Business, Legal & Accounting Glossary
The balanced scorecard, a concept for measuring whether the activities of a company are meeting its objectives in terms of vision and strategy, was developed and first used at Analog Devices in 1987. By focusing not only on financial outcomes but also on the human issues, the balanced scorecard helps to provide a more comprehensive view of a business which in turn helps organizations to act in their best long-term interests. The strategic management system helps managers focus on performance metrics while balancing financial objectives with customer, process and employee perspectives. Measures are often indicators of future performance.
In 1992, Robert S. Kaplan and David P. Norton began publicizing the balanced scorecard through a series of journal articles and then in the 1996 book The Balanced Scorecard. Since the original concept was introduced, balanced scorecards have become a fertile field of theory and research, and many practitioners have diverted from the original Kaplan & Norton articles. Kaplan & Norton themselves revisited the scorecard with the benefit of a decade’s experience since the original article.
Implementing the scorecard typically includes four processes:
The BSC is a performance measurement framework, with similar principles as Management by Objectives, which was publicized by Robert S. Kaplan and David P. Norton in the early 1990s. Having realized the shortcomings of traditional management control systems, Kaplan and Norton designed the BSC as a result of a one-year research project with 12 companies. Since its introduction, the Balanced Scorecard has been awarded a prize by the American Accounting Association as the “best theoretical contribution in 1997” and its industry and academic attention has placed it alongside approaches such as Activity-based costing and Total Quality Management.
The BSC is a framework or what can be best characterized as a “strategic management system” that claims to incorporate all quantitative and abstract measures of true importance to the enterprise. According to Kaplan and Norton, 1996, “The Balanced Scorecard provides managers with the instrumentation they need to navigate to future competitive success”.
The earliest Balanced Scorecards comprised simple tables broken into four sections – typically these ‘perspectives’ were labeled “Financial”, “Customer”, “Internal Business Processes”, and “Learning & Growth”. Designing the Balanced Scorecard required selecting five or six good measures for each perspective. Many writers have since suggested alternative headings for these perspectives and also suggested using either additional or fewer perspectives: these suggestions being triggered by a recognition that different but equivalent headings will yield alternative sets of measures. The major design challenge faced with this type of Balanced Scorecard is justifying the choice of measures made – “of all the measures you could have chosen why did you choose these…?” is a common question asked (and using this type of design process, hard to answer). If users are not confident that the measures within the Balanced Scorecard are well-chosen, they will have less confidence in the information it provides. Although less common, these early styled Balanced Scorecards are still designed and used today.
The early style Balanced Scorecards are hard to design in a way that builds confidence that they are well designed. Because of this, many are abandoned soon after completion.
In the mid-1990s, an improved design method emerged. In the new method, selection of measures was based on a set of ‘strategic objectives’ plotted on a ‘strategic linkage model’ or ‘strategy map’. With this modified approach, the strategic objectives are typically distributed across a similar set of ‘perspectives’ as is found in the earlier designs, but the design question becomes slightly more abstract. Managers have to identify the five or six goals they have within each of the perspectives, and then demonstrate some inter-linking between them by plotting causal links on the diagram. Having reached some consensus about the objectives and how they inter-relate, the Balanced Scorecard’s measures are chosen by picking suitable measures for each objective. This type of approach provides greater contextual justification for the measures chosen, and is generally easier for managers to work through. This style of Balanced Scorecard has been the most common type for the last ten years or so.
Several design issues still remain with this modified approach to Balanced Scorecard design, but it has been much more successful than the design approach it supersedes.
Since the late 1990s, various alternatives to the Balanced Scorecard have emerged – examples being The Performance Prism, Results-Based Management and Third Generation Balanced Scorecard for example. These tools seek to solve some of the remaining design issues – in particular issues relating to the design of sets of Balanced Scorecards to use across an organization, and in setting targets for the measures selected.
Many books and articles on Balanced Scorecard topics confuse the design process elements and the Balanced Scorecard itself: in particular, it is common for people to refer to a ‘strategic linkage model’ or ‘strategy map’ as being a Balanced Scorecard.
Balanced Scorecard is a performance management tool: although it helps focus managers’ attention on strategic issues and the management of the implementation of strategy, it is important to remember that Balanced Scorecard itself has no role in the formation of strategy. Balanced Scorecard can comfortably co-exist with strategic planning systems and other tools.
