Excellence in Financial Management
Course 11: The Balanced
Prepared by: Matt H. Evans, CPA, CMA, CFM
This course provides a step-by-step guide on how to build a Balanced Scorecard. An understanding of strategic planning is recommended prior to taking this course. Refer to Course 10 on strategic planning. This course is recommended for 2 hours of Continuing Professional Education. In order to receive credit, you will need to pass a multiple-choice exam which is administered by installing the exe file version of this short course. The exe file can be downloaded from www.exinfm.com/training
NOTE: This short course includes the following supplemental materials:
- Excel Templates: Set of basic templates for building the Balanced Scorecard
- PowerPoint presentation: Outlines overall development steps
- Case Study: Short case study on the Balanced Scorecard at UNUM Corporation
Supplemental materials are posted on the internet at www.exinfm.com/training
Revised: February 4, 2002
Accountants communicate with financial statements. Engineers communicate with as-built drawings. Architects communicate with physical models. It seems that almost every profession has some means of communicating clearly to the end user. However, for people engaged in strategic planning there has been an on-going dilemma. The finished product, the strategic plan, has not communicated and reached the end user. Sure strategic plans are nice to look at, full of bar charts, nice covers, well written, and professionally prepared; but they simply have not impacted the people who must execute the strategic plan. The end result has been poor execution of the strategic plan throughout the entire organization. And the sad fact of the matter is that execution of the strategic plan is everybody’s business, not just upper level management. Upper level management creates the strategy, but execution takes place from the bottom up.
So why do strategic plans fail? According to the Balanced Scorecard Collaborative, there are four barriers to strategic implementation:
1. Vision Barrier – No one in the organization understands the strategies of the organization. 2. People Barrier – Most people have objectives that are not linked to the strategy of the
3. Resource Barrier – Time, energy, and money are not allocated to those things that are
critical to the organization. For example, budgets are not linked to strategy, resulting in
4. Management Barrier – Management spends too little time on strategy and too much time on
short-term tactical decision-making.
Only 5% of the workforce understands their company strategy. Only 25% of managers have incentives linked to strategy. 60% of organizations don’t link budgets to strategy. 86% of executive teams spend less than one hour per month discussing strategy. – Balanced Scorecard Collaborative
Therefore, we need a new way of communicating strategy to the end-user. Enter the Balanced Scorecard. At long last, strategic planners now have a crisp and clear way of communicating strategy. With balanced scorecards, strategy reaches everyone in a language that makes sense. When strategy is expressed in terms of measurements and targets, the employee can relate to what must happen. This leads to much better execution of strategy.
Not only does the Balanced Scorecard transform how the strategic plan is expressed, but it also pulls everything together. This is the so-called “cause and effect” relationship or linking of
all elements together. For example, if you want strong financial results, you must have great customer service. If you want great customer service, you must have excellent processes in
place (such as Customer Relations Management). If you want great processes, you must have the right people, knowledge, and systems (intellectual capital).
In the past, many components for implementing a strategic plan have been managed separately, not collectively within one overall management system. As a result, everything has moved in different directions, leading to poor execution of the strategic plan. Like a marching band, everyone needs to move in lockstep behind one overall strategy.
Therefore, you should think of the Balanced Scorecard as a management system, not just another performance measurement program. And since strategy is at the center of value-creation for the organization, the Balanced Scorecard has become a critical management system for any organization. In 1997, Harvard Business Review called the Balanced Scorecard one of the most significant business developments of the previous 75 years.
Balanced Scorecards provide the framework around which an organization changes through the execution of its strategy. This is accomplished by linking everything together. This is what makes the Balanced Scorecard so different; it captures the cause and effect relationship throughout every part of the organization. In the case of Mobil Oil, the truck driver pulls a balanced scorecard off the visor in his cab, outlining the five things he must do as a truck driver. Like a laser beam, strategy now has a clear path to everyone in the organization.
Balanced Scorecards tell you the knowledge, skills and systems that your employees will need (learning and growth) to innovate and build the right strategic capabilities and efficiencies (internal processes) that deliver specific
value to the market (customer) which will eventually lead to higher
shareholder value (financial).
– “Having Trouble with Your Strategy? Then Map It” by Robert S. Kaplan and David P. Norton - Harvard Business Review
Throughout the entire process of building and implementing a balanced scorecard, we all need to speak the same language. Therefore, the first thing to get out of the way is to understand a few terms:
Cause Effect Relationship: The natural flow of business performance from a lower level to an upper level within or between perspectives. For example, training employees on customer relation’s leads to
better customer service which in turn leads to improved financial results. One side is the leader or driver, producing an end result or effect on the other side.
