Chapter 1: Introduction - Erasmus University Thesis Repository



An investigation into the optimal performance measurement for investment centers in logistic industry (Management Accounting) Name: Yuqi Chen Student Number: 369307 Professor: Ted WeltenTable of Contents TOC \o "1-3" \h \z \u Chapter 1: Introduction PAGEREF _Toc298709028 \h 3Chapter 2: Responsibility centers and investment centers PAGEREF _Toc298709029 \h 5Introduction PAGEREF _Toc298709030 \h 5Results PAGEREF _Toc298709031 \h 5Conclusion PAGEREF _Toc298709032 \h 7Chapter3: The performance measures in investment centers PAGEREF _Toc298709033 \h 8Introduction PAGEREF _Toc298709034 \h 8Results PAGEREF _Toc298709035 \h 8Conclusion PAGEREF _Toc298709036 \h 14Chapter 4 : Relevance of performance measures to logistic industry PAGEREF _Toc298709037 \h 15Introduction PAGEREF _Toc298709038 \h 15Result PAGEREF _Toc298709039 \h 16Conclusion PAGEREF _Toc298709040 \h 17Chapter 5 : Criteria to evaluate each performance measurement PAGEREF _Toc298709041 \h 18Introduction PAGEREF _Toc298709042 \h 18Results PAGEREF _Toc298709043 \h 18Conclusion PAGEREF _Toc298709044 \h 21Chapter 6 Comparisons among performance measurements PAGEREF _Toc298709045 \h 23Introduction PAGEREF _Toc298709046 \h 23Results PAGEREF _Toc298709047 \h 23Conclusion PAGEREF _Toc298709048 \h 27Chapter 7: Conclusion PAGEREF _Toc298709049 \h 29Bibliography PAGEREF _Toc298709050 \h 30Chapter 1: IntroductionIn today’s work place, performance improvement and the role of performance management is an increasingly popular topicCITATION sucnd \l 2052 (Success factors, n.d). In a decentralized company, organizational unit managers are normally responsible for the profits generated. Additionally, they have the power to influence the assets employed (Anthony et al, 2014), making the investment center a responsibility center (definitions of responsibility center and investment center will be clarified later). In these investment centers, performance measurement systems were developed as a means of monitoring and maintaining organizational control, which is the process of ensuring that an unit aims at strategies that lead to the achievement of its overall goals and objectives CITATION Mad06 \l 1033 (Maditinos, Sevic, & Theriou, 2006). Performance measures, the components of performance measurement systems, play a significant role because they are regarded as forward-looking indicators which help management to predict an investment center’s economic performance and reveal the necessity of improving operational decisions CITATION Otl99 \l 1033 (Otley, 1999) CITATION Sim99 \l 1033 (Simons, 1999) CITATION Nan90 \l 1033 (Nanni, Dixon, & Vollmann, 1990).However, the choice of performance measures is one of the most critical challenges facing organizations CITATION Kni98 \l 1033 (Knight, 1998). Wrong signal might be produced due to poorly chosen performance measures, and this would lead to poor decisions and bad results CITATION Mad06 \l 1033 (Maditinos, Sevic, & Theriou, 2006). For instance, many financial analysts tend to use return on equity as the best company performance measurement. Nevertheless, management can always maintain a healthy ROE for a while by growing debt leverage and share buybacks event though operational profitability is eroding CITATION Hag10 \l 1033 (Hagel, Brown, & Davison, 2010). The fact mentioned above leaves a room to investigate what is the optimal performance measurement for investment centers. In order to narrow down the investigation range, only one industry that is logistics industry will be focused on. Logistics is a backbone for the global supply chains. It plays a significant role in both micro and macro perspective. From micro perspective, logistics industry offers services that could fulfill customer’s needs. From macro perspective, it keeps contributing to a country’s economic development CITATION BakND \l 1033 (Baker et al, N.D). For example, it was reported that the Malaysia logistics industry made great contribution to the gross domestic product (GDP), i.e. 13%(Malaysia Logistics Council, 2013). In a global supply chain context, moving goods across borders has been one of its significant role recently and the international expansion of logistics industry requires better performance measurements. Yet many companies do not use an optimal performance measurement although they admit the fact that logistic industry is developing. Hence, this paper is aiming at giving a specific answer to what is the optimal performance measurement for investment centers in logistics industry. By these given answers, companies in logistics industry are able to choose a suitable performance measurement so that they could obtain a more accurate result, conducting a more effective compensation plan, identifying opportunities for improvements and comparing performance against internal or external standards CITATION DepND \l 2052 (Department of Trade and Industry, N.D). Therefore, the central research problem of this paper is:What is the optimal performance measurement for investment centers in logistics industry?The research will be carried out as follows: in the next section a literature review shall be conducted which will be used to answer several sub-questions in support of the main question.The first sub-question is:S1: what are responsibility centers and what is investment center?The following question then is:S2: What are the performance measures used in investment centers?After answering the second question, a comparison among these performance measurements will be made in order to choose an optimal performance indicator in logistics industry. However, before making this comparison, the relevance of performance measures to logistic industry and several criteria need to be chosen for the purpose of comparisons first. Hence, the following three sub-questions are:S3: How are performance measures relevant to logistic industry?S4: What criteria should be chosen to evaluate each performance measurement?S5: How are these performance measurements compared to each other in investment centers in logistics industry?In the third section, the conclusion will be drawn based on the results of the literature review to close the whole discussion. Chapter 2: Responsibility centers and investment centers IntroductionThis chapter is aiming at clarifying theoretical definitions of responsibility centers and investment centers. Sub-question that needs to be answered is as follows: S1: what are responsibility centers and what is investment center?ResultsIn a company with a decentralized structure, daily operations and decision-making responsibilities are delegated by top management to middle and low-level managers within the organization, allowing top managers to focus more on major decisions and overall strategic planning. Since unit managers have accepted authority and accountability and each manager is responsible for assets and activities which are defined by responsibility centers, making these independent business units responsibility centers CITATION Hol13 \l 1033 (Holtzman, 2013). A responsibility center exits to achieve objectives. The company as a whole has its goal, and senior management decides on a set of strategies to achieve these goals. Responsibility centers are there to help implement