Design of Performance Management Systems
--- A Stakeholder Analysis Framework
Dr. Pingli Li (Middlesex University Business School)
(draft)
This stakeholder analysis framework for design of performance
management systems (PMS) recognises the influence from the
environment in which the company operates and links stakeholder
analysis to the company’s objective setting and strategy formulation.
The design of PMS is based on the understanding of this environment,
and the relationship between stakeholders and company that has been
formed in this specific environment. The response to environment
change makes the model dynamic.
Key words : performance management system; stakeholder; environment; objective
and strategy.
1. INTRODUCTION
If “what you measure is what you get” (Kaplan and Norton 1996), then the first
question for design of performance management system (PMS) is: “what do you
really want?”. While the Balanced Scorecard, Economic Value Added (EVA) and
many other models take the shareholder’s value as the primary objective, other
researchers have taken into account the stakeholders’interests. (e.g. Neely & Adams,
2002; Anthony, Waterhouse and Wells, 1997). In this ‘forest of models’, how should
we choose the starting point for developing an appropriate PMS for a specific
business? Why does a model fail in some organizations while it succeeds in others?
The aim of this paper is to build a practical, dynamic framework for designing
performance management systems based on stakeholder theory. The model links
environment analysis, stakeholder identification and classification, objective setting
and strategy development into the design of PMS. The development of the framework
is based on the experience of active participation in design of PMS for Chinese firms
and the observation on adoption of different models in these firms. Its theoretical
structure has been inductively developed and the framework has been used
2
successfully in some “blue chip”companies in China. In the paper, a case study has
been used to assess the framework’s practicability.
In the last two decades, performance management has become a popular topic, not
only for research. The practice of performance management also has undergone many
innovations. Since the criticism of traditional financial accounting information was
first formulated by Norton and Kaplan (1987), there have been many new models,
including Activity-Based Costing, Balanced Scorecard, and EVA. The common
conclusion is that performance management systems based primarily on financial
performance indicators fail to communicate decision-relevant information to
managers. Performance management should be linked to strategic planning. As we
know, strategy is not about destination; instead it is about the route you choose to take
- how to reach the desired destination. Organizations adopt particular strategies
because they believe these strategies will help the organization to achieve a specific,
desirable goal in the specific environment. So the meaning hidden behind ‘design the
measures from the strategy’should be to start the design of PMS from recognising the
objective and the strategy of the organization. This is why Balance Scorecard and
EVA start by asking “what do the shareholders want?”. Here Balance Scorecard and
EVA assume implicitly that the shareholder alone is the most important stakeholder,
and the shareholder is the only stakeholder group that determines the organization’s
objectives. This concentration on the shareholder ignores the growing recognition of
other stakeholders’interests and influences. The Balanced Scorecard does highlight
the importance to the business of some stakeholders, such as customer or employee.
But it focuses only on the influences that these stakeholders have on the ability of the
business to achieve its objectives. It does not provide an analysis framework to
identify all of the stakeholders that may affect the organization’s objectives
themselves, and the way the stakeholders may influence the ability to achieve these
objectives in a specific environment. Failure to recognize the different influences
from various stakeholder groups in a specific environment during the design of a PMS
is one of the critical reasons why some internationally well known companies have
not achieved success in China, as they have done in other countries.
Otlay’s (1999) argues that ‘management accounting and other performance
measurement practices need to be evaluated not just from an economic perspective,
3
but from a social, behavioural and managerial perspective, within an overall
organisational context.’In his ‘performance management framework, he addressed
five main sets of issues that are represented as a set of questions:
1. What are the key objectives that are central to the organization’s overall future
success, and how does it go about evaluating its achievement for each of these
objectives?
2. What strategies and plans has the organization adopted and what are the
processes and activities that it has decided will be required for it to
successfully implement these? How does it assess and measure the
performance of these activities?
3. What level of performance does the organization need to achieve in each of
the areas defined in the above two questions, and how does it go about setting
appropriate performance targets for them?
4. What rewards will managers (and other employees) gain by achieving these
performance targets (or, conversely, what penalties will they suffer by failing
to achieve them)?
5. What are the information flows (feedback and feed- forward loops) that are
necessary to enable the organization to learn from its experience, and to adapt
its current behaviour in the light of that experience?
This framework was widely used in case studies. We also find it helpful in the process
of developing PMS in emerging economies. It draws manager’s and researcher’s
attention to objectives and strategies. It is also devised to all types of organizations
and other performance management models. But some limitations also have been
revealed during its applications. Firstly, it is a static, not dynamic framework. The
framework tends to look at PMS from a static perspective. Even though Otley argues
that organizations need to continually develop new answers to these questions, the
framework itself fails to provide a device for analys ing change. Secondly, it is
devised for all types of organization, but does not provide the research devices to
explore the effects of different characteristics of organizations on design PMS. From
our experience and observation, we realise that the environments in which an
organization is operating are extremely important for its objective setting and strategy
formulation, therefore influenc ing the design of PMS. The change of the
environments requires a dynamic PMS.
4
Our stakeholder analysis framework explicitly recognises the influence from the
environment, and links stakeholder analysis to the company’s objective setting and
strategy formulation. The design of performance management system (PMS) is based
on the understanding of the environment and the relationship between stakeholder and
company formed in that specific environment.
