Balanced Scorecard: Concept, Performance Indicators and Advantages

In this article we will discuss about:- 1. The Concept of Balanced Scorecard 2. Key Performance Indicators 3. Advantages of Balanced Scorecard.

The Concept of Balanced Scorecard:

Balanced scorecard (BSC) is a tool for effective implementation of strategy. It measures progress in achieving long-term objectives set out in the corporate plan, which translates strategy into action plan. It was created by Professor R. S. Kaplan of Harvard Business School in 1990s.

The underlying philosophy is that in the present business environment firms build competitive advantage by managing capabilities, innovation, and other intangibles rather than by managing tangible assets. Management of intangibles is decisive in successful implementation of strategy. Therefore, firms monitor progress in imple­mentation of strategy from four perspectives- financial perspectives, customer per­spective, internal business process perspective, and learning and growth perspective.

Balanced scorecard centres around ‘critical success factors’ (CSF). The firm iden­tifies CSF with reference to assumptions (hypotheses) underlying the strategy. For each CSF, key performance indicators (KPI) are identified. For each KPI, measures and targets are established and initiatives are planned to ensure that the targets are achieved.

Cause and Effect Relationship:

There is a cause and effect relationship between those four perspectives. Every business firm has to earn adequate profit for survival and growth. Therefore, from the financial perspective or shareholder perspective, a firm has to set a target, e.g., in terms of EVA. It should monitor progress against the target EVA. The financial objective can be achieved only by satisfying customer needs.

The balanced scorecard captures the customer satisfac­tion by monitoring progress from customer’s perspective. It monitors customer satisfaction using a proxy measure such as ‘reduction in the number of customer complaints’. The customer needs can be satisfied only by strengthening the internal process. Therefore, firms monitor progress in strengthening the internal process.

If innovation is important, the firm develops a measure like ‘revenue from new products’ to monitor the progress from internal process perspective. The internal process can be strengthened only by having the necessary knowledge and tools available. Therefore, the firm measure progress from learning and growth perspective in terms of say ’employee turnover ratio’ or ’employee satisfaction’.

Integrated Approach:

Balanced scorecard provided integrated view of the progress in strategy implementation. It focuses on both short- and long-term perspectives. It helps to link long-term strategies to short term actions.

Financial targets focus on short-term objectives. Except in the formation stage of a firm and in case of certain industries (e.g. airlines industry) in the initial years of opera­tion, a firm has to earn profit every year for survival and growth. Therefore, the target to earn profit is a short-term target.

A firm should not sacrifice the long-term health of the firm in its effort to meet financial targets. It should not cut discretionary costs (e.g. research and development expenses, advertising expenses, expenses on training and development of people, and expenses on system development) to achieve financial targets.

Therefore, financial targets should be supplemented by non-financial targets. It is often said that financial performance indicators are lag indicators in the sense that they indicate how the firm performed in past, but they fail to indicate how the firm will perform in future.

Targets established from customer perspective also focus on short-term objectives. It indicates how well the firm had satisfied customer’s needs, but it fails to indicate whether the firm will be able to satisfy customer’s needs in future. Customer’s need in future may change because the firm might have decided to serve a new market segment or the pur­chasing power of customers in the market segment has changed or the industry leader has set a new standard for the performance of the product in terms of functionality and qual­ity.

Frequent changes in minimum acceptable standards are prominent in some industries like computer hardware and software industry, telecommunication industry, automobile industry, and entertainment industry. A firm that fails to build capability and strengthen internal process might fail to satisfy customer needs in future. Therefore, KPIs from the customer perspective are also ‘lag indicators’.

KPIs from internal process perspective and learning and growth perspective are lead indicators. They indicate whether the firm will be able to achieve financial targets and satisfy customer’s needs.

There is no clear distinction between lag indicators and lead indicators. E.g., a healthy growth in EVA, which is a financial indicator, indicates that the firm will do better in future. Similarly, rate of acquisition of new customers, which is a KPI from customer per­spective, indicates that the firm will do well in future. Therefore, an exercise to classify indicators into lag indicators and lead indicators is futile. What is important is that all KPIs together should be able to link long-term strategies with short-term actions.

Key Performance Indicators:

KPI is a set of quantifiable measures that a company or industry uses to gauge or compare performance in terms of meeting their strategic and operational goals. KPIs vary between companies and industries, depending on their priorities or performance criteria.

A com­pany must establish its strategic and operational goals, and then choose the KPIs which best reflect those goals. E.g., if a software company’s goal is to have the fastest growth in its industry, its main performance indicator may be the measure of revenue growth year-on-year.

