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Describing
The Essentials Of What We Do
Responsibility
and trust are watchwords at today’s companies. But what
is a manager responsible for? For decades we have been
talking about "decentralized profit responsibility".
We usually measure results in monetary terms. The income
statements which we prepare for particular business units
and departments are modelled on the income statement of
the company.
Is
this enough? Is the mission of the various parts of a
company simply to create profits and return on investment?
In many cases probably not. Wise executives know that
their company must develop the capabilities which it will
need to prosper in the future. But doing so will produce
no profits in the current year, only costs.
Here,
we believe, lies the fundamental reason why companies
require a balanced scorecard. The need is even
clearer for the many organizations without profit as a
goal, including government agencies, internal staff units
in industry, and others. We have to do more to describe
what we expect of an operation, and how well our expectations
are being met.
Perhaps
this matter was less urgent before. Both sales and production
were primarily focused on the short run. Preparing for
the future was something companies did in their development
departments and through requirements of centralized authorization
for capital expenditures.
Today
we no longer consider this approach adequate. Preparing
for the future is about investing in competence, cultivating
customer relationships, and creating databases. Much of
this work is done elsewhere in the organization than at
headquarters. There is a danger that profit targets will
clash with long-term decisions.
Later
we will consider how profit targets can be reformed so
as better to reflect what is really important. But for
many employees throughout the company, other ways of describing
what they do will say more and be more convincing. These
other ways are what we want to use in our scorecards.
The balanced scorecard is a method for reaching agreement
on where an operation should be heading and for making
sure that it stays on course.
Using
terms other than monetary ones to explain what you are
doing is nothing new. Various kinds of key ratios can
be found in abundance in business and the public sector.
The difference lies in focusing on a deliberately selected
set of measures – few enough to keep track of – and in
using them to achieve and communicate a shared view of
the organization’s strategy for its future development.
As the term implies, the scorecard is an aid in creating
a "balance" among various factors to be considered.
The balance adopted reflects the strategic choices of
the business.
We
regard the measures selected as a complement to financial
controls, and as a means of reducing the danger of a harmful
short-term approach while at the same time making the
employees of the organization more aware of the meaning
of their work and of the underlying assumptions about
the future and about the company. Some refer to a change
of approach from economic control to strategic control.
However, the question is really one of economy in a deeper
sense than the monetary one carelessly used in everyday
parlance. Good economy means good resource management.
Today’s companies are so much more than just an investment
in monetary capital. For many of us, how we manage talent,
market position, and accumulated knowledge is at least
as important!
An
Example
For
a number of years the Product Company had been endeavouring
to spread profitability awareness throughout the organization.
Capital turnover was satisfactory, and production costs
had been squeezed down. Selling efforts were focused on
the most profitable products.
But
there was a hitch. The factory was extremely reluctant
to modernize its technology, and sales gave higher priority
than ever to existing customers. The reason was their
concern with profitability. Certainly the Product Company
was anxious not to spend too much on uncertain projects
for the future. But the managing director realized that
the company would be in trouble if something happened
to the existing plant and equipment or to existing customers.
The board of directors had just been discussing visions
and strategies for the coming century. But were the employees
also thinking along these lines?
The
managing director brought up this subject with the financial
vice-president, who agreed that financial control at the
company tended to be short-sighted. But there was a way
to add other considerations beside profitability awareness,
and to emphasize a balance between profits today and preparedness
for tomorrow. The methods, referred to as the balanced
scorecard, meant that employees would share the vision
of the board of directors.
A
Simple Basic Concept
The
initial thinking on the balanced-scorecard concept was
presented in an article by Robert S. Kaplan and David
P. Norton in the first issue of the 1992 Harvard Business
Review. In viewing a company from four vital perspectives
(Figure 1.1), the balanced scorecard is intended to link
short-term operational control to the long-term vision
and strategy of the business. In this way the company
focuses on a few critical key ratios in meaningful target
areas. In other words, the company is forced to control
and monitor day-to-day operations as they affect development
tomorrow. Therefore, the balanced-scorecard concept is
based on three dimensions in time: yesterday, today, and
tomorrow. What we do today for tomorrow may have no noticeable
financial impact until the day after tomorrow. The company’s
focus is thus broadened, and it becomes relevant to keep
a continuous watch on non-financial key ratios.
Key
ratios or non-financial measures are nothing new. It has
long been known that running a company can hardly be reduced
to optimizing monetary profits, and the necessity of using
non-financial measures to keep track of the business is
not new, either. But the management style of the 1980s
at many companies was based on decentralized profit responsibility
and an internal division of the business into a number
of separate companies. This recipe had been tried not
only at large corporations but surprisingly often at smaller
ones as well. Now in the 1990s it was time for alternatives.
Since
1992 interest in the balanced scorecard has become widespread.
We have noticed that the concept strikes a responsive
chord with many executives. Middle managers have been
especially receptive; it has been easy for them to see
their operations in balanced-scorecard terms, as a balancing
act between different significant interests. At upper
levels of management, though, the suggestion that key
ratios and non-financial measures be used for control
has had a hard time competing with seemingly more business
like profit goals. Therefore, it is important that we
consider carefully what we want from a scorecard and what
traps we may encounter along the way.
