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As business becomes more complex and competitive, traditional financial measures of performance fail to give managers all the information they need to make intelligent strategic and day-to-day decisions. A powerful new means of delivering this information is called the balanced scorecard, a mix of financial and nonfinancial indicators about customers, internal processes, organizational learning, shareholder value, quality, community relations, and so on. The balanced scorecard enables managers to accelerate continuous performance improvement, facilitate strategic formulation and execution, and strengthen internal and external accountability for creating value. This publication describes the concept of the balanced scorecard; explains the critical steps in implementing one; and shows how companies have applied scorecards to corporate advantage.
Why Business Needs the Balanced Scorecard
The Nomenclature Today
To Manage Within the Company
To Manage Outside the Company
The Development of Various Models
Implementing the Balanced Scorecard
Getting Started
Measurement Mix
Devising the Measures
Pinning Down Cause and Effect Linkages
Why Business Needs the Balanced Scorecard
Since the late 1980s, a growing number of managers at the corporate and business unit levels have concluded that traditional management and financial accounting fails to give them complete information for managing their companies. Although these managers receive a prodigious flow of financial figures, they often get few of the nonfinancial figures critical to making decisions about day-to-day operations or long-term strategy. These managers have called for a revolution in performance measurement. In particular, they are calling for more measures of quality, customer satisfaction, turnaround times, pollution control, and other nonfinancial factors. The result of these calls for change has been a management innovation that helps managers implement complex and nuanced corporate strategies: the balanced scorecard.
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The Nomenclature Today
The balanced scorecard is a focused set of vital financial and nonfinancial measures of performance. The notion is simple, but the nomenclature of the balanced scorecard can be confusing. To many people, "balanced scorecard" refers to the model developed by Robert Kaplan and David Norton in a definitive set of Harvard Business Review articles (1992, 1993, 1996c). But in practice, consultants and managers use the term loosely to refer to any set of financial and nonfinancial measures. In a study by Walker Information, 59 percent of Canadian executives and 33 percent of U.S. executives claimed familiarity with the terms "balanced scorecard" or "balanced measurement system" (Walker Information, 1998:4). The term has thus apparently gained a strong foothold as part of the management lexicon.
To be sure, the notion of using a balanced set of measures developed over many years. As far back as 1900, managers in France began using the "tableau de bord," or dashboard of financial and nonfinancial measures (Epstein and Manzoni 1998). In the 1980s, with the advent of total quality management, executives in the North America began to take the same approach, attempting to manage with the vital few indicators of success (The Society of Management Accountants of Canada 1994). The concept came to be increasingly associated with the term "balanced scorecard." Thus the term is used in its generic fashion throughout this guideline.
The term is popular for good reason. Managers have embraced the notion of "scorecard," which suggests a simple document, a shorthand way of putting all critical variables for running the organization on one page. They have also embraced the notion of "balance" among performance measures—balance between the leading and lagging, financial and nonfinancial, internal and external. Note that "balance" does not necessarily imply equivalence among all measures. It simply means balancing the single-minded focus on financial measures with additional focus on nonfinancial ones.
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To Manage Within the Company
Managers can use the balanced scorecard as a means to articulate strategy, communicate its details, motivate people to execute plans, and enable executives to monitor results. The advantages of using a focused set of financial and nonfinancial measures in this way are legion, as documented in many recent works (Epstein and Birchard 1999; The Society of Management Accountants of Canada 1994; Hronec 1993; Kaplan and Norton 1996a; Lynch and Cross 1995; Rummler and Brache 1995). Perhaps the prime advantage is that a broad array of indicators can improve the decision making that contributes to strategic success, whether in big organizations or small, profit-focused or nonprofit, whether at the executive level or the team level. Nonfinancial measures enable managers to consider more factors critical to long-term performance. These factors, flowing directly from the organization's strategy, vary from how well the organization cares for customers to how fast it innovates.
The gap is huge between the kinds of measures managers consider critical and the variables they actually measure. In a recent study, 63 percent of firms rated innovation as highly important, but only 22 percent measured it; 76 percent rated morale and corporate culture as important, but only 38 percent measure them; and 76 percent of firms considered core competencies as important, but only 36 percent measure them (Stivers et al. 1998:47). Although hard to quantify, variables like innovation and competencies often rank among the most pivotal measures in accurately gauging the success of organizational strategy.
