Balanced Scorecard Management must consider both financial and operational performance measures Measures should be linked with company goals and strategy Financial measures are only one measure among many Uses key performance indicators The balanced scorecard recognizes that management must consider both financial performance measures and operational performance measures when judging the performance of a company and its subunits. These measures should be linked with the company’s goals and its strategy for achieving those goals. The balanced scorecard represents a major shift in corporate performance measurement. Rather than treating financial indicators as the sole measure of performance, companies recognize that they are only one measure among a broader set. Keeping score of operating measures and traditional financial measures gives management a “balanced” view of the organization. Management uses key performance indicators—such as customer satisfaction ratings and revenue growth—to measure critical factors that affect the success of the company. 1

The Balanced Scorecard The balanced scorecard provides managers with a roadmap that indicates how the company intends to increase its ROI. I’m glad we used the balanced scorecard to tell which approach is best. Reduce Expenses Increase Sales Reduce Assets

Examples of critical factors and corresponding KPIs COMPANY GOALS Examples of critical factors and corresponding KPIs CRITICAL FACTORS Customer satisfaction Operational efficiency Employee excellence Financial profitability As shown here, key performance indicators (KPIs) are summary performance measures that help managers assess whether or not the company is achieving its goals. KEY PERFORMANCE INDICATORS Market share Yield rate Training hours Revenue growth 3

Four Perspectives Financial Customer Internal Business Learning and Growth The balanced scorecard views the company from four different perspectives, each of which evaluates a specific aspect of organizational performance: 1. Financial perspective 2. Customer perspective 3. Internal business perspective 4. Learning and growth perspective Companies that adopt the balanced scorecard usually have specific objectives they wish to achieve within each of the four perspectives. Once management clearly identifies the objectives, they develop KPIs that will assess how well the objectives are being achieved. To focus attention on the most critical elements and prevent information overload, management should use only a few KPIs for each perspective. 4

Financial Perspective How do we look to shareholders? Ultimate goal is to generate income for owners KPIs: Sales revenue growth Gross margin growth Return on investment Working capital used The financial perspective helps managers answer the question, “How do we look to shareholders?” The ultimate goal of companies is to generate income for their owners. Therefore, company strategy revolves around increasing the company’s profits through increasing revenue growth and increasing productivity. Companies grow revenue through introducing new products, gaining new customers, and increasing sales to existing customers. Companies increase productivity through reducing costs and using the company’s assets more efficiently. Managers may implement seemingly sensible strategies and initiatives, but the test of their judgment is whether these decisions increase company profits. The financial perspective focuses management’s attention on KPIs that assess financial objectives, such as revenue growth and cost cutting. Some commonly used KPIs include: sales revenue growth, gross margin growth, and return on investment. 5

Customer Perspective How do customers see us? Top priority for long-term success Customer concerns: Product price Product quality Sales service quality Product delivery time KPIs: Customer satisfaction Market share Number of customers and repeat customers Rate of on-time deliveries The customer perspective helps managers evaluate the question, “How do customers see us?” Customer satisfaction is a top priority for long-term company success. If customers are not happy, they will not come back. Therefore, customer satisfaction is critical to achieving the company’s financial goals outlined in the financial perspective of the balanced scorecard. Customers are typically concerned with four specific product or service attributes: (1) the product’s price, (2) the product’s quality, (3) the sales service quality, and (4) the product’s delivery time (the shorter, the better). Since each of these attributes is critical to making the customer happy, most companies have specific objectives for each of these attributes. Businesses commonly use KPIs, such as customer satisfaction ratings, to assess how they are performing on these attributes. No doubt you have filled out a customer satisfaction survey. Because customer satisfaction is crucial, customer satisfaction ratings often determine the extent to which bonuses are granted to restaurant managers. Other typical KPIs include percentage of market share, increase in the number of customers, number of repeat customers, and rate of on-time deliveries. 6

