Balanced Scorecard

In 1992, Robert S. Kaplan and David Norton introduced the balanced scorecard (BSC), a method for measuring a company's activities in terms of its vision and strategies. It gives managers a comprehensive view of the performance of a business as a combination of Financial and non-financial indicator. It is a management tool that continuously reveals whether a company and its employees achieve the results set forth by the strategy. But it is also a tool that helps the company express the necessary objectives and initiatives to support the strategies.

Why did Kaplan and Norton develop the scorecard?

They were concerned about the deficiencies in exusting performance measurements. Explicitly on the focus on historical financial measures. Giving the Dupont Pyramid as an example looking, it gave little indication of future performance and promoted short-termism. Consequently, they felt there was a need to balance largely backward looking financial measures with other organizational measures in a coherent framework that would reflect cost and not cost measures as well as external and internal measures

Summary of Features of the Balanced Scorecard

• Customer perspective
• Facilitates Learning
• Focuses on nternal processes
• As well as Financial measures seen in other performance models

• It is Objective
• It Measures
• Can be translated into initiatives
• Sets Targets

Why use it?

• Enhances the Feedback mechanism - Double Loop thinking
• It's an Integrated set of performance measures not an ad-hoc set of measures
• The major [[Strategic objectives are translated into measures
• It shows a Cause and effect relationship linking strategy formulations to financial outcomes
• It distinguishes between two types of measures LAGGING financial indicators and LEADING measures of future performance such as Customer Service

Benefits and Limitations

• Brings the measures under a single understandable report
• A comprehensive co-herent approach
• Considers all the important measures
• BUT
• Lacks empircal underpinning
• No support for underlying linkages
• Omits Social environmental factors - pollutions
• Lacks a strong competitive set of measures

Remember it's a framework not a template - Allows Companies to develop their OWN BUSINESS MODEL (Yip)

Implementation issues

• CEO/CFO need to be involved - Strategy
• Targets should stretch the organization
• Difficulty in selecting and measuring the targets or weighting their importance - "You get what you measure".
• Creativity and Openess - Is it going to be understood and accepted by the organization

A more detailed view of the Balanced Scorecard

The scorecard seeks to measure a business from the following perspectives:

• Financial perspective - measures reflecting financial performance, for example number of debtors, cash flow or return on investment. The financial performance of an organization is fundamental to its success. Even non-profit organizations must make the books balance. Financial figures suffer from two major drawbacks:

• They are historical. Whilst they tell us what has happened to the organization they may not tell us what is currently happening, or be a good indicator of future performance.

It is common for the current market value of an organization to exceed the market value of its assets. Tobin's-q measures the ratio of the value of a company's assets to its market value. The excess value can be thought of as intangible assets. These figures are not measured by normal financial reporting.

• Customer perspective - measures having a direct impact on customers, for example time taken to process a phone call, results of customer surveys, number of complaints or competitive rankings.

• Business process perspective - measures reflecting the performance of key business processes, for example the time spent prospecting, number of units that required rework or process cost.

• Learning and growth perspective - measures describing the companies learning curve, for example number of employee suggestions or total hours spent on staff training.

The specific measures within each of the perspectives will be chosen to reflect the drivers of the particular business. The method can facilitate the separation of strategic policy making from the implementation, so that organizational goals can be broken into task oriented objectives which can be managed by front-line staff. It can also help detect correlation between activities. For example, we might find that the internal business objective of implementing a new telephone system can help the customer objective of reducing response time to telephone calls, leading to increased sales from repeat business.

In many senses, the objectives chosen are leading indicators of future performance. Effort we make today is reflected in the future profits of the company. In this way, current expenditure can be viewed as investment in the future of the company.

Purpose of the balanced scorecard

Kaplan and Norton found that companies are using the scorecard to:

• Clarify and update strategy
• Communicate strategy throughout the company
• Align unit and individual goals with strategy
• Link strategic objectives to long term targets and annual budgets
• Identify and align strategic initiatives
• Conduct periodic performance reviews to learn about and improve strategy

Adoption results survey

In 1997 Kurtzman found that 64% of companies questioned were measuring performance from a number of perspectives in a similar way to the balanced scorecard.

