Introduction to the balanced scorecard
A barrier to many small business’ growth and/or improved efficiencies is the owner’s inability to manage the increasing complexities of his or her company. In many small companies, the owner is involved in every aspect of running the business. This hands-on approach may now be limiting growth or compromises competitiveness. Owners may find:
- They are constantly solving problems that should never have occurred or could have been resolved by someone else.
- Employees’ work is not always focused on company goals.
- Communications break down.
- Profit margins are being squeezed.
The scorecard is a step in the right direction for business owners to create a management structure that clarifies direction, communicates that direction, aligns everyone’s work to support those goals and ultimately perform more efficiently and be more competitive.
Several books have been written on the balanced scorecard; see our recommended reading list section. These references provide great insight into the concepts but may not show small businesses how to do it. This process, designed by the Missouri Small Business & Technology Development Centers, bridges that gap with an easy to follow step-by-step process. Ultimately, these steps will help you develop a measurement system that balances financial and operational measures, leading and lagging measures, mission- and vision-related measures that reflect the unique personality of your company.
Why do you need one?
Owners generally have a pretty clear picture of where they want their company to go, but their strategy is not very clear to anyone else in the company. Research shows that most companies fail to execute strategy successfully*. For example:
- Only 5 percent of the workforce understands their company strategy.
- Only 25 percent of managers have incentives linked to strategy.
- 60 percent of organizations don’t link budgets to strategy.
- 86 percent of executive teams spend less than on hour per month discussing strategy.
Developing a balanced scorecard forces a company to clarify strategy and focus on key activities to achieve success. The scorecard becomes a tool that improves communication, empowers people to make informed decisions and aligns work throughout the company. It reinforces behaviors crucial to reaching company goals.
Using an effective employee evaluation process is another common problem many small companies have. Evaluations are rarely based on clear performance measures, if they exist at all. The company scorecard can be broken down for each individual to provide meaningful measures that support the company’s success. This can be the first step to creating a pay for performance system, though setting up such a system will not be covered in these steps.
New terms and concepts
Before you begin the nine “Steps to Developing a Balanced Scorecard,” take some time to understand these terms and concepts.
- Cause-and-effect relationships. These relationships can be expressed by a sequence of if-then statements. A properly constructed scorecard should tell the story of the business strategy through such a sequence. For example, if our people are trained properly, then they will be able to perform our key activities well. If our company’s key activities are executed well, then our customers will be very satisfied. If our customers are highly satisfied with our performance, then sales will grow steadily.
- Leading and lagging indicators. Financial outcomes are lagging indicators of company performance. Many managers fail to link other measures (such as those for employees, customers or processes) to outcomes that directly influence future financial performance. Financial measures tend to be lagging (have already occurred) measures. A leading indicator to financial outcomes might be highly satisfied customers. Keep in mind that customer satisfaction measures may be considered lagging measures in measuring quality products, which would be a leading indicator of customer satisfaction. The point is, the earlier our measurement system can catch a problem, the more quickly corrections can be made with positive financial outcomes.
The scorecard perspectives
The balanced scorecard provides a framework to create value from different perspectives. Four generic perspectives will be used to further explain this concept.
- Financial: Measures that support growth, profitability, and risk from the perspective of an owner or shareholder.
- Customer: Measures creating value and differentiation from the perspective of the customer.
- Internal: Establishes priorities for various business or operational processes critical in creating customer and shareholder satisfaction.
- Learning and growth: Measures activities that create a climate that support change, innovation and growth.
These perspectives are for illustrative purposes; each company will come up with their own that makes sense in their business environment.
The financial perspective
The financial perspective should have the proper mix of measures that give an accurate overview of the company’s health. Traditional historic measures must be mixed with current and future data. Current data might be cash flow, orders in the pipeline, accounts receivable, liquidity measures and daily sales figures. Future oriented data might include percentage of sales from new products, dollars invested in R&D as a ratio to sales or profit, and sales growth in a new region or market segment.
How excellent companies measure financial performance
- A few key financial statistics are used to measure overall company performance.
- Financial metrics cover past, present and future performance.
- Financial statistics are tightly linked to key success factors.
