The paper "To Which Performance Measures Is Kaplan Referring " is a great example of a finance and accounting assignment. In his 1984 quote, Kaplan primarily refers to the use of return on investment (ROI) as the primary measure of performance of profit centers and their managers. The profit center concept was first developed by DuPont and General Motors in the United States in the 1920s. This has meant that each division within the organization was treated as if it was a separate “ mini-company” (Kaplan, 1984). The two organizations have used ROI, formal budgeting and incentive plans in their management accounting practices across these profit centers which meant that profit was the key motivator for the companies and performance was also appraised based on purely financial terms where tangible assets and short-term profit targets were central.
As Johnson (1980, p. 97) put it, “ the primary responsibility of top management was to ensure that the company earned the required market return on invested capital” , not the overall economic value of the organization. While these profit center measures seemed to work well at the time, their flaws became increasingly apparent by the 1980s.
Perhaps, the biggest problem of these measures was the focus on short-term economic performance (Kaplan, 1984, What’ s Wrong With Management, 1982). This emphasis brought about two separate difficulties. On the one hand, there was the issue with short-termism. Managers attempted to measure performance over brief periods, which many times led to adverse consequences: while short-range goals were met, they often undermined future operations and the financial health of the business. The importance of short-term profit also led to profit center managers reducing investment and expenditure on intangibles, such as product development or promotions – especially in weaker sales periods – in order to maximize departmental profits (Kaplan, 1984, p. 411). On the other hand, the centrality of finances as performance evaluators was also problematic.
As performance measures were monetary in nature, both senior and profit center managers were incentivized to boost company earnings through financial transactions, such as mergers and acquisitions. While the trades increased earnings in the short-run, they typically did not add long-term value to the firm. (Ittner, & Larcker, 2001 p. 401)
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