Some scholars also have built performance management models based on stakeholder
theory and started from stakeholder analysis. Anthony, Waterhouse and Wells (1997)
define the purpose of strategic planning as to achieve company’s primary objectives,
which are decided by the organization’s owners. What the company expects from and
gives to each stakeholder group to achieve its primary objectives, are the secondary
objectives. They proposed a model “that views performance on a company’s primary
objectives as a result of the processes used to generate results. For companies to
improve performance on their primary objectives, they must develop a comprehensive
systems of measures that monitor and evaluate the ability of its processes to achieve
its secondary objectives”. Neely and Adams (2002) also start from ‘the stakeholder
satisfaction perspective’in their five- faceted ‘performance prism’, addressing the first
question as “who are the most influential stakeholders and what do they want and
need?”. These models link stakeholder analysis to the strategic planning and operating
process, and then produce a clearer picture of the relationship between the company
and its stakeholders for designing the performance management system. But they still
fail to recognise the environment, which affects the relationship between the company
and its stakeholders.
The remainder of the paper is organized as follows. Section 2 discusses the research
methods used in this paper. Section 3 contains a description of the new framework
and an outline of the main characteristics of the framework. Section 4 theoretical
development. Section 5 a case study. Section6 discussion and conclusion.
2. RESEARCH METHOD
In recent years, many researchers in China have been actively involved in the
evolution process of enterprise management. The characteristics of emerging
economy provide opportunities and motivations for academic researchers to act as
5
participant observers (Smith, 2003). Although their contributions to the development
of management practice and their influence on policy- making are significant, the
contributions to management theory still need further generalisations.
We aim to explore a theoretical, and also practical framework, which is able to
integrate environment elements into design of PMS and is applicable to all types of
economy and organisation. In the design of this framework, both inductive and
participate case study research methods are adopted.
From the observation of the applications of different models in China’s big firms and
our direct experience in designing PMS in China, we recognise the core issue of
designing a PMS is how to identify the stakeholders and their influences on
company’s objective- setting and objective achievement. This identification could
provide a practical device to integrate environments analysis into design of PMS. In
order to achieve this integration, we have developed a theoretical framework
inductively and applied it in a number of consultancy and research projects. The
inductive research and active participate research are used simultaneously to develop,
verify and revise the framework.
3. Introduction to the STAKEHOLDER ANALYSIS FRAMEWROK
.
The stakeho lder analysis framework, as shown in Figure1, is developed from our
inductive theoretical research and participation in the reform of management control
systems in China’s big firms. The characteristics could be summarised as follows:
•
Stakeholders are identified and classified into two categories: key-stakeholder
and non-key stakeholder. The definitions are discussed in part 4.
•
The objectives of the company represent the expectations and interests of key
stakeholders, and key stakeholders exercise their power on objective-setting
through corporate governance structure.
•
Although non-key stakeholders are not powerful in objective-setting, they
exercise their powers through external mechanisms on strategy, while strategy
concerns how to achieve the objectives in specific environment
6
PMS starts from strategy and acts as a bridge between managers’behaviour and
Deleted: ¶
stakeholders’expectations.
MARKET
Stakeholders
Key
Stakeholder
Non-Key
Stakeholder
CULTURE
Corporate
Governance
External
Mechanism
HISTORY
via
via
Objectives
Strategy
PMS
Manager抯
Behaviour
LEGISLATION
Figure1. Stakeholder Analysis Model
4. THEORETICAL DEVELOPMENT
4.1 STAKEHOLDER ANALYSIS --- definition and classification
Since Freeman’s landmark work ‘Strategic Management: A Stakeholder Approach’
(Freeman, 1984), the concept of ‘stakeholder’has become embedded in management
theory and practise. The identification and classification of stakeholders is well
discussed in the literature (e.g., Mitchell, Agle and Wood, 1997; Carroll, 1996;
Clarkson, 1995; Jones, 1995(2)). Mitchell, Agle and Wood (1997) list Freeman’s ‘A
stakeholder in an organization is any group or individual who can affect OR be
affected by the achievement of the organization’s objectives’(Freeman 1984) as one
of the broadest definitions, while Clarkson’s definition of stakeholders as those who
have placed something at risk in relationship with the firm (1994:5) is one of the
narrowest definitions. In our model we identify stakeholders dynamically as ‘
the
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group or individual who can affect AND be affected by the achievement of the
organization’s objectives’.
In this definition, we take interests and power as basic characteristics to identify
stakeholders, and DO NOT include any group or individual who is affected by the
achievement of the organization’s objectives but cannot obtain the power currently or
in foreseeable future to influence the achievement of the organization. For example,
the health of the citizens is influenced by the pollution created by the cars, but citizens
would not be qualified as the car-producer’s stakeholder group in our analysis model
until they get legal or political support to influence car-producers. By this definition
we try to consider stakeholder analysis in a practical and dynamic way. If we adopted
Mitchell, Agle and Wood’s model (1997), our definition would include “Dominant”
stakeholders (who are powerful and legitimate) and “Definitive”stakeholders (with
all three attributes: power, legitimacy and urgency), but not “Latent stakeholders”
(who only have one of the three attributes), “Dependent”stakeholders (with urgent
legitimate claims but lack power) and “Dangerous”Stakeholders (with urgency and
power but lack legitimacy).
