Page 34 - Performance Leadership

Chapter 2 Traditional Performance Management • 23

an extrapolation into the future is possible. Ratios on an aggregated level
also make it possible to benchmark organizations against other organi-
zations, if they are all using the same definition. Essentially, these ratios
provide almost immediate insight for the skilled reader.
The more popular financially oriented performance indicator today
is the economic value added (EVA) formula. This measure aims to cap-
ture the true economic profit of an enterprise and to describe creation
of shareholder wealth over time. EVA formula equals net operating
profit after taxes (NOPAT) minus the required return times capital
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invested. EVA explains to business managers on all levels that capital
is not for free and should be applied to activities that at least provide a
higher return than the cost of capital. Managers are forced to focus on
creating value. Business unit plans, investment proposals, and even
some projects can be evaluated on their return in the EVA formula as
to their contribution to the net operating profit and their expected
return. But EVA doesn’t describe your company strategy, nor does it
give guidance on how to create the highest return. You would need a
more operationally focused methodology to help you figure out how
to get there.
Activity-based costing (ABC), popular in the 1980s but dating back
to the 1930s in Germany, bridges finance and operations. On the oper-
ational level, it identifies the activities that are required by a company
to deliver the goods or the services that it produces. It also defines
which resources are needed to fuel these activities. On the financial
level, activity-based costing provides managers with insight about the
costs of business activities or processes by allocating direct and indirect
costs to various steps for each activity or process, the so-called cost driv-
ers. Examples of cost drivers include purchasing, warehousing, sales,
invoicing, shipping, customer service, and so on.
Activity-based management (ABM) aligns activities, resources, and
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financial results. Financial results are achieved by selling products
and services that are produced through certain activities. Activities, in
turn, are fueled by resources. If the products and services are not pro-
viding the right results, on the financial side you can either adjust the
price (increasing the price for a higher margin or decreasing it for
lower margins but higher turnover), or you can adjust the resource
cost by renegotiating contracts or switching to a supplier that will