Kaplan and Norton found that companies are using the scorecard to:
In 1997, Kurtzman found that 64 per cent of the companies questioned were measuring performance from a number of perspectives in a similar way to the balanced scorecard.
Balanced scorecards have been implemented by government agencies, military units, corporate units and corporations as a whole, nonprofits, and schools; many sample scorecards can be found via Web searches, though adapting one organization’s scorecard to another is generally not advised by theorists, who believe that much of the benefit of the scorecard comes from the implementation method.
A criticism of balanced scorecard is that the scores are not based on any proven economic or financial theory and have no basis in the decision sciences. The process is entirely subjective and makes no provision to assess quantities like risk and economic value in a way that is actuarially or economically well-founded. The Balanced scorecard does not provide a bottom-line score or a unified view with clear recommendations, it is simply a list of metrics. Positive responses from users of balanced scorecard may merely be a type of placebo effect. There are no empirical studies linking the use of balanced scorecard to better decision making or improved financial performance of companies.
Applied Information Economics (AIE) has been researched as an alternative to Balanced Scorecards. In 2000, the Federal CIO Council commissioned a study to compare the two methods by funding studies in side-by-side projects in two different agencies. The Dept. of Veterans Affairs used AIE and the US Dept. of Agriculture applied balanced scorecard. The resulting report found that while AIE was much more sophisticated, AIE actually took slightly less time to utilize. AIE was also more likely to generate findings that were newsworthy to the organization while the users of balanced scorecard felt it simply documented their inputs and offered no other particular insight. However, balanced scorecard is still much more widely used than AIE.
The grouping of performance measures in general categories (perspectives) is seen to aid in the gathering and selection of the appropriate performance measures for the enterprise. Four general perspectives have been proposed by the BSC.
The financial perspective examines if the company’s implementation and execution of its strategy are contributing to the bottom-line improvement of the company. It represents the long-term strategic objectives of the organization and thus it incorporates the tangible outcomes of the strategy in traditional financial terms. The three possible stages as described by Kaplan and Norton (1996) are rapid growth, sustain and harvest. Financial objectives and measures for the growth stage will stem from the development and growth of the organization which will lead to increased sales volumes, acquisition of new customers, growth in revenues etc. The sustain stage, on the other hand, will be characterized by measures that evaluate the effectiveness of the organization to manage its operations and costs, by calculating the return on investment, the return on capital employed, etc. Finally, the harvest stage will be based on cash flow analysis with measures such as payback periods and revenue volume. Some of the most common financial measures that are incorporated in the financial perspective are EVA, revenue growth, costs, profit margins, cash flow, net operating income etc.
The customer perspective defines the value proposition that the organization will apply in order to satisfy customers and thus generate more sales to the most desired (i.e. the most profitable) customer groups. The measures that are selected for the customer perspective should measure both the value that is delivered to the customer (value position) which may involve time, quality, performance and service and cost and the outcomes that come as a result of this value proposition (e.g., customer satisfaction, market share). The value proposition can be centred on one of the three: operational excellence, customer intimacy or product leadership, while maintaining threshold levels at the other two.
The internal process perspective is concerned with the processes that create and deliver the customer value proposition. It focuses on all the activities and key processes required in order for the company to excel at providing the value expected by the customers both productively and efficiently. These can include both short-term and long-term objectives as well as incorporating innovative process development in order to stimulate improvement. In order to identify the measures that correspond to the internal process perspective, Kaplan and Norton propose using certain clusters that group similar value-creating processes in an organization. The clusters for the internal process perspective are operations management (by improving asset utilization, supply chain management, etc), customer management (by expanding and deepening relations), innovation (by new products and services) and regulatory & social (by establishing good relations with the external stakeholders).
The learning and growth perspective is the foundation of any strategy and focuses on the intangible assets of an organization, mainly on the internal skills and capabilities that are required to support the value-creating internal processes. The learning and growth perspective is concerned with the jobs (human capital), the systems (information capital), and the climate (organization capital) of the enterprise. These three factors relate to what Kaplan and Norton claim is the infrastructure that is needed in order to enable ambitious objectives in the other three perspectives to be achieved. This, of course, will be in the long term, since an improvement in the learning and growth perspective will require certain expenditures that may decrease short-term financial results, whilst contributing to long-term success.
According to each perspective of the balanced scorecard there are a number of KPIs that can be used such as:
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This glossary post was last updated: 21st April, 2020 | 124 Views.