Performance Measurement, Operational and Financial Performance

Empirical studies in business management repeatedly use business performance as dependent variable in order to predict the potential effect of managerial, operational and behavioral activities within the firm. This second article in the series concerns of financial and operational performance; through the summarization of two seminal papers written by Venkatraman and Ramanujam (1986) and Kaplan and Norton (1992).

Venkatraman and Ramanujam (1986) study consider as an important document for the theoretical discussion regarding the evaluation of the measurement of business performance. One of the key issues addressed by this study is the attempt to delineate the performance concept. More specifically, whether business performance should be differentiated from the overall discussion on organizational effectiveness. The view taken by Venkatraman and Ramanujam (1986) was that business performance, which reflects the perspective of strategic management, is a subset of the overall concept of organizational effectiveness. The narrowest conception of business performance centers on the use of simple outcome based financial indicators that are assumed to reflect the fulfillment of the economic goals of the firm. Venkatraman and Ramanujam (1986) refer to this concept as financial performance. Financial performance measurement is a multi-dimensional one. Sample of financial measures, group into dimensions can be presented as follow: Profitability – return on investment (ROI), earning before interest and tax (EBIT), gross profit margins. Growth - market share growth, Sales Growth. Efficiency – return on sales (ROS), return on equity (ROE). Analyses made by using single financial measure or several measures relating to only one dimension may lead to misleading conclusions. According to Venkatraman and Ramanujam (1986) a border conceptualization of business performance would include emphasis on measures of operational performance, which consists of those key parameters which may lead to an improvement in financial performance. Venkatraman and Ramanujam (1986) note that it would be logical to treat operational performance measures such as market-share, new product introduction, product quality, marketing effectiveness, manufacturing value-added, within the domain of business performance.

Kaplan and Norton (1992) have presented another seminal paper regarding the measurement of business performance. Its name, “The Balanced Scorecard – measures that drive performance” could suggest for the way they approach the issue. According to the writers, since there is increasing need, both for large and small businesses, to master a variety of capabilities in different fields, the traditional measures of financial performance gives inadequate, or in some cases inaccurate, perspective for the status of the business and its ability to keep improving. The balanced scorecard tries to overcome these difficulties through the completion of financial measures, which reflect for actions that already have been taken, with those of operational performance measures, which consists of parameters that may drive the forthcoming financial performance. Operational measures according to the balanced scorecard constructed from three dimensions – How do customers see us? (Customer perspective), What must we excel at? (Internal perspective), Can we continue to improve and create value? (Innovation and learning perspective).

Performance Measurement, Organization Theory

Business performance is probably one of the must widespread dependent variable used by scholars, while at the same time its remains one of the most vague variables (Rogers and Wright, 1998). In order to minimize the level of ambiguity regarding the construction and definition of business performance, as well as to suggest for performance measurement alternatives in a way to provide with the most accurate and effective measurement, both for small business and large business, I present a series of articles focusing on seminal papers discussing the issue of performance measurement and a literature review of studies using business performance as dependent variable.

The first article presents a discussion on organization theory by Murphy, Trailer and Hill (1996), which argue that much of the research on performance has come from organization theory and strategic management. The view taken by Venkatraman and Ramanujam (1986) in their paper was that business performance, which reflects the perspective of strategic management, is a subset of the overall concept of organizational effectiveness.

Murphy et al., (1996) argue that in organization theory, three fundamental theoretical approaches to measuring organizational effectiveness have evolved: The goal-based approach – suggests that an organization be evaluated by the goals that it sets for itself Etzioni (1964). However, organizations have varied and sometimes contradictory goals, making cross-firm comparisons difficult. Reinforcement for the notion that organization are varied in various aspects is that scholars often restricted their study sample to definite industries in order to control the disparities between the various industries with respect to performance and the firm's profitability (Beard and Dess, 1981; Miller and Tolouse, 1986). The systems approach – this approach partially compensates for the weakness of the goal-based approach by considering the simultaneous achievement of multiple, generic performance aspects (Georgopolous and Tannenbaum, 1957; Yuchtman and Seashore, 1967; Steers, 1975). Both the goal and system approaches fail to adequately account for differences between stakeholder groups perspectives on performance. The multiple constituency approach – this approach factors in these differences in perspectives and examines the extant to which the agenda of various stakeholders groups are satisfied (Thompson, 1967; Pennings and Goodman, 1977; Pfeffer and Salancik, 1978; Connolly, Conlon and Deutsch, 1980).

Venkatraman and Ramanujam (1986), which discuss organizational performance measurement in terms of three hierarchically construct (i.e., organizational effectiveness, operational performance, financial performance) argue that these three organization theoretic perspectives are reflecting the writings on organizational effectiveness construct. The coming articles discuss about the other two constructs – operational performance and financial performance.