Most companies have shareholder, employee, consumer, supplier, bank and
government as stakeholders, but the relationships between these stakeholders and
companies differ in various businesses and various periods.
Classification of stakeholders is a way to analyse the relationship between
stakeholders and company. How to classify stakeholders depends on the objective of
the stakeholder analysis. We have to analyse the stakeholders’influence on objectivesetting and strategy-developing, so we classify them into two categories according to
the mechanisms they choose to influence the setting and achieving of the objectives.
We name the first category as Key Stakeholder, which has a direct control over the
operation of the company. Key stakeholders invest economic resources in the
organization --- these are basic for the existence of the organization, and these
stakeholders hold the power of “decision control”and impose direct constraints on
managers’behaviour by the mechanisms of separating decision management and
decision control (Fama and Jensen, 1976). They are the owner(s) of the organization,
8
and their claims are expressed in the objectives of the company. Their satisfaction
depends on the achievement of the objectives.
If we apply contract theory, key stakeholder(s) are individuals or groups that have
incomplete contracts with company and have to keep the power of control in order to
protect their own interests. Certainly shareholder is a key stakeholder. In most
instances shareholder is the only key stakeholder, but this is not always the case.
Whether there should be other stakeholders as key stakeholders depends on the
environment in which the company operates in. This discussion will be left to the next
part. When shareholder is the sole key stakeholder, the objective of the organization
might be value maximization. But when there are other stakeholder(s) besides
shareholders in this category, we have to redefine the objective of the organization.
If stakeholders choose external mechanisms, which could be the combination of
markets, legislation, culture and tradition, to protect their interests, they would be in
second category--- Non-key stakeholders. Non-key stakeholders do not have the right
to hire, fire, and compensate managers, they have no direct influence on the decisions
of the organization, but they still exercise power over the achievement of the
organization’s objectives via external mechanisms. Their influence on the
achievement of the company’s objectives ensures that a manager has to satisfy their
claims by a specific strategy. The interests of non-key stakeholders are not a part of
the organisation’s objective, but the achievement of the objectives relies on their
satisfaction. The increasing importance of customer satisfaction is a good example.
When we have the shareholder as the sole key stakeholder and define the objective of
the organization as maximization of shareholder value, we still have to develop a
specific strategy according to the influence of customer satisfaction on the
organization. Here non-key stakeholders are powerful because of their influence on
the achievement of the objectives.
There are different stakeholder classifications in different corporate governance
models. In the UK and USA, shareholde r is key stakeholder, while in Japan and
Germany, employee and bank both may have an important role in corporate
governance as key stakeholders. How did these corporate governance models come
into being? Why does a difference exist? The answer is crucial of r the reform of
9
corporate governance in developing countries such as China, and is also important for
the design of PMS because of the link between stakeholder analysis and the
organization’s objectives.
We argue how stakeholders choose mechanisms to pro tect their interests in a
company depends on the specific environment faced by the stakeholders. These
environment factors cover markets, legislation, culture and tradition. The difference in
the environment creates different corporate governance models and makes PMS
variable.
Market pressure is the most fundamental mechanism to prevent business corporations
from abusing their power in a free market economy. In a fully competitive market we
assume market pressure is sufficient to keep companies from taking advantage of
consumers, employees, suppliers and other stakeholders.
These stakeholders would
like to choose external mechanisms and to become non-key stakeholders. Because of
the efficiency of product markets, input markets and labour markets in the UK and
USA, most often customers, suppliers, and employees prefer to remain in the second
category as non-key stakeholders. At an earlier stage in the development of capital
markets, shareholders, as the key stakeholders, exercised their power on managers by
decision control instead of market pressure. But in contemporary capital markets,
shareholders are becoming more and more likely to rely on market pressures instead
of involving themselves in control. This trend causes problems with a corporate
governance model that has the shareholder as the sole key stakeholder while market
failure exists. Correspondingly, how to keep a manager’s autonomy under control has
become an important issue for the Anglo-American model1 .
If the market is not efficient enough, and stakeholders are still in the category of nonkey stakeholder, they have to devise other mechanisms to protect their interests. When
market failure exists, the government would step in and these non-key stakeholders
1
An example is Enron. It has been suggested that just before the collapse of the
company, directors were recommending to their shareholders to purchase the
company shares after they had sold theirs. So the question is: could the Enron scandal
have been avoided if shareholders were directly involved with the management of
Enron, through the AGM and asked the right questions at the meeting? (for further
discussion, see for example Stratling 2003 ).
10
would acquire political power or legal support. For consumers or suppliers in
uncompetitive markets, the government would step in to set regulation on the prices
of products or to regulate the process of transaction. For instance, if customers
suffered the loss of their rights (as customers), this could cause regulations to be
revised or new consumer protection laws to be designed. 2 . Another solution is
ownership: once one recognizes that external mechanisms do not work, and that both
parties cannot keep their co-operation relationship, inte gration could be an
alternative 3. Then a non- key stakeholder would become a key stakeholder.
