What is the Balanced Scorecard?
by Philip Sheldrake, 2011
We have found that good summaries of the Balanced Scorecard and strategy maps are too few and far between online. We thought then we’d provide our own here, adapted from a section of Chapter 6 of The Business of Influence. You may also appreciate our critique of traditional approaches to return on investment (ROI).
The Balanced Scorecard
I aim here simply to give the briefest introduction to business performance management as encompassed by the Balanced Scorecard approach pioneered by Prof. Robert Kaplan and Dr David Norton. This introduction aims solely to be sufficient in helping me to communicate how our influence framework fits in. It cannot be in-depth, for that would take a whole book or five. Indeed, if you’re serious about getting up to speed on this management approach I recommend the following books, all by Kaplan and Norton, approaching them in chronological order until you’ve had your fill, all from Harvard Business School Press:
- The Balanced Scorecard (1996)
- The Strategy Focused Organization (2000)
- Strategy Maps (2004)
- Alignment (2006)
- The Execution Premium (2008).
According to the Balanced Scorecard Institute:
The Balanced Scorecard transforms an organization’s strategic plan from an attractive but passive document into the ‘marching orders’ for the organization on a daily basis. It provides a framework that not only provides performance measurements, but helps planners to identify what should be done and measured. It enables executives to truly execute their strategies. It is a management system (not only a measurement system) that enables organizations to clarify their vision and strategy and translate them into action.
Business 101 – the problem
Here’s the problem with business 101 as it pre-dated the Balanced Scorecard. The objective of business is to ensure that more money comes in over an acceptable timeframe than goes out and covers the cost of the capital employed to fund the business during that time. Basically, the business should make its owners more money than they might make elsewhere for the same risk, and definitely more than they’d make leaving the capital in the bank. So it’s all about money – the return (profit) on investment (the capital at risk), or ROI for short.
It’s also about money for non-profit organizations. They may set overarching non-financial goals, but a less efficient use of money means less effective progress towards those non-financial goals. A non-profit organization must excel at bringing in funds and employing those funds efficiently and effectively.
But how do you track financial performance, whether your objective is to maximize returns or maximize efficient and effective use of funds to meet the end goals?
Step up the triumvirate of financial reporting:
- Profit and loss statement – or P&L for short, reports over a specified timeframe how much money you’ve earned (your revenue), how much you’ve spent (your expenses), and the difference between the two (your profit, or loss)
- Cash flow statement – is a report that indicates whether the business has enough cash at a certain date to pay its current liabilities (the bills it needs to pay now and very shortly)
- Balance sheet – reports the overall status of your finances at a certain date; it totals all your assets and subtracts all your liabilities to compute your overall net worth.
These reports are essential to all organizations, but it’s become apparent that while they are very capable of quantifying business performance historically, they’re less than ideal instruments by which to orchestrate business day-to-day and week-to-week. Senior management in any business will hear phrases such as ‘we aim to close last month by the 12th’ and ‘we’re still working to close last quarter’. In other words, these reports represent the past; how we performed last month, or last quarter, or last year. That makes them incredibly inadequate real-time performance feedback tools and it’s for this reason that business performance management (BPM) experts refer to them as lagging indicators.
They lag where the business finds itself right now, and they definitely struggle – to the point of failing – to indicate how likely we are to be ‘on plan’ next quarter, or the quarter after that. Or how to quantify ‘unlikely’. Or what might be done about it.
They have another weakness. Traditional financial accounting isn’t a natural at representing intangible assets and capabilities, despite these frequently being pivotal to the modern organization. (For more on this, see our page discussing return on investment.)
The Balanced Scorecard perspectives
It appears Kaplan and Norton weren’t content simply to recognize this. Rather, they dedicated themselves to finding complementary reports that might be called leading indicators, throwing a light on how critical aspects of an organization are performing right now and therefore indicating how likely the money side of things might come good.
But while money is common currency to all businesses with common metrics, no other universal metrics spring to mind. There’s no point in proposing a report called ‘on-time deliveries’ for example, which might work for a florist or parcel delivery company, but not a utility or a school. Or ‘widgets in stock’, which is a perfectly valid metric in organizations with factories and shops, but less so for a consultancy firm or telecommunications company.
Kaplan and Norton’s first task was to identify other aspects of organizational life that were not only universal but proved to be powerful foci in directing operations, executing strategy and pursuing the vision. We have seen that metrics are too contextual to the nature of the business at hand to be universally relevant, so we need to go up a level so to speak. Kaplan and Norton developed four foci that are known as the Balanced Scorecard perspectives:
- Financial – to succeed financially, how should we appear to our shareholders?
- Customer – to achieve our vision, how should we appear to our customers?
- Internal business processes – to satisfy our shareholders and customers, what business processes must we excel at?
- Learning and growth – to achieve our vision, how will we sustain our ability to change and improve?
While the financial perspective remains an essential lagging indicator, we now have the opportunity with the three other leading indicator perspectives to ameliorate its weaknesses. The measures within the financial perspective are outcomes, and the measures within the other three perspectives are drivers.
What about the other stakeholders? Why just a customer perspective? Shareholders are catered to in the financial perspective. Internal processes address relationships with partners. And the learning and growth perspective encompasses employees and citizens.
