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Balanced Scorecard

Balanced Scorecard

HISTORY OF THE BALANCED SCORECARD APPROACH
THE FOUR PERSPECTIVES
DEVELOPING A BALANCED SCORECARD
AVOIDING POTENTIAL PITFALLS
SOFTWARE AND SUPPORT
BIBLIOGRAPHY

The balanced scorecard is a performance measurement tool developed in 1992 by Harvard Business School professor Robert S. Kaplan and management consultant David P. Norton. Kaplan and Norton's research led them to believe that traditional financial measures, like return on investment, could not provide an accurate picture of a company's performance in the innovative business

environment of the 1990s. Rather than forcing managers to choose between hard financial measures and soft operational measuressuch as customer retention, product development cycle times, or employee satisfactionthey developed a method that would allow managers to consider both types of measures in a balanced way. The balanced scorecard includes financial measures that tell the results of actions already taken, Kaplan and Norton explained in the seminal 1992 Harvard Business Review article that launched the balanced scorecard methodology. And it complements the financial measures with operational measures on customer satisfaction, internal processes, and the organization's innovation and improvement activitiesoperational measures that are the drivers of future financial performance.

The balanced scorecard provides a framework for managers to use in linking the different types of measurements together. Kaplan and Norton recommend looking at the business from four perspectives: the customer's perspective, an internal business perspective, an innovation and learning perspective, and the financial (or shareholder's) perspective. Using the overall corporate strategy as a guide, managers derive three to five goals related to each perspective, and then develop specific measures to support each goal. Ideally, the scorecard helps managers to clarify their vision for the organization and translate that vision into measurable actions that employees can understand. It also enables managers to balance the concerns of various stake-holders in order to improve the company's overall performance. The balanced scorecard is a powerful concept based on a simple principle: managers need a balanced set of performance indicators to run an organization well, Paul McCunn wrote in Management Accounting. The indicators should measure performance against the critical success factors of the business, and the balance is the balancing tension between the traditional financial and nonfinancial operational, leading and lagging, and action-oriented and monitoring measures.

The popularity of the balanced scorecard has declined over the past few years. According to the Financial Times, it was adopted by 80 percent of large U.S. companies as of 2004, making it the nation's most popular management tool for increasing performance. However, the 2007 Management Tools and Trends survey by Bain & Company found that only 66 percent of executives used a balanced scorecard, and its satisfaction rating was significantly below average.

Even so, some companies have enjoyed considerable success using the balanced scorecard. Since Minneapolis-based electronics retailer Best Buy Co., Inc. implemented the balanced scorecard in 2003, its revenue, stock price, and dividends have risen dramatically. CFO Darren Jackson found that the company's performance culture has improved since they began linking their strategy with metrics, publishing the information and rewarding progress. Even CEO Brad Anderson's bonus is tied to customer-loyalty scores, employee-turnover improvement, and a metric called customer centricity store revenue. According to Jackson, the balanced scorecard approach reinforces positive strategic outcomes.

HISTORY OF THE BALANCED SCORECARD APPROACH

In 1990 Robert S. Kaplan, a professor of accounting at the Harvard Business School, and David P. Norton, co-founder of a Massachusetts-based strategy consulting firm called Renaissance Worldwide Inc., conducted a year-long research project involving twelve large companies. The original idea behind the study, as Anita van de Vliet explained in her 1997 article in Management Today, was that relying primarily on financial accounting measures was leading to short-term decision-making, over-investment in easily valued assets (through mergers and acquisitions) with readily measurable returns, and under-investment in intangible assets, such as product and process innovation, employee skills, or customer satisfaction, whose short-term returns are more difficult to measure.

