The Balanced Scorecard: A Useful Tool for Strategy Implementation and Improved Performance

June 24, 2005

By Gerald K. DeBusk, CPA, CMA, Ph.D.

Harvard Business Review has proclaimed the Balanced Scorecard (BSC) to be one of the 75 most influential ideas of the 20th century. A Bain & Co. survey gives an indication of the scorecard's gain in popularity since its introduction in 1992. According to the survey, approximately 50 percent of Fortune 1000 companies and between 40 and 45 percent of European companies are using the BSC.

Let's take a look at the BSC — its origins, its uses and some problems with its implementation.

Origins

The BSC was originally developed as a new type of performance measurement system by Robert Kaplan, a professor at Harvard University and co-developer of Activity Based Costing, and David Norton, a consultant. Convinced that companies rely too heavily on financial measures, they propose a more "balanced" approach.

Kaplan and Norton recommend using a group of 20–25 measures to evaluate organizational performance. The choice of which measures is left to the organization, but the majority of the measures should be nonfinancial. They also recommend balance between leading and lagging indicators of performance and between short-run and long-run indicators of performance.

Kaplan and Norton propose four perspectives or views for measuring performance — four categories of measures within the BSC. Three perspectives are from the point of view of major stakeholders in the organization, with the fourth perspective representing internal processes. They are the financial (shareholder or owner) perspective, the customer perspective, the internal business process perspective and the learning and growth (employee) perspective.

Using Nonfinancial Measures to Overcome Problems with Financial Measures

Nonfinancial measures are often used to overcome difficulties associated with the use of financial performance measures. Financial measures have been criticized in recent years for a number of shortcomings, including being backward-looking and too focused on short-term results.

The most common financial performance measures, like earnings per share and return on investment, are earnings-based. Typically, the earnings reflect the prior quarter or year (backward-looking and short-term focused). Many nonfinancial measures are more predictive and forward-looking than earnings-based financial measures. Changes in customer satisfaction and numbers of warranty claims, as an example, often signal future changes in revenues and profits.

Financial measures also can be easily manipulated. Without committing accounting fraud, managers can avoid spending funds for research and development, advertising and repairs. This will dramatically improve performance in the short-term (a few quarters or maybe a couple of years) but can have disastrous long-term consequences. Managers may be able to get away with pursuing this strategy if they can receive their next promotion or move to another organization before performance starts to decline. Utilization of nonfinancial performance measures in key areas can help top management keep an eye on the broader operations and lessen the likelihood of managers pursuing such dangerous, self-serving tactics.

Return on investment (ROI) is perhaps the most widely used of financial performance measures. A great many organizations evaluate business-unit performance using ROI. Measures like ROI focus on earning a return on the net assets reported on the balance sheet. Today's organizations are also investing in "intangible assets" that are not reported on the balance sheet (i.e. intangible assets that are not goodwill, patents and copyrights).
As an example, employees are often touted as the organization's greatest asset. Also important are items like brand recognition, quality processes, relationships with distributors and suppliers, etc. These intangible assets require financial investments and are critical to the success of the organization. However, they are not reflected on the balance sheet and consequently the denominator of ROI.

A company's physical assets accounted for 62 percent of its market value in 1982; but today, physical assets only account for about 25 percent of a company's market value. Measures like ROI have not kept pace with the "new economy." It is important today to measure returns on investment in employee training, development of new products, customer and public relations and a host of other intangibles. Organizations today are often using nonfinancial measures to track performance of these intangible assets.
Many organizations have been using both financial and nonfinancial measures for years. The Total Quality movement, in particular, led many organizations to adopt nonfinancial measures of performance in the customer arena. So what's different about the BSC?

Two important things distinguish the BSC from a general use of financial and nonfinancial measures. First is the tie between strategy and the BSC. Kaplan and Norton found in the early and mid-1990s that several organizations were using the BSC as a strategy implementation tool. Kaplan and Norton's later writings focused on this as a primary benefit of BSC adoption. The second unique feature of a well-done BSC is the cause-and-effect linkage that exists between the measures.

The BSC as a Strategy Implementation Tool

An Ernst & Young whitepaper suggests that analysts believe the execution of strategy is at least as important as the quality of the strategy. A 1999 Fortune magazine article suggests 70 percent of CEO failures occur as a result of poor execution of strategy. Kaplan and Norton believe implementation of the BSC leads to four new business processes that connect actions with long-term strategic objectives and thus leads to successful implementation of an organization's strategy.  Those processes are:

1. Translating the vision
2. Communicating and linking
3. Business planning
4. Feedback and learning

The first of these new processes, translating the vision, provides a framework to build an understanding of the organization's vision and strategy — which must be translated into operational terms. Managers at the operating level have difficulty taking action on broad objectives like "becoming the supplier of choice." However, they understand the impact of good quality and on-time delivery on a customer's satisfaction. The overall vision ("supplier of choice") must be translated into operational terms like "defects per 1,000 units" or "on-time delivery percentage" for operating mangers to understand the vision.

