Now that we have covered the different types of measures and how to choose them, let us turn our attention to how mangers set and measure target levels of performance.
Historical-cost-based accounting measures are usually inadequate for evaluating economic returns on new investments and, in some cases, create disincentives for expansion. Despite these problems, managers can use historical-cost ROIs to evaluate current performance by establishing meaningful target ROIs. For Hospitality Inns, we need to recognize that the hotels were built in different years, which means they were built at different construction-price levels. The firm could adjust the target historical-cost-based ROIs accordingly, say, by setting San Francisco’s ROI at 26%, Chicago’s at 21%, and New Orleans’ at 19%.
This useful alternative of comparing actual results with targeted, or budgeted, results is often overlooked, but should not be. Companies should tailor and negotiate a budget for a particular subunit, a particular accounting system, and a particular performance measure while keeping in mind the pitfalls of using historical-cost accounting. For example, many problems related to valuing assets and measuring income can be resolved if top managers can get subunit managers to focus on what is attainable in the forthcoming budget period—whether ROI, RI, or EVA is used and whether the financial measures are based on historical costs or some other measure, such as current costs.
A popular way to establish targets is to set continuous improvement targets. If a company is using EVA as a performance measure, the firm can evaluate operations on the year-to-year changes in EVA, rather than on absolute measures of EVA. Evaluating performance on the basis of improvements in EVA makes the initial method of calculating the measure less important.
Companies using balanced scorecards establish targets for financial performance measures, while simultaneously setting targets in the customer, internal-business-process, and learning-and-growth perspectives. For example, Hospitality Inns will establish targets for employee training and satisfaction, customer-service times for reservations and check-in, the quality of room service, and customer satisfaction levels that each hotel must reach to achieve its ROI and EVA targets.