Kaplan and Norton looked at the way these companies used performance measurements to control the behavior of managers and employees. They used their findings to devise a new performance measurement system that would provide businesses with a balanced view of financial and operational measures. Kaplan and Norton laid out their balanced scorecard approach to performance measurement in three Harvard Business Review articles beginning in 1992. Before long, the balanced scorecard had become one of the hottest topics at management conferences around the world. In fact, the Harvard Business Review called it one of the most important and influential management ideas of the past 75 years. In 1996 Kaplan and Norton expanded upon their original concept in a book titled The Balanced Scorecard: Translating Strategy into Action. They followed up with two other books that further developed the approach: The Strategy-Focused Organization: How Balanced Scorecard Companies Thrive in the New Business Environment (2001) and Strategy Maps: Converting Intangible Assets into Tangible Outcomes (2004).

THE FOUR PERSPECTIVES

Kaplan and Norton's basic balanced scorecard asks managers to view their business from four different perspectives: the customer perspective, an internal business perspective, an innovation and learning perspective, and the financial or shareholder perspective. These perspectives are relevant to all types of businesses. However, additional perspectives also may be important in certain types of businesses. For example, a company in the oil industry might wish to incorporate an environmental regulation perspective. In this way, the balanced scorecard maintains some flexibility for companies with special needs to add other perspectives.

Customer Perspective. According to Kaplan and Norton, viewing a business from the customer perspective involves asking the question: How do customers see us? They contend that many companies in a wide range of industries have made customer service a priority. The balanced scorecard allows managers to translate this broad goal into specific measures that reflect the issues that are most important to customers. For example, Kaplan and Norton mention four main areas of customer concern: time, quality, cost, and performance. They recommend that companies establish a goal for each of these areas and then translate each goal into one or more specific measurements. Kaplan and Norton note that some possible measures, like percent of sales from new products, can be determined from inside the company. Other measures, like on-time delivery, will depend on the requirements of each customer. To incorporate such measures into the balanced scorecard, managers will need to obtain outside information through customer evaluations or benchmarking. Collecting data from outside the company is a valuable exercise because it forces managers to view their company from the customers' perspective.

Internal Business Perspective. The internal business perspective is closely related to the customer perspective. After all, excellent customer performance derives from processes, decisions, and actions occurring throughout an organization, Kaplan and Norton wrote. Managers need to focus on those critical internal operations that enable them to satisfy customer needs. Viewing a company from the internal business perspective involves asking the question, What must we excel at? Kaplan and Norton recommend focusing first on the internal processes that impact customer satisfaction, such as quality, productivity, cycle time, and employee skills. Using these critical processes as a base, managers should develop goals that will help the company to meet its customers' expectations. These goals should then be translated into measures that can be influenced by employee actions. It is important that internal goals and measures are broken down at the local level in order to provide a link between top management goals and individual employee actions. This linkage ensures that employees at lower levels in the organization have clear targets for actions, decisions, and improvement activities that will contribute to the company's overall mission, the authors explained.

Innovation and Learning Perspective. In including the innovation and learning perspective in their balanced scorecard, Kaplan and Norton recognized that modern companies must make continual improvements in order to succeed in an intensely competitive global business environment. A company's ability to innovate, improve, and learn ties directly to the company's value, they noted. That is, only through the ability to launch new products, create more value for customers, and improve operating

efficiencies continually can a company penetrate new markets and increase revenues and marginsin short, grow and thereby increase shareholder value. Accordingly, viewing a business from the innovation and learning perspective involves asking the question, How can we continue to improve and create value? Managers should establish goals related to innovation and learning, and then translate the goals into specific measuressuch as increasing the percentage of the company's sales derived from new products.

Financial Perspective. Kaplan and Norton developed the balanced scorecard at a time when financial measures were increasingly coming under attack from management experts. Critics claimed that judging performance by financial measures encouraged companies to focus on short-term results and avoid taking actions that would create value over the long term. They also argued that financial measures looked backward at past actions rather than forward at future possibilities. Some experts told managers to focus solely on operational improvements and allow the financial performance to improve on its own.

