The Balanced Scorecard: Translating Strategy Into Action (10 page)

Companies with long operating cycles, such as construction companies, find it equally important to manage working capital. Such companies need to track progress payments against cash expended for work completed to date. Rockwater, the undersea construction company, had a particular problem with accounts receivable. It often had to wait more than 100 days before the customer made its final project payment. One of Rockwater’s principal financial objectives was to significantly reduce the length of this closeout cycle, an objective that, if reached, would produce a dramatic improvement for its return-on-capital-employed, another one of its financial objectives.
⁶

Many of an organization’s resources supply the infrastructure for accomplishing work: designing, producing, selling, and processing. These resources may require considerable capital investments. The investments certainly include physical capital, such as information systems, specialized equipment, distribution facilities, and other buildings and physical facilities. But the investments also include intellectual and human capital, such as skilled technologists, data bases, and market-and customer-knowledgeable personnel. Companies can increase the leverage from these infrastructure investments by sharing them across multiple business units. Apart from the potential revenue benefits from sharing knowledge and customers, cost reductions can be achieved by not replicating similar forms of physical and intellectual assets across multiple units. Thus, companies attempting to achieve some economy of scale or scope across investments in specialized
physical and intellectual capital can set objectives to increase the percentage of system resources that are shared with other business units.

Return-on-investment in intellectual assets, such as research and development, employees, and systems, will also increase an organization’s overall return-on-investment. We, however, defer discussion of objectives for these intellectual assets to
Chapters 5
and
6
, where we explicitly consider the objectives and measures for innovation, employees, and systems.

We have noted that, in addition to increasing returns—through growth, cost reduction, productivity, and asset utilization—most organizations are concerned with the risk and variability of their returns. When it is strategically important, these organizations will want to incorporate explicit risk management objectives into their financial perspective. Metro Bank chose a financial objective to increase the share of income arising from fee-based services not only for its revenue growth potential (as already mentioned) but also to reduce its current heavy reliance on income from core deposit and transaction-based products. Such income fluctuated widely with variations in interest rates. As the share of fee-based income increased, the bank believed that the year-to-year variability of its income stream would decrease. Thus, an objective to broaden revenue sources may serve both a growth and a risk management objective.

Risk is an essential part of the business of insurance companies, so National Insurance, a large property and casualty insurance company, included measures of loss exposure and reserve adequacy against maximum possible losses. A capital-intense company addressed its risk concerns by setting an objective that operating cash flow at the bottom of an economic cycle should still cover expenditures on physical capital maintenance and process and product improvement.

Some companies have recognized their generally poor record in forecasting actual operating results. Poor forecasts, especially when actual results
were well below expected, led to unexpected borrowings and, therefore, higher risk to the businesses. These businesses chose an objective to reduce the percentage deviation between actual and projected results. Clearly, if this were the only measure in the financial perspective, managers would tend to issue conservative forecasts that they could easily fulfill. But since other financial objectives provided incentives to achieve stretch targets for revenue growth and return-on-assets, the forecast reliability objective could be balanced by growth and profitability objectives. Increasing backlogs of sales and orders was a risk-reducing objective chosen by one company that believed that a large and growing backlog made revenue and forecasts more reliable.

Eventually, all objectives and measures in the other scorecard perspectives should be linked to achieving one or more objectives in the financial perspective, a theme we develop in
Chapter 7
. This linkage to financial objectives explicitly recognizes that the long-run goal for the business is to generate financial returns to investors, and all the strategies, programs, and initiatives should enable the business unit to achieve its financial
objectives. Every measure selected for a scorecard should be part of a link of cause-and-effect relationships, ending in financial objectives, that represents a strategic theme for the business unit. Used this way, the scorecard is not a group of isolated, unconnected, or even conflicting objectives. The scorecard should tell the story of the strategy, starting with the long-run financial objectives, linking these to the sequence of actions that must be taken with financial processes, customers, internal processes, and finally employees and systems to deliver the desired long-term economic performance. For most organizations, the financial themes of increasing revenues, improving cost and productivity, enhancing asset utilization, and reducing risk can provide the necessary linkages across all four scorecard perspectives.

1
. See, for example, G. Bennett Stewart,
The Quest for Value
(New York: Harper Business, 1991) and G. B. Stewart, “EVA™: Fact and Fantasy,”
Journal of Applied Corporate Finance
(Summer 1994): 71–84.

2
. C. W. Hofer and D. E. Schendel,
Strategy Formulation: Analytical Concepts
(St. Paul: West Publishing, 1978); I. C. MacMillan, “Seizing Competitive Initiative,”
Journal of Business Strategy
(Spring 1982): 43–57; and P. Haspeslagh, “Portfolio Planning: Uses and Limits,”
Harvard Business Review
(January–February 1982): 58–73.

3
. This treatment was influenced by Ernest H. Drew, “Scaling the Productivity of Investment,”
Chief Executive
(July/August 1993).

4
. Some businesses no longer fit the strategic objectives of the company or can no longer generate adequate cash or financial returns. These businesses must be maintained just sufficiently for the company to implement an “exit” strategy, either through sale or an orderly shutdown. In the exit stage, financial measurements must focus on sustaining existing value. The measurements for business in this stage must be derived from a clear understanding with the company CEO and CFO about what is required to prepare the business for an orderly and value-maximizing sale. Factors that might jeopardize the marketability of the unit, such as growth in liabilities and creating waste, scrap, pollution, or disappointed customers, can all be closely monitored.

5
. S. L. Mintz, “Spotlight on SG&A,”
CFO Magazine
(December 1994): 63–65.

6
. We discuss how Rockwater addressed its long payment-cycle problem in
Chapter 5
, “Internal-Business-Process Perspective,” since the solution required improving how project managers worked with customers. This example illustrates the importance of linking objectives across scorecard perspectives.