Performance management systems design - Goal congruence resp...

Learning Outcomes

After reading this article, you will be able to explain the design features of effective performance management systems, including how to achieve goal congruence, classify responsibility centres, and assess the effects of decentralisation. You will also understand the problems that can arise if systems are poorly aligned, and how to recommend practical solutions to improve divisional performance and organisational results.

ACCA Advanced Performance Management (APM) Syllabus

For ACCA Advanced Performance Management (APM), you are required to understand the organisational design features that affect performance management systems, as well as the behavioural consequences of different systems. In particular, you must be able to:

• Evaluate how goal congruence can be achieved within performance management designs
• Distinguish and analyse the functions of different types of responsibility centres (cost, revenue, profit, investment)
• Assess the advantages and risks of decentralisation in organisational structures
• Identify typical problems with divisional performance measures and propose improvements
• Discuss how information, autonomy, and reward systems interact to affect divisional and overall performance

Test Your Knowledge

Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.

1. Which of the following most accurately describes "goal congruence" within a divisionalised business?
   1. Each division pursues its own objectives, regardless of group strategy
   2. Divisions are rewarded for acting only in their own best interests
   3. Divisions and managers are incentivised to make decisions supporting overall corporate objectives
   4. All targets and budgets are identical across divisions

2. True or false? A profit centre manager is accountable for both the revenues generated and the capital invested in their division.

3. Give two potential advantages and two common risks associated with decentralising decision-making in an organisation.

4. You observe divisional managers taking actions to boost their own reported profit, but which harm the organisation's long-term prospects. What performance management design flaw might explain this behaviour?

5. List the four main types of responsibility centre.

Introduction

Performance management systems must direct managers toward decisions that benefit the whole organisation, not just their own areas. In practice, this requires careful alignment of objectives, performance measures, reward systems, and organisational structure. Focusing on goal congruence and using appropriate responsibility centres within a decentralised environment helps deliver organisational strategy—if designed well.

This article explains how management can use responsibility centres and decentralisation structures to drive the right behaviour. It also analyses the challenges faced—such as dysfunctional decisions or lack of coordination—and how to address these issues in the design of effective systems.

Key Term: goal congruence
The alignment of individual, divisional and organisational objectives, so that managers make decisions which support the organisation as a whole.

Goal Congruence: Definition and Importance

Goal congruence ensures divisional or personal objectives are consistent with corporate aims. Without it, managers may optimise their own results at the expense of group value. Achieving goal congruence requires:

• Clear communication of strategic goals
• Performance measures and incentives aligning local actions with organisation-wide success
• Sufficient, relevant information to guide decisions

If measures or incentives reward short-term or local success only, misalignment arises.

Key Term: dysfunctional decision
A decision made by a manager that optimises performance at the local or divisional level but is detrimental to group or company-wide goals.

Responsibility Centres: Types and Purposes

Responsibility centres separate the organisation into segments, each with a manager accountable for certain results. The structure chosen affects both control and motivation. Main types are:

• Cost centre: Manager controls costs only
• Revenue centre: Manager responsible for generating revenue
• Profit centre: Manager responsible for both revenues and costs
• Investment centre: Manager accountable for profit and for capital employed

Key Term: responsibility centre
A segment of an organisation for which a manager has authority and accountability for specific financial outcomes.

Key Term: profit centre
A responsibility centre where the manager has control over both the revenues generated and the costs incurred, but not necessarily investment decisions.

Key Term: investment centre
A responsibility centre where the manager controls revenues, costs, and asset investment decisions.

Key Term: decentralisation
The delegation of decision-making authority and responsibility to divisional or departmental managers within an organisation.

Decentralisation: Features, Benefits and Risks

Decentralisation gives local managers authority to make decisions quickly, respond to changes, and use detailed knowledge of their operations. Properly structured, it supports motivation and rapid adaptation. Key features:

• Local autonomy over costs, revenues, or investment (depending on centre type)
• Performance measured via financial and non-financial indicators
• Head office oversees strategic alignment and provides support

Benefits:

• Faster decisions and adaptability
• Clear accountability for outcomes
• Manager development via wider responsibility

Risks:

• Loss of overall control if measures are misaligned
• Potential for dysfunctional decisions (e.g., suboptimal transfer prices)
• Internal competition or lack of coordination

Worked Example 1.1

A manufacturing company has three autonomous product divisions, each treated as a profit centre. Division A can sell a component to Division B at a transfer price, or sell externally at market price. The current transfer pricing system rewards Division A solely based on divisional profit.

