as organisations often take advantage of
potential synergies.
• The use of the matrix is best suited to SBUs as opposed to products, or to broad markets (which might comprise many market
segments).
• The position of dogs is frequently misunderstood, as many dogs play a vital role in helping SBUs achieve competitive
advantage. For example, dogs may be required to complete a product range and provide a credible presence in the market.
Dogs may also be retained in order to reduce the threat from competitors.
Notwithstanding these limitations, the Boston Consulting Group matrix provides a useful starting point in the assessment of the
performance of products and services and, more importantly, of SBUs.
Example 2
Domestic Appliances Ltd (DAL) commenced trading in 1955, when it started to manufacture semi-automatic washing machines. From
1965, DAL expanded its product portfolio. Core products now include fully automatic washing machines, dishwashers, and cookers.
The market in domestic appliances is extremely competitive. DAL’s principal competitor is the Jarvis Electrical Group (JEG), which
has achieved the position of market leader in many similar areas of the market. Other information is as follows:
1. JEG is the market leader in dishwashers, having 48% of the market. DAL has only 30% of the market. Environmentalist pressure
groups, concerned about water consumption, have caused a significant diminution in the size of the market for dishwashers.
However, the market remains profitable and this is expected to continue.
2. DAL continues to manufacture washing machines using a process which uses new materials for each unit. Legislation now
requires that 35% of all materials used comprise recycled materials, which means that DAL will no longer be able to sell its
washing machines in certain markets.
3. Both DAL and JEG have invested very heavily in the manufacture of steam ovens. DAL has 12% of the new market, while JEG
has an 18% share of the new market.
4. DAL has recently produced a new washing machine, the Celeribus, which washes three times faster than any other machine on
the market. Market awareness of this machine is growing. The development costs of the Celeribus were significant. At present
the company is making heavy losses on production of this product.
Analyse the product portfolio of DAL using the Boston Consulting Group matrix.
Answer: Domestic Appliances Ltd
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The steam oven appears to be a star at the moment since it has a relatively large market share in what is a high growth market. The
Celeribus is a problem child as it has generated losses to date, and has a relatively low market share in a high-growth market. The
challenge facing the management of DAL is to convert the product into a star. The dishwashers are cash cows as even though the
rate of market growth is low, DAL has a relatively high market share. Cash generated can be used not only to further develop stars
but also problem children where it is deemed appropriate. The washing machines will soon become dogs as they are no longer able
to be sold in certain markets.
Factors to consider for performance management
When conducting a BCG assessment an organisation will need to consider:
• how to measure each of the categories in the matrix and how reliable those measurements are
• how to manage the different categories identified to mitigate their influence on the organisation’s future performance
• what performance indicators are required as a result of the BCG categorisation, how those tie into both overall organisational
performance and individual performance.
References
• Johnson G, Scholes K, and Whittington R, Exploring Corporate Strategy, FT Prentice Hall, seventh edition, 2005
• Porter M E, Competitive Strategy, Free Press, 1980
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The pyramids and pitfalls of

performance measurement
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The pyramids and pitfalls of performance measurement
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It has become increasingly important for organisations to develop systems of performance measurement which not only reflect the
growing complexity of the business environment but also monitor their strategic response to this complexity. The need for good
performance management is an ongoing issue which should be addressed by the management of all organisations.
This article considers issues which are central to the understanding and assessment of performance measurement within any
organisation. The main issues requiring consideration by management are:
• linking performance to strategy
• setting performance standards and targets
• linking rewards to performance
• considering the potential benefits and problems of performance measures.
In attempting to establish a clear link between performance and strategy it is vital that management ensures that the performance
measures target areas within the business where success is a critical factor. The performance measures chosen should:
• measure the effectiveness of all processes including products and/or services that have reached the final customer
• measure efficiency in terms of resource utilisation within the organisation
• comprise an appropriate mix of both quantitative and qualitative methods
• comprise an appropriate focus on both the long-term and short-term
• be flexible and adaptable to an ever-changing business environment.
The last point stresses how important it is that performance measurement systems are dynamic so that they remain relevant and
continue to reflect the issues important to any business. There are a number of models of performance measurement which can be
used by management. This article considers the 'performance pyramid' of Lynch and Cross (1991)1. The model represents an
acknowledgement by the writers that traditional performance measurement systems were falling short of meeting the needs of
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managers in a much changed business environment.
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Lynch and Cross suggest a number of measures that go far beyond traditional financial measures such as profitability, cash flow and
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return on capital employed. The measures that they propose relate to business operating systems, and they address the driving
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forces that guide the strategic objectives of the organisation. Lynch and Cross propose that customer satisfaction, flexibility and
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productivity are the driving forces upon which company objectives are based. They suggest that the status of these driving forces can
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be monitored by various indicators which can be derived from lower level (departmental) measures of waste, delivery, quality and
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cycle time. The performance pyramid derives from the idea that an organisation operates at different levels each of which has a
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different focus. However, it is vital that these different levels support each other. Thus the pyramid links the business strategy with
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day-to-day operations.
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In proposing the use of the performance pyramid Lynch and Cross suggest measuring performance across nine dimensions. These
are mapped onto the organisation - from corporate vision to individual objectives.
Within the pyramid the corporate vision is articulated by those responsible for the strategic direction of the organisation. The pyramid
views a range of objectives for both external effectiveness and internal efficiency. These objectives can be achieved through
measures at various levels as shown in the pyramid. These measures are seen to interact with each other both horizontally at each
level, and vertically across the levels in the pyramid.
George Brown (1998)2 explains what Lynch and Cross refer to as 'getting it done in the middle' focuses on business operating
systems where each system is geared to achieve specific objectives, and will cross departmental/functional boundaries, with one
department possibly serving more than one operating system. For example, an operating system may have new product introduction
as its objective, and is likely to involve a number of departments from design and development to marketing. At this level,
performance focus will be on three needs. First, there will be a focus on the need to ensure customer satisfaction. Second, there will
be a focus on the need for flexibility in order to accommodate changes in methods and customer requirements. Third, there will be a
focus on the need to achieve productivity which necessitates looking for the most cost effective and timely means of achieving
customer satisfaction and flexibility.
At the bottom level of the pyramid is what Lynch and Cross refer to as 'measuring in the trenches'. Here the objective is to enhance
quality and delivery performance and reduce cycle time and waste. At this level a number of non-financial indicators will be used in
order to measure the operations. The four levels of the pyramid are seen to fit into each other in the achievement of objectives. For
example, reductions in cycle time and/or waste will increase productivity and hence profitability and cash flow
The strength of the performance pyramid model lies in the fact that it ties together the hierarchical view of business performance
measurement with the business process review. It also makes explicit the difference between measures that are of interest to
external parties - such as customer satisfaction, quality and delivery - and measures that are of interest within the business such as
productivity, cycle time and waste.
Lynch and Cross concluded that it was essential that the performance measurement systems adopted by an organisation should fulfil
the following functions:
The measures chosen should link operations to strategic goals. It is vital that departments are aware of the extent to which they are
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contributing - separately and together - in achieving strategic aims.
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The measures chosen must make use of both financial and non-financial information in such a manner that is of value to
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departmental managers. In addition, the availability of the correct information as and when required is necessary to support decision-
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making at all levels within an organisation.
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The real value of the system lies in its ability to focus all business activities on the requirements of its customers.
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These conclusions helped to shape the performance pyramid which can be regarded as a modelling tool that assists in the design of
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new performance measurement systems, or alternatively the re-engineering of such systems that are already in operation. See
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Figure 1.
Figure 1: the performance pyramid (Lynch and Cross, 1991)
David Otley (2005)3 has observed that other related frameworks exist, such as the results and determinants framework by Fitzgerald
et al (1991), the balanced scorecard by Kaplan and Norton (1992) and Neely et al's performance prism. A common thread in all of
them is that performance measures should:
• be linked to corporate strategy
• include external as well as internal measures
• include non-financial as well as financial measures
• make explicit the trade-offs between different dimensions of performance
• include all important but difficult to measure factors as well as easily measurable ones
• pay attention to how the selected measures will motivate managers and employees.
Setting standards and targets
To set standards and targets, management could choose to make use of benchmarking and/or target costing while being mindful of
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the critical need to link rewards to performance as appropriate.
Benchmarking
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Benchmarking is 'a continuous, systematic process for evaluating the products, services, and work processes of organisations that
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are recognised as representing best practices for the purposes of organisational improvement' (Spendolini 1991)4. The most
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common approach is process benchmarking, where the standard of comparison is a 'best practice' firm which may be entirely
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unconnected with the benchmarking organisation. It may not even operate within the same industry. The objective is to improve
performance. This is best achieved through the sharing of information which should be of mutual benefit to both parties taking part in
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the benchmarking programme. As a result of receiving new information, each party will be able to review their policies and
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procedures. The process of comparing respective past successes and failures can serve as a stimulus for greater innovation within
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each organisation.
Target costing
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Target costing should be viewed as an integral part of a strategic profit management system. The initial consideration in target
costing is the determination of an estimate of the selling price for a new product which will enable a firm to capture its required share
of the market. It is then necessary to reduce this figure to reflect the firm's desired level of profit, having regard to the rate of return
required on new capital investment and working capital requirements. The deduction of required profit from the proposed selling price
will produce a target price that must be met in order to ensure that the desired rate of return is obtained. The main theme of target
costing is, therefore, what a product should cost in order to achieve the desired level of return.
Target costing will necessitate comparison of current estimated cost levels against the target level. This must be achieved if the
desired levels of profitability, and hence return on investment, are to be achieved. Where a gap exists between the current estimated
cost levels and the target cost, it is essential that this gap is closed.
Performance rewards
Management will encourage employees to achieve organisational goals by having rewards linked to their success or failure in
achieving desired levels of performance. It is critical that management establish an appropriate performance-rewards linkage.
Management should consider a rewards package comprising both financial and non-financial rewards. Typical organisational rewards
include salary increases, bonuses, promotion, and recognition. Employees may also earn intrinsic rewards through a sense of
achievement and perceived success. Management should also give serious consideration to the establishment of 'negative rewards'
or 'punishments' which should be linked to failure to achieve desired levels of performance. These may include failure to obtain
potential rewards, demotions, and possibly the loss of employment.
Potential benefits
There are several potential benefits for an organisation that implements a reward scheme:
• Rewards and incentives can make a positive contribution to strategy implementation by shaping the behaviour of individuals
and groups. A well-designed reward scheme will be consistent with organisational objectives and structure.
• There is evidence which suggests the existence of a reward scheme provides an incentive to achieve a good level of
performance. Moreover, the existence of effective schemes helps not only to attract but also to retain employees who make
positive contributions to the running of an organisation.
• Key values can be emphasised by incorporating key performance indicators in the performance-rewards mechanisms which
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underpin the scheme. This helps to create an 'understood environment' in which it is clear to all employees the performance
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aspects that contribute to organisational success.
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• An effective reward scheme will create an environment in which all employees are focused on continuous improvement.
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• Schemes that incorporate equity share ownership for managers and employees alike can encourage behaviour which, in the
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longer-term, focuses on actions aimed at increasing the market value of the organisation.
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Some of the principal areas that warrant management consideration in the design of a reward scheme include:
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• Whether performance targets should be set with regard to results or effort. It is more difficult to set targets for administrative
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and support staff since in many instances the results of their efforts are not easily quantifiable. For example, good sales
administrators will improve levels of customer satisfaction but quantifying this is extremely difficult.
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• Whether rewards should be monetary or non-monetary. Money means different things to different people. In many instances
people will prefer increased job security which results from improved organisational performance and adopt a longer-term
perspective. For these employees share option schemes might appeal. Well-designed schemes will correlate the prosperity of
the organisation with that of the individuals it employs.
• Whether the reward promise should be implicit or explicit. Explicit reward promises are easy to understand but in many
respects management will have their hands tied. Implicit reward promises such as the promise of promotion for good
performance is also problematic since not all organisations are large enough to offer structured career progression. In situations
where not everyone can be promoted, a range of alternative reward systems need to be in place to acknowledge good
performance and encourage commitment from the workforce.
• The size and time span of the reward. This can be difficult to determine especially in businesses which are subject to seasonal
variations. Activity levels may vary and there remains the potential problem of assessing performance when an organisation
operates with surplus capacity.
• Whether the reward should be individual or group-based.
Whether the reward scheme should involve equity participation. Such schemes invariably appeal to directors and senior
managers but should arguably be open to all individuals if 'perceptions of inequity' are to be avoided.
• Tax implications also need to be considered.
Performance measures - benefits and problems
Berry, Broadbent and Otley (1995)5 suggest that the following benefits can be derived from the use of performance measures:
• Clarification of the objectives of the organisation.
• The development of agreed measures of activity.
• A greater understanding of the processes within the organisation.
• The facilitation of comparisons of performance between different organisations.
• The facilitation of the setting of targets for the organisation and its managers.
• The promotion of the accountability of the organisation to its stakeholders.
However, they also draw attention to the potential problems that may develop from the use of performance measures by an
organisation. These could include:
• tunnel vision
• sub-optimisation
• myopia
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• measure fixation
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• misrepresentation
• misinterpretation
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• gaming
• ossification.
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It is vital that management give detailed consideration as to whether there are likely to be problems in using performance measures
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as targets for the organisation and its managers. Of particular importance is the need to assess whether the use of performance
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measures will help to provide accountability of the organisation and its employees to the stakeholder. This raises the question of the
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compatibility (congruence) of individual and organisational goals.
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Individual goals may focus on financial and non-financial areas such as remuneration, promotion prospects, job security, job
satisfaction, and self-esteem. There may be a conflict for each individual between actions to ensure the achievement of individual
goals and/or organisational goals. The list of potential problems cited by Berry, Broadbent and Otley may be illustrated in the context
of any type of organisation. The comments which follow are illustrated in the context of what could occur (although should not occur)
in a firm of practising accountants.
• Tunnel vision may be seen as undue focus on performance measures to the detriment of other areas. For example, efforts to
ensure a staff utilisation ratio of 72%, measured in terms of chargeable hours as a proportion of total hours available, may lead
to inadequate documentation of client records and developments in areas such as communication and teamwork.
• Sub-optimisation may occur where undue focus on some objectives will leave others not achieved. For example, an audit
partner may be focused on winning new clients but this may result in inadequate supervision regarding the work of current
clients.
• Myopia refers to short-sightedness leading to the neglect of longer-term objectives. An undue focus on generating current client
income could be to the detriment of longer-term goals such as practice development or innovations in approaches to the
management of client affairs.
• Measure fixation implies behaviour and activities in order to achieve specific performance indicators which may not be effective.
For example, using too junior staff on an audit in order to limit costs might result in much re-work, costly delays, and client
dissatisfaction.
• Misrepresentation refers to the tendency to indulge in creative reporting in order to suggest that a performance measure result
is acceptable. For example, a client survey report statistic might indicate that 95% of respondents indicated their satisfaction
with a particular service provided by the practice while in actual fact only a carefully selected 20% of clients were sent the
questionnaire.
• Misinterpretation involves the failure to recognise the complexity of the environment in which the organisation operates. Within
an accountancy practice, one partner might be focused on the achievement of profit whereas another partner might be focused
on winning high-profile clients, and another paying attention to establishing a local reputation. Within such a scenario, the
existence of multiple motives creates a complex environment in which the objectives of the principal players may not always
coincide.
• Gaming is where there is a deliberate distortion of the measure in order to secure some strategic advantage. This may involve
deliberate under-performing in order to avoid higher targets being set. For example, when conducting an audit, a manager
might become aware of a potentially lucrative opportunity to supply consultancy services. If such services were not budgeted
for in respect of the forthcoming year then the manager would undoubtedly be perceived in a good light when a contract for
those services suddenly came to fruition. Another example of gaming would be the restriction of departmental consultancy
earnings in one year in order that the target for the next year will not be increased and/or to hold back consultancy possibilities
which are in the pipeline in order to create slack.
• Ossification, which by definition means 'a hardening', refers to an unwillingness to change the performance measure scheme
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once it has been set up. An example might be the use of a standard set of questions in a questionnaire to test client satisfaction
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with a particular service. Good responses may simply indicate a poorly-structured questionnaire, rather than a high degree of
client satisfaction.
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Addressing the problems
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One should acknowledge that imperfections will exist in any performance measurement scheme. George Brown (1998) has outlined
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a number of actions that may be taken in order to minimise the impact of imperfections which may exist. These are as described
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below.
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Involving staff at all levels in the development and implementation of the scheme
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People are involved in the achievement of the performance measures at all levels, and in all aspects, of an organisation. It is
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important that all staff are willing to accept and work towards any performance measures which are developed to monitor their part in
the operation of the organisation and in the achievement of its objectives. This should help to reduce the extent of gaming and tunnel
vision.
Being flexible in the use of performance measures
It is best to acknowledge that performance measures should not be relied on exclusively for control. A performance measure may
give a short-term measure which does not relate directly to actions which are taking place in order to lead to an improved longer-term
level of performance. To some extent it should be acknowledged that improved performance may be achieved through the informal
interaction of individuals and groups. This flexibility should help to reduce the extent of measure fixation and misrepresentation.
Keeping the performance measurement system under constant review
This should help to overcome the problems of ossification and gaming. Another requirement in overcoming problems is to give
careful consideration to the dimensions of performance. Actions that may be taken include quantifying all objectives (however difficult
this may appear to be) and to try and focus on measuring customer satisfaction. Efforts to quantify an objective will improve the
efforts to understand and take action to achieve the intended output of the objective. Such actions should help to overcome sub-
optimisation. Measuring customer satisfaction is a vital goal. Without continuing and improved levels of customer satisfaction, any
organisation is underachieving and is likely to have problems in its future effectiveness. Positive signals from performance measures
earlier in the value chain are only of relevance if they contribute to the ultimate requirement of customer satisfaction. Once again,
tunnel vision and sub-optimisation should be reduced through recognition of this requirement.
Consideration should also be given to the audit of the system. Seeking expert interpretation of the performance measurement system
should help in considering the likely incidence of any or all of the problems cited above. It is important that this issue is considered at
arms length and is not influenced by the views of those operating the scheme. In addition, maintaining a careful audit of the data
used should help to reduce the incidence and impact of measure fixation, misinterpretation, or gaming. This is because any
assessment scheme is only as good as the data on which it is founded and how such data is analysed and interpreted. It is also
relevant to recognise key features necessary in any scheme. Once again, such measures should help to overcome the range of
problems outlined above. Key features will include:
• nurturing a long-term perspective among staff. This may be difficult to achieve where rewards such as bonus or promotion are
based on relatively short-term measures.
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• trying to limit the number of performance measures. Better to focus on the key events which are likely to result in customer
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satisfaction. Too many performance measures may simply dissipate effort and could lead to conflicting actions.
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• developing performance benchmarks which are independent of past activity. This refers to the need to focus on the way ahead
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- and how, by appropriate action, to improve from whatever the current situation may be.
References
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1. Lynch R L, and Cross K F, Measure up!: Yardsticks for Continuous Improvement (1st edition, 1991), Blackwell (USA).
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2. Brown G, Accountability and performance measurement, Students' Newsletter, October 1998.
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3. Berry A J, Broadbent J, and Otley D T, Management Control: Theories, Issues and Performance (2nd edition, 2005), Palgrave
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Macmillan.
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4. Spendolini M J, The Benchmarking Book, (1991), American Management Association.
5. Berry A J, Broadbent J, and Otley D T, Management Control: Theories, Issues and Practices (1st edition, 1995), Macmillan Press.
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Performance measures to support

