Today we will discuss the balanced scorecard (BSC), which is a great tool that helps management continuously improve performance. It provides feedback on internal processes and outcomes so you can measure the performance and take necessary action to improve it further.
These days, all industries, regardless of their functional area, use balanced scorecards.
Let’s dive deeper.
The balanced scorecard came into existence in the nineties when a group of Harvard professors undertook a study titled “measuring performance in the organization of the future” to investigate the role of non-financials on organizations’ performance. Over 32 executives took part in this study, which spanned 12 months.
Before this study, organizations used to benchmark their success on financials consisting of market share, revenue, and profit. This strategy was useful for past events but did not say anything about the future.
The Balanced Scorecard (BSC) discusses both past events and future potentials of the organization
The BSC is a bridge between short-term indicators such as cost-reduction, low price competition and long-term indicators such as growth opportunities, value-added products, and services.
What is a Balanced Scorecard?
A balanced scorecard is a concept of measuring and managing organizational performance with a holistic look at critical components, including financials and non-financials.
In the early days, organizations judged performance based on revenue, cost-savings, and profitability. As the market gradually turned competitive, organizations needed new tools to improve performance, and so they started using balanced scorecards.
The balanced scorecard considers:
Organizations want a balance between short-term and long-term goals.
And also between financial and non-financial.
Sometimes pressure for short-term financial performance causes companies to reduce spending on product development, process improvements, human resource development, digital technology, databases, systems, and customer and market development.
A company may show huge profit through price exploitation of customers and low employee salary. In the short run, the company’s financials look good. But the balanced scorecard will show this is not good for the organization’s growth, as customers and organizational capabilities will be negative.
What are the Four Balanced Scorecard Perspectives?
The four balanced scorecard perspectives are:
- Internal Business Process
- Learning and Growth
This perspective concerns how the company uses its financial resources. Here you look at whether the organization’s strategy, implementation, and execution are contributing to the bottom line.
Return on investment (ROI), return on capital employed (ROCE), and economic value added (EVA) are helpful tools in finding financial indicators.
ROI is a performance measurement that shows the efficiency of an investment.
ROCE shows how well a company is generating profits from its capital.
EVA is a company’s residual wealth, arrived at by subtracting the cost of capital from operating profit.
Other financial measures are profitability, current share price, earnings per share, sales, operating margins, operating expenses, operating income, gross margin, cash flow, cash paybacks, etc.
You are free to choose metrics as per your organization’s requirements.
You can see from the above diagram that improvement in learning and growth will improve internal business processes, which brings customer satisfaction and thus results in more sales, revenue, share, and profitability.
So, the logic is a bottom-up flow of value.
Here, you look at customers’ commitment, loyalty, and satisfaction. Customers are the core of the business, so measuring “management of customers” is essential.
Ignoring customers’ requirements means a loss of business. The BSC ensures customers are not ignored and are satisfied at all times. It brings everything together to ensure business continuity and competitiveness.
Today, most organizations have mission statements in line with value delivery to customers. They focus on their market segment while the price is a major driver. In this case, innovative and cost-effective solutions could be a game-changer.
Your product may have a price advantage, but associated costs such as installation and maintenance also have a key role in delivering value. The BSC considers not just the price of your product or services but also the cost-effectiveness.
There are two categories of measures here:
- Core Customer Outcome Measures
- Performance Measures
Core Customer Outcome Measures
This includes market share, customer satisfaction, acquisition, loyalty, retention, and profitability.
Market Share: This is the company’s customer base. In-depth market research will help you understand the various market segments, their inclinations as per price, product features, and quality.
A subset of market share is called the account share, which shows how many of your customers transact with your business. How many customers’ wallets do you have? It shows your customers’ loyalty.
Customer Satisfaction: This is the feedback on your organization’s performance. Every organization should aim to complete customer satisfaction. Instead of waiting for customers to provide you with their feedback, you should ask them for it first. You can get the feedback through a survey via email, telephone conversation, etc., immediately after a customer receives the service.
Customer Acquisition: You always need new customers to grow your business. You can use different marketing tactics to secure new customers.