It is difficult to interpret the impressive survey based adoption statistics for the Balanced Scorecard, however, without being clear on how the term was both defined and understood by those participating in the survey. In practice, it appears, there are wide variations in understanding between organisations. In 2002, Cobbold and Lawrie developed a classification of Balanced Scorecard designs based upon intended method of use within an organisation. They describe how Balanced Scorecard can be used to support two distinct management activities, management control and strategic control, and asserts that due to differences in the performance data requirements of these applications, planned use should influence the type of Balanced Scorecard design adopted. They also describe characteristics of Balanced Scorecards appropriate for each purpose, and suggests a framework to help select between them.

Later that year the same authors reviewed the evolution of the Balanced Scorecard as a strategic management tool, recognising three distinct generations of Balanced Scorecard design. In their paper, they relate the empirically driven developments in Balanced Scorecard thinking with literature concerning strategic management within organisations. Cobbold and Lawrie argue that over the dozen years that have passed since its introduction significant changes have been made to the physical design, application and the design processes used to implement the tool within organisations. This Balanced Scorecard evolution can largely be attributed to empirical evidence of changes driven primarily by weaknesses in earlier design processes, rather than in the architecture of the original idea they write. They conclude that it is these changes, in what they refer to as 3rd Generation Balanced Scorecard that have enhanced the utility of Balanced Scorecard as a strategic management tool.

The Balanced Scorecard and Corporate Governance

The Balanced Score Card has benefits that other performance measures have lacked in previous eras. Its popularity can be attested to the fact that majority of medium to large size companies have used it but this should be tempered by the suggestion that 70% of implementations are not meeting initial expectations (Lewey 1998 Smith Review of BSC)

Where it is used successfully it can help the decision making process and aid corporate governance because:

• It is a Broad-based organizational tool and it can be used to develop strategy as well as measure it and encourages a longer term perspective.
• It has internal and external perspectives.
• It links corporate strategy to management processes and can help manage risk.

Broad-based Management tool

Firstly it is broader-focused management tool that measures not just financial perspectives but customer, learning and growth and internal perspectives. The Balanced Scorecard helps the company develop critical success factors and judges success not only in financial terms but in the ways it builds customer relationships, organizational learning, personnel development and the improvements in the internal processes of the organization. A purely financial measurement might just measure for instance, the volume and margin on the sales of the products and service. The Balanced Scorecard would balance that measurement with the an analysis of on-time delivery (Customer Perspective) and the core competence resulting from the increasing experiencing of delivering the product or service (Learning Perspective) and the reduction in the total manufacturing lead-time through improved processes (Process perspective). The output of the measurements has implications for the decision-making process. The quality of decision-making is determined by management’s ability to address the correct problem; be in possession of the pertinent information and the ability to measure the quality of the decision and its implementation. If this cause and effect relationship does indeed exist, the BSC can help the Executive team evaluate the trade-off between low cost and optimized but potentially less flexible supply-chain or the merits of a flexible and effective supply-chain that values customer service higher than achieving the lowest cost. Used in the correct way it can generate a set of balanced and linked targets and objectives that are complementary and not mutually exclusive.

Internal and External Perspectives

The Executive management team works at the boundary of the organization. It is both inward looking; measuring the performance of the organization but it is also outward looking; measuring how the customers, shareholders and other external stakeholders view the company. Financial analysis by itself provides only a lagging indicator of the performance of the company. Existing and potential investors are sometimes unwilling to invest solely on the basis of past performance and will look for indicators that are predictive of future performance. The level of investment in both physical assets and employee skills is one indicators as well as possession of patents, long-term supply contracts and favorable purchasing contacts. These types of information are increasingly required by external parties who can be skeptical of published financial results, which although easy to read and comparable to similar companies are not often very good for discerning trends or indicative of future challenges. For instance Microsoft is a very profitable company with a large cash mountain yet it is vulnerable to anti-trust legislation, the rate of software innovation is slowing down and there is increasing competition in the form of on-demand and on-line applications which may impact revenues in future periods.

Linking Corporate Strategy to the Management Process

The linking of corporate strategy to the management process has multiple dimensions. Increasingly, companies are evaluated by how they perceived by the community as much as much as by what they do. Ethos describes how companies are viewed by what they do; how well they will be recognized; the organization’s raison-d’etre and its organizational style. By using the Balanced Scorecard the organization has the opportunity to develop the measures and targets that reflect its ethos and reward the managers accordingly. The key aspirations of good corporate governance includes honesty, trust, respect openness, responsibility and accountability and commitment to the organization and the measures and targets should reflect those aspirations. The aspirations are by their nature intangible and impossible to measure but approximations can be made by using proxies such as equal opportunities policies, anti-harassment and ethical training provided to employees on an ongoing basis. The Body Shop ethos very closely associate with brand but so it Ryan air and Enron for different reasons.