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Performance measures to support competitive advantage
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The emergence in the 1990s of low-cost airlines and the expansion of the European travel market has shown how competition can
significantly affect the structure of an industry.
Ryanair and easyJet are now well-established and their on-going success will depend upon a continuing ability to attract customers
and maintain operational efficiency. This must be done in the context of increased competition from schedule and charter airlines that
now recognise the effectiveness of the business model adopted by the low-cost carriers. This article examines how the balanced
scorecard might be used to maintain the low-cost carriers' competitive edge.
The business model adopted by low-cost carriers can be viewed as having three broad elements on which success is based:
• route network development
• brand development and marketing effectiveness
• low-cost operations.
These aspects can be seen to be structural as they reflect major decisions and developments which set the context for operational
performance and day-to-day management.
The route network is the product dimension of first importance to customers. Before European air travel was deregulated in the mid-
1990s, the market was neatly divided. Schedule carriers focused primarily on business travellers with 75% of the market, the other
25% being provided by charter airlines as part of the package holiday industry. Low-cost carriers use aircraft which for European
routes are generally larger than those used by schedule airlines and routes the balanced scorecard must be selected to provide high
load factors, ie percentage of available seats sold.
Routes chosen should be new routes or those served by high-cost carriers, and have appeal to leisure and private travellers. This
approach allows low-cost carriers to use secondary airports at major European cities or regional airports which provide overseas
homeowners greater access to properties with minimum travel in the destination country. Another major aspect of the route network
decision is the departure airport. Low-cost carriers' use of secondary airports in the UK provides convenience to travellers, and
important cost savings for the company.
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Another important factor in the development of the route network is to avoid direct competition from other low-cost carriers. In 2002,
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of 128 low-cost routes, only 17 involved the same departure and destination airports - and Ryanair and easyJet adopted distinct
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positions in the market. While Ryanair has become the 'least-cost provider', easyJet has positioned itself to have a significant appeal
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to the business traveller by flying three times a day to major cities such as Amsterdam, Madrid, Paris, and Zurich from London's
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Luton and Gatwick airports, which are generally viewed as more accessible from London than Stansted (Ryanair's base airport). The
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success of the route network strategy is supported by the fact that easyJet carried 11 million passengers in 2004, operating 153
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routes to 44 European airports.
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Brand development and marketing effectiveness is essential for a product which has a high level of market acceptance which is
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evidently the case with the low-cost carriers' route network strategy outlined already.
There are two major factors which have allowed both Ryanair and easyJet to capitalise on product strengths to become leading UK
brand names. First, the accepted practice in the industry of discounting prices just before departure dates was reversed so that fares
are initially low and rise as departure dates approach. This practice, especially when supported by aggressive promotional
campaigns such as '200,000 seats at 99p - must be booked before September 200X' promotes the company's central market
message in an extremely effective manner. This strategy is particularly effective since the average price paid per seat is greatly in
excess of the 'loss leader' promotional price and is comparable to that obtained by traditional charter airlines. Secondly, the brand is
promoted by the adoption of direct selling to the customer either via the telephone or the Internet. The customer deals with Ryanair or
easyJet and not the travel agent, with a consequent increase in brand identification. The removal of the latter from the purchase
transaction also provides a significant cost saving since no commission is paid.
Low-cost operations are in part based on the cost advantages of operating from secondary airports, and the direct selling strategies
outlined above. These cost advantages in relation to schedule airlines are enhanced by aircraft fleet utilisation decisions. Firstly,
increased number of seats per aircraft provides a considerable reduction in passenger unit costs. Secondly, the daily flying time per
aircraft is increased significantly. Thirdly, the elimination of free in-flight passenger services, particularly catering, removes a cost
which is not necessarily value-adding to the customer and allows faster turnaround times between flights. The final factor providing
significant cost savings are crew compensation and utilisation factors based on the higher usage time of aircraft. Lower costs and
high load factors permit the low-cost carriers to offer fares 50 to 70% below those offered by schedule airlines. Binggeli and
Pompeo1 have estimated that the cumulative cost savings for a lower cost carrier such as Ryanair are reflected in the cost per
available seat kilometre (ASK) statistic. They estimate that in 2001, this cost to the top three major schedule airlines was 12 cents
(US) compared with 4.5 cents (US) for Ryanair. On this basis, Ryanair's breakeven load factor is 55%.
The scorecard approach
In maintaining the competitive position arising from the business model of the low-cost carriers, it is necessary for management to
develop a set of performance measures which focus on key aspects of performance. The balanced scorecard provides a framework
which can be utilised to develop a multi-dimensional set of performance measures for strategic control of the business. The Balanced
Scorecard as shown in Figure 1 has been developed to reflect important aspects of the low-cost carrier's business model outlined
above.
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Figure 1: The balanced scorecard
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The business process element of the scorecard is the logical starting point since it must reflect the 'do wells' of the business. In this
context, no airline can be successful unless it has an excellent safety record and a reputation for punctuality of service. The high
utilisation of aircraft of the low-cost carrier makes it vulnerable to delays, since there is inevitably a 'knock-on' effect within a flight
timetable. The principal measure here, must therefore be 'adherence to schedule', which will depend on the effectiveness of
managing three interconnected areas of activity.
Engineering management involves maintenance and safety work on aircraft between flights and the longer-term maintenance,
requiring the aircraft to be withdrawn from service. Selection of an appropriate set of measures in this area must not lead to any
compromise to safety standards or the inappropriate funding of short-term cost savings against long-term lifetime costs of operations.
Crew management, both of pilot and cabin staff, has to balance the need to have back-up staff to cover for unplanned absences and
problems arising from flight delays. Again, this is a potential pressure point for the low-cost carrier, since staff utilisation is more
intense than on schedule airlines. Ground and passenger handling activities, loading and unloading of passengers, luggage, fuel etc
involves the co-ordination of different parties working to an agreed timetable. The lower level of passenger service and open seat (as
opposed to allocated seat) policy of the low-cost carrier simplifies these relationships and as such work to their advantage.
The three above activities will in combination affect punctuality and the relationship with Air Traffic Control, whose goodwill can often
be important in recovering 'lost' landing and take-off slots. The fundamental measure in this area must be percentage of flights on
schedule with an analysis of delayed flights by reason - distinguishing unavoidable and avoidable delays. The latter will indicate the
areas where management action needs to be directed to improve performance.
Measures must also be developed for customer-company interaction with regard to both the booking and administrative aspects of
travel, since the direct selling strategy is critical to on-going success. The enquiry-to-booking conversion rate would be the principal
measure with an analysis of potential problem areas, again attempting to classify avoidable and unavoidable problems. Other
conventional measures in an e-commerce world would need to be employed to assess the quality of customer service, eg response
times to information requests via the Internet/telephone etc.
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The innovation and growth elements must reflect the ability of the business to maintain competitive advantage. Two principal areas of
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innovation can be identified - route network development and the management of operational-based relationships. The first of these
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reflects the ongoing understanding of customer demand in terms of new route development. Two measures could be employed:
• time period required to build traffic to breakeven load factor level
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• number of routes withdrawn, eg within 18 months.
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In evolving a new route structure, important relationships will have to be developed with handling agents, suppliers in destination
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airports, and time periods to establish effective relationships could be monitored against a standard time period. A major strategic
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development for low-cost carriers is their ability to establish 'hub-based' businesses abroad (eg in Germany) and to monitor this
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activity and assess similar initiatives. Other measures would focus on the development of individuals within the company, either by
measures of expenditure on training or success in jobs as measured by internal promotion rates. These businesses require flexibility
in the individuals they employ and this needs to be measured and managed.
The last two elements - customer and financial perspectives - are dependent on the performance achieved in the business
processes, and innovation and growth elements should reflect achievements in the market and the effectiveness of management
processes.
The customer perspective measures included customer satisfaction, rating of service/value-for-money, levels of customer
complaints/compensation payments and measure of loyalty in terms of 'repeat business' and 'switching behaviour' between other low
cost/schedule carriers. Other measures might assess the convenience of travel as measured by the average miles travelled to UK
airport/from overseas airports to destination, a composite measure of total journey time, a key factor in customer satisfaction ratings.
The financial perspective will embrace the high-level performance measures such as return on capital employed (ROCE) and gearing
which reflect the financial strength of the company - a key factor in entering long-term contracts for new aeroplanes and for
evaluating the terms within leasing agreements. Key operational statistics influencing financial performance should be considered,
such as load factors, route flying times, and other revenue/cost measures analysed in terms of ASK statistics, eg cabin crew costs
per ASK. Other measures might focus on specific initiatives which might have profit potential, eg the sale of targeted in-flight services
beyond those conventionally provided such as catering and duty-free sales. Exceptional items such as fuel charge excesses might
need to be monitored, given its potential impact on the profit outcome.
The above review of strategic developments within the European airline market and how the balanced scorecard might be used to
monitor performance is essentially 'a rear-view mirror' approach and is limited in this respect. The key to success is future-oriented
and while certain elements of the scorecard are fundamental to the industry, the key driver of success is the strategy adopted and the
ability to keep ahead of competitors. On this basis, it might be argued that the innovation and growth element needs special thought
and analysis since the modern world is characterised by persistent change, and successful business models have to be re-
formulated in line with these changes. Nonetheless, the importance of performance measurement systems has long been
recognised, since individuals know that 'what counts is counted'.
The performance measurement system adopted by an organisation is a very powerful means of not only evaluating an existing
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strategy, but is also useful for developing the mindsets within an organisation which will allow new strategies to be developed on the
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basis of a coherent analysis of the existing strategy and company performance.
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Reference
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1. Binggeli, U and Pompeo, L: Hyped Hopes for Europe's Low-Cost Airlines, The McKinsey Quarterly, 2002, number 4.
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Graham J Morgan is a senior lecturer in strategy and management at The University of Central England
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Management control - a pre-requisite

