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Learn about challenges in measuring performance across different countries and effective evaluation methods, including financial and non-financial measures.
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A Multinational Company is one that does business in more than one country in such a volume that its well being and growth rest in more than one country.
1. A large decentralized firm having a corporate head office and many divisions or 2. A parent Company and a number of subsidiaries Multinational Companies may be either
There are certain peculiar problems in measuring and comparing the performance of divisions of an MNC
Economic, Legal, Political, Social and Cultural environments differ significantly across countries. 2. Governments in some countries may impose controls and limit selling prices of a company’s product. 3. Availability of materials and skilled labour as well as costs of materials, labour and infrastructure (power, transportation and communication) may also differ significantly across countries.
4. Divisions operating in different countries keep score of their performance in different countries. Issues of inflation and fluctuations in foreign currency exchange rate affect performance measure greatly.
Performance evaluations provide a way for managers and individual contributors to work together to increase employee performance through training, mentorship and collaborative goal setting. The most significant thing to be kept in mind while designing performance evaluation is that it can apply with equal relevance in all regions or department. A well designed interval evaluation system seven four important objectives:
1. It enables the top management to judge the profitability of the operations.2. Provides an early morning signal for areas that are not within control.3. Optimizes resource allocation.4. Evaluates managerial performance.
Performance Measures :Traditionally, performance evaluation system were characterized by a prevailing fours in financial measures of evaluation. However post1990strend towards highly competitive environment as a consequences of liberalization and privatisation, globalization non – financial measures such as movement in market share, corporative productivity of the organization, credit, measurement, custom satisfaction etc. to have assured great relevance as measures of performance in organisation globally.
Budgets are useful control measures in the evaluation of performance of divisions in the domestic scenario. A budget may be defined as a quantitative expression of the money inflows and outflows that predicts the consequences of current operation, decisions and reveals whether a financial plan until meet organizational objective. Financial Measures:
In case of performance evaluation of foreign subsidiaries by MNS various studies until take reveal that ’’Budget profit compared and actual profit” were the most important for performance appraisal:
Measures focusing on Budgets: • Budgeted profit compared to actual profit. • Budgeted sales compared to actual sales. • Budgeted return on sales compared to actual return on sales. • Budgeted return on investment(ROI) compared to actual ROI • Budgeted return on assets (ROA) compared to actual ROA. • Budgeted return on equity (ROE) compared to actual ROE.
Measures focusing on returns • Return on investment/ Residual income. • Return on assets. • Return on equity • Return on sales.
Other measures • Contribution to earnings per share. • Contribution to corporate cash flows. • Asset/liability managemt.
Budget Performance and ROI have been identifies as the most widely used financial criteria for performance evaluation by MNCs. The issues associated with these criteria that need to be taken care of relate to elements of income and investment base. To overcome this shortcoming, some companies have resorted to adopting an alternative measures of performance, i.e. economic where the EVA is positive, it indicates that the company is creating wealth, and if it is negative, it means that the concern is destroying capital.
In the long run, only those companies that create wealth would survive. It is preferred by investors because it relates profits to the resources required to earn the same.
Non-financial Measures Some of the non-financial measures are as follows: • Customer Satisfaction • Product and service quality • Employee development • Productivity improvement • Increasing market share • Cooperation with parent • Cash flows • Introduction of innovative products and services • Environmental compliance • Relationship with the host country
Customer Satisfaction This is a measure of how products and services supplied by a company meet or surpass the customer expectations. In a competitive environment, where business compete with each other for customers, while targeting prospective ones. In such a scenario customer satisfaction is seen as the key differentiator between the striving and thriving. Its importance was also recognized by the propounders (Kaplan and Norton) of the balanced scorecard and is part of the four perspectives of the same. Since satisfaction is basically a psychological state,
The actual manifestation of the state of satisfaction will differ from person to person. Ten Domains of satisfaction include : quality of the product or service compared to the available or best known to the customer; value compared with the best price the customer has experienced or known of ; timeliness of the delivery ; environment, i.e. the suppliers plant/office/store, etc,; ease of access to the place of seller or provider of the service; inter-department teamwork; behaviour of frontline service providers; efficiency; commitment to customers; and innovation in products and service.