these sets of strategies. This decentralized structure with responsibility centers has several advantages. First, employees are given more autonomy. They can make better use of their knowledge and experience they have gained and implement some of their own ideas. Second, managers can make decisions more efficiently. Managers can react to situations more fast instead of waiting for top managers’ command. And third, it is easy to measure the performance of units’ managers when there is less influence coming from top management and make adjustments based on these measurements. There are roughly four types of responsibility centers: Revenue center, Cost center, Profit center and Investment center (Anthony et al, 2014). These four main responsibilities are assigned to business units based on the analysis of their core operations. The core operations are analyzed through the relationship between inputs and outputs. In revenue centers, output is measured in monetary terms and managers are responsible for revenue only. Here, input is not directly related to output because these outputs are partially dependent on the company’s marketing function. Expense center can be divided into two categories: engineer expense center and discretionary expense center. The former means that outputs are measured in physical terms, and an optimal relationship can be established between inputs and outputs. Output is purely dependent on a company’s manufacturing function. In the latter case, an optimal relationship between inputs and outputs cannot be established since these expenses are resulted from research and development activities, thus hard to be controlled. In profit centers, both revenues and expenses are measured and managers are responsible for profits. Here, outputs are measured in monetary terms and inputs are directly related to outputs because the cost of inputs decides how much outputs you can get. The last one is investment center and this paper will only focus on this one. Investment center is an organizational unit that responsible to top management for its profitability in relation to the unit’s own investment base. In investment centers, revenues, expenses and assets employed are measured CITATION Jam78 \l 2052 (James & Cool, 1978). Outputs, which are measured in monetary terms, are related to the capital employed and inputs. The purposes of measuring assets employed are analogous to the purpose of profit centers in two ways:1.To provide information that is useful in making sound decisions about assets employed and to motivate managers to make decisions in the best interest of the company. 2. To measure the performance of the business unit as an economic entity.Management evaluates an investment center based on its return on those assets invested CITATION Acc12 \l 2052 (Accounting Tools, 2012). An example of investment center in logistic industry is Amazon logistic department. Amazon is the largest internet-based retailer in the United States. It is selling electronic products, books and nowadays, even food and clothes online. In order to make sure that its delivery is efficient and on time, Amazon keeps improving its logistic chain. Today, Amazon logistics is not only just logistics department for delivering products of Amazon, it is also a more independent business unit in logistic industry, which offers delivery services for other companies as well. Managers in logistics divisions are responsible for their own performances.ConclusionThis section clarifies theoretical definitions of responsibility centers and investment centers. Findings are summarized as follows: 1) responsibility centers are decentralized divisions, where managers are responsible for assets and activities, which are defined by responsibility centers. There are four types of responsibility centers: revenue centers, expense centers, profit centers and investment centers. The criteria, which are used for assigning responsibilities, are the core operations of the unit and the measurement possibilities of input and output 2) Investment centers are one type of responsibility centers, where managers can relate its profitability to its investment base. Methods, which measure these investment centers’ performance, will be discussed in next section.Chapter3: The performance measures in investment centersIntroductionThis chapter mainly focuses on answering the sub-question: what are the performance measurements in investment centers. There are roughly two types of performance measurements: non-financial measures and financial measures. In this paper, non-financial measures are referred to market measures and financial measures are referred to accounting measures. Accounting measures can be divided into two categories: ratio measures such as return on investment and residual income. Other than traditional residual income measures, an important extension form of residual income method is economic value added method. CITATION Mer11 \l 2052 (Merchant & Van der Stede, Management Control Systems, 2011). In this paper, all measurements mentioned above will be described in detail. The sub-question to be answered is as followsS2: What are the performance measurements used in investment centers?ResultsAccording to Merchant and Van der Stede, market measures are any measures for which the value created can be measured directly for any period as the sum of the dividends paid to shareholders in the measurement period plus, or minus the change in the market value of the stock CITATION Mer09 \l 1033 (Merchant & Sandino, Four Options for Measuring Value Creation, 2009). He believes that market measure can be used in a financial. However, other researchers believe that market measurements cannot be expressed in a financial term since they are brought up for compensating the drawbacks of traditional financial measures. Hoque and Mia argue that in today’s environment of global competition, other than traditional financial measures, market measures should be focused on non-financial aspects, in order to make the whole performance measurement system more multidimensional. It is supposed to provide executives with continuous signals as to what is most important in their day-to-day activities and where efforts must be directed CITATION Hoq01 \l 1033 (Hoque & Mia, 2001). Kaplan & Norton possess the same idea. They believe that non-financial dimensions including customer, internal business processes and learning and growth should be taken into considerations CITATION Kap96 \l 1033 (Kaplan & Norton, 1996). In addition, according to David M. Raab, he argues that there should be some non-value market measures that marketers need to build into their reporting systems CITATION Raa12 \l 1033 (Raab, 2012). For instance, benchmarks, strategy goals and projections. Benchmarks is helping to place the numbers, which can be this year’s revenue or next year’s market plan, in the context in order to have a sense of whether these numbers are good or bad. Strategy goals, on the other hand, help the managers have an insight of the cumulative impact of deviations from the original plans. This market measure can provide them with direct indicators of strategic objectives. In this way, long-term goals would not fade away because managers start making choices based on day-to-day