Internal Business Perspective At what business processes must we excel? Three factors: Innovation KPI: Number of new products developed Operations KPIs: Product efficiency – number of units produced Product quality – defect rate Post-sales service KPIs Number of warranty claims Average wait time on phone for customer service The internal business perspective helps managers address the question, “At what business processes must we excel to satisfy customer and financial objectives?” The answer to this question incorporates three factors: innovation, operations, and post-sales service. All three factors critically affect customer satisfaction, which will affect the company’s financial success. Satisfying customers once does not guarantee future success, which is why the first important factor of the internal business perspective is innovation. Customers’ needs and wants change as the world around them changes. Companies must continually improve existing products and develop new products to succeed in the future. Companies commonly assess innovation using KPIs, such as the number of new products developed or new-product development time. The second important factor of the internal business perspective is operations. Efficient and effective internal operations allow the company to meet customers’ needs and expectations. For example, the time it takes to manufacture a product (manufacturing cycle time) affects the company’s ability to deliver quickly to meet a customer’s demand. Production efficiency (number of units produced per hour) and product quality (defect rate) also affect the price charged to the customer. To remain competitive, companies must be at least as good as the industry leader at those internal operations essential to their business. The third factor of the internal business perspective is post-sales service. How well does the company service customers after the sale? Claims of excellent post-sales service help to generate more sales. Management assesses post-sales service through the following typical KPIs: number of warranty claims received, average repair time, and average wait time on the phone for a customer service representative. 7

Learning and Growth Perspective How can we continue to improve and create value? Three factors: 1) Employee capabilities KPIs: Hours of employee training Employee satisfaction and turnover Number of employee suggestions implemented Dollars per worker on Workers Compensation Exp Sales dollars per worker The learning and growth perspective helps managers assess the question, “How can we continue to improve and create value?” The learning and growth perspective focuses on three factors: (1) employee capabilities, (2) information system capabilities, and (3) the company’s “climate for action.” The learning and growth perspective lays the foundation needed to improve internal business operations, sustain customer satisfaction, and generate financial success. Without skilled employees, updated technology, and a positive corporate culture, the company will not be able to meet the objectives of the other perspectives. First, because most routine work is automated, employees are freed up to be critical and creative thinkers who therefore can help achieve the company’s goals. The learning and growth perspective measures employees’ skills, knowledge, motivation, and empowerment. KPIs typically include hours of employee training, employee satisfaction, employee turnover, and number of employee suggestions implemented. Second, employees need timely and accurate information on customers, internal processes, and finances; therefore, other KPIs measure the maintenance and improvement of the company’s information system. For example, KPIs might include the percentage of employees having online access to information about customers, and the percentage of processes with real-time feedback on quality, cycle time, and cost. Finally, management must create a corporate culture that supports communication, change, and growth. Copyright (c) 2009 Prentice Hall. All rights reserved. 8

Learning and Growth Perspective 2) System capabilities KPIs: Percentage of employees with online access to customer data Percentage of processes with real-time feedback 3) Company’s climate for action A balance of responsibility and authority The learning and growth perspective helps managers assess the question, “How can we continue to improve and create value?” The learning and growth perspective focuses on three factors: (1) employee capabilities, (2) information system capabilities, and (3) the company’s “climate for action.” The learning and growth perspective lays the foundation needed to improve internal business operations, sustain customer satisfaction, and generate financial success. Without skilled employees, updated technology, and a positive corporate culture, the company will not be able to meet the objectives of the other perspectives. First, because most routine work is automated, employees are freed up to be critical and creative thinkers who therefore can help achieve the company’s goals. The learning and growth perspective measures employees’ skills, knowledge, motivation, and empowerment. KPIs typically include hours of employee training, employee satisfaction, employee turnover, and number of employee suggestions implemented. Second, employees need timely and accurate information on customers, internal processes, and finances; therefore, other KPIs measure the maintenance and improvement of the company’s information system. For example, KPIs might include the percentage of employees having online access to information about customers, and the percentage of processes with real-time feedback on quality, cycle time, and cost. Finally, management must create a corporate culture that supports communication, change, and growth. Copyright (c) 2009 Prentice Hall. All rights reserved. 9

Key Features of Performance Management

Key Features of Performance Management Is an essential part of organisation strategy: - derived from the mission and vision statements - links the mission and vision, strategy, goals and processes of the organisation

Key Features of Performance Management (Continued) Provides quantitative and qualitative information: - assesses non-financial as well as financial criteria - is a decision making tool - provides a standardised and consistent approach

Key Features of Performance Management (Continued) Provides a multidimensional focus on people and processes: - is a process not a system - measures processes not functions - needs top-down and bottom-up communication and understanding - enables delegation and empowerment - enhances employee satisfaction

Key Features of Performance Management (Continued) Provides both external and internal perspectives: - focuses on customer satisfaction - can be used to benchmark against competitors

Key Features of Performance Management (Continued) Continuous Improvement - emphasises causes, promotes self-diagnosis and identifies areas for improvement - promotes effective planning

Why Balanced Scorecard ?