KPIs provide vital information to the organization for tracking and predict­ing business performance against strategic objectives in a way that compliments financial measures. KPIs can be part of a corporate-wide BSC implementation or can be used to monitor each individual business function.

i. Financial Perspective:

Commonly used measures are ROIC, EVA, capital turnover, earnings before interest, tax, depreciation, and amortization (EBITDA) to sales ratio and cash flow to sales ratio.

ii. Customer Perspective:

The generic measures, which are applicable to almost all firms, are customer satisfaction, customer retention, new customer acquisition, customer profitability, and market and account share in target market segments. A firm should develop specific KPIs translating its strategy.

In developing specific KPIs, a firm should take into consideration its value proposition to customers. E.g., a logistic company like Shine Logistics Private Limited, located in India, which has specialization in delivery of pharmaceutical and clinical trial medicines, provides value by offering temperature-controlled packing solutions and time- bound delivery. The KPIs should include the ‘number of times the company failed to maintain temperature’ and ‘number of times the company failed to meet the delivery schedule’.

iii. Internal Business Process Perspective:

The internal business process measures are focused on the internal processes that will have the greatest impact on customer satisfaction and achieving the firm’s financial objec­tive. KPIs should be developed by examining the internal value chain. They allow the managers to know how well their business is running, and whether its products and services conform to customer requirements. These KPIs have to be carefully designed by those who know these processes most intimately.

Usually, internal process includes three distinct activities- innovation, operation, and post-sales services. All three may not be equally important for all firms. However, in present competitive environment, only those firms that are capable of performing first two activities efficiently and effectively are successful.

In some industries like automobile industry, capital goods and consumer durables post-sales services are equally important. Examples of KPIs for innovation are ‘revenue from new products as a percentage of total revenue’, ‘number of new products introduced’, ‘number of patents registered’, and ‘average time required for product devel­opment’. Examples for KPI for operations are ‘rework time’, ‘rejections’, ‘warranty claims’ ‘cycle time’, and ‘throughput contribution’.

Examples of KPI for post-sales services are ‘average response time’, ‘number of cases in which response time was more than target response time’, and ‘number of customer complaints’. Post-sales activities include billing and collection. KPIs that can be used to monitor these activities are ‘cash collection to sales ratio’, and ‘receivables turnover ratio’.

A firm may introduce new processes linked to strategy. It should develop KPIs to monitor these new processes. Special focus to these processes is required until they are stabilized.

Learning and Growth Perspective:

This perspective includes employee training and corporate cultural attitudes related to both individual and corporate self-improvement. Learning and growth constitute the essential foundation for success of any knowledge-worker organization.

In the current business environment of rapid technological change, it is becoming necessary for knowledge workers to be in a continuous learning mode.

Capability building should also include system capabilities. E.g., the top line biscuit Major Britannia has recently tied up with Hewlett-Packard (HP) as its transformation part­ner. Britannia, as a strategy, has decided to use IT to increase productivity and competi­tiveness. Capturing the market dynamics faster and more effectively is one of the main areas of focus for Britannia through this new initiative.

Another area of immediate focus is linking the entire chain across procurement, logistics, and sales and marketing more effectively than at present. Britannia should include KPIs, which will be useful to monitor the outcome of this new initiative.

Generic outcome measures are employee satisfaction, employee retention, employee training, and employee skills.

Advantages of Balanced Scorecard:

BSC as Strategic Management system links an organization’s long-term strategy with its short-term actions through four processes:

i. Translating the vision,

ii. Communication and linking,

iii. Business planning, and

iv. Feedback and learning.

BSC helps managers build a consensus around the organization’s vision and strategy and to translate the vision into operational terms that provide useful guides to action at the local level.

BSC represents a succinct presentation of what the organization is trying to achieve for stakeholders, customers, and staff and facilitates the setting of goals for individuals and departments, which are aligned to the strategy.

BSC enables organizations to integrate their business and financial plans, which can be used as a basis for allocating resources and setting priorities. It creates a framework for managing an organization’s various change programs and initiatives and encourages the establishment of specific milestones for the measures that mark progress towards achiev­ing the strategic goals.

BSC assists a firm to monitor progress from all four perspectives and evaluate strategy in light of performance. It represents an essential strategic feedback system and allows the relationship between performance measures and objectives to be tested and evaluated.

BSC- Summary of Strategic Applications:

(a) It helps to clarify and update strategy.

(b) It communicates strategy throughout the organization.

(c) It helps to align team and individual goals with the strategy.

(d) It links strategic objectives to long-term targets and annual budgets.

(e) It induces identification and alignment of strategic initiatives.

(f) It facilitates periodic performance reviews to learn about and improve strategy.