11_BackgroundReading_UsingTheBalancedScorecard_KaplanNorton

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Unformatted text preview: Building a scorecard can help managers link today’s actions With tomorrow’s goals. Using the Balanced Scorecard as a Strategic Management System by Robert S. Kaplan and David P. Norton As companies around the world transform them- selves for competition that is based on informa- tion, their ability to exploit intangible assets has he- come far more decisive than their ability to invest in and manage physical assets. Several years ago, in recognition of this change, We introduced a con- cept we called the balanced scorecard. The balanced scorecard supplemented traditional financial mea- sures witb criteria that measured performance from three additional perspectives 7 those of cuss tomcrs, internal business processes, and learning and growth. (See the chart "Translating Vision and Strategy: Four Perspectives”) It therefore enabled companies to track financial results while simulta- neously monitoring progress in building the capa- bilities and acquiring the intangible assets they would need for future growth. The scorecard wasn't a replacement for financial measures; it was their complement. Recently, we have seen some companies move beyond our early vision for the scorecard to dis- cover its value as the cornerstone of a new strategic management system. Used this way, the scorecard addresses a serious deficiency in traditional man- agement systems: their inability to link a compa- ny’s long-term strategy with its shortrterm actions. Most companies’ operational and management control systems are built around financial mea- sures and targets, which bear little relation to the HARVARD BUSINES‘E REVIEW Ianuary-lebruan with company’s progress in achieving long—term strate- gic objectives. Thus the emphasis most companies place on short-term financial measures leaves a gap between the development of a strategy and its im- plementation. Managers using the balanced scorecard do not have to rely on short-term financial measures as the sole indicators of the company’s performance. The scorecard lets them introduce four new man- agement processes that, separately and in combina- tion, contribute to linking long-term strategic ob- jectives with short-term actions. {See the chart ,“Managing Strategy: Four Processes”! ‘ The first new process— translating the vision — helps managers build a consensus around the orga- nization‘s vision and strategy. Despite the best in- tentions of those at the top, lofty statements about becoming “best in class, ” “the number one supplier,” Robert 5'. Kaplan is the Arthur Lowcs Dickinson Profes- sor of Accounting at the Harvard Business School in Boston. Massachusetts. David P. Norton is the founder and president of Renaissance Solutions. a consulting firm in Lincoln. Massachusetts. They are the authors of "The Balanced Scorecard — Measures That Drive Perfor- mance" (HER Iannary—February 1992} and "Putting the Balanced Scorecard to Work ” (HBR September-October 1993}. Kitplau and Norton have also written a book on the balanced scorecard to he published in September 1990 by the Harvard Business School Press. 75 BALANCED SCORECARD Translating Vision and Strategy: Four Perspectives financial "To succeed Obgecfives financially, haw should we appear to our shareholders?" 'Ta achieve Initiatives our vision. how should we appeat in our customers?" Obiectives Measures Targets --.r.- -_fi--. 'To achieve our vision, haw will we sustain our ability to change and improve?‘ Obiaclives "1"’I‘"F" or an “empowered organization” don‘t translate easily into operational terms that provide useful guides to action at the local level. For people to act on the words in vision and strategy statements, those statements must be expressed as an inte- grated set of objectives and measures, agreed upon by all senior executives, that describe the long- term drivers of success. The second process ‘ communicating and link- ingw lets managers communicate their strategy up Lofty vision and strategy statements don’t translate easily into action at the local level. and down the organization and link it to depart- mental and individual objectives. Traditionally, de- partments are evaluated by their financial perfor- 76 Measures Vision and Strategy Measures Targets Targets initiatives -1--r-r“ -—1—-_ “To satisfy our Obiectives Initiatives shareholders and customers, what business processes must we excel at?" Measures Targets Initiatives mance, and individual incentives are tied to short- term financial goals. The scorecard gives managers a way of ensuring that all levels of the organization understand the long-term strategy and that both de- partmental and individual objectives are aligned with it. The third process — business planning — enables companies to integrate their business and financial plans. Almost all organizations today are imple- menting a variety of change programs, each with its own champions, gurus, and consul- tants, and each competing for senior executives’ time, energy, and re- sources. Managers find it difficult to integrate those diverse initiatives to achieve their strategic goals—a situa- tion that leads to frequent disap- pointments with the programs” re- sults. But when managers use the ambitious goals set for balanced scorecard mea- sures as the basis for allocating resources and set- ting priorities, they can undertake and coordinate HARVARD BUSINESS REVIEW lanuary-Eehruary WW» mr'-.:"‘i‘r"- _-'u 7 ,r.7 w -- -,-r,-_-...