Market Share In strategic management and marketing, market share is defined as the percentage or proportion of the total available market or market segment that is being serviced by a company. For computing, the market share it is, however, first necessary to define the market share index, i.e. the ratio of sales of the affiliate to total sales in the market served by the product. Market share is a good measure of performance evaluation for subsidiaries that have been established with the motive of capturing a particular market for a certain product. If the subsidiary has been able to enhance its market share over the period of evaluation, it would be deemed to be doing well and vice versa.
Productivity This is an efficiency measure that relates the output of a given unit to the inputs used in the production of the outputs. Thus, in simple terms, productivity= output/input. Productivity is a key measure of the relative competitiveness of the affiliate. The trends in productivity indicate the efficiency with which the department is utilizing its labour and capital resources. Total factor productivity index may be computed as follows: Unit productivity= Where: Value added= Unit sales-Input costs of all materials and services.
Measuring the cost of quality Prior to the 1980s, quality as a measure of performance was practically non-existent. Though quite a few managers in principle agreed to the importance of producing better quality products, they still focused their attention on short-term financial performance measures expressed in earnings per share and return on investment. The present competitive business environment demands quality being delivered at the lowest price. Quality has, therefore, become an important dimensions for both manufacturing and service organizations.
A product or service will therefore be deemed to have quality when it satisfies the user’s needs both explicit and implied. Improvement in quality can also lead to an increase in profitability by enhancing demand from satisfied customers and reduction in cost of non-performance. Concerns about quality improvement have been broken down into two components: quality of design and quality of conformance. Quality of design which is generally viewed as the responsibility on inventors, engineers, architects, and draftsmen, relates to the functioning and physical characteristics of the product to satisfy customer expectations. Quality of conformance on the other hand relates to how closely the final product achieves its design specifications and, ultimately customer satisfaction.
It is the component of quality on which managers and accountants have focused their attention, since there are costs involved in non-conformance. The focus of quality control today is on preventing defects, rather than identifying and correcting them.
Personnel development This measure gauges the effectiveness of the personnel development programmes of the unit. It measures the investment in human resources, the contribution of employee training programmes to promotion is monitored, to gauge whether persons identified as promoted have been promoted in a timely manner.
Employee attitudes This measures attempts to assess the extent to which such needs of employees as safety, security, creativity, growth, belonging, etc. are met by the company. It is measured by employing traditional measures such as labour turnover, absenteeism, tardiness, safety, etc. Periodic surveys that attempt to sample the attitudes of employees towards their work are also conducted. Thus, a judicious combination of financial and non-financial criteria should be made use of in evaluation of the performance of subsidiaries.
MAJOR ISSUES IN PERFORMANCE EVALUATION OF FOREIGN AFFILIATES
The major issues that need a more detailed analysis are : unit versus managerial performance, impact of currency fluctuations on budgeting and translation, effects of inflation, environmental problems, transfer pricing policy and of accounting standards that particularly impact performance evaluation.
An important issue which arises in the evaluation of the performance of an affiliate is whether a distinction is necessary between the performance of the unit and its manager. Divergent views are prevalent in this regard. There are some corporate controllers who hold the view that the operation of the unit is the responsibility of the manager and how the unit performs is closely associated with the evaluation of his performance. However, Controllability should be the deciding factor to be taken into consideration when evaluating the manager of the subsidiary. Unit of Managerial Performance
Internal non-controllable factors • Policy regarding transfer pricing • Royalties, interests and other indirect expenses charged by parent • Policy with regard to foreign exchange risks management Below mentioned should be ideally exchanged while PTE
Non-controllable factors in the external environment • Exchange rate • Tax rates • Policies and regulations of the host country Below mentioned should be ideally exchanged while PTE
Evaluation of foreign affiliates is further complicated by inflation. Evaluation by the same yardstick of subsidiaries located in low inflation and in high inflation economics would not be appropriate. Inflation has an effect upon the earnings and non adjusting for it generally results in overstating the computed return on investment, since current prices of the product are matched with outdated costs of production. An optimistic appraisal of performance of the unit is the outcome of the following factors: • Profitability measured according to ROI is overstated as it is measured in relation to an inaccurately small investment base. Effect of Inflation
Depreciation is understated being based on historic costs. • Accumulated depreciation is not adequate to replace assets.
