Read The Balanced Scorecard: Translating Strategy Into Action Online
Authors: Robert S. Kaplan,David P. Norton
Tags: #Non-Fiction, #Business
The Balanced Scorecard: Translating Strategy Into Action (3 page)
All the new programs, initiatives, and change management processes of information age companies are being implemented in an environment governed
by quarterly and annual financial reports. The financial-reporting process remains anchored to an accounting model developed centuries ago for an environment of arm’s-length transactions between independent entities. This venerable financial accounting model is still being used by information age companies as they attempt to build internal assets and capabilities, and to forge linkages and strategic alliances with external parties.
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Ideally, this financial accounting model should have been expanded to incorporate the valuation of a company’s intangible and intellectual assets, such as high-quality products and services, motivated and skilled employees, responsive and predictable internal processes, and satisfied and loyal customers. Such a valuation of intangible assets and company capabilities would be especially helpful since, for information age companies, these assets are more critical to success than traditional physical and tangible assets. If intangible assets and company capabilities could be valued within the financial accounting model, organizations that enhanced these assets and capabilities could communicate this improvement to employees, shareholders, creditors, and communities. Conversely, when companies depleted their stock of intangible assets and capabilities, the negative effects could be reflected immediately in the income statement. Realistically, however, difficulties in placing a reliable financial value on such assets as the new product pipeline; process capabilities; employee skills, motivation, and flexibility; customer loyalty; data bases; and systems will likely preclude them from ever being recognized in organizational balance sheets. Yet these are the very assets and capabilities that are critical for success in today’s and tomorrow’s competitive environment.
The collision between the irresistible force to build long-range competitive capabilities and the immovable object of the historical-cost financial accounting model has created a new synthesis: the Balanced Scorecard. The Balanced Scorecard retains traditional financial measures. But financial measures tell the story of past events, an adequate story for industrial age companies for which investments in long-term capabilities and customer relationships were not critical for success. These financial measures are inadequate, however, for guiding and evaluating the journey that information age companies must make to create future value through investment in customers, suppliers, employees, processes, technology, and innovation.
The Balanced Scorecard expands the set of business unit objectives beyond summary financial measures. Corporate executives can now measure how their business units create value for current and future customers and how they must enhance internal capabilities and the investment in people, systems, and procedures necessary to improve future performance. The Balanced Scorecard captures the critical value-creation activities created by skilled, motivated organizational participants. While retaining, via the financial perspective, an interest in short-term performance, the Balanced Scorecard clearly reveals the value drivers for superior long-term financial and competitive performance.
Many companies already have performance measurement systems that incorporate financial and nonfinancial measures. What is new about a call for a “balanced” set of measures? While virtually all organizations do indeed have financial and nonfinancial measures, many use their nonfinancial measures for local improvements, at their front-line and customer-facing operations. Aggregate financial measures are used by senior managers as if these measures could summarize adequately the results of operations performed by their lower and mid-level employees. These organizations are using their financial and nonfinancial performance measures only for tactical feedback and control of short-term operations.
The Balanced Scorecard emphasizes that financial and nonfinancial measures must be part of the information system for employees at all levels of the organization. Front-line employees must understand the financial consequences of their decisions and actions; senior executives must understand the drivers of long-term financial success. The objectives and the measures for the Balanced Scorecard are more than just a somewhat ad hoc collection of financial and nonfinancial performance measures; they are derived from a top-down process driven by the mission and strategy
of the business unit. The Balanced Scorecard should translate a business unit’s mission and strategy into tangible objectives and measures. The measures represent a
balance
between external measures for shareholders and customers, and internal measures of critical business processes, innovation, and learning and growth. The measures are
balanced
between the outcome measures—the results from past efforts—and the measures that drive future performance. And the scorecard is
balanced
between objective, easily quantified outcome measures and subjective, somewhat judgmental, performance drivers of the outcome measures.
Figure 1-1
The Balanced Scorecard Provides a Framework to Translate a Strategy into Operational Terms
Source:
Robert S. Kaplan and David P. Norton, “Using the Balanced Scorecard as a Strategic Management System,”
Harvard Business Review
(January–February 1996): 76. Reprinted with permission.
- Clarify and translate vision and strategy
- Communicate and link strategic objectives and measures
- Plan, set targets, and align strategic initiatives
- Enhance strategic feedback and learning
LARIFY AND
T
RANSLATE
V
ISION AND
S
TRATEGY
The scorecard process starts with the senior executive management team working together to translate its business unit’s strategy into specific strategic objectives. To set financial goals, the team must consider whether to emphasize revenue and market growth, profitability, or cash flow generation. But especially for the customer perspective, the management team must be explicit about the customer and market segments in which it has decided to compete. For example, one financial institution thought its top 25 senior executives agreed about its strategy: to provide superior service to targeted customers. In formulating customer objectives for the scorecard, however, it became clear that each executive had a different definition as to what superior service represented and who were the targeted customers. The process of developing operational measures for the scorecard brought consensus among all 25 executives as to the most desirable customer segments, and the products and services the bank should offer to those targeted segments.
