Balanced Scorecard -
The Balanced Scorecard—Measures that Drive Performance - Sun and Planets Spirituality AYINRIN
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What
you measure is what you get. Senior executives understand that their
organization’s measurement system strongly affects the behavior of
managers and employees. Executives also understand that traditional
financial accounting measures like return-on-investment and
earnings-per-share can give misleading signals for continuous
improvement and innovation—activities today’s competitive environment
demands. The traditional financial performance measures worked well for
the industrial era, but they are out of step with the skills and
competencies companies are trying to master today.
As managers and academic researchers have tried to remedy the inadequacies of current performance measurement systems,
some have focused on making financial measures more relevant. Others
have said, “Forget the financial measures. Improve operational measures
like cycle time and defect rates; the financial results will follow.”
But managers should not have to choose between financial and operational
measures. In observing and working with many companies, we have found
that senior executives do not rely on one set of measures to the
exclusion of the other. They realize that no single measure can provide a
clear performance target or focus attention on the critical areas of
the business. Managers want a balanced presentation of both financial
and operational measures.
During
a year-long research project with 12 companies at the leading edge of
performance measurement, we devised a “balanced scorecard”—a set of
measures that gives top managers a fast but comprehensive view of the
business. The balanced scorecard
includes financial measures that tell the results of actions already
taken. And it complements the financial measures with operational
measures on customer satisfaction, internal processes, and the
organization’s innovation and improvement activities—operational
measures that are the drivers of future financial performance.
Think
of the balanced scorecard as the dials and indicators in an airplane
cockpit. For the complex task of navigating and flying an airplane,
pilots need detailed information about many aspects of the flight. They
need information on fuel, air speed, altitude, bearing, destination, and
other indicators that summarize the current and predicted environment.
Reliance on one instrument can be fatal. Similarly, the complexity of
managing an organization today requires that managers be able to view
performance in several areas simultaneously.
The
balanced scorecard allows managers to look at the business from four
important perspectives. (See the exhibit “The Balanced Scorecard Links
Performance Measures.”) It provides answers to four basic questions:
The Balanced Scorecard Links Performance Measures
- How do customers see us? (customer perspective)
- What must we excel at? (internal perspective)
- Can we continue to improve and create value? (innovation and learning perspective)
- How do we look to shareholders? (financial perspective)
While
giving senior managers information from four different perspectives,
the balanced scorecard minimizes information overload by limiting the
number of measures used. Companies rarely suffer from having too few
measures. More commonly, they keep adding new measures whenever an
employee or a consultant makes a worthwhile suggestion. One manager
described the proliferation of new measures at his company as its “kill
another tree program.” The balanced scorecard forces managers to focus
on the handful of measures that are most critical.
Several
companies have already adopted the balanced scorecard. Their early
experiences using the scorecard have demonstrated that it meets several
managerial needs. First, the scorecard brings together, in a single
management report, many of the seemingly disparate elements of a
company’s competitive agenda: becoming customer oriented,
shortening response time, improving quality, emphasizing teamwork,
reducing new product launch times, and managing for the long term.
Second,
the scorecard guards against suboptimization. By forcing senior
managers to consider all the important operational measures together,
the balanced scorecard lets them see whether improvement in one area may
have been achieved at the expense of another. Even the best objective
can be achieved badly. Companies can reduce time to market, for example,
in two very different ways: by improving the management of new product
introductions or by releasing only products that are incrementally
different from existing products. Spending on setups can be cut either
by reducing setup times or by increasing batch sizes. Similarly,
production output and first-pass yields can rise, but the increases may
be due to a shift in the product mix to more standard, easy-to-produce
but lower-margin products.
We
will illustrate how companies can create their own balanced scorecard
with the experiences of one semiconductor company—let’s call it
Electronic Circuits Inc. ECI saw the scorecard as a way to clarify,
simplify, and then operationalize the vision at the top of the
organization. The ECI scorecard was designed to focus the attention of
its top executives on a short list of critical indicators of current and
future performance.
Customer Perspective: How Do Customers See Us?
Many companies today have a corporate mission that focuses on the customer.
“To be number one in delivering value to customers” is a typical
mission statement. How a company is performing from its customers’
perspective has become, therefore, a priority for top management. The
balanced scorecard demands that managers translate their general mission
statement on customer service into specific measures that reflect the
factors that really matter to customers.
Customers’
concerns tend to fall into four categories: time, quality, performance
and service, and cost. Lead time measures the time required for the
company to meet its customers’ needs. For existing products, lead time
can be measured from the time the company receives an order to the time
it actually delivers the product or service to the customer. For new
products, lead time represents the time to market, or how long it takes
to bring a new product from the product definition stage to the start of
shipments. Quality measures the defect level of incoming products as
perceived and measured by the customer. Quality could also measure
on-time delivery, the accuracy of the company’s delivery forecasts. The
combination of performance and service measures how the company’s
products or services contribute to creating value for its customers.