Currency considerations further complicate performance evaluation in multinational corporations. In fact, it is one of the major issues involved, as the assessment of a foreign subsidiary’s performance is considerably influenced by the currency framework employed. A foreign operation’s financial performance can be evaluated in terms of local currency (subsidiary) or home country (parent) currency or both. Those who advocate the use of the parent currency in measuring performance put forward the argument that the shareholders in the parent currency in measuring performance put forward the argument that the subsidiaries of the same parent. On the other hand, the use of local currency, is supported by those who feel that since the transaction of foreign currency, adoption of this approach would eliminate the consideration of foreign currency translation gains and losses. The manager of the foreign subsidiary is, therefore, evaluated on the basis of his ability to compare in terms of local currency. Currency Considerations
Comparisons of actual versus planned financial performance in the context of the operating budget is the most common method of evaluating performance of foreign affiliates. It is also one of the principal tools used for the communication in the multinational firm and helps to knit together its heterogeneous submits. The Complexities encountered in budgeting for overseas operations resolve around exchange rate considerations. The fundamental issues involved are; which exchange rate should be used for budgetary planning and for reporting performance, and should managers of foreign affiliated be held responsible for exchange rate variances ? Budgetary Process
The environmental characteristics of a particular country also have an important bearing on the performance of the subsidiary and ought to be taken into consideration while evaluating it. It is particularly difficult to compare the performance of a manager of a subsidiary in one country with that of another country. There are a host of environmental variables with the local manager is called upon to face. These may broadly be put into four categories, which include: Environmental Factors
The economic environment has a far reaching impact on the performance of the subsidiary as it influences both the demand and supply side of the product or service. For instance, backward economies will have little demand for sophisticated equipment's or other luxury products. Efficient means of transportation and communication also improve productivity and reduce cost of production. Similarly , inadequate power supply situation in many states of India hampers production. Economic factors
The level of inflation not only impacts exchange rates but also wage structures and taxes and transfer prices. Restrictions on imparts and supplies, foreign exchange controls, administered prices of products all hamper the efficient functioning of the subsidiary and need to be considered when evaluating it.
Political stability and a well- developed and efficient legal system are conductive to investment in the country and subsequent retention of that investment. If government policies particularly with regard to foreign investment keep changing frequently it hinders the progress of industrial set ups. Plans for expansion are held back for fear of expropriation in future. Frequent strikes and lockouts also reduce the efficiency of the managers of the subsidiary. When comparing performance these considerations deserve attention of the parent. Political and legal factors
Educational variables also vary from country to country. The competence of the workforce will, to a large extent, depend on the level and quality of education in a particular country. The extent and degree of formal education and training systems and technical education system determine not only the competence of the workers but also their lifestyles and type of products and services that will be demanded. Subsidiary of MNCs operating in environments which are developed in this respect will do better than others. State of education in the country
The impact of social and cultural factors is far reaching. It effects the attitude of the workers in various ways. In a social structure where the family is predominant moral and ethical values are generally higher. These values in turn affect the attitude of the workers towards the organization, colleagues and ambition to achieve more. Cultural attitude towards authority and persons in subordinate positions also influences the performance of the organizations as a whole. Attitude towards industry and business also imparts organizations in a big way. Sociological factors
The experience of KFC in India in the initial years is an evidence to this fact. The existence of differing environmental factors makes inter company comparisons misleading unless they are taken into account when evaluating the foreign subsidiaries
Financial accounting provides the database upon which control systems are built. It is, therefore, reasonable to expect that accounting regulations will have a significant impact upon the performance evaluation system. Accounting regulations with regard to provision for depreciation or revenue recognition treatment of exchange gains or losses, will exercise a decisive influence on the reported profits. An evaluation system that does not discount for the differences in accounting principles and practices of the host country of the subsidiary would not be fair to the manager of the subsidiary. Accounting Regulations
Thus while devising an effective performance evaluation system for foreign affiliates, a host of complicated international variables such as exchange rate volatility, foreign inflation, transfer pricing, environmental factors, accounting regulations, etc. need to be taken into considerations. The performance evaluation system ought to reflect the specific nature of a foreign operation and be considered with foreign objectives in relation to overall corporate goals. In practice, however, many of these considerations are not given their due weightage for pragmatic reasons which may lead to faulty comparisons.
RathoreShirin, International Accounting, PHI Learning Private Limited, New Delhi,2012 References
With Inputs from Dr. Navdeep Kaur Department of Commerce
