MALCOLM SMITH PERFORMANCE MEASUREMENT & MANAGEMENT A STRATEGIC APPROACH TO MANAGEMENT ACCOUNTING R3011049-Prelims.qxd 2/7/05 1:14 PM Page i PERFORMANCE MEASUREMENT & MANAGEMENT R3011049-Prelims.qxd 2/7/05 1:14 PM Page ii R3011049-Prelims.qxd 2/7/05 1:14 PM Page iii PERFORMANCE MEASUREMENT & MANAGEMENT A STRATEGIC APPROACH TO MANAGEMENT ACCOUNTING Malcolm Smith R3011049-Prelims.qxd 2/7/05 1:14 PM Page iv © Malcolm Smith, 2005 First published 2005 Apart from any fair dealing for the purposes of research or private study, or criticism or review, as permitted under the Copyright, Designs and Patents Act, 1988, this publication may be reproduced, stored or transmitted in any form, or by any means, only with the prior permission in writing of the publishers, or in the case of reprographic reproduction, in accordance with the terms of licences issued by the Copyright Licensing Agency. Enquiries concerning reproduction outside those terms should be sent to the publishers. SAGE Publications Ltd 1 Oliver’s Yard 55 City Road London EC1Y 1SP SAGE Publications Inc. 2455 Teller Road Thousand Oaks, California 91320 SAGE Publications India Pvt Ltd B-42, Panchsheel Enclave Post Box 4109 New Delhi 110 017 British Library Cataloguing in Publication data A catalogue record for this book is available from the British Library ISBN 1-4129-0763-2 ISBN 1-4129-0764-0 (pbk) Library of Congress Control Number: 2004116097 Typeset by Selective Minds Infotech Pvt Ltd, Mohali, India Printed and bound in Great Britain by TJ International Ltd, Padstow, Cornwall R3011049-Prelims.qxd 2/7/05 1:14 PM Page v Contents Preface vii Acknowledgements ix 1 Introduction 1 2 Emerging Issues 7 Historical development 7 Management accounting research 9 3 Performance Measurement and Analysis 14 Strategic management accounting 15 Objectives 19 Situation audit (SWOT analysis) 20 Benchmarking 53 Resource-based view of the firm 57 Performance measurement alternatives 60 4 Strategy Alternatives 64 Creative thinking 65 Developing an innovation culture 68 Evaluation 75 5Product and Customer Profitability 86 Accounting system implications 86 Product profitability 87 Customer profitability 89 Customer relationship management 103 6 Know Your Processes 108 Cost behaviour: random variation and interdependent events 108 Activity-based costing 112 Operationalizing activity-based costing 115 Target costing 130 Activity-based management 132 R3011049-Prelims.qxd 2/7/05 1:14 PM Page vi vi Contents Innovation and the activity-based management trade-off 141 Operationalizing activity-based management: the time dimension 144 Value-added management 160 7 Know Your People 168 Total quality management 168 Operationalizing total quality management 170 Overcoming total quality paralysis 179 Control: the missing link of total quality management 181 Total employee involvement 184 Strategic internal control 190 Employee empowerment 206 8 Management Information Systems 224 Non-financial indicators 224 The balanced scorecard 238 Measurement challenges for the not-for-profit sector 250 Challenges of technological innovation 253 9 Financial Modelling 255 Forecasting methods 256 Delphi methods 257 Heuristic methods 257 Probabilistic simulation 258 Time series analysis 259 Regression analysis 261 Discriminant analysis: failure prediction and corporate turnaround 262 Risk measurement 268 Risk analysis 270 Value-based management 278 References 285 Index 296 R3011049-Prelims.qxd 2/7/05 1:14 PM Page vii Preface Accounting journals abound in a variety of three-letter acronyms, each describing the very latest innovative tool or technique which purports to be the solution to all our ills. The content and presentation of these terms often seem to be designed to intimidate the unwary user, both by their apparent complexity and by the suggestion that our current ways are out- dated and must be mended. The proponents of such views suggest, often with vested interests, that the new developments are both original and must completely supplant our traditional ways of doing things. The adoption of such ideas is potentially disastrous, since most of the techniques are not suitable to all commercial circumstances. Far from being ‘original’, some of the developments are merely repackaged and remarketed versions of accept- ed concepts. They represent a revised approach or the integration of exist- ing methods already in use in accounting, or stolen from other disciplines. The examples of activity-based costing (ABC), the balanced scorecard and business process re-engineering (BPR) most readily spring to mind. Numerous examples of failed implementations of such schemes are to be found in the practitioner literature, often when the powers of persuasion of the consultant have overcome the evidence available from the