Scorecards and new measures of performance - why now?

Looking through the recent Fortune 500 list, it is striking how the "immaterial" assets of companies are gaining in importance as part of shareholder value. The balance sheet of Wal-Mart accounts for only about one fifth of the value of Wal-Mart, according to the stock market. For Coca-Cola, the relation is one to ten; for Microsoft one to eighteen.

Balance sheet valuations can be disputed, and the stock market is fickle. To some extent these discrepancies may be a consequence of exaggerated expectations about continued future growth and profits. But the tendency is the same for most firms: the most important assets are moving out from the balance sheet. Boardroom discussions increasingly concern strategic investments in markets, abilities, talents, information systems, and contacts. None of these turn up on the balance sheet. And these investments are not even recognised as such in the accounts.

This should worry chief executives and controllers, but also legislators and educators. So much of our conventional means of controlling and understanding industrial activity is linked to traditional accounting. Accepted and widely-taught metrics like 'return on capital employed' are firmly based on the idea that management is responsible for maintaining and utilising the assets put at their disposal by the owners, as described in the accounts. Of course we could change accounting principles and recognise immaterial investment as assets, depreciate them over a suitable number of years, etc. But this creates new problems in agreeing on how to do this. International accounting rules will take time to change, even if we would agree they should.

So many businesses are left with a daunting control problem: How to plan and control our most important assets, when traditional accounting gives little guidance, and maybe even a distorted and misleading image? This concerns not only world-famous companies like the ones mentioned above. The problem may be even larger for start-ups who have to convince their bank that a first-year accounting loss was really an essential investment in customer contacts and program code. On the national level, statistics on investment behaviour are probably gravely misleading. When I write this, there are worries over the profit performance of Swedish telecom equipment company Ericsson. Maybe the markets should instead worry that it does show a profit, when all earnings should be invested in immaterial investments?

It is obviously not enough to reduce profits and claim that all costs are really investments. Which leads us back to the planning-and-control question: how can anyone know the difference between waste and essential immaterial investments, when both show up as costs? This is true of top management, as well as the stock market and national policy makers.

One could claim that the difference is not possible to judge, because only the future will tell. Investments in new information systems, abilities, or business contacts, may prove highly profitable and useful - but they often turn out to have been mistakes. But so do the investments that are recognised as assets: equipment, properties, shops. There is no good reason to believe that immaterial assets will always be more risky than material ones. Maybe we even add to their risk by writing them off immediately and treating them as invisible?

We recently talked to a group of Swedish executives about this and also ran a small questionnaire study. Most believed that at least 10-20% of their costs could be regarded as immaterial investments. Asked if it happens that they avoid discussing such spending with their boards in order to "protect" them from cuts, 40% said 'never'. But this means that it does happen for 60%, and 18% thought they did so 'fairly often'.

What I have been saying here is not new. There are movements afoot to change accounting standards both nationally and internationally - but these are happening slowly. A large number of books are issued with titles like Knowledge management, Intellectual capital, Learning organisations - all attempts to get a grip on how you control the invisible. (Two years ago I co-authored a Wiley book which describes a specific type of immaterial business leadership: Bo Hedberg et al., Virtual Organizations and Beyond - Discover Imaginary Systems. In the book, we discuss a situation which is more and more common: that the organisation which is managed transcends the borders of the legal company and includes partners elsewhere i.e. an 'imaginary organisation'. Immaterial investments are made in building trustful relationships and sometimes even in financing assets that will be legally owned by partners.)

The most promising development, at least for someone like myself with a background in management control, is the idea to improve our use of control information. In particular, the concept of a 'balanced scorecard' has gained wide currency since introduced by Kaplan and Norton in an HBR article in 1992. The idea really is quite simple. Faced with the control problem as described above, the best we can do is to improve communication between all involved. We have to work more systematically to describe immaterial assets, the logic behind them, and what they yield in terms of benefits. Responsibilities and ownership are at least as important for such assets as they are for other forms of 'capital employed'. If there is uncertainty about their future value, this only makes it even more important to discuss how they should be developed and utilised. If we cannot talk about them, decisions are left at the discretion of a few people who may be seen as experts. But immaterial investments in development departments, new markets, competence, alliances, etc. should be logically motivated by the vision that a company has of its role in its future market. Such bets may of course be "covered": all eggs should not be in the same basket, and a certain volume of totally free experimentation may be valuable. But we should be able to discuss how much. Usually, there is no one expert who should judge this, and we also need to gain the support and trust of the many employees who will assist in making these investments a success.