for survival
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Management control - a pre-requisite for survival
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Recent years have witnessed major changes in business structure. In general, today's businesses are far more complex in terms of
both structure and operation. Increasing recognition is given to satisfying the needs of different stakeholders who include customers,
suppliers, employees, local communities, investors, lenders and national governments.
We live in a world of change. Organisational success is hugely dependent on how well an organisation is able to predict and respond
to changes in technology and the requirements of industrial and consumer-buyers alike. Those organisations that are able to
accommodate such changes are likely to continue to prosper. Organisations that fail to recognise or respond in an appropriate
manner to changes that occur in both technology and the marketplace may well lose a large share of their sales volumes and in the
worst case scenario may be forced out of business.
Business units are larger and more complex, often spread over several territories. The growth of multinational organisations and
increased globalisation is widely acknowledged and the business environment itself is subject to rapid change. Therefore it is of
paramount importance that organisations have effective control mechanisms that will enable management to ensure the survival of
the organisation. Management need to be able to focus on adopting the right tactics and actions in order to achieve the goals and
objectives of the organisation.
While the need for effective management control has never been greater, one should acknowledge how critical the design and
operation of effective management control systems are and their interface with accounting information systems. One should also be
aware that accounting is one of the many control tools available to management. While it may assume a central position in a control
structure it will need to be supplemented by other initiatives.
Many accountants subscribe to the view that cash is the lifeblood of an organisation and marketeers are often quick to point out that
innovation is essential in order to ensure organisational longevity. However, while one must acknowledge the truth attached to these
propositions, from an organisational control viewpoint, the importance of appropriate information to facilitate the control of the sphere
of operations must also be recognised. Without a constant supply of relevant information an organisation would inevitably flounder.
An organisation's management information system lies at the heart of the information gathering process and the management
accounting system will invariably be an important part of this. The management accounting system produces pertinent information for
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use by management since it measures activities in terms of its base and (often) other currencies. The multi-currency capability of
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today's management accounting systems enables management to maintain more effective control relating to what are very often
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geographically disparate operations.
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Although many commentators argue that the fundamental nature of management accounting systems and practices remains
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unchanged, in today's business world management tends to use the accounting systems at its disposal in a far more flexible manner
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than previously and also uses financial reports to an increasing extent in conjunction with a range of financial and non-financial
performance measures.
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Contingency theory of management accounting
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The question arises as to whether or not there is an appropriate accounting-based control system which will suit all organisations in
all situations. The answer to this question must be 'no', as organisations vary in size, structure and complexity. What constitutes an
effective management control system therefore depends on the circumstances surrounding its use.
The question that management accountants need to answer is 'which is the most appropriate accounting-based control system that
will best fit the circumstances of our organisation?' In order to answer this question they need to give consideration to the
identification of the most important contingent variables and undertake an assessment of their impact on the design of a
management accounting control system. These considerations are encapsulated in what has become known as 'the contingency
theory of management accounting'.
Otley has provided the following widely-used definition of contingency theory:
'The contingency theory of management accounting is based on the premise that there is no universally appropriate accounting
system applicable to all organisations in all circumstances. Rather a contingency theory attempts to identify specific aspects of an
accounting system that are associated with certain defined circumstances and to demonstrate an appropriate matching.'
Otley drew attention to the fact that management accountants, in acknowledgement of changing circumstances, have always
attempted to adapt systems in order to make them more useful. However, adoption of a contingency approach was novel because it
required management accountants to identify and assess the impact of contingent variables on the design of a management
accounting control system. Otley concluded that the theory was more successful in identifying contingent variables than it was in
assessing their impact on the design of a management accounting control system. He suggested that this could be partially
explained by the fact that the theory focused exclusively on management accounting controls whereas, in fact, organisations use a
much wider range of overall controls.
Many studies have been undertaken and these have concluded that the following are considered to be the major classes of
contingent variable:
• environment
• technology
• size
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• strategy
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• culture.
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Environment
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Features within the external environment of an organisation that affect the design of an accounting-based control system include its
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degree of predictability, the degree of competition faced in the marketplace, the number of different product-markets faced, and the
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degree of hostility exhibited.
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Technology
The nature of a manufacturing process determines the type of costing system that is required and the extent to which costs can be
traced to products. The growth in the number of service organisations is also significant since a large proportion of the total cost of
the services provided is in the nature of overheads. This, together with the fact that services are often consumed at the time of
purchase, will influence the type of costing system used and the extent to which costs can be traced to services.
Size and complexity
Organisational size is an important variable which affects both structure and control. It can be frequently observed that as an
organisation starts to grow it will initially be organised on a functional basis. As further growth is achieved via diversification, and the
organisation becomes exposed to a greater number of product markets, many organisations then choose to re-organise activities into
semi-autonomous units. Top management is then able to utilise the accounting control system to measure and compare the
performance of its divisions using similar performance measures as those employed to assess the overall performance of the firm.
Increasing structural complexity will also lead to an increase in the number of accounting tools used by an organisation, while
environmental discontinuity may require new tools to replace those which have become obsolete.
Strategy
More recently, attention has been focused on the intervention of corporate strategy as a contingent variable. Much research relating
to corporate strategy has centred on classifications proposed by Porter. The majority of contingency theory research focused on the
strategy variables cited by Porter has concentrated on the differences between business units pursuing differentiation and low-cost
production strategies. A control system is aimed at ensuring that corporate objectives are obtained and thus management attention
needs to be placed on the nature of those objectives which are embodied in the overall corporate strategy. Moreover, in any
contingency theory, the appropriate matching of controls to circumstances requires the assessment of 'effectiveness' which can only
be measured by reference to corporate objectives.
Culture
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It is essential that a management accounting control system is consistent with the value system of the organisation or with the
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language and symbols that comprise its culture. If not, resistance may well arise and the management control system will lose its
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raison d'etre as people direct their attention to finding 'work-arounds' in order to 'buck the system'. In much the same vein, new
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control systems which are perceived as likely to threaten existing power relationships may be resisted by affected personnel.
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In order to maximise the effectiveness of the management control system, management should always attempt to maintain a
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corporate culture which is totally supportive of organisational aims, objectives and methods of working and is consistent with the
demands of the organisation's business environment.
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Institutional theory
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During recent years, accounting has come to be regarded as a social and institutional practice which reflects social relations. Much
attention has been focused on the ways in which management accounting practices influence and can be influenced by agencies,
institutions and processes. Institutional theory explains the change and stability of institutions by the way the formal organisation
structure reflects internally the institutionalised rules of the wider state and society.
There is no universally applicable definition of what constitutes an 'institution'. However, one might regard an organisation as
comprising the taken for granted assumptions which inform and influence the actions of individual members of an organisation.
Habits and customs are very important in this context. It is accepted that organisations do not exist in a vacuum. Indeed,
organisations and the management accounting practices within them are dynamic in nature. Thus an organisation may be viewed as
a social entity which has two-way links with many interested parties.
Miller observed that institutional theorists have argued that formal organisations are driven to incorporate the practices and
procedures defined by prevailing concepts of what is rational. The conventions of modern accounting have been identified as a key
mechanism for isomorphism between environmental institutions and organisational practices. It is the contention of many institutional
theorists that the legitimacy and indeed, survival prospects of an organisation are increased by the incorporation of such 'rational'
practices and procedures.
Perhaps at this juncture it is useful to try and demonstrate how institutional theory may provide a framework for changes in
management accounting. If we take the example of the acquisition of a new subsidiary by a conglomerate, it is quite probable that
the board of directors of the acquiring company will require different forms of information in order to monitor the activities of the
newly-acquired subsidiary.
Practices and procedures will change and this will necessitate changes in the form of the management accounting system. As these
rules are introduced and implemented within the newly-acquired subsidiary, new management accounting routines will inevitably
evolve. New procedures will be developed and reproduced by those personnel who have been given the responsibility for their
implementation. New procedures must work in parallel with many other organisational routines which are already in place and they
will be shaped by the existing institutions, ie those taken for granted assumptions about the nature of organisational activities and the
relationships between the various members of the organisation.
These new management accounting routines may gain widespread acceptance within the organisation to such an extent that they
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are regarded as essential features of the management control process. In circumstances where this is so, they can be said to have
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become 'institutionalised' and assume far greater significance than being just another set of management accounting procedures that
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the board of directors of the acquiring company require to be implemented.
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Further reading
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Drury, C, Management and cost accounting, 6th edition, Thompson Learning Press, 2004.
Hopwood, A and Miller, P, Accounting as social and institutional practice, 1st edition, Cambridge Studies in Management, 1994.
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Otley D et al, Accounting for management control, 2nd edition, Thomson Learning, 1990.
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Porter, M, Competitive advantage, New York, Free Press, 1985.
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Business failure
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Business failure
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Prediction and prevention
Students are required to be familiar with failure prediction models based on both quantitative and qualitative information,
and also to comprehend the underlying factors leading to the decline and eventual demise of a company. In this article, the
various failure prediction models are critically discussed and an attempt is made to identify the most significant reasons for
eventual company failure.
THE MODELS
Corporate failure models can be broadly divided into two groups: quantitative models, which are based largely on published financial
information; and qualitative models, which are based on an internal assessment of the company concerned. Both types attempt to
identify characteristics, whether financial or non-financial, which can then be used to distinguish between surviving and failing
companies.
Quantitative models
Quantitative models identify financial ratios with values which differ markedly between surviving and failing companies, and which
can subsequently be used to identify companies which exhibit the features of previously failing companies. Commonly-accepted
financial indicators of impending failure include:
• low profitability related to assets and commitments
• low equity returns, both dividend and capital
• poor liquidity
• high gearing
• high variability of income.
The pioneer of corporate failure prediction models which used financial ratios was William Beaver (1966). He applied a univariate
model in which a classification model was carried out separately for each ratio, and (also for each ratio), an optimal cut-off point was
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identified where the percentage of misclassifications (failing or non-failing) was minimised. The misclassification could be either
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classifying a failing firm as non-failing (a Type I error), or classifying a non-failing firm as failing (a Type II error). Beaver selected a
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sample of 79 failed firms and 79 non-failing firms and investigated the predictive power of 30 ratios when applied five years prior to
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failure. Of the ratios examined, he found that the ‘cash flow to total debt’ ratio (Figure 1) was most significant in predicting failure, with
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a success rate of 78% for five years before bankruptcy.
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Although the simplicity of the univariate approach is appealing, there are a number of potential problems:
• Company classification is based on one ratio at a time, which may give inconsistent and confusing classification results for
different ratios used on the same company.
• It contradicts reality, in that the financial status of a company is complex and cannot be captured by one single ratio.
• The optimal cut-off point is chosen on an ex-post basis, ie when the actual failure status of each company is known. As a result,
the cut-off points may be sample-specific and the classification accuracy may be much lower when applied on a predictive
basis.
The logical solution is to select a combination of ratios, a multivariate approach, in an attempt to provide a more comprehensive
picture of the financial status of a company. Following Beaver, Altman (1968) proposed ‘multiple discriminant analysis’ (MDA). This
provided a linear combination of ratios which best distinguished between groups of failing and non-failing companies. This technique
dominated the literature on corporate failure models until the 1980s and is commonly used as the baseline for comparative studies.
In the MDA model, the ratios are combined into a single discriminant score, termed a ‘Z score’, with a low score usually indicating
poor financial health. Altman’s study involved 66 manufacturing companies with equal numbers of failures and survivors, and a total
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of 22 ratios from five categories, namely liquidity, profitability, leverage, solvency, and activity. From this set of ratios, five were finally
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chosen on the basis of their predictive ability. Altman’s original Z score equation was:
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Z = 0.012X1 + 0.014X2 + 0.33X3 + 0.006X4 + X5
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Where:
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X1 = working capital/total assets
X2 = retained earnings/total assets
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X3 = profit before interest and tax/total assets
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X4 = market value of equity/book value of debt
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X5 = sales/total assets
The pass mark for Altman’s Z score was three, above which companies would be considered relatively safe. Companies with Z
scores below 1.8 would be classified as potential failures; scores between 1.8 and three were in a grey area. He found a
misclassification rate of 5% one year prior to failure and 17% two years prior to failure.
In the UK, a similar methodology was employed by Taffler and Tishaw (1977) based on a sample of 92 manufacturing companies.
The resulting Z score equation was based on a combination of four ratios, albeit with undisclosed coefficients:
Z = co + c1X1 + c2X2 + c3X3 + c4X4
Where:
X1 = profit before tax/current assets (53%)
X2 = current assets/current liabilities (13%)
X3 = current liabilities/total assets (18%)
X4 = no credit interval (16%)
The percentages reveal a guide to the relative weightings of the ratios. Taffler and Tishaw claimed a 99% successful classification
based on the original 92 companies from which the model was derived. However, when the model was tested by Taffler (1983) on a
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sample of 825 companies, the results were less convincing. The equation then classified 115 out of the 825 quoted industrial
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companies as being at risk. In the following four years, 35% went bankrupt and a further 27% were still at risk.
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Both Altman and Taffler’s original models were then developed further. Altman et al (1977) addressed the problem of the assumption
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regarding the normal distribution of ratios in their ZETA model. Taffler then adapted the Z score technique to develop the
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Performance Analysis Score (PAS).
This forms a ranking of all company Z scores in percentile terms, measuring relative performance on a scale of 0 to 100. A score of X
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means that 100 - X% of companies have higher Z scores (eg a score of 80 means 20% have higher scores). As the PAS score over
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time shows the relative performance trend of a company, any downward trend should be investigated immediately.
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Ezzamel, Brodie and Mar-Molinero (1987) briefly reviewed the earlier research and reported their UK study of financial ratios using
factor analysis. Using 53 ratios, they described five broad patterns:
• capital intensiveness
• profitability expressed as earnings, or cash flows as related to assets or funds
• working capital position
• liquidity position
• asset turnover.
They concluded that these patterns were not stable during the period of their study, even when considering the same group of
companies. However, their general conclusions were that it was possible to identify distinct financial patterns and that these could be
used to reduce the number of ratios being studied, but that the long-term instability of the patterns made their application to different
periods or countries difficult.
The last in the category of quantitative models is the H score, devised by Company Watch ( www. companywatch.net ). As with the Z
score, the H score is based on discriminant analysis, in which characteristics of companies are used to optimally discriminate
between those which subsequently failed within a specified time period and those which survived. Similar to Taffler’s PAS, it is a
ranked percentile score taking a value between 0 and 100. The interpretation of a particular H score, for example 20, is that only 20%
of companies have characteristics even more indicative of failed companies, and therefore the company’s health would be judged as
relatively weak.
The threshold identified by Company Watch is a score of 25, below which companies are described as being in the ‘Warning Area’.
The H score distinguishes between different types of company by using a suite of sub-models – these are associated with a
particular category of company with broadly similar balance sheet structures.
A company’s valuation is based on seven key discriminating factors which are grouped into three key management areas, each on a
percentile basis:
1. Profit management, as measured by changes in profitability.
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2. Asset management, as measured by liquidity, working capital, and current asset cover.
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3. Funding management, as measured by adequacy of the capital base, dependency on debt, and dependency on current liabilities.
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In conclusion, the statistical evidence supporting both univariate and multivariate techniques of predicting failure is generally
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impressive and often reveals considerable predictive power. Certain caveats should, however, be borne in mind:
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• The precise specification of a model will be sample specific, and decision makers should exercise care when using previous
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models.
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• The value of a model is difficult to assess without a realistic costing of Type I and II errors.
Qualitative models
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This category of model rests on the premise that the use of financial measures as sole indicators of organisational performance is
limited. For this reason, qualitative models are based on non-accounting or qualitative variables. One of the most notable of these is
the A score model attributed to Argenti (1976), which suggests that the failure process follows a predictable sequence:
Defects can be divided into management weaknesses and accounting deficiencies as follows:
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Management weaknesses:
• autocratic chief executive (8)
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• failure to separate role of chairman and chief executive (4)
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• passive board of directors (2)
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• lack of balance of skills in management team – financial, legal, marketing, etc (4)
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• weak finance director (2)
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• lack of ‘management in depth’ (1)
• poor response to change (15).
Accounting deficiencies:
• no budgetary control (3)
• no cash flow plans (3)
• no costing system (3).
Each weakness/deficiency is given a mark (as shown) or given zero if the problem is not present. The total mark for defects is 45,
and Argenti suggests that a mark of 10 or less is satisfactory.
If a company’s management is weak, then Argenti suggests that it will inevitably make mistakes which may not become evident in the
form of symptoms for a long period of time. The failure sequence is assumed to take many years, possibly five or more. The three
main mistakes likely to occur (and attached scores) are:
1. high gearing – a company allows gearing to rise to such a level that one unfortunate event can have disastrous consequences
(15)
2. overtrading – this occurs when a company expands faster than its financing is capable of supporting. The capital base can
become too small and unbalanced (15)
3. the big project – any external/internal project, the failure of which would bring the company down (15).
The suggested pass mark for mistakes is a maximum of 15.
The final stage of the process occurs when the symptoms of failure become visible. Argenti classifies such symptoms of failure using
the following categories:
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1. Financial signs – in the A score context, these appear only towards the end of the failure process, in the last two years (4).
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2. Creative accounting – optimistic statements are made to the public and figures are altered (inventory valued higher, depreciation
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lower, etc). Because of this, the outsider may not recognise any change, and failure, when it arrives, is therefore very rapid (4).
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3. Non-financial signs – various signs include frozen management salaries, delayed capital expenditure, falling market share, rising
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staff turnover (3).
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4. Terminal signs – at the end of the failure process, the financial and non-financial signs become so obvious that even the casual
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observer recognises them (1).
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The overall pass mark is 25. Companies scoring above this show many of the signs preceding failure and should therefore cause
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concern. Even if the score is less than 25, the sub-score can still be of interest. If, for example, a score over 10 is recorded in the
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defects section, this may be a cause for concern, or a high score in the mistakes section may suggest an incapable management.
Usually, companies not at risk have fairly low scores (0–18 being common), whereas those at risk usually score well above 25 (often
35–70).
The A score has therefore attempted to quantify the causes and symptoms associated with failure. Its predictive value has not been
adequately tested, but a misclassification rate of 5% has been suggested. While Argenti’s model is perhaps the most notable, a large
number of non-accounting or qualitative variables have been included in other studies. These include:
• company-specific variables – such as management experience, customer concentration, dependence on one or a few
suppliers, level of diversification, qualified audit opinions, etc
• general characteristics – such as industry type
• factors in the external environment – such as the macroeconomic situation, including interest rates, the business cycle, and the
availability of credit.
OTHER SYMPTONS OF FAILURE
Many other lists of symptoms of failure exist. For example, there is a list of 65 reasons on the UK Insolvency website which include:
1. Failure to focus on a specific market because of poor research.
2. Failure to control cash by carrying too much stock, paying suppliers too promptly, and allowing customers too long to pay.
3. Failure to control costs ruthlessly.
4. Failure to adapt your product to meet customer needs.
5. Failure to carry out decent market research.
6. Failure to build a team that is compatible and has the skills to finance, produce, sell, and market.
7. Failure to pay taxes (insurances and VAT).
8. Failure of businesses’ need to grow. Merely attempting stability or having even less ambitious objectives, businesses which did
not try to grow didn’t survive.
9. Failure to gain new markets.
10. Under-capitalisation.
11. Cash flow problems.
12. Tougher market conditions.
13. Poor management.
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14. Companies diversifying into new, unknown areas without a clue about costs. 15
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15. Company directors spending too much money on frivolous purposes thus using up all available capital.
ULTIMATE REASON FOR FAILURE
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It has been suggested that the ultimate reason for business failure is poor leadership. According to business guru, Brian Tracy,
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‘Leadership is the most important single factor in determining business success or failure in our competitive, turbulent, fast-moving
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economy.’ Based on a study by the US Bank, the main reasons why businesses fail are:
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• poor business planning
• poor financial planning
• poor marketing
• poor management.
Proper application of these key factors is a function of good leadership. According to the study, in the business planning category,
78% of businesses fail due to the lack of a well-developed business plan. Remember the old saying: ‘If you fail to plan, you plan to
fail.’
Leadership is about planning for success before it happens. Sun Tzu, the 6th century Chinese philosopher, in his epic work The Art of
War , gave some sound advice that still applies to business today: ‘When your strategy is deep and far-reaching, then what you gain
by your calculations is much, so you can win before you even fight. When your strategic thinking is shallow and near-sighted, then
what you gain by your calculations is little, so you lose before you do battle.’
In the financial planning category, 82% of businesses failed due to poor cash flow management skills, followed closely by starting out
with too little money. Business leadership is about taking financial responsibility, conducting sound financial planning and research,
and understanding the unique financial dynamics of one’s business. Half of the UK’s small businesses fail within the first three years
because of cash flow problems. They either run out of money or run out of time. Consumer debt, personal bankruptcies, and
company insolvencies are all now on the increase.
The third business failure factor profiled in the study, and a critical one, was marketing. Over 64% of the businesses surveyed in the
marketing category failed because their owners ignored the importance of properly promoting their business, and then ignored their
competition. Again, as a business leader, you must be able to effectively communicate your idea to the right people and understand
their unique needs and wants. Leadership is all about taking initiative, taking action, getting things done, and making decisions. If you
are not doing anything of significance to market and promote your business, you are most likely headed for business failure.
You must also know your competition. Leadership is about providing value to customers; if your main competitors are all providing a
better quality and lower priced product, how can you possibly create any value? Either you harness your strengths to provide
different benefits (such as speed, convenience, or better service), lower your price and improve quality, create a different product for
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an unmet demand, or get out of the game.
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Finally, one of the most important reasons why businesses fail is due to poor management. In the management category, 70% of
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businesses failed due to owners not recognising their failings and not seeking help, followed by insufficient relevant business
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experience. Not delegating properly and hiring the wrong people were additional major contributing factors to business failure in this
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category.
An interesting, alternative method of classifying reasons for failure is provided by Richardson et al (1994), who use the analogy of
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frogs and tadpoles:
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1. Boiled frog failures
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These are long-established organisations which exhibit the often observed organisational characteristics of introversion and
inertia in the presence of organisational change. This category can be illustrated by the problems faced by ICI.
2. Drowned frog failures
Less to do with management complacency and more to do with managerial ambition and hyperactivity. In the smaller company
context, this is the failed ambitious entrepreneur, whereas in the bigger context this is the failed conglomerate kingmaker,
perhaps typified by Robert Maxwell.
3. Bullfrogs
Expensive show-offs who need to adorn themselves with the trappings of success. The bullfrog exists on a continuum from the
‘small firm flash’ to the ‘money messing megalomaniac’. The behaviour of bullfrogs often raises ethical issues due to a failure to
separate business expenditure from personal expenditure (for example, Conrad Black).
4. Tadpoles
Tadpoles never develop into frogs and represent the failed business start-up in the small business setting. In the large business
context, the tadpole is typified by the business which is dragged down by a big new project which turns out to be such an
expensive failure that it destroys its parent. New products and services often fail, such as the Sinclair home computer. Small
tadpoles usually fail to become frogs because of over-optimism, a failure to make contingency plans and a lack of interest in
overall success as a result of too much focus on the product.
AVOIDING FAILURE
Perhaps the best way to avoid failure is to examine the myriad explanations for business failure. Many books and articles have
focused on identifying reasons for failure as a remedy for prevention. One of the more significant earlier works was by Ross and
Kami (1973); they gave ‘Ten Commandments’ which, if broken, could lead to failure:
1. You must have a strategy.
2. You must have controls.
3. The Board must participate.
4. You must avoid one-man-rule.
5. There must be management in depth.
6. Keep informed of, and react to, change.
7. The customer is king.
8. Do not misuse computers.
9. Do not manipulate your accounts.
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10. Organise to meet employees’ needs.
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FURTHER REFERENCES
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• Altman, E, 1968. Financial ratios, discriminant analysis and the prediction of corporate bankruptcy. Journal of Finance.
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• Altman, E, Haldeman, R G, Narayanan, P, 1977. ZETA analysis: a new model to identify bankruptcy risk of corporations.
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Journal of Banking & Finance.
• Argenti, J, 1976. Corporate Collapse: The Causes and Symptoms . McGraw Hill.
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• Beaver, W, 1966. Financial ratios as predictors of failure. Journal of Accounting Research, Supplement 4.
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• Ezzamel, M, Brodie, T, Mar-Molinero, C, 1987. Financial Patterns of UK Manufacturing companies. Journal of Business Finance
& Accounting .
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• Richardson, F M et al, 1994. Understanding the Causes of Business Failure Crises. Management Decision .
• Ross, J E and Kani, M J, 1973. Corporate Management In Crisis: Why the Mighty Fail . Prentice Hall.
• Taffler, R J and Tishaw, H, 1977. Going, Going, Gone: Four Factors Which Predict. Accountancy , 88.
• Taffler, R J, 1983. The assessment of company solvency and performance using a statistical model: a comparative UK-based
study. Accounting & Business Research, 15.
• Tzu, S, Zi, S, Giles, L, 2006. The Art of War. Filiquarian Press.
• www.companywatch.net
• www.insolvencyhelpline.co.uk
• www.briantracy.com
• www.nationalbusiness.org/NBAWEB/Newsletter2005/2029.htm
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Environmental management
accounting
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This article is intended to help students understand environmental management accounting, its increasing importance, and new
developments.
The global profile of environmental issues has risen significantly during the past two decades, precipitated in part by major incidents
such as the Bhopal chemical leak (1984) and the Exxon Valdez oil spill (1989). These events received worldwide media attention and
increased concerns over major issues such as global warming, depletion of non-renewable resources, and loss of natural habitats.
This has led to a general questioning of business practices and numerous calls for change. These questions have not only been
raised by organisations such as Friends of the Earth, Greenpeace, or groups of 'eco-warriors', but from the United Nations, the
European Union, the UK government, the British Bankers Association, insurance companies and pension funds. Recognition that our
current way of life poses a threat to us and our planet, has led to global agreements on action to prevent future environmental
damage. Such agreements include the Montreal Protocol, the Rio Declaration, and the Kyoto Protocol.
Businesses have become increasingly aware of the environmental implications of their operations, products and services.
Environmental risks cannot be ignored, they are now as much a part of running a successful business as product design, marketing,
and sound financial management. Poor environmental behaviour may have a real adverse impact on the business and its finances.
Punishment includes fines, increased liability to environmental taxes, loss in value of land, destruction of brand values, loss of sales,
consumer boycotts, inability to secure finance, loss of insurance cover, contingent liabilities, law suits, and damage to corporate
image.
Nearly all aspects of business are affected by environmental pressures, including accounting. From an accounting perspective, the
initial pressures were felt in external reporting, including environmental disclosures in financial reports and/or the production of
separate environmental accounts. Much has been written about the nature and quality of these accounts (see Gray and Bebbington,
2001 for an introduction into this area). However, environmental issues cannot be dealt with solely through external reporting.
Environmental issues need to be managed before they can be reported on, and this requires changes to management accounting
systems.
Environmental review of conventional management