-- .t _---.--», only those initiatives that move them toward their long—term strategic objectives. The fourth process A feedback and learning — gives companies the capacity for what we call stra- tegic learning. Existing feedback and review pro— cesses focus on whether the company, its depart- ments, or its individual employees have met their budgeted financial goals. With the balanced score- card at the center of its management systems, a company can monitor short-term results from the three additional perspectives~ customers, internal business processes, and learning and growth a and evaluate strategy in the light of recent perfor» mance. The scorecard thus enables companies to modify strategies to reflect real-time learning. None of the more than 100 organizations that we have studied or with which we have worked imple- mented their first balanced scorecard with the in- tention of developing a new strategic management system. But in each one, the senior executives dis- covered that the scorecard supplied a framework and thus a focus for many critical management processes: departmental and individual goal set- ting, business planning, capital allocations, strate- gic initiatives, and feedback and learning. Previous- ly, those processes were uncoordinated and often directed at short—term operational goals. By build- ing the scorecard, the senior executives started a process of change that has gone well beyond the original idea of simply broadening the company's performance measures. For example, one insurance company — let's call it National Insurance—developed its first bal- anced scorecard to create a new vision for itself as an underwrit- ing specialist. But once National started to use it, the scorecard al- lowed the CEO and the senior management team not only to in- troduce a new strategy for the or- ganization but also to overhaul the company’s management sys— tem. The CEO subsequently told employees in a letter addressed to the whole organization that Na- tional would thenceforth use the balanced scorecard and the philos- ophy that it represented to man- age the business. National built its new strategic management system step-by-step over 30 months, with each step representing an incremental im- D Communicating and educating DSdfinggnub HARVARD BUSINESS REVIEW JanuaryeFebruary 1996 provement. (See the chart “How One Company Built a Strategic Management System.”] The itera- tive sequence of actions enabled the company to reconsider each of the four new management pro- cesses two or three times before the system sta- bilized and became an established part of National’s overall management system. Thus the CEO was able to transform the company so that everyone could focus on achieving long-term strategic obiec~ tives — something that no purely financial frame- work could do. Tronsloting the Vision The CEO of an engineering construction com— pany, after working with his senior management team for several months to develop a mission state- ment, got a phone call from a project manager in the field. “I want you to know, " the distraught manager said, “that I believe in the mission statement. I want to act in accordance with the mission state- ment. I’m here with my customer. What am I sup- posed to do?” The mission statement, like those of many other organizations, had declared an intention to "use high-quality employees to provide services that surpass customers' needs.” But the project manager in the field with his employees and his customer Managing Strategy: Four Processes 77 —-= :-u.4r— cur,— gummy; gratin-nun- BALANCED SCORECARD ’-’L\—Hr" n. :V‘aans": -- - —~- —=-- Lawns. How One Company Built a Strategic Management System... 2A Communicate to Middle Managers: The top three layers of management {100 people) are brought together to learn about and discuss the new strategy. The balanced 23 Develop Business Unit Scorecards: Using the corporate scorecard as a template, each business unit translates its strategy into its own scorecard. 