Question:
Division A refuses to transfer components to Division B, choosing to sell externally only, even when internal sales would benefit the group. Why is this happening, and how can this be improved?

Answer:
Division A's performance is measured on divisional profit—there is no incentive for them to make internal transfers unless these are as profitable as external sales. This can lead to sub-optimal group performance (lack of goal congruence). Solutions include adjusting the transfer pricing policy (e.g., market-based or dual pricing), introducing a group profit-sharing component in rewards, or measuring and rewarding on combined divisional and group objectives.

Exam Warning

In ACCA questions, always check whether divisional performance measures and reward systems actually encourage goal congruence. Be ready to explain dysfunctional behaviour and propose specific, practical changes to the performance management system.

Barriers to Goal Congruence in Performance Systems

Common causes of poor alignment include:

• Using only short-term financial metrics (e.g., quarterly profit)
• Ignoring controllability—appraising managers for costs or results outside their control
• Setting aggressive targets without stakeholder buy-in
• Neglecting interdependencies between divisions (e.g., transfer pricing, shared resources)

Performance management systems should address these risks when allocating targets, designing key performance indicators (KPIs), and establishing incentive schemes.

Worked Example 1.2

A divisional manager is evaluated on ROI, based on book value of assets. She rejects a new project earning higher returns than the company's cost of capital, because it would lower her division's ROI.

Question:
How does this reflect a flaw in the performance management system, and what is a better alternative?

Answer:
This shows "dysfunctional decision-making": the manager acts to maximise her own reported ROI, rather than group value. This is often seen with ROI or similar measures. A better approach is to use residual income (RI) or economic value added (EVA), which encourage managers to accept any project exceeding the cost of capital, thus supporting group objectives.

Designing Effective Responsibility Centres

To ensure good control and motivation:

• Match the level of authority and accountability: Do not hold managers responsible for items outside their control (controllability principle)
• Allow appropriate autonomy but monitor against group targets
• Provide timely, relevant information for decision-making

Key Term: controllability principle
The principle that managers should be held accountable only for results and decisions they can control significantly.

Information, Rewards, and Autonomy—Striking the Balance

For a decentralised structure to work well:

• Information: Flows both ways—local managers need sufficient data to manage, and head office requires reporting for oversight
• Rewards: Balanced to encourage local optimisation and group performance (e.g., mix divisional and group performance criteria)
• Autonomy: Must be meaningful; avoid reversing decisions or creating constant interference

Worked Example 1.3

A group gives divisional managers full autonomy, but their bonuses depend only on divisional profit. Division C slashes product quality to increase short-term profits, damaging the company’s reputation.

Question:
What design issues exist, and how could the system be improved?

Answer:
Lacking balanced measures, the system incentivises harmful short-term gains. To prevent this, introduce non-financial KPIs (e.g., quality, customer complaints), link rewards to long-term metrics, and provide group-level performance adjustments to ensure organisational reputation is protected.

Revision Tip

When evaluating a performance management system, always check if: (1) objectives are clearly communicated; (2) controllability is respected; (3) all interdependencies between units are considered; and (4) the reward system supports both divisional and group performance.

Summary

Effective performance management system design requires:

• Alignment of divisional and corporate goals (goal congruence)
• Careful allocation and definition of responsibility centres
• Appropriate decentralisation, supported by relevant measures and controlled autonomy
• Control systems that balance local decision-making with overall group success

Systems that fail to consider these factors can drive behaviour that is locally optimal but damaging to the organisation.

Key Point Checklist

This article has covered the following key knowledge points:

• Define goal congruence and explain why it is important for organisational success
• List and distinguish between the four main types of responsibility centre
• Assess the roles of decentralisation, responsibility allocation, and autonomy in organisational performance
• Identify common barriers to goal congruence and dysfunctional behaviours resulting from poor system design
• Describe the controllability principle and its application in setting divisional targets
• Recommend improvements to performance management systems to encourage group objectives over local optimisation

Key Terms and Concepts

• goal congruence
• dysfunctional decision
• responsibility centre
• profit centre
• investment centre
• decentralisation
• controllability principle