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In an ideal world, organisations would reflect environmental factors in their accounting processes via the identification of the
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environmental costs attached to products, processes, and services. Nevertheless, many existing conventional accounting systems
are unable to deal adequately with environmental costs and as a result simply attribute them to general overhead accounts.
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Consequently, managers are unaware of these costs, have no information with which to manage them and have no incentive to
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reduce them (United Nations Division for Sustainable Development (UNDSD), 2003)). It must be recognised that most management
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accounting techniques significantly underestimate the cost of poor environmental behaviour. Many overestimate the cost and
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underestimate the benefits of improving environmental practices.
Management accounting techniques can distort and misrepresent environmental issues, leading to managers making decisions that
are bad for businesses and bad for the environment. The most obvious example relates to energy usage. A recent UK government
publicity campaign reports that companies are spending, on average, 30% too much on energy through inefficient practices. With
good energy management, we could reduce the environmental impact of energy production by 30% and slash 30% of organisations'
energy expenditure. Frost and Wilmhurst (2000) suggest that by failing to reform management accounting practices to incorporate
environmental concerns, organisations are unaware of the impact on profit and loss accounts and the balance sheet impact of
environment-related activities. Moreover, they miss out on identifying cost reduction and other improvement opportunities; employ
incorrect product/service pricing, mix and development decisions. This leads to a failure to enhance customer value, while increasing
the risk profile of investments and other decisions with long-term consequences. If management accounting as a discipline is to
contribute to improving the environmental performance of organisations, then it has to change. Environmental Management
Accounting (EMA) is an attempt to integrate best management accounting thinking and practice with best environmental
management thinking and practice.
EMA is the generation and analysis of both financial and non-financial information in order to support internal environmental
management processes. It is complementary to the conventional financial management accounting approach, with the aim to
develop appropriate mechanisms that assist in the identification and allocation of environment-related costs (Bennett and James
(1998a), Frost and Wilmhurst (2000)). The major areas for the application for EMA are:
• product pricing
• budgeting
• investment appraisal
• calculating costs, and
• savings of environmental projects, or setting quantified performance targets.
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EMA is as wide-ranging in its scope, techniques and focus as normal management accounting. Burritt et al (2001) stated: 'there is
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still no precision in the terminology associated with EMA'. They viewed EMA as being an application of conventional accounting that
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is concerned with the environmentally-induced impacts of companies, measured in monetary units, and company-related impacts on
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environmental systems, expressed in physical units. EMA can be viewed as a part of the environmental accounting framework and is
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defined as 'using monetary and physical information for internal management use'.
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Burritt et al developed a multi-dimensional framework of EMA. Their framework considers the distinctions between five dimensions:
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• internal versus external
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• physical versus monetary classifications
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• past and future timeframes
• short and long terms, and
• ad hoc versus routine information gathering in the proposed framework for the application of EMA.
Within this framework the different techniques of EMA – such as environmental lifecycle costing or environmental cost accounting –
can be placed and assigned. The management of a company can choose appropriate tools on the basis of their information needs.
Similarly, in a series of publications (1997, 1998a, 1998b), Bennett and James describe the diverse range and scope of
environmental management accounting. They provide a set of useful models, one of which is 'The Environment-Related
Management Accounting Pyramid', to help evaluate environmental management accounting practices as well as to help in the design
and implementation of new systems.
According to Bennett and James (1998a), EMA is concerned with gathering data related to the environment (lowest levels), which are
converted through techniques and processes (middle level) into information which is useful for managers (top). Key data is both non-
financial and financial in nature. Management accounting techniques such as performance measurement, operational budgeting,
costing or pricing are used for the transformation.
Examples of techniques
Defining environmental costs
A literature review reveals various approaches to the definition of environmental costs. In 1998, the US Environmental Protection
Agency argued that the definition of environmental costs depended on how a company intends to use the information, for example in
capital budgeting or product design. They made a distinction between four types of costs:
• Conventional costs are those raw material and energy costs having environmental relevance.
• Potentially hidden costs are those which are captured by accounting systems, but then lose their identity in 'overheads'.
• Contingent costs may be incurred at a future date – for example, costs for cleaning up. They are also referred to as contingent
liabilities.
• Image and relationship costs are intangible in nature and include, for example, the costs of producing environmental reports.
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However, such costs pale into insignificance when compared with the costs associated with being seen to behave in an irresponsible
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manner. The infamous Brent Spar incident that cost the Shell oil company millions of pounds in terms of lost revenues via the
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resultant consumer boycott is an example of the powerful influence that environmental concern has in today's business environment.
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Shell learned the lesson, albeit somewhat belatedly, and as a result completely re-engineered its environmental management
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system.
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ACCA has also published a research report outlining an agenda for action on full cost accounting (Bebbington, Gray, Hibbit and Kirk,
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2001), which contains a detailed review of the business case for adopting full environmental costing. One example of the potential
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gains from using full costing (sometimes referred to as lifecycle costing, Bennett and James (1998b)) can be seen in the case of
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Xerox limited.
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Xerox limited, a subsidiary of Xerox Corporation, introduced the concept of lifecycle costing for its logistic chain. The core business of
Xerox limited is manufacturing photocopiers, which are leased rather than sold. This means the machines are returned to Xerox
limited at the end of their lease. Previously, machines were shipped in a range of different types of packaging, which could rarely be
re-used by customers to return the old copiers. The customer had to dispose of the original packaging and to provide new packaging
to return the machine at the end of its lease, which in turn could not be used to re-ship other machines. This meant Xerox lost the
original costs and had to bear the costs of disposal of the packaging.
A new system was invented which used a standard pack (tote). Two types of totes were introduced to suit the entire range of
products sold by Xerox. Totes can be used for both new machines delivery and return carcasses. The whole-chain cost analysis
showed the considerably lower cost of the tote system, compared to the previously existing system and the supply chain became
more visible. The tote system resulted not only in cost savings but also in reduced 'de-pack' times and improved customer relations
(Bennett and James, 1998b).
UNDSD (2003) described total corporate environmental costs as environmental protection costs (emission treatment and pollution
prevention) plus costs of wasted materials, plus costs of wasted capital and labour. Waste in this context means production
inefficiency (purchase value of non-material output). UNDSD stated that wasted materials account for 40% to 90% of environmental
costs according to a survey. One should recognise that environmental costs are not a separate type of cost; rather they are part of
money flowing throughout a corporation.
The main difficulty associated with environmental costs is their identification and allocation. According to UNDSD (2003),
conventional accounting systems tend to attribute many of the environmental costs to general overhead accounts with the result that
they are 'hidden' from management. Thus, management is often unaware of the extent of environmental costs and cannot identify
opportunities for cost savings. EMA attempts to make all relevant, significant costs visible so that they can be considered when
making business decisions (Jasch, 2003). UNDSD (2003) identified management accounting techniques which are useful for the
identification and allocation of environmental costs as: input/output analysis, flow cost accounting, activity-based costing (ABC), and
life-cycle costing. The two techniques specifically mentioned in the APM syllabus are activity-based costing and life-cycle costing.
Environmental activity-based accounting
Activity-based costing (ABC) '...represents a method of managerial cost accounting that allocates all internal costs to the cost centres
and cost drivers on the basis of the activities that caused the costs,' (UNDSD, 2003). ABC applied to environmental costs
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distinguishes between environment-related costs and environment-driven costs. The former are attributed to joint environmental cost
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centres, for example incinerators or sewage plants. The latter are hidden in the general overheads and do not relate directly to a joint
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environmental cost centre – eg increased depreciation or higher cost of staff. Nevertheless they vary with the amount of throughput.
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Schaltegger and Muller (1998) stated 'the choice of an adequate allocation key is crucial for obtaining correct information'. The four
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main allocation keys are:
• volume of emissions or waste
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• toxicity of emission and waste treated
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• environmental impact added (volume x input per unit of volume) volume of the emissions treated, and
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• the relative costs of treating different kinds of emissions.
Life-cycle costing
Within the context of environmental accounting, life-cycle costing is a technique which requires the full environmental consequences,
and, therefore, costs, arising from production of a product to be taken account across its whole lifecycle, literally ‘from cradle to
grave’. It summarises all the costs associated with the lifecycle of a product regardless of who bears those costs. This method
connects the conventional approach to life-cycle costing to also including environmental and social costs.
Environmental management as part of total quality management
The pursuit of environmental quality management via the development of an Environmental Management System (EMS) can only be
achieved if 'environmental audit' is a concomitant feature of such a system. In this respect the organisation becomes self-regulating
and the undertaking of environmental audits on a regular basis provides the platform for organisations to adopt a self-critical and
analytical posture as part of their routine organisational management processes. Organisations should be striving to achieve an
integrated environmental strategy underpinned by the same type of culture that is required for the successful operation of a
programme of total quality management (TQM).
It is arguable that the two are inextricably linked insofar as good environmental management is increasingly recognised as an
essential component of TQM. In common with TQM, the focus is upon 'continuous improvement' and the pursuit of excellence. Such
organisations pursue objectives that may include zero complaints, zero spills, zero pollution, zero waste and zero accidents.
Information systems need to be able to support such environmental objectives via the provision of feedback –on the success or
otherwise – of the organisational efforts in achieving such objectives. This approach to environmental quality management requires
the development of environmental performance measures and indicators that will enable a comprehensive review of environmental
performance to be undertaken. Many - if not all - total quality management accounting techniques can be modified and effectively
adopted to help manage environmental issues.
Conclusion
It can be said that most companies do not know about the extent of their environmental costs and tend to underestimate them. This
leads to distorted calculations of improvement options. For example, Amoco Yorktown Refinery estimated their environmental costs
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at 3% of non-crude operational costs. Actually they comprised 22% of non-crude operating costs as the case study of Ditz et al
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(1998) revealed. However, the study also discovered a large proportion of environmental costs were caused by other processes that
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had not been identified by Amoco.
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EMA can solve these problems. The above-mentioned accounting techniques are useful for EMA to identify and allocate
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environmental costs. In addition, there are alternative techniques to estimate environmental costs such as the 'environmental cost
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decision tree' as described by Rimer (2000).
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The most significant problem of EMA lies in the absence of a clear definition of environmental costs. This means it is likely that
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organisations are not monitoring and reporting such costs. The increase in environmental costs is likely to continue, which will result
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in the increased information needs of managers and provide the stimulus for the agreement of a clear definition. If a generally
applicable meaning of environmental costs is established, the use of EMA will probably increase with positive effects for both
organisations and the environment in which they operate. In the future it will not only be large companies which can afford to
implement EMA but also small and medium-sized enterprises which have fewer available financial resources.
References:
• Bebbington, J, Gray, R, Hibbitt, C and Kirk, E Full Costs Accounting: An Agenda for Action (ACCA Research Report No. 73,
Certified Accountants Educational Trust, London, 2001)
• Bennett, M and James, P Environment-Related Management Accounting Current Practice and Future Trends, Greener
Management International, Spring 97 (No.17, pp32-41, Business Source Premier, 1997)
• Bennett, M and James, P The Green Bottom line, in: Bennett, M and James, P (Eds) The Green Bottom line – Environmental
Accounting for Management: Current Practice and Future Trends (Greenleaf Publishing, Sheffield, 1998a)
• Bennett, M and James, P life Cycle Costing and Packaging at Xerox Ltd, in: Bennett, M and James, P (Eds) The Green Bottom
line – Environmental Accounting for Management: Current Practice and Future Trends (Greenleaf Publishing, Sheffield, 1998b)
• Burritt, L, Hahn, T and Schaltegger, S Current Developments in Environmental Management Accounting – Towards a
Comprehensive Framework for Environmental Management Accounting (EMA) (Universitaet Lueneburg, 2001).
• Ditz, D, Ranganathan, J and Banks, R D Green Ledgers – An Overview, in: Bennett, M and James, P (Eds) The Green Bottom
line – Environmental Accounting for Management: Current Practice and Future Trends (Greenleaf Publishing, Sheffield, 1998)
• Envirowise Increase your profits with environmental management accounting, (Envirowise – Practical environmental advice for
businesses, 2003, last update)
• Frost, G R and Wilmshurst, T D The adoption of environment-related management accounting: an analysis of corporate
environmental sensitivity (Accounting Forum Vol 24, No 4, pp 344-365, Business Source Premier, 2000)
• Gray, R and Bebbington J Accounting for the Environment (2nd edition) (Sage Publications Ltd, 2001)
• Jasch, C The use of Environmental Management Accounting (EMA) for identifying environmental costs, Journal of Cleaner
Production
• Rimer, A E Identifying, Reducing and Controlling Environmental Costs, Plant Engineering (Vol 54, No 3, pp114-118, Business
Source Premier, 2000)
• UNDSD – United Nations Division for Sustainable Development, Environmental Management Accounting Procedures and
Principles (EMARIC Environmental Management Accounting Research and Information Center, 2003)
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During the 1980s, many businesses started to introduce activity-based costing (ABC) systems. The aim of these was to achieve a
more accurate calculation of product costs. However, it soon became apparent that the information that had been produced for
activity based costing had much wider use than just calculating the cost per unit of a product or service.
Activity-based management (ABM) can be defined as the entire set of actions that can be taken on a better informed basis using
ABC information. The aim is to achieve the same level of output with lower costs.
Stages in ABM
The initial stages in ABM are the same as for ABC, so these should be familiar from earlier studies:
1. Identify the activities that the organisation performs
2. Calculate the cost of each activity
3. Identify the activity cost driver for each activity.
Identifying the activities
Organisations perform hundreds, if not thousands, of different activities. It would not be feasible, or even beneficial, to identify every
activity that the organisation performs – so judgment will need to be used to identify the significant activities; perhaps based on the
amount of time that is spent performing them or based on the expected cost.
Some organisations may try to define only high-level activities to keep the number of activities defined to less than 30, while other
organisations may define much more detailed activity lists. These activities may be summarised in an activity dictionary.
The following list shows examples of some of the activities that may take place in a manufacturing organisation:
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• Schedule production jobs
• Set up machines
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• Receive materials
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• Run machines
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• Support existing products
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• Introduce new products
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• Calculate the cost of the activities
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All indirect costs must be apportioned to the particular activities that they relate to using an appropriate basis. Staff may be asked, for
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example, to estimate how much time they spend on each of the activities above so that factory staff costs can be apportioned to the
relevant activities. Other costs such as rent and heating and lighting will also have to be apportioned. This is similar to the principle of
allocating and apportioning costs to cost centres in traditional absorption costing.
As far as ABM is concerned, simply having the information about the cost of each activity may be all that is required. In the case of
ABC however, it is then necessary to apportion the costs of each activity to the products using the cost driver information.
Identifying the cost driver
The cost driver is the factor that causes the cost of an activity to vary. In traditional costing, it was always assumed that the cost
driver was volume of production, measured either in terms of the number of units, or a proxy, such as the number of labour hours or
the number of machine hours. In ABM however, it is recognised that the cost of a particular activity may depend on something other
than volume of output. In the case of sales order processing, the costdriver may be the number of orders processed; so whether a
sales order contains five line items, or 10 line items, the amount of time to process it will be the same.
The cost drivers for the activities listed above may be as follows:
Activity Driver
Schedule production jobs Number of production runs
Set up machines Number of setups
Receive materials Number of receipts
Run machines Machine hours
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Support existing products Number of products
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Introduce new products
Number of new products introduced
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ABC then apportions the costs of each activity among the different products that use them, based on the use of the drivers by each
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product.
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There are two main types of activity-based management:
1. Operational activity based management (doing things right) – this relates to making the organisation more efficient by reducing
the cost of the activities and eliminating those activities that do not add value.
2. Strategic activity based management (doing the right thing) – which essentially involves deciding which products to make, and
which customers to sell to, based on the more accurate analysis of product and customer profitability that activity based costing
allows.
Operational ABM
One of the greatest advantages of ABM is that costs are categorised by activities rather than by traditional cost categories. A
simplified analysis of expenses from a traditional costing system may look something like this:
Cost of sales X
Staff costs X
Rent of factory
X
Maintenance X
Depreciation X
Total costs X
ABM analyses costs by activity. For example:
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Direct materials costs
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Direct labour costs

