What Is Being Balanced in the Balanced Scorecard?
Professor Robert S. Kaplan and David Norton, PhD, co-creators of the balanced scorecard method, wrote their first book in 1996, The Balanced Scorecard: Translating Strategy into Action.
Although it's now been around for many years, there is still little consensus as to what a balanced scorecard is. While many organizations claim to have a balanced scorecard, the paradox is that few of them have actually created the strategy map that is based upon the scorecard’s metrics.
Why is there confusion and inconsistency concerning this entire topic of measures?
Let’s start with understanding the origin of the balanced scorecard as I understand it.
What Kaplan and Norton observed is that too many executives were overreacting to surprises in their financial results reported at the end of a time period.
They suggested executives should shift their attention from financial measures to the nonfinancial measures collected during the time period (e.g., monthly and weekly) that collectively influence the financial results eventually reported. This shift in focus creates a balance in the balanced scorecard.
Kaplan and Norton continued their prescription by designing a strategy map of interdependent strategic objectives with four main categories. The idea is that the initial category of learning, growth and innovation starts with people—employees and partners.
As these people accomplish those strategic objectives, they will then help accomplish the pre-defined strategic objectives of the second category—those that create or improve internal business processes.
This accumulation of work alignment and priorities continues to contribute to the third category—to increase customer intimacy, satisfaction and loyalty.
So, like a force-field of magnetism in physics, the energy of employees and choices collectively contributes to meeting the strategic objectives of the fourth and final category—the financial objectives, such as revenue growth and productivity-driven future cost reduction or avoidance.
Once this arrangement is in place, mission-critical projects, initiatives and core processes can be identified and addressed. Subsequently, measurements—commonly called key performance indicators (KPIs)—can be defined, assigned target levels and monitored.
With these cause-and-effect relationships linked in sequence, one could arguably say that maximizing shareholder wealth creation winds up not really being a goal, but rather the result of accomplishing all the strategic objectives in the strategy map.
One could also argue that executives don't really have a strategy, but rather a vision of where they want their organization to go. The linked strategic objectives, like the musical instruments in a Beethoven symphony, then become the strategy. This is not about every instrument playing loudly, but rather playing together in harmony.
Shifting from a disproportionately high emphasis on financial to nonfinancial measures is one aspect of balance. What are others?
- Short- and long-term results: Many complain this one is often imbalanced by executives. They are accused of narrow-minded decisions (e.g., overly aggressive cost-cutting) that temporarily make them look good to investors but jeopardize long-term, sustainable performance.
- Leading versus lagging indicators: There is a misconception that leading indicators are in the first two strategy map categories (i.e., learning, growth, innovation and internal business processes) and the lagging indicators are results in the last two categories (i.e., customer and financial). Leading indicators influence lagging indicators. In reality, each strategic objective has both types.
- For example, a lagging indicator for the strategic objective to acquire new customers might be revenues isolated only for new customers of an advertising campaign. For this case, a leading indicator might be the advertising expense level of this campaign intended to target those new customers. If the advertising expenses are substantially less than planned, it will be no surprise if new customer revenues are also under target.
- An example of a leading indicator for existing customers might be the up-sell and cross-sell offers with their sales acceptance level as the lagging indicator.
- Key performance indicators versus process indicators: The issue here is that organizations often have way too many KPIs. If you have 300 KPIs, how can they all be “key?” Balance comes from reporting KPIs in a scorecard and process (or simply performance) indicators, or PIs, in a dashboard. PIs are important too, but they serve a different purpose. A scorecard and dashboard are not the same thing. To learn more about the differences between dashboards and scorecards, visit here.
- Tangible versus intangible asset investment: There is a shift in the source of return on investment (ROI) from tangible to intangible assets. That is, there is a shift from investing in tangible assets, such as equipment and buildings, to intangible assets, such as knowledge workers and information. Retaining and growing good employees is increasingly critical for innovation and competency. Regrettably, with the economic downturn, some organizations may be excessively laying off employees, which will reduce the ROI that could be had from retaining them. The ROI from information comes from transforming raw data and standard reports, typically from ERP systems, into knowledge for making better decisions that becomes a competitive differentiator—competing on analytics.
You get the idea. You can probably think of other types of balancing where there are trade-offs. A balanced scorecard is more than shifting focus from financial to nonfinancial measures. Organizations that use strategy maps as the basis for their scorecards will predictably determine and manage the optimal balance of measures compared to ones that do not.