January 18th, 2012 Balanced Scorecard
The balanced scorecard is a strategic planning and management system used;
- To align business activities to the vision and strategy of the organization,
- Improve internal and external communications and,
- Monitor organization performance against strategic goals.
The balanced scorecard suggests us to view 4 critical perspectives of our business:
1. Learning & growth: includes training, learning, corporate culture and attitudes, self growth. Individuals are the main repository of knowledge of an organisation and the critical resource. Communication among workers is key, as is avoiding brain drain.
2. Business process: Metrics based on internal business processes allow management to monitor how well the business is running and wether it's products/services are well accepted by clients.
3. Customer: Indicators on customer satisfaction and tools to improve and monitor customer relations are critical
4. Financial: Timely and accurate financial data is still a key to manage the business. Data should be centralised and of fast and easy access, but financial data should not be the only indicator, thus the original intention of the word balanced.
The Balanced Scorecard automates and centralizes the issuance and tracking of objectives, targets, measures and initiatives.
The Balanced Scorecard (BSC) began as a concept for measuring whether the smaller-scale operational activities of a company are aligned with its larger-scale objectives in terms of vision and strategy. It was developed and first used at Analog Devices in 1987. By focusing not only on financial outcomes but also on the human issues, the Balanced Scorecard helps provide a more comprehensive view of a business, which in turn helps organizations act in their best long-term interests. The strategic management system helps managers focus on performance metrics while balancing financial objectives with customer, process and employee perspectives. Measures are often indicators of future performance.
History of Balanced Scorecard
In 1992, Robert S. Kaplan and David P. Norton began publicizing the Balanced Scorecard through a series of journal articles. In 1996, they published the book The Balanced Scorecard. Since the original concept was introduced, Balanced Scorecards have become a fertile field of theory and research, and many practitioners have diverted from the original Kaplan & Norton articles. Robert S. Kaplan and David P. Norton themselves revisited Balanced Scorecards with the benefit of a decade's experience since the original article.
The Balanced Scorecard is a performance planning and measurement framework, with similar principles as Management by Objectives, which was publicized by Robert S. Kaplan and David P. Norton in the early 1990s. Having realized the shortcomings of traditional management control systems, Robert S. Kaplan and David P. Norton designed the Balanced Scorecard as a result of a one-year research project involving 12 companies. Since its introduction, the Balanced Scorecard has been awarded a prize by the American Accounting Association as the best theoretical contribution in 1997, and its industry and academic attention has placed it alongside approaches such as Activity Based Costing and Total Quality Management.
Balanced scorecard is a tool to execute and monitor the organisational strategy by using a combination of financial and non financial measures. It is designed to translate vision and strategy into objectives and measures across four balanced perspectives: financial, customers, internal business process and learning and growth. It gives a framework ensuring that the strategy is translated into a coherent set of performance measures.
Use of Balanced Scorecard
Implementing Balanced Scorecards typically includes four processes:
1. Translating the vision into operational goals;
2. Communicating the vision and link it to individual performance;
3. Business planning;
4. Feedback and learning, and adjusting the strategy accordingly.
The Balanced Scorecard is a framework, or what can be best characterized as a strategic management system that claims to incorporate all quantitative and abstract measures of true importance to the enterprise. According to Kaplan and Norton, The Balanced Scorecard provides managers with the instrumentation they need to navigate to future competitive success.
Many books and articles referring to Balanced Scorecards confuse the design process elements and the Balanced Scorecard itself. In particular, it is common for people to refer to a strategic linkage model or strategy map as being a Balanced Scorecard.
Balanced Scorecard is a performance management tool. Although it helps focus managers' attention on strategic issues and the management of the implementation of strategy, it is important to remember that the Balanced Scorecard itself has no role in the formation of strategy. In fact, Balanced Scorecards can comfortably co-exist with strategic planning systems and other tools.