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Schedule production jobs
X
Set-up machines A X
Receive materials X
Support existing products X
Introduce new products X
Total costs X
Having costs analysed by activity provides much more relevant information to managers. There may be activities that are being
performed that do not add value, so these can be stopped. Management may also identify activities that cost more than expected,
and can investigate these. Management might decide for example that the cost of setting up machines is too high. Using their
knowledge of the drivers of that activity, management would realise that having longer production runs could reduce the cost of this
activity as the number of set ups would be reduced.
Many writers discuss using ABM to eliminate non-value added activities. Cooper and Kaplan claim that it is not always clear whether
an activity is value added or not. It might be argued for example that setting up the machines is a non-value added activity, as
customers do not value it. However, without setting up machines, there can be no production. Instead, Kaplan and Cooper suggest
discussing how efficient an activity currently is, and therefore how much opportunity there is for improvement.
Use of ABM with other performance improvement strategies
ABM does not have to be used in isolation, and can be used alongside performance management improvement strategies, such as
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Total Quality Management, Six Sigma and Business Process Reengineering, where the information provided can support the
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projects.
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In Total Quality Management, costs are analysed into costs of conformance (appraisal and prevention costs) and costs of non
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conformance (internal and external failure costs). The aim of TQM is to reduce the costs of non-conformance. Activity-based
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management enables organisations to more accurately calculate these quality related costs and to monitor improvements.
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Six Sigma, Business Process Improvements and Business Process Reengineering aim to achieve large one off (discontinuous)
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improvements in particular business processes relating to efficiency and better customer satisfaction. ABM can support these
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methodologies in several ways:
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1. Identifying processes that need improvement and establishing priorities
2. Providing cost justification for proceeding with the project
3. Monitoring the benefits of the projects.
As far as establishing priorities is concerned, ABM enables management to identify which activities or processes it is spending the
most on, and where the biggest financial savings can be made. It can also identify activities where management believe big
improvements can be made. Typically these are the processes that are highly fragmented, and involve people from many different
departments.
Many business improvement projects may require considerable capital expenditure, and it will be necessary therefore to do a cost
benefit analysis to establish whether it is worthwhile going ahead. ABM can provide more accurate information about the potential
savings from a particular project, therefore leading to a more accurate assessment.
After completion of a business process improvement project, many businesses do not measure the benefits achieved by the project,
and in some cases fail to take full advantage of them. For example, the project may have reduced the amount of time spent on
dealing with customer complaints, but have the excess staff members whose time has now been freed up been re-deployed in other
departments?
ABM models also provide information about cost incurred on the various activities, so it is easier to monitor how much the costs of an
activity have been cut by a particular project.
Example
A case described by Kaplan and Cooper related to a producer of technical manuals for the computer industry. The company had run
out of storage space in their main factory in South Street, due to a large amount of slow moving inventory for their biggest customer,
IBM. So additional storage space was rented in Elmore Street, several kilometres away from South Street. After production, the
manuals for all other customers were transported to Elmore Street for storage. They would then be returned to South Street for
despatch to the customer when required. This was often only two or three weeks later.
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The management knew that this movement of finished goods to and from Elmore Street was inefficient. However, since the company
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used a traditional cost accounting system, the only visible cost relating to this was the cost of transport – this was $200,000 per year.
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A solution to redesign the storage process in the South Street factory for the fast moving goods, and to move the slow moving
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inventory to Elmore Street (or destroy it entirely) was estimated to cost $600,000. It did not seem worth investing in this, given that
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the annual saving would be only $200,000.
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Activity based management was then introduced, and this identified that fact that the actual costs of operating the inefficient system
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were much higher than expected. The annual savings of the proposed solution analysed by activity were:
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$
Reduced rental expense