For employees, political power is another important mechanism alongside market
pressure. Pressure from labour unions has an important role in the negotiation of
salaries, in manager’s decisions on redundancies, take- over etc. But for specialized
human capital, especially for workers with skills highly specific to current employers
or the technical employees in hi-tech industries in which their contributions are vital
to the success of the companies, they could bear the same residual risk with their
investments of their own human capital as shareholders do with their investments of
4
financial capital . Can they protect their interests by external mechanisms, or should
2
Tempo’
s case is an example. According to the report from Watchdog of BBC 15.11.01: Tempo sold
thousands of extended warranties - or as Tempo call them Coverplans. In the Tempo training manual
staff are informed to “Offer the coverplan on every item that you can. Extended warranties sold by
Tempo before April 1997 were underwritten by an insurance company. After that date, the warranties
they sold were no longer insured, but customers were not told. When the company went into
administration in September 2001, half a million customers were left without cover. Even if finally
400,000 of the warranty holders who bought on credit or in store credit will be issued with new
agreements by Dixon, there are still more than 100,000 customers who bought on cash will be left with
worthless warranties. The amazing thing is there is nothing to stop this kind of thing happening again.
Companies who sell warranties are under no legal obligation to set aside customers' money, so if they
get into trouble - like Tempo - these warranties could be worthless. Shadow minister Nigel Waterson is
demanding a change in the law. As he explained to the programme (Watchdog): “there is clearly a legal
loophole here which must be closed, and I intend to do everything I can in the House of Commons to
make this happen, so that people like this are protected in the future, that they get the protection they
paid for, that they are entitled to, and also so that this situat ion can never ever happen again."
3
Oliver Hart (1995) use the well- known example of Fisher Body to explain why a merger might be
desirable in a world of contract costs. For a long time Fisher Body and General Motor were separate
firms linked by a long-term contract. That means GM ( customer) and Fisher Body (supplier) both
acted as Non-key stakeholders to each other. However, in the 1920s GM’s demand for car bodies
increased substantially. After Fisher Body refused to revise the formula for determining price, GM
bought Fisher out. Then GM became the key stakeholder of Fisher Body.
4
Margarat Blair(1995) draw her conclusion in her work on corporate governance. “Investment in
human capital are almost likely to be important in technology –intensive or service-oriented enterprises,
where most of the value added comes from innovation, product customization, or specialized
services. …… In such enterprises employees whose skills are specialized to the company will
inevitably bear some of the risk associated with the enterprise, and this fact gives them a ‘stake’in the
company that is at risk in exactly the same way as the stake held by shareholders.” (1995, P. 238). She
also refers to the same conclusions from Paul Milgrom and John Roberts (1992)
11
they become key stakeholders and involve themselves directly in control over the
company? There have been different solutions from different corporate governance
models. To limit ourselves to the topic of this paper, we must leave this to further
research.
The difference of stakeholder classification in different companies is not only from
different market conditions, but also from the difference of the legislation systems,
culture and tradition. The employees’ role in corporate governance as key
stakeholders in German companies, by taking positions in the Supervisory Board, is
an example of the difference caused by legislation and tradition. In Japan, companies
can keep stable co- operation relationships with their suppliers even if no complete
contracts exist; while in some other countries, it may be necessary to take ownership
of a supplier to achieve a satisfactory relationship. We argue that the choice of
mechanism used by specific stakeholders to protect their own interests depends on the
external environments they face. Under different external environments, the specific
stakeholder chooses different interest-protecting mechanisms. This creates different
corporate governance models and necessarily makes PMS vary.
Based on this point, we also argue that stakeholder theory and shareholder value
maximisation are not in conflict with each other, they are simply logical choices under
different environments. Anglo -America model chooses shareholder as the only key
stakeholder and prefers shareholder value maximisation because of the existing
efficient markets and the culture developed from capitalism in the USA and the UK.
But the recent scandals in the USA, such as Enron, WorldCom, etc., raise concerns
about the problems of this corporate governance model, and research on stakeholder
theory could contribute to the reforms of the corporate governance systems in these
countries. Similarly for Germany, Japan and other countries with emerging
economies, they have different choices on their corporate governance systems and
they also need to reform when the environments change.
4.2
BUILD STAKEHOLDER ANALYSIS INTO THE DESIGN
OF PMS
12
When we have managers as agent, the principals are not only key stakeholder(s), but
also non-key stakeholders. 5 The interests of all the stakeholders could be affected by
the manager’s behaviour. We argue that expectations from stakeholders are expressed
in objectives and strategy via corporate governance and via external mechanisms.
When we design a PMS as an expression of objective s and strategy in specific
aspects, the PMS acts as a bridge reconciling the objectives and strategy of the
company with the managers’personal objectives, and also reconciling stakeholders’
expectations with managers’behaviour. It is as shown in Figure1.
The objective is the goal the organization aims to achieve according to the
expectations from key stakeholder(s) .6 It depends on the relative strengths of the
various key stakeholders. When conflicts exist, the key stakeholders who can exert the
most powerful influence on the organisation will have most input into objectivesetting. Even where there is only one key stakeholder group (e.g. shareholder), there
are still conflicts between sub-groups, such as long-term investors and short-term
investors.
Difference of environment has a further influence on the expression of the objective.
