The Balanced Scorecard: Translating Strategy Into Action (23 page)
Read The Balanced Scorecard: Translating Strategy Into Action Online
Authors: Robert S. Kaplan,David P. Norton
Tags: #Non-Fiction, #Business
How can we build a Balanced Scorecard that translates a strategy into measurements? We introduced, in
Chapter 2
, three principles that enable an organization’s Balanced Scorecard to be linked to its strategy:
We discuss each of these principles in turn.
As discussed in the previous four chapters, all Balanced Scorecards use certain generic measures. These generic measures tend to be core outcome measures, which reflect the common goals of many strategies, as well as similar structures across industries and companies. These generic outcome measures tend to be lag indicators, such as profitability, market share, customer satisfaction, customer retention, and employee skills. The performance drivers, the lead indicators, are the ones that tend to be unique for
a particular business unit. The performance drivers reflect the uniqueness of the business unit’s strategy; for example, the financial drivers of profitability, the market segments in which the unit chooses to compete, and the particular internal processes and learning and growth objectives that will deliver the value propositions to targeted customers and market segments.
A good Balanced Scorecard should have a mix of outcome measures and performance drivers. Outcome measures without performance drivers do not communicate how the outcomes are to be achieved. They also do not provide an early indication about whether the strategy is being implemented successfully. Conversely, performance drivers—such as cycle times and part-per-million defect rates—without outcome measures may enable the business unit to achieve short-term operational improvements, but will fail to reveal whether the operational improvements have been translated into expanded business with existing and new customers, and, eventually, to enhanced financial performance.
A good Balanced Scorecard should have an appropriate mix of outcomes (lagging indicators) and performance drivers (leading indicators) that have been customized to the business unit’s strategy.
With the proliferation of change programs under way in most organizations today, it is easy to become preoccupied with such goals as quality, customer satisfaction, innovation, and employee empowerment for their own sake. While these goals can lead to improved business-unit performance, they may not if these goals are taken as ends in themselves. The financial problems of some recent Baldrige Award winners give testimony to the need to link operational improvements to economic results.
A Balanced Scorecard must retain a strong emphasis on outcomes, especially financial ones like return-on-capital-employed or economic value-added. Many managers fail to link programs, such as total quality management, cycle time reduction, reengineering, and employee empowerment, to outcomes that directly influence customers and that deliver future financial performance. In such organizations, the improvement programs have incorrectly been taken as the ultimate objective. They have not been linked to specific targets for improving customer and, eventually, financial performance. The inevitable result is that such organizations eventually become
disillusioned about the lack of tangible payoffs from their change programs.
Ultimately, causal paths from all the measures on a scorecard should be linked to financial objectives.
We can illustrate the applications of these three principles in two case studies: Metro Bank and National Insurance.
ETRO
B
ANK
Metro Bank was confronted with two problems: (1) excessive reliance on a single product (deposits) and (2) a cost structure that made it unprofitable to service 80% of its customers at prevailing interest rates. Metro embarked upon a two-pronged strategy to deal with these two problems:
- Revenue Growth. Reduce volatility of earnings by broadening the sources of revenue with additional products for current customers.
- Productivity. Improve operating efficiency by shifting nonprofitable customers to more cost-effective channels of distribution (e.g., electronic banking).
The process of developing a Balanced Scorecard at Metro translated each of these strategies into objectives and measures in the four perspectives. Particular emphasis was placed on understanding and describing the cause-and-effect relationships on which the strategy was based. A simplified version of the results of this effort is shown in Figure 7-1. For the revenue growth strategy, the financial objectives were clear: broaden the mix of revenues. Strategically, this meant that Metro would focus on its current customer base, identify the customers who would be likely candidates for a broader range of services, and then sell an expanded set of financial products and services to these targeted customers. When customer objectives were analyzed, however, Metro’s executives determined that its targeted customers did not view the bank, or their banker, as the logical source for a broader array of products such as mutual funds, credit cards, mortgages, and financial advice. The executives concluded that if the bank’s new strategy were to be successful, they must shift customers’ perception of the bank from that of a transactions processor of checks and deposits to a financial adviser.
Figure 7-1
The Metro Bank Strategy
These measures, in turn, provided the basis for introducing entirely new management processes. For example, consider the measure, strategic job coverage ratio. Every strategy for change, including Metro Bank’s, ultimately requires a selected set of the work force to be reskilled and equipped to take on the new demands. The availability of these strategic competencies is either an asset (when you have them) or a liability (when you don’t). Developing such intellectual assets is usually the longest-lead event for determining the ultimate success of the business unit’s strategy. The most effective measure that we have found for strategic competencies, deceptive in its simplicity, is derived from the answers to three questions: (1) What are the required competencies?, (2) What currently exists?, and (3) What and how large is the gap? The strategic job coverage ratio measure defines the strategic liability (recall the gap displayed in Figure 6-4). While the measure is fundamental and simple, very few organizations are able to construct it because their human resource and planning systems are unable to answer the three questions posed above. The definition of this measure has caused several companies to redesign the basic structure of their staff development process. Figure 7-2 illustrates the relationship of the scorecard measures to the strategic initiative that was instituted to close the strategic job coverage gap. The logic of defining the strategic priorities and the measures that best describe it led to the redefinition of a basic management program required to execute the strategy. Had it not been for the construction of the Balanced Scorecard and the logical systems thinking that it fostered, these organizations would most likely not have addressed the staff deficiencies in such a focused way with such a sense of urgency.