128,000
Reduced transport costs 271,000
Reduced costs of moving WIP within factory 38,000
Reduced costs of moving finished goods within factory

91,000
Reduced costs of finding materials

88,000
Equipment savings 27,000
Reduced cost of managing WIP

44,000
Reduced cost of managing finished goods

68,000
Eliminated use of outside warehouses

53,000
Total annual savings 808,000
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This activity based information clearly gave management a much more accurate idea of the savings that could be made by going
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ahead with the proposed solution, and since the required investment was $600,000 it was clearly worthwhile.
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Strategic ABM
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The first application of strategic ABM is to help decide which products or services to make. The use of ABC enables the cost per unit
of a product or service to be measured accurately and therefore the profit per unit can be predicted. Many organisations find that
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when they rank their products according to total profit, it is typical that 20% of their products generate 300% of the company’s profits.
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[1] This means that between them, the remaining 80% of products lose 200% of the company’s profits. The loss making products are
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normally those that are produced in low volumes, or require a high level of customisation.
While it may be tempting to suggest that all such loss making products should be stopped, there are two possible dangers to such a
simplistic decision. First, if 80% of the products were stopped, demand for the remaining 20% might fall, as many customers prefer to
buy all their requirements from one supplier. A second danger is that even if the business were to stop producing the loss making
products, the costs associated with them would not all be saved.
A more realistic approach that can be used is to adjust the price of the loss-making products, or to employ tools such as target
costing to reduce the cost.
A second application of ABM is customer profitability analysis where overheads are allocated to customers using activity based
management processes to obtain a more accurate analysis of the profit or loss generated by each customer. In traditional costing it is
assumed that if a customer generates positive contribution, then servicing that customer must increase the profits of the company.
This ignores the fact that many 'fixed' overhead costs are customer specific – such as the time spent by customer service
departments.
Using ABM, overhead costs are also apportioned to customers using appropriate cost drivers, giving a more accurate picture of how
profitable each customer is. Such exercises have produced surprising results for many businesses, where the 'best' customers have
often turned out to generate losses when ABM is employed.
Example
In Hometown, there are several providers of electricity, and domestic consumers can easily switch from one provider to another.
One of the providers of electricity is First Electric. The company recently had an aggressive advertising campaign and increased its
customer base from 30,000 users to 40,000. Management was surprised to discover that this led to a fall in profits.
The company introduced customer profitability analysis, using activity-based principles. The analysis identified the following activities,
along with their cost per unit of driver.
Activity Driver
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Cost per unit of driver
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a
Meter reading
Number of visits $20
Customer service
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Number of calls
b $30
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Invoicing
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Customer complaints
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The meter reading took place every three months, after which an invoice was issued.
For an 'easy' customer, the overhead cost per quarter was $30, the cost of reading the metre, and issuing the invoice. More difficult
customers could cost much more. Many customers were out when the metre reader came, so a second visit was necessary.
Sometimes the customer was not home second time either, so was requested to read their own metre and then call the customer
service centre.
Using this information, First Electric was able to analyse accurately the profit per customer. The company was surprised to learn that
it made a loss on 20% of its customers and only broke even on a further 30%.
In order to remedy the situation, the company made a number of changes. First, it reduced the number of meter readings to once per
year, and issued invoices based on estimated consumption for the other quarters of the year. It introduced a website where
customers could enter their own meter readings if they were not home at the date of the reading, thus reducing the amount of time
used by the customer service department. These actions are examples of operational activity-based costing as they relate to
reducing the cost of existing activities.
The company also made attempts to stop supplying loss making customers by increasing prices above those of competitors,
encouraging loss making customers to switch to other providers, while offering big discounts to profitable customers, encouraging
them to remain loyal. This is an example of strategic activity-based costing, as it focuses on which customers the company should
supply to.
Evaluation of ABM
The benefits of ABM (and ABC) are greatest in organisations that have high indirect costs. A major reason for the increase in the use
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of ABC in the last 30 years has been the fact that as manufacturing processes have become more IT based and sophisticated,
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overhead costs have increased, while direct costs, particularly labour, have fallen.
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ABC is most useful in organisations with a wider range of products, as it is these organisations that will have the most difficulty in
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allocating overhead costs among different products.
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ABM can be criticised for being too inwardly focused. It aims to increase profits by reducing the cost of the activities that it already
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performs. It does not consider external factors, such as changes in consumer demand for its product.
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Users of ABM and ABC often assume that all overhead costs are variable. This is not the case, and some overhead costs will be
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fixed, so will not be saved if activities are reduced.
ABM is also complex and is expensive to implement. For small businesses, or businesses with narrow product ranges, the benefits of
implementing ABM may not justify the costs.
Question
Note – this question is an abridged version of a question that appeared in the June 2013 Paper P5 exam.
Navier Aerials Co (Navier) manufactures satellite dishes for receiving satellite television signals. Navier supplies the major satellite
TV companies who install standard satellite dishes for their customers. The company also manufactures and installs a small number
of specialised satellite dishes to individuals or businesses with specific needs resulting from poor reception in their locations.
The CEO wants to initiate a programme of cost reduction at Navier. His plan is to use activity-based management (ABM) to identify
non-value adding activities. The first department to be analysed is the customer care department, as management believe that the
costs of this department are too high. The costs for the most recent year from the existing accounting system are shown in Table 1.
Table 1: Existing cost data
$000
Computer time 165
Telephone 79
Stationary and sundries 27
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Depreciation and equipment
36
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b
707
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The cost accountant has gathered information for the customer care department in Table 2 from interviews with the finance and
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customer care staff. She has used this information to correctly calculate the total costs of each activity.
Table 2: Activity-based data
Staff Total cost %

Activities of department
Comments
time
($)
Handling enquiries and preparing quotes for relates to 35,000

40% 282,800
potential orders enquiries/orders
Staff Total cost %

Activities of department
Comments
time
($)
Receiving actual orders

10% 70,700 relates to 16,000 orders
done once an order is

Customer credit checks 10% 70,700
received
Supervision of orders through manufacturing to

15% 106,050
delivery
Complaints handling 25% 176,750
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relates to 3,200 complaints
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a
707,000
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The CEO wants you to consider the implications for management of the customer care process of the costs of each activity in that
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department. The CEO is especially interested in how this information may impact on the identification of non-valued added activities
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and quality management at Navier.
Required:
Assess how the information on each activity can be used and improved upon at Navier in assisting cost reduction and quality
management in the customer care department. (12 marks)
Solution
The information in Table 2 shows that the main cost activities of the CC department are pre-sale preparation (handling enquiries and
quotes) and post-sale complaints handling. Together, these activities consume 65% of the resources of the customer care
department.
The pre-sale work is essential for the organisation and the department converts 46% (16,000/35,000) of enquiries to orders. It would
be beneficial to try to benchmark this ratio to competitor performance although obtaining comparable data will be difficult, due to its
commercially sensitive nature.
However, the complaints handling aspect is one, which would be identified as non-value; adding in an activity-based management
analysis. Non-value adding activities are those that do not increase the worth of the product to the customer; common examples are
inspection time and idle time in manufacturing. It is usually not possible to eliminate these activities but it is often possible to minimise
them. Complaints handling is not value adding as it results from failure to meet the service standards expected (and so is already
included in the price paid).
Complaints handling links directly to issues of quality management at Navier as improved quality of products should reduce these
costs. These costs are significant at Navier as complaint numbers are 20% (3,200/16,000) of orders. Complaints may arise in many
ways and these causes need to be identified. As far as the operation of the CC department is concerned, it may cause complaints
through poor work at the quotation stage where the job is improperly understood or incorrectly specified to the manufacturing or
installation teams. This leads to non-conformance costs as products do not meet expected standards and, in this case, complaints
imply that these are external failure costs as they have been identified by customers
Quality of the end product could also be affected by the supervision activity and in order to ensure that this is functioning well, the CC
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department will need to have the authority to intervene with the work of other departments in order to correct errors – this could be a
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key area for prevention of faults and so might become a core quality activity (an inspection and prevention cost).
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The other activities in the department are administrative and the measures of their quality will be in the financial information systems.
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Order processing quality would be checked by invoice disputes and credit note issuance. Credit check effectiveness would be
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measured by bad debt levels.
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Bibliography
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Kaplan and Cooper, Cost and Effect, Chapters 6 to 10, published by Harvard Business Press 1998.
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"Activity-based management (ABM) can be defined as the entire

set of actions that can be taken on a better informed basis using
ABC information. The aim is to achieve the same level of output
with lower costs."
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appraisal system
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Human resource management and the appraisal system
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This article looks at the nature of human resource management, and at the link between human resource management and
performance management. It then examines aspects of the staff appraisal system, and considers the impact of these on the
performance of an organisation.
Nature of human resource management
Human resource management is defined by Bratton as ‘a strategic approach to managing employment relations, which emphasises
that leveraging people’s capabilities is critical to achieving competitive advantage.’ (1)
From this definition, we can see that human resource management has grown in importance from the traditional view of the
personnel department, whose role was primarily seen as that of hiring and firing employees to a much broader role. Human resource
management includes the recruitment of employees, the development of policies relating to human resources, and the management
and development of employees.
It also follows that human resources management is not carried out exclusively by the HR department. Line managers are involved in
managing the human resources in their departments.
Importance of human resources
The modern terms ‘human resources’ and ‘human capital’ reflect the increasing recognition of the strategic importance of
employees. The terms actually refer to the traits that people bring to the workplace, such as knowledge, intelligence, enthusiasm, an
ability to learn, and so on. Employees are seen less and less as an expensive necessity, and more and more as a strategic resource
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that may provide an organisation with competitive advantage.
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In service industries such as restaurants, for example, where employees have direct contact with customers, having employees that
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are friendly and helpful has a large impact on how customers will view the business. In IT industries, having staff with good technical
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knowledge is essential.
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The problem with human resources is that they require more management than other factors of production. We humans are complex,
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emotional creatures, and it can be challenging to ensure that we behave in the right way, remain motivated and give our best to the
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employer. William James, the 19th century American sociologist, once remarked that most people only use 15% of their combined
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intelligence, skills and aptitudes in their employment. Whether this still remains the case or not, it is clearly a challenge to get
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employees to contribute more of their abilities in the workplace.
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Strategic human resource management
Given that human resources are a strategic capability, many human resource practitioners talk about ‘strategic human resource
management’. This means aligning the human resource management of organisations with the organisations’ strategy.
The human resources management process should support the corporate strategy by:
• ensuring that the organisation has the right number of qualified employees
• employees have the right skills and knowledge to perform efficiently and effectively
• employees exhibit the appropriate behaviours consistent with the organisation’s culture and values
• employees meet the organisation’s motivational needs.
A low-cost supermarket, for example, may have an HR policy of recruiting unskilled staff, who are prepared to work for low wages,
but would not provide customers with excellent service. A more upmarket supermarket on the other hand would want to provide
excellent customer care. HR strategies would include the recruitment of individuals who have excellent personal skills, and training of
all staff in customer care.
Recruitment and selection
‘Recruitment is the process of generating a pool of capable people to apply to an organisation for employment. Selection is the
process by which managers and others use specific instruments to choose from a pool of applicants the person or persons most
likely to succeed in the job given management goals and legal requirements.' (2)
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Recruitment is the first stage in the process of human resource management. The organisation needs to recruit individuals with the
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right skills, and the right attitudes to contribute to the strategic goals of the organisation. Employees should also have the personality
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that will fit into the culture of the organisation.
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From the point of view of potential employees, the recruitment process provides them with the opportunity to see if the organisation
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matches their expectations. The organisation should provide honest information about the position so that the potential employee
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forms the right expectations about the role that they are applying for. If not, this may lead to disappointment and high staff turnover.
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When recruiting, the amount of time and effort spent in selecting the right employee depends on the amount of responsibility that the
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position requires. Managerial or problem-solving positions, where employees would be required to have deeper skills, a higher level
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of responsibility and greater commitment, thus contributing to the strategy of the organisation, would merit a much greater effort in
the selection process. The selection process will need to ensure that candidates should possess the ability to acquire the skills
needed, and the attitude that fits the culture of the organisation. Organisations may use psychometric tests to assess candidates for
such positions. Psychometric tests are described later in this article.
Lower level employees would be employed if they have the right skills. Less screening would take place for this group of employees.
Competency frameworks
In many organisations, competency frameworks may be developed prior to the recruitment stage. A competency framework shows a
set of behaviour patterns and skills that the candidate needs in order to perform a job with competence.
ACCA has developed a comprehensive competency framework for ACCA students to help plan careers in different roles. In ACCA's
competency frameworks, competencies are categorised into exams, experience, ethics, job profiles, technical competencies and
behavioural competencies. An example of a technical competence relating to management accounting is performance objective 13,
Contribute to budget planning and production.
Appraisal system
An appraisal is the analysis of the performance of an individual, which usually includes assessment of the individual’s current and
past work performance. Broadly speaking, there are two main reasons for the appraisal process. The first is the control purpose,
which means making decisions about pay, promotions and careers. The second is about identifying the development needs of
individuals.
Control objective of appraisals

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In recent years, there has been a drive towards linking the appraisal of employees to the strategic objectives of an organisation. The
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idea is that the organisation sets its own goals and performance measures. These goals are then translated into goals for managers
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and employees. Measurable targets are identified and set for employees, and their performance against the targets will be used as
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part of their appraisal.
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Appraisal is, therefore, seen as part of management control. By measuring the performance of employees against targets,
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management is seen to be proactively managing the performance of employees and therefore improving the performance of the
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organisation.
While such an approach may appear rational, in practice it is very unpopular with employees, who do not like to feel they are being
controlled. It can also be criticised for trying to make a complex relationship between employees and managers appear to be too
simple. In practice, however, such control models are the most popular models of assessment.
Developmental objectives of appraisals
A second way in which the appraisal system can support performance management is by identifying the development needs of staff
and managers. Some organisations use a development centre, where an individual is assessed, often by a qualified occupational
psychologist, against the required competencies for his role. Personal development plans are then made to develop the individual in
areas where weaknesses are recognised.
Difficulties in appraisal
In assessing employees, managers are required to make judgments about an employee’s performance and capabilities. Such
judgments are naturally subject to potential bias in favour of some and against others. There are many statistics showing how
prejudice may affect the promotional prospects of some groups. In the UK, for example, 40% of the workforce are women, but only
30% of managers are women.
Another difficulty is the effect that negative criticism can have on performance. A study carried out in the 1960s by Meyer, Kay and
French (3) investigated the impact of the appraisal process at a factory in the US. The study concluded that where staff are given
criticism, they react defensively to the criticism and try to blame others for their shortcomings. They will also become demotivated.
Interestingly, praise given during the process had little impact on performance.
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One potential solution to the difficulties mentioned above in relation to appraisal is to be aware that, in addition to the formal appraisal
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process, employees receive continuous informal feedback from their managers on the job. Employees generally accept this informal
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feedback more readily, and it is more likely to lead to improvement in their performance. Placing more emphasis on this informal type
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of assessment, and less on the formal appraisal process, may improve the overall performance of employees.
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Measurement of performance
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When measuring the performance of employees for the purpose of appraisal, three different approaches can be used:
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• Measurement of inputs
• Behaviour in performance
• Measurement of results and outcomes.
Measurement of inputs
Measurement of inputs means attempting to assess the traits of an individual. Traits are those skills, knowledge and attitudes that the
employee possesses. Assessment aims to identify whether the staff member has the competencies (or traits) for a job, perhaps with
reference to a competency framework. Attributes such as leadership, commitment, ability to work within a team and loyalty are traits
that are typically desired.
Where assessment is performed by the line manager, the subjectivity of the exercise may well lead to real or perceived bias in the
assessment. As a result of this, many organisations now use professionally designed psychometric tests.

