The Balanced Scorecard Concept - Essay Example

The Balanced Scorecard The Balanced Scorecard Introduction The concept of the Balanced Scorecard was introduced in the early 1990s with considerable excitement and promised to change the way performance measurement was conducted and how companies were managed. This study is an investigation into the conception of the Balanced Scorecard. It critically evaluates the use of the "Balanced Scorecard as part of modern business management accounting. In addition the paper tries to understand the way in which performance can be assessed in terms of financial and non-financial measures and to appreciate the use of modern methods of performance measurement. Who and how it is being promoted today, how it is being used to link employee performance to organizational strategy, and how successful have the companies been who have adopted the Scorecard as a performance measurement and strategy implementation tool in the long-term. This study will answer these questions. Performance Measurement. Evaluation, and The Balanced Scorecard "What you measure is what you get" is an often-heard phrase, which emphasizes the importance of performance measurement to the success of an organization. Performance measurement can be defined as the quantification of either a process output or the activities that constitute that process. An effective set of performance measures should have the following characteristics: (a) communicate and summarize those critical activities necessary to meet customer requirements, (b) reflect outputs of processes and outcomes (how customers value the outputs), (c) be comprehensive, and (d) provide feedback to the organization (Atkinson, Waterhouse, & Wells, 1997). Selecting the proper performance measures is one of the key challenges facing management (Ittner & Larcker, 1998), yet it is perhaps the most misunderstood and difficult aspect of a management control systems (Atkinson, Waterhouse et al., 1997). Performance measures can be financial or non-financial. Financial (or traditional) performance measures are dollar value measures produced by the organization's accounting system. Examples of financial measures would include return on investment, return on equity, operating margin, unit cost, or cost variances. Non-financial performance measures are typically derived from outside the accounting system. Examples of non-financial measures include customer satisfaction measures, manufacturing cycle time, new product introductions, R&D productivity, market growth, and market share. Observers have noted that performance measurement has gained added significance, because organizations are faced with the twin challenges of adapting to new rules of competition and responding to the rapid changes often taking place in the marketplace (Stivers & Joyce, 2000). The factors driving this evolution are the opportunities and formidable challenges of escalating globalization, the increasing transparency of manager actions, the need to develop intangible assets to sustain competitive advantage, the escalating pace of technological change, an increase in competition among firms, and the rise of process change initiatives such as TQM (Malina & Selto, 2001). The right measures correctly linked to the organization's strategy gives managers and employees the guidance they need to act appropriately (Kaplan & Norton, 1996). This conclusion is echoed by a survey of executives indicating that performance measurement is critical in translating a business strategy into results (Lingle & Schiemann, 1996). Performance measures designed outside of the strategic planning process creates potential for disconnect. The reason performance measurement systems fail to live up to expectations is commonly attributed to this disconnect (Atkinson, Waterhouse et al., 1997). Traditional accounting-based performance measures, with their one-dimensional focus on financial results, have been criticized as not being up to the task faced by modern organizations. The sense is that financial performance measures are backward looking, foster a short-term managerial focus, and are subject to manipulation. These perceived shortcomings are attributed to the observation that financial accounting systems are designed "with the priority of consistency and hardness" (Atkinson, Waterhouse et al., 1997, p. 26) for the purpose of generating comparative information useful to absentee owners and the capital markets in which ownership interests are traded. As such, the information derived from this system lacks the focus and range needed by internal decision-makers (Atkinson, Waterhouse et al., 1997). Ironically, despite these perceived shortcomings, a survey conducted by Ittner and Larcker (1998) found that financial measures still form the cornerstone for most, if not all, organizations. Atkinson, Waterhouse et al. advanced two reasons for this practice. First, financial measures are valued for their perceived reliability and consistency, a desired attribute if the measures are used for reward and accountability. Second, they are seen as a direct link to the primary corporate objective of creating profits for owners. Improved Performance Measurement Systems The response to this situation has been twofold. On one hand there exists a movement to improve traditional financial performance measures. At the forefront of this movement is the Economic Value Added (EVA) metric (a form of residual income) popularized by G. Bennett Stewart, III (1990) and the Stern Stewart consulting group (Myers & Welch, 1997). The leading challenger is Cash Flow Return on Investment (CFROI) championed by HOLT Value Associates. Another representative approach is Shareholder Value Added (SVA) promoted by LEK/Alcar Consulting Group (Myers, 1996). At the other end of the spectrum is the movement to integrate nonfmancial performance measures with financial metrics. At the forefront of this approach is the balanced scorecard concept developed by Kaplan and Norton (1992). Research on the ability of the new financial metrics to explain shareholder returns better than traditional accounting measures is mixed. Biddle, Bowen, and Wallace, (1998) show that traditional accounting measures explain stock prices better than EVA. The researchers did find that EVA's capital charge and accounting adjustments did have some explanatory power, but the effect was not statistically significant. Myers and Welch (1997) argue that EVA did marginally better in tracking shareholder returns than traditional accounting measures. On a more positive note, Wallace (1997) examined the relative performance of adopters and non adopters of EVA and other residual income measures. Their data suggested that EVA type measures changed manager behavior such that new investments decreased and assets were utilized more efficiently, leading to a greater change in residual income. Payouts to shareholders also increased. Even though the jury is still out regarding the efficacy of these new financial measures, an even more fundamental criticism can be made. Hamel (1997) noted the new financial metrics focus on the efficient use of capital, and observed that even though the efficient use of capital, like any scarce resource, is essential; it cannot be the sole focus if firms are to prosper against their competitors. Strategy and the ability to respond to the competitive landscape are central to long run survival. This perceived need to link strategy and innovation with financial performance is at the core of the balanced scorecard concept. The Balanced Scorecard The case has been made that traditional performance measures fall short in supporting managers as they make decisions in today's fluid economic environment. Financial measures are lag indicators reflecting past actions (Ittner & Larcker, 1998). Furthermore, as an output of the traditional financial accounting system, it is believed by many observers that these measures do not reflect the resource allocation decisions that drive value in today's marketplace. Knowledge-based and other intangible assets often play a central role in organizational success (Kaplan & Norton, 1996; Stivers & Joyce, 2000). The balanced scorecard (BSC) grew from a long-term research project involving twelve companies (Kaplan & Norton, 1992) and has been introduced as a methodology which supplements financial performance measures, such as return on investment, earnings per share, sales growth, or cash flow with non-financial measures which focus on other stakeholders and processes. These measures are organized into three additional dimensions: the customer perspective, the internal business perspective, and the innovation and learning perspective. Therefore, the typical balanced scorecard measures organizational performance along four dimensions or perspectives (Norton & Kaplan, 1992, 1996): the customer perspective: "How do our customers see us" the internal process perspective: "How do we see ourselves" the innovation and learning perspective: "Where do we see ourselves headed" the financial perspective: "How do our investors see us" A balanced scorecard is derