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To develop a performance management framework every organisation has to answer a set of questions in order to deal with issues that it is going to meet in the real world environment. The set of questions will always remain the same however organisations has to keep on finding new answers for them. This is mainly because of ongoing changes in the environment that an organisation is placed. David Otley (1999) argues that there are five main questions and every organization has to answer them to be able to develop a strategy for coping with changes in the business environment.
"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?
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? 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?
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)?
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 behavior in the light of that experience? ( D. Otley 1999)
With the list of questions organization is ready to come up with a strategy that will help to form a framework. Strategy consists of three parts which are mission, goals and objectives. Mission of the organisation states what role in the society it plays which is reflected by its products or services. In other words mission of an organisation is a reason for it existence. Goals explain why organisation makes certain decisions and are more specific than a mission. Lastly objectives are goals that can be shown in a measurable way. We can say strategy is a plan that enables organisation to reach everything that is represented by mission, goals and objectives. With a strategy set up we can talk about measurement performance hence we know what organisation is aiming for and we can check how well it is coping with this task.
With clearly formulated strategy organisation has to decide what performance measures it is going to use to have effective performance management system. Process of selecting right performance measurements is vital to check the real performance of organisation. We should use both financial and non-financial measures. Covering both of these groups is important because only this can give us a full picture of organisations performance. The most popular framework in developing performance measures is the idea of Balanced Scorecard developed by Kaplan and Norton originally in 1992. The idea behind Balanced Scorecard is to develop an appropriate set of performance measures for the chosen business strategy. Balanced Scorecard help managers to look at the business from four different perspectives which are:
internal business perspective
innovation and learning perspective
First perspective is the most traditional one because it can be represented in financial terms hence it is easy to apply and show. Measure of financial can be presented by return on capital employed, profit or shareholder value added. Customer perspective helps to show how organisation is responding to its customers needs. This is very important as to be successful every company needs customer that will return and buy its products or use its services hence customers have to be kept happy. Internal business perspective measures the ways of how the organisations goals are being achieved. Last perspective in difference to the first 3 is orientated around long period of time. It has to measure aspects like new product development or staff training, thing that will help to achieve competitive advantage over competition. Balanced Scorecard is a simple framework that can be applied in a wide range of organisations and it helps to set up correct performance measurements which are vital in achieving organisation's strategy. Below diagram illustrates four perspectives of Balanced Scorecard presented in paper 'Linking the Balanced Scorecard to Strategy' (R. Kaplan, D. Norton 1996).
When appropriate performance measures are chosen next stage in developing performance management system is to set up right standards and targets. By this is meant to set the level of every measure that has been identified in the previous stage. It is important to set up targets at the right levels so they are actually possible to meet yet they are not set too low and lead to underperformance. Good practice is to get management involved in setting targets as this will strength their commitment to achieve them. However they might set the levels lower than the levels they could actually meet mainly because they performance is judged upon meeting targets and they want to set a safe target. To prevent this kind of situation targets should be also set with the context of previous periods' achievements as well as present circumstances in the business environment. External benchmarking is also a solution that helps to set targets in comparison with organisation's competitors.
When the targets are set next thing to prepare is the system of rewards and incentives. Organisation needs it because managers and employees have to be motivated to meet the previously established targets. Rewards can be financial and non-financial they are awarded by the appraisal and evaluation of performance. Well designed reward system helps to keep commitment and high performance amongst employees of all levels. 'Thus incentives, rewards and the performance appraisal are central to the design of an effective performance management system.' (Otley 2005)
Final part of performance management system is information flows. According to Otley "information flows, systems and networks are essential enabling mechanisms to any performance management system" (Otley 1999). It is so important because organization can compare information on actual performance with the targets and standards that were set up earlier. If there are any deviations managers can quickly make necessary adjustments and make sure that all the targets and standards are met. Information also helps to predict some problems that may occur and help managers to prevent them from taking place by taking appropriate actions. Good information flows also prevents from reoccurring of unwanted errors. It can also show that certain strategy that was taken by an organization is failing and there has to be a change made in this part of performance management system.
In my opinion the process shown above is suitable to develop performance management system in both service type organization as well as manufacturing firm. However according to Otley 'there is no single set of performance measures, no single basis for setting standards for those measures, and no universal reward mechanism that constitutes a perfect performance management system in all contexts'.(Otley 2005) Main differences in developing systems in different kind of organizations lie in choosing different performance measurements. This is determined by the fact that they are operating in different environments and have different strategies and the performance management system should be especially fit to these circumstances. If the organization will answer correctly to the five questions outlined by Otley, it will be able to develop effective performance management system.