Original Balanced Scorecard Methodology
The earliest Balanced Scorecards comprised simple tables broken into four sections – typically these "perspectives" were labeled "Financial", "Customer", "Internal Business Processes", and "Learning & Growth". Designing the Balanced Scorecard required selecting five or six good measures for each perspective.
Many authors have since suggested alternative headings for these perspectives, and also suggested using either additional or fewer perspectives. These suggestions were notably triggered by a recognition that different but equivalent headings would yield alternative sets of measures. The major design challenge faced with this type of Balanced Scorecard is justifying the choice of measures made. "Of all the measures you could have chosen, why did you choose these?" This common question is hard to ask using this type of design process. If users are not confident that the measures within the Balanced Scorecard are well chosen, they will have less confidence in the information it provides. Although less common, these early-style Balanced Scorecards are still designed and used today.
In short, early-style Balanced Scorecards are hard to design in a way that builds confidence that they are well designed. Because of this, many are abandoned soon after completion.
Improved Balanced Scorecard Methodology
In the mid 1990s, an improved design method emerged. In the new method, measures are selected based on a set of "strategic objectives" plotted on a "strategic linkage model" or "strategy map". With this modified approach, the strategic objectives are typically distributed across a similar set of "perspectives", as is found in the earlier designs, but the design question becomes slightly less abstract.
Managers have to identify five or six goals within each of the perspectives, and then demonstrate some inter-linking between these goals by plotting causal links on the diagram. Having reached some consensus about the objectives and how they inter-relate, the Balanced Scorecard is devised by choosing suitable measures for each objective. This type of approach provides greater contextual justification for the measures chosen, and is generally easier for managers to work through. This style of Balanced Scorecard has been commonly used since 1996 or so.
Several design issues still remain with this enhanced approach to Balanced Scorecard design, but it has been much more successful than the design approach it supersedes.
Popularity of Balanced Scorecard
Kaplan and Norton found that companies are using Balanced Scorecards to:
- Drive strategy execution;
- Clarify strategy and make strategy operational;
- Identify and align strategic initiatives;
- Link budget with strategy;
- Align the organization with strategy;
- Conduct periodic strategic performance reviews to learn about and improve strategy.
In 1997, Kurtzman found that 64 percent of the companies questioned were measuring performance from a number of perspectives in a similar way to the Balanced Scorecard.
Balanced Scorecards have been implemented by government agencies, military units, business units and corporations as a whole, non-profit organizations, and schools.
Many examples of Balanced Scorecards can be found via Web searches. However, adapting one organization's Balanced Scorecard to another is generally not advised by theorists, who believe that much of the benefit of the Balanced Scorecard comes from the implementation method.
Variants, Alternatives and Criticisms About Balanced Scorecard
Since the late 1990s, various alternatives to the Balanced Scorecard have emerged, such as The Performance Prism, Results Based Management and Third Generation Balanced Scorecard. These tools seek to solve some of the remaining design issues, in particular issues relating to the design of sets of Balanced Scorecards to use across an organization, and issues in setting targets for the measures selected.
Applied Information Economics (AIE) has been researched as an alternative to Balanced Scorecards. In 2000, the Federal CIO Council commissioned a study to compare the two methods by funding studies in side-by-side projects in two different agencies. The Dept. of Veterans Affairs used AIE and the US Dept. of Agriculture applied Balanced Scorecards. The resulting report found that while AIE was much more sophisticated, AIE actually took slightly less time to utilize. AIE was also more likely to generate findings that were newsworthy to the organization, while the users of Balanced Scorecards felt it simply documented their inputs and offered no other particular insight. However, Balanced Scorecards are still much more widely used than AIE.
A criticism of Balanced Scorecards is that the scores are not based on any proven economic or financial theory, and therefore have no basis in the decision sciences. The process is entirely subjective and makes no provision to assess quantities (e.g., risk and economic value) in a way that is actuarially or economically well-founded.