In the example where the shareholder is the sole key stakeholder, shareholder value
maximisation could be expressed as “maximisation of market value” in an efficient
capital market; but it must be expressed by profit or cash flow measures if the capital
market is not efficient. In some companies, not only markets but also culture and
business tradition influence the setting of objectives.
For example, in Japan,
companies focus on long-term development and on stable relationships with all
stakeholders more than on shareholder value or the short-term interests of any one of
the enterprise’s stakeholders.7
5
See Michael C. Jensen (2001) and Hill & Jones (1992)
There are different arguments about the types of objective and who sets business objectives. Our
viewpoint is that objective is the goal a organization pursues and it is set by the key stakeholder(s) of
the organizat ion. An organization’
s statement of its objectives, such as the targets for market share and
quality of the services, most often is just a strategy to achieve its implicit objectives.
7
Many researchers active in corporate governance reform have discussedcompany’s objectives other
than shareholder value maximization. For example, see Druker (1991a), and Millstein(1992)
6
13
The development of the strategy is a process to analyse the influences from non-key
stakeholders, and to harmonize the interests of key stakeholders and non-key
stakeholders. When profit maximisation meets the expectations of all of the key
stakeholders, managers have to choose different strategies to pursue profit according
to the different characteristics of their non-key stakeholders, most often including
customers, suppliers, employees, governments, and banks. For instance, in a
competitive market, customer’s satisfaction could be the main focus of the strategies,
but in some industries, banks could have most important inputs in the development of
strategies. 8
When the relationship between non-key stakeholders and company
changes following the change of the environment, strategy has to change accordingly.
The following case study will explore the way non-key stakeholders affects the
development of strategies at more detailed level.
4.3 DESIGNING A PMS
8
for example, the relationship with the bank is important for China’s big state- owned companies. See
analysis in following case study.
14
In the stakeholder analysis model, PMS is a bridge between objective, strategy and
the manager’s behaviour, while objective and strategy represent the interests of key
stakeholders and non- key stakeholders. All of the analysis of stakeholder, objective
and strategy are based on the environment analysis. So the processes of designing
PMS are shown as Figure2 .
As shown by Figure2, “analysis of environment” is not only the first step of the
model, but also has influences on all the steps during the design process, as we
discussed above. We have included ‘reform of corporate governance’, but we use a
dotted line in Figure2. Because stakeholder analysis opens up the problems of current
corporate governance, it could be a good starting point for discussing improvement of
corporate governance, but limiting ourselves to the topic of this paper, we must leave
this to further research. Reform of corporate governance is not a necessary
precondition for the design of PMS. However recognition of the delegation of
decision power under the current corporate governance, which we can get from
stakeholder analysis, is important for PMS.
Analysis of Environment
Recognition of
Two Categories of Stakeholders
Reform
of Corporate Governance
Objectives and Strategy
PMS
Figure 2. The Process of Designing PMS
.
15
5. CASE ATUDY
During 1997-1998, we were involved in the design of a PMS for MM Group, one of
the 37 “backbone”state-owned enterprises in China, following the process shown in
Figure2. The research process is combined with a consultancy project, with the
objective to design a performance management system for MM Group. MM Group
already have a statement about its objective and strategy, but without an
implementation plan of strategy. The expected outcome from this project is to build a
performance management system to communicate the objective and strategy in the
group, and to provide a foundation for management control and performance
evaluation.
The whole system we designed for MM Group includes a balanced scorecard, target
set for each indicator, and an information system for budgeting and feedback. The
application of the stakeholder analysis model highlights the contribution of
stakeholder analysis in the following aspects:
1. The bala nced scorecard is designed on the basis of understanding the
expectations from key stakeholders and non- key stakeholders. The recognition
of stakeholders and their effects on the objective-setting and the development
Deleted:
of strategies is helpful for goal congruence in the organization.
2. Because of the importance of non- financial resources on the success of the
businesses, which is highlighted by stakeholder analysis, we take into account
the difference in non-financial resources among different sub- companies to set
up the targets. As we will see from stakeholder analysis, these non- financial
resources include government polices, customer and supplier networks,
employees’experience, relationship with banks, etc.
3. Because of the knowledge we get from stakeholder analysis that managers in
sub-companies do not have decision power on financing and taxation, we use
earnings before interest and taxation (EBIT) as the profit indicator to match
measurements with delegation of decision power.
(Why is the above list repeated in Sectin 5.3?)
5.1 BACKGROUND OF MM GROUP
Deleted:
16
MM group is a comprehensive, large-scale enterprise group in China. Its major
business is foreign trade, which is combined with other businesses, specifically
finance, insurance, real estate, and informa tion technology. MM Group owns 98
subsidiaries and joint ventures in China, and 44 overseas subsidiaries spread over 22
countries and regions around the world. Its total assets are around 20 billion Reminbi
Yuan (around 1.7billion British Pounds). From 1996 to 1998, MM group successfully
issued commercial bills and follow-ups in American market with a value of US$200
million for each year. In 1997, its core enterprise was listed on Shanghai Stock
Exchange and was selected as one of the Shanghai Stock Excha nge’s Index of 30
leading shares. In 1999 the group was included as one of the 39 “backbone" stateowned enterprises in China. These enterprises play important roles in the national
stock market and are economic lifelines in China.
