Traditional financial measures – ROI, net profit, sales growth, and market share – fail to capture the true picture of a firm’s value propositions because they focus on the past. They tell the story of what has happened to the organization. They explain the results of past transactions and disregard what the future benefits could be. Traditional financial measures are only part of the information that managers need to successfully guide their organizations through highly competitive marketplaces.
Background
During the 1990s, two Harvard professors and consultants – Kaplan and Norton, devised a tool, the Balanced Scorecard, to rectify the deficiencies in relying primarily on traditional financial measures. A Balanced Scorecard allows better measurement of a firm’s capabilities to create long-term value by identifying the key drivers of this value. The drivers are then translated into four categories of measures- customer, internal/operational, innovation/learning, and financial. The financial measures are typically focused on short-term results; while the other three categories are coupled to future oriented activities needed to successfully sustain the enterprise.
Get the Free Guide for Writing Better SMART Goals
Obviously financial health is critical for any business organization- cash in the bank is necessary to pay the bills. However, many managers become nearsighted as a result of this requirement and believe that by making fundamental improvements in their operations, the financial numbers will resolve themselves. This is an utter fallacy. For example, if a firm has a goal of increasing net profit from 10% to 13% for the current fiscal year, there are a number of interrelated factors that must be in place to succeed. Possibly customer satisfaction must be enhanced to increase the number of customers or increase the loyalty of existing customers. May be the product/service’s defect level must be decreased to boost customer satisfaction? So if the manager waits until the end of the fiscal year to determine if he/she was successful, there will be a “history” lesson on the events of the past period. However, if the defect rate is currently monitored or customer returns observed, the manager can make mid-course corrections to the firm’s strategy in order to accomplish the goal of increasing net profit. In other words, the manager should develop and monitor measures of drivers of that net profit goal. As such, managers should develop strategic measures that are specifically tied to their firms’ unique strategy. There is not a “one size fits all” Balanced Scorecard. The following is the basic categorization for balanced measures of firm performance.
The 4 Perspectives
I. Financial perspective-how do we look to investors? Measures that indicate whether the company’s strategy, implementation, and execution are contributing to bottom line improvement.
- Cash flow
- Sales growth
- Market share
- ROE
II. Customer perspective-how do customers see us? Customer concerns in four categories.
- Time-measures time required for company to meet customers’ needs.
- Quality-defect level as sent to customers.
- Performance-how company’s products/services contribute to creating value for its customers.
- Cost-not just price of goods/services, but what does it “cost” the customer when he finally uses it.
III. Internal/Operational perspective-what must be excelled at?
- Business processes that have the greatest impact on customer satisfaction.
- What competencies are needed to maintain market leadership?
IV. Innovation/Learning perspective-can we continue to improve and create value?
- Ability to innovate, improve, and learn ties directly to company’s value.
- Launch new products.
- More value for customers.
- Penetration of new markets.
Caution- a balanced performance measurement tool is not a collection of disparate financial and non-financial measures. It is more than supplementing traditional financial measures with non-financial measures. It is a process of developing interrelated measures, some leading and some lagging, that uniquely depicts a firm’s strategy in attempting to create competitive advantage.
Using A Scorecard
- Focuses manager’s attention on a handful of measures that are critical for the firm’s success.
- Is a way to clarify, simply, and then operationalize the mission and vision of the organization.
(Excerpted from Robert Kaplan and David Norton (1992), Harvard Business Review, January-February, pages 71 to 79 and (1996), California Management Review, Fall v39n1, pages 53 to 79.)
What is the Balanced Scorecard Institute
The balanced scorecard institute certainly has a lot to say about the use and value of the balanced scorecard. One of the problems, however, is that the information can get rather detailed, and make for a rather poor quick reference. This particular site does a nice job of presenting a concise overview, and also offers links to an interesting perspectives section on each of the four major points.
(Excerpted from Robert S. Kaplan and David P. Norton (1993), Harvard Business Review, September-October, p.34-147, (1992), Harvard Business Review, January-February, p.71 to 79 and (1996), California Management Review, Fall v39n1, p.53-79.)