Other Measures for the Customer’s Perspective
To
put the balanced scorecard to work, companies should articulate goals
for time, quality, and performance and service and then translate these
goals into specific measures. Senior managers at ECI, for example,
established general goals for customer performance: get standard
products to market sooner, improve customers’ time to market, become
customers’ supplier of choice through partnerships with them, and
develop innovative products tailored to customer needs. The managers
translated these general goals into four specific goals and identified
an appropriate measure for each. (See the exhibit “ECI’s Balanced
Scorecard.”)
ECI’s Balanced Business Scorecard
To
track the specific goal of providing a continuous stream of attractive
solutions, ECI measured the percent of sales from new products and the
percent of sales from proprietary products. That information was
available internally. But certain other measures forced the company to
get data from outside. To assess whether the company was achieving its
goal of providing reliable, responsive supply, ECI turned to its
customers. When it found that each customer defined “reliable,
responsive supply” differently, ECI created a database of the factors as
defined by each of its major customers. The shift to external measures
of performance with customers led ECI to redefine “on time” so it
matched customers’ expectations. Some customers defined “on-time” as any
shipment that arrived within five days of scheduled delivery; others
used a nine-day window. ECI itself had been using a seven-day window,
which meant that the company was not satisfying some of its customers
and overachieving at others. ECI also asked its top ten customers to
rank the company as a supplier overall.
Depending on customers’ evaluations
to define some of a company’s performance measures forces that company
to view its performance through customers’ eyes. Some companies hire
third parties to perform anonymous customer surveys, resulting in a
customer-driven report card. The J.D. Powers quality survey, for
example, has become the standard of performance for the automobile
industry, while the Department of Transportation’s measurement of
on-time arrivals and lost baggage provides external standards for
airlines. Benchmarking procedures are yet another technique companies
use to compare their performance against competitors’ best practice.
Many companies have introduced “best of breed” comparison programs: the
company looks to one industry to find, say, the best distribution
system, to another industry for the lowest cost payroll process, and
then forms a composite of those best practices to set objectives for its
own performance.
In
addition to measures of time, quality, and performance and service,
companies must remain sensitive to the cost of their products. But
customers see price as only one component of the cost they incur when
dealing with their suppliers. Other supplier-driven costs range from
ordering, scheduling delivery, and paying for the materials; to
receiving, inspecting, handling, and storing the materials; to the
scrap, rework, and obsolescence caused by the materials; and schedule
disruptions (expediting and value of lost output) from incorrect
deliveries. An excellent supplier may charge a higher unit price for
products than other vendors but nonetheless be a lower cost supplier
because it can deliver defect-free products in exactly the right
quantities at exactly the right time directly to the production process
and can minimize, through electronic data interchange, the
administrative hassles of ordering, invoicing, and paying for materials.
Internal Business Perspective: What Must We Excel at?
Customer-based
measures are important, but they must be translated into measures of
what the company must do internally to meet its customers’ expectations.
After all, excellent customer performance derives from processes,
decisions, and actions occurring throughout an organization. Managers
need to focus on those critical internal operations that enable them to
satisfy customer needs. The second part of the balanced scorecard gives
managers that internal perspective.
Other Measures for the Internal Business Perspective
The
internal measures for the balanced scorecard should stem from the
business processes that have the greatest impact on customer
satisfaction—factors that affect cycle time, quality, employee skills,
and productivity, for example. Companies should also attempt to identify
and measure their company’s core competencies, the critical
technologies needed to ensure continued market leadership. Companies
should decide what processes and competencies they must excel at and
specify measures for each.
Managers
at ECI determined that submicron technology capability was critical to
its market position. They also decided that they had to focus on
manufacturing excellence, design productivity, and new product
introduction. The company developed operational measures for each of
these four internal business goals.
Read more about
To
achieve goals on cycle time, quality, productivity, and cost, managers
must devise measures that are influenced by employees’ actions. Since
much of the action takes place at the department and workstation levels,
managers need to decompose overall cycle time, quality, product, and
cost measures to local levels. That way, the measures link top
management’s judgment about key internal processes and competencies to
the actions taken by individuals that affect overall corporate
objectives. This linkage ensures that employees at lower levels in the
organization have clear targets for actions, decisions, and improvement
activities that will contribute to the company’s overall mission.
Information
systems play an invaluable role in helping managers disaggregate the
summary measures. When an unexpected signal appears on the balanced
scorecard, executives can query their information system to find the
source of the trouble. If the aggregate measure for on-time delivery is
poor, for example, executives with a good information system can quickly
look behind the aggregate measure until they can identify late
deliveries, day by day, by a particular plant to an individual customer.
