EVALUATION AND CONTROL IN STRATEGIC MANAGEMENT
The strategic management model at the beginning of each chapter shows evaluation and control information being fed back and assimilated into the entire management process. Such information consists of performance data and activity reports (gathered in Step 3). If undesired performance is the result of inappropriate use of strategic management processes, operational managers must know about it. They can then correct the employee activity without involving top management. However, if undesired performance results from the processes themselves, both top managers and operational managers must know about it. They must then develop new implementation programs or procedures.
An implemented strategy gives strategic managers a series of questions to use in the evaluation. Management usually initiates such a strategy review when a planning gap appears between a company`s financial objectives and the expected results of current activities. Answering this set of questions (or a similar set), should give a manager a good idea of where the problem originated and what must be done to solve it.
There are three types of control: strategic, tactical, and operational.
Strategic control deals with the basic strategic direction of the corporation in terms of its relationship with its environment. It focuses on the organization as a whole and might emphasize long-term measures (one year or more), such as return on investment and changes in shareholder value. Strategic control measures may be categorized as concerning either external effectiveness or internal efficiency. Flexibility overlaps these categories. It relates to effectiveness and efficiency. Thus, an organization must be externally flexible in responding to changing customer needs and internally flexible in reordering its structural arrangements, retraining employees, etc.
Measures such as cycle time, waste, productivity are internal efficiency measures.
Tactical control, in contrast, deals primarily with carrying out the strategic plan. It emphasizes the implementation of programs and might use medium-range measures (considering six months to a year), such as market share in particular product categories. Operational control deals with near-term (considering today to six months) corporate activities and focuses on what might be going on now to achieve near- and long-term success. An example of an operational control is the use of statistical process control, or SPC, to provide immediate feedback to workers to enable them to minimize defects in the production process.
There is also a hierarchy of control. At the corporate level, control focuses on maintaining a balance among the various activities of the corporation as a whole. Strategic and tactical controls are most important. Overall annual profitability is key. At the divisional level, control is concerned primarily with maintenance and improvement of competitive position. Tactical control dominates. Market share and unit costs are watched carefully on a monthly and quarterly basis. At the functional level, the role of control becomes one of developing and enhancing function-based distinctive competencies. The number of sales calls completed, the number of customer complaints, and the number of defects are watched daily and weekly. Because of their short-term time horizons, operational and tactical controls are the most important types at this level, with only slight concern for strategic control.
To help achieve organizational objectives, strategic managers have an obligation to ensure that the entire hierarchy of controls are integrated and working properly. According to W. Edwards Deming, 85% of product defects are caused by the system within which the worker must perform and only 15% can be directly traced to the worker. Unfortunately, during the past several decades top management has almost forgotten the importance of strategic control. It often shifted control to the tactical and operational levels and led to short-term crisis management.
The measures to be used to assess performance depends on the organizational unit to be appraised and the objectives to be achieved. The objectives established in the strategy formulation stage of the strategic management process (regarding profitability, market share, and cost reduction, among others) should certainly be used to measure corporate performance during strategy implementation.
Some measures, such as return on investment (ROI), are appropriate for evaluating the corporation`s or division`s ability to achieve a profitability objective. This type of measure, however, is inadequate for evaluating other corporate objectives such as social responsibility or employee development. Even though profitability is the major objective for a corporation, ROI can be computed only after profits are totaled for a period. It tells what happened after the fact-not what is happening or what will happen. A firm therefore needs to develop measures that predict likely profitability. These are referred to as steering or feed-forward controls because they measure variables that influence future profitability. One example of this type of control is the use of control charts in Statistical Process Control (SPC). In SPC, workers and managers maintain charts and graphs detailing quality and productivity on a daily basis.
Managers may establish controls to focus either on activities that generate the performance (behavior) or on actual performance results (output). Behavior controls specify how something is to be done through policies, rules, standard operating procedures, and orders from a superior. Output controls specify what is to be accomplished by focusing on the end result of the behaviors through the use of objectives and performance targets or milestones. Behavior and output controls are not interchangeable. Behavior controls (such as following company procedures, making sales calls to potential customers, and getting to work on time) are most appropriate for situations in which results are hard to measure and a clear cause-effect connection exists between activities and results.
Output controls (such as sales quotas, specific cost reduction or profit objectives, and surveys of customer satisfaction) are most appropriate for situations in which there are specific agreed-upon output measures and there is no clear cause-effect connection between activities and results. Generally, output measures serve the control needs of the corporation as a whole, whereas behavior measures serve the individual manager."