One of the key reasons managers yearn for more nonfinancial measurement is that financial measures, used alone, give an incomplete picture of an organization's performance. Employees evaluated according to their ability to achieve short-term targets cannot be expected to consistently make the best possible long-term decisions. In an attempt to meet quarterly revenue targets, for example, they will fast track at least some high-value product shipments, even at the risk of breaking delivery promises on low-value shipments. The harm to organizational reputation will not show up in the quarterly budget but will certainly reappear later in the form of dissatisfied customers.
Another reason managers yearn for more nonfinancial measures is that traditional financial measures give an historical view of performance—"through the rearview mirror," as the saying goes. The "lagging" financial figures, like sales volume, help the firm keep score for quarters and years just past. They often do not provide as much insight as forecasted data on quality and shipping performance. In other words, financial measures often don't offer the predictive information contained in many nonfinancial metrics. They enable managers only to extrapolate from the past—clearly a risky practice in fast-paced organizations today.
By incorporating new measures in a balanced scorecard, an organization's managers arm themselves to compete in the 21st century:
· To improve performance continuously. Improving financial results depends on improving upstream quality, customer satisfaction, product innovation, and other results. Managers who identify the vital few nonfinancial factors in their business will have the capability to fine-tune them to deliver reliable long-term financial results.
· To implement more complex strategies. Many organizations today compete through highly differentiated strategies, strategies that rely on unique products, reengineered processes, premium service, superior information, a select mix of sales channels, and so on. To execute these strategies, managers need measures that define organizational objectives precisely.
· To better run lean, decentralized organizations. Today's lean organizations rely on managers, workers, and teams with the responsibility and authority to act quickly and independently to achieve the objectives set by top executives. Managers most effectively empower people across the organization by providing them with precise, quantified, financial and nonfinancial targets to act upon.
· To feed systems for organizational learning. Both continuous and breakthrough improvement first demand that people understand where they are falling short. Managers need quantified measures that let them make "fact-based" decisions about where they must change to successfully execute the strategy and continue to add value to the organization over the long term.
· To drive organizational change. Managers and executives who believe they must execute a new strategy need hard data that show the effectiveness of the new strategy. They next need measurement targets to guide everyone in aligning their efforts with the new strategy. Executives must use measures to communicate the fine points of the strategy, and give clear marching orders on how to proceed.
By managing the operations and strategy of an organization with an expanded family of financial and nonfinancial measures, managers essentially create a new nervous system for sending and receiving signals. This new system, summarized in a single document, helps top executives to align action, change, and innovation at every level, with the strategy set at the top. The power and utility of this system—the balanced scorecard—has been widely embraced by managers around the world.
Surveys show just how much companies need this capability. In a 1996 study, 57 percent of respondents reported only "little" or "some" linkage between the priorities of the long-range strategy and the annual budget. More than two thirds (69 percent) said that strategic planning had only "some," "little," or "no" influence on the company's overall success (Renaissance Solutions and CFO 1996:4,5). Business organizations clearly need a means to integrate and execute the details of corporate strategy.
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To Manage Outside the Company
While managers have found they need a broader set of measures to manage inside the organization, they are also finding that they need a broader set to identify external issues and manage external relationships. Much of the organization's success depends on managing the partners, suppliers, customers, shareholders, and other stakeholders through whom the organization creates value. To this end, a balanced scorecard helps in a variety of ways:
· To sense the demands of markets, competition, and society. In the past, many managers gauged their success compared to year-earlier results, or compared to peer-group companies. But to stay apprised of all threats and opportunities, managers must measure not just their own performance but that of the "best in class"—direct and indirect competitors, organizations running similar processes, and organizations competing broadly for the favor of the same customers, shareholders, employees, and other stakeholders.
· To broaden and deepen supply-chain relationships. Companies today are cutting costs, increasing speed, accelerating innovation, and making other improvements by working as business partners with customers and suppliers. To compete through integrating the supply chain, managers need to measure and report internal and external variables that inform decision making along this chain.
· To broaden and deepen relationships with stakeholders. Competition in product, labor, and capital markets has intensified inexorably in recent years. Today, to secure the loyalty of increasingly powerful customers, employees, and shareholders, managers need to develop and report measures that demonstrate the company is delivering the value demanded.
· To demonstrate accountability for performance. Regulators and the public continue to pressure companies for greater transparency. People outside the firm seek reassurance that companies operate with acceptable, if not superior, performance. Managers need measures—of performance and management-system implementation—to demonstrate they deserve a "license to operate."