- Overall financial measures push profitable growth.
- The company knows the true costs of its processes and products/services.
- The company continually evaluates and improves metrics that predict long- and short-term success.
The customer perspective
Customers all want good quality at a fair price. Beyond that, individual customers want and expect many different things from the products and services they buy. Becoming a customer-focused organization requires segmenting customers and determining the needs and desires of each group. Customer satisfaction measures mix hard and soft measures. Soft measures predict customer behavior and include such things as customer opinions, perceptions and feelings. Perceived value is a strong predictor of customer buying behavior; soft measures should include at least one measure about the customer’s perception of value. Hard measures quantify what customers do, not what they say. These measures may include gains and losses of customers, market share relative to competitors and repeat business. Price verses competition is also a hard measure of value.
How excellent companies measure customer satisfaction and value
- Customers are segmented according to similar characteristics and their specific needs determined regularly.
- Surveys are developed to measure satisfaction levels of each group of customers.
- Large customer samples are surveyed at least twice a year and the surveys have a large (50 percent or more) response rate.
- Focus groups or similar meetings are conducted to gather qualitative customer satisfaction data.
- Telephone and mail surveys are evaluated and continually improved.
- Hard data such as repeat business are collected to supplement customer opinion data.
- Customer satisfaction levels of key competitors are determined.
- Internal support functions have simple methods for determining customer satisfaction levels.
- A variety of hard and soft data are collected on perceived value.
- Price and quality data on key competitors are collected to assess value.
The internal perspective
The key to excellence is controlling the processes that produce reliable and consistent products and services. Achieving good performance levels on these measures leads to high-quality products and services, the first in a chain reaction that creates satisfied customers, which leads to repeat business, which supports long-term survival and success. Process measures can easily be confused with output measures.
Simplicity is the key to establishing a good set of measures, which means screening out all extraneous data.
How excellent companies measure process and operational results
- Cycle time for all key processes is measured.
- Rework time and/or costs are tracked for key production and service delivery processes.
- Key measures of productivity are identified and tracked for major company processes.
- Key processes have been identified in each unit and department, with measures defined for each.
- Measures are correlated with factors of prime importance to customers.
- Standards or goals are set for all key measures based on appropriate benchmarks and customer requirements.
- Measures promote a preventive approach to achieving quality products and services.
- A safety index is developed that incorporates both output and preventative measures.
- Data is collected on key variables for goods and services it buys from suppliers.
The learning and growth perspective
To execute internal business processes, the company must have an infrastructure that develops the skills, capabilities and knowledge of employees. Additional measures may indicate the employee’s view of the work climate and satisfaction they receive from their work.
How excellent companies measure the learning perspective
- Measures indicate knowledge achieved through training and education.
- Levels of pertinent achievement are measured, such internal certification, professional licenses, degrees or continuing education.
- Measures balance technical and non-technical skills based on their importance to the business and/or position.
- Measures indicating the working conditions or work environment.
- Data is segmented for the types of workers in the company.
- Growth measures such as the number of new ideas and sales from new products.
Frequently asked questions
- What is the balanced scorecard? It’s a measurement and management system that can channel the energies, abilities and specific knowledge held by people throughout the company to achieve long-term strategic goals.
- What does that mean? The balanced scorecard, in its simplest terms, is a system that allows an organization to measure performance key to its success. Most organizations produce a balance sheet and income statement every month. These common financial statements are successful measurement tools that have been used for years. The balanced scorecard makes use of both qualitative and quantitative measures in conjunction with traditional measurement instruments to give management and employees a snapshot of the past health and future of the company.
- What are some common measurements? Financial measurements continue to be important and include such things as sales, profits, return on investment, liquidity measures and others. Measures that lead to financial results include efficiency measures (such as cycle time, scrap, responsiveness, etc.), quality measures (i.e. warrantee costs, returns, rework, accuracy, etc.), customer satisfaction measures (i.e. complaints, new customers, referrals, survey results, etc.), employee skills and satisfaction measures (i.e. training hours, certification, cross training, absenteeism, turnover, survey results, etc.) and growth/innovation measures (i.e. R&D expenditures, sales from new products, employee suggestions, etc.). The balanced scorecard can be tailored to fit the needs of any organization.