Measures of Corporate Performance
The most commonly used measure of corporate performance (in terms of profits) is ROI. It is simply the result of dividing net income before taxes by total assets. Although there are several advantages to the use of ROI, there are also several distinct limitations. Although ROI gives the impression of objectivity and precision, it can be easily manipulated.
Other popular profit measures are earnings per share (EPS) and return on equity (ROE). Earnings per share also has several deficiencies as an evaluation of past and future performance. Because alternative accounting principles are available, EPS can have several different but equally acceptable values, depending on the principle selected for its computation. Moreover, EPS is based on accrual income involving both the near-term and delayed conversion of income to cash thereby ignoring the time value of money. Return on equity also has its share of limitations because it also is derived from accounting-based data. In addition, there is some evidence that EPS and ROE may be unrelated to a company`s stock price. Because of these and other limitations, EPS and ROE by themselves are inadequate measures of corporate performance.
Because any one measure is hound to have some shortcomings, C. W. Hofer recommends the use of value-added measures in evaluating a corporation`s performance. Value added is the difference between dollar sales and the cost of raw materials and purchased parts. Return on value added (ROVA) is a measure that divides net profits before tax by value added and converts the quotient to a percentage. Hofer argues that ROVA might be a better measure of corporate performance in various industries than other measures currently in use. Value added is a useful way to apply Porter`s value chain concept. Unfortunately, the major disadvantage of using value added is that the necessary figures aren`t readily available. In the United States, value added can`t be calculated from traditional financial reports because of the allocation of direct labor costs, indirect costs, and overhead costs to the total cost of goods manufactured. Nevertheless, authorities on the subject argue that combining value-added measures with traditional performance measures creates a more complete and realistic picture of a corporation`s performance.
Because of the belief that accounting-based numbers such as return on investment, return on equity, and earnings per share aren`t reliable indicators of a corporation`s economic value, many corporations are using shareholder value as a better measure of corporate performance and strategic management effectiveness. Shareholder value may be defined as the present value of the anticipated future stream of cash flows from the business plus the value of the company if liquidated. Based on the argument that the purpose of a company is to increase shareholder wealth, shareholder value analysis concentrates on cash flow as the primary measure of performance. The value of a corporation thus is the value of its cash flows discounted to their present value, using the cost of capital as the discount rate. So long as the returns from a business exceed its cost of capital, the business will create value and be worth more than the capital invested in it.
Economic Value Added (EVA)
Economic value added (EVA), also called residual income (RI), has become an extremely popular shareholder value method of measuring corporate and divisional performance and may eventually replace ROI as the standard performance measure. EVA equals income in excess of a minimum desired return. That is, EVA = income - (cost of capital x capital assets). Thus, it is measured in dollars.
EVA represents the business unit`s true economic profit; that is, the return that could have been obtained on the best alternative investment of similar risk. Hence, the EVA measures the managerial benefit obtained by using resources in a particular way. It is useful for determining whether a segment of a business is increasing shareholder value. EVA measures the difference between the pre-strategy and post-strategy value of the business. If the difference, discounted by the cost of capital is positive, the strategy is generating value for shareholders. Among the many companies using the new measure are Coca-Cola, AT&T, Quaker Oats, and CSX. EVA is after-tax operating profit minus the total annual cost of capital. Unlike ROI, one of EVA`s most powerful properties is its strong relationship to stock price. Managers can improve a company`s or business unit`s EVA by (1) earning more profit without using more capital, (2) using less capital, and (3) investing capital in high-return projects.
Evaluation of Top Management
Through its strategy, audit, and compensation committees, a board of directors may evaluate the job performance of the CEO and the top management team. Of course, the board is concerned primarily with overall profitability as measured quantitatively by return on investment, return on equity, earnings per share, and shareholder value. The absence of short-run profitability certainly is a factor contributing to the firing of any CEO, but the board also will be concerned with other factors .
Members of the compensation committees of today`s boards of directors generally agree that measuring a CEO`s ability to establish strategic direction, build a management team, and provide leadership is more important in the long run than are a few quantitative measures. The board should evaluate top management not only on typical output-oriented quantitative measures, but also on behavioral measures-factors relating to its strategic management practices. Unfortunately, less than 30% of companies systematically evaluate their CEOs` performance.
The specific measures used by a board to evaluate its top management should be based on the objectives agreed on earlier by both groups. If better relations with the local community and improved safety practices in work areas were selected as objectives for the year (or for five years), progress toward meeting them should be evaluated. In addition, other factors that tend to lead to profitability might be included, such as market share, product quality, and investment intensity.