5.2 STAKEHOLDER ANALYSIS
Stakeholders involved in MM Group are identified as follows: shareholder (stateowner), customer, supplier, bank, government(regulator), and employee. In the
present corporate governance structure, only the shareholder (the state-owner) is seen
as the key stakeholder. We will discuss the rationality and the risk of this structure
below.
5.2.1 Key stakeholder analysis and the objective
The state-owner, as key stakeholder, defines the objective as ‘maximisation of profit
with an emphasis on net cash flow’. This reflects the expectation from the state-owner
in China’s environment.
Because of the important position of the group in China’s economy and the non- liquid
state-owned capital, the state-owner keeps the power to hire, fire and compensate
managers. The objective of the group used to be “maximization of sales”because of
the political objective of the state owner. Following the reform of state- owned firms,
the market, which MM Group is operating in, has changed from a monopolistic
market to a competitive market. The group has been acting more and more like an
independent commercial entity and accordingly the objective has been changed to
‘maximisation of profit with an emphasis on net cash flow( NCF )’by the state owner.
17
Applying profit, instead of market capitalization figures, to express the shareholder
value seems a reasonable choice for the following reasons. First, MM Group has its
core enterprise listed on Shanghai Stock Exchange, but still has much unlisted
business. Second, as state ownership is not tradable, market capitalisation and market
prices may be distorted. Thirdly the research suggests that accounting earnings
reported in China are value-relevant and provide useful information to domestic
investors in valuation decisions( Haw etc., 1999). But even with these reasons the
disadvantages of using profit as a sole measurement of objective are obvious 9 . The
state-owner realizes it from the past experience (Jones,etc., 1999) and expects using
NCF as a supplement performance measurement could limit the drawback from profit
maximisation. It appears that the statement of objective reflects the reality of China’s
environment and it does limit the scope of earnings management and push managers’
focus more on the growth of the firm’s value. This emphasis on NCF is the prime
incentive for us to develop a new NCF/Profit ratio for MM Group as one of the key
performance indicator in the balanced scorecard.
5.2.2 Non-key stakeholder analysis and strategy formulation
The strategy stressed by the managers of the group is to ‘maximise profit with an
emphasis on net cash flow and with a target market share as precondition’. This
strategy implies a balance between profit and turnover. It reflects the requirements
from key stakeholders, and also suggests the response to the expectations from nonkey stakeholders. The analysis of influences from different stakeholder groups on
strategy formulation provides the guidance for the PMS design.
Recognition of the influences from different stakeholders on the strategy formulation
is important for the design of PMS in the stakeholder analysis model, even if strategy
formulation is out of our scope in this case. Why should MM Group have target
market share as a precondition while its objective is to maximize profit with emphasis
9
since Kaplan and Norton‘s work(1987), there have been many discussions about disadvantages of
using profit maximization as objective. China’
s reform of state- owned enterprises experienced the
problem of profit maximization in a restrict market. Atypical example is the introduction of “Economic
Responsibility Contracts” and “internal Responsibility Contracts” in 1980s(Jones, etc., 1999) .
Deleted:
18
on NCF? The interviews with the managers responsible for the development of
strategy at the group level and the managers from sub-companies have given us a full
Deleted: ,
understanding on the influences from different stakeholders and the environment in
which MM group operates. This knowledge has had a direct role in the design of
PMS.
Firstly, although the customers and suppliers are non-key stakeholders, they have
important inputs in strategy formulation because of their importance as non-financial
resources.
The major business of MM Group is trading, so the relationships with its customers
and suppliers are vital to the success of the group. MM Group’s valuable customer
and supplier networks, as its important non- financial resources, formed from its longterm operation in this trading business area as the biggest firm in China. This market
used to be monopolised by MM Group, but now it has become a competitive market.
After more than 20 years development of the market economy in China, suppliers and
customers have gained the freedom to choose trading partners and can protect their
interests by the economic mechanism and by legislation. Therefore, even though some
customers and suppliers have had a long-term relationship with MM Group, they are
still non- key stakeholders. An analysis of the expectation from these non-key
stakeholders also highlights that the most important reason for the customers and
suppliers to retain their relationships with MM Group is its credit policy, which is to
provide credit sales to its customers and pay suppliers on time. This credit policy
brings MM Group strong competitive advantage but also results in the dependence on
the banks for the requirement of strong financing ability.
The value of customer and supply networks varies for different sub-companies
because the distribution of these non- financial resources in sub-companies is not even.
Some companies operating in MM group’s traditional areas get more advantage from
MM Group’s reputation and government’s policies; while the others have to face
more competitive market and have to develop new customer and supply networks.
Deleted: ¶
The recognition of the value of and the expectation from customer and supplier has
direct influence on the design of PMS. We take into account the difference in nonfinancial resources among different sub-companies to set up the targets for subcompanies. We also suggested to measure the value added in those non- financial
Deleted:
19
resources to encourage retaining and strengthening the relationship with the cus tomers
and suppliers.
Secondly, Banks, as the most fundamental financing resources, give priority to big
firms with big turnover when they make loan decisions.
