Question
Exhibits
1. Company information
Harray Keyboards （Harray） is a family-owned business which manufactures computer keyboards. It has contracts to supply three large desktop computer manufacturers. Harray won its contracts to supply these manufacturers under severe price competition as the manufacturers themselves have seen the price of their whole desktop package fall in the past 10 years.
The contracts are for five years and have at least three years each left to run. At the end of the contract, the desktop manufacturers will retender for（重招标） suppliers and Harray expects to be in a strong position as the existing supplier to win more work.
The chief executive officer （CEO） and leader of the Harray family is Graham Harray. He and the board believe that the success of the business has been built on an emphasis on strategic focus. He recently declared at a board meeting, ‘Cost leadership wins business in our niche market and we should not over-stretch（过度伸长） ourselves into non-core activities – we make cheap keyboards!’

Exhibits
2. Performance pyramid
The CEO has indicated that he wants to use the performance pyramid to analyse the performance indicators used at Harray. He has asked you, as the company’s performance management expert, to undertake three pieces of work on this area.
First, whilst the CEO is familiar with the headings in pyramid （vision, market, financial, customer satisfaction, flexibility, productivity, waste, quality, delivery and cycle time）, he would like you to explain how they fit together in the pyramid structure and how Harray could use this to analyse a performance measurement system.
Second, the CEO would like you to complete the analysis provided in Appendix 1. Appendix 1 contains the work done so far by a junior accountant on the pyramid headings and their associated indicators for Harray, with additional notes and information about Harray’s performance. He would then like you to evaluate only the operational performance indicators at Harray.
Third, there are a number of non-financial indicators used in the performance pyramid and the CEO wants to get a sense of the reliability of these indicators compared to the financial ones which are usually presented in the board reports. He would like this part of the work to focus on the methods of measuring such indicators including the information sources, and the methods of processing and checking which is normally undertaken.

Exhibits
3. Appendix 1
Harray’s performance indicator information （for the year ended 30 June 20X5）

Notes:
1. Vision does not have an indicator. There is a separate project being carried out within the finance department to deal with this.
2. The absolute profit figure is used.
3. Market share is measured by an external marketing expert.
4. Customer complaints are measured by customer returns.
5. Many orders require customisation of the production process. Customers see timely delivery as critical.
6. There are a number of other margins available for use in measuring productivity in specific areas of operations but operating margin is used as the summary indicator of productivity.
7. There are 16 manufacturing production lines in the factory. These lines are active for nine hours a day for six days a week （52 weeks a year）. A keyboard is produced from the production line every 2·2 minutes （including set-up time）, while the machines are operating. Last year, the factory produced 1·05 million keyboards.
8. The number of keyboards rejected by quality inspectors in the factory was 15,750 in the year. Of these, 9,450 were able to be reworked at an average cost of $2 and the rest were scrapped. The standard cost of a keyboard is $8.
9. Harray uses an external logistics firm （Achall） to handle all deliveries. Harray calls Achall to collect an order and Achall’s lorry fleet picks up orders from Harray’s factory and delivers to the customer. There are service level agreements governing how long Achall has to deliver the goods to Harray’s customers. Achall supplies Harray with data from its own systems on the number of packages delivered and how many were late. Below is the report for last year:

10. Working capital cycle is calculated as inventories days （22） + trade receivables days （42） – trade payables days （27）.

Requirements
It is now 1 September 20X5.
（a） Explain how the headings in the performance pyramid link together to aid analysis of the performance indicators used in a business. （6 marks）
（b） Complete the analysis and evaluate the operational performance indicators at Harray, using the headings and data in Appendix 1. （12 marks）
（c） Evaluate the reliability of non-financial indicators as requested by the CEO, using the operational performance indicators from part （b）. （7 marks）

3 （a） The performance pyramid aims to link the drivers of performance with the traditional financial results through the different layers of an organisation.
It is based on the belief that each level of an organisation has different concerns but they must support each other in order to achieve the overall objective （vision） of the organisation. The aim is to produce a set of performance measures which covers the outputs （traditionally financial） and the drivers of those outputs. The pyramid shape is to emphasise that the measures should support this vision, through all layers of the organisation （from operational to strategic）. Thus the vision flows down through each layer generating appropriate measures which, in turn, support it.
The pyramid is split vertically between the driving forces of customer satisfaction （external） and flexibility/productivity （internal）. These forces are monitored and controlled via measures at the operational level which cover day-to-day issues of quality, delivery, and the cycle time of different processes and waste.
Some of the terms in the pyramid are well understood but others are more specific to the model. Flexibility is a concept which indicates the business systems’ ability to change in response to internal and external factors such as customer needs. Cycle time relates to all processes in the organisation from the credit cycle to product development to order processing. Waste is a general term relating to the optimal utilisation of the business’s resources and elimination of non-value adding activities.

（b） There are four operational headings in the pyramid which shall be considered in turn.
Waste is about optimal use of resources and minimisation of non-value adding activity. There are 1·05 million keyboards produced but this only represents 86% utilisation of the capacity of the factory （2,695,680 minutes of production line time are available at 2·2 minutes per keyboard meaning that the factory can produce 1,225,309 at full capacity）. Therefore, capital invested in the factory is under-utilised, although an 80+% utilisation would be considered efficient for many manufacturing operations.

Quality can be measured through four cost types: inspection and prevention costs （which represent the costs of preventing faults in the production process and inspecting to avoid faulty goods leaving the factory） and internal and external failure costs （which are costs resulting from faulty goods being identified before and after delivery to the customer）. There are no data given for 20X5 on the costs of inspection and prevention.
However, the effectiveness of inspection can be measured in that only 0·4% of orders were returned while inspection stopped the delivery of 1·5% of faulty goods. There was a loss of $50,400 at standard cost from the scrapping of faulty keyboards although 60% of faulty boards identified were able to be repaired. The effectiveness of prevention can be measured in that there is a roughly 1·9% failure rate in total, which must reflect the good production practice at the factory.
There are data on measures of the costs of internal failure from reworking goods （$18,900）. But there are no data on the costs of external failures from 0·4% of customer returns which may incur further repair or warranty claim costs.
Delivery has been outsourced to Achall and Harray is reliant on Achall to provide the data on the quality of Achall’s own service.
This represents a risk which Harray can control by monitoring its own customer feedback to identify if Achall is under-reporting the late deliveries. Based on Achall’s data, 92% of orders are delivered on time at an average time of 3·4 days.

（c） In order to understand the issues surrounding measurement of non-financial indicators, it is necessary first to consider the more commonly used financial ones. Financial indicators will be produced by Harray’s financial systems. These systems will generate much of the cost information used, for example, in measuring the costs of quality. They are internally controlled and additionally monitored by the external auditors of the organisation. Such systems are by definition working with easily quantified data （invoice values）. For these reasons, they are likely to be the most reliable data available.
However, for the measurement of headings such as cycle time, the data are often going to be non-financial. Cycle time requires measuring how long processes take, for example, the length of time it takes a production line to produce a keyboard. These data are within the control of Harray and the data will be obtained by production records and interviewing the key personnel. However, they will not be subject to the checking and controls over financial data and, therefore, may be more prone to error.

Other non-financial data used may come from external sources. For example, at Harray, they are using the delivery data of Achall. This data must be treated carefully as there is an incentive for Achall to under-report late deliveries as there may be penalties for such non-performance in their contract with Harray （there is also the threat of losing the contract）.
Harray will want to ensure that Achall’s data is reliable by checking it against its own customer complaint records. Also, the definition of non-financial data is more subjective, for example, what constitutes a late delivery （though this should be consistent with the service level agreed in the contract）.