Utilized by various consulting firms as a way to measure performance, audits of corporate activities are frequently suggested for use by boards of directors and by managers alike. Management audits have been developed to evaluate activities such as corporate social responsibility, functional areas such as the marketing department, and divisions such as the international division-and the corporation itself in a strategic audit. To be effective, the strategic audit should parallel the corporation`s strategic management process.
Measures of Divisional and Functional Performance
Companies use a variety of techniques to evaluate and control performance in divisions, SBUs, and functional areas. If a corporation is organized by SBU or division, it will use many of the same performance measures (ROI or EVA, for instance) that it uses to assess overall corporation performance. When it can isolate specific functional units, such as R&D, the corporation may develop responsibility centers. It also may use typical functional measures such as market share and sales per employee (marketing), unit costs and percentage of defects (operations), percentage of sales from new products and number of patents (R&D), and turnover and job satisfaction (HRM).
During strategy formulation and implementation, top management approves a series of programs and supporting operating budgets submitted by its business units. During evaluation and control, management contrasts actual expenses with planned expenditures and assesses the degree of variance, typically each month. In addition, top management probably will require periodic statistical reports that summarize data about key factors, such as the number of new customer contracts, volume of received orders, and productivity, among others.
Investment Decisions under ROI And RI
The decision whether to use ROI or RI as a measure of divisional performance affect financial managers` investment decisions. Under the ROI method, division managers tend to accept only the investments whose returns exceed the division`s ROI; otherwise, the division`s overall ROI would decrease. Under the RI method, on the other hand, division managers would accept an investment as long as it earns a rate in excess of the minimum required rate of return. The addition of such an investment will increase the division`s overall RI.
Control and Business Unit Strategy
The strategy chosen by an SBU should influence the type of controls chosen. High-performing SBUs following a cost leadership competitive strategy tend to use output controls, such as piece rate or straight commission. This approach is logical because costs usually can be easily determined. In contrast, high-performing SBUs following a differentiation competitive strategy tend to use behavior controls, such as salaried compensation. Factors such as creative flair, strong R&D, and innovative product development are extremely important to this strategy but are difficult to quantify.
Control systems can be established to monitor specific functions, projects, or divisions. For example, budgets typically are used to control the financial indicators of performance in conjunction with responsibility centers. A responsibility center is a unit that can be evaluated separately from the rest of the corporation. Each responsibility center is headed by a manager who is responsible for its performance, has its own budget, and is evaluated on its use of budgeted resources. The center uses resources (measured in terms of costs or expenses) to produce a service or a product (measured in terms of volume or revenues). The type of responsibility center used is determined by the way the corporation`s control system measures these resources and services or products. There are five major types of responsibility centers.
1. Standard cost centers: Primarily used in manufacturing facilities, standard (or expected) costs are computed for each operation on the basis of historical data. In evaluating the center`s performance, its total standard costs are multiplied by the units produced; the result is the expected cost of production, which is then compared to the actual cost of production.
2. Revenue centers: Production, usually in terms of unit or dollar sales, is measured without consideration of resource costs (e.g., salaries). The center is thus judged in terms of effectiveness rather than efficiency. The effectiveness of a sales region, for example, is determined by the comparison of its actual sales to its projected or previous year`s sales. Profits are not considered because sales departments have limited influence over the cost of the products they sell.
3. Expense centers: Resources are measured in dollars without consideration of service or product costs. Thus budgets will be prepared for engineered expenses (costs that can be calculated) and for discretionary expenses (costs that can be only estimated). Typical expense centers are administrative, service, and research departments. They cost an organization money, but they contribute only indirectly to revenues.
4. Profit centers: Performance is measured in terms of the difference between revenues (which measure production) and expenditures (which measure resources). A profit center typically is established whenever an organizational unit controls both its resources and its products or services. By having such centers, a company can be organized into divisions of separate product lines. The manager of each division is given autonomy to the extent that profits remain at a satisfactory (or better) level.
5. Investment centers: Because many divisions in large manufacturing corporations use significant assets to make their products, their asset bases should be factored into the performance evaluation. Thus focusing only on profits, as in the case of profit centers, is insufficient. An investment center`s performance is measured in terms of the difference between its resources and its services or products. For example, if two divisions in a corporation make identical profits but one division has a capital investment of $3 million in a plant and the other has a capital investment of $1 million in a plant, the smaller plant obviously is more efficient: it provides shareholders with a better return on their investment.