Comparison between the Balance Scorecard and other Financial Measure and their impact on Strategy Formulation

Traditional financial measures such as Activity Based Costing, Internal Rate of Return, Discounted Cash Flows, Ratio Analysis are numerous and been used over many decades. Financial measure are the most popular method of analyzing and choosing between options. This is because in many cases:

• The choices can be converted into a common currency base.

• A calculation can be generated that has a measurable result that can then be ranked against other choices.

• Managers can then chose between or choose a combination of choices using Net Present Value, Internal Rate of Return Residual Income, Contribution etc.

These traditional financial measures are valuable where the decision:

• Is “tame” (De Wit and Meyer ) and easily converted into a financial calculation.

• Where the decision does not impact non-financial factors (for example the choice between one production machine or another) or

• The decision would not change even if the impact of non-financial factors was taken into account (the closure of a loss-making factory to avoid bankruptcy)

However, the practice of strategy requires thinking and acting strategically which requires good decision-making abilities. The decision-making process requires understanding the problem, analyzing information from potentially many sources, an evaluation of the options available, understanding the context under which the decision will be made (for instance the economic conditions, the culture of the organization, this history of the company) and ensuring the decision is aligned with the overall strategy of the organization. Consequently, it is not as straightforward or well-defined as the output of traditional financial measures would lead managers to believe. The strategist role is not necessarily to simplify and rank issues or avoid uncertainty but instead to work within the parameters and mitigate risk and uncertainty by using a balanced a broad-based set of qualitative and quantitative data. A limitation of the financial performance measures is therefore that they are more likely to be used to choose between different options but they are not a good way of formulating strategies.

The balanced scorecard has benefits over the traditional financial measures in the following ways

• 1. Communicating Strategy between all the stakeholders.
• 2. Enhances motivation, feedback and teamwork.
• 3. BSC Can be used to address the triple bottom line.
• 4. BSC Can be used to address the movement away from capital to human asset utilization.

Communicating Strategy between all the stakeholders

The purpose of the Executive Board is to represent the interests of shareholders, communicate with stakeholders and develop and monitor strategy and ensure compliance through corporate governance. An over reliance on financial measures can blinker the Executive Board to think in terms of short–term financial gain instead of developing a long-term sustainable organizational strategy. The Balanced Scorecard approach can be a way communicating the strategy of the organization to non-financial managers that is both relevant and has practical application in their roles. The traditional financial measures can still be included within the Financial Perspective. The sales manager is no longer required to meet just a contribution margin or sales revenue target but implement and measure targets that can affect the volume of sales, such as on-time delivery targets and customer satisfaction survey responses. The IT director uses the balanced scorecard to develop IT systems and applications that reduce the transaction costs of doing business. The supply chain manager can use it as a tool for identifying and tracking the most critical processes which are pivotal for the success of the organization.

For example a simplified Ryan air and BA Balanced Scorecard could look the diagram below:

Enhances motivation, feedback and teamwork

The enhanced relevancy of the measures for all levels of mangers increases motivation and enables performance appraisal which can be used to monitor, adjust or change the strategy. It can be used as part of the reward system. Many organizations still rely on rewarding managers based upon meeting financial targets and ratios. The individual manager often feels that they have little impact by themselves on the meeting those targets but using the relevant sales or production targets they can have a direct impact which ultimately has a positive effect on the financial target.

Alternatively, the focus of meeting financial targets may detrimentally affect the other parts of the organization. For instance if the financial target is to increase the return on assets that may influence the managers to delay or even dispose of assets in order to attain a short-term benefit on an increased ROA. Consequently the production department is negatively impacted by a fall in the efficiency of machinery.

Using the Balance Sheet to Address Corporate Social Responsibility

The so called ‘triple bottom line’ that includes financial as well environmental and social performance. is not an explicit part of the four perspectives but Kaplan and Norton devised the BSC as a flexible and not prescriptive tool that can be tailored to meet the requirements of the organization. Nike (Using sub-contracted child labour in Asia) and Shell (for political and environmental concerns) are examples of two large organizations that would have benefited from having a wider perspective beyond those relying on financial measures. Shell, for instance, was criticized for proposing to scuttle the Brent Spar oil rig in the North Sea and creating an environmental disaster. The “costs” to the company in terms of lost reputation associated with this decision outweighed the benefit that was derived from making the decision on purely financial terms.