The balanced scorecard is:
- A measurement system that provides a comprehensive framework that translates a company’s strategic objectives into a coherent set of performance measures
- A management system that can motivate breakthrough improvements.
A balanced scorecard is both a general measurement system to incorporate non-financial measures with traditional financial ones, as well as a central management system to motivate breakthrough competitive performance in implementing a company’s strategic vision. It is a process of developing interrelated measures, some leading and some lagging, that uniquely depicts a firm’s strategy in attempting to create competitive advantage.
It is the translation of a business strategy into a linked set of measures that define both the long-term strategic objectives, as well as the mechanisms for achieving and obtaining feedback on those objectives. A balanced scorecard:
- Focuses manager’s attention on a handful of measures that are critical for the firm’s success.
- Is a way to clarify, simply, and then operationalize the mission and vision of the organization.
Performance Measurements for Success
The scorecard functions as the cornerstone of a company’s current and future success. Traditional financial measures – ROI, net profit, sales growth, and market share – fail to capture the true picture of a firm’s value propositions because they focus on the past. They tell the story of what has happened to the organization. They explain the results of past transactions and disregard what the future benefits could be. Traditional financial measures are only part of the information that managers need to successfully guide their organizations through highly competitive marketplaces.
Get Balanced. Four Critical Areas
During the 1990s, two Harvard professors and consultants – Kaplan and Norton, devised a tool, the Balanced Scorecard, to rectify the deficiencies in relying primarily on traditional financial measures. A Balanced Scorecard allows better measurement of a firm’s capabilities to create long-term value by identifying the key drivers of this value. The drivers are then translated into four categories of measures- financial, customer, internal business processes, innovation and learning. The financial measures are typically focused on short-term results; while the other three categories are coupled to future oriented activities needed to successfully sustain the enterprise. The information from the four perspectives provides balance between external measures like operating income and internal measures like new product development. It provides a balanced picture of current operating performance as well as the drivers of future performance.
Measure Areas that Lead
Obviously financial health is critical for any business organization- cash in the bank is necessary to pay the bills. However, many managers become nearsighted as a result of this requirement and believe that by making fundamental improvements in their operations, the financial numbers will resolve themselves. This is an utter fallacy. For example, if a firm has a goal of increasing net profit from 10% to 13% for the current fiscal year, there are a number of interrelated factors that must be in place to succeed.
Possibly customer satisfaction must be enhanced to increase the number of customers or increase the loyalty of existing customers. May be the product/service’s defect level must be decreased to boost customer satisfaction? So if the manager waits until the end of the fiscal year to determine if he/she was successful, there will be a “history” lesson on the events of the past period. However, if the defect rate is currently monitored or customer returns observed, the manager can make mid-course corrections to the firm’s strategy in order to accomplish the goal of increasing net profit. In other words, the manager should develop and monitor measures of drivers of that net profit goal.
The Balanced Scorecard at a Glance
Managers should develop financial and non-financial measures that are specifically tied to their firms’ unique strategy. There is not a “one size fits all” Balanced Scorecard. The Balanced Scorecard provides executives with a comprehensive framework that can translate a company’s vision and strategy into a coherent and linked set of performance measures. The measures should include both outcome measures and the performance drivers of those outcomes.
Rather than using the Balanced Scorecard as a traditional control and performance measurement system, it is being used as a measurement and management system to implement a company’s strategic vision. It is being used to articulate and communicate the strategy of the business; to help align individual, organizational, and cross-departmental initiatives to achieve a common goal; and as a communication, information, and learning system. Thus, the measures must provide a clear representation of the organization’s long-term strategy for competitive success.
Generic Strategic Measures for the Four Perspectives
The Balanced Scorecard should be viewed as the instrumentation for a single strategy. Strategic measures are those that define a strategy designed for competitive excellence. Properly constructed scorecards contain a unity of purpose since all the measures are directed toward achieving an integrated strategy.
Financial Perspective
>How do we look to investors?