information base. We are concerned here with the strategic advantage that might accrue to our businesses from the adoption of the latest management accounting tools and from the non-adoption of the latest fads. By burrowing beneath the surface of the accounting jargon, this book identifies the underlying themes and integrates common messages. By seeing what is new and what is useful, we can achieve a fresh awareness of the way in which we currently operate and observe how innovations can complement existing methods by improving on current practice. Measurement practices, current and possible, pervade all of these issues, and we are closely concerned with improvements in performance measurement and all its implications. We accept that we cannot manage what we cannot measure, but also that managers and supervisors may only respond to what is being measured and reported. The onus is therefore on us to get the measurement framework right so that dysfunctional activity is discouraged. This book analyses developments with respect to five key themes: 1 strategic goals: (a) strategic management accounting, (b) strength, weaknesses, opportunities and threats (SWOT) analysis, (c) resource-based view of the firm; 2 customer focus: (a) total quality management (TQM), (b) target costing, (c) customer profitability analysis; 3 employee creativity: (a) total employee involvement (TEI), (b) lateral thinking, (c) employee empowerment; R3011049-Prelims.qxd 2/7/05 1:14 PM Page viii viii Preface 4 processes: (a) activity-based costing, (b) activity-based management (ABM), (c) value-added management (VAM), (d) just-in-time scheduling (JIT), (e) theory of constraints (TOC), (f) business process re-engineering, (g) supply-chain management; 5 information: (a) non-financial indicators (NFI), (b) balanced scorecard, (c) performance measurement, (d) risk measurement; (e) predictive modelling. By increasing our awareness of new developments, we are forced to question the appropriateness of existing systems and measures, and to consider the relevance of management initiatives for doing things better. Throughout the text we recognize that we are working in a dynamic process; just as globalization has changed the nature of business, so too what was once acceptable in accounting research may no longer be so because of a more appropriate emphasis on research ethics. Many journals remain very conservative in the type of research they will publish, often on the grounds that it is difficult to demonstrate that ‘new’ methods constitute ‘good’ research in the same way as is possible with traditional methods. But thankfully this situation is changing gradually, and the wider opportunities for publishing case-based research in recent years provide evidence of this. Similarly, the timeliness and relevance of much of the content of the refereed literature does little more than suggest that it is written by academics for academics! If dynamism has not impacted on all refereed journals, the same cannot be said of the professional journals: there were once two such journals called Management Accounting, but now there are none, the US version becoming Strategic Finance and the UK one Financial Management. These changes both reflect the need suggested, among others, by Otley (2001) for there to be more ‘management’ in ‘management accounting’ – so that a move towards strategic management and recognition of the wider financial implications is much appreciated. This dynamism parallels that between ‘accounting system change’ and ‘performance measurement innovation’. While the incidence of management accounting system change is both low and slow, the same cannot be said of performance measurement frameworks, where initiatives are embraced more readily. Thus it is appropriate that throughout we are concerned with measurable improvements in performance that address the interests of all stakeholders of the organization, especially where those benefits result from embracing accounting change. Professor Malcolm Smith Leicester Business School October 2004 R3011049-Prelims.qxd 2/7/05 1:14 PM Page ix Acknowledgements The helpful comments of academics and management accounting practi- tioners have been essential to the successful completion of this volume. Special mention must be made of Peter Phillips of Alcoa Australia; Shane Dikolli of the University of Texas at Austin; Richard Taffler, of the Cranfield School of Management; Keith Houghton, of the Australian National University in Canberra; Bev Schutt, Paul Martin, Chris Graves, Basil Tucker, Bruce Gurd and Chen Chang of the University of South Australia; John Cullen of Sheffield Hallam University and John Darlington. Grateful acknowledgement is made to the following sources for permis- sion to reproduce material in this