Goal: An overall achievement that is considered critical to the future success of the organization Goals express where the organization wants to be.
Measurement: A way of monitoring and tracking the progress of strategic objectives. Measurements can be leading indicators of performance (leads to an end result) or lagging indicators (the end results).
Objective: What specifically must be done to execute the strategy; i.e. what is critical to the future success of our strategy? What the organization must do to reach its goals!
Perspectives: Four or five different views of what drives the organization. Perspectives provide a framework for measurement. The four most common perspectives are: Financial (final outcomes), Customer, Internal Processes, and Learning & Growth.
Programs: Major initiatives or projects that must be undertaken in order to meet one or more strategic objectives.
Strategic Area: A major strategic thrust for the organization, such as maximizing shareholder value or improving the efficiency of operations. Strategic areas define the scope for building the balanced scorecard system.
Strategic Grid: A logical framework for organizing a collection of strategic objectives over four or more perspectives. Everything is linked to capture a cause and effect relationship. Strategic grids are the foundation for building the Balanced Scorecard.
Strategic Model: The combination of all strategic objectives over a strategic grid, well connected and complete, providing one single model or structure for managing the strategic area.
Strategy: An expression of what the organization must do to get from one reference point to another reference point. Strategy is often expressed in terms of a mission statement, vision, goals, and objectives. Strategy is usually developed at the top levels of the organization, but executed by lower levels within the organization.
Target: An expected level of performance or improvement required in the future.
Templates: Visual tools for assisting people with building a balanced scorecard, typically used for capturing and comparing data within the four components of the Balanced Scorecard: Strategic Grids, Measurements, Targets, and Programs.
Vision: An overall statement of how the organization wants to be perceived over the long-term (3 to 5 years).
Now that you understand the purpose and terminology behind the Balanced Scorecard, let’s
describe the overall process on how we will build the Balanced Scorecard. The process consists of seven steps over three phases:
Phase I: The Strategic Foundation
Step 1: Communicate and align the organization around a clear and concise strategy. This is the fundamental starting point behind everything else. Your strategy is what “feeds” the Balanced Scorecard.
Step 2: Determine the major strategic areas or scope for getting the organization focused on those things the organization can actually do.
Step 3: Build a strategic grid for each major strategic area (step 2) of the business. Out of all the steps in the entire process, this can be the most difficult since we must take our entire strategy (step 1) and transform it into specific terms that everyone can understand. And everything must be linked to form one complete strategic model.
Phase II: Three Critical Components
Step 4: Establish Measurements: For each strategic objective on each strategic grid, there needs to be at least one measurement. Measurement provides the feedback on whether or not we are meeting our strategic objectives.
Step 5: Set Targets for each measurement: For each measurement in your scorecard, establish a corresponding target.
Step 6: Launch Programs: Things will not happen unless the organization undertakes formal programs, initiatives or projects. This effectively closes the loop and links us back to where we started – driving the strategy that was formulated in phase I.
Phase III: Deployment
Step 7: Once the Balanced Scorecard has been built, you need to push the entire process into other parts of the organization until you construct a single coherent management system. This pulls everything together, allowing successful execution of your strategy.
Don’t worry if all of this doesn’t make sense yet! The remainder of this short course will describe in detail each of the steps outlined above. Once you have completed this short course, you should have a solid understanding of what is required for building a great balanced scorecard.
Phase I: The Strategic Foundation
When balanced scorecards were first introduced, it seems that everyone rushed to put a whole new set of measurements in place. However, this is not how to build a balanced scorecard.
Strategizing is critically important to building a good balanced scorecard. In fact, it is so important that the authors of the book, The Balanced Scorecard, Robert S. Kaplan and David P.
Norton, released a follow-up book titled: The Strategy Focused Organization. Therefore, we
need to focus on building a strategic foundation, culminating with a set of strategic grids or maps. This is the watershed event within the entire process! The combination of strategic grids, measurements, targets and programs represent the four key components that makeup the Balanced Scorecard. All of these components will be described in detail as we work our way through the seven step / three phase process.
When designing a balanced scorecard, we always start by asking: “What is
your strategy?” Once we understand the strategy, we can build a new
framework for describing the strategy, which we call a strategy map.
– The Strategy Focused Organization by Robert S. Kaplan & David P. Norton
So let’s get started with step one; namely by establishing our strategy for driving the rest of the process. If you took course 10 (and I am assuming you did), then you already have an understanding of how to construct a strategic plan. However, we want to make sure that we have a crystal clear and sharp strategic plan for feeding our balanced scorecard. A clear strategy requires two things: Specific objectives that tell people what to do and a set of targets for communicating what is expected.
