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 (4 page)
A properly constructed Balanced Scorecard articulates the theory of the business. The scorecard should be based on a series of cause-and-effect relationships derived from the strategy, including estimates of the response times and magnitudes of the linkages among the scorecard measures. For example, how long before improvements in product quality and on-time delivery will lead to an increased share of customers’ business and higher margins on existing sales, and how large will the effect be? With such quantification of the linkages among scorecard measures, periodic reviews and performance monitoring can take the form of hypothesis testing.
If an organization’s employees and managers have delivered on the performance drivers—such as reskilling of employees, availability of information systems, development of new products and services—then failure to achieve the expected outcomes—for example, higher sales or multiple products sold per customer—signals that the theory embodied in the strategy may not be valid. Such disconfirming evidence should be taken seriously. Managers must then engage in an intense dialogue to review market conditions, the value propositions they are delivering to targeted customers, competitor behavior, and internal capabilities. The result may be to reaffirm belief in the current strategy but to adjust the quantitative relationship among the strategic measures on the Balanced Scorecard. Alternatively, the intensive strategic reviews may reveal that an entirely new strategy is
required—a double-loop learning outcome—in light of the new knowledge about market conditions and internal capabilities. In either case, the scorecard will have stimulated learning among key executives about the viability and validity of their strategy. In our experience, this process of data gathering, hypothesis testing, reflection, strategic learning, and adaptation is fundamental to the successful implementation of business strategy.
This strategic feedback and learning process completes the loop embodied in Figure 1-2. The strategic-learning process feeds into the next vision and strategy process where the objectives in the various perspectives are reviewed, updated, and replaced in accordance with the most current view of the strategic outcomes and required performance drivers for the upcoming periods.
Information age companies will succeed by investing in and managing their intellectual assets. Functional specialization must be integrated into customer-based business processes. Mass production and service delivery of standard products and services must be replaced by flexible, responsive, and high-quality delivery of innovative products and services that can be individualized to targeted customer segments. Innovation and improvement of products, services, and processes will be generated by reskilled employees, superior information technology, and aligned organizational procedures.
As organizations invest in acquiring these new capabilities, their success (or failure) cannot be motivated or measured in the short run by the traditional financial accounting model. This financial model, developed for trading companies and industrial age corporations, measures events of the past, not the investments in the capabilities that provide value for the future.
The Balanced Scorecard is a new framework for integrating measures derived from strategy. While retaining financial measures of past performance, the Balanced Scorecard introduces the drivers of future financial performance. The drivers, encompassing customer, internal-business-process, and learning and growth perspectives, are derived from an explicit and rigorous translation of the organization’s strategy into tangible objectives and measures.
The Balanced Scorecard, however, is more than a new measurement system. Innovative companies use the scorecard as the central, organizing
framework for their management processes. Companies can develop an initial Balanced Scorecard with fairly narrow objectives: to gain clarification, consensus, and focus on their strategy, and then to communicate that strategy throughout the organization. The real power of the Balanced Scorecard, however, occurs when it is transformed from a measurement system to a management system. As more and more companies work with the Balanced Scorecard, they see how it can be used to
- clarify and gain consensus about strategy,
- communicate strategy throughout the organization,
- align departmental and personal goals to the strategy,
- link strategic objectives to long-term targets and annual budgets,
- identify and align strategic initiatives,
- perform periodic and systematic strategic reviews, and
- obtain feedback to learn about and improve strategy.
The Balanced Scorecard fills the void that exists in most management systems—the lack of a systematic process to implement and obtain feedback about strategy. Management processes built around the scorecard enable the organization to become aligned and focused on implementing the long-term strategy. Used in this way, the Balanced Scorecard becomes the foundation for managing information age organizations.
1
. A. D. Chandler, Jr.,
Scale and Scope: The Dynamics of Industrial Capitalism
(Cambridge, Mass.: Harvard University Press, 1990).
2
. See A. D. Chandler, Jr.,
The Visible Hand: The Managerial Revolution in American Business
(Cambridge, Mass.: Harvard University Press, 1977) and T. H. Johnson and R. S. Kaplan,
Relevance Lost: The Rise and Fall of Management Accounting
(Boston: Harvard Business School Press, 1987).
3
. H. Itami,
Mobilizing Invisible Assets
(Cambridge, Mass.: Harvard University Press, 1987).
4
. J. Champy and M. Hammer,
Reengineering the Corporation: A Manifesto for Business Revolution
(New York: HarperBusiness, 1993).
5
. Industrial age companies used traditional production and service delivery processes to supply different models and options to diverse consumers. This high-cost approach was not made visible until the development of activity
based cost systems in the mid-1980s; see R. Cooper and R. S. Kaplan, “Measure Costs Right: Make the Right Decisions,”
Harvard Business Review
(September–October 1988): 96–103. Now companies recognize they must either achieve greater focus in the customer segments they choose to serve or deploy technology-based product and service delivery processes that enable high-variety outputs to be supplied at low resource costs.
6
. J. L. Bower and C. M. Christensen, “Disruptive Technologies: Catching the Wave,”
Harvard Business Review
(January–February 1995): 43–53.
7
. R. S. Kaplan and A. Sweeney, “Romeo Engine Plant,” 9-194-032 (Boston: Harvard Business School, 1994).