Psychometric testing aims to ‘measure’ the abilities and personal skills of an individual. An example of an ability would be the number
of words per minute that the individual can type on a keyboard. Personal skills focus on areas such as emotional stability of the
individual, whether the individual is introvert or extrovert, and how flexible the employee is.
Some organisations hold ‘moderation meetings’ for bigger teams. The purpose of these meetings is to ensure that the various
managers involved in assessing the different members of staff within a team are doing so consistently.
Behaviour in performance
This type of appraisal looks at the behaviour of the employee during work, and at how the employee applies his or her skills. Both
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quantitative and qualitative data is collected on a continuous basis relating to how the employee displays the expected behaviour for
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the position – for example, ‘gives praise where it is due to others on the team’ might be one of the behaviours looked for.
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A common method for assessing behaviour in performance is the use of behaviour-anchored rating scales (BARS). Descriptions of
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desired (and undesirable) behaviour are listed, and the appraiser gives a score for each one. A good example of BARS is the course
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assessment forms used by many ACCA tuition providers, where students are asked to rate the tutor on various attributes, such as
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‘clarity of explanations’, and ‘approachability’. Students then give the tutor a grade for each of these attributes – for example, from 1
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to 5, where 5 is excellent, and 1 is poor.
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Behavioural observation scales (BOS) are where specific actions are listed, and the appraisee is judged on how many times he
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performs that action. For example, how often does a supervisor provide constructive feedback to colleagues?
An obvious problem with BARS and BOS is the subjectivity involved. BOS are designed to be slightly less subjective as they are
based on the number of times behaviour is observed, which is more factual.
Measurement of behaviour in performance generally is beneficial because not only is information about the employee’s performance
obtained, but more detailed understanding of the requirement of the job can be ascertained, and this can be used for defining
standards in future.
Measurement of results and outcomes
Under these types of appraisals, individuals are assessed on quantifiable outcomes – for example, the amount of sales achieved by
a salesman, the volume of production achieved, the number of customer complaints. Where competency frameworks are used, it
may also be possible to measure the number of competencies achieved during a period.
Frequently, targets may be set for individuals and their performance will be judged against these. In setting such targets, it is
appropriate to consider the principles relating to the setting of standards from the Fitzgerald and Moon building blocks model. In
particular, standards should be achievable, or staff will become demotivated; they should be controllable – that is, staff should not be
judged on targets that are outside of their control.
Measurement of results and outcomes is usually easy to perform, but suffers from the problem that it does not take into account the
differing external factors that may have occurred. It may also lead to measure fixation among staff, such as the famous example in
the call centres, where the performance of call centre staff was measured based on the number of calls per day. It was quite common
for call centre staff to keep this high by simply hanging up when presented with difficult customers.
Control mechanisms for employees
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Ouchi developed a model for helping to determine what types of controls are most appropriate for employees in different situations:
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• Personnel controls, also known as clan controls, are based on fostering a sense of solidarity in the people who work for an
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organisation. If personnel believe in the objectives that the organisation is trying to achieve, then they will be motivated to work
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towards those objectives and will not require detailed supervision or control. Personnel controls include recruitment of people
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with the right attitudes, training and job design. These are closely related to appraisal systems based on inputs.
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• Behavioural controls involve observing the employee – for example, the foreman on a production line watches the employees
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to ensure that the work is done as prescribed. Such controls are consistent with appraisal systems that focus on the behaviour
of employees.
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• Output or results controls that focus on measuring some aspect of work performed. Examples could include measuring the
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number of defective products. Appraisal systems based on results or outcomes are examples of output controls.
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The type of control system that is appropriate depends on two variables – the ability to measure output, and the knowledge of the
transformation process. Ouchi forms a matrix from these two that helps to determine what types of control system are most
appropriate for a particular organisation:
Knowledge of the transformation process is low in situations where there is no obvious way to do a task. Those performing the task
may have to learn on the job, rather than be provided with a detailed instruction manual showing them how to do it. This may occur in
project-based work, for example, where each project brings new tasks and challenges to the project team.
In manufacturing industries, it is likely that it is easy to measure output, and knowledge of the transformation process is high – the
tasks have been performed many times before. So behavioural or output controls are appropriate, and appraisal will focus on the
behaviour of employees or on results and outcomes.
A situation where the knowledge of the transformation system is imperfect but measurement is easy might be a sales department.
Management may not be aware of the exact processes involved by the sales team, and there may not be one ‘right way’ of making
sales. However, measurement of sales is easy to do, so output controls may be used. The problem with this approach, however, is
that it does not take into account external factors. It may be difficult to make sales in some markets, for example, and so appraising
employees on results alone might be deemed unfair.
The ability to measure output may be difficult in certain activities, such as research work. Where people work in teams, measuring
the output of the individuals within the team may be difficult. Some individuals may put in more effort than others, for example. If
knowledge of the transformation process is also low, then the organisation may have to rely on personnel and clan controls. In such
situations, the appraisal process may focus on traits.
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Linking appraisal to the reward scheme

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The appraisal process may be linked to a reward scheme whereby employees or managers earn some incentives, such as promotion
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or financial incentives if targets are met. Reward schemes were discussed in another article, ‘Reward schemes for employees and
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management’ (see Related links).
CC
Nick Ryan is the lead tutor for ACCA Performance Management.
References
1. Human Resource Management, Theory and Practice, 4th edition, Bratton and Gold, published by Palgrave Macmillan, p3
2. Bratton and Gold, p239
3. Bratton and Gold, p285
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Reward schemes for employees and management
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A major part of performance management involves managing employees and managers, as their performance will have a
major effect on the performance of the organisation as a whole. This article looks at how reward schemes can be used to
influence the behaviour of employees
Meaning of reward schemes
A broad definition of reward schemes is provided by Bratton:
‘Reward system refers to all the monetary, non-monetary and psychological payments that an organisation provides for its employees
in exchange for the work they perform.’
Rewards schemes may include extrinsic and intrinsic rewards. Extrinsic rewards are items such as financial payments and working
conditions that the employee receives as part of the job. Intrinsic rewards relate to satisfaction that is derived from actually
performing the job such as personal fulfilment, and a sense of contributing something to society. Many people who work for charities,
for example, work for much lower salaries than they might achieve if they worked for commercial organisations. In doing so, they are
exchanging extrinsic rewards for the intrinsic reward of doing something that they believe is good for society.
Objectives of a reward scheme
What do organisations hope to achieve from a reward scheme? The following are among the most important objectives:
1. To support the goals of the organisation by aligning the goals of employees with these.
2. To ensure that the organisation is able to recruit and retain sufficient number of employees with the right skills.
3. To motivate employees.
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4. To align the risk preferences of managers and employees with those of the organisation.
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5. To comply with legal regulations.
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6. To be ethical.
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7. To be affordable and easy to administer.
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Aligning the goals of the organisation and employees
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The reward scheme should support the organisation’s goals. At the strategic level, the reward scheme must be consistent with the
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strategy of the organisation. If a strategy of differentiation is chosen, for example, staff may receive more generous benefits, and
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these may be linked to achieving certain skills or achieving pre determined targets. In an organisation that has a strategy of cost
leadership, a simple reward scheme offering fairly low wages may be appropriate as less skilled staff are required, new staff are easy
to recruit and need little training, so there is less incentive to offer generous rewards. The US supermarket group Walmart competes
on low cost. It recruits employees with low skills, and pays low wages. It discourages staff from working overtime, as it wishes to
avoid paying overtime rates.
To recruit and retain sufficient employees with the right skills
If rewards offered are not competitive, it will be difficult to recruit staff since potential employees can obtain better rewards from
competitors. Existing staff may also be tempted to leave the organisation if they are aware that their reward system is uncompetitive.
High staff turnover can lead to higher costs of recruitment and training of new staff. Losing existing employees may also mean that
some of the organisation’s accumulated knowledge is lost forever. For many knowledge-based organisations, the human capital may
be one of the most valuable assets they have. High technology companies such as Microsoft are companies that trade on
knowledge, so offer competitive remuneration to key staff.
To motivate employees
Motivation of employees is clearly an important factor in the overall performance of an organisation. Organisations would like their
employees to work harder, and be flexible. The link between reward schemes and motivation is a complex issue that is hotly debated
in both accounting and human resource-related literature.
A well-known theory relating to motivation is Maslow’s hierarchy of needs. Maslow stated that people’s wants and needs follow a
hierarchy. Once the needs of one level of the hierarchy are met, the individual will then focus on achieving the needs of the next level
in the hierarchy. The lower levels of the hierarchy are physiological, relating to the need to survive (eg eating and being housed);
once these have been met, humans then desire safety, followed by love, followed by esteem, and finally at the top of the hierarchy,
self actualisation, or self fulfilment.
Applying Maslow’s hierarchy of needs to reward schemes suggests that very junior staff, earning very low wages will be motivated by
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receiving higher monetary rewards, as this will enable them to meet their physiological needs. As employees become progressively
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more highly paid, however, monetary rewards become relatively less important as other needs in the hierarchy, such as job security,
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ability to achieve one’s potential, and feeling of being needed become more important.
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Herzberg argued that increasing rewards only motivates employees temporarily. Once they become de-motivated again, it is
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necessary to ‘recharge their batteries’ with another increase. A far better way to motivate employees is to ‘install a generator in an
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employee’ so they can recharge their own batteries; in other words to find out what really motivates them. According to Herzberg, it is
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the intrinsic factors in a job that motivate employees, such as ‘achievement, recognition for achievement, the work itself,
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responsibility and growth or advancement.’ Giving greater responsibility to employees, for example, can increase motivation.
CC
Perhaps the conclusion to be gained from this is that monetary rewards alone are insufficient to motivate employees. Other factors
A
such as giving greater recognition and greater responsibility may be equally important, for example giving praise at company
meetings, promoting staff, and involving staff more in decision making.
Aligning the risk preferences of managers and employees with those