Objectives need to communicate the action people must undertake. As strategy guru Michael Porter of Harvard University points out – “The essence of strategy is in the activities, choosing to perform activities differently or to perform different activities than rivals.” We must define
what these activities are if we expect to have a clear and sharp strategy.
Exhibit 1: Strategic objectives expressed in relation to action and activities
Over the next six months, delivery times will decrease by 15% through
more localized distribution centers.
By the year 2003, customer turnover will decline by 30% through
newly created customer service representatives and pro-active
customer maintenance procedures.
Operating downtimes will get cut in half by cross training front line
personnel and combining all four operating departments into one single service center.
The second key ingredients for a clear strategy are targets. Targets put teeth into a strategy by imposing criteria that the organization must achieve. For example, the strategy needs to be clarified by defining market share, revenue growth, new products introduced, and other specifics that set forth the end results of our strategy. In order to have targets, we need measurements. Since both targets and measurements are critical components of the Balanced Scorecard, we will defer discussion of targets and measurements until we get into the design phase (phase II). However, suffice it to say that if you have measurements and targets as components of your strategy, then building the Balanced Scorecard will be much easier.
Once you have defined a clear strategy (objectives and targets), then you must rally the organization around it. This requires a major communication initiative. A good starting point is to develop a communication plan. A communication plan outlines how you will communicate the strategy to each stakeholder group:
Exhibit 2: Basic Communication Plan
Shareholders Press Conference
Division Managers Management Retreat / Presentation
District Managers Site to Site Visits / Handouts
Operating Staff Site to Site Visits / Handouts
Administrative Staff Site to Site Visits / Handouts
Suppliers Personal Contact / Mailing
Distributors Personal Contact
Effective communication is the Achilles Heel in this entire process. Therefore, extensive and continuous communication is vital to getting the organization aligned around its strategy.
“I sure wish I’d done a better job of communicating with GM people. I’d do that
differently a second time around and make sure they understand and shared my vision for
the company. Then they would know why I was tearing the place up, taking out whole
divisions, changing our whole production structure . . . I never got this across.”
Roger Smith, CEO of General Motors
– Strategic Choices by Kenneth Primozic, Edward Primozic, and Joe Leben
Finally, you need to align and re-configure the various parts of the organization around the strategy. This may require changes to the organizational structure, selling off assets, making sure you have a “productive” culture, and other significant changes. Strategy is about closing
the gaps between the present position of the organization and where the organization wants to be. Therefore, you must make changes to the organization if you expect success with your strategy.
Once the organization is set around its strategy, then and only then can you begin building the balanced scorecard system. In the case of Mobil Oil, it took over one year to create the right number of operating divisions around its new strategy.
“One of the mistakes companies make is coming up with a list of measures of what they
could measure instead of what they should be measuring. If a company thinks about what
it needs to achieve to be successful in the eyes of its shareholders, clients and internal
stakeholders, that will yield operational activities that the organization needs to do well to
achieve those strategies.”
Vicki Elliott, Principal, William M. Mercer
“Putting the Scorecard to Work” – Business Finance Magazine
Before we start designing the Balanced Scorecard, we need a “fence line” of strategic areas.
This restricts the organization to a selected area for achieving strategic success; otherwise the organization may find itself trying to do too many things. Strategy is about choices and making decisions on those things the organization can do vs. those things the organization cannot do. Or to put it another way: A few successes are better than a lot of failures.
Therefore, the strategic thrust of the organization needs to be confined to a few major areas. This will provide the “scope” we need for building a set of balanced scorecards. For most organizations, the strategic thrust of the organization will revolve around stakeholder groups; such as customers, shareholders, and employees. For example, most publicly traded corporations will have “shareholder value” as a major strategic area. This becomes one of the strategic areas for building the Balanced Scorecard. Additionally, each strategic area will flow across all four perspectives of the Balanced Scorecard: Financial, Customer, Internal Processes, and Learning and Growth. The following exhibit illustrates how shareholder value flows up across the four perspectives of the Balanced Scorecard:
Exhibit 3: Basic flow of Strategic Area within the Balanced Scorecard
Financial Revenue Growth
Customer More Customers
Processes Customer Marketing & Service Programs
Learning Support Systems & Personnel
Notice how each lower perspective layer supports and enables the upper perspective layer; such as More Customers will enable Revenue Growth. Keep in mind that we are trying to link everything together. This is critical to building a great balanced scorecard; i.e. capturing the cause effect relationship.
