Saturday, 15 March 2014

The Advantages & Limitation of Using ROI as a Measure of Corporate Performance

  • ROI is a number that includes all revenues, costs, and expenses.
  • It can be used to evaluate the performance of a general manager of a division or SBU.
  • It can be compared across companies to see which firms are performing better.
  • It provides an incentive to use current assets efficiently and to acquire new assets only when they would increase profits significantly.
  • ROI is sensitive to depreciation policy and can be increased by writing down the value of assets through accelerated depreciation.
  • It can discourage investment in new facilities or the upgrading of old ones. Older plants with depreciated assets have an advantage over newer plants in earning a higher ROI.
  • It provides an incentive for division managers to set transfer prices for goods sold to other divisions as high as possible and to lobby for corporate policy favoring in-house transfers over purchases from other firms.
  • Managers tend to focus more on ROI in the short-run over its use in the long-run. This provides an incentive for goal displacement and other dysfunctional consequences.
  • ROI is not comparable across industries which operate under different conditions of favorability.
  • It is influenced by the overall economy and will tend to be higher in prosperity and lower in a recession.

SOURCE: From Higgins. Organizational Policy and Strategic Management, 2nd edition

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