The Hindu Business Line : PSE performance appraisal: The MoU paradigm

An analysis of perceptions of top management in PSEs revealed that the MoU as an instrument was valid and is likely to remain so and that the need of the hour is an add-on.

R. Venkatesan

The MoU (Memorandum of Understanding) route was introduced in 1987-88 on an experimental basis to provide greater functional autonomy to Central Public Sector Enterprises (PSEs) with well-defined accountability. Since then, the MoU has become the instrument to measure performance — that is, how the PSEs use their strategic assets.PSE performance appraisal till then was mainly an analysis of cash flows. Concerns about its efficacy were raised when over 40 per cent of the PSEs were graded excellent. The result was the MoU paradigm of 2004 that was to make a Business Performance Appraisal or grade the ability of PSEs to manage sustained, buoyant future cash flows, the ability of their managements to leverage emerging opportunities and avoid or prepare to meet emerging threats.

Monitoring tools

This meant using management and econometric tools/concepts to understand/monitor business performance in a framework that used or depended on the information contained in the usual published financial statements.

There are many conventional approaches to measuring the business performance. Of these, the accounting perspective that monitorspast cash flows, the ability of the enterprise to use resources profitably and to acquire resources quickly is the most visible. The other approach is the marketing perspective, that is, evaluating the effectiveness of marketing programmes and measuring marketing productivity besides making marginal cost/marginal revenue analyses. Then, there is the operations perspective, which normally aims at measuring the manufacturing efficiency (total factor productivity /partial productivity, etc.), quality and so on, covered by the now widely used Enterprise Resource Planning system.

Parameters

While it was tempting to amalgamate/blend various perspectives, the MoU approach was designed to have two major sections − Static Parameters, which explain the past year’s performance, and Dynamic Parameters, that forecast future static growth.

Or to be precise, dynamic parameters are indicators of how different static parameters are likely to perform in the three -four years.

The static parameters were subdivided in terms of profitability parameters (how profitably resources were used by the PSE the previous year), productivity parameters (what is the “added value” per unit of sales or what economists term as the Total Factor Productivity – TFP) and size related parameters (obviously the larger the size, the more complex the decision making process and thus necessitating a higher weightage to the management efforts).

A key challenge was deriving the equivalent of TFP from published annual statements. Since TFP is a composite measure of technological change and changes in efficiency with which known technology is applied to production. The financial equivalent was derived as the “Added Value” per unit of sale. Since wages and salaries reflect the marginal productivity of labour, expenses on inputs reflect the true value of these inputs and the capital employed in the enterprise need to earn a minimum IRR equal to the weighted cost of capital of the firm, the net returns obtained after deducting the returns to labour, input suppliers and capital was defined as the Added Value and its ratio to sales was the surrogate measure of the TFP.

Drivers of future cash flow

The dynamic parameters pertain to quality achievement, those that measure customer satisfaction, HRD effort that impart training and maintain staff motivation, Research and Development for sustained innovation, project implementation milestones, and capital expenditure incurred on greenfield and brownfield projects. These parameters were identified as the likely drivers of future cash flows.

The first major challenge was how to identify the relevant static and dynamic parameters and accord weights to them. The factor analytic model, a statistical tool that allows combining the variables such that it reflects the underlying correlation among them and reduces the dimensionality of the original time series data on central PSEs, was adopted.

While the need to have a common framework consisting of static and dynamic parameters to evaluate all PSEs in a similar framework remained an important objective, there was a need to recognise certain amount of heterogeneity in the enterprises. The factor analytic model was fine-tuned to accommodate changes required in these static and dynamic parameters.

Effects of global trends

Besides these parameters, PSE businesses suffer/benefit because of international demand/supply situation, adversarial/beneficial trends in movement of international prices, etc., on which themanagement does not have any control.

For instance, a fertiliser enterprise using naphtha gets affected as the feedstock prices go up in the international market or a steel PSE benefits due to prevailing high international prices for metals; the weights need to be adjusted for these aspects. Thus to account for these variables not under the direct control of the enterprise, a sector-specific weight was assigned.

Similarly, for enterprises that invest in improving the environment or other intangibles as part of their corporate social responsibility, but which are not likely to reflect either in dynamic or static parameters, an enterprise-specific variable for adjustment of scores was introduced.

An analysis of perceptions of top management in PSEs in 2003-04 revealed that while the MoU approval was good, needed was some form of the Public Enterprises Governance, on the lines of the private sector “Corporate Governance” model. The MoU system was instrumental in improving the productivity of the PSEs and had leveraged well their infrastructure — social, physical and financial.

The MoU framework of static and dynamic parameters with sector- and enterprise-specific adjustments, which started off with the objective of increasing accountability, has now become a model of performance appraisal of PSEs.

(The author is a Senior Fellow with NCAER, New Delhi.)