5 Refine the Wsion: The review of business unit scorecards identifies several crossbusiness issues not initially included in the corporate strategy. The scorecard is the (months 4 c 5} Time Frame (in months} 0 'l 2 3 4 5 Actions: I Clarify the Vision: Ten members of a newly formed executive team work together for three months. A balanced scorecard is developed to translate a generic vision into a strategy that is understood and can be communicated. The process helps build consensus and commitment to the strategy. did not know how to translate those words into the appropriate actions. The phone call convinced the CEO that a large gap existed between the mission statement and employees’ knowledge of how their day-to-day actions could contribute to realizing the company's vision. Metro Bank [not its real name), the result of a communication vehicle. {months 6 - 9} corporate scorecard is updated. {month 12) 6 7 8 9 10 l 1 3A Eliminate Nonstrategic investments: The corporate scorecard, by clarifying strategic priorities, identifies 4 Review Business Unit Scorecards: The CEO and the executive team review the individual business units' many octiVB_Pr°9mm-" "10* 0'9 scorecards. The review not contributing to the strategy. permns the CEO to participate {month 6} momedgmbly in shaping 33 launch Corporate Change Programs: The corporate scorecard identifies the need for cross-business change programs. They are launched while the business units prepare their scorecards. (month 6) business unit strategy. {months 9 - ii) for the customer-perspective portion of their bal— anced scorecard, however, it became apparent that although the 25 senior executives agreed on the words of the strategy, each one had a different defi- nition of superior service and a different image of the targeted customers. The cxcrcisrz of developing operational measures merger of two competitors, encountered a similar l for the four perspectives on the bank’s scorecard Building a scorecard enables a company to link its financial budgets with its strategic goals. gap while building its balanced scorecard. The se- nior executive group thought it had reached agree- ment on the new organization’s overall strategy: “to provide superior service to targeted customers.” Research had revealed five basic market segments among existing and potential customers, each with different needs. While formulating the measures 78 forced the 25 executives to clarify the meaning of the strategy state- ment. Ultimately, they agreed to stimulate revenue growth through new products and services and also agreed on the three most desirable customer segments. They developed scorecard measures for the specific products and services that should be ‘ delivered to customers in the targeted segments as well as for the relationship the bank should build with customers in each segment. The scorecard al- so highlighted gaps to employees’ skills and in in- formation systems that the bank would have to close in order to deliver the selected value proposi- | tions to the targeted customers. Thus, creating a HARVARD BUSINESS REVIEW [urinary-February 1996 '. .- ‘V ’.1W-M-’wi#"z aura: yea-w 7 Update Long-Range Plan and Budget: Five-year goals are established for each measure. The investments 9 Conduct Annual Strategy Review: At the start of the third year, the initial strategy has been achieved and the corparote strategy requires updating. The executive committee lists ten “(Wired '0 meal tho” goals strategic issues. Each business unit is asked to ill: Ezggffinffiflliefim develop}: position on each issue as a prelude Plan becomes Hm annual to updating its strategy and scorecard. budget. (months l5 - l'fl (Month 25 - 26) 13 14 15 16 17 IS I9 20 21 22 23 24 25 26 6A Communicate the Balanced Scorecard to the Entire Company: At the end at one year, when the management teams are comfortable with the strategic approach, the scorecard is disseminated to the entire organization. {month 12 - ongoing) 63 Establish individual Performance Obfectives: The top three layers of management link their individual objectives and incentive compensation to their scorecards. {months l 3 - 14) 8 Conduct Monthly and Quarterty Reviews: After corporate approval of the business unit scorecards, a monthly review process, supplemented by quarterly reviews that focus more heavily on strategic issues, begins. (month l8 - ongoing} to Link Everyone’s Performance to the Balanced Scorecard: All employees are asked to link their individual obiectives to the balanced scorecard. The entire organization's incentive compensation is linked to the scorecard. {months 2.5 - 26} Note: Steps 7, 8, 9, and 10 are performed on a regular schedule. The balanced scorecard is new a routine part at the management process. balanced scorecard forced the bank’s senior man- agers to arrive at a consensus and then to translate I their vision into terms that had meaning to the people who would realize the vision. ...Around the Balanced Scorecard l l Communicating and Linking “The top ten people in the business now under- stand the strategy better than ever before. It’s too bad,” a senior executive of a major oil company ‘ complained, “that we can’t put this in a bottle so that everyone could share it.” With the balanced scorecard, he can. One company we have worked with deliberately involved three layers of management in the cre— ation of its balanced scorecard. The senior execu- tive group formulated the financial and customer objectives. It then mobilized the talent and infor- I mation in the next two levels of managers by hav- . ing them formulate the internalbusiness-process . and lcarning-and-growth objectives that would drive the achievement of the financial and cus- tomer goals. For example, knowing the importance of satisfying customers’ expectations of on-timc HARVARD BUSINESS REVIEW lanuary-Fcbruary 1996 79 rv es!