Figure 1-2
The Balanced Scorecard as a Strategic Framework for Action
Source:
Robert S. Kaplan and David P. Norton, “Using the Balanced Scorecard as a Strategic Management System,”
Harvard Business Review
(January–February 1996): 77. Reprinted with permission.
The process of building a Balanced Scorecard clarifies the strategic objectives and identifies the critical few drivers of the strategic objectives. In our experience with the design of scorecard programs, we have never encountered a management team that had reached full consensus on the relative importance of its strategic objectives. In general, these are harmonious teams in well-managed organizations. The reason for the lack of consensus can usually be related to the functional history and culture of the organization. Executives tend to build careers within a single function. Certain functions tend to dominate the priorities. For example, oil companies tend to be dominated by the technical and cost focus of the refineries, at the expense of marketing, while consumer goods companies tend to be dominated by a marketing and sales focus, at the expense of technology and innovation. High-tech companies have a strong engineering and technology culture, with manufacturing often being a stepchild. When executives from different functional perspectives, especially in companies that historically operated with strong functional silos, attempt to work together as a team, there are blind spots—areas of relative ignorance around which it is difficult to form teams and create consensus because so little shared understanding exists about overall business objectives and the contribution and integration of different functional units.
The development of a Balanced Scorecard, while making such lack of consensus and teamwork more visible, also contributes to the solution of the problem. Because the scorecard is developed by a group of senior executives, as a team project, the scorecard creates a shared model of the entire business to which everyone has contributed. The scorecard objectives become the joint accountability of the senior executive team, enabling it to serve as the organizing framework for a broad array of important team-based management processes. It creates consensus and teamwork among all senior executives, regardless of previous employment experience or functional expertise.
OMMUNICATE AND
L
INK
S
TRATEGIC
O
BJECTIVES AND
M
EASURES
The Balanced Scorecard’s strategic objectives and measures are communicated throughout an organization via company newsletters, bulletin boards,
videos, and even electronically through groupware and networked personal computers. The communication serves to signal to all employees the critical objectives that must be accomplished if an organization’s strategy is to succeed. Some organizations attempt to decompose the high-level strategic measures of the business unit scorecard into specific measures at the operational level. For example, an on-time delivery (OTD) objective on the business unit scorecard can be translated into an objective to reduce setup times at a specific machine, or to a local goal for rapid transfer of orders from one process to the next. In this way, local improvement efforts become aligned with overall organizational success factors. Once all employees understand high-level objectives and measures, they can establish local objectives that support the business unit’s global strategy.
The scorecard also provides the basis for communicating and gaining commitment to a business unit’s strategy with corporate-level executives and the board of directors. The scorecard encourages a dialogue between business units and corporate executives and board members, not just about short-term financial objectives, but about the formulation and implementation of a strategy for breakthrough performance for the future.
At the conclusion of the communication and linkage process, everyone in the organization should understand the business unit’s long-term goals, as well as the strategy for achieving these goals. Individuals have formulated local actions that will contribute to achieving business unit objectives. And all organizational efforts and initiatives will be aligned to the needed change processes.
LAN
, S
ET
T
ARGETS, AND
A
LIGN
S
TRATEGIC
I
NITIATIVES
The Balanced Scorecard has its greatest impact when it is deployed to drive organizational change. Senior executives should establish targets for the scorecard measures, three to five years out, that, if achieved, will transform the company. The targets should represent a discontinuity in business unit performance. If the business unit were a public company, target achievement should produce a doubling or more of the stock price. Organizational financial targets have included doubling the return on invested capital, or a 150% increase in sales during the next five years. An electronics company set a financial target to grow at a rate nearly double the expected growth rate of its existing customers.
To achieve such ambitious financial objectives, managers must identify stretch targets for their customer, internal-business-process, and learning
and growth objectives. These stretch targets can come from several sources. Ideally, the targets for the customer measures should be derived from meeting or exceeding customer expectations. Both existing and potential customer preferences should be examined to identify the expectations for outstanding performance. Benchmarking can be used to incorporate existing best practice and to verify that internally proposed targets will not keep the business unit trailing in strategic measures.
Once targets for customer, internal-business-process, and learning and growth measures are established, managers can align their strategic quality, response time, and reengineering initiatives for achieving the breakthrough objectives. Thus, the Balanced Scorecard provides the front-end justification, as well as focus and integration for continuous improvement, reengineering, and transformation programs. Rather than just apply fundamental process redesign to any local process where gains might be easily obtained, managerial efforts are directed to improving and reengineering processes that are critical for the organization’s strategic success. And unlike conventional reengineering programs, where the objective is massive cost cutting (the slash and burn rationale), the reengineering program’s objective need not be measured by cost savings alone. The targets for the strategic initiative are derived from such scorecard measures as dramatic time reductions in order fulfillment cycles, shorter time-to-market in product development processes, and enhanced employee capabilities. These time compressions and expanded capabilities, of course, are not the ultimate objective. Through a series of cause-and-effect relationships embodied in the Balanced Scorecard, these capabilities eventually become translated into superior financial performance.