If
the information system is unresponsive, however, it can be the
Achilles’ heel of performance measurement. Managers at ECI are currently
limited by the absence of such an operational information system. Their
greatest concern is that the scorecard information is not timely;
reports are generally a week behind the company’s routine management
meetings, and the measures have yet to be linked to measures for
managers and employees at lower levels of the organization. The company
is in the process of developing a more responsive information system to
eliminate this constraint.
Innovation and Learning Perspective: Can We Continue to Improve and Create Value?
The
customer-based and internal business process measures on the balanced
scorecard identify the parameters that the company considers most
important for competitive success. But the targets for success keep
changing. Intense global competition requires that companies make
continual improvements to their existing products and processes and have the ability to introduce entirely new products with expanded capabilities.
A
company’s ability to innovate, improve, and learn ties directly to the
company’s value. That is, only through the ability to launch new
products, create more value for customers, and improve operating
efficiencies continually can a company penetrate new markets and
increase revenues and margins—in short, grow and thereby increase
shareholder value.
ECI’s
innovation measures focus on the company’s ability to develop and
introduce standard products rapidly, products that the company expects
will form the bulk of its future sales. Its manufacturing improvement
measure focuses on new products; the goal is to achieve stability in the
manufacturing of new products rather than to improve manufacturing of
existing products. Like many other companies, ECI uses the percent of
sales from new products as one of its innovation and improvement
measures. If sales from new products are trending downward, managers can
explore whether problems have arisen in new product design or new
product introduction.
In
addition to measures on product and process innovation, some companies
overlay specific improvement goals for their existing processes. For
example, Analog Devices, a Massachusetts-based manufacturer of
specialized semiconductors, expects managers to improve their customer
and internal business process performance continuously. The company
estimates specific rates of improvement for on-time delivery, cycle
time, defect rate, and yield.
Other
companies, like Milliken & Co., require that managers make
improvements within a specific time period. Milliken did not want its
“associates” (Milliken’s word for employees) to rest on their laurels
after winning the Baldridge Award. Chairman and CEO Roger Milliken asked
each plant to implement a “ten-four” improvement program: measures of
process defects, missed deliveries, and scrap were to be reduced by a
factor of ten over the next four years. These targets emphasize the role
for continuous improvement in customer satisfaction and internal
business processes.
Financial Perspective: How Do We Look to Shareholders?
Financial
performance measures indicate whether the company’s strategy,
implementation, and execution are contributing to bottom-line
improvement. Typical financial goals have to do with profitability,
growth, and shareholder value. ECI stated its financial goals simply: to
survive, to succeed, and to prosper. Survival was measured by cash
flow, success by quarterly sales growth and operating income by
division, and prosperity by increased market share by segment and return
on equity.
But
given today’s business environment, should senior managers even look at
the business from a financial perspective? Should they pay attention to
short-term financial measures like quarterly sales and operating
income? Many have criticized financial measures because of their
well-documented inadequacies, their backward-looking focus, and their
inability to reflect contemporary value-creating actions. Shareholder
value analysis (SVA), which forecasts future cash flows and discounts
them back to a rough estimate of current value, is an attempt to make
financial analysis more forward looking. But SVA still is based on cash
flow rather than on the activities and processes that drive cash flow.
Some
critics go much further in their indictment of financial measures. They
argue that the terms of competition have changed and that traditional
financial measures do not improve customer satisfaction, quality, cycle
time, and employee motivation. In their view, financial performance is
the result of operational actions, and financial success should be the
logical consequence of doing the fundamentals well. In other words,
companies should stop navigating by financial measures. By making
fundamental improvements in their operations, the financial numbers will
take care of themselves, the argument goes.
Assertions
that financial measures are unnecessary are incorrect for at least two
reasons. A well-designed financial control system can actually enhance
rather than inhibit an organization’s total quality management program.
(See the insert, “How One Company Used a Daily Financial Report to
Improve Quality.”) More important, however, the alleged linkage between
improved operating performance and financial success is actually quite
tenuous and uncertain. Let us demonstrate rather than argue this point.
How One Company Used a Daily Financial Report to Improve Quality*
Over
the three-year period between 1987 and 1990, a NYSE electronics company
made an order-of-magnitude improvement in quality and on-time delivery
performance. Outgoing defect rate dropped from 500 parts per million to
50, on-time delivery improved from 70% to 96% and yield jumped from 26% to 51%.
Did these breakthrough improvements in quality, productivity, and
customer service provide substantial benefits to the company?
Unfortunately not. During the same three-year period, the company’s
financial results showed little improvement, and its stock price
plummeted to one-third of its July 1987 value. The considerable
improvements in manufacturing capabilities had not been translated into
increased profitability. Slow releases of new products and a failure to
expand marketing to new and perhaps more demanding customers prevented
the company from realizing the benefits of its manufacturing
achievements. The operational achievements were real, but the company
had failed to capitalize on them.