of the organisation
Managers and senior employees make decisions on behalf of the company, acting as agents of the company. It is desirable that the
risk preferences of these employees should match the risk preferences of the organisation and its stakeholders. One problem with
many reward schemes is that managers are too risk averse, and will not make investments that may risk their targets not being met.
The events leading up to the financial crisis of 2008 are a good example of the opposite situation, where the risk appetites of
employees at investment banks did not match the risk appetites of the owners. During this period, individuals working in the banks
were paid large commissions for selling mortgage loans to customers. The problem was that the employees were selling loans to
customers that posed a large risk to the banks, due to their low credit worthiness.
The problem was confounded by the fact that in many cases, the employees of the banks were paid commissions on the date that
the loan agreements were signed, while the loans lasted for 25 years. In situations where the borrower defaulted, however, there was
no claw back, so the employee would not be required to repay the commission.
Many countries have put in place new laws and codes to change this situation. In the UK for example, the financial services authority
introduced a code whereby remuneration structures should be based on sound risk management practices, incentive payments
should be deferred over a number of years, and there should be claw back provisions whereby employees are required to repay
bonuses in the event that the longer term results of their actions leads to similar problems experiences in the financial crisis.
Share options may also create a miss-match between the risks faced by the organisation and the risks faced by the holders of the
options, since the holders benefit if share prices increase, but do not bear any losses if the share price falls. Share options are
discussed in more detail later in this article.
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Complying with legal regulations
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Rewards should comply with legal regulations. Typically, employment laws include areas such as minimum pay, and equal pay
a
legislation to ensure that no groups are prejudiced against. There have been high profile cases of female investment bankers winning
b
legal cases against their employers because their bonuses were far less than those paid to male colleagues.
lo
Ethics and reward schemes
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In recent decades there has been a move away from fixed remuneration systems towards reward systems where at least part of an
A
employee’s rewards are based on performance of the individual and the business as a whole. Some writers claim that this is
unethical for two reasons. First, such systems tend to place increased business risk onto employees. Second, such systems
undermine collective bargaining systems, and reduce the power of unions. This leads to a situation where employees as a collective
have less bargaining power.
The size of total remunerations paid to directors of large public companies has also become a hot political issue, with a perception
that the gap between top earners, and average earners is becoming larger. In the US, the average directors of S&P 500 companies
earn 200 times more than the average household income in the US. Defenders of such large differences in pay point out that this
difference has actually declined in recent years; in the year 2000, directors of S&P 500 companies earned 350 times the average
household income. According to some research, such high packages are justified as they do reflect the performance of those
directors.
Affordable and easy to administer
It is an obvious fact that there is an inherent conflict of interest in the relationship between employer and employee. The employee’s
rewards represent a cost to the employer, which the employer wants to minimise. Clearly whatever reward scheme is in place, it must
be affordable to the employer.
Target setting
Many reward schemes are based on employees achieving pre-determined targets, so some consideration of target setting is
required.
In Fitzgerald and Moon’s building block’s model, three principles are given when setting standards or targets: equity, ownership and
achievability. Equity in this context means fairness; when setting targets for the various managers, those targets should be equally
challenging. Ownership means that the targets should be accepted and agreed by those managers for whom they are set. This can
usually be achieved by participation. Finally targets must be achievable; otherwise the employees for whom they were set will
become demotivated.
x
The building block’s model then goes on to specifically cover reward schemes. It states that there are three principles of a good
o
reward scheme. First, there should be clarity – it should be clear how the reward scheme works. If your boss tells you that you will
l B
receive a bonus at the end of the year ‘if you do a good job,’ that is not very clear, since the boss has not specified what doing a good
a
job means. Rewards should be motivational. Finally there is the important controllability principal. Employees should only be judged
b
and rewarded based on things within their control. This is why profit-related pay might not be relevant to a junior administrative
lo
assistant, for example.
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A
Hope and Fraser warn against the use of linking rewards to fixed performance targets, as this leads to gaming. In particular,
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managers whose rewards depend on fixed targets may be tempted to ‘always negotiate lowest targets and highest rewards,’ which
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suggests that management plans will understate the potential that the organisation can make. ‘Always make the bonus, whatever it
A
takes,’ is another example of gaming suggested by Hope and Fraser, which suggests that managers may indulge in unethical
behaviour such as fraudulent accounting in order to ensure that targets are met.
Hope and Fraser suggest divorcing the planning process and the target setting process, and basing rewards on relative targets and
benchmarks. A relative target might be market share, for example, where rather than setting an absolute target for a sales manager,
a market share (%) target is provided. If the market rises, then more is expected in absolute terms. This adds to controllability, since
the sales manager could not be held responsible for a rise (or fall) in the overall market, which is outside of his control, but would be
able to control whether or not he achieves the expected share of the market.
Types of reward scheme
Base pay Base pay, or basic pay, is the minimum amount that an employee receives for working for an organisation. For example,
the employee may be paid $10 per hour for a minimum of 40 hours per week. The employee will therefore earn at least $400 per
week. This will be paid regardless of how many of those 40 hours the employee is actually working. A fixed annual salary is another
example of basic pay.
Basic pay may be supplemented by other types of remuneration. A blue collar worker may be paid overtime for example if he works
more than 40 hours per week, and a manager may receive some form of performance pay in addition to the base pay. Basic pay is
likely to address the lower levels of Maslow’s hierarchy of needs mentioned above.
Performance-related pay Performance-related pay is a generic term for reward systems where payments are made based on the
performance, either of the individual (individual performance-related pay) or a team of employees (group performance-related
schemes).
In recent decades there has been a move toward performance-related pay schemes in many organisations. This has lead to a
situation where a higher portion of the employees pay is dependent on performance. This rationale for performance-related pay is
that it motivates employees to work harder, and rewards those who make a greater contribution to the organisation’s goals. This
should lead to efficiency savings. There are many types of performance-related pay, and the most popular ones are described below:
1. Piecework schemes
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Under Piecework schemes, a price is paid for each unit of output. Piecework schemes are the oldest form of performance pay, and
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were used for example in the textile industries in Great Britain during the industrial revolution. Piecework schemes are appropriate
a
where output can be measured easily in units. They are typically used for paying freelance, creative people. Freelance writers for
o b
example are often paid based on the number of words.
G l
The benefit of piecework schemes is their inherent fairness. The higher the output, the more the employee (or subcontractor)
A
receives. From the employer’s perspective, the employer does not have to pay for idle time or inefficiencies.
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From the employee’s perspective, such schemes mean that the employee bears commercial risk if demand for their product falls.
A
A further disadvantage of piecework schemes is that the payment is not based on the quality of output. However, some sort of quality
control is likely, and if the quality is not of a required standard, the employee or subcontractor will not be paid.
2. Individual performance-related pay schemes
Individual performance-related pay schemes are where the employee receives either a bonus, or an increase in base pay on meeting
previously agreed objectives or based on assessment by their manager, or both. They are typically used for middle managers in
private sector organisations and for professional staff.
The advocates of individual performance-related pay schemes claim that their they are an obvious way to align to objectives of
middle managers with the goals of the organisation. If performance targets set are based on the goals of the organisation, then it
appears obvious that making part of the rewards of employees’ contingent on achieving those targets will mean that employees are
motivated to achieve the goals of the organisation.
Individual performance-related schemes also have the advantage over group schemes that the employee has control over her
rewards, as they do not depend on the effort (or lack of) of other members of the team.
Critics of such schemes point out that the link between rewards and motivation is far from clear, as discussed above. It is also argued
that performance-related schemes lead a situation of tunnel vision whereby if something is not measured, and then rewarded, it won’t
get done.
Individual reward schemes may lead to a lack of teamwork and may lead to variances in pay among individuals, which can lead to ill
feeling.
An example of an individual performance-related pay scheme is one that is operated by a UK bank. Under the scheme, a bonus pool
is allocated to each region based on the performance of that region. From this pool, individual awards are made based on
assessment of performance, taking into account the rating on a five-point scale. Those with scores of 1 to 3 qualify for a discretionary
bonus. The assessment depends on how much new business the individuals have brought in, or how much efficiency savings they
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have generated. The rewards are usually paid in cash, although for senior employees receive a portion as deferred stock.
3. Group-related performance-related pay schemes
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b a
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Group-related performance-related schemes are similar to individual, in that rewards are paid based on the achievement of targets.
l
However the targets are set for a group of employees, such as a particular department, or branch of a company, rather than for an
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individual. Since the rewards apply to a group, they are likely to be based on a pre-determined quantitative formula, rather than on
A
assessment of staff.
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A bonus pool is calculated based on the performance of the team, and this is shared among the members of the team. Bonuses may
A
be paid up at the end of the year, or may be deferred, and paid at a later date, as this may encourage staff and managers to take a
longer term view, rather than simply focusing on the current year’s bonus.
The advantage claimed for group schemes is that they encourage teamwork. The disadvantage is that the lazier members of the
team benefit from the hard work of the more dedicated.
Hope and Fraser give the example of a scheme operated by Svenska Handelsbanken, where each year, a portion of the banks
profits are paid to a profit sharing pool for employees, provided that certain conditions are made. The main conditions are that the
Handelsbanken Group must have a higher return on shareholder’s equity than the average of its peer group. The upper limit of the
amount paid into the scheme is 25% of the total dividends paid to shareholders. Employees do not actually receive anything from the
pool until they reach the age of 60, at which point they receive a pay out based on the number of years that they have worked for the
bank. The CEO of Handlesbanken claimed that employees are not motivated by financial targets, but by the challenge of beating the
competition. The reward scheme is designed to be a dividend on their intellectual capital.
4. Knowledge contingent pay
Knowledge contingent pay is where an employee will receive a pay rise or a bonus, or both, for work-related learning. An ACCA
candidate, for example, may receive a higher salary once he has passed all the knowledge level papers, and an even higher salary
after passing all of his exams.
5. Commissions
Commissions are a form of remuneration normally used for sales staff. The staff may receive a low basic pay, but will then receive
commission, based on a percentage of the amount of their sales.
The advantages of commission are that they should motivate sales staff to achieve higher sales, as their rewards depend on it, and
they mean that the large part of the salesman’s salary becomes variable. If sales are low, the organisation will have to pay less.
The disadvantage of commission is that it may lead to dysfunctional behaviour. Sales staff may indulge in window dressing, for
x
example to meet this years sales target, by selling on a ‘sale and return basis’ in the final month of the year, with the inherent
o
understanding that the goods will be returned in the following month of next year. They may also lead to short termism, where sales
B
staff ‘never put the customer above the sales target’ to quote Hope and Fraser.
6. Profit-related pay
al
lo b
Profit-related pay is a type of group performance-related pay scheme where a part of the employee’s remuneration is linked to the
G
profits of the organisation. If the company’s profits hit a pre-determined threshold, a bonus will be paid to all members of the scheme.
A
Typically the bonus will be a percentage of the basic pay. The bonus may be paid during the year in question; for example, quarterly,
C
or it may be deferred until some later date, such as the retirement of the staff.
A C
Advocates of profit-related pay argue that it motivates employees to become more interested in the overall profitability and therefore
become more motivated to ‘do their bit’ to improve it. It may also encourage loyalty in cases where staff may lose their bonus if
leaving the organisation means that they lose the right to it.
The obvious disadvantage with profit-related pay is that it does not match the primary objective of commercial organisations, which is
to maximise the wealth of the shareholders. Managers may be motivated to increase profits by taking short-term actions that will
harm the business in the long run, for example, or destroy wealth by investing in projects that increase the profits of the organisation,
but produce a return that is below the cost of capital of the organisation.
Profit-related pay might not be a motivator for junior employees, who may fail to see the link between their effort and the overall
profits of the organisation.
7. Stock option plans
Stock option plans have become very popular since the 1990s, when greater emphasis started to be given to shareholder value.
Under stock option plans, staff receive the right to buy shares in their company at a certain date in the future, at a price agreed today.
For example, Alpha Co is listed on the stock exchange of Homeland. Today, shares in Alpha Co are trading at $100 each. The
company has just awarded the CEO of Alpha Co the option to buy 1 million shares for $100 each in exactly ten years time. These
options have no intrinsic value at the granting date.
If the share price rises to say $200 in 10 years time, the CEO could exercise his options, buying 1 million shares at a price of $100
each. Since the shares would be worth $200 each by then the CEO would make a gain of $100 per share, or $100m in total.
Stock option plans are most appropriate for the senior management of organisations as they are the people who have the most
influence over its share price. The rational for using stock option plans is that they align the objectives of the directors with the
objectives of shareholders. If the share price rises, the senior management benefit because their options increase in value. Thus
senior managers will start to think like investors.
The big weakness of stock option plans is that share prices may depend on external factors as much as on the performance of the
directors. During the bull markets of the 1990s and 2000s, many companies share prices rose simply because the market rose.
o x
B
Another weakness is risk misalignment. Share options reward managers if the share price goes up. If the share price falls, however,
l
there is no difference in reward between the share price remaining the same ($100) and falling to ($1) – so managers may be
a
motivated to take extreme risks where the exercise price may not be met.
lo b
What shareholders really want is the performance of their company to be better than the market. One solution to this is to use an
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indexed exercise price, where the price at which the director can buy the shares is equal to the current market price, plus the
A
increase in the stock market index between the date that the options are issued, and the exercise date. This means that the share
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option reflects the controllability principle more closely, as directors would not be rewarded for rises in the stock market in general.
Pension schemes
A C
Defined benefit pension schemes used to be a popular form of reward. Under such schemes, the employee pays a pension to former
employees based on their final salary, and the number of years that the employee worked for the organisation. A typical example is
that the former employee receives 1/60ths of their final salary for every year of service. An employee who works for 40 years for the
same organisation would therefore receive a pension equal to 40/60ths of their final salary from the date of retirement to the date of
death.
Defined benefit schemes leave organisations with an uncertain, often large liability, and for this reason, many organisations have now
discontinued such schemes.
Defined contribution schemes are another form of pension scheme where the employer pays a certain percentage of the employee’s
salary into an account for the employee in a pension ‘pot.’ The employee may also have the option of making additional voluntary
contributions into this pension pot. The pension pot is then invested, and the employee receives whatever is in their account on
retirement. In some countries, employees may be required to use what is in the pot to buy an annuity, which pays them a fixed
income for the rest of their lives.
Many countries offer tax incentives for such pension schemes, such as allowing employees to reduce their taxable income by the
value of contributions made to the schemes.
Benefits in kind
Benefits in kind (or indirect pay) are paid to employees in addition to their base salary and performance-related pay. Benefits in kind
include items such as health insurance and meal vouchers. They are usually provided to more junior staff in order to provide
additional incentives at a lower cost. They are often used as a form of recognition, so the employee of the month for example will be
given a benefit rather than a cash payment.
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The advantage of benefits in kind is that greater flexibility can be given in designing a reward scheme for an individual.
B o
l
‘Cafeteria’ schemes have also become popular, whereby employees are told that they may select benefits from a menu up to a
a
certain value. The advantage of this is that employees will select the benefits that they value most. Benefits from which the
b
employees can choose typically include such items as health insurance, holiday vouchers, company cars or sports vouchers.
lo
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Cafeteria schemes may be difficult to administer. Staff may also find them complex to understand, as they will have to select a
A
number of benefits that have a value that is within the agreed limit.
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Establishing the level of benefits
A
How much should employees be paid? Two factors need to be taken into account here. First, competitiveness, and second internal
equity.
As already mentioned above, unless the level of pay is competitive, it will be difficult to recruit and retain the right number of skilled
employees. If it is too much, the cost to the organisation will be too high. Here the organisation will compare its pay levels with
competitors. Such information may be available from job adverts in newspapers or on the Internet, or from recruitment consultants.
Internal equity relates to the pay differentials within the organisation itself. Staff will become demotivated if they feel that the
remuneration system is ‘unfair’ and that other people are being paid more generously. Job evaluation techniques are used that try to
determine the value of a specific job to the organisation. Based on this, the level of rewards for that particular position will be
determined.
The role of appraisal in reward systems
Many of the performance-related reward schemes depend on the performance of the employees. As such, the employees’
performance has to be assessed. This usually takes place during the appraisal process. Staff will be assessed on a regular basis, for
example twice a year. During the appraisal, targets will be set for the next period, and rewards agreed if the targets are met.
Conclusion
A good reward system aims to motivate employees to work harder, and align their goals with those of the organisation they work for.
The current trend towards performance-related reward systems is designed to lead to greater rewards and motivation for those who
contribute the most. However, designing such reward systems is complex, as they aim to influence human behaviour. As the human
resources director of Flowpack Engineering said (quoted in Bratton) ‘There is no such thing as a good pay system; there is only a
series of bad ones. The trick is to choose the least bad one.’
Nick Ryan is a freelance lecturer and writer
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References Bratton and Gold, Human Resource Management Theory and Practice, 4th edition chapter 10, Palgrave Macmillan,
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2007 Hope and Fraser, Beyond Budgeting, Harvard Business School Press, 2003 Frederick Herzberg, 'One More Time: How Do You
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Motivate Employees?' Harvard Business Review, Sept/Oct 1987
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CA
A C

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ALL P5 (APM) TECHNICAL ARTICLES

Advanced Performance Management (APM)

Study support videos

Advanced Performance Management examiner approach

Making the most of ACCA’s Advanced Performance Management resources

and what issues they specifically address.

Value for Money (VFM) and performance measurement in not-for-profit organisations

Sustainability and performance management

Demystifying value-based management

Developments in IT and the impact on performance management – part 1

Developments in IT and the impact on performance management – part 2

and measuring performance.

Big data 1: What is big data?

Big data 2: How companies use big data

Data analytics and the role of the management accountant

Lean enterprises and lean information systems

Also available as a podcast on iTunes

Complex business structures

How critical success factors are used.

The risks of uncertainty – part 1

expected values and measures of dispersion.

The risks of uncertainty – part 2

Economic value added versus profit-based measures of performance – part 1

Not-for-profit organisations – part 1

Not-for-profit organisations – part 2

Performance management models

but also in the appraisal of business performance.

The pyramids and pitfalls of performance measurement

Performance measures to support competitive advantage

Also available as a podcast on iTunes

low-cost carriers' competitive edge.

Management control – a pre-requisite for survival

Also available as a podcast on iTunes

The various failure prediction models.

Reward schemes for employees and management

Also available as a podcast on iTunes

Changes to APM question

performance metric at IC’. So what are the instructions?

• Evaluation of the accuracy of the calculation with a revised calculation

Advanced Performance Management –

• assess the impact of risk and uncertainty on organisational performance

Links to other exams

will now be used in a more critical capacity.

Section A (a single compulsory question)

Approaching the APM exam

• cover the whole syllabus

• be prepared to apply all of this knowledge to a business scenario

• read and answer the question asked

Cover the whole syllabus

Apply your knowledge to the question scenario

Candidates must make sure that they can:

Create information from data

overall picture of changes.

Written by a member of the APM examining team

Making the most of ACCA's Advanced

Using the examiner's reports

Example 1: (Taken from Q1, December 2014)

Example 2: (Taken from Q1, June 2014)

Q1(i) Evaluate the current performance report in Appendix 1. (15 marks)

that CSF and then provide a justified KPI. (6 marks)