By managing relationships outside the company with an expanded family of measures, managers position themselves to turn corporate accountability to competitive advantage. Measures of financial, operational, and social performance become the language of strategic execution, from developing goals and initiatives to setting targets and dispensing pay and incentives. Many firms today have embedded measurement systems in both their internal and external management systems to win in the marketplace for low-cost capital, talented employees, loyal, profitable customers, and supportive local communities.
Ultimately, the balanced scorecard can provide the basis for fulfilling a new model of accountability known as the accountability cycle (Epstein and Birchard 1999:143). The measures, monitored by an enlightened board of directors, integrated in management control systems, and reported broadly inside and outside the corporation, become the fuel for powering a cycle of continuous and breakthrough performance. In this way, the balanced scorecard helps managers deliver maximum value for the organization.
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The Development of Various Models
With the swirl of activity in the late 1980s and early 1990s, academics and consultants proposed a number of new models for developing balanced scorecards. In each case, these experts sought to provide managers with a formula to develop the critical measures for guiding long-term corporate management. They posed the question: How can managers choose measures, financial and nonfinancial, that will guide them in delivering consistent value for the enterprise over the course of months and years?
From the results of a research project conducted in 1990 with twelve companies, Kaplan, of Harvard Business School, and Norton, of Renaissance Worldwide, answered that question in their first article introducing the balanced scorecard (Kaplan and Norton 1992). They presented the scorecard as an organizational scheme. The concept breaks out the critical categories of performance measurement into four "perspectives": financial, customer, internal business, and innovation and learning.
Taken together, the measures that fall into Kaplan and Norton's four balanced scorecard categories comprise a broad set of financial and nonfinancial gauges for running the organization. They aid people in focusing on more than financial measures.
One of Kaplan and Norton's most significant contributions was to stress that executives should use the measures to translate vision and strategy into concrete directions for action by people throughout the organization. In their later work, Kaplan and Norton showed managers how to use the balanced scorecard as a strategic management system (Kaplan and Norton 1996). The measures in the balanced scorecard were not to be a wish list for continuous improvement. They prescribe a plan for strategic execution.
Meanwhile, in Sweden, at Skandia Group, a team led by Leif Edvinsson, corporate director, intellectual capital, operated under the belief that to succeed as an insurer, the company had to build value through "intellectual capital." That is, to deliver reliable financial results, Skandia had to build and leverage the value of intangible assets like solid customer relationships and unique computer software. In 1990, Skandia pioneered new ways to value intellectual capital and created measures for managing a firm that relies on intellectual capital to build value (Edvinsson and Malone 1997). Skandia created a balanced scorecard called the "navigator" (Edvinsson and Malone 1997), separating corporate performance into five categories, or "focuses": financial, customer, human, process, and renewal and development. As with the Kaplan and Norton model, performance in the latter four contribute to financial performance. Note that Edvinsson, like Kaplan and Norton, stressed the importance of learning and renewal as a root source of financial results.
At about the same time, other companies were experimenting with a third approach to the balanced scorecard. In Canada, at Bank of Montreal, a team led by the then Chief Executive Matthew Barrett operated under the belief that, to succeed as a bank, executives had to deliver top performance to four stakeholder groups: shareholders, customers, employees, and communities. The team thus created measurements of performance for each group, and became one of the leaders in this "stakeholder" balanced scorecard (Atkinson et al. 1997:33-35 and Epstein and Birchard 1999:91-93).
In various versions of the stakeholder-style balanced scorecard, managers organize corporate measures into three to five categories, according to stakeholder groups. Managers first choose the three to five stakeholder groups who contribute most to execution of corporate strategy. They then, as with other versions of the balanced scorecard, ask a series of probing questions to devise measures to gauge performance in each category. The measures created for customers, employees, communities, and suppliers drive performance for shareholders in much the same cause-and-effect fashion as proposed by Edvinsson and Kaplan and Norton.
Note that some organizations operating with a stakeholder-style scorecard may give priority to one stakeholder or another. Bank of Montreal gives a weight of 40 percent to shareholders, 30 percent to customers, 20 percent to employees, and 10 percent to communities. But other organizations steer clear of priority rankings. Eastman Chemical of Kingsport, Tennessee breaks out five stakeholders, customers, employees, investors, suppliers, and publics (i.e., communities, government agencies). Eastman gives all five stakeholder categories equal priority (Epstein and Birchard 1999:149).