result. Besides, projections make the mangers understand the factors that determine the future results. Changes in these factors provide an insight of development opportunities or competitive risks. A second measure of performance is accounting measures. Accounting measures of performance have been the traditional mainstay of quantitative approaches to organizational performance measurement (Neely, 2007). They are also referred to financial measures. Andy Neely outlines three functions of financial measures. They are: The use of financial measures of performance as a tool of financial management.The role of financial performance as a major objective of a business organizationThe function of financial performance measure as a mechanism for motivation and control within the organization. (Neely, 2007)Although the functions of financial measures are widely admitted in the past decades, and they definitely contribute to business control and motivation within organizations, nowadays people have doubts regarding to these financial measures functions, especially the third one. After all, a financial number just reveals result from a financial perspective. But, how about other perspectives that are equally important to financial perspectives? Do accounting measures motivate and control managers in those aspects too?Mostaque Hussain finds that non-financial measures can play a significant role in motivating and controlling managers’ decision making too. Non-financial measures contain more specific information. Also he finds that there is a trend of using non-financial performance measures CITATION Hus05 \l 1033 (Hussain, 2005). This finding is remarkable because it focuses on the functions of non-financial measures and these functions can partially replace those of financial measures. Although Mostaque Hossain only focuses on financing service industry, but his findings are very useful for this paper.However, there are still researchers who believe that some functions of financial measures cannot be replaced. This section will only focus on important representatives of accounting measures: ROI, RI and EVA as well as their functions.ROIAfter discussing accounting measures in general, the focus will be on one specific ratio measure, namely return on investment (ROI). The formula for ROI is :It can also be written as:ROI method is a ratio measure and easy for managers and outsiders to understand and make comparisons CITATION Way12 \l 2052 (Way, 2012). Also ROI method is the most widely used performance measures CITATION Jam78 \l 1033 (James & Cool, 1978). ROI can capture controllable aspects of performances by not only offer accounting information, but rather, represents the underlying activities that are being managed. Every item on balance sheet can affect ROI, which make managers more careful of the decision they take. Besides, in an organization, there is a need to be able to represent a variety of different activities in terms of a common language or unit of measurement (Neely, 2007). ROI makes it possible that denominator can be applied to any organizational unit, regardless of size or type of business. In addition, based on the formula mention above, ROI also equals net profit margin times asset turnover. A low capital turnover implies that the business unit needs more invested capital to produce revenues and profits. Through this formula, ROI can graphically be shown as different curves in a diagram, which many managers find very useful for internal communication. Here, it can be seen that a business unit can produce 20% ROI by maintaining 10% profit margin and 2 asset turnover. Another business unit with 20% profit margin onle need 1 asset turnover to reach 20% ROI. Figure1: Residual incomeAccording to Solomons, residual income is a measure of managerial success CITATION Sol83 \l 1033 (Solomons, 1983). It is money that is earned on a continual basis, but is often based from one original activity CITATION SchND \l 1033 (Schofield, N.D). He defines residual income as:The excess of net earnings over the cost of capitalThe formula for Residual Income is :The main rationale advanced for the use of residual income in divisional performance measurement is its consistency with the net present value for decision-making. CITATION Egg95 \l 1033 (Egginton, 1995). An advocate of residual income is Preinreich who first demonstrates that the present value of the stream of residual income for a project equals the net present value of the project CITATION Pre38 \l 1033 (Preinreich, 1938). In 1938, Preinreich showed that residual income could be easily derived from an expression for the capital value of a machine that is, its present value. He predicted that the ability to reconcile accounting figures with capital values is the dominating foundation of both the residual income debate and of value management approach. He argued that the accounting book value of a machine plus discounted excess profits it generated equals to the capital value of the machine. Excess profits are defined as the differences between profit per unit of capital investment less interest per unit of capital investment. He also used this concept to discover the relationship between accounting figures and stock market values. In addition to Preinreich, Hicks further described the concept of residual income but he used a different name, which is called “economist’s income”(equal to economic income) CITATION Hic46 \l 1033 (Hicks, 1946). He used several formulas. First, economist’s income can be defined as :Y(t)= K * V(t-1) = C(t) – D (t) = V(t) + C(t) – V(t-1) (1)Where y is economic income, k is the interest rate and V(t-1) and V(t) are the present value of future net cash flows at the beginning and end of period t. C(t) represents the net cash flow of the period and D(t) is the depreciation in the period where D(t)= V(t-1) V(t). This approach reveals the importance of the clean surplus concept where all gains and losses are passed through income statement. Also, the economic income formula offers guidelines for what adjustments can be done to RI without reducing its congruence with capital market. One difference between economic income and residual income is that RI attempts to provide a performance measurement for elements of the organization, that is divisions. Edwards and Bell contributes to the RI definition through substituting accounting figures into the economic income definition, which shows RI’s reliance on the ideas underlying economic income CITATION Edw61 \l 1033 (Edwards & Bell, 1961). O’hanlon and Peasnell gave a formal formula of this issue: (2)-57150151765000Where X is residual income for period t, D(t) is depreciation expressed as the difference between opening and closing book values A(t-1) and A(t) respectively. K*A(t-1) is the cost of capital charged on the periodic opening book value of the firm CITATION Oha98 \l 1033 (O'hanlon & Peasnell, 1998). Summing the discounted residual income over a project lifetime gives:(3)The left hand element of the third formula is the sum of discounted residual income over a project lifetime, which is the present value of RI. The right hand element is NPV. Hence, it can be concluded that the essence of RI is NPV. EVAOne extension of residual income method is named of Economic Value Added (EVA), which