The most widely used measure of investment center performance is return on investment (ROI). Another measure, called economic value added (EVA) or residual income, or after-capital charge is obtained by subtracting an interest charge from net income. This interest charge could be based on the interest the corporation is actually paying to lenders for the assets being used. It could also be based on the amount of income that could have been earned if the assets had been invested somewhere else. Even though the residual income method is superior to ROI because it takes into account the cost of capital, it never attained ROI`s popularity.
Most single-business corporations, such as Apple Computer, tend to use a combination of cost, expense, and revenue centers. In these corporations, most managers are functional specialists and manage against a budget, and total profitability is integrated at the corporate level. Dominant product companies, such as Anheuser-Busch, which have diversified into a few small businesses but which still depend on a single product line for most of their revenue and income, generally use a combination of cost, expense, revenue, and profit centers. Multidivisional corporations such as General Electric tend to emphasize investment centers-although in various units throughout a corporation other types of responsibility centers also are used. One problem with using responsibility centers, however, is that they sometimes complicate the calculations necessary for the kind of value chain analysis that looks for synergistic linkages among units.
Benchmarking is the continual process of measuring products, services, and practices against the toughest competitors or those companies recognized as industry leaders. An increasingly popular program, benchmarking is based on the concept that reinventing something that someone else is already using makes no sense. It involves openly learning how others do something and imitating or perhaps even improving on their techniques. The benchmarking process usually involves the following steps.
Identify the area or process to be examined. It should be an activity that has the potential to determine a business unit`s competitive advantage.
Find behavioral and output measures of the process and obtain measurements.
Select an accessible set of competitors and best-in-class companies against which to benchmark. These companies may be in completely different industries but perform similar activities.
Calculate the differences among the company`s performance measurements and those of the best-in-class company. Determine why the differences exist.
Develop tactical programs for closing performance gaps.
Implement the programs, measures the results, and compare the results with those of the best-in-class company.
In conventional planning, the correctness of a plan is generally judged by how close projections come to outcomes. In discovery-driven planning, it is assumed that plan parameters may change because new information is revealed; therefore the plan is subject to change. With conventional planning, it is considered appropriate to fund the entire project as the expectation is that one can predict a positive outcome. In discovery-driven planning, funds are released based on the accomplishment of key milestones or checkpoints, at which point additional funding can be made available predicated on reasonable expectations for future success. Conventional project management tools, such as stage-gate models or the use of financial tools to assess innovation have been found to be flawed in that they are not well suited for the uncertainty of innovation-oriented projects Innovative growth that involves the development of an innovative new product or service can be attained by establishing and systematically testing project assumptions at progressively more challenging checkpoints, learning from the outcomes, and changing direction as appropriate. If the results live up to your assumptions, you release more funds until you get to the next checkpoint. If they don`t, you alter the project or kill it. Ego, corporate politics, and a desire to recoup some kind of return on investment almost guarantee that good money will be thrown after bad. The important thing is that you`re embedding learning into the planning process."
Strategic Information Systems
Before performance measures can have any impact on strategic management, they must first be communicated to the people responsible for formulating and implementing strategic plans. Strategic information systems-computer-based or manual, formal or informal-can perform this function to serve the information needs of top management. One of the main reasons given for the bankruptcy of International Harvester was the inability of the corporation`s top management to determine precisely its income by major class of similar products. Because of this inability, management kept trying to fix ailing businesses and was unable to respond flexibly to major changes and unexpected events. In contrast, one of the key reasons for the success of Toys `R` Us has been management`s use of the company`s sophisticated information system to control purchasing decisions.
Critical success factors (CSFs), also called key success factors (KSFs), are the things that must go well to ensure a corporation`s success. Typically, they are the 20% of the factors that determine 80% of the corporation`s or business unit`s performance. Critical success factors should be
Important to achieving overall corporate goals and objectives.
Measurable and controllable by the organization to which they apply.
Relatively few in number-not everything can be critical.
Expressed as things that must be done.
Applicable to all companies in the industry with similar objectives and strategies.
Hierarchical in nature-some CSFs will pertain to the overall corporation, whereas others will be more narrowly focused, say, in one functional area.
The CSFs provide a starting point for developing an information system. Such an information system will thus pinpoint the principal areas that need attention.
At the divisional or SBU level, the information system should support, reinforce, or enlarge business-level strategy with a decision support component. An SBU pursuing a strategy of overall cost leadership could use its information system to help reduce costs either by the improvement of labor productivity or the utilization of other resources, such as inventory or machinery.