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Implementing the Balanced Scorecard
To implement the balanced scorecard, managers must take into account not only organizational structure and systems; they must consider their organization's history, management style, and culture. The approach to implementation that suits one organization will not always suit the next. This is especially true of nonprofit organizations, whose missions vary dramatically. For example, when the United Way of Southeastern New England created a balanced scorecard in 1996, a big question was which constituency to stress as the "customer" for the sake of scorecard measures. Was it donors, charitable organizations, or communities? Any of the three could have been appropriate. But managers chose donors because the United Way unit's total quality management efforts had already made the organization donor-focused (Kaplan 1997).
The size of the organization does not significantly matter to implementation. Research shows that the scorecard works for companies of all sizes. Chow, Haddad, and Williamson (1997), for example, show that the scorecard, though developed at large companies, functions equally well for companies with just 100 to 1,200 employees. The United Way of Southeastern New England, again, provides a good example. The organization had less than 50 full-time employees, albeit supplemented by many volunteers.
How long does the implementation of a balanced scorecard take? Generally about one to three years. This assumes a small team of under a half dozen people initially works full time on the effort, and executives make themselves available for interviewing, brainstorming, and support. The initial rollout of performance measures takes considerably less time, roughly four months, but experience shows that integrating the scorecard into organizational management systems can take an additional year of time (The Society of Management Accountants of Canada 1994:48-49; Kaplan and Norton 1996a:278, 288, 309).
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Getting Started
The objective from the start is to create a list of measures that, by gauging only the most critical factors of success, telegraphs to all managers and employees what they need to do to help achieve corporate strategy. As Kaplan and Norton say, the balanced scorecard should tell the story of the strategy. In fact, someone without knowledge of the strategy should be able to infer it from the final set of measures, which will number perhaps no more than two dozen. The measures will then become the marching orders of the corporation, and if measures are poorly chosen, the corporation will march off in the wrong direction.
Managers should not make the mistake of building a scorecard comprised solely of lagging, internal, financial, or nonstrategic indicators. Certainly some of the indicators will be financial, and will lag, since these are the characteristics that describe the "outcome," or "results," measures of traditional financial systems. Many of these indicators—net income, for example—are even the same from company to company. But most of the indicators should measure the elements of corporate performance that lead to good results and may include input and process measures in addition to output measures. Note how the four perspectives also connect in a chain of cause and effect: innovation and learning improve internal business processes; internal business processes improve customer satisfaction; and customer satisfaction leads to improved financial performance. In other words, one category of measurement drives performance in the next. These indicators should reinforce each other, all contributing to measuring the accomplishment of a unified strategy.
In practice, the notion of leading versus lagging should be thought of as a continuum. Customer satisfaction is a leading indicator of financial performance, and also a lagging indicator of on-time delivery. Toxic emissions are a leading indicator of environmental costs, and also a lagging indicator of process efficiency. Managers should think of measures as data points in a complex flow of causes and effects. They will then better understand that they have to pinpoint the drivers of corporate performance to succeed with their scorecard effort.
As a rule, the final list of measures should be both financial and nonfinancial; external and internal; and lagging and leading. A rich mix of measures reflects the complexity of business today. In coming up with a diverse list, managers will have several difficulties. The first is coming up with new measures of factors, like innovation, that the company has never measured before. In some instances, developing a reliably quantifiable outcome measure may not be feasible, owing to lack of data or to high cost. Substituting an "input" measure, however, may have to suffice. Hours of training, for example, may have to substitute as an indicator of organizational learning.
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Measurement Mix
A bit of both makes the scorecard balanced.
A second difficulty is winnowing the list of measures to the vital few, and thus blessing a final list that embraces all critical factors while avoiding duplication. One guide to minimizing the number of measures is seeking those that are both complete and controllable (Epstein and Manzoni 1998:201-202). Complete means the measure sums up in one number the contribution of all elements of performance that matter. For example, long-term financial returns are the most complete measure of corporate performance at the executive level. Controllable means that people can actually control improvement in the factor measured. So that the scorecard translates strategy into action, employees should believe that they or their work groups could act personally to make at least a small difference in a measured variable.
In practice, managers creating the balanced scorecard will find much room for disagreement. They will disagree on the fine points of strategy, and they will disagree on which factors drive success of the strategy. Gaining consensus takes time, as manager's work out their differences over, say, the drivers of innovation, customer satisfaction, and profits. Conflicts in points of view actually offer an opportunity to align, sometimes for the first time, the details of strategic execution so that people down in the organization do not work at cross purposes. In this sense, the process of creating a scorecard, of gaining consensus and alignment, can be more valuable than the result itself.