Using the Balanced Scorecard to evaluate the performance of human capital When a company has heavy capital intensive investments, financial measures are much more relevant. Physical assets can be valued, counted and depreciated. Their output and value vis-à-vis their costs is relatively straightforward to estimate. However the nature of business and operations has changed over the last twenty-years. The emphasis has shifted away from exploiting physical assets such as land and machinery to exploiting social capital. Easton and Araujo (1994) see the rise of inter-organizational networks and a shift away from transactions as the primary unit of analysis to relationships. Therefore the focus has moved in favour of developing core competences and creating and facilitating knowledge to add-value to the organization. The BSC can be used to communicate the importance of core competences and inter-organizational relationships to improve future performance and the organization can create measures and targets that encourage and build the organization’s bank of intellectual capital.

Enron and the use of the Balanced Scorecard

The senior executives at Enron perpetuated a pre-meditated fraud on such a grand scale that the Balanced Scorecard had it been adopted would have not avoided the eventual demise of the company.

Off balance sheet accounting

The financial ‘vehicles’ that the CFO used such as Special Purpose Entities removed $1.27bn of assets off the balance sheet. These vehicles were deliberately complex in nature to thwart external oversight. The SPE’s rarely included any tangible assets and made financial and other measurements difficult to create and measure. The ownership of the SPE’s was vague and it was not always possible to distinguish what assets or liabilities Enron owned. Assets were frequently moved between the SPE’s in further attempts at obfuscation. By the end of the 1990’s Enron had set up several thousand accounting companies (Deakin) . It would have been difficult to generate a comprehensive set of Balanced Scorecard targets and measures to track these policies and companies. In addition, being off balance sheet would have also limited the availability of data and it would have been difficult to determine the integrity of the data even had it been available.

The hollowing out of the company

Enron slowly moved away from the ownership and generation of energy to an energy trading company. The Natural Gas Trading model that Jeff Skilling developed was built around an “asset light” strategy which meant that the key to market domination was the ownership and manipulation of information. Consequently, Enron derived 50% of its revenue from gas options on Enron online. As Enron increasingly became a virtual trading company the number of scorecard measures is reduced to financial and other hard to measure targets thereby limiting its effectiveness.

Collusion of the Auditors

The first two points highlight the difficulty of developing a consistent and comprehensive set of scorecard measures and targets. However, oversight of the measures and targets would have been equally problematic. Andersen acted as the auditors for Enron and suffered from a conflict of interest. They were simultaneously involved in helping Enron develop and manage the SPE’s and tax avoidance schemes as well as scrutinizing the financial accuracy of Enron’s performance. As one of the stakeholders at Enron, the lack of oversight was an example of poor ethical practice by failing to follow accounting procedure. The development of a Balanced Scorecard Approach would have been flawed insofar as those who created and measured the performance were also the same body who were being measured.

Lack of Non-executive oversight

One of the key facets of good corporate governance is to have non-executive directors approve and monitor corporate strategy and in some cases even help develop the strategy. For the BSC to be effective would have required the non-executive directors to judge comprehensive and clear performance targets and measure them effectively. However, the non-executive board was rendered ineffective because they were not given access to information or were not given the time to properly evaluate what they were being asked to approve. “They were not fully briefed and given only 15 minutes to review the dubious transactions underlying the surge in earnings” (Tonge) Tonge.

A Culture that Subverted the Aims of Effective Corporate Governance

As well as the collusion of the Auditors and lack of Non-executive oversight there was a general dismantling of the good corporate governance that would have enabled the development and analysis of performance measurements. It found ways of getting around the US GAAP accounting rules, it used political lobbying to force the SEC to back off imposing conflict of interest rules, it set aside its Code of Ethics and removed directors who questioned its policies It seems impossible given that culture that the Balanced Scorecard would have been anything but yet another smokescreen to hide its fraudulent activity.

The Balanced Scorecard approach can only succeed therefore if the correct corporate governance structure is in place and a culture exists in which targets and objectives can be created that reflect the strategy and ethos of the organization. The Enron and other corporate collapses can only be avoided through a combination of internal and external controls exerted by a variety of stakeholders backed up by legal sanction for non-compliance in addition to tools such as the Balanced Scorecard.

See Also

Performance Pyramid