Although these arguments convinced Kaplan and Norton to conduct their study of performance measurement, they found that financial controls are an important part of the puzzle. They claim that managers need to know whether or not their operational improvements are reflected in the bottom line. If not, it may mean that management needs to reevaluate its strategy for the business. Measures of customer satisfaction, internal business performance, and innovation and improvement are derived from the company's particular view of the world and its perspective on key success factors. But that view is not necessarily correct, Kaplan and Norton wrote. Periodic financial statements remind executives that improved quality, response time, productivity, or new products benefit the company only when they are translated into improved sales and market share, reduced operating expenses, or higher asset turnover.

Thus, the fourth perspective in the balanced scorecard asks the question: How do we look to shareholders? Some of the goals a company might set in this area involve profitability, growth, and shareholder value. The measures attached to these goals might include traditional financial performance measures, such as return on assets or earnings per share. Although these measures can prove misleading when taken alone, when incorporated into a balanced scorecard they can provide managers with valuable information about whether the strategy has contributed to bottom-line improvement. According to Kaplan and Norton, a common mistake for managers making large-scale operational improvements is failing to follow up with additional actions. For example, a company might undertake a quality improvement initiative which, when implemented successfully, creates excess capacity or makes certain employees redundant. Financial measurements will point out the need to make further changes.

DEVELOPING A BALANCED SCORECARD

Development of a balanced scorecard begins with the company's overall strategy or vision. It is important to consult with top management, rather than line managers, to obtain a clear picture of where the company wants to be in three to five years. The next step is to appoint a scorecard architect to establish the framework and methodology for designing the scorecard. With this framework in mind, the organization must define a linked set of strategic objectives that will lead the company toward top management's vision. These objectives should be true drivers of performance for the business as a whole, rather than a list of separate goals for business units or departments. It may be helpful to begin with the four perspectives included in the balanced scorecard model and then add more if needed, depending on the industry.

At this point, most companies will begin to involve line managers and staff membersand perhaps even customersin establishing goals or objectives. The involvement might take the form of an executive workshop at which participants review and discuss the goals and appropriate measures. This approach builds consensus around the balanced scorecard and reduces the potential for unrealistic goals to be handed down from the top.

The strategic objectives provide a framework for managers to use in developing specific performance measures. Most of the measures we use are not new, but they had been held in different silos, different boxes, in the organization, Rick Anderson, a performance analyst at BP Chemicals, told van de Vliet. The [balanced scorecard] approach has brought existing measures onto one piece of paper, so everybody can relate to one area. The goals and measures in an organization's balanced scorecard can be broken down to provide custom scorecards for all business levels, even down to individual employees. These custom scorecards show how an employee's work activities link to the business's overall strategy. For incentive and compensation purposes, it is possible to assign weights to each measure based on its importance to the company and the individual's ability to affect it.

Once the balanced scorecard is in place, the next step is to collect and analyze the data for performance measurements. This data will enable the organization to see its strong performance areas, as well as areas for potential improvement. It is important to supply the performance data to employees, and to empower employees to find ways to sustain high performance and improve poor performance. Managers also must realize that the balanced scorecard is not set in stone. Experience in using the scorecard

may point out areas that should be modified or adapted. In addition, managers may find ways to tie the scorecard into other areas, such as budgets, resource allocation, compensation, succession planning, and employee development.

AVOIDING POTENTIAL PITFALLS

Numerous organizations have implemented some version of the balanced scorecard since its introduction in 1992. However, professor Claude Lewy of the Free University of Amsterdam found that 70 percent of scorecard implementations failed. Many companies are attracted by the power and simplicity of the balanced scorecard concept, but then find implementation to be extremely time-consuming and expensive. Lewy admits that the balanced scorecard can be an effective way of translating an overall strategy to the many parts of an organization. However, he stresses that organizations must have a clear idea of what they want to accomplish, and be willing to commit the necessary resources in order to successfully implement the balanced scorecard. Along with Lex Du Mee of KPMG Management Consulting, Lewy conducted a study of seven European companies and came up with what he called the Ten Commandments of Balanced Scorecard Implementation.

