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May 27, 2010

Balanced Scorecards

Introduction
A Balanced Scorecard (BSC) is a strategic management tool that measures how well the business activities are aligned with the organization’s strategic vision. It balances financial results with non-financial performance metrics. The novelty of the Balanced Scorecard is the addition of non-financial metrics.

Without a balanced scorecard, a business tends to be judged only by short-term financial results. These may hide serious problems. An example would be: reduce short-term costs by deferring all maintenance expenditures. If the balanced scorecard were to include a question probing “percentage of maintenance completed on schedule”, this would be discovered.

It is also a management system – not just a measurement tool – in that it helps to clarify vision and to translate strategy into activity.

Overview

The following steps describe, at a high level, how to build a balanced scorecard:

•Identify a few significant financial and non-financial metrics
•Attach targets
•Measure results
•Report deviations from the targets
•Take corrective action.
To implement a Balanced Scorecard system:

•Translate the strategic vision into operational targets
•Communicate the vision and targets throughout the organization
•Make plans for the business: set performance targets by unit or department
•Measure, obtain feedback, learn from mistakes, adjust the strategy
It is rare to have more than 20 metrics in a BSC; only about a quarter should be financial.

The BSC should answer 4 questions:

•How do shareholders (owners of small firms; stakeholders in not-for-profit organizations) perceive the organization?
•How do customers perceive the organization?
•How excellent are our internal processes?
•How well are we innovating, learning and improving?

Barriers to Successful Strategy
There seem to be four barriers to successfully reaching strategic objectives:

•Understanding the Vision: Too few people understand the strategic vision.
•Divergent Objectives: Too many people have objectives which differ from the strategy.
•Inadequate Resources: Time, money and energy are not applied to strategic objectives.
•Management Distraction: Upper management is distracted from strategic objectives by short-term issues.

Hurdling over the Barriers
The BSC helps to overcome all four barriers:

•The BSC should be published, distributed to, and explained to all employees.
•The BSC names targets for each department. This should reduce the divergence of objectives.
•Since the BSC identifies strategic goals and department objectives, it should also have assigned adequate resources.
•Since the entire business will be measured on results versus the targets named in the BSC, the focus should remain on meeting the strategic objectives.

Making a Strong Start

The BSC starts with strategy, not with detailed performance objectives.
It is tempting to say, “We know that our strategy is to be profitable and to grow the business. So let’s set our BSC goals around profit and revenue; increasing our customer base; oh, yes, let’s throw in growing the average order quantity. That should do it”.

No, it does not. The above paragraph does not even begin to cover the “customer” situation. Should the company set targets on customer retention? Should it use customer satisfaction scores as an early indicator of retention problems? Would it be wise to track customer referrals versus gaining new customers from cold calls?

This also did not address resources. How will the company increase customer satisfaction? By reducing defects? By reducing late deliveries? By reducing standard order-to-ship times? How will the company make these improvements? Is there a budget for kaizen (continuous improvement) or for other, more specific improvement programs?

Final Motivation
An organization that only uses financial results for guidance is like driving a car by looking at the rear-view mirror – you know where you have been, but you are not planning for the next curve. The Balanced Scorecard system forces the organization to look forward, and later checks how well the curve has been followed.