The choice of business-level strategy will thus dictate the type of information system that the SBU needs both to implement and to control strategic activities.
The information systems will be constructed differently to monitor different activities because the two types of business-level strategies have different critical success factors.
Problems in Measuring Performance
Performance measurement is crucial to evaluation and control. The lack of quantifiable objectives or performance standards and the inability of the information system to provide timely, valid information are two obvious control problems. Without objective and timely measurements, making operational, let alone strategic, decisions would be extremely difficult. Nevertheless, the use of timely, quantifiable standards doesn`t guarantee adequate performance. The very act of monitoring and measuring performance may cause side effects that interfere with overall corporate performance. Among the most frequent negative side effects are short-term orientation and goal displacement.
In many situations top executives do not analyze either the long-term implications of present operations on the strategy they have adopted or the operational impact of a strategy on the corporate mission. Long-run evaluations are not conducted because executives (1) may not realize their importance, (2) may believe that short-run considerations are more important than long-run considerations, (3) may not be personally evaluated on a long-term basis, or (4) may not have the time to make a long-run analysis. There is no real justification for the first and last "reasons." If executives realize the importance of long-run evaluations, they make the time to conduct those evaluations. Even though many chief executives point to immediate pressures from the investment community and to short-term incentive and promotion plans to support the second and third reasons, the evidence doesn`t always support their claims.
Many accounting-based measures do, however, encourage a short-term emphasis. One of the limitations of ROI as a performance measure is its short-term nature. In theory, ROI is not limited to the short run, but in practice applying this measure to long-term performance often is difficult. Moreover, because managers can manipulate both the numerator (earnings) and the denominator (investment), an ROI figure may be meaningless. Advertising, maintenance, and research efforts may be reduced. Mergers may be undertaken that will do more for this year`s earnings (and next year`s paycheck) than for the corporation`s future profits.
Efforts to compensate for these distortions tend to create a burdensome accounting control system, which stifles creativity and flexibility and leads to even more questionable "creative accounting" practices.
Monitoring and measuring performance (if not carefully done) can actually result in a decline in overall corporate performance. Goal displacement is the confusion of means with ends and occurs when activities originally intended to help managers attain corporate objectives become ends in themselves-or are adapted to meet ends other than those for which they were intended. Two types of goal displacement are behavior substitution and suboptimization.
Managers tend to focus more of their attention on those behaviors that are clearly measurable than on those that are not. Employees receive little or no reward for cooperation and initiative. However, easy-to-measure activities might have little or no relationship to the desired performance. Rational people, nevertheless, tend to work for the rewards that a system has to offer. Therefore workers will tend to substitute behaviors that are recognized and rewarded for those behaviors that are ignored, without regard to their contribution to goal accomplishment. A U.S. Navy quip sums up this situation: "What you inspect is what you get." If the evaluation and control system of an auto plant rewards the meeting of quantitative goals and pays only lip service to qualitative goals, consumers can expect to get a large number of poorly built cars.
The most frequently mentioned problem process partially distorts the realities of the job. Objectives are set for areas in which the measurement of accomplishments is relatively easy, such as ROI, increased sales, or reduced cost. But these might not always be the most important areas. This problem becomes crucial in professional, service, or staff activities for which quantitative measurement is difficult. For example, if a divisional manager is achieving all the quantifiable objectives set but, in so doing, alienates the workforce, the result could be a long-term, significant drop in the division`s performance. If promotions are based strictly on measurable short-term performance results, this manager is likely to be promoted or transferred before the employees` negative attitudes result in complaints to the personnel office, strikes, or sabotage. The law governing the effect of measurement on behavior seems to be that quantifiable measures drive out nonquantifiable measures.
The emphasis in large corporations on developing separate responsibility centers may create some problems for the corporation as a whole. To the extent that a division or functional unit views itself as a separate entity, it might refuse to cooperate with other units or divisions if cooperation could in some way negatively affect its performance evaluation. The competition between divisions to achieve a high ROI may result in one division`s refusal to share its new technology or work-process improvements. One division`s attempt to optimize the accomplishment of its goals may cause other divisions to fall behind and thus negatively affect overall corporate performance. One common example of this type of suboptimization occurs when a marketing department approves an early shipment date to a customer as a means of getting an order. That commitment forces manufacturing to work overtime to get the order out, raising production costs and reducing manufacturing`s overall efficiency. Although marketing might achieve its sales goal, the corporation as a whole might not achieve its expected profitability.