The financial performance measure will vary based upon the long-run objective and strategy of a business in the growth, sustain, or harvest stage. In general companies use the following three categories to achieve their business strategy:
- Revenue growth and mix
- Cost reduction/ Productivity improvement
- Asset utilization/ Investment strategy
Measures that indicate whether the company’s strategy, implementation, and execution are contributing to bottom line improvement are the following:
- Cash flow
- Sales growth
- Market share
- ROE
- ROCE – return on capital employed
- Economic value added
Customer Perspective
How do customers see us?
In customer perspective, the company measures the business performance in targeted segments. In general, customer concerns can be grouped into the following four categories.
- Time-measures time required for company to meet customers’ needs.
- Quality-defect level as sent to customers.
- Performance-how company’s products/services contribute to creating value for its customers.
- Cost-not just price of goods/services, but what does it “cost” the customer when he finally uses it.
Measures are customized to the targeted customer groups from which the business expects growth and profitability. The following are customer measures:
- Market share
- Account share – the account share of those customers’ business
- Customer retention – retaining existing customers, customer loyalty, percentage of growth due to existing customers
- New customer acquisition – number of new customers, total sales to new customers, number of customer responses to solicitations and the conversion rate, solicitation cost per new customer acquired
- Customer satisfaction – provides feedback on how well the company is doing. It customer’s complete buying experience. It includes uniqueness, functionality, quality, price, time
- Customer profitability – measures not only the extent of business they do with the customers, but the profitability of the business in the targeted customer segment. This financial measure can help keep customer-focused organizations from becoming customer-obsessed.
Internal Business Perspective What must be excelled at?
The internal business process perspective identifies the most critical internal processes for the organization’s strategy to succeed. The internal perspective examines the following process categories:
Innovation Cycle
- Identify the market
- Create the service offering
Operations Cycle
- Build the services
- Deliver the services
Post-sale Service Cycle
- Service the customer
Measures should be focused on…
- Business processes that have the greatest impact on customer satisfaction, such as factors that affect process cycle time, process quality, employee skills, and productivity.
- Business processes that achieve the organizations financial objective.
- Core competencies and processes that are needed to maintain market leadership.
Learning and growth perspective
Can we continue to improve and create value?
The learning and growth perspective identifies the infra-structure that the organization must build to create long-term growth and improvement. Ability to innovate, improve, and learn ties directly to company’s value. Organizational learning and growth can be categorized into three main areas:
- People
- Systems
- Organizational procedures
In order to achieve business objectives, companies most like will have to invest in re-skilling employees, enhancing information technology and systems, and aligning organizational procedures and routines.
The following are measures for people, systems and organizational procedures:
People
- Employee satisfaction
- Employee retention
- Employee training
- Employee skills
Systems
- Real-time availability of accurate customer and internal process information to front-line employees
- Ability to launch new products
- Ability to create more value for customers
- Ability to penetrate new markets
Organizational procedures
- Alignment of employee incentives with overall organizational success factors
- Rates of improvement in critical customer-based and internal processes
Examples of Measures
Building a Health Care Strategic Balanced Scorecard Framework (Kaplan & Norton conference promotion materials)
Financial
- Patient revenue
- Funding and contributions
- Cost management
Customer
- Patients
- Referring physicians
- Payers
- Community
- Academics
Internal Processes
- Planning
- Innovation
- Relationship management
- Care delivery
- Operations efficiency
Learning & Personal Development
- Recruiting, training, retaining
- Cultural values
- Tools, knowledge, information
Relationship between Measures and Performance Drivers
A Balanced Scorecard should have a mix of outcome measures and performance drivers. Outcome measures without performance drivers do not communicate how the outcomes are to be achieved. Conversely, performance drivers without outcome measures may fail to reveal whether the improvements have resulted in expanded business and enhanced financial performance.