The Balanced Scorecard also enables an organization to integrate its strategic planning with its annual budgeting process. At the time when a business establishes 3–5 year stretch targets for the strategic measures, managers also forecast milestones for each measure during the next fiscal year—how far along they expect to be during the 12 months of year one of the plan. These short-term milestones provide specific targets for assessing progress in the near term along the business unit’s long-term strategic trajectory.
The planning and target-setting management process enables the organization to:
NHANCE
S
TRATEGIC
F
EEDBACK AND
L
EARNING
The final management process embeds the Balanced Scorecard in a strategic learning framework. We consider this process to be the most innovative and most important aspect of the entire scorecard management process. This process provides the capability for organizational learning at the executive level. Managers in organizations today do not have a procedure to receive feedback about their strategy and to test the hypotheses on which the strategy is based. The Balanced Scorecard enables them to monitor and adjust the implementation of their strategy, and, if necessary, to make fundamental changes in the strategy itself.
By having near-term milestones established for financial, as well as other BSC measures, monthly and quarterly management reviews can still examine financial results. More important, however, they can also examine closely whether the business unit is achieving its targets for customers, for internal processes and innovation, and for employees, systems, and procedures. Management reviews and updates shift from reviewing the past to learning about the future. Managers discuss not only how past results have been achieved but also whether their expectations for the future remain on track.
The process of strategic learning starts with the first process in Figure 1-2, the clarification of a shared vision that the entire organization wants to achieve. The use of measurement as a language helps translate complex and frequently nebulous concepts into a more precise form that can gain consensus among senior executives. The communication and alignment process, the second process in Figure 1-2, mobilizes all individuals into actions directed at attaining organizational objectives. The emphasis on cause and effect in constructing a scorecard introduces dynamic systems thinking. It enables individuals in various parts of an organization to understand how the pieces fit together, how their role influences others and, eventually, the entire organization. The planning, target setting, and strategic initiative process—the third process in Figure 1-2—defines specific, quantitative performance goals for the organization across a balanced set of outcomes and performance drivers. A comparison of the desired performance goals with current levels establishes the performance gap that strategic
initiatives can be designed to close. Thus the Balanced Scorecard not only measures change; it fosters change.
The first three critical management processes shown in Figure 1-2 are vital for implementing strategy. But, by themselves, they are insufficient. For a simpler world, they would be adequate. The theory behind the top-down command-and-control model is that the captain of the ship (the CEO) determines the direction and speed of the ship (the business unit). The sailors (the managers and front-line employees) carry out the orders and implement the plan determined by the captain. Operational and management control systems are established to ensure that the managers and employees act in accordance with the strategic plan established by senior executives. This linear process of establishing a vision and strategy, communicating and linking the vision and strategy to all organizational participants, and aligning organizational actions and initiatives to achieving long-run strategic goals is an example of a single-loop feedback process. With single-loop learning, the objective remains constant. Departures from planned results do not cause people to question whether the planned results are still desirable. Nor do they question whether the methods being used to accomplish the objectives are still appropriate. Departures from the planned trajectory are treated as defects, with remedial actions launched to bring the organization back onto the intended path.
The strategies for information age organizations, however, cannot be this linear or this stable. Today’s information age organizations operate in more turbulent environments, and senior managers need to receive feedback about more complicated strategies. The planned strategy, though initiated with the best of intentions and with the best available information and knowledge, may no longer be appropriate or valid for contemporary conditions. The metaphor is closer to that of sailing in a highly competitive race, under changing weather and sea conditions, than that of steering an isolated ship, through a stable environment, to a destination. In a sailboat race, a chain of command still exists. But the captain is constantly monitoring the environment, being highly sensitive and often responding tactically and strategically to shifts in competitors’ behavior, team and boat capabilities, wind conditions, and water current. And the captain must receive information from a myriad of sources, such as personal observation, instrumentation and measurements, and, especially, the advice of tacticians on the boat who also survey the conditions so that they can devise plans to take advantage of environmental changes and to counter competitor behavior.
In such constantly shifting environments, new strategies can emerge from capitalizing on opportunities or countering threats that were not anticipated when the initial strategic plan was articulated. Frequently, ideas for seizing new opportunities come from managers farther down in the organization.
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Yet traditional management systems do not encourage nor facilitate the formulation, implementation, and testing of strategy in continually changing environments.
Organizations need the capacity for double-loop learning.
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Double-loop learning occurs when managers question their underlying assumptions and reflect on whether the theory under which they were operating remains consistent with current evidence, observations, and experience. Of course, managers need feedback about whether their planned strategy is being executed according to plan—the single-loop learning process. But even more important, they need feedback about whether the planned strategy remains a viable and successful strategy—the double-loop learning process. Managers need information so that they can question whether the fundamental assumptions made when they launched the strategy are valid.