- ' r rat-I Wrmimm—m. swig? Ww-m-‘mmwmmwnn- immWa—nm delivery, the broader group identified several inter- nal business processes — such as order processing, scheduling, and fulfillment—in which the company had to excel. To do so, the company would have to retrain frontline employees and improve the infor- mation systems available to them. The group de- veloped performance measures for those critical processes and for staff and systems capabilities. Broad participation in creating a scorecard takes longer, but it offers several advantages: Information from a larger number of managers is incorporated into the internal objectives; the managers gain a better understanding of the company's long—term strategic goals; and such broad participation builds a stronger commitment to achieving those goals. But getting managers to buy into the scorecard is only a first step in linking individual actions to cor- porate goals. The balanced scorecard signals to everyone what the organization is trying to achieve for sharehold- ers and customers alike. But to align employees‘ in- dividual performances with the overall strategy, scorecard users generally engage in three activities: communicating and educating, setting goals, and linking rewards to performance measures. Communicating and Educating. Implementing a strategy begins with educating those who have to execute it. Whereas some organizations opt to hold their strategy close to the vest, most believe that they should disseminate it from top to bottom. A broad-based communication program shares with all employees the strategy and the critical objec- tives they have to meet if the strategy is to succeed. The personal scorecard helps to communicate corporate and unit objectives to the people and teams performing the work. Onetime events such as the distribution of bro- chures or newsletters and the holding of "town meetings” might kick off the program. Some orga- nizations post bulletin boards that illustrate and explain the balanced scorecard measures, then up- date them with monthly results. Others use group- ware and electronic bulletin boards to distribute the secrecard to the desktops of all employees and to encourage dialogue about the measures. The same media allow employees to make suggestions for achieving or exceeding the targets. 80 BALANCED SCORECARD The balanced scorecard, as the embodiment of business unit strategy, should also be communi- cated upward in the organization—to corporate head- quarters and to the corporate board of directors. With the scorecard, business units can quantify and communicate their long-term strategies to senior executives using a comprehensive set of linked fi- nancial and nonfinancial measures. Such commu— nication informs the executives and the board in specific terms that long-term strategies designed for competitive success are in place. The measures also provide the basis for feedback and accountabil- ity. Meeting short-term financial targets should not constitute satisfactory performance when other measures indicate that the long-term strategy is ei- ther not working or not being implemented well. Should the balanced scorecard be communicated beyond the boardroom to external shareholders? We believe that as senior executives gain confi- dence in the ability of the scorecard measures to monitor strategic performance and predict future financial performance, they will find ways to in— form outside investors about those measures with- out disclosing competitively sensitive information. Skandia, an insurance and financial services company based in Sweden, issues a supplement to its annual report called "The Business Navigator” — “an instrument to help us navigate into the future and thereby stimulate renewal and development.” The supplement describes Skandia’s strategy and the strategic measures the company uses to com- municate and evaluate the strategy. It also provides a report on the company’s performance along those measures during the year. The mea- sures are customized for each operat- ing unit and include, for example, market share, customer satisfaction and retention, employee compe— tence, employee empowerment, and technology deployment. Communicating the balanced scorecard promotes commitment and accountability to the business’s long—term strategy. As one executive at Metro Bank declared, "The balanced scorecard is both motivating and obligating.” Setting Goals. Mere awareness of corporate goals, however, is not enough to change many people’s be- havior. Somehow, the organization’s high-level strategic objectives and measures must be trans- lated into objectives and measures for Operating units and individuals. The exploration group of a large oil company de- veloped a technique to enable and encourage indi- viduals to set goals for themselves that were consis- HARVARD BUSINESS REVEEW January-February 1996 W The Personal Scorecard Double our corporate value in seven years. 