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Performance Measurement 101  (Printable version)

Performance measurement is a tool to help managers control the outcomes of their organizations.  It enables them to be the driver rather than a passenger on their organizational journey.  The value of performance measurement is summarized in this lighthearted ditty.

• If it can't be measured, it can't be managed.

• What gets measured gets watched.

• What gets watched gets done.

The concept of performance measurement is not new but it was not recognized as a formal management process until the late 1960's when the Department of Defense, as part of an effort to reduce program cost overruns, issued a set of criteria defining standards for management control systems.  This criteria approach was implemented throughout the Department of Defense by publishing the Cost/Schedule Control Systems Criteria Joint Implementation Guide.  All DOD prime contractors were required to develop or modify their management control systems to comply with these criteria.  This requirement was later extended to include second and third tier subcontractors.  

These criteria define the capabilities that effective management control systems must possess and establish rules for implementation.  A performance measurement system that provides timely information for management decisions is their unifying component.  These criteria were developed for DOD programs but the theory and principles involved have universal management applications.  This concept paper adapts these criteria for use by business and nonprofit organizations.

PRINCIPLES OF PERFORMANCE MEASUREMENT

All significant work activity must be measured.

• Work that is not measured or assessed cannot be managed because there is no objective information to determine its value.  Therefore it is assumed that this work is inherently valuable regardless of its outcomes.  The best that can be accomplished with this type of activity is to supervise a level of effort.
• Unmeasured work should be minimized or eliminated.
• Work measurement must include the resources (manpower, expenses, and investment) required to accomplish the desired results.

Desired performance outcomes must be established for all measured work.

• Outcomes provide the basis for establishing accountability for results rather than just requiring a level of effort.

• Desired outcomes are necessary for work evaluation and meaningful performance appraisal.

• Defining performance in terms of desired results is how managers and supervisors make their work assignments operational.

A time phased performance baseline must be developed to evaluate total organizational performance.

• This baseline must incorporate all organizational activity.  This includes:

• Operating performance outcomes that define the desired results from operations and the operational resources (manpower, material, assemblies, etc.) required to achieve these results.

• Financial performance outcomes that define the expected revenue and expense results, and investment required to support operating activity.

• Schedule performance that defines when these results and investment are expected to occur.

• This baseline provides the standard for evaluating organizational results, determining variances from the plan, and implementing corrective action.

Operating and financial performance reporting must be synchronized with the same reporting periods and reporting frequency.

• Reporting periods and frequency must be consistent with the time phasing of the performance baseline.

Performance reporting and variance analyses must be accomplished frequently.

• Frequent reporting enables timely corrective action.

• Timely corrective action is needed for effective management control.

DEVELOPING THE PERFORMANCE MEASUREMENT BASELINE

Work should be planned at the organizational level accountable for the results of that work.

• This planning establishes accountability for variance analysis and corrective action.

• Work planning may include breaking down the work into lower level results and resource requirements.  Examples:

• Subdividing marketing expense requirements into advertising, promotion, administrative, etc.

• Subdividing production manpower requirements into direct manpower, indirect manpower, and overhead manpower.

• Subdividing sales expectations into product A sales, product B sales, etc.

• The lower the level of work planning and reporting the more accurate will be the variance analysis.

• Meaningful work planning can not go lower than the organization's management reporting capability.

• Work planning includes identifying the desired results from the work activity and estimating the physical and financial resources needed to accomplish these results.

Operational planning begins by determining the operating results to be achieved and estimating the physical resources needed to achieve them.

• Estimating relationships used to relate operating results and physical resources should be formalized so they can be monitored during performance measurement.

  • Example- direct production man-hours per unit produced.

Financial planning involves estimating the income and expense results from the operating plan and the investment needed to support the plan.

• Estimating relationships used to relate physical activity and resources to income, expense, and investment dollars should be formalized so they can be monitored during performance measurement.

  • Example- revenue per unit sold.

The performance measurement baseline integrates operational and financial planning results and displays them on a common timeline.

• Operational and financial planning results and resource requirements may be summarized to the organizational level accountable for the results of that work.

• Summary reporting may be more convenient for upper management needs.

• Lower reporting levels must still be maintained for variance analysis.

Operating plans and budgets must be consistent with the performance measurement baseline.

• Functional operating budgets lower than the baseline can be used to provide an incentive to managers and supervisors but operating budgets may not exceed the baseline values.

• When operating budgets are less than the baseline the resource requirements must be reduced commensurately to preserve the estimating relationships used to develop the budget. 

Changes to the performance measurement baseline must be controlled and justified.

• No retroactive changes to completed work are permissible since this negates any meaningful variance analysis.

VARIANCE ANALYSIS

The purpose of variance analysis is to determine the corrective action needed (if any) to accomplish the desired operating and financial results.

• Variance analysis effectiveness is directly proportional to the level of detail used to develop the performance measurement baseline.

• Comparing the estimating relationships used to develop the baseline with current measured values provides advance notice of the accuracy of the baseline estimates.

• Comparing the baseline to an estimate using these updated relationships will show how current results are impacting final performance.

• The decision whether to take corrective action is driven by the impact of current performance on estimated final results.

• Variance analysis contributes to learning and understanding the system dynamics that causes the observed results.

Variance analysis has the following objectives.

• Analyze the impact of current performance on final operating and financial results.

• This will determine whether corrective action is indicated.

• If the estimated final results are unacceptable, corrective action is needed.

• Determine the root causes of the existing variances.

• Evaluating the estimating relationships used to develop the baseline will assist in this process.

• A Root Cause Problem Solving model in this website provides a technique to do this.

• Determine the corrective action needed to achieve the desired results. 

Operating results must be reported promptly and on a consistent schedule.

• Timely corrective action requires prompt variance analysis.

• Performance reporting should include the data needed to analyze the estimating relationships that were used to develop the baseline.

Three Sigma can help you develop or enhance a performance measurement process for your organization.  

Contact TheCoach@ThreeSigma.com.