Guidelines for Proper Control
In designing a control system, top management needs to remember that controls should follow strategy. That is, unless controls ensure the proper use of a strategy achieve objectives, dysfunctional side effects are likely to undermine completely the implementation of that strategy. The following guidelines are recommended.
1. Controls should involve only the minimum amount of information needed to give a reliable picture of events. Too many controls create confusion. Focus on that 20% of the factors that determine 80% of the results.
2. Controls should monitor only meaningful activities and results, regardless of measurement difficulty. If cooperation between divisions is important to corporate performance, some form of qualitative or quantitative measure should be established to monitor cooperation.
3. Controls should be timely so that corrective action can be taken before it is too late. Steering controls, or controls that monitor or measure the factors influencing performance, should be stressed so that advance notice of problems is given.
4. Controls should be long term as well as short term because emphasizing only short-term measures is likely to lead to a short-term managerial orientation.
5. Controls should pinpoint exceptions, with only those activities or results that fall outside a predetermined tolerance range being identified for attention.
6. Controls should be used to reward meeting or exceeding standards rather than to punish failure to meet standards. Heavy punishment of failure will typically result in goal displacement. Managers will falsify reports and lobby for lower standards.
Surprisingly, the best managed companies often have few formal objective controls. They focus on measuring critical success factors and control other factors by means of the corporate culture. When the firm`s culture complements and reinforces its strategic orientation, there is little need for an extensive formal control system. The stronger the culture and the more it was directed toward the marketplace, the less need was there for policy manuals, organization charts, or detailed procedures and rules. In these companies, people way down the line know what they are supposed to do in most situations because the handful of guiding values is crystal clear.
Strategic Incentive Management
To ensure congruence between the needs of the corporation as a whole and the needs of its employees as individuals, management and the board of directors should develop an incentive program that rewards desired performance. Research confirms the conventional wisdom that, when pay is tied to performance, it motivates higher productivity, and strongly affects both absenteeism and work quality. Studies of compensation plans in all types of companies-manufacturing and service, large and small, growing and declining, in stable and turbulent markets-showed that the higher the percentage of management`s compensation that is linked to performance, the greater is the company`s profitability. Corporations therefore have developed various types of incentives for executives that range from stock options to cash bonuses. Unfortunately, research consistently reveals that CEO compensation is related more to the size of the corporation than to the size of its profits. The gap between CEO compensation and corporate performance is most noticeable in those corporations with widely dispersed stock ownership and no dominant shareholder group to demand performance-based pay.
The following three approaches are tailored to help match measurements and rewards with explicit strategic objectives and time frames.
1. Weighted-factor method: This method is particularly appropriate for measuring and rewarding the performance of top SBU managers and group-level executives when performance factors and their importance vary from one SBU to another. The measurements used by one corporation might contain the following variations: the performance of high-growth SBUs measured in terms of market share, sales growth, designated future payoff, and progress on several future-oriented strategic projects; the performance of low-growth SBUs, in contrast, measured in terms of ROI and cash generation; and the performance of medium-growth SBUs measured for a combination of these factors.
2. Long-term evaluation method: This method compensates managers from achieving objectives set over a multi-year period. An executive is promised some company stock or "performance units" (convertible into money) in amounts to be based on long-term performance. An executive committee, for example, might set a particular objective in terms of growth in earnings per share during a five-year period. Awards would be contingent on the corporation`s meeting that objective within the designated time limit. Any executive who leaves the corporation before the objective is met receives nothing. The typical emphasis on stock price makes this approach more applicable to top management than to business unit managers.
3. Strategic-funds method: This method encourages executives to look at developmental expenses differently from current operating expenses. The accounting statement for a corporate unit enters strategic funds as a separate entry below the current ROI. Distinguishing between funds consumed in the generation of current revenues and funds invested in the future of the business is possible. Hence the manager can be evaluated on both a short- and a long-term basis and has an incentive to invest strategic funds in the future.
An effective way to achieve the desired strategic results through a reward system is to combine the weighted-factor, long-term evaluation, and strategic-funds approaches. To do so, first, segregate strategic funds from short-term funds, as is done in the strategic-funds method. Second, develop a weighted-factor chart for each SBU. Third, measure performance on the basis of the pretax profit indicated by the strategic-funds approach, the weighted factors, and the long-term evaluation of SBU and corporate performance. General Electric and Westinghouse are two of the firms that use a version of these measures.