The chain of cause and effect should pervade all four perspectives of a Balanced Scorecard. Additionally, all aspects of the measures on a Scorecard should be linked to specific targets for improving customer satisfaction, and eventually, financial performance. For example, the return on capital employed (ROCE) may be an outcome measure in the financial perspective. The driver of this could be repeated and expanded sales from existing customers due to on-time delivery (OTD). Thus, customer loyalty and OTD are listed under the customer perspective. To achieve OTD, the company may need to achieve short cycle time in operating processes and high-quality internal processes. Thus both factors are listed under internal perspective. In order for processes to improve, employees skills will need to improve, which is thus listed under learning and growth perspective. For another example: refer to Exhibit 8 – National Insurance: Lag and Lead Indicators (Kaplan and Norton, “Linking the Balanced Scorecard to Strategy,” 1996)
You should be able to look at your measures and infer the business strategy the company is intending to use to get to breakthrough performance. What are you doing that’s unique? Your measures should address which customers you’re going after; which market segments are you attacking; what you have to do exceptionally well to get penetration and share into those markets and those segments; and what kind of new product developments do you need to deliver to achieve long-term value for your customers and shareholders. You should feel really upset if a competitor gets hold of your scorecard.
It is important to build a scorecard that accurately reflect the business strategy. The scorecard:
Describes the vision of the future for the entire organization. It creates shared understanding. It focuses change efforts. It permits organized learning at the executive level.
IMPLEMENTING THE STRATEGIC PLAN VIA BALANCED SCORECARD
The real benefit comes from making the scorecard the cornerstone of the way you run the business. Imagine an organization in which everyone understands the strategy and his or her role in executing it. A high performance workforce prepared and motivated to achieve the results. An organization so agile that strategy can be tested and adapted in a continual process of feedback, learning, and innovation. Where all resources are aligned toward a unified strategy view. This new management model is called the Strategy-Focused Organization (SFO). (Kaplan & Norton promotional brochure)
Kaplan and Norton present a SFO framework that describes the five principles that organizations use to achieve breakthrough performance. The principles transform the Balance Scorecard from a measurement to a leadership and management system. Each SFO principles actively support the roles of leadership and management.
- Translate the strategy to operational terms
- Align the organization to the strategy
- Make strategy everyone’s job
- Make strategy a continual process
- Mobilize change through executive leadership
Rockwater, an undersea construction company, did a correlation study between employees attitudes and customer satisfaction. What they discovered is that the customers in the top quintile of satisfaction were being served by employees in the top quintile of attitude, as measured by the attitude survey.
Balanced Scorecard Software: Dialog Strategy 2.0
The Dialog Strategy 2.0 software system, available for free from the Dialog Software website at http://www.dialogsoftware.com, is used to help design and implement a Balanced Scorecard strategy. The version that is available for free on the company’s website has limited features with more advanced versions available for $199 and $399.
The website of the company has limited information on the program, but the free version of the program does come with an extensive instruction manual. The interface of the program is not intuitive, but it does include an example of an organization that may benefit from implementing a Balanced Scorecard strategy. A screenshot of the interface is on the following page.
Even with its faults, the program would be helpful for anyone trying to implement or trying to learn the Balanced Scorecard. For most organizations, however, the commercial versions with the additional features would probably be more beneficial.
What is a balanced scorecard?
- This portion describes the management system of the balanced scorecard measurement. It provides a diagram indicating the four areas of score card: The learning and growth, businesss process, customer, and financial perspectives
- This portion of the web site also discusses how the balanced scorecard builds to the total quality management ideas
- Double-Loop feed back is also discussed which focuses on both the process outputs and the outcomes of the business strategy
- Discussion of outcome metrics: “You can’t improve what you can’t measure”
- Management by fact discussion, analysis of factual data allows for a clear view of the company from multiple angles.
The learning and growth perspective
- Knowledgeable people are an organizations main resource. Thus mentoring and training are very important
The business process perspective
- Mission oriented process
- Support process
The customer perspective
- Customers must be analyzed for the types of services and products being provided to them and there satisfaction of them.
The financial perspective
- Risk assessment
- Cost-benefit
- To much emphasis on financial data can lead to an unbalanced scorecard