nowadays is a representative measure of modern value-based performance measurement. As Anthony et al say, economic value added focuses, among other things, on the measurement problems of intangible non-current assets (Anthony et al, 2014). EVA proponents suggest that a set of adjustments need to be performed to get better measurement of profit and asset employed than only book value of asset. Thus, EVA is calculated as :EVA=adjusted net operating profits after taxes – (cost of capital * adjusted assets emploed)Most of the adjustments are related to intangible assets such as the capitalization of research and development expenses. Some firms tend to be R&D intensive. The capitalization of intangible assets of R&D and then amortizing them over a selected life would change how the business unit manager views these expenditures. By viewing these assets as long-term investments, managers will gain less short-run benefit from reducing outlays on such items. For example, if R&D expenditures are expensed right now, each euro of research and development cut will be a euro more in pre-tax profits. On the other hand, if R&D costs are capitalized, each euro will reduce the asset employed by a euro, the capital charge is then reduced only by one euro times the cost of capital, which has a smaller impact on EVA. So when the company possesses lots of intangible assets, EVA can reflect a more accurate performance. In addition, many articles support this new concept by stressing that EVA gives to value creation. However, there are still many critics of EVA for not being very different from traditional financial measures. Some academics argue that in fact EVA is only a variation of residual income and internal rate of return (eg. Chen and Dogg,1997; Ittner and Larcker,1998).Conclusion In conclusion, there are roughly two types of performance measures: market measures and accounting measures. It is believed in this paper that market measures are not referred to the change of market value of stocks plus dividends. In order to differ from traditional financial measures, market measures should focus more on market perspective and reflect facts regarding to market elements such as customer retention rate, strategic goals and learning and growth rate. Accounting measures are also named as financial measures. Accounting measures are often criticized for not being able to offer multidimensional information of investment centers and their functions are tending to be replaced by market measures. However, based on the discussion above, there are still some financial measures that cannot be replaced. Return on investment is the most popular performance measures among investment centers. ROI makes it possible to represent a variety of different activities in terms of a common language or unit of measurement, which market measures cannot achieve. Also, because profit margin alone is not enough for comparisons if business differ in capital turnover, managers need to consider the effect of their decisions on balance sheet(capital turnover) as well as on income statement( profit margin), and also consider the tradeoffs between these two. Residual income is another branch of accounting measures. It is consistent with the net present value for decision-making, while market measures are not. Also, it reconciles accounting measures with capital value, yet market measures cannot relate the capital value to its accounting measure in a simple way. Last, Economic Value Added is an extension form of residual income. It is made some adjustments that related to intangible assets. When it comes to measure the performance of a company which possesses lots of intangible assets, EVA can reveal a more accurate result.All of these performances have their own functions and they are all found being used in investment centers in logistic industry. Like other industries, ROI is the most popular among business units in logistic industry. However, there is a clear trend that many logistic companies are seeking for performance measurements which not only increase its financial figures, but also improve non-financial performance such as customer satisfaction rate and quality. Next section will be focused on the relevance of these performance measures to logistic industry. Chapter 4 : Relevance of performance measures to logistic industryIntroductionLogistics is a backbone for the global supply chains. In a global supply chain context, moving goods across borders has been one of its significant role recently. It plays a significant role in both micro and macro perspective. From micro perspective, logistics industry offers services that could fulfill customer’s needs. Logistics have influences on customer retention rate, product delivery, and many other core business processes. From macro perspective, it keeps contributing to a country’s economic development CITATION BakND \l 1033 (Baker et al, N.D). Unfortunately, the performance measures that many logistics companies are using are not keeping up with the increasing position and scope of logistics industry yet the international expansion of logistics industry requires better performance measurements. In this chapter, the definition of logistics industry will be clarified. Also the relevant aspects of logistics industry to performance measures will be listed and the reasons why they are relevant will be discussed. The sub-question will be answered by the conclusion of the discussion is :S3: How are the performance measures relevant to logistic industry?ResultLogistics is the management of the flow of things between the point of origin and the point of consumption in order to meet requirements of customers or corporations. The resources involved in logistics process include food, materials and abstract items such as time, energy and information. Normally, the motivation of logistics industry to import and export is to minimize the use of resources. According to the Council of Logistics Management, logistics includes planning, control, realization and motitoring of all materials, and products. Other researchers believe that logistics is the process of planning, implementing, and controlling the effective and efficient flow of goods and services from the point of origin to the point of consumption. This process is also referred to the value chain of logistic companies. In a research conducted by Zhou, he contstructed a model of logistics value chain of express enterprises through analyzing the value of the activities in the process of express delivery. The value chain that involved in logistics business process is: delivery of raw materials and finished goods, and production and selling. He found that the key competitiveness of logistics industry are four aspects: strategic location, networking optimization, value added services and performance measures CITATION Zho13 \l 1033 (Zhou, 2013). Performance measures play a significant role in enhancing value-added activities in logistics process. In addition, Popova and Schut find that performance measures play a significant role in planning process, which is a stage of assigning individual tasks to resources at a certain point in time in logistics industry. Lohman et al. (2004) also perceive performance measurements as elements for process control system within