Criticism/Disadvantages or Limitations of Return on Investment (ROI) Method of Performance Evaluation:

Learning Objectives:

1. What are the limitations of return on investment method of performance evaluation?

Although the return on investment is widely used in evaluating performance, it is not a perfect tool. The method is subject to the following criticism:

1. Just telling managers to increase ROI may not be enough. Managers may not know how to increase ROI; they may increase ROI in a way that is inconsistent with the company's strategy; or they may take actions that increase ROI in the short run but harm company the long run (such as cutting back on the research and development). This is why ROI is best used as part of a balanced scorecard. A balanced scorecard can provide concrete guidance to managers, making it more likely that action taken are consistent with the company's strategy and reducing the likelihood that short-run performance will be enhanced at the expense of long-term performance.

2. A manager who takes over a business segment typically inherent many committed costs over which the manager has no control. These committed costs may be relevant in assessing the performance of the business segment as an investment but make it difficult to fairly assess the performance of the manager relative to other managers.

3. A manager who is evaluated based on return on investment (ROI) may reject investment opportunities that are profitable for the whole company but that would have a negative impact on the manager's performance evaluation.

 

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