What is a balance scorecard
The Balanced Scorecard (BSC) was published in 1992 by Robert Kaplan and David Norton. In addition to measuring current performance in financial terms, the Balanced Scorecard evaluates the firm's efforts for future improvement using process, customer, and learning and growth metrics. The term "scorecard" signifies quantified performance measures and "balanced" signifies that the system is balanced between:
- short-term objectives and long-term objectives
- financial measures and non-financial measures
- lagging indicators and leading indicators
- internal performance and external performance perspectives
Financial Measures Are Insufficient
While financial accounting is suited to the tracking of physical assets such as manufacturing equipment and inventory, it is less capable of providing useful reports in environments with a large intangible asset base. As intangible assets constitute an ever-increasing proportion of a company's market value, there is an increase in the need for measures that better report such assets as loyal customers, proprietary processes, and highly-skilled staff.
Consider the case of a company that is not profitable but that has a very large customer base. Such a firm could be an attractive takeover target simply because the acquiring firm wants access to those customers. It is not uncommon for a company to take over a competitor with the plan to discontinue the competing product line and convert the customer base to its own products and services. The balance sheets of such takeover targets do not reflect the value of the customers who nonetheless are worth something to the acquiring firm. Clearly, additional measures are needed for such intangibles.
Scorecard Measures are Limited in Number
The Balanced Scorecard is more than a collection of measures used to identify problems. It is a system that integrates a firm's strategy with a purposely limited number of key metrics. Simply adding new metrics to the financial ones could result in hundreds of measures and would create information overload.
To avoid this problem, the Balanced Scorecard focuses
on four major areas of performance and a limited number of metrics within those areas. The objectives within the four perspectives are carefully selected and are firm specific. To avoid information overload, the total number of measures should be limited to somewhere between 15 and 20, or three to four measures for each of the four perspectives. These measures are selected as the ones deemed to be critical in achieving breakthrough competitive performance; they essentially define what is meant by "performance".
A Chain of Cause-and-Effect Relationships
Before the Balanced Scorecard, some companies already used a collection of both financial and non-financial measures of critical performance indicators. However, a well-designed Balanced Scorecard is different from such a system in that the four BSC perspectives form a chain of cause-and-effect relationships. For example, learning and growth lead to better business processes that result in higher customer loyalty and thus a higher return on capital employed (ROCE).
Effectively, the cause-and-effect relationships illustrate the hypothesis behind the organization's strategy. The measures reflect a chain of performance drivers that determine the effectiveness of the strategy implementation.
Objectives, Measures, Targets, and Initiatives
Within each of the Balanced Scorecard financial, customer, internal process, and learning perspectives, the firm must define the following:
- Strategic objectives - what the strategy is to achieve in that perspective.
- Measures - how progress for that particular objective will be measured.
- Targets - the target value sought for each measure.
- Initiatives - what will be done to facilitate the reaching of the target.
The following sections provide examples of some objectives and measures for the four perspectives.
The financial perspective addresses the question of how shareholders view the firm and which financial goals are desired from the shareholder's perspective. The specific goals depend on the company's stage in the business life cycle.
Growth stage - goal is growth, such as revenue growth rateSource: www.netmba.com