To ensure an effective balanced scorecard implementation, Lewy and Du Mee recommended that organizations obtain the commitment of a top-level sponsor, as well as relevant line managers. The balanced scorecard initiative must be the organization's top priority if implementation is to succeed. They also emphasized the importance of putting strategic goals in place before implementing the scorecard. Otherwise, the goals and measures included in the scorecard are likely to drive the wrong behavior. Lewy and Du Mee also suggested that organizations try a pilot program before moving on to full-scale implementation. Testing the balanced scorecard in a few key business areas enables managers to make necessary changes and increase support for the initiative before involving the entire company. It also is important to provide information and training to employees prior to an organization-wide rollout.

Lewy and Du Mee also warn managers against using the balanced scorecard as a way to achieve extra top-down control. Employees are unlikely to support the goals and measures if the scorecard is used as a gotcha by management. Another potential pitfall, according to the researchers, is trying to use a standardized scorecard. Instead, they stress that each organization must devote the time and resources to develop its own customized program. Lewy and Du Mee found that balanced scorecard implementation was more likely to fail when companies underestimated the amount of training and communication required during the introductory phase, or the extra workload and costs involved with periodic reporting later on. Even though the balanced scorecard appears to be a simple idea, implementing it is likely to mean huge changes in an organization.

SOFTWARE AND SUPPORT

Once the balanced scorecard has been implemented successfully, the next significant task involves collecting and analyzing measurement data. A dashboard is an executive information system user interface that collects data from numerous different computer systems throughout the organization and presents it in an easily readable format. A dashboard can obtain information from the local operating system in a computer, from one or more applications, and from one or more sites on the Web. Business dashboards are used to track corporate functions such as recruiting, human resource, sales, operations, and security. The content of a digital dashboard project might include key performance indicators and sales performance figures.

SEE ALSO Performance Measurement; Strategy Formulation

BIBLIOGRAPHY

. The Balanced Scorecard: Translating Strategy into Action. Boston: Harvard Business School Press, 1996.

Cameron, Preston. The Balancing Act: Even in Today's Volatile Economic Climate, Many Organizations Are Turning to the Balanced Scorecard to Help Steer Their Organization in the Right Direction. CMA Management 75, no. 10 (2002).

Fox, Justin. Are Today's CFOs Batting a Thousand? Fortune October 2006. Available from: http://money.cnn.com/magazines/fortune/fortune_archive/2006/10/30/8391732/index.htm.

Giving the Boss the Big Picture. Business Week Magazine February 2006. Available from: http://www.businessweek.com/magazine/content/06_07/b3971083.htm.

Kaplan, Robert S., and David P. Norton. The Balanced ScorecardMeasures That Drive Performance. Harvard Business Review 70, no. 1 (1992): 71.

. Putting the Balanced Scorecard to Work. Harvard Business Review 71, no. 5 (1993).

. The Strategy-Focused Organization: How Balanced Scorecard Companies Thrive in the New Business Environment. Boston: Harvard Business School Press, 2001.

. Strategy Maps: Converting Intangible Assets into Tangible Outcomes. Boston: Harvard Business School Press, 2004.

. Using the Balanced Scorecard as a Strategic Management System Harvard Business Review 74, no. 1 (1996): 75.

Lester, Tom. Measure for Measure: The Balanced Scorecard Remains a Widely Used Management Tool, but Great Care Must Be Taken to Select Appropriate and Relevant Metrics. The Financial Times 6 October 2004.

Lewy, Claude, and Lex Du Mee. The Ten Commandments of Balanced Scorecard Implementation. Management Control and Accounting April 1998.

McCunn, Paul. The Balanced Scorecardthe Eleventh Commandment. Management Accounting 76, no. 11 (1998): 34.

Rigby, Darrell. Management Tools and Trends Boston: Bain & Company, 2007. Available from: http://www.bain.com/management_tools/Management_Tools_and_Trends_2007.pdf.

van de Vliet, Anita. The New Balancing Act. Management Today July 1997, 78.

Williams, Kathy. What Constitutes a Successful Balanced Scorecard? Strategic Finance 86, no. 5 (2004).

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