Customer Profitability: It is possible to have a loyal customer base but still be unprofitable. For example, a low price product makes you unprofitable. Try re-engineering or redesigning to find a profitable path.
This is based on three categories:
- Product/Service: In this category, you look at the price, functionality, and quality. Low and moderate prices are preferred. Functionality is the product’s features. The product must be high quality, though the grade can be lower. Quality can be measured by defect rate, product recall, warranty claims, field service requests, etc.
- Relationship: This deals with timeliness, empathy, after-sales service, home delivery, etc. Many customers prefer relationships over price.
- Image and Brand Reputation: Advertisements and looks can help bring customers. Organizations can use image and reputation as an opportunity to define themselves proactively. The BSC takes a holistic look at your business, bringing every part under scrutiny and connecting the dots to better position the business for competitiveness.
Internal Business Process Perspective
Organizations produce value to its customer through three stages.
Here, new business ideas are generated based on customer needs. You get customers’ feedback through continuous communication and engagement. Innovation is a critical value process.
Innovations help get new markets and businesses. Market research has a key role here.
The matrices for the R&D internal value process are as follows:
- Percentage of sales from new products
- Percentage of sales from proprietary products
- Ratio of operating profit to development cost
- Break-even time
You must recover the investment cost for the R&D process to break even. You can offer the product at an attractive price that brings profit to the organization and returns the cost of investment.
So, you see that BSC leaves virtually nothing out. It scans all business angles to position the business for competitiveness. In today’s dynamic environment, a company must create future value through investment in customers, employees, suppliers, processes, technology, and innovation, and the BSC helps you with all of it.
This deals with the production of existing goods or solutions according to customers’ requirements. Metrics such as quality, cycle time, and cost are useful here.
Total Quality Management is used to address quality.
The cost is addressed through activity-based costing, where all overheads are factored into the product cost.
Cycle Time: Automation helps organizations reduce their cycle time drastically. Inspection in manufacturing is now being deemphasized as we build quality into the design through a measure called Manufacturing Cycle Effectiveness (MCE).
MCE = processing time/throughput time
Throughput time = processing time + inspection time + movement time + waiting/storage time
With JIT (Just-in-time) methodology, organizations shifted from just in case to Just-in-time, reducing the inventory cost and improving efficiency. You can now order a customized car from a dealer, and it gets manufactured and delivered in two weeks as opposed to months.
Process automation has reduced waiting times.
This is also referred to as after-sales service; for example, disposal services, training, installation, service agreement, etc.
Learning and Growth Perspective
This is a long-term investment and for the organization’s growth.
There are three categories:
- Employee Capabilities
- Information System Capabilities
- Motivation, Empowerment, and Alignment
#1. Employee Capabilities
Employees’ roles have shifted from workers to contributors. We have moved from the industrial era to the information age. This requires re-skilling employees to become knowledge workers.
Some measurements worth noting here are employee satisfaction, employee retention, and employee productivity.
Employee Satisfaction: It’s been discovered that “employees who scored highest in the satisfaction survey tend to have the most satisfied customers.” Satisfied employees are a precondition for increasing productivity. A random monthly satisfaction survey can help with this on a BSC.
Employee Retention: Unwanted departure of an employee is a huge intellectual loss. This is measured by attrition rate or staff turnover.
Employee Productivity: This is the revenue/impact per employee. Organizations want to increase this factor by increasing the revenue generated. Many organizations try to reduce the number of employees to reduce net costs. Downsizing may have short-term gains but sacrifice long-term capabilities.
Skill is one driver for productivity. You may need to re-skill the workforce if employees are new.
We can measure employee competencies along with skills, knowledge, and attitude.
It could also be strategic or massive re-skilling where the skill is new and apparently not visible. Employees can be required to build skills up from junior to mastery level.
#2. Information Availability Capabilities
Availability of information can also help organizations and employees improve their capabilities. Real-time feedback can help avoid costs and more damage.
If employees are to be effective in today’s competitive business environment, they need information on customers, internal processes, and the financial consequences of their decisions.