Successful implementations follow a rough sequence of steps, covered in detail in other publications (The Society of Management Accountants of Canada 1994). The essential precondition for success is top management support, followed by engaging a broad-cross section of people in the organization to assure buy-in at all levels. The sequence of implementation generally begins after top managers articulate strategy. Among the most critical aspects of implementation:
· Devising the measures;
· Pinning down causal linkages;
· Cascading the scorecards;
· Linking to compensation; and
· Preparing the technology infrastructure.
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Devising the Measures
To speed the process of both brainstorming and winnowing the set of measures, managers may turn to one of the models of balanced measurement for guidance (The Society of Management Accountants of Canada 1994; Hronec 1993; Kaplan and Norton 1996; Epstein and Birchard 1999; Lynch and Cross 1995; Rummler and Brache 1995). Each model provides a means to surface ideas, group them, and guide the logic of linking each driver to final outcome measures. To begin with, managers can consider the four categories in the Kaplan and Norton model:
I. Financial. The first category on the Kaplan and Norton balanced scorecard is financial. Managers devising financial measures should ask themselves, How can we show our strategy is succeeding financially? At the highest level, long-term profitability and stock price growth demonstrate financial success of the strategy. But managers should also consider financial measures particular to their strategy. If the firm is young, on a high-growth trajectory, sales growth by sales channel may be a critical financial measure. If the firm operates in a mature business, cash flow may be the right measure. If it falls in between, economic profit, a measure that charges the company for the cost of equity capital, may be the right measure.
II. Customer. The second box in the Kaplan and Norton model is the customer perspective. Managers devising customer measures should ask themselves, How can we show we're delivering to customers the value they expect? At the highest level, many companies track customer satisfaction. But other measures are also necessary, like customer retention, market share, and share of wallet (i.e., share of a customer's business in a particular product or service line). Companies may also devise specific surveys. For example, Eastman Chemical surveys companies to find out how they score Eastman on "customer value."
III. Internal business process. The third box in the Kaplan and Norton model is internal business. Managers developing measures for this perspective should ask, What processes must we excel at to deliver value to our customers? For example, Analog Devices measures chip yield, cycle time, on-time delivery, and parts per million defects to gauge the performance of manufacturing processes. CIGNA Property & Casualty, the Philadelphia insurer acquired by Ace Ltd. of Bermuda, developed a system to measure underwriting quality (by survey) and loss ratio (claims paid divided by premium collected) to gauge the quality of its underwriting processes.
IV. Learning and growth. The fourth box in the Kaplan and Norton model is learning and growth. For this perspective, managers should ask, What action must the company take to prepare the people and organization for the future? As an example, CIGNA Property & Casualty developed measures for competency development, key staff turnover, and acquisition of key staff. Whirlpool developed measures of variables such as completion of cultural milestones and, by survey, strength of leadership, commitment, and diversity. The measures in the learning and growth perspective stress reskilling, systems development, change procedures, and development of personal and organizational capabilities.
One business that followed Kaplan and Norton's balanced scorecard model was Mobil Corporation's U.S. Marketing and Refining Division. In 1994, the $20 billion division was searching for a means to cement in place a new strategy of targeting and selling to specific market segments. Mobil's research showed that American gas buyers come in five varieties, which Mobil dubbed road warrior (generally men who drive a lot), true blues (affluent, loyal customers), generation F3 (yuppies on the go who want fuel, food, and want them fast), homebodies (generally homemakers), and price shoppers. Mobil aimed to focus on just the first three, which included 61 percent of all gas buyers (Kaplan 1996a:1, 3).
In the development of measures, managers don't brainstorm directly from strategy, but first come up with objectives. After creating objectives and measures, they launch initiatives to meet them. In Mobil's case, the division upgraded its stations to give fast, friendly service—with "speed, smiles, and strokes." It also redesigned its onsite convenience stores to recast them as destination shops with the right food and snacks for its segments of buyers.
As with every other management model, managers should view the balanced scorecard as flexible. The Kaplan and Norton model, and the other models, offer a starting point. Many managers will see fit to alter the groups in each model or add different ones. Companies that rely heavily on good relationships in the local community—a bank for example—might add a category for community. Companies that consume vast amounts of raw materials—oil, wood products, and mining firms—might add a category for the environment. Companies that rely heavily on upstream suppliers might single out a category for performance with partners in the supply chain.
