Criticism/Disadvantages or Limitations of Return on Investment (ROI)
Method of Performance Evaluation:
Learning Objectives:
- 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. |