Why Balanced Scorecard? Financial performance measurements no longer adequate Financial evaluations are reactive Financial measures not able to reflect contemporary value creating actions A Holistic measurement tool formulating an integral part of strategy (cross functional integration)

Why Balanced Scorecard? (Continued) Bridges financial measurements and strategy Lever to streamline and focus strategy Translate company strategy into specific measurable objectives Put strategy not control at the centre Pulls people to the overall vision

Why Balanced Scorecard? (Continued) It is a framework for creating a set of measures that gives managers a fast and comprehensive view of the business. It is a tool providing all of the critical indicators of a businesses current and future performance. It supplements traditional financial measures with three additional perspectives:

Balanced Scorecard - Principles

Balanced Scorecard - Principles Performance measures are balanced to reflect key areas of corporate activity which will create long term shareholder value Performance measurement are designed to monitor value drivers - quality, cycle time and service are key determinants of customer satisfaction which is the ultimate driver

Balanced Scorecard - Principles (Continued) Financial measures are used to explicitly include shareholder value calculations Organisation learning is specifically measured - ability to change, rate of change and continuous improvements

Balanced Scorecard - Principles (Continued) A top-down process is used to directly link vision and strategy - both senior management sponsorship, involvement and commitment, and lower level participation and agreement are all necessary Measures must link individual worker performance to overall organisation vision and strategy

Balanced Scorecard Value’s

Balanced Scorecard Value’s Translate business plan into a set of clear measures and targets As a reporting tool, will give managers regular feedback on their performance, allowing them to assess their situation and improve Provide a fair, data based, systematic mechanism for setting performance targets and rewarding achievement

Balanced Scorecard Value’s (Continued) Allow each business unit to focus on a few high value opportunities Be able to pinpoint issues and identify performance improvement opportunities Provide a checks and balances system to manage short term performance and strategic implications Ensure a comprehensive measurement system, measuring all perspectives of the business

What does the Balanced Scorecard measure?

What does the Balanced Scorecard measure? Product Internal Processes Customer Innovation and improvements

Vision & Strategy FINANCIAL “Financial Health” INT. BUS. CUSTOMER “Happy Customers” “how should we appear to our customer - to achieve our vision?” LEARNING & I NNOVATION “Happy Employees” “how will we sustain our ability to service, change and improve - to achieve our vision?” INT. BUS. PROCESS “Way of doing things” “what business processes must we excel at - to satisfy our shareholders?” FINANCIAL “Financial Health” “how should we appear to our shareholder - to succeed financially?”

Customer Perspective Demands that managers translate their general mission statements on customers into specific measures that reflect what really matters to the customer eg. - Lead time - Quality - performance - Service

Internal Processes Internal measures should stem from the business processes that have the greatest impact on customer satisfaction, e.g. - Factors that effect cycle time - Quality - employee skills - productivity

Innovation and learning perspective A company’s ability to innovate, improve and learn, ties directly to the company’s value. Only through the ability to launch new products, create more value for customers and improve operating efficiencies continually can a company penetrate new markets and increase revenue and margins.

Financial Perspective Financial performance measures indicates whether the company’s strategy, implementation and execution are contributing to bottom-line improvement e.g. - profitability - growth - shareholder value

The Balanced Scorecard is like the dials in an airplane cockpit: It gives managers complex information at a glance Kaplan and Norton

How does these measures differ from traditional measurements?

How does these measures differ from traditional measurements? Grounded in Organisations Strategic Objectives Focus strategic vision Provide balance Ensure a focus beyond the current year

Barriers to Effective Balanced Scorecard Implementation

Barriers to effective Balanced Scorecard Implementation Measurements are non quantifiable Measurements are input rather than output driven No buy-in from employees/management Balanced Scorecard perceived as latest fad. No migration planning No system to support measurements

Barriers to effective Balanced Scorecard Implementation (Continued) No follow-up on operational improvements with another round of actions Strategies not effectively executed Lack or no clear understanding on Balanced Scorecard mechanism Preoccuaption of measurements instead of outputs

Balanced Scorecard Benefits

Balanced Scorecard Benefits Synergy between efforts Focus Cross functional integration Create customer and supplier partnership Continuous improvement Team rather than individual accountability Assist managers in understanding interrelationships