Alternatively, companies can include a broader array of measures than suggested by any of the models. Other possible areas of measurement include society, regulators, and even milestones for major strategic projects, such as building a plant, establishing an overseas distribution operation, or reengineering a process. Managers may also want to complement their internal data gathering with information from benchmarking and competitive analysis. They can then report scorecard results not just for their own operations but for the operations of peers and competitors, heightening management's awareness of future threats and opportunities.
Managers must bear in mind, however, that too many measures can spoil the scorecard as an effective management tool, especially if the measures fail to contribute in an overall cause-and-effect fashion to strategic success. Many critical measures, such as order turnaround time, may be necessary for operational control, but not necessary to include on the corporate-level scorecard. If managers cannot justify a measure as critical to organizational priorities, they should consider dropping it during the winnowing process.
Allstate Insurance Corporation is an example of one company that has customized its scorecard to fit its industry. Allstate operates with a strategy of winning through the building of strong, enduring relationships with customers, employees, agents, shareholders, and even community partners. As a result, the company has devised a scorecard that today essentially follows the stakeholder model of measurement, as discussed in Epstein and Birchard (1999:144-154).
For Allstate, taking care of stakeholders means taking care of the bottom line.
Allstate, for example, maintains that expanding career and advancement opportunities equally for all employees drives employee satisfaction. These measures are captured under the "employee" focus. Employee satisfaction drives customer growth and retention. The latter two measures are captured under the "customer" focus. And customer growth and retention drive profitability, captured under the "shareholder" focus. In practice, feeding the community stakeholder, as Allstate does through financial and volunteer support, feeds the customer and employee stakeholders, which in turn feeds the shareholder stakeholder.
How does a company get started on the process of developing measures? The spur to action may come from a variety of causes: a financial shock, in which profits turn down for several quarters; a new strategic vision, in which executives lay a new course to attack growth markets; a change in chief executive, in which priorities shift sharply to align with the new executive's way of managing. Whatever the cause, the spur convinces top executives that the company has to adopt a new approach to managing, and probably a new culture that values measurement and accountability. Source: The Allstate Corporation, 1999.
Once the top management team commits itself to a balanced scorecard project, a single executive or senior manager can lead a team of managers to guide and coordinate a series of executive interviews and brainstorming sessions that result in a group of tentative objectives and measures. These interviews and sessions often reveal that executives do not all agree on the answers to two questions: Where do we want to be? How are we going to get there?
The balanced scorecard team can highlight for executives the inconsistencies in their responses. The executive team can subsequently debate elements of strategy, objectives, and measures—in several sessions with breakout groups as necessary. By ironing out the kinks in corporate strategy, executives can arrive at clear priorities and, in turn, create the final scorecard (Kaplan and Norton 1996:300-308).
During the early 1990s, BC Rail, in North Vancouver, Canada, developed business-unit scorecards, which managers incorporated into the monthly corporate financial package. Although useful, the measures never became integral to the company's management process. Alan Owen, BC Rail Controller, maintained that the reason for this lack of takeup was that the measures never connected directly to corporate goals. When BC Rail introduced a formal balanced scorecard in 1996, the measures came directly from the strategic plan. BC Rail managers adopted the following process to create their scorecard (Owen 1997:12-13):
· Involve a broad senior management team.
· Reexamine the corporate mission.
· Analyze strengths, weaknesses, opportunities, and threats.
· Reexamine the successes and failures of the previous five-year strategic plan.
· Define the company's three critical goals.
· Establish core strategies to achieve each goal.
· Identify key metrics to measure progress toward each goal.
· Establish clear responsibilities and targets for each metric.Develop action plans to achieve targets.
· Develop annual objectives for each manager and link them to incentive compensation.
Note that, to succeed, top management must remain intensively involved with the scorecard. This involvement, throughout the early phases of the scorecard development, may last six to twelve months. Rarely do balanced scorecards succeed when the chief executive and his or her team withdraw their support before completion of the initial rollout, or play only a token role in the process (Kaplan and Norton 1996a:294). The executives may also have to change their attitudes or behavior to stress measurement, and accountability for measured results, as a management priority. If they do not hold themselves and the organization responsible for reporting and reviewing results, people within the company will not take the effort seriously.
