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Authors: Robert S. Kaplan,David P. Norton

Tags: #Non-Fiction, #Business

The Balanced Scorecard: Translating Strategy Into Action (8 page)

BOOK: The Balanced Scorecard: Translating Strategy Into Action
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BALANCED SCORECARD COMPANIES

Throughout the book, we illustrate the innovative measurement practices from many companies. But the comprehensive use of the Balanced Scorecard is told through the experiences of five companies that we have followed closely for the past three years: Rockwater, Metro Bank, Pioneer Petroleum, National Insurance, and Kenyon Stores.

Rockwater is a several-hundred-million-dollar undersea construction company whose clients are major oil, gas, and offshore construction companies. Rockwater, headquartered in Aberdeen, Scotland, is an operating division of Brown & Root Energy Services which, in turn, is part of the Halliburton Corporation, a $4-billion worldwide construction company, headquartered in Dallas, Texas. Rockwater was formed in 1989 by merging two previously independent construction companies, one British and one Dutch. Rockwater’s first president, Norman Chambers, used the Balanced Scorecard, starting in 1992, to unite the culture and operating philosophy of the two companies and to enable the new company to compete on the basis of quality, safety, and value-added relationships with customers, not low price. In 1994, Norman Chambers was promoted to president of Brown & Root Energy Services, where he continues to use the Balanced Scorecard as his strategic management system, now applying it at the group level and to each of the operating companies in the group.

Metro Bank is the retail banking division of a major bank with 8,000 employees, a 30% market share of the region’s core deposit accounts, and about $1 billion in total revenue. The corporate parent is the surviving entity of a merger of two large and highly competitive banks in a major U.S. metropolitan area. The CEO of Metro Bank implemented the Balanced Scorecard, starting in 1993, to communicate and reinforce a new strategy for the merged retail bank, which would shift from its current focus and strengths in transaction-oriented services to offering a full range of financial products and services to targeted customer segments.

Pioneer Petroleum is the U.S. marketing and refining division of a large worldwide integrated petroleum company. Its CEO launched a scorecard process in 1993 to replace the division’s extensive financial analysis and control approach with a new strategic performance-management process. The effort started with a divisionwide scorecard that identified targeted customer segments and broad themes, and then rolled out to developing scorecards for every business and service unit in the division.

National Insurance is the property and casualty division of one of the major, comprehensive U.S. insurance companies. In 1993, when it launched its scorecard project, National had 6,500 employees and $4 billion in revenues. But its operating results were so dismal, with losses measured in the hundreds of millions of dollars, that the parent corporation was considering closing down the company and exiting the property and casualty business entirely. Corporate, in a last ditch effort to save the division, brought in a new management team from outside. The team decided to shift the company from its generalist strategy, where it attempted to provide all underwriting services to all customers and market segments, to a specialist strategy. The team launched its scorecard program to clarify the new strategy and to develop and coordinate the necessary implementation programs. This program also expanded to develop a new strategic management system that succeeded in transforming National into a profitable insurer.

Kenyon Stores is a preeminent U.S. clothing retailer that operates 10 independent retail chains with more than 4,000 outlets and about $8 billion in annual sales. Historically, the individual chains operated independently with little central coordination or integration. Kenyon’s CEO turned to the Balanced Scorecard in 1994 as part of his new strategy to leverage key corporate-level resources and direction to achieve an ambitious sales growth target of $20 billion by the year 2000, mainly from internal growth.

In addition to these five companies, we also draw upon the experience of Analog Devices and FMC Corporation, which were early adopters of the Balanced Scorecard.

C h a p t e r T h r e e
Financial Perspective

B
UILDING A
B
ALANCED
S
CORECARD
should encourage business units to link their financial objectives to corporate strategy. The financial objectives serve as the focus for the objectives and measures in all the other scorecard perspectives. Every measure selected should be part of a link of cause-and-effect relationships that culminate in improving financial performance. The scorecard should tell the story of the strategy, starting with the long-run financial objectives, and then linking them 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-run 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.

Many corporations, however, use identical financial objectives for all their divisions and business units. For example, each business unit may be asked to achieve the same 16% return-on-capital-employed objective that has been established for the entire corporation. Alternatively, if the corporation is employing the economic value-added metric,
1
every business may be told to maximize its economic value-added each period. While this uniform approach is certainly feasible, consistent, and, in some sense, “fair” since all business unit managers will be evaluated by the same metric, it fails to recognize that different business units may follow quite different strategies. Thus, it would be unlikely for one financial metric,
and especially a single target for a single financial metric, to be appropriate across a wide range of business units. So when they start developing the financial perspective for their Balanced Scorecard, business unit executives should determine appropriate financial metrics for their strategy. Financial objectives and measures must play a dual role: they define the financial performance expected from the strategy, and they serve as the ultimate targets for the objectives and measures of all the other scorecard perspectives.

