BALANCED SCORECARD



Balanced Scorecard 625
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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, such as return on investment, could not provide an accurate picture of a company's performance in the innovative business environment of the 1990s. But rather than forcing managers to choose between "hard" financial measures and "soft" operational measures—such as customer retention, product development cycle times, or employee satisfaction—they 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 their 1992 Harvard Business Review article. "And it complements the financial measures with operational measures on customer satisfaction, internal processes, and the organization's innovation and improvement activities—operational measures that are the drivers of future financial performance."

The balanced scorecard provides a framework for managers to use in linking 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. Then they 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 stakeholders 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 non-financial operational, leading and lagging, and action-oriented and monitoring measures."

The balanced scorecard concept has enjoyed significant success since its introduction. It was adopted by 60 percent of the top 100 U.S. companies as of 1996, and by half of the Fortune 1000 companies by the beginning of 1999. In addition, it was promoted for use in the public sector by the National Partnership for Reinventing Government. Part of the balanced scorecard's popularity can be attributed to the fact that it is consistent with many common performance improvement initiatives undertaken by companies, such as continuous improvement, cross-functional teamwork, or customer-supplier partnering. It complements these initiatives by helping managers understand the complex interrelationships among different areas of the business. By linking the elements of a company's competitive strategy in one report, the balanced scorecard points out situations where improvement in one area comes at the expense of another. In this way, the scorecard helps managers make the decisions and tradeoffs necessary to succeed in today's fast-paced and competitive business environment.

HISTORY OF THE BALANCED
SCORECARD APPROACH

In 1990 Robert S. Kaplan, a professor of accounting at the Harvard Business School, and David P. Norton, cofounder of a Massachusetts-based strategy consulting firm called Renaissance Worldwide, Inc., conducted a year-long research project involving 12 large companies. The original idea behind the study, as Anita van de Vliet explained 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, The Balanced Scorecard: Translating Strategy into Action.

In 1999 Kaplan and Norton introduced computer resources to provide information and support for organizations that adopt the balanced scorecard. For example, Norton's consulting firm, Renaissance Worldwide, Inc., and Gentia Software formed the Balanced Scorecard Technology Council. This virtual users group sponsors a web site that provides research, product information, and a forum for ideas. Kaplan and Norton also founded an organization called the Balanced Scorecard Collaborative "to facilitate worldwide awareness, use, enhancement, and integrity of the Balanced Scorecard as a value-added management process." The collaborative also hosts a site on the Internet.

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 relavent to all types of businesses. Additional perspectives may also 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.

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 in the 1990s. The balanced scorecard allows managers to translate this broad goal into specific measures that reflect the issues 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 of customer concern, then translate each goal into one or more specific measurements. They note that some possible measures, such as percent of sales from new products, can be determined from inside the company. But other measures, such as 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.

The next perspective for the balanced scorecard, 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 affect 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 meet its customers' expectations. Then these goals should be translated into measures that can be influenced by employee actions. It is important that internal goals and measures are broken down to 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.

In including the innovation and learning perspective in their balanced scorecard, Kaplan and Norton recognized that today's 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 margins—in 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 measures—such as increasing the percentage of the company's sales derived from new products.

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 of the need to conduct their study of performance measurement, they found that financial controls are an important part of the puzzle. They claimed that managers need to know whether 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."

The fourth perspective in the balanced scorecard is the financial perspective, which 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 that, 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 define a linked set of strategic objectives that will lead the company toward that 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 members—and perhaps even customers—in establishing goals or objectives. This approach increases support for 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 measures of performance. "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 the performance measurements. This data will enable the organization to see both its areas of strong performance and its areas for potential improvement. At one time, many companies found collecting and analyzing the performance data to be time-consuming and expensive, because it often resided on numerous different computer systems throughout the organization. In the late 1990s, however, several software vendors addressed this problem by creating balanced scorecard applications for desktop computers. 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 must also 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, compensation, succession planning, and employee development.

AVOIDING POTENTIAL PITFALLS

Numerous organizations have implemented some version of the balanced scorecard since its introduction in 1992. But 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 admitted that the balanced scorecard can be an effective way of translating an overall strategy to the many parts of an organization. But he stressed that organizations must have a clear idea of what they want to accomplish, and be willing to commit the necessary resources, in order to implement the balanced scorecard successfully. 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.

In order 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 top priority of the organization 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 is also important to provide information and training to employees prior to an organization-wide rollout.

Lewy and du Mee also warned 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.

[ Laurie Collier Hillstrom ]

FURTHER READING:

Gooderham, Gay. "Power Tool: How to Overcome the Barriers to the Balanced Scorecard." CMA The Management Accounting Magazine, September 1998, 11.

Hyde, A. C. "The Balanced Scorecard: Moving above the Bottom Line." Public Manager: The New Bureaucrat, fall 1998, 57.

Kaplan, Robert S., and David P. Norton. "The Balanced Scorecard: Measures that Drive Performance." Harvard Business Review, January/February 1992, 71.

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

——. "Putting the Balanced Scorecard to Work." Harvard Business Review, September/October 1993.

"Using the Balanced Scorecard as a Strategic Management System." Harvard Business Review, January/February 1996, 75.

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

Loganbach, Paul. "Results Management: Learning Can Do It." Public Manager: The New Bureaucrat, summer 1998, 25. McCunn, Paul. "The Balanced Scorecard." Management Accounting, December 1998, 34.

McKenzie, Francine C., and Matthew D. Shilling. "Avoiding Performance Measurement Traps: Ensuring Effective Incentive Design and Implementation." Compensation and Benefits Review, July/August 1998, 57.

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



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