The Balanced Scorecard

Say goodbye to seat-of-the-pants performance: in their search for the Holy Grail of performance measurement, more and more companies are switching on to the model for measurement called the ‘balanced scorecard’. The Institute of Management Accountants found that 64% of US companies are experimenting with some sort of performance measurement system- the balanced scorecard is a favoured option

What is it?

In essence, the scorecard is a measurement model which takes a company’s strategic objectives and translates them into measurable actions.

A good scorecard:

Takes a holistic view of a firm’s performance
i.e. Is interested in financial and non-financial measures of a firm’s performance; akin to a flight control panel – is a pilot interested in fuel levels only? e.g. measures return on capital employed, profitability, defect rates, employee retention

Is not generally used to set strategy
But is used instead as a health check for strategic goals already set; e.g. a failure to convert improved operational performance into improved financial performance should spark a strategy re-think

Shows the cause-and-effect relationships between objectives and measures
It is interested in both:

the outcomes or results, referred to in the scorecard as the ‘lag’ indicators; these show whether the strategy has been a success; e.g. revenue from new products, customer retention
the mechanisms, referred to as the ‘lead’ indicators; these serve as a warning signal to show whether the strategy is likely to be a success; e.g. product development cycle, customer satisfaction survey

Is weighted
Measures are grouped and given a weighting according to their importance to the individual firm; e.g. financial measures (60%), customer measures (30%), operations (10%).

Is an ideal measurement model for stand-alone business units
Most corporations are too diverse (e.g. different products, strategies, processes) for meaningful application of the scorecard which likes to measure like with like; e.g. for a business unit with its own strategy, marketing, customers, internal processes, and direct management, it is ideal.

Can be used as a diagnostic tool?
If top-line results take a dip, a look at the measures which drive these results should show what is causing it; e.g. if the scorecard shows a dip in customer satisfaction, a look at more detailed layers of the scorecard could reveal this is due to improperly filled orders, or poor customer service.

Comprises of approx. 25 measures
If the scorecard focuses on just 1 or 2 measures, it can give a distorted view of performance, and encourage the wrong corporate behaviour; e.g. if managers track only cash-flow, the firm may eventually stop investing in long-term opportunities.

Finding the ideal weight

An international oil company gauges its progress using a scorecard comprising 23 measures, only 5 of which are strictly financial

how does it work?

The scorecard aims to set objectives and measures in 4 main areas (referred to as ‘perspectives’ on the scorecard):

Financial

At the core of the scorecard, the financial perspective is essentially the focus or the objectives and measures in all the other scorecard areas; the most common financial objectives and measures used for scorecards are:

ROI
EVA
profitability
revenue growth/mix
cost reduction/productivity

These objectives will vary depending, for example, at which stage the firm finds itself in its industry cycle – e.g. the growth stage will call for revenue generation, the mature stage cashflow.

Customer

The company’s key customer segments represent the sources that will deliver the revenue component of the firm’s financial objectives; key customer measures used are:

Market share

customer retention
customer acquisition
customer satisfaction
customer profitability

Internal processes

Here, managers must identify the processes that are most critical for achieving customer and financial objectives; due to its complexity, the scorecard carves up the ‘process’ section into 3 parts, setting core objectives and measures for each:

Innovation processes

% of sales from new products, time to develop next generation products
operations processes
quality, cycle time, cost
post-sale processes
speed of response to failures, payment processing

An example

A walk-through example showing the chain of cause and effect between the 4 perspectives of the scorecard:

Financial

The outcome chosen is return on capital employed (ROCE)

Customer

The driver of this financial measure could be repeat and new sales from existing customers, the result of customer loyalty; so customer loyalty becomes one measure on the scorecard; but how to achieve customer loyalty? Analysis of customer preferences may reveal that on-time delivery (OTD) of orders is valued by customers; so OTD is incorporated as a further measure into the scorecard (the logic being that OTD leads to customer loyalty which leads to improved financial performance)

Internal processes

The next step is to pinpoint the processes in which the company must excel to achieve exceptional OTD e.g. the business may need to achieve short cycle times in operating processes, which is included as a measure on the scorecard