A big part of signaling the shift in priorities is a change in reporting. Internal reports should broadcast the critical balanced scorecard priorities, targets, and results—to every level of the organization. The new internal reports will help to demonstrate management commitment. Many companies will want to go on to broadcast key measures and results externally as well. Putting balanced scorecard targets and results in the annual report shows convincingly that management is serious and expects shareholders and other stakeholders to hold it accountable for executing strategy.
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Pinning Down Cause and Effect Linkages
If managers have chosen measures to fit carefully in a chain of cause and effect, they will end up with a concrete logic for creating value. They will be able to express this logic in a number of if/then hypotheses. If we train employees more intensively, then we will satisfy more customers. If we satisfy more customers, then we will sell more services. If we sell more services, then we will boost both margins and profits. The obvious question remains: Will the hypothesized logic, albeit a product of the collective wisdom of many executives, prove out in practice?
This is not always easy to answer when a scorecard has a dozen or more measures, especially given the complexity of some causal links. At Allstate, for example, managers measure such front-line statistics as claim contact time (the elapsed time between an auto accident and when an Allstate customer is contacted by an Allstate adjuster to begin the repair process). By Allstate's way of thinking, shorter contact time leads to higher customer satisfaction; higher customer satisfaction leads to higher renewal rates; higher renewal rates to higher premium revenues; and higher premium revenues to higher operating income and share prices. In graphical form, the linkage looks like this:
Contact time › customer satisfaction › customer retention › premium revenues › operating income › share prices
Allstate also believes that shorter contact time leads to lower claims costs (such as amounts paid for rental vehicles and storage of disabled vehicles); lower claim costs lead to lower claims payments; lower claims payments lead to lower loss ratios; and finally lower loss ratios lead, again, to higher operating income and share prices. In graphical form, this parallel linkage looks like this:
Contact time › lower costs › severities › loss ratio › operating income › share prices
This complexity—especially when drawn as a web of interdependencies among numerous front-line and corporate measures—makes clear why managers must take a rigorous approach to creating a "performance logic" (Rummler and Brache 1995). Getting the performance logic right, a far more complex job than drafting a few linear chains of cause and effect, means constantly retesting to be sure that the entire executive team achieves a genuine consensus on each element of strategy: which markets and segments the firm will serve; which elements of value the firm will promise customers; and which processes and capabilities the company will develop to deliver on its value proposition. Only then will the measures of, say, competency development, actually contribute to customer value and create sales in the targeted market segments.
To the extent that companies are betting their future on their strategy, they should then prove the links between specific nonfinancial measures and financial success. Managers can take their cue from models like the service profit chain: internal service quality leads in turn to employee satisfaction, employee retention, external service quality, customer satisfaction, customer retention, and finally to profit (Heskett et al. 1997). This was the approach taken by Sears, Roebuck, when it examined the chain of causation linking employee attitudes to customer satisfaction, and customer satisfaction to profits (Rucci et al. 1998).
Sears's dedication to nonfinancial performance developed in 1993 and 1994, when the company's top 150 managers crystallized the company's new direction in what they called the three Cs: to make Sears a compelling place to work, a compelling place to shop, and a compelling place to invest. They then began an attempt to correlate all three, and they found they could not only quantify the factors that drive each kind of performance, they could also quantify how much an improvement in each link of the "employee-customer-profit" chain stemmed from improvements in a previous link.
By 1996, Sears actually developed a corporate-wide, statistically rigorous means to manage employee attitudes and customer impressions to boost financial returns. It can now actually calculate that a five-point gain in employee attitudes will translate into a 1.3-unit increase in customer impressions. The 1.3-unit customer-impression increase will then boost revenue growth by 0.5 percent. The model even predicts the lag time between one improvement and the next.
Though many companies rely on a common-sense approach to linkage, Sears relies on data—data verified by external auditors. Why is this so important? Sears managers found, for example, that two measures originally proposed for the employee-customer-profit chain—personal growth and development, and empowered teams—failed to relate statistically to any customer data. The two measures do matter to managers, but they don't lie on the causal pathway from employee satisfaction to profits. Sears also found that 10 of 70 questions in the company's employee survey do relate well to customer data, in particular those in just two categories: peoples' attitude about their jobs and attitude about the company. So Sears uses those ten questions in its employee-customer-profit chain, giving managers uncanny insight on how to manage the contributors of company value. This is precisely the kind of thinking, if not the approach, that other companies should consider.
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