- Who uses the balanced scorecard? Many Fortune 500 companies currently use the balanced scorecard or a similar system, including General Electric, IBM, Boeing, Anheuser Busch and Amazon.com. It is also very applicable to almost every small business. The MO SBTDC has assisted numerous small businesses in creating balanced scorecards and all agreed the process is valuable and will help their business.
- What are some advantages of the balanced scorecard approach? The balanced scorecard does not force organizational leaders to choose between financial and operational measures. The concept recognizes that no single measure can provide a clear target or focus attention on critical areas. Instead, the balanced scorecard gives leaders a set of measures that provide a fast but comprehensive view of the company — a snapshot of overall performance that focuses attention on factors critical to success. The balanced scorecard helps a company organize and communicate its strategies to employees and shareholders, then aligns work at all levels to ensure day-to-day tasks line up with these critical success factors. One of the most effective outcomes of the balanced scorecard is it reinforces desired employee behavior and helps eliminate unwanted behavior with very clear, precise measurements of how employees perform.
- Is the balanced scorecard costly? There are some costs associated with initiating the balanced scorecard, though it varies from one organization to another based on the amount of data the company is already capturing. Companies who capture virtually no data may have an added cost in setting up the infrastructure to capture important data points. However, the cost outlay is generally overshadowed by the power of the measurements and the information they convey to the companies’ leaders.
- How difficult is it to implement the balanced scorecard? Not difficult. It can usually be done through three meetings. The first session usually helps the client map out the strategies critical for the business’ success. The second session focuses on identifying measurement categories. The third and final session helps the client determine which measures are most critical to the business. A fourth meeting is often scheduled in the distant future to follow up on how the process is working. The company will have some work between the meetings, and it is best to assign that responsibility to ensure it is completed. A counselor’s role is to facilitate the process, guide discussion and offer assistance.
Missouri SBTDC facilitators are trained to draw out unique company strengths and help leaders articulate what is important to the success of their company. They will also ensure that the measurements selected are balanced between a number of perspectives, can be collected using existing systems or don’t overburden the company with new systems, establish goals that are both realistic and challenging, provide guidance on communicating the measures and help the company cascade these measures to all levels in the company.
To get started, call the Missouri Small Business & Technology Development Centers at 573-884-1555 or find the office nearest you.
Keeping Score — Mark Graham Brown
Brown has a down to earth, easy to read writing style. He takes academic language out of his books, which makes the information a little easier to apply to the real world. It’s a close toss-up between this book and the next one listed as best to read first.
The Balanced Scorecard — Robert S. Kaplan & David P. Norton
This is the book that started the balanced scorecard movement. It is an excellent first book to read on the subject.
The Strategy-Focused Organization — Robert S. Kaplan & David P. Norton
This is a follow-up to Kaplan and Norton’s first book. Some of the lessons learned from their first book are in this one. It is good reading, but we recommend it after reading Mark Graham Brown’s Keeping Score.
Winning Score — Mark Graham Brown
This is a good book to read to avoid some of the pitfalls of developing a scorecard. He talks about the lessons learned since 1992, when the balanced scorecard was first introduced.
The Six Sigma Way — Peter S. Pande, Robert P. Neuman & Roland R. Cavanagh Motorola and GE have incorporated this strategy into their scorecards. It provides an in-depth guide to fully implement Six Sigma, an analytical process used to refine scorecards.
The Great Game of Business — Jack Stack
This book’s easy reading style presents outstanding management information and should be high on any business owner’s reading list. It shows how a company can be focused on the numbers while keeping work fun — hence the name GAME of business.
Open-Book Management — John Case
This book uses many of the same concepts as the balanced scorecard. It talks about selecting measures important to success and sharing them with everyone in the company. John Case uses Jack Stack as an example for his book. He shows how the principles of The Great Game of Business can apply to any kind of organization.
The Memory Jogger Plus+ — Michael Brassard
This book explains a number of facilitation techniques that make groups and teams more effective. It is an excellent resource to have in every office.
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