13 Increase our earnings by an average of 20% per year. : Achieve on internal rate of return 2% above the cost of capital. :‘ Increase both production and reserves by 20% in the next decade. com-rm museum 1998 ran—mimosa 1998 ten Foiririmril Corporate Obiectives l: ‘l’ llndlvld l Obloefive "m and nudism ‘ || Eornins in millions of dollars _ rm mm Overhead and o roiin exenses 0pm (illi'ltl m Production costs - r barre! - Develomenr costs - r barrel - Total annual reduction Team/Individual Measures Location: tent with the organization’s. It created a small, fold- up personal scorecard that people could carry in their shirt pockets or wallets. [See the exhibit "The Personal Scorecard”) The scorecard contains three levels of information. The first describes corpo- rate obiectives, measures, and targets. The second leaves room for translating corporate targets into targets for each business unit. For the third level, the company asks both individuals and teams to articulate which of their own objectives would be consistent with the business unit and corporate ob- jectives, as well as what initiatives they Would take to achieve their objectives. It also asks them to de- fine up to five performance measures for their ob- jectives and to set targets for each measure. The personal scorecard helps to communicate corporate and business unit objectives to the people and teams performing the work, enabling them to translate the objectives into meaningful tasks and targets for themselves. It also lets them keep that information close at hand—in their pockets. Linking Rewards to Performance Measures. Should compensation systems be linked to bal- anced scorecard measures? Some companies, he— lieving that tying financial compensation to perfor- mance is a powerful lever, have moved quickly to HARVARD IlUSlNESS RLVlEW l:!nll.ll’l\’el:€l1lllfll‘_{ i996 ----- — — — _ _ — — 4 — — establish such a linkage. For example, an oil com- pany that we’ll call Pioneer Petroleum uses its scorecard as the sole basis for computing incentive compensation. The company ties 60% of its execu- tives’ bonuses to their achievement of ambitious targets fora weighted average of four financial indi— cators: return on capital, profitability, cash flow, and operating cost. It bases the remaining 40% on indicators of customer satisfaction, dealer satis- faction, employee satisfaction, and environmental responsibility [such as a percentage change in the level of emissions to water and air). Pioneer's CEO says that linking compensation to the scorecard has helped to align the company with its strategy. "I know of no competitor," he says, “who has this de- gree of alignment. It is producing results for us. ” As attractive and as powerful as such linkage is, it nonetheless carries risks. For instance, does the company have the right measures on the scorecard? Does it have valid and reliable data for the selected measures? Could unintended or unexpected conse— quences arise from the way the targets for the mea- sures are achieved? Those are questions that com— panies should ask. Furthermore, companies traditionally handle multiple objectives in a compensation formula by 8] assigning weights to each objective and calculating incentive compensation by the extent to which each weighted objective was achieved. This prac- tice permits substantial incentive compensation to be paid if the business unit overachieves on a few objectives even if it falls far short on others. A bet- ter approach would be to establish minimum threshold levels for a critical subset of the strategic measures. Individuals would earn no incentive compensation if performance in a given period fell short of any threshold. This requirement should motivate people to achieve a more balanced perfor- mance across short- and long-term objectives. Some organizations, however, have reduced their emphasis on short-term, formula-based incentive systems as a result of introducing the balanced scorecard. They have discovered that dialogue among executives and managers about the score- card — both the formulation of the measures and objectives and the explanation of actual versus targeted results — provides a better opportunity to observe managers’ performance and abilities. in- creased knowledge of their managers' abilities makes it easier for executives to set incentive re- wards subjectively and to defend those subjective evaluations—a process that is less susceptible to the game playing and distortions associated with ex- plicit, formula-based rules. One company we have studied takes an interme- diate position. It bases bonuses for business unit managers on two equally weighted criteria: their achievement of a financial objective — economic value added — over a three-year period and a sub- jective assessment of their performance on mea- sures drawn from the customer, internal-business- process, and learning-and—growth perspectives of the balanced scorecard. That the balanced scorecard has a role to play in the determination of incentive compensation is not in doubt. Precisely what that role should be will be- come Clearer as more companies experiment with linking rewards to scorecard measures. Business Planning “Where the rubber meets the sky": That’s how one senior executive describes his company’s long- range-planning process. He might have said the same of many other companies because their finan- cially based management systems fail to link change programs