Five minutes on … the balanced scorecard

which measure?
A recent survey by the Institute of Management Accountants found that 64% of US companies are experimenting with some sort of new performance measurement system.
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
    ie 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? eg 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; eg 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; eg 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; eg product development cycle, customer satisfaction survey 
  • is weighted
    measures are grouped and given a weighting according to their importance to the individual firm; eg financial measures (60%), customer measures (30%), operations (10%) 
  • is an ideal measurement model for stand-alone business units
    most corporations are too diverse (eg different products, strategies, processes) for meaningful application of the scorecard which likes to measure like with like; eg 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; eg 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 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; eg if managers track only cashflow, the firm may eventually stop investing in long-term opportunities
FINDING THE IDEAL WEIGHT
  • the Americas Marketing & Refining Division of Mobil Oil now gauges its progress using a scorecard comprising 23 measures, only 5 of which are strictly financial
  • in contrast, while financials comprise just one of four categories on Cigna P&C’s scorecard, the financials count for 50% of employees’ bonus
how does it work?
The scorecard aims to set objectives and measures in 4 main areas (referred to as ‘perspectives’ on the scorecard):1. 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 – eg the growth stage will call for revenue generation, the mature stage cashflow.
2. 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
3. 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
IN PRACTICE
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 eg 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
4. 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:1. strategy
what is the company/business unit trying to achieve?

2. action
given this strategy, what are the actions crucial to achieving it?

3. 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, Rexam Customer Europe, a precision coater and laminator, 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, don’t 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 can’t 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 won’t know their effect on business performance
Plot the course correctly, and your firm’s journey should be turbulence-free. Get it wrong, and you’ll 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 %
  • No. 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
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