Figure 7-2
Increasing Employee Productivity
Figure 7-3
Metro Bank’s Balanced Scorecard
ATIONAL
I
NSURANCE
C
OMPANY (LONG LAG TIMES)
National Insurance was a major property and casualty insurance firm that had been plagued by unsatisfactory results for the past decade. A new management team was brought in to turn the situation around. Its strategy was to move the company away from its generalist approach—providing a full range of services to the full market—to that of a specialist, a company that would focus on more narrowly defined niches. The new senior executive team identified several key success factors for its new specialist strategy:
- Become better at understanding and targeting desired market segments;
- Better select, educate, and motivate agents to pursue these segments;
- Improve the underwriting process as the focal point for executing this strategy; and
- Better integrate information about claims into the underwriting process to improve market selectivity.
National’s executives selected the Balanced Scorecard as the primary tool for the new management team to use to lead the turnaround. They selected the scorecard because they believed it would help clarify the
meaning of the new strategy to the organization, and provide early feedback that the ship was turning.
In the first step, the executives defined the strategic objectives for the new specialist strategy, shown in the lefthand column of Figure 7-4. They selected measures to make each objective operational by gaining agreement on the answer to a simple question, “How would we know if National Insurance achieved this objective?” The answers to this question yielded the measures shown in the center column, “Core Outcomes,” of Figure 7-4. The core outcome measures were also referred to as “strategic outcome measures” because they described the outcomes that the executives wished to achieve from each part of their new strategy.
Figure 7-4
The Balanced Scorecard at National Insurance
The strategic outcome measures presented a “balanced” view of the strategy, reflecting customer, internal process, and learning and growth measures, in addition to the traditional financial ones. But a scorecard consisting only of lagging indicators would not satisfy management’s goal of providing early indicators of success. Nor would it help to focus the entire organization on the drivers of future success: what people should be doing day-by-day to produce successful outcomes in the future. While the issue of balancing lagging outcome measures with leading performance driver measures occurs for all organizations, the extremely long lags between actions today and outcomes in the future was more pronounced in the property and casualty insurance company than in any other we have encountered.
National Insurance executives went through a second design iteration to determine the actions that people should be taking in the short term to achieve the desired long-term outcomes. For each strategic outcome measure, they identified a complementary performance driver—see righthand column of Figure 7-4. In most cases, the performance drivers described how a business process was intended to change. For example, the strategic outcome measures for the underwriting process were:
- Loss ratio
- Claims frequency
- Claims severity
Improving performance of these measures required a significant improvement in the quality of the underwriting process itself. The executives developed
criteria for what they considered good underwriting. The criteria defined the actions desired in underwriting a new opportunity. The executives introduced a new business process, to audit, periodically, a cross-section of policies for each underwriter to assess whether the policies issued by the underwriter conformed to these criteria. The audit would produce a measure, the underwriting quality audit score, that would show the percentage of new policies written that met the standards of the redesigned underwriting process. The theory behind this approach is that the underwriting quality audit score would be the leading indicator, the performance driver, of the outcomes—loss ratio, claims frequency, and claims severity—that would be revealed much later. In addition to the underwriting quality audit, similar programs were developed for outcome objectives related to agency management, new business development, and claims management. New metrics, representing performance drivers for these outcomes were constructed to communicate and monitor near-term performance. These included:
| Outcome Measure | Performance Driver Measures |
| Key agent acquisition/retention | Agency performance versus plan |
| Customer acquisition/retention | Policyholder satisfaction survey |
| Business mix (by segment) | Business development versus plan |
| Claims frequency and severity | Claims quality audit |
| Expense ratio | Headcount movement; indirect spending |
| Staff productivity | Staff development versus plan; IT availability |
The righthand column of Figure 7-4 shows the new set of leading indicators, the performance drivers, selected by National Insurance.
Figure 7-5 presents the Balanced Scorecard graphically, illustrating two directional chains of cause and effect: from learning and growth and internal-business-process objectives to customer and financial objectives; and with each outcome measure in the customer, internal, and learning perspectives linked to a performance driver measure.
Figure 7-5
National Insurance—Cause-and-Effect Relationships
The ultimate success of this turnaround program at National Insurance will take some time to play out (we describe the evolution of the Balanced Scorecard at National Insurance in
Chapter 12
), and will, of course, be influenced by many factors beyond the measurement system. But executives readily concurred that the Balanced Scorecard has been a major part of their turnaround strategy and near-term success. The scorecard, by providing short-term indicators of long-term outcomes, has become National Insurance’s guidance system to the future.
The Metro Bank and National Insurance cases illustrate the translation of an SBU business strategy into a measurement framework. In this macro-level design process, we have emphasized the importance of specifying the relationships among the measures as a basis for describing the strategy more than the construction of the individual measures themselves. Having established this overall strategic framework, however, the design and selection of specific measures or subsets of measures is where the execution of strategy begins. The Balanced Scorecard is not really a strategy formulation
tool. We have implemented scorecards in organizations where the strategy has already been well articulated and accepted in the organization. But, more often we have found that even when the senior executive team thought it had prior agreement on the business unit’s strategy, the translation of that strategy into operational measurements forced the clarification and redefinition of the strategy. In effect, the disciplined measurement framework enforced by the Balanced Scorecard stimulated a new round of dialogue about the specific meaning and implementation of the strategy. It is this debate that usually leads to elevating specific management processes into matters of strategic necessity.
Having a linked set of performance measures also enables organized learning at the executive level. By making explicit the cause-and-effect hypotheses of a strategy, managers can test their strategy and adapt as they learn more about the implementation and effectiveness of their strategy, a theme that we explicate in greater detail in
Chapter 12
. Without explicit cause-and-effect linkages, no strategic learning can occur.