and resource allocation to long- term strategic priorities. The problem is that most organizations have separate procedures and organizational units for strategic planning and for resource allocation and 82 BALANCED SCORECARD budgeting. To formulate their strategic plans, se- nior executives go off-site annually and engage for several days in active discussions facilitated by se- nior planning and development managers or exter- nal consultants. The outcome of this exercise is a strategic plan articulating where the company ex- pects [or hopes or prays) to be in three, five, and ten years. Typically, such plans then sit on executives‘ bookshelves for the next 12 months. Meanwhile, a separate resource-allocation and budgeting process run by the finance staff sets fi- nancial targets for revenues, expenses, profits, and investments for the next fiscal year. The budget it produces consists almost entirely of financial num- bers that generally bear little relation to the targets in the strategic plan. Which document do corporate managers discuss in their monthly and quarterly meetings during the following year? Usually only the budget, because the periodic reviews focus on a comparison of actu- al and budgeted results for every line item. When is the strategic plan next discussed? Probably during the next annual off-site meeting, when the senior managers draw up a new set of three~, five-, and ten- year plans. The very exercise of creating a balanced score- card forces companies to integrate their strategic planning and budgeting processes and therefore helps to ensure that their budgets support their strategies. Scorecard users select measures of progress from all four scorecard perspectives and set targets for each of them. Then they determine which actions will drive them toward their tar- gets, identify the measures they will apply to those drivers from the four perspectives, and establish the short—term milestones that will mark their progress along the strategic paths they have selected. Build- ing a scorecard thus enables a company to link its financial budgets with its strategic goals. For example, one division of the Style Company (not its real name] committed to achieving a seem- ingly impossible goal articulated by the CEO: to double revenues in five years. The forecasts built into the organization's existing strategic plan fell $1 billion short of this obiective. The division’s managers, after considering various scenarios, agreed to specific increases in five different perfor- mance drivers: the number of new stores opened, the number of new customers attracted into new and existing stores, the percentage of shoppers in each store converted into actual purchasers, the portion of existing customers retained, and average sales per customer. By helping to define the key drivers of revenue growth and by committing to targets for each of HARVARD BUSINESS REVIEW lanuary-February 1996 them, the division’s managers eventually grew comfortable with the CEO’s ambitious goal. The process of building a bal- anced scorecard — clarifying the strategic objectives and then iden- tifying the few critical drivers — also creates a framework for man- aging an organization’s various change programs. These initia- tives - reengineering, employee empowerment, time-based man- agement, and total quality man- agement, among others e promise to deliver results but also com- pete with one another for scarce resources, including the scarcest resource of all: senior managers’ time and attention. Shortly after the merger that created it, Metro Bank, for exam- ple, launched more than 70 differ— ent initiatives. The initiatives were intended to produce a more competitive and successful insti- tution, but they were inadequate- ly integrated into the overall strat— egy. After building their balanced scorecard, Metro Bank’s managers dropped many of those programs~ such as a marketing effort directed at individuals with very high net worth — and consolidated others into initiatives that were better aligned with the company’s stra- tegic objectives. For example, the managers replaced a program aimed at enhancing existing low- leVel selling skills with a maior initiative aimed at retraining salespersons to become trusted fi- nancial advisers, capable of selling a broad range of newly introduced products to the three selected customer segments. The bank made both changes because the scorecard enabled it to gain a better un- derstanding of the programs required to achieve its strategic objectives. Once the strategy is defined and the drivers are identified, the scorecard influences managers to Concentrate on improving or reengineering those processes most critical to the organization‘s strate- gic success. That is how the scorecard most clearly links and aligns action with strategy. The final step in linking strategy to actions is to establish specific short-term targets, or milestones, HARVARD BUSINESS REVIEW Ianuary-February 1996 How One Company Linked Measures from the Four Perspectives for the balanced scorecard measures. Milestones are tangible expressions of managers’ beliefs about when and to what degree