The next question typically raises the fact that almost all organizations already have non-financial performance metrics for essential business functions; these are often referred to as key performance indicators (KPIs). So what’s the difference? Significantly, the Balanced Scorecard fervently insists that non-financial metrics aren’t designed at the coalface for matters that appear to be important at the coalface, but rather are determined by the diligent cascade down from the organization’s vision and strategy. In other words, they are determined by what really is important and in harmony with all other metrics.
Objectives are set for each perspective that, if nothing else changes, should be wholly necessary and sufficient to result in the organization achieving its vision, or at least the overarching objectives set this year in pursuit of that vision: the objectives for each perspective guide metric selection, target setting and strategy formulation. Of course things do change in the operational environment, and such changes then demand adjustment of the overarching strategy and the objectives and strategies for each perspective and a re-cascade in order to keep the organization on track to deliver on its promises.
One of my favourite observations from the Balanced Scorecard book is that the authors had never come across a management team that had reached full consensus on the relative importance of its strategic objectives. They attribute this to executives’ obsession with their own specialism and corresponding ‘blind spots’ when it comes to the other disciplines, and propose that the Balanced Scorecard helps to iron out such subjectivity.
Cause and effect
A well-designed metric must be visible to everyone whose behaviour it is designed to guide in an optimal way. This sounds obvious when you write it down, but sometimes you come across managers who like to keep these things tight to their chests. There must be, if you like, an individual cause and effect at play. The individual develops an affinity for the cause through the performance metrics, or at least his part in the bigger scheme of things, and the effect demanded of him. Often, just this clarification and new appreciation for his role and how he fits into the organization has a motivational benefit.
We’re also looking for an organizational cause and effect. We’re seeking via the Balanced Scorecard to achieve organizational coherence and coordination and effectiveness, and this becomes apparent as you look up through the perspectives. A properly constructed scorecard recognizes a chain of causes and effects that bind the four perspectives together. An acid test of a good Balanced Scorecard is that it should ‘tell the story of the business unit’s strategy’, and this idea is expanded further in strategy maps, as we shall see.
Kaplan and Norton consider there to be two kinds of feedback loop at play. Feedback about whether the planned strategy is being executed according to the plan is known as ‘single loop learning’, and feedback about whether the planned strategy remains a viable and successful strategy is known as ‘double loop learning’.
The Balanced Scorecard is a powerful management tool with many more features, characteristics, qualities and implications than I have space to discuss here.
Kaplan and Norton write:
the measurement system should focus on the entity’s strategy – how it expects to create future, sustainable value. …Without a comprehensive description of strategy, executives cannot easily communicate the strategy among themselves or to their employees. Without a shared understanding of the strategy, executives cannot create alignment around it. And, without alignment, executives cannot implement their new strategies.
A strategy map provides the visual framework for integrating the organization’s objectives in the four perspectives of a Balanced Scorecard. It portrays the cause-and-effect relationships that link specific capabilities in human, information and organization capital with process excellence, and process excellence with the desired outcomes in the customer and financial perspectives.
It’s worth mentioning that Kaplan and Norton base their work on Michael Porter’s articulation of strategy – about selecting the set of activities in which an organization will excel to create a sustainable difference in the marketplace, and thereby creating sustained value for its shareholders (or sustainable value in the case of non-profits).
And for the sake of clarity, let’s expand on what’s encompassed by those different forms of ‘capital’ referred to above:
- Human capital – skills, knowledge and values
- Information capital – systems, databases, networks
- Organization capital – culture, leadership, alignment, teamwork.
(We do not have permission to republish the copyrighted strategy map figures licensed for The Business of Influence here. Sorry.)
Arrows on the strategy map indicate cause and effect over time, and each perspective is examined in more detail offering up a normative checklist of a strategy’s components and interrelationships. Indeed, Kaplan and Norton go so far as to say that if your strategy fails to address an element in the standard strategy map then it is probably flawed. In other words, the strategy mapping process is often so demanding, in a constructive way, that it prompts an immediate review of the strategy definition phase.
As you might suspect, developing a comprehensive strategy, mapping it and then designing and maintaining the corresponding Balanced Scorecard isn’t a simple task that you can start during morning coffee and complete in time for afternoon tea. Every organization is unique, every business unit is unique, every business unit’s strategy is unique, and every business unit’s strategy map and Balanced Scorecard is unique. BPM consultants and in-house specialists make it their job to get to grips with the strategy maps and Balanced Scorecard processes and their continued honing.
In The Execution Premium, Kaplan and Norton present a six-stage, closed-loop management process:
- Define the strategy – mission, values, vision, strategic analysis and formulation
- Plan and translate the strategy – with strategy maps and Balanced Scorecards
- Align the organization – with cascading linked strategy maps and Balanced Scorecards, to team and employee personal objectives and incentives
- Link to operational processes – plan how operations should run to execute the strategy
- Monitor and learn – management review meetings focused on problems, barriers and challenges
- Test and adapt the strategy – apply the knowledge accrued in the context of the changing operational environment and emerging strategies to prepare to recommence this loop.