logistics companies. They are used to evaluate the operational level and adjust its goals. Fidlerova says that the objective of logistics is to meet customer’s requirements on products with minimum costs, but customers insist not only on delivering product on right time on right place but they wish to fulfill their special requirements on quality and environmental friendly products CITATION HRD12 \l 1033 (HRDINOVA, Sakal, & Fidlerova, 2012). Hence, performance measures are crucial in monitoring what customers really need and want. In addition, Weber(2002) finds that performance measures which can be used to control the business process should pay attention to performance of delivery to customers, processing time and customs clearance time. Besides, Knemeyer et al. (2003) also studies the perspective of a customer and he finds customer reflection of the services that a logistic company offers significant. And performance measures can strengthen the relationship between the companies and customers.On the other hand, in order to achieve a balance, the management should also take the needs and desires of other parties into account. For instance, decreasing the price of logistics services will benefit the consumers, however, they may hurt the benefits of other parties. Hence, performance measures can also control the management to balance the desires of all parties. In addition to the function of offering better services to various parities, performance measurements also play a significant role in influencing the market share of logistic companies. For instance, Daugherty,Stank and Ellinger(1998) find that performance measures will influence market share indirectly through consumer satisfaction.ConclusionTo be concluded, performance measurements are relevant to logistic industry in many aspects. They can enhance the value chain of the company from the process of production to the end of delivery of the products by identifying value-added activities. Also, they help monitor the planning process, which help to improve the efficiency and effectiveness of usage of resources. In addition, they are influencing process control system within logistics companies by adjusting operational goals. Lastly, they motivate the logistics services to focus on consumers’ requirements but at the same time, fulfill the needs of other parties. And then indirectly, they have an impact on market shares.Chapter 5 : Criteria to evaluate each performance measurementIntroductionBefore finally start investigating what is the optimal performance measurement for investment centers in logistics industry, some criteria which are used to do the evaluations need to be presented. Four criteria in total are chosen and the reasons why these criteria are selected are going to be discussed. Sub-question, which will be answered in this section, is as follows:S4: What criteria should be chosen to evaluate each performance measurement?ResultsAccording to Anthony et al, managers in investment centers receive authority and they are responsible for the profits and the assets employed in generating profits. However, in the meanwhile, top management still needs to monitor and control the performance of these divisions. It might happen that these divisional managers have less incentive to behave in the best interest of the company and this would lead to severe agency problems. In order to avoid agency problems, they argue that performance measurements should meet these two criteria, which are also the purposes of measuring performances:To provide information that is useful in making sound decisions about assets employed and to motivate managers to make these sound decisions that are in the best interest of the company.To measure the performance of the business unit as an economic entity. Scapens also argues that the corporate management should remain responsible for the entire operations of the business and must exercise some control over delegated activities CITATION Sca79 \l 1033 (Scapens, 1979). This control function could be implemented by setting divisional objectives, which are the criteria that define the required or desirable performance for the division, reinforced by periodic reports of actual divisional performance. These reports provide data for top management to monitor divisional activities and act as a motivating tool for divisional managers. It is essential that the performance reports be expressed in terms of the criteria that are used by the corporate management to define the performance required of the division CITATION Sca79 \l 1033 (Scapens, 1979). For instance, its actual performance should be measured in terms of NPV if a division’s objective is expressed in terms of maximizing the NPV of its projects. Otherwise, these periodic reports might not be useful if divisional performance is measured in different terms, such as accounting profits because managers could just focus on maximizing performance measures instead of realizing divisional goal. Hence, it is crucial that before choosing a performance measurement, management assigns clear objectives to each division.In addition, Solomon also mentions that some performance measurements do not actually control economic profits; instead they pay more attention to managerial behavior. However, Solomon believes that there is a distinction between the success of a division and the success of the men responsible for managing it CITATION Sol83 \l 1033 (Solomons, 1983). Thus, there should be different standards of success for judging both the division and the manager. And when it comes to measure the performance of the division, it is significant that these performance indicators are measuring the division as an economic entity. Otherwise, unit managers are not going to focus on achieving its economic goal, which will lead the unit to develop in the wrong track. Also, since business units are results of company’s decentralized structure, whether each unit can achieve its objective has an impact on the whole company. Hence, it might happen that the development of the whole company is slow down due to the mistake of one business unit.On the other hand, some researchers disagree that choosing performance measurements should be based on objectives of divisions. Instead, they focus more on subjective perspective. For instance, Neely, Gregory & Platts argue that performance measures should be derived from strategy; that is they should be used to reinforce the importance of certain strategic variables (Neely, Gregory, & Platts, 2005). A strategy consists of decisions that are made and actions that are taken. For example, if a business unit’s strategy is to “produce profitably high quality cars sold in Europe”, however, one manufacturing department manager decides to buy low-quality components, and then the result might be that the strategy cannot be followed. Strategic visions can be difficult to communicate, but by dividing the top goal into smaller concrete targets managers are able to make it easier to deliver them. In this way, strategy and day-to-day operations have a special link. Hence, performance measurements also play a significant role in monitoring the actions that are taken and decisions that are made within the business unit. A good performance measurement should be helpful to some