Communication about the resources we devote to preparing for our future has to be linked with more traditional planning and budgeting. The balanced scorecard is called balanced because it tries to give a balanced picture of a business - or indeed of any human activity. Most of us prepare for the future at the same time as we produce some form of results short-term. How much we invest should depend on our ideas about the future, what kind of impact we believe it has on our future abilities, and how much we care about the future.

The people you want to attract to your company increasingly think about the "fit" between their lives and their professional activities. Scorecard discussions should extend downwards in the firm to provide believable rationales for our activities. A sales person nowadays is expected not only to sell, but also to find new customers, improve customer satisfaction, learn about and introduce new products (and encourage customers to discontinue old ones), provide feedback from users to guide product development, maintain computerised files on customer contacts, learn new information systems, and maybe teach new colleagues. Yet the most widespread measure of success still is sales volume. (Probably not even the profit from these sales as it is harder to calculate.) And it is a common experience in most industries that you maximise sales by concentrating on repeat customers and well-known products. If you really want to involve sales personnel and create the new role that we read about in the books on 'relationship marketing' or the 'learning organisation', you have to develop new measures and use them in new ways to motivate and reward people.

The balanced scorecard does this through a few simple means. One is the almost simplistic format of the scorecard itself, where a restricted number of measures are used for each of four perspectives on a business activity: its financial performance; its customer interface; its internal processes; and its learning and development. Another is the insistence that these perspectives should be "linked". The particular efforts we decide to make in order to learn, or improve our processes, or make customers happier, should be based on our conviction that these will cause future success. It is rarely possible to prove such linkages in any strict manner. But when we talk about them in the organised way required for the scorecard process, our views of the future and the logic of our ideas will be scrutinised and communicated to everyone concerned. The goal is to find agreement about how much time, effort, and money should be spent on preparing for the future, and in what ways, and how this should be balanced against short-term tasks that often seem more urgent. By doing this, we also may recognise that the sales person who was described earlier is an important part of our immaterial investments in an improved customer base, and even contributes to product development. This recognition is good for the sales person, and a small step in explaining how current activities affect the 'intellectual capital' which the market values when it sets a high share price.

Yet another reason that the idea of scorecards is catching on is the availability of improved information systems. The measures used in scorecards can now be reported and made available on a company's intranet. For employees who were involved in setting targets for their activities, this kind of feedback should function as highly motivating reinforcement of the intended "balanced" priorities. For instance, we could keep track of how the sales person in the example above handles their different tasks. It may be as important to celebrate successes with the future-oriented tasks as it is to reward for improved current sales.

Performance Drivers - a Practical Guide to Using the Balanced Scorecard (by Olve, Roy, and Wetter) discusses these matters in more depth. In the book we provide examples from a dozen companies who are using scorecards, or similar methods.

We believe this interest confirms the importance of what we said before. The management control practices in an economy where the most important assets are immaterial, intangible and information-based will need to be adapted to the industries, situations and strategies of individual firms, much more than traditional accounting is. We are now developing some of the ground-rules. Maybe in a few years from now, the term 'Balanced scorecard' will be regarded as yet another business fad. If this happens, it will be because a more systematic use of control information will be normal and the label no longer necessary. But the underlying thinking, and the shift in what assets are important, will have a lasting impact on management.

(Nils-Göran Olve, Jan Roy, and Magnus Wetter based their book Performance Drivers - a Practical Guide to Using the Balanced Scorecard on their experiences from Cepro (now ConcoursCepro), a Stockholm-based consultancy firm, and interviews especially for the book with managers in leading Swedish and British firms. It also reflects Professor Olve's research at Linköping University.)