Another criticism is that the Balanced Scorecard does not provide a bottom line score or a unified view with clear recommendations: it is simply a list of metrics.
Some people also claim that positive feedback from users of Balanced Scorecards may be due to a placebo effect, as there are no empirical studies linking the use of Balanced Scorecards to better decision making or improved financial performance of companies.
The Four Perspectives of The Balanced Scorecard
The grouping of performance measures in general categories (perspectives) is seen to aid in the gathering and selection of the appropriate performance measures for the enterprise. Four general perspectives have been proposed by the Balanced Scorecard:
- Financial perspective;
- Customer perspective;
- Internal process perspective;
- Learning and growth perspective.
The financial perspective examines if the companyï¿½s implementation and execution of its strategy are contributing to the bottom-line improvement of the company. It represents the long-term strategic objectives of the organization and thus it incorporates the tangible outcomes of the strategy in traditional financial terms. The three possible stages as described by Kaplan and Norton (1996) are rapid growth, sustain and harvest. Financial objectives and measures for the growth stage will stem from the development and growth of the organization which will lead to increased sales volumes, acquisition of new customers, growth in revenues etc. The sustain stage on the other hand will be characterized by measures that evaluate the effectiveness of the organization to manage its operations and costs, by calculating the return on investment, the return on capital employed, etc. Finally, the harvest stage will be based on cash flow analysis with measures such as payback periods and revenue volume. Some of the most common financial measures that are incorporated in the financial perspective are EVA, revenue growth, costs, profit margins, cash flow, net operating income etc.
The customer perspective defines the value proposition that the organization will apply in order to satisfy customers and thus generate more sales to the most desired (i.e. the most profitable) customer groups. The measures that are selected for the customer perspective should measure both the value that is delivered to the customer (value position) which may involve time, quality, performance and service and cost and the outcomes that come as a result of this value proposition (e.g., customer satisfaction, market share). The value proposition can be centered on one of the three: operational excellence, customer intimacy or product leadership, while maintaining threshold levels at the other two.
The internal process perspective is concerned with the processes that create and deliver the customer value proposition. It focuses on all the activities and key processes required in order for the company to excel at providing the value expected by the customers both productively and efficiently. These can include both short-term and long-term objectives as well as incorporating innovative process development in order to stimulate improvement. In order to identify the measures that correspond to the internal process perspective, Kaplan and Norton propose using certain clusters that group similar value creating processes in an organization. The clusters for the internal process perspective are operations management (by improving asset utilization, supply chain management, etc), customer management (by expanding and deepening relations), innovation (by new products and services) and regulatory & social (by establishing good relations with the external stakeholders).
The learning and growth perspective is the foundation of any strategy and focuses on the intangible assets of an organization, mainly on the internal skills and capabilities that are required to support the value-creating internal processes. The learning and growth perspective is concerned with the jobs (human capital), the systems (information capital), and the climate (organization capital) of the enterprise. These three factors relate to what Kaplan and Norton claim is the infrastructure that is needed in order to enable ambitious objectives in the other three perspectives to be achieved. This of course will be in the long term, since an improvement in the learning and growth perspective will require certain expenditures that may decrease short-term financial results, whilst contributing to long-term success.
Key Performance Indicators (KPI) of Balanced Scorecard
According to each perspective of the Balanced Scorecard, a number of KPIs can be used such as:
- Cash flow
- Financial Result
- Return on capital employed
- Return on equity
- Delivery Performance to Customer – by Date
- Delivery Performance to Customer – by Quality
- Customer satisfaction rate
- Customer Loyalty
- Customer retention
Internal Business Processes
- Number of Activities
- Opportunity Success Rate
- Accident Ratios
- Overall Equipment Effectiveness
Learning & Growth
- Investment Rate
- Illness rate
- Internal Promotions
- Employee Turnover
- Gender/Racial Ratios
Further lists of general and industry-specific KPIs can be found in the case studies and methodological articles and books presented in the references section.