Collectively, we want to limit our strategic areas to no more than five areas. This helps ensure successful implementation of our strategy. Some common strategic areas are: Customer Service, Shareholder Value, Operational Efficiency, Product Innovation, and Social Responsibility. We can refer to our strategic goals (created from our strategy in phase I) to help us isolate our strategic areas. The following exhibit illustrates how a strategic goal leads us into a strategic area:
Exhibit 4: Example of linking a strategic goal to a strategic area
By the year 2005, our company will
have the most innovative product
line of hand held computers
Finally, there is the possibility that one strategic area may conflict with another. For example, Operational Efficiency may require cost reductions while Market Share may require more expenses. If such conflicts do exist, make sure all stakeholders involved are fully aware of these conflicting areas and how they fit within your strategic plan.
Now that we have a strategy in place (step 1) and now that we have defined our strategic areas or scope (step 2), we will translate the specifics of our strategy into a set of grids. As you may recall, we noted that balanced scorecards are structured over four perspectives or layers: Financial, Customer, Internal Processes, and Learning and Growth. Strategic grids include these four layers. Within each layer, we will place our strategic objectives, making sure everything links back. Trying to develop strategic objectives and placing them into the correct layers for all strategic grids is probably the most difficult step in building the Balanced Scorecard. Consultants sometimes refer to this step as straw modeling; trying to string connecting lines over a map that presents an overall strategic model.
Building a strategic grid starts at the very top – strategic goals and areas. As we indicated
earlier, most publicly traded companies have shareholder value as a strategic area. In order to improve shareholder value, the organization can do things like grow revenues or increase operating performance. Once you decide on your strategy for improving shareholder value, then you have to decide on how you will grow revenues or improve operating performance. The following exhibit illustrates this bottom up flow within the Financial Perspective:
Exhibit 5: Flowing strategic objectives within the Financial Perspective
Grow Revenues ; ; Operating Improvements
; ; ; ;
New Sources of Increase Customer Lower Costs High Utilization of
Revenues Profitability Assets
We will flow our strategic objectives down each perspective within a grid of boxes, making sure everything is linked. This grid will serve as the foundation for constructing the Balanced Scorecard.
Next, we move down to the Customer Perspective. In order to construct the customer perspective, we need to understand the value(s) we provide to our customers. For example, Federal Express is extremely efficient in getting packages delivered on time. Therefore, on time delivery is the specific value that Federal Express delivers to its customers. Companies that emphasize operational efficiency usually provide certain value attributes, such as competitive pricing, on-time delivery, or superb quality. Other companies may create value for customers
through their great relationship with the customer. Finally, some companies may add value by emphasizing innovative and unique products and / or services. It is extremely important to define your customer and the values you provide; otherwise you run the risk of building a scorecard that doesn’t fit with the capabilities of the organization.
Once you have clearly defined your customer values, you can define strategic objectives within the Customer Perspective, linking these objectives to the financial perspective objectives. For example, suppose we have a strategic goal that stipulates that our company will be the price leader in long distance phone service. We can flow this goal within the scorecard grid as follows:
Exhibit 6: Linking customer objectives to financial objectives
; Grow Revenues
; Acquire More Customers
; Leader in Pricing
Notice how “Leader in Pricing” is the driver behind acquiring more customers. In turn, more
customers will flow up to the next layer of growing revenues. And growing revenues is our strategy for meeting our strategic thrust or area of creating shareholder value.
Next, we need to ask the question: How will we become a leader in competitive pricing for attracting new customers? This brings us down to the next perspective: Internal Processes. Internal Processes represent the collection of activities that give a company a competitive advantage in the marketplace.
Referring back to the Customer Perspective, we could choose between three strategies:
1. Operational Efficiency – Value for customers through competitive pricing, superior
quality, on-time delivery or diverse product lines.
2. Customer Relationships – Value for customers through personal service, building trust,
brand loyalty, providing customized solutions, and other one-to-one relationships.
3. Innovative Products & Services – Inventing new products and features, fast delivery of
products and services, forming partnerships to expand product lines, and other product
If we go back to our example on price leadership in long distance phone service, we need to emphasize operational efficiency within our strategy since this will enable competitive pricing. Next, the company must define its strategic objectives for operational efficiency (which leads to competitive pricing). This can include numerous objectives: Supply chain management, cycle time improvements, cost reduction programs, and any objective aimed at operational excellence. Once we decide on objectives, we can extend our strategic grid down into the next perspective as follows:
Exhibit 7: Linking objectives down to Internal Processes
Acquire More Customers
Become the Price Leader