subjective aspects such as how much they follow the strategy, do the managers take right actions. These subjective aspects will lead to reinforcement of its strategy within its company.There is a third view regarding to the criteria that used to choose performance measures. The researchers who possess the third view argue that “objective” and “subjective” cannot be the only criteria to select performance measures. For instance, Muckler & Seven argue that the distinction between “objective” and “ subjective” measurement is neither meaningful nor useful in human performance studies. All measurement in science and technology is necessarily filled with subjective elements, whether in selecting measures or in collecting, analyzing, or interpreting dataCITATION Muc92 \l 1033 (Muckler & Seven, 1992). In his research, he proposes several remarkable criteria for selecting measures. First, it has to possess relative simplicity. In all but the most trivial cases, human and system performance measurement is enormously complex, with multitudes of measurement dimensions. Considerations should only be given to the most critical dimensions and activities instead of all aspects of performances. Also, these measures should be simply understandable without deep interpretation. Second, performance measures need to possess generalizability, which means that they can be used across many researches and test settings, leading to measurement standardization and probably to better development of all measures. The third criterion is precision. This precision relates to two aspects: (1) the fineness or grain of the unit measurement and (2) the accuracy or correctness of the measurement. In the first aspect, the shorter time is always more precise than the longer one. In the second aspect, it is crucial to guarantee the performance measurements are accurate. Other criteria that he mentioned including adequate validity, sufficient reliability, data-processing requirements and resource requirements. Meister (1938) also argues that selecting performance measures based on objectivity-subjectivity distinction is not a particularly useful or valid rule. He proposed 14 specific criteria for selecting measures: directly relevant to the output, directly observable in task performance, not requiring additional interpretation, reflecting critical task events, precisely definable, objective, quantitative, unobtrusive, easily collected, without specialized instrumentation requirements, at appropriate level etc. Among these criteria, achieving objective is just one rule rather than the only one criterion. ConclusionIn this paper, all three views are taken into consideration in order to choose a multidimensional performance measurement, which best suits the fast developing and global competitive situation of logistics industry. This paper assumes that the overall objective of each investment center in logistic industry is to maximize its economic profit because profit is the main responsibility of divisional managers. Hence, it is crucial that managers strive for realizing overall divisional objectives, which is keeping maximizing the economic profits of the divisions. Performance measures should be selected to motivate divisional managers to realize these divisional objectives. The performance measure should guarantee that managers set the goal of the divisions in the priority and behave in the best interest of the whole company. Only logistics companies that achieve to realize high economic profits will survive from the severe global competition. Thus, the first criteria which is used to select the optimal performance measurement in investment centers in logistic industry is :Goal congruenceAlso, based on the fact that in a logistics company, sometimes a division can perform well even though the manager performs poorly, while a good manager can be in a division which performs badly, the criteria should also focus on a subjective perspective. Also, logistics companies always have a clear value chain, from the stage of collecting products to the stages of deliver them. Good performance measurement should control the performance of each stage and improve the performance of each stage. The most representative of performance measures from subjective perspective and able to monitor every stage’s performance is reinforcing the strategy. It does not only control whether the divisional strategy is inline with the whole logistics company’s strategy, but also it monitors the actions at each stage that managers take to follow the strategy. In this way, each manager’s action is under control of the top management and each action can be evaluated. Therefore, the second criteria is :Reinforcing company’s strategyThe last criteria are the discussion results of the third point of view that a performance measure is not necessarily objective or subjective. It can be a characteristic that a performance measurement is supposed to possess. For instance, it should be simple in form and easily understandable. It should be accurate and reliable. The best way to satisfy first characteristic is to present the performance measurement in a number. Since logistics companies have various business activities, if the performance measurements are not conducted in a number, there will be too much variation and inconsistency among evaluations of these activities. Also if different people carry out the measurements at different times, it is probable that the results are also different. A number is simple and easily understandable enough, even the outsiders of the company can evaluate the performance based on the numbers. Presenting in a number is called quantifiable here. Also, in order to be accurate and reliable, the performance measures should be measure something controllable by managers. If they are measuring factors that cannot be controlled, then it is unfair to evaluate the performance of them. For instance, one might choose interest rate as a determinant of performance for a certain type of business, but one cannot use the national bank’s base rate as a performance indicator because this base rate is not something that can be controlled by managers, and it is not something that a business can change. In the contrary, for example, a business’s cost of capital, which is its exposure to certain risk, can be controlled and so this might be considered as a performance measurement. In logistics company, it is also crucial for them to choose a performance measurement that is controllable. Choosing something that the business division cannot change will lead to inefficiencies and ineffectiveness. In summary, last criteria that used to select performance measures are :Quantifiable and controllableTo be concluded, there are three views of criteria from researchers used to select performance measures. First, performance measures should be based on the division’s objective. Second, performance measures should contain some subjective elements. Third, a performance measure does not necessarily be objective or subjective. In this paper, four criteria are chosen and each criterion is based on one view. The four criteria are : goal congruence, reinforcing strategy and quantifiable and controllability. Chapter 6 Comparisons among performance measurementsIntroductionIt is assumed that