#3. Motivation, Empowerment, and Alignment
Motivation: Organization can take suggestions from employees and implement useful ideas. This can boost employees’ morale and give them a sense of ownership.
Measuring the number of suggestions implemented shows the degree of employee participation. Executives should create a system that follows up and provides feedback on every submitted suggestion.
Empowerment: Empowerment helps employees perform well.
Alignment: We measure whether the goals of individuals and units align with the corporate goal.
How to Draw a Balanced Scorecard
A balanced scorecard has four components: financial, customer, internal business process, and learning and growth. You can draw it bottom-up in a cause-effect manner. If you improve learning and growth, the internal business process will also improve, bringing customer satisfaction and eventually more revenue.
You start developing a balanced scorecard by identifying the elements at the bottom, i.e., learning and growth. Let’s take training, for instance. You assess the training process. Are staff competent in skills, knowledge, and attitudes? You then conduct a gap analysis, develop training, and evaluate if the gap has been closed through training.
Other aspects of the learning and growth perspective are analyzed.
When the human resources are well aligned, machines, equipment, and procedures perform better, which is the internal business process.
When this happens, the next beneficiaries are external shareholders and customers. And when customers are satisfied, the business thrives, meaning more revenue and market share.
Another approach to drawing a balanced scorecard is to start from the high-level strategic goal and mission of the organization.
What is the strategic goal of the organization?
Complete all balanced scorecard perspectives with measures and targets in line with the strategic goal. Measures should be quantitative or qualitative.
Identify initiatives that are specific projects or actions executable to achieve the set objectives.
NB: To ensure these objectives and initiatives are executable, there must be a collaboration between employees and management during the BSC development process.
Characteristics of a Balanced Scorecard Model
- It is both a performance measurement and management tool.
- It has four perspectives: financial, customer, internal business process, and learning and growth.
- It has a logical flow of value from learning and growth through internal business processes and customers to the ultimate financial perspective.
- It works with measurable targets, which are reviewed over time to track progress.
- It is collaboratively developed by all stakeholders, employees, and management to ensure collective responsibilities.
Benefits of a Balanced Scorecard
- It helps companies align strategies to the day-to-day activities of employees.
- It guarantees the future sustainability and growth of the company when properly implemented.
- It is a good organizational communication tool and gets employees’ buy-in.
- It transforms an organization’s mission and strategy into a comprehensive performance measure.
- It makes a company more human-centric, thus promoting staff retention and development and customer satisfaction.
- It can make a company innovative as employees brainstorm on the initiative and suggest achieving company objectives.
- It helps the company look inward and invest in processes, infrastructure, and technology for better performance (This is common with the internal business process perspective).
Examples of a Balanced Scorecard
We will look at an agricultural business.
Strategy: Be the preferred destination for poultry products in the XYZ community.
Balanced Scorecard FAQs
Q:1 – Is the balanced scorecard another vibe?
Ans: No, it’s been a concept since the early nineties and is one of the most useful management tools for strategic performance measurement.
Q:2 – How many perspectives does the balanced scorecard consider, and which is most important?
Ans: Four perspectives – Financial, customer, internal business process, and learning and growth. They are equally prioritized and work in a logical fashion.
Q:3 – Who originated the balanced scorecard?
Ans: The corporate scorecard was first conceptualized by Schneiderman of Analog Devices in 1987 but was later developed into the balanced scorecard by two Harvard professors, Robert and Norton.
Q:4 – Can the balanced scorecard be used for both strategy formulation and implementation?
Ans: The balanced scorecard is best suited for strategic implementation.
Q:5 – Is the balanced scorecard developed by the human resources department of a company?
Ans: No, the senior executives develop the balanced scorecard in collaboration with employee representatives.
The balanced scorecard has become the cornerstone of organizational performance measurement and management. With the four perspectives of financial, customer, internal business process, and learning and growth, an organization can navigate successfully from past success to future growth and sustainability.
Have you been involved in developing a balanced scorecard? Please share your experience with it through the comments section.
- R. David and H. Norton, The Balanced Scorecard: Translating strategy into actions, Harvard Business School Press, 1996, pg. 1-120.