their current programs will affect those measures. in establishing milestones, managers are expand- ing the traditional budgeting process to incorporate strategic as well as financial goals. Detailed finan- cial planning remains important, but financial goals taken by themselves ignore the three other balanced scorecard perspectives. In an integrated planning and budgeting process, executives contin- ue to budget for short—term financial performance, but they also introduce short-term targets for mea- sures in the customer, internal-business~process, 83 and learning-and-growth perspectives. With those milestones established, managers can continually test both the theory underlying the strategy and the strategy’s implementation. At the end of the business planning process, man- agers should have set targets for the long-term objectives they would like to achieve in all four scorecard perspectives; they should have identified the strategic initiatives required and allocated the necessary resources to those initiatives,- and they should have established milestones for the measures that mark progress toward achieving their strategic goals. Feedback and Learning “With the balanced scorecard, ” a CEO of an engi- neering company told us, “I can continually test my strategy. It’s like performing real-time re- search.“ That is exactly the capability that the scorecard should give senior managers: the ability to know at any point in its implementation wheth- er the strategy they have formulated is, in fact, working, and if not, why. The first three management processes — translat- ing the vision, communicating and linking, and business planning — are vital for implementing strategy, but they are not sufficient in an unpre- dictable world. Together they form an important single—loop-learning process — single-loop in the sense that the objective remains constant, and any departure from the planned trajectory is seen as a defect to be remedied. This single-loop process does not require or even facilitate reexamination of ei- ther the strategy or the techniques used to imple- ment it in light of current conditions. Most companies today operate in a turbulent en- vironment with complex strategies that, though valid when they were launched, may lose their va- lidity as business conditions change. In this kind of environment, where new threats and opportunities arise constantly, companies must become capable of what Chris Argyris calls double-loop learning— learning that produces a change in people’s assump— tions and theories about cause-and-effect relation— ships. (See “Teaching Smart People How to Learn, ” HBR May—June 1991.) Budget reviews and other financially based man- agement tools cannot engage senior executives in double—loop learning—first, because these tools address performance from only one perspective, and second, because they don’t involve strategic learning. Strategic learning Consists of gathering feedback, testing the hypotheses on which strategy was based, and making the necessary adjustments. 84 BALANCED SCORECARD The balanced scorecard supplies three elements that are essential to strategic learning. First, it ar- ticulates the company’s shared vision, defining in clear and operational terms the results that the company, as a team, is trying to achieve. The score- card communicates a holistic model that links in- dividual efforts and accomplishments to business unit objectives. Second, the scorecard supplies the essential stra- tegic feedback system. A business strategy can be viewed as a set of hypotheses about cause-and- effect relationships. A strategic feedback system should be able to test, validate, and modify the hy- potheses embedded in a business unit's strategy. By establishing short-term goals, or milestones, with- in the business planning process, executives are forecasting the relationship between changes in performance drivers and the associated changes in one or more specified goals. For example, execu— tives at Metro Bank estimated the amount of time it would take for improvements in training and in the availability of information systems before em- ployees could sell multiple financial products effec- tively to existing and new customers. They also estimated how great the effect of that selling capa- bility would be. Another organization attempted to validate its hypothesized cause—and-effect relationships in the balanced scorecard by measuring the strength of the linkages among measures in the different per- spectives. [See the chart “How One Company Linked Measures from the Four Perspectives”) The company found significant correlations between employees' morale, a measure in the learning—and- growth perspective, and customer satisfaction, an important customer perspective measure. Cus- tomer satisfaction, in turn, was correlated with faster payment of invoices— a relationship that led to a substantial reduction in accounts receivable and hence a higher return on capital employed. The company also found correlations between employ— ees’ morale and the number of suggestions made by employees [two learning~and-growth measures) as well as between an increased number