8
. R. K. Elliott, “The Third Wave Breaks on the Shores of Accounting,”
Accounting Horizons
(June 1992): 61–85.
9
. R. Simons,
Levers of Control: How Managers Use Innovative Control Systems to Drive Strategic Renewal
(Boston: Harvard Business School Press, 1995), 20.
10
. For an extensive discussion of single-and double-loop learning in management processes, see Chris Argyris and Donald A. Schön,
Organizational Learning II: Theory, Method, and Practice
(Reading Mass.: Addison-Wesley, 1996); and “Teaching Smart People How to Learn,”
Harvard Business Review
(May–June 1991): 99–109.
C h a p t e r T w oWhy Does Business Need a Balanced Scorecard?
M
EASUREMENT MATTERS
: “If you can’t measure it, you can’t manage it.” An organization’s measurement system strongly affects the behavior of people both inside and outside the organization. If companies are to survive and prosper in information age competition, they must use measurement and management systems derived from their strategies and capabilities. Unfortunately, many organizations espouse strategies about customer relationships, core competencies, and organizational capabilities while motivating and measuring performance only with financial measures. The Balanced Scorecard retains financial measurement as a critical summary of managerial and business performance, but it highlights a more general and integrated set of measurements that link current customer, internal process, employee, and system performance to long-term financial success.
Historically, the measurement system for business has been financial. Indeed, accounting has been called the “language of business.” Bookkeeping records of financial transactions can be traced back thousands of years, when they were used by Egyptians, Phoenicians, and Sumerians to facilitate commercial transactions. A few centuries later, during the age of exploration, the activities of global trading companies were measured and monitored
by accountants’ double-entry books of accounts. The Industrial Revolution, during the nineteenth century, spawned giant textile, railroad, steel, machine-tool, and retailing companies. Innovations in measuring the financial performance of these organizations played a vital role in their successful growth.
1
And financial innovations, such as the return-on-investment (ROI) metric, and operating and cash budgets, were critical to the great success of early-twentieth century enterprises like DuPont and General Motors.
2
The post–World War II trend to diversified enterprises created an intracorporation demand for reporting and evaluation of business unit performance, a practice used extensively by diversified companies like General Electric and made famous, if not notorious, by the rigorous financial reporting and controls of Harold Geneen at IT&T.
Thus, as we stand at the end of the twentieth century, the financial aspect of business unit performance has been highly developed. Many commentators, however, have criticized the extensive, even exclusive use of financial measurements in business.
3
At its heart, an overemphasis on achieving and maintaining short-term financial results can cause companies to overinvest in short-term fixes and to underinvest in long-term value creation, particularly in the intangible and intellectual assets that generate future growth.
As a specific example, the FMC Corporation through the 1970s and 1980s produced one of the best financial performances of any large U.S. corporation. Yet in 1992, a new management team performed a strategic review to determine the best future course to maximize shareholder value. The review concluded that while excellent short-run operating performance was still important, the company had to launch a growth strategy. Larry Brady, president of FMC, recalled:
As a highly diversified company
, …
the return-on-capital-employed (ROCE) measure was especially important to us. At year-end, we rewarded division managers who delivered predictable financial performance. We had run the company tightly for the past 20 years and had been successful. But it was becoming less clear where future growth would come from and where the company should look for breakthroughs into new areas. We had become a high return-on-investment company but had less potential for further growth. It was also not at all clear from our financial reports what progress we were making in implementing long-term initiatives.
4
As another example, Xerox, up through the mid-1970s, enjoyed a virtual monopoly on plain paper copiers. Xerox did not sell its machines; it leased them and earned revenues on every copy made on these machines. Sales and profits from leasing machines, and those of supporting items like paper and toner, were large and growing. But customers, apart from concern about high copying costs, for which no ready alternative was available, were disgruntled about the high breakdown rates and malfunctions of these expensive machines.
5
Rather than redesign the machines so that they would break down less frequently, Xerox executives saw an opportunity to enhance their financial results even further. They permitted direct purchase of their machines, and then established an extensive field service force as a separate profit center, to repair broken machines at customer locations. Given the demand for its services, this division soon was a substantial contributor to Xerox’s profit growth. Furthermore, since no output could be produced while waiting for the service person, companies bought additional machines as backups, so sales and profits grew even higher. Thus, all the financial indicators—sales and profit growth, return on investment—were signaling a highly successful strategy.
But customers were still unhappy and surly. They did not want their supplier to excel at having a superb field service force. They wanted cost-efficient machines that did not break down. When Japanese and American entrants were eventually able to offer machines that produced comparable or even better quality copies, that did not break down, and that were lower priced, they were embraced by Xerox’s dissatisfied and disloyal customers.
Xerox, one of the most successful U.S. companies from 1955 to 1975, almost failed. Only under a new CEO, with a passion for quality and customer service that he communicated throughout the organization, did the company make a remarkable turnaround in the 1980s.
Financial measures are inadequate for guiding and evaluating organizations’ trajectories through competitive environments. They are lagging indicators that fail to capture much of the value that has been created or destroyed by managers’ actions in the most recent accounting period. The financial measures tell some, but not all, of the story about past actions and they fail to provide adequate guidance for the actions to be taken today and the day after to create future financial value.