Besides shareholder’s funding and retained profit, the most fundamental financing
resources for big firms in China are banks. Because of the dependence of the group on
the bank for its strong financing ability, which is vital for the success of the group as
we discussed above, the bank has become prominent in the non-key stakeholders. The
intervie w with the managers revealed that the most important criteria of the banks in
China, in making loan decision, is still the firm’s turnover. In order to sustain the
competitive advantages and to achieve the objectives, the group has to keep turnover
growing at a level which satisfies the banks.
Thirdly, Government policies are still important for the success of the group.
Government expects to keep the trading area under control and to maintain the
employment rate. Both of these expectations require the size of the business, and
specifically require the foreign currency inflows from exports.
Government policies used to play a vital role in the success of the Group, and are still
important in some areas. The government distributes the import quota for
international trading firms in some specific business sectors, and issues the licence for
some businesses. Even though this influence is not as important as it used to be, it still
has an important influence on some sub-companies of the Group, and it still
encourages the group to consider the government’s satisfaction in their development
of strategy. The expectations from government include keeping government control in
this area; collecting sufficient foreign currencies to keep the balance of foreign
currency inflow and outflow; and to reduce unemployment. For MM Group, it means
keeping market share and turnover growth at a certain level.
Finally, employees in MM group are in a weaker position, but the influence from
other non-key stakeholders on Group’s strategy satisfies their expectations.
20
From the viewpoint of culture and tradition, employees in China were powerfully
involved in corporate governance. But during the process of the market reform they
lost the power given to them by the socialist culture, and this has not been replaced by
market force as in capitalist countries. ( However, the pressure from the bank and
from the government to maintain the scale of production, and the dependence for
success on the experienced employees, oblige the Group to satisfy these employees
and to keep employee turnover down. On the other hand, a good position of status,
better payment for working in a big firm, and a big labour market with many potential
employees help the group to keep employees’ loyalty. So the employees and the
group are balanced at this moment, even if it could be argued that employees are in a
disadvantaged position, which leads the Group to underestimate the value of human
capital.
Assessment of China’s government and bank’s policies, or evaluation of principles of
corporate governance, is not in the scope of this paper. The analysis above does
highlight the influence from non- key stakeholders on the process of the development
of the strategy. To retain its customer and supplier networks, MM Group has to keep
its strong financing ability. This makes the bank, as the most important financing
source, become prominent in non-key stakeholders. Along with the expectations from
other non-key stakeholders, the turnover requirement from the banks compels MM
Group to keep turnover and market share at a certain level. Even if the key
stakeholders require profitability, the size of the business is still an important part of
the strategy for MM Group.
A business must balance the expectations of non-key stakeholders with the
satisfaction of key stakeholders. MM Group’s strategy is the result of this trade-off.
If at some time these stakeholders change their policies and expectations following
environment change, the firm would adjust their strategy, even their objective,
accordingly.
5.3 THE DESIGN OF PMS
Based on the stakeholder analysis and the review of the objective and strategy, we
suggested that the balanced scorecard for the Group includes four elements: key
performance indicators (KPIs); process performance indicators (PPIs) ; adjustive
Deleted: referernce
21
measures; and overrulers. This is shown in Figure3. The knowledge highlighted by
the stakeholder analysis are communicated into the process of design of the balanced
scorecard and of setting the targets.
Formatted
5.3.1 the balanced scorecard
(review of Balanced scorecard)
Key performance indicators (KPIs) are expression of objective and strategy. We
suggested four key performance indicators: profit, net cash flow/profit ratio, turnover
and foreign currency inflow from export. In these four indicators, the first two express
the objectives and are given higher weighting, while the other two represent the
specific requirements from non-key stakeholders. The key performance indicators and
their weighting could be adjusted according to any change of the strategy followed by
the change of environment.
Process performance indicators (PPIs) are measures that indicate how business
processes must excel for achievement of KPIs. They transfer performance
measurement to process control, and are important to create a performance
management culture in the organization. Most of the process performance indicators
are non- financial measures. According to the stakeholder analysis, the most critical
competitive advantage of the group is its customer network and financing ability. The
business process management of MM Group should focuses on the efficient customer
relationship management and working capital management. So we suggested
efficiency measures, such as trade debtor collection period.
The performance is scored according to the results of KPIs, PPIs and their weightings.
It will be adjusted by adjustive measures and overrulers too.
Balanced Scorecard
Key Performance
Indicators
Expression of
objective and
strategy
weighting
Process Performance
Indicators
Transfer
performance
management to the process
control
weighting
Adjustive
Measures
Give prominence to
the emphasis of
operation
and
management
Overrulers
Behaviours or events
would have significant
influence
on
the
profitability
or
competitive advantage
22
adjustment
overrule
Figure 3, Balanced Scorecard of MM Group
Adjustive measures give prominence to the emphasis of strategy and management on
the basis of KPI and PPIs. The result of adjustive measures adjusts the score directly .
MM Group uses two adjustive measures: market share (quantitative) and a 360 degree
questionnaire (qualitative), in which the latter measures co-operation between
departments, the quality of budgeting, and the relationship with bank, customer and
supplier. These two measures stress the Group’s strategic and internal management
emphasis. They also draw the management’s attention to the non-key stakeholders.