The second process, communicating and linking, allows management to communicate the strategy and link it to departmental objectives. Resources within the organization are then aligned with these strategic objectives. The strategy is communicated to employees through the act of using the BSC to measure their performance in achieving the organization's strategic objectives. Alignment of resources occurs when the employees work to meet their targets on the BSC measures. Because the measures were picked with the organization's strategy in mind, they are, by default, working to achieve the same goal.

Planning is always a component of success. Business planning is the third process. As the organization sets forth on a path to achieve important strategic objectives, it is vital that they integrate their operational plans, financial budgets and performance measurement systems. The integration of the organization's planning systems with its performance measurement system, i.e. the BSC, will maximize their chances for success by making resources available for the implementation of strategy.

The fourth process, feedback and learning, allows managers and all employees to monitor performance in achieving the organization's strategic objectives and take corrective actions where necessary. The implementation of the BSC allows the organization to monitor its progress not only from the traditional financial perspective but also from three additional perspectives: customer perspective, internal business process perspective and from the employee perspective (learning and growth). The feedback in any and all of these perspectives can help the organization take the necessary actions to stay on track to achieve their strategic objectives.

Cause-and-Effect Linkages Among the BSC Measures

It is not enough simply to pick measures for the scorecard that relate to the organization's strategy. These measures also have to be linked together in a causal chain. Success in achieving the learning and growth (employee) measurement targets should lead to improvement in the internal business process measures.

As an example, meeting targets in employee training and turnover should lead to productivity improvements and improvements in on-time delivery to customers. Continuing with the example, achieving these internal business process targets should lead to improved customer loyalty measured in terms of customer satisfaction and repeat sales. Success in the customer measures should lead to revenue growth and bottom-line financial improvements. BSC measures should be chosen with a sort of cascade effect in mind. A leads to B, which leads to C, until finally profits are improved as the end result.
The BSC and improved financial results

There is much anecdotal evidence supporting a link between adoption of the BSC and improved long-term financial performance. Kaplan and Norton have supplied numerous case studies. The focus on key strategic objectives represented by performance measures logically should lead to improved financial performance because of the cause-and-effect linkages between the measures. A recent survey of accounting leaders provides additional support for the idea that adoption of the BSC is associated with improved financial performance. A majority of accounting managers and CFOs whose organizations have adopted the BSC believe profits have improved. An overwhelming number believe operating performance has improved.

Potential BSC Implementation Problems

While there are plenty of positive results to report concerning the BSC, some firms have had difficulty with its implementation. Some potential BSC implementation problems include:

• As with any shift in paradigms, there is the natural resistance to change that might hinder implementing the BSC.
• Top management support is crucial to the success of any change project. Lack of top management support will be disastrous for the implementation of the BSC.
• Additionally, some believe that managing with a set of 20–25 measures, like those found in the BSC, is inherently more difficult than managing with 3–5 super-critical performance measures. They argue that the focus is spread over too large a set of measures with the BSC. Information overload may lead a manager to place most of their focus on the financial measures — an "unbalanced" scorecard.
• Linking pay to the organization's critical performance measures can be a powerful tool in the drive for improved performance. However, linking the BSC to incentive compensation plans can prove to be difficult. Kaplan and Norton support flexibility in the weighting of the measures to determine incentive pay. Theoretically, flexible weighting helps keep subordinate managers from gaming the system by concentrating only on a few key measures. However, allowing the supervising manager flexibility in the incentive compensation calculation may lead to complaints about fairness. A formula-based scheme also has difficulties. A scheme that uses all 20–25 measures is usually too cumbersome to be practical.

Conclusion

The BSC, while offering great potential for an organization, is not a silver bullet solution. Implementation of the BSC will require diligence to deal with the complexities inherent in adopting a new strategic management and performance measurement system. However, the BSC is a powerful tool in improving financial performance. It reinforces the organization's strategy and aligns resources. A BSC with well-chosen, linked performance measures can serve as a road map to improved financial results.

References

1. Lori Calabro, "On Balance," CFO Magazine, February 01, (2001): 73–77.
2. Paul R. Niven, Balanced Scorecard Step-By-Step: Maximizing Performance and Maintaining Results (New York: John Wiley & Sons, Inc., 2002).
3. Measures That Matter (Boston, Ernst & Young, 1998).
4. Ram Charan and Geoffrey Colvin, "Why CEOs Fail", Fortune, June 21 (1999): 68–75.
5. Robert S. Kaplan and David P. Norton, "Using the Balanced Scorecard as a Strategic Management System," Harvard Business Review, January–February (1996): 75–85.
6. Gerald K. DeBusk and Aaron D. Crabtree, "Does the Balanced Scorecard Really Improve Performance," (working paper, Appalachian State University).

Gerald K. DeBusk, CPA, CMA, Ph.D., is an assistant professor of accounting at Appalachian State University. His 17 years of public accounting and industry experience included roles as a cost accounting manager, plant controller and corporate controller/treasurer. Gerald also serves on the VSCPA Editorial Task Force.