Overview of the Balanced Scorecard
In 1991 Harvard Business School economists Robert Kaplan and David Norton introduced the concept of a balanced scorecard to the accounting world. The balanced scorecard is a method for organizations to consider both financial performance and operational performance when evaluating an investment center within a company.
An investment center is a business unit within a larger business that is responsible for its own income, expenses, and assets and that can contribute directly to the profitability of the larger business. An investment center is almost like a stand-alone company because its manager has full authority over how to use assets.
Companies create balanced scorecards by taking the company's overall corporate strategy and creating a set of integral performance measures that support that strategy. For example, a company may have a broad-based corporate strategy to offer excellent value for their product and service offerings to their customer base. This value proposition may be made up of a variety of factors such as low prices, ease of purchase, and product reliability.
One company that makes affordability its primary corporate focus is regional airline Triumph Air. This airline only purchases used airplanes that are of the same type to save money and lower maintenance and training costs. The airline flies out of smaller airports, or out of the secondary airport in major markets, to simplify scheduling and reduce costs. Triumph Air keeps overall fares for the flights low by charging for all upgrades—including luggage, food and drink of any type on the plane, seat assignment, boarding priority, and making flight reservations or obtaining boarding passes any way other than through the Internet. All these methods together allow the company to have some of the lowest average airfares in the industry for the routes it covers.
Using a balanced scorecard system to evaluate a manager at Triumph Air, the company might track how long customers have to wait at a check-in counter at the airport to have their bags checked for a flight. The manager of the check-in counter would know they are being evaluated on how long customers have to wait in line. Based on this evaluation, the manager can adopt strategies to improve customer wait time and therefore score higher on a balanced scorecard evaluation of their performance in this area. The company would then benefit because faster checked bag procedures will save money by reducing the number of delayed or missed flights. Faster checked bag procedures will also improve customer satisfaction by reducing the amount of time people have to wait in line to check a bag before flying.
When Triumph Air uses a balanced scorecard approach, the company can break down many of the tasks and areas of operations that its managers handle into recognizable and achievable smaller areas. Then it can evaluate those areas and make changes as needed.
Balanced Scorecard Characteristics
Parts of the Balanced Scorecard
When companies consider the financial part of a balanced scorecard, they consider the company's progress (or lack of progress) from the viewpoint of the corporate shareholders. A shareholder is a person or entity that buys at least one share of the company's stock. Those who buy stock in a company are mainly concerned with the company's profit levels, as those levels drive the price of the company's stock more than anything.
Managers will seek to improve financial perspectives in three main ways: increasing revenue, becoming more efficient, and lowering costs. Common KPIs for financial perspective considerations are sales growth, sales margin, return on investment, residual income, and earnings per share. The higher the sales margin is, the more profitable the company is likely to be. Return on investment (ROI) measures how much income is generated through the use of company resources relative to the size of the company's assets. Residual income is how much income the company generates beyond the minimum required rate of return.
When organizations consider the customer part of a balanced scorecard, they look at things from the clients' viewpoint. How the customer sees the company is an important factor in achieving long-term success. Happy customers tend to be repeat customers, and unhappy customers will not return, so customer satisfaction is always important. Customers tend to care about four primary areas: price, quality, service, and delivery time. Common KPIs for customer perspective include average customer satisfaction rating, growth in market share, growth in the number of unique customers, growth in the number of repeat customers, and how long it takes to make and deliver a product after it is ordered.
Internal business perspective in a balanced scorecard is considered from the viewpoint of the manager. The goal in this area is to improve business processes to meet or exceed customer satisfaction and achieve the financial objectives of the shareholders. To be successful in the long run, a company must please its customers, which will lead to revenues and profits that will please the company shareholders. Common KPIs for internal business perspective are the development of new products, how long it takes to manufacture products, how efficiently products are made, what the defect rate is in the manufacturing process, how many products wind up having warranty claims, how long it takes to produce an item from the time it is ordered, and how long it takes to repair or replace defective goods.
The learning and growth perspective within a balanced scorecard requires senior managers to be forward thinking. Managers using this perspective take a human resources viewpoint. They evaluate whether the company can be successful in the long term by making sure that the company employs the right individuals in the right roles to achieve success. Common KPIs of learning and growth perspective are levels of employee training, employee turnover rate, reported levels of employee satisfaction, how many employees make suggestions for improvement and how many of those suggestions are implemented, employee ratings of communication, and overall corporate culture.
Using Balanced Scorecards in Management
Each company must tailor the balanced scorecard to measure whatever area of emphasis it wants to focus on strategically. This is true at a company-wide level or by product line. For example, in the food industry, a fast-food company focuses on speed and value. A casual dining restaurant focuses on providing a pleasant atmosphere for a sit-down meal with service by a server at a moderate price. A higher-end restaurant provides ambience and excellence in both quality of food offerings and atmosphere. Each of these restaurants then would have different strategies and would create a unique balanced scorecard that emphasizes different areas that are relevant to its particular business.
A well-constructed balanced scorecard is backward-looking in that the performance measures are related to one another on a cause-and-effect basis. In theory, if you improve in the first performance area, then the result in the next performance measure area should also improve.
For example, a high-end restaurant called Perfect Steakhouse moves from the learning and growth performance measurement area through the internal business processes, customer, and financial performance areas. In the learning and growth area of the balanced scorecard, Perfect Steakhouse can make it a goal to improve the skill of its chefs and other workers in the kitchen to allow them to prepare more types of food and to do so more efficiently. These changes will allow Perfect to improve in the internal business process area by offering more entrée selections and allowing the menu to be updated and changed more frequently as the kitchen becomes more efficient and adept at cooking different items. These improvements should then cause improvements in Perfect Steakhouse’s efficiency measures.
The company will then feel the impact in the customer experience area. Customers will visit the restaurant more often if the menu is updated more frequently and they can sample the new dishes. Customers also will be more pleased with their meals overall, since the food will be more tailored to their particular preferences. These changes affect the financial performance measurement. Increased consumer demand for Perfect Steakhouse's food will allow the restaurant to raise prices, resulting in higher revenues and increased profitability. A company-wide balanced scorecard would have different goals like this for each department. The company would seek to improve factors throughout each performance management area individually to generate positive results for the company as a whole.