Especially because of the importance of non- financial resources highlighted by
stakeholder analysis, we suggested to measure the value added in those non- financial
resources to encourage retaining and strengthening the relationship with these
valuable non-key stakeholders. The application of this suggestion has to be postponed
because MM Group has not finished the development of its database on customer and
supply networks. The above qualitative measurement becomes a replacement.
Overrulers are Group’s listed forbidden behaviours or events, which will have
significant influence on the profitability and competitive advantage of the group. If
one of them happened or existed, the performance measured on the basis of KPIs,
PPIs and adjustive measures could be overruled partly or entirely.
5.3.2 the setting of targets
While we are able to use industry benchmark to set the targets for process
performance indicators and adjustive measurements, how to set the targets for KPIs,
especially profit, becomes crucial.
23
Historically the sub-companies in MM Group possess different quality and quantity of
non- financial resources. Because of the importance of these non- financial resources
on the succes s of the businesses, which is highlighted by stakeholder analysis, we take
into account the difference in non- financial resources among different sub-companies
when setting up the targets.
As we have seen from stakeholder analysis, these non-financial resources include
government polices, customer and supplier networks, employees’ experience,
relationship with banks, etc. The uneven distribution of these non- financial resources
among sub-companies and their effects on the profitability make the performance
measurement difficult. The group used to set different targets of return on investment
(ROI) for different sub- companies with consideration of non- financial resources
implicitly. Because of the lack of explicit recognition and measurement of these nonfinancial resources, the required return can only be compared to financial resources.
This provided opportunities for sub- managers to complain about the unfairness and
turned the annual budget to an endless bargaining. Under this circumstance the target
could only be accepted under the authority from hierarchy, and the performance
management failed to provide incentives and to improve goal congruence. To find a
solution for this embarrassment is one of the main reasons for MM group to seek help
from outside profession.
Benefit from the stakeholder analysis, we assessed the value of non- financial
resources and their distribution in the group and managed to set a return on nonfinancial resources based on the number of the employees. The profit target for each
sub-company is determined by the required returns on financial resources and on nonfinancial resources and these resources each sub- company possess.
The design of a PMS for MM group demonstrates a number of contributions of
stakeholder analysis can make:
First, the balanced scorecard is designed on the basis of understanding the
expectations from key stakeholders and non-key stakeholders. The recognition of
stakeholders and their effects on the objective- setting and the development of
strategies are he lpful for goal congruence in the organization.
Second, because of the importance of non-financial resources on the success of
the businesses, which is highlighted by stakeholder analysis, we take into account
the difference in non-financial resources among different sub-companies to set up
Deleted: ¶
24
the targets. It relieves MM Group from endless bargaining for annual budgeting
and makes PMS works better on motivating sub- managers.
Thirdly, because of the knowledge we get from stakeholder analysis that managers
in sub-companies do not have decision power on financing and taxation, we use
earnings before interest and taxation (EBIT) as the profit indicator to match
measurements with delegation of decision power.
We revisited the financial director of MM Group in 2002. The group has rebuilt its
management control system. The PMS we discussed above, and points highlighted by
stakeholder analysis, are still an important part in the new management control
system.
6. CONCLUSION
Taking stakeholder analysis as the starting point, the paper proposes an analysis
framework that helps to build and shape the performance measurement systems in
companies.
We define a stakeholder of a business as the group or individual who can affect AND
be affected by the achievement of the organisation’s objectives. Stakeholders of a
business that are identified according to our definition could be classified into two
categories according to the mechanism they choose to influence managers’behaviour
and to protect their own interests. They are ‘
Key Stakeholders’involved in decision
management, and holding supervisory right over the managers directly via the
systems of corporate governance; and “Non-key Stakeholders”exercising power on
the operation of the company indirectly via external mechanisms (such as market
forces). We argue that the choices to act as key stakeholders or non- key stakeholders
depend on the environments the stakeholders are facing. These environment factors
cover markets, legislation, culture and business tradition. It is the difference of the
environments in different countries or areas which creates different corporate
governance models and which makes the performance measurement system dynamic.
Based on this point we also argue that stakeholder theory and shareholder value
25
maximisation are not in conflict with each other, they are simply logical choices under
different environments.
Key stakeholders and non-key stakeholders have different influences on developing
objectives and strategy in a business. Their effects are expressed in PMS by these
influences. Therefore, the design of PMS becomes a process of analysing the
stakeholders and their relationship with the business. The performance measurement
system we designed for MM Group in China based on the stakeholder analysis
framework acts as a bridge between stakeholders’ expectations and managers’
decisions.
The stakeholder analysis framework discussed in this paper thus makes a contribution
to the management accounting and control literature in two ways. Firstly, it provides
an explicit structure to integrate environment analysis to the design of PMS. With this
integration, PMS becomes dynamic and works better on goal congruence. Secondly,
the general nature of the stakeholder analysis framework allows that other
frameworks or models can be easily used in complement to it, just like we used the
balanced scorecard in the design of PMS for MM Group. It helps the theories and
practical models developed in advanced economy to be used in emerge economies.
The areas need to be further studied could be (1) more case studies to verify and
Deleted: ¶
¶
improve the model’s practicability at large; (2) further studies related to the reform of
corporate governance according to stakeholder analysis based on specific
environments, and effects of the reform of corporate governance in western capitalist
environment on the design of PMS.
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