Learning and growth

Finally, how do organisations improve the quality and reduce the cycle times of their internal processes? by training and improving the skills of their operating employees – so training becomes a measure on the learning and growth section of the scorecard

Learning and growth

The objectives and measures in this section are meant to ‘enable’ the other 3; the focus here is firmly on employees, and is measured mainly by variants of:

employee satisfaction
employee retention
employee productivity

Of course, the scorecard should be tailored to each company. There are 3 key steps to arriving at your objectives and measures:

strategy – what is the company/business unit trying to achieve?
action – given this strategy, what are the actions crucial to achieving it?
measurement – how would we know if we achieved this objective?

Tailoring the scorecard

With its overall strategy centred on ‘extraordinary growth’ and ‘continuous improvement’, and an aim of growing its business by 20% year on year, a European Engineering company set about implementing a balanced scorecard. But instead of using the 4 perspectives typical of scorecards, Rexam adopted 3 perspectives of its own, which were:

perspective objectives measures
shareholder’s return on net assets improvement gross margin
target XX% by 1997 overhead % of sales
working capital
extraordinary sales growth/broader customer base % sales growth year on year
growth XX%/yr. compound % sales from top 4 customers
market share in markets where No 1
continuous profit improvement capacity utilisation
improvement target return on sales XX% by 1999 % waste
cycle time reduction production cost yr./yr. improvement target reduce by XX% by 1997 R&D time on new projects
on time delivery

Merit in the method?

Two clear camps of opinion are now emerging as to the value of the scorecard method -; on the one hand are the scorecard supporters who claim:

people can finally understand where what they are doing fits into the firm’s overall performance
under traditional accounting systems, you might know to the penny the cost of the raw materials, but be clueless about the effectiveness of the production process using them
many of the newly-revered intangible assets, also indicators of a firm’s health, do not appear on a balance sheet

Those against, however, argue:

straying from non-financial measures confuses the issue; at least financial measures provide clear goals
financial measures are also more objective
intangibles cannot be measured anyway

What are the problems?

Potential barriers to successful scorecard implementation include:

vague vision – when the organisation cannot act upon the strategy
strategy in a vacuum – where the strategy is not linked to departmental, team or individual goals
long-term, short-term mismatch – where, for example, the strategy is long-term, but the measures are short-term
too much lag – too many lag factors, and the firm misses early warning signals
too much lead – too many lead factors and the firm may see operational improvements, but will not know their effect on business performance

Plot the course correctly, and your firm’s journey should be turbulence-free. Get it wrong, and you will send it careering off-course, or force it down to earth with one rather large bump.

A sample scorecard

The following is an example of the types of objectives and measures for each of the 4 main ‘perspectives’ found in a balanced scorecard:

FINANCIAL

Objectives Measures Unit Current Target Weighting
Profit growth Operating profit %
Profitability Return on sales
Asset utilisation Return on net assets %
Survive Working capital %
Harvest Cashflow

CUSTOMER

Objectives Measures Unit Current Target Weighting
Customer On time delivery %
satisfaction Complaints No.
Customer satisfaction Ranking
Product avail. Key items out-of-stock rate %
Growth Sales from new customers %
Market share %
Share of customer wallet %
Partnership Sales with ‘partner’ cust. %
Average order turnaround Days

INTERNAL BUSINESS PROCESS

Objectives Measures Unit Current Target Weighting
Innovation R&D time on new products %
of items first to market %
Sales from new products %
Break-even lag on new Months products
Process Parts-per-million defect rate %
improvement Average set-up time Hours
Schedule achieved %
Product cost yr./yr. improvement $
Average throughput time Weeks
(processing + inspection time + waiting/storage time)
Re-work %
Waste recycled %

LEARNING & GROWTH

Objectives Measures Unit Current Target Weighting
Employee Workforce requiring re-skilling %
capabilities Strategic job coverage (tracks no. of employees qualified for Ratio specific jobs)
Lag between training and effect Months
Processes achieving targeted
rates of improvement %
Sales per employee
Employee
Employee morale survey Ranking
satisfaction
Employee
retention %
Employee
suggestions made/ % implemented