the overall goal of the division is to maximize NPV in this paper. Under this assumption, the advantages and disadvantages will be discussed in this section under each criterion: goal congruence, reinforcing strategy, quantifiable and controllable. After that, the sub-question that is going to be answered in this section is :S6: How are the performance measurements compared to each other in investment centers in logistic industry?ResultsGoal CongruenceSince market measures are referred to non-financial measures in this paper, it can provide information regarding to goal achievements of various perspectives of markets. For instance, it can be known that whether a division has achieved its target customer retention rate or whether a division has occupied a bigger market share. In addition, in today’s competitive environment, businesses cannot rely solely on the narrowly focused financial goal and internal financial measures for performance evaluations. Performances should be judged from more aspects and market measures can balance multi aspects. However, one can also argue that accounting measures can also work in line with the company’ goal. When measuring the economic success of a division, the division that generates more profits is judged more successful. However, when the performance measurement is ROI, managers will change their focus from maximizing NPV into maximizing ROI. Achieving high ROI can also be resulted from selling assets, destroying long-term value, both of which are not good for the division’s long-term goal. Besides, according to the affairs of General, ROI tends to retard incentive to growth and expansion because it dampens the incentive of the more profitable business to growCITATION Rob55 \l 1033 (Lewis, 1955). Managers are likely to dispose projects with 25% return on investment (ROI) with preference to a 30% ROI project. This will cause profit reduction for the whole company (Anthony et al, 2014). Besides, given an investment opportunity of which ROI is higher than the cost of capital but below an investment center’s current ROI, the center’s manager will forgo this opportunity CITATION Jam78 \l 1033 (James & Cool, 1978). Residual income has the advantage over other performance measurements in goal congruence. There are three reasons. First, residual income in essence is NPV. According to the formula mentioned in chapter 3, when managers accept investment projects whose residual income is positive, it automatically means managers accept projects with positive NPV. Since maximizing NPV of a division is overall economic goal of investment centers, residual income is the best performance measure in controlling goal congruence. Second, the purpose of maximizing NPV of a division is to increase shareholder’s wealth. Wealth creation refers to changes in the wealth of shareholders on a periodic basis. These changes are inferred mostly from changes from stock prices, dividend paid and equity raised CITATION Ins97 \l 1033 (Institute of Management Accountant, 1997). In order to increase shareholder wealth, it follows naturally that the manager of a division should make investment decisions based on NPV of projectsCITATION Don15 \l 1033 (Donnelly, 2014). They will maximize their value and hence shareholder wealth if they accept projects with positive NPV and reject projects with negative NPV. Third, compared to ROI, residual income will not forgo investment opportunities. One disadvantage of ROI is that managers dispose projects of which ROI is higher than cost of capital but lower than current overall ROI, because managers worry that these projects will lower their current overall ROI level, and this will affect their performance evaluation. If this is the case, managers missed opportunities of generating profits and this is not good for the goal. However, when residual income is used, all projects with positive residual income will be attractive to managers and managers have no need to worry about lowering its current financing situation. EVA, as an extension form of residual income, it possesses the advantages of residual income. Hence, EVA also works well in goal congruence.In logistics industry, which is facing global competition and fast developing, it is significant for those investment centers to keep realizing high economic profits and thus, managers should only invest in projects which generate positive NPV. High economic profits lead to wealth creation of shareholders and it supports company’s expansion and long-term growth. Therefore, logistics companies should seriously consider residual income method. However, it is not enough for top management to only evaluate the overall goal. Strategic goals such as customer retention rate, market share and satisfaction rate are also important elements of a company. It is possible that a division does not realize high profits while it does achieve high customer satisfaction rate. Or it might happen that a division occupies a big market share in a new market while does not realize high economic profit. Therefore, market measures also play a significant role in realizing goal congruence in logistics industry. So it can be concluded that residual income is a better performance measure for evaluating overall goal but market measures are better performance measurements for evaluating various strategic goals.Reinforcing company’s strategyLamber&Larcker find that firms place relatively more weight on market performance measures for situations in which:(i) the variance of the accounting measure of performance measure is high relative to the variance of the market measure of performance, (ii) the firm is experiencing high growth rates in assets and sales, and (iii) the value of the manager’s personal holding of his firm’s stock is low CITATION Lam871 \l 1033 (Lambert & Larcker, 1987). In these situations, firms can reinforce their strategy through market measures. For instance, if the firm’s strategy is to increase its sales by 10%, then market measure that focus on sales can be used. Market measures cannot only control whether the divisional strategy is inline with the whole company’s strategy, but also it monitors the actions that managers take to follow the strategy. In this way, each manager’s action is under control of the top management and each action can be evaluate.Accounting measures, on the contrary, do not meet this criterion. These internal financial measures are incomplete and focuses on data largely historical and internal to the firm. Kaplan & Norton believe that these traditional financial measures report on what happened last period without indicating how managers can improve performance in the next period CITATION Kap96 \l 1033 (Kaplan & Norton, 1996). In addition, John Deard argues that traditional performance measures are not set validly to meet future plans, because the historical costs of assets- on which it is based-are meaningless in planning future action. In a word, these accounting measures do not provide forward-looking suggestions of what should be done to follow company’s strategy.It is especially crucial for logistics company to follow their strategy because logistics companies have their own value chain. From the process of receiving products, distribution, to the time of delivery, each stage has strong