Chapter 9: Performance Evaluation in Decentralized Organizations

Disadvantages of Decentralization

-Can lead to duplication of assets and services -Goal congruence can be an issue -Can lead to lack of coordination

Advantages of Residual Income

-Encourages managers to generate sales AND control costs; -Overcomes some goal congruence issues

Manufacturing Cycle Efficiency (MCE)

-Focuses on value-added vs. non-value added activities -Monitor MCE to improve delivery time and control costs MCE= Value Added (i.e., Process Time)/ Throughput Time

Advantages of Decentralization

-Managers with first-hand knowledge make decisions -Provides management training -Frees upper-management to focus on strategic decisions -Motivation tool for managers -Allows for faster response to change

Responsibility Accounting

-Responsibility accounting involves accumulating and reporting costs (and revenues) on the basis of the manager who has the authority to make the day-to-day decisions about the items. -Break organization into responsibility centers (a subunit responsible for specified activities); prepare a report for each segment to be used to evaluate managers' performance.

Disadvantages of Residual Income

-Some goal congruence issues remain -Gives favor to larger investment centers (due to relative nature of the calculations

Throughput (Manufacturing Cycle) Time

-The amount of time required to convert raw materials into completed products -Is PART of Delivery Cycle Time -Is made up of: 1. Process Time 2. Inspection Time 3. Move Time 4. Queue Time

Name the three primary ways to increase ROI

1) Increase Sales -> Increase Income (numerator) 2) Decrease Costs -> Increase Income (numerator) 3) Decrease Assets -> Decrease Denominator

Types of Responsibility Centers

1. Cost Centers 2. Profit Centers 3. Investment Centers

The four most commonly employed perspectives are as follows:

1. The FINANCIAL PERSPECTIVE employs financial measures of performance. 2. The CUSTOMER PERSPECTIVE evaluates how well the company is performing from the viewpoint of those people who buy and use its product. 3. The INTERNAL PROCESS PERSPECTIVE evaluates the internal operating processes critical to success. 4. The LEARNING AND GROWTH PERSPECTIVE evaluates how well the company develops and retains its employees. -The different perspectives are linked together so a company can better understand how to achieve its goals and what measures to use to evaluate performance.

Evaluating Investment Centers

A. Return on Investment (ROI) B. Residual Income

Cost Centers (Evaluating)

Compare Actual Costs Incurred to Flexible Budget Costs.

Profit Centers (Evaluating)

Compare Actual Profits to Flexible Budget Profit (i.e., both revenues and costs)

Residual Income Formula

Division Net Operating Income Less: Investment Charge (Minimum ROI x Avg. Operating Assets) =Residual Income

Advantages of ROI

Encourages managers to focus on generating sales and controlling costs.

Investment Centers (Evaluating)

Evaluate based on Net Operating Income, but consider investment available.

Operating Performance Measures

Focus on Non-financial measures of performance A. Delivery Cycle Time B. Throughput (Manufacturing Cycle) Time C. Manufacturing Cycle Efficiency (MCE)

Evaluating Responsibility Centers

For Performance evaluation, manager utilize responsibility accounting performance reports to compare actual results with budgeted amounts. (i.e., compare actual results to the FLEXIBLE budget)

Disadvantages of ROI

Goal congruence issues- Managers may make decisions that benefit their division, but do not align with company goals.

Decentralization in Organizations

In a decentralized organization: Decision making occurs at all levels of management.

Non-Value Added

Inspection Time, Move Time, Queue Time

Economic Value Added (EVA)

Is special type of Residual Income calculation that focuses on adding value for the company's primary stakeholders: its investors and long-term creditors.

Residual Income

Is the net operating income that an investment center earns above the minimum rate of return on its operating assets.

Profit Centers

Manager can influence both revenues and costs of their segment. Ex: Sales Dept. Manager, Division Manager

Cost Centers

Manager can influence only costs of their segment. Ex: Production manager, ACCT, HR and IT Department managers

Investment Centers

Manager can influence revenues, costs and the allocation of resources. Ex: Division Manager, CEO Ex: CEO of PepsiCo- must allocate assets among Soft Drink Sales, Frito Lay, + Tropicana

Profit Margin=

Net Operating Income/Sales

Interpretation of Residual Income: IF it is a

Positive Number: division earning GREATER than the minimum ROI; Zero: division is earning EQUAL TO the minimum ROI; Negative Number: division is earning LESS than the minimum ROI

Value Added

Process Time

Return on Investment (ROI) Formula

ROI= Net Operating Income/ Average Operating Assets *Average Operating Assets= (Beginning Assets + Ending Assets) / 2

Margin and Turnover- a closer look at ROI

ROI= Profit Margin x Asset Turnover

Asset Turnover=

Sales/Average Operating Assets

Delivery Cycle Time

The amount of time from when a customer order is received to the time the completed order is shipped to the customer. WAIT TIME + THROUGHPUT TIME

What is the Balanced Scorecard?

The process in which companies use both financial and non financial measures to evaluate performance.

Inspection Time

Time spent ensuring no defects exist.

Move Time

Time spent moving direct materials and/or work-in-process inventory form department to department.

Queue Time

Time spent waiting to be moved, inspected, processed or shipped.

Process Time

Time spent working on the product.