LINKING FINANCIAL OBJECTIVES TO BUSINESS UNIT STRATEGY

Financial objectives can differ considerably at each stage of a business’s life cycle. Business strategy theory suggests several different strategies that business units can follow, ranging from aggressive market share growth down to consolidation, exit, and liquidation.
2
For simplification purposes, we identify just three stages:
3

  • Growth
  • Sustain
  • Harvest

Growth
businesses are at the early stages of their life cycle. They have products or services with significant growth potential. To capitalize on this potential, they may have to commit considerable resources to develop and enhance new products and services; construct and expand production facilities; build operating capabilities; invest in systems, infrastructure, and distribution networks that will support global relationships; and nurture and develop customer relationships. Businesses in the growth stage may actually operate with negative cash flows and low current returns on invested capital (whether one expenses investments in intangible assets or capitalizes them for internal purposes). The investments being made for the future may consume more cash than can currently be generated by the limited base of existing products, services, and customers. The overall financial objective for growth-stage businesses will be percentage growth rates in revenues, and sales growth rates in targeted markets, customer groups, and regions.

Probably the majority of business units in a company will be in the
sustain
stage, where they still attract investment and reinvestment, but are required to earn excellent returns on invested capital. These businesses are expected to maintain their existing market share and perhaps grow it somewhat from year to year. Investment projects will be directed more to relieving bottlenecks, expanding capacity, and enhancing continuous improvement, rather than the long payback and growth option investments that were made during the growth stage.

Most business units in the sustain stage will use a financial objective related to profitability. This objective can be expressed by using measures related to accounting income, such as operating income and gross margin. These measures take the capital invested in the business unit as given (or exogenous) and ask the managers to maximize the income that can be generated from the invested capital. Other, more autonomous business units, are asked not only to manage income flows but also the level of invested capital in the business unit. The measures used for these business units relate accounting income earned to the level of capital invested in the business unit; measures such as return-on-investment, return-on-capital-employed, and economic value-added are representative of those used to evaluate the performance of such business units.

Some business units will have reached a mature phase of their life cycle, where the company wants to
harvest
the investments made in the two earlier stages. These businesses no longer warrant significant investment—only enough to maintain equipment and capabilities, not to expand or build new capabilities. Any investment project must have very definite and short payback periods. The main goal is to maximize cash flow back to the corporation. The overall financial objectives for harvest-stage businesses would be operating cash flow (before depreciation) and reductions in working capital requirements.

Thus, the financial objectives for businesses in each of these three stages are quite different. Financial objectives in the growth stage will emphasize sales growth—in new markets and to new customers and from new products and services—maintaining adequate spending levels for product and process development, systems, employee capabilities, and establishment of new marketing, sales, and distribution channels. Financial objectives in the sustain stage will emphasize traditional financial measurements, such as ROCE, operating income, and gross margin. Investment projects for businesses in this category will be evaluated by standard, discounted cash flow,
capital budgeting analyses. Some companies will employ newer financial metrics, such as economic value-added and shareholder value. These metrics all represent the classic financial objective—earn excellent returns on the capital provided to the business. And the financial objectives for the harvest businesses will stress cash flow. Any investments must have immediate and certain cash paybacks. Accounting measurements—such as return-on-investment, economic value-added, and operating income—are less relevant since the major investments have already been made in these business units. The goal is not to maximize return-on-investment, which may encourage managers to seek additional investment funds based on future return projections. Rather, the goal is to maximize the cash that can be returned to the company from all the investments made in the past. There will be virtually no spending for research or development or to expand capabilities because of the short time remaining in the economic life of business units in the harvest phase.

The development of a Balanced Scorecard, therefore, must start with an active dialogue between the CEO of the business unit and the CFO of the corporation about the specific financial category and objectives for the business unit. This dialogue will identify the role for the business unit in the company’s portfolio. Of course, this dialogue requires that the company CEO and CFO have an explicit financial strategy for each business unit. The positioning of divisions in a financial category is not immutable. A normal progression, which could occur over decades, moves units from growth, to sustain, to harvest, and finally to exit.
4
But occasionally, a business even in a mature, harvest stage might unexpectedly find itself with a growth objective. A sudden technological, market, or regulatory change may take what had previously been a mature, commoditized product or service, and transform it into one with high-growth potential. Such a transformation would completely shift the financial and investment objectives for the business unit. That is why the financial objectives for all business units should be reviewed periodically, probably at least annually, to reaffirm or change the unit’s financial strategy.

BOOK: The Balanced Scorecard: Translating Strategy Into Action
7.96Mb size Format: txt, pdf, ePub
ads

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