autonomy. However, the performance of each latter stage is highly dependent on the performance of the former stage. If a manager is not following the strategy, it is likely that the managers in the latter stage cannot follow the strategy either and the whole value chain is damaged. Hence, it is significant that every part of this value chain is working according to the strategy to prevent from working toward a wrong direction. Under this criterion, market measures are better than accounting measures including ROI, traditional RI and EVA.Quantifiable and controllableMarket measures can be quantifiable. For instance, customer retention rate and market share can both be expressed in absolute numbers. However, most of market measures are not quantifiable, especially in some subjective areas such as customers’ satisfaction rate and how much do they follow the strategy. Non-quantifiable makes the performance measurements lack consistency among different people and there is no single standard for top management to judge their performance. Also it makes the comparisons among different periods impossible. In addition, they are always hard to be controlled. The advantages of market shares are that they are forward-looking, however, this also indicates they are not under control of the managers because managers cannot be responsible for something that has not happened. Accounting measures are both controllable and quantifiable. The first advantages of these accounting measures are that they make comparisons of performances between past and today, actual result and objective result possible. The second advantage is that these accounting measures enable outsiders of investment centers understand their performance situations. For outsiders who do not possess internal information, they can judge different investment centers’ performance based on these accounting measures and numbers are easily to be compared by these outsiders. For instance, 30% ROI is definitely better than 20% ROI. Hence, it is straightforward for them to make decisions. ConclusionTo be concluded, market measures are better at reaching goal congruence when divisional managers emphasize on strategic perspectives such as objective customer retention rate and target market share. However, when performances are evaluated based on the achievements of overall economical goals, residual income is a better indicator because it is similar to NPV. When you accept a project with a positive residual income, you automatically accept a project with positive NPV. And this will lead to the maximization of logistics company’s economic profits. ROI do not guarantee goal congruence because managers have more incentives to maximize ratio instead of economic profit. Reaching high ROI can be done through selling assets and reducing investments, which are not beneficial for the company’s long-term development. In a word, logistics companies should use residual income to support its economic goal and some market measures to support its strategic goals. In addition, market measures are best at reinforcing strategy within the company because market measures can not only control whether the divisional strategy is inline with the whole company’s strategy, but also it monitors the actions that managers take to follow the strategy. Besides, market measures offer forward-looking information, which means they indicate what the company to make improvement should do. On the other hand, accounting measures do not provide forward-looking information. They only focus on historical data and can only be used to evaluate past performances. It does not offer specific suggestion of what to do within the company to reinforce its strategy. In logistics industry, it is especially important to use a performance measurement that can reinforce the strategy within the company because each stage of logistic is influencing the performance of the next stage. Only when all stages of the value chain are behaving according to the strategy, will the whole company move towards the direction it wants. Last, market measures are neither quantifiable nor controllable. The evaluations given by market measures are hard to be expressed as an absolute number, which make the performance measurements lack consistency among different people. And there is no single standard for top management to judge their performances and it makes the comparisons among different periods impossible. In addition, market measures are barely controllable because they are forward-looking and focus on market perspective. Managers cannot control something that has not happened and the market elements are almost impossible to be changed by divisions. Accounting measures are both quantifiable and controllable, and they make comparisons of performances between past and today, actual result and objective result possible. Also, they are understandable even for outsiders of the company. It is very straightforward to make sense. For instance, 20% ROI is always better than 10% ROI. In addition, nowadays accounting measures tend to only take items which can be controlled by managers into account. Manages can change these financial figures from both income statement and balance sheet. They decide how much to be invested and which projects to be accepted. Quantifiable and controllable are both significant characteristics of performance measurements used in logistics industry. Obviously when a logistic company wants to survive from the global competition, it has to realize good financial figures. Accounting measures enable companies in logistics industry easily to be compared with each other. Also, they offer opportunities to evaluate the performance of companies on timely basis. Lastly, they give general ideas of how these business divisions perform as a whole. If the final financial figures are bad, then maybe the business division should consider about rebuild its value chain. Conclusion table:Performance measuresCriteriaMarket measuresROIResidual Income(Including EVA)Goal CongruenceYesNoYesReinforcing strategyYesNoNoQuantifiableNoYesYesControllableNoYesYesChapter 7: ConclusionBased on the discussion above, the research question of this paper, what is the optimal performance measurement for investment centers in logistics industry, shall be answered. Market measures and residual income method works best when investment centers in logistics industry combine them together. They together enable business units to reach goal congruence, reinforce strategies and they are quantifiable and controllable, supporting business units to realize good accounting figures and improve constantly in all aspects. Combining market measures with residual income method leads to a multidimensional performance measurement system, which helps investment centers in logistics industry to maintain high developing speed and win from global competition.The limitations of this paper are that first; no logistics companies are selected as samples so that no empirical data are available for the discussion. The whole paper is based on theoretical discussion and it lacks data support. Second, only four criteria are chosen due to the scope of the paper, yet there might be other criteria which are significant for logistic industry. 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