In
this book we will devote special attention to how the
balanced-scorecard concept has worked in a number of practical
cases. The simplicity of the basic concept has led people
to mean and to do different things in the name of introducing
it. We ourselves have seen some beneficial effects, but
also some efforts which have not advanced beyond the discussion
stage. For this reason we will place particular emphasis
on the various ways of applying the balanced-scorecard
concept in practice.
Outcome
Measures Or Performance Drivers?
In
a balanced scorecard, outcome measures are combined with
measures that describe resources spent or activities performed.
In principle, the former are located higher up in Figure
1.1, and the latter further down. However, we may want
to measure the outcomes of a development project as part
of the scorecard’s "learning and growth" perspective,
and this in turn may be seen as an input for marketing
or production, i.e. "internal processes". By
talking of "performance drivers", we underline
that we want to measure those factors that will determine
or influence future outcomes.
Traditionally,
management control stresses decentralized profit goals
which means that it is mostly focused on outcomes. In
Figure 1.2 we use a traditional input-output model to
illustrate how goals and measures may be placed along
a causal chain, from resource input to the effects obtained.
By effect we mean the action of one thing on another,
or some kind of outcome: a higher reported profit, a better
reputation, or a diminished environmental impact, for
example. Several of these effects will in turn influence
the company’s future operations, thus becoming a kind
of input for the operations of the subsequent period.
This relationship is clearest in the case of internal
outcomes: new learning, improved processes, a greater
volume of registered data on customers.
In
general it is better to measure at the right of the figure.
Only when we see the effects do we know whether an intelligently
planned resource input or a well-managed operation was
actually successful. But often the effects which we seek
are not immediately or clearly apparent. Moreover, people
in charge of an operation may justifiably claim that their
performance should be monitored and judged on the basis
of how the operation is managed, or even how economically
it is managed. The responsibility for whether an operation
produces the desired effects lies with the executives
who have decided that the operation is to be conducted.
Measures should then describe operations or even inputs.
Therefore,
in actual practice there are often reasons to exercise
management control through measures at the left of the
figure. Sometimes these act as "surrogate measures"
of conditions closer to the actual effects. We believe
that satisfied customers will be loyal, but we do not
know for sure. We believe that rapid delivery means satisfied
customers, but we do not know the exact nature of the
relationship, or at least we would need a certain period
of observation to learn how the two are connected. It
is because of this that we may refer to the measures at
the left of the figure as performance drivers. By understanding
them, and taking care to manage them well, we can improve
performance in a way which over time will result in better
outcomes and effects.
Management
control which focuses solely on decentralized short-term
profit will fail to present a large part of this fuller
picture of an operation. Profit is a good measure, but
usually it does not tell us enough about how an operation
is managed. At least if the operation is based on some
form of identity which is cultivated over time and intended
to last over a longer period.
Good
scorecards will combine outcome measures, of which profit
is only one, with performance drivers. Often it is difficult
to draw the line between the two. They are interrelated
in a chain of ends and means; for people in charge of
logistics, delivery time is an outcome, but for purposes
of customer relations it may be considered as one of several
performance drivers that can improve customer loyalty.
We believe that to an increasing degree scorecards will
also illustrate how our business is based on assumptions
about links among different measures; these assumptions
are in turn used to justify the way we do our work.
Being
Foresighted And Yet Flexible
We
are all aware that we live in an era of change. Technology
influences our daily lives to a greater extent than we
could possibly have imagined only a few years ago. Markets
become fragmented when customers realize how they can
satisfy their individual demands. This development poses
a challenge to the adaptive capacity of business. Communication
with customers must be accommodated to suit virtually
every individual. This requirement applies not only to
companies that sell to other companies but also to the
so-called mass market. Communication fosters growing customer
expectations that products will be especially suited to
their own needs, perhaps increasingly often even totally
individualized.
Such
demands can be met. But the conclusion is not that we
can avoid planning and content ourselves with reacting
defensively. Individually adapted, relationship-based
marketing presupposes that we have cultivated the ability
to manage customers and products accordingly. For there
are no standard recipes, no ready-made solutions which
we can purchase as needed. To an increasing extent, the
decisive factors will be information systems and employee
competence. And of course the goodwill capital which we
have built up in our customer relationships.
All
these requirements call for dynamic organizations with
a high degree of employee autonomy. Traditional financial
control is ill-adapted to such an environment. Not only
is the information which it produces often outdated and
too imprecise to provide a basis for decisions on customer
relationships or products; in addition, autonomous employees
need goals and incentives other than the usual ones based
on profit and return on investment and modelled on the
income statements used in financial accounting. Other
guides are needed to show the way consistent with the
comprehensive vision or concept of business. The organization
as a whole must be aware of and understand the overall
strategies and rules of the game. These in turn should
be based on a consensus regarding the necessary priorities.
For
these reasons, we believe that the balanced scorecard has
its place and an important role to play. The concept is
an aid in the essential process of arriving at a shared
view of the business environment and of the company. It
also provides a new foundation for strategic control.
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