Balanced Scorecard Benefits (Continued) Tool to measure individual as well as group performance Scientific approach to quantifying strategic objectives

Practical Application of the Balanced Scorecard

“If you can’t measure it you can’t manage it’’ Kaplan and Norton

A Strategic Framework for Action Clarifying and Translating the Vision and Strategy Clarifying the vision Gaining consensus Strategic Feedback and Learning Communicating and Linking Articulating the shared vision Supplying strategic feedback Facilitating strategy review and learning Communicating and educating Setting goals Linking rewards to performance measures Balanced Scorecard Planning and Target Setting Setting targets Aligning strategic initiatives Allocating resources Establishing milestones Kaplan & Norton, 1996

Strategy linked to Balanced Scorecard Financial perspective • Satisfy Stakeholders Customer & Stakeholder Learning & Growth perspective perspective MPT Strategy • Develop employees • Satisfy customers • Motivate employees • Retain customers Process perspective • Increase efficiency • Provide high quality Port service

Balanced Scorecard Tying the Balanced Scorecard Measures to the Strategy for Success Company develops three to five performance measures for each dimension Measures should be tied to company strategy Balance among the dimensions is critical You get what you measure!

How Balance is Achieved in a Balanced Scorecard Performance is assessed across a balanced set of dimensions Balance quantitative measures with qualitative measures There is a balance of backward-looking measures and forward-looking measures

Developing a Strategy Map for a Balanced Scorecard A strategy map is a diagram of the relationships of the strategic objectives across the four dimensions Used to test the soundness of the strategy Identifies how strategy is linked to measures on the scorecard Communicates strategic objectives to employees

Keys to a Successful Balanced Scorecard Targets For each measure, there should be a target so managers know what they are expected to achieve Initiatives For each measure, the company must identify actions that will be taken to achieve the target Responsibility A particular employee must be given responsibility and held accountable for successfully implementing each initiative Funding Initiatives must be funded appropriately Top Management Support It is crucial to have the full support of top management

Return on Investment (ROI) Formula Income before interest and taxes (EBIT) ROI = Net operating income Average operating assets Average Current & Non Current Assets.

Return on Investment (ROI) Formula Regal Company reports the following: Net operating income $ 30,000 Average operating assets $ 200,000 $30,000 $200,000 = 15% ROI =

Controlling the Rate of Return Three ways to improve ROI . . . Reduce Expenses Reduce Assets Increase Sales

ROI and the Balanced Scorecard The balanced scorecard provides managers with a roadmap that indicates how the company intends to increase its ROI. I’m glad we used the balanced scorecard to tell which approach is best. Reduce Expenses Increase Sales Reduce Assets

Criticisms of ROI In the absence of the balanced scorecard, management may not know how to increase ROI. Managers often inherit many committed costs over which they have no control. Managers evaluated on ROI may reject profitable investment opportunities.

As division manager would you Criticisms of ROI As division manager at Winston, Inc., your compensation package includes a salary plus bonus based on your division’s ROI -- the higher your ROI, the bigger your bonus. The company requires an ROI of 15% on all new investments -- your division has been producing an ROI of 30%. You have an opportunity to invest in a new project that will produce an ROI of 25%. As division manager would you invest in this project?

Criticisms of ROI As division manager, I wouldn’t invest in that project because it would lower my pay!

Criticisms of ROI Your division before new investment: Net operating income $ 60,000 Average operating assets 200,000 ROI 30% New investment: Net operating income $ 10,000 Average operating assets 50,000 ROI 20% Your division after new investment: Net operating income $ 70,000 Average operating assets 250,000 ROI 28%

Criticisms of ROI Gee . . . I thought we were supposed to do what was best for the company!

Residual Income - Another Measure of Performance Net operating income above some minimum return on operating assets

Residual Income Let’s calculate residual income. A division of Zepher, Inc. has average operating assets of $100,000 and is required to earn a return of 20% on these assets. In the current period the division earns $30,000. Let’s calculate residual income.

Residual Income (EVA)

Motivation and Residual Income Residual income encourages managers to make profitable investments that would be rejected by managers using ROI.

Your division before new investment: Net operating income $ 60,000 Average operating assets 200,000 ROI 30%

Your division after new investment: Net operating income $ 70,000 Average operating assets 250,000 ROI 28% An increase of $2,500 in residual income!!