The
disparity between improved operational performance and disappointing
financial measures creates frustration for senior executives. This
frustration is often vented at nameless Wall Street analysts who
allegedly cannot see past quarterly blips in financial performance to
the underlying long-term values these executives sincerely believe they
are creating in their organizations. But the hard truth is that if
improved performance fails to be reflected in the bottom line,
executives should reexamine the basic assumptions of their strategy and
mission. Not all long-term strategies are profitable strategies.
Measures
of customer satisfaction, internal business performance, and innovation
and improvement are derived from the company’s particular view of the
world and its perspective on key success factors. But that view is not
necessarily correct. Even an excellent set of balanced scorecard
measures does not guarantee a winning strategy. The balanced scorecard
can only translate a company’s strategy into specific measurable
objectives. A failure to convert improved operational performance, as
measured in the scorecard, into improved financial performance should
send executives back to their drawing boards to rethink the company’s
strategy or its implementation plans.
As
one example, disappointing financial measures sometimes occur because
companies don’t follow up their operational improvements with another
round of actions. Quality and cycle-time improvements can create excess
capacity. Managers should be prepared to either put the excess capacity
to work or else get rid of it. The excess capacity must be either used
by boosting revenues or eliminated by reducing expenses if operational
improvements are to be brought down to the bottom line.
As
companies improve their quality and response time, they eliminate the
need to build, inspect, and rework out-of-conformance products or to
reschedule and expedite delayed orders. Eliminating these tasks means
that some of the people who perform them are no longer needed. Companies
are understandably reluctant to lay off employees, especially since the
employees may have been the source of the ideas that produced the
higher quality and reduced cycle time. Layoffs are a poor reward for
past improvement and can damage the morale of remaining workers,
curtailing further improvement. But companies will not realize all the
financial benefits of their improvements until their employees and
facilities are working to capacity—or the companies confront the pain of
downsizing to eliminate the expenses of the newly created excess
capacity.
If
executives fully understood the consequences of their quality and
cycle-time improvement programs, they might be more aggressive about
using the newly created capacity. To capitalize on this self-created new
capacity, however, companies must expand sales to existing customers,
market existing products to entirely new customers (who are now
accessible because of the improved quality and delivery performance),
and increase the flow of new products to the market. These actions can
generate added revenues with only modest increases in operating
expenses. If marketing and sales and R&D do not generate the
increased volume, the operating improvements will stand as excess
capacity, redundancy, and untapped capabilities. Periodic financial
statements remind executives that improved quality, response time,
productivity, or new products benefit the company only when they are
translated into improved sales and market share, reduced operating
expenses, or higher asset turnover.
Ideally,
companies should specify how improvements in quality, cycle time,
quoted lead times, delivery, and new product introduction will lead to
higher market share, operating margins, and asset turnover or to reduced
operating expenses. The challenge is to learn how to make such explicit
linkage between operations and finance. Exploring the complex dynamics
will likely require simulation and cost modeling.
Measures that Move Companies Forward
As companies have applied the balanced scorecard,
we have begun to recognize that the scorecard represents a fundamental
change in the underlying assumptions about performance measurement. As
the controllers and finance vice presidents involved in the research
project took the concept back to their organizations, the project
participants found that they could not implement the balanced scorecard
without the involvement of the senior managers who have the most
complete picture of the company’s vision and priorities. This was
revealing because most existing performance measurement systems have
been designed and overseen by financial experts. Rarely do controllers
need to have senior managers so heavily involved.
Probably
because traditional measurement systems have sprung from the finance
function, the systems have a control bias. That is, traditional
performance measurement systems specify the particular actions they want
employees to take and then measure to see whether the employees have in
fact taken those actions. In that way, the systems try to control
behavior. Such measurement systems fit with the engineering mentality of
the Industrial Age.
The balanced scorecard,
on the other hand, is well suited to the kind of organization many
companies are trying to become. The scorecard puts strategy and vision,
not control, at the center. It establishes goals but assumes that people
will adopt whatever behaviors and take whatever actions are necessary
to arrive at those goals. The measures are designed to pull people
toward the overall vision. Senior managers may know what the end result
should be, but they cannot tell employees exactly how to achieve that
result, if only because the conditions in which employees operate are
constantly changing.
This
new approach to performance measurement is consistent with the
initiatives under way in many companies: cross-functional integration,
customer-supplier partnerships, global scale, continuous improvement,
and team rather than individual accountability. By combining the
financial, customer, internal process and innovation, and organizational
learning perspectives, the balanced scorecard helps managers
understand, at least implicitly, many interrelationships. This
understanding can help managers transcend traditional notions about
functional barriers and ultimately lead to improved decision making and
problem solving. The balanced scorecard keeps companies looking—and
moving—forward instead of backward.
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