of sugges- tions and lower rework [an internal-business-pro- cess measure). Evidence of such strong correlations help to confirm the organization’s business strat~ egy. If, however, the expected correlations are not found over time, it should be an indication to exec- utives that the theory underlying the unit’s strategy may not be working as they had anticipated. " Especially in large organizations, accumulating sufficient data to document significant correlations and causation among balanced scorecard measures can take a long time — months or years. Over the HARVARD BUSINESS REVIEW Ianuary-February 1996 short term, managers‘ assessment of strategic im- pact may have to rest on subjective and qualitative judgments. Eventually, however, as more evidence accumulates, organizations may be able to provide more objectively grounded estimates of cause-and- effect relationships. But just getting managers to think systematically about the assumptions under- lying their strategy is an improvement over the cur- rent practice of making decisions based on short- term operational results. Third, the scorecard facilitates the strategy re- view that is essential to strategic learning. Tradi- tionally, companies use the monthly or quarterly meetings between corporate and division execu- tives to analyze the most recent period’s financial results. Discussions focus on past performance and on explanations of why financial objectives were not achieved. The balanced scorecard, with its specification of the causal relationships between performance drivers and objectives, allows corpo- rate and business unit executives to use their peri- odic review sessions to evaluate the validity of the unit‘s strategy and the quality of its execution. If the unit’s employees and managers have delivered on the performance drivers (retraining of employ- ees, availability of information systems, and new fi- nancial products and services, for instance], then their failure to achieve the expected outcomes (higher sales to targeted customers, for example) signals that the theory underlying the strategy may not be valid. The disappointing sales figures are an early warning. Managers should take such disconfirming evi- dence seriously and reconsider their shared conclu- sions about market conditions, customer value propositions, competitors’ behavior, and internal capabilities. The result of such a review may be a decision to reaffirm their belief in the current strat- egy but to adjust the quantitative relationship among the strategic measures on the balanced scorecard. But they also might conclude that the unit needs a different strategy (an example of dou- ble-loop learning) in light of new knowledge about market conditions and internal capabilities. In any case, the scorecard will have stimulated key execu- tives to learn about the viability of their strategy. This capacity for enabling organizational learning at the executive level—strategic learning— is what HARVARD BUSINESS REWEW lanuary-February 1996 distinguishes the balanced scorecard, making it in- valuable for those who wish to create a strategic management system. Toward a New Strategic Management System Many companies adopted early balanced-score— card concepts to improve their performance mea- surement systems. They achieved tangible but nar- row results. Adopting those concepts provided clarification, consensus, and focus on the desired improvements in performance. More recently, we have seen companies expand their use of the bal» anced scorecard, employing it as the foundation of an integrated and iterative strategic management system. Companies are using the scorecard to I clarify and update strategy, : communicate strategy throughout the company, _ align unit and individual goals with the strategy, link strategic objectives to longsterm targets and annual budgets, E identify and align strategic initiatives, and : conduct periodic performance reviews to learn about and improve strategy. The balanced scorecard enables a company to align its management processes and focuses the en- tire organization on implementing long-term strat- egy. At National Insurance, the scorecard provided the CEO and his managers with a central frame- work around which they could redesign each piece of the company’s management system. And be- cause of the cause-and-effect linkages inherent in the scorecard framework, changes in one compo- nent of the system reinforced earlier changes made elsewhere. Therefore, every change made over the 30-month period added to the momentum that kept the organization moving forward in the agreed- upon direction. Without a balanced scorecard, most organiza- tions are unable to achieve a similar consistency of vision and action as they attempt to change direc- tion and introduce new strategies and processes. The balanced scorecard provides a framework for managing the implementation of strategy while also allowing the strategy itself to evolve in re- sponse to changes in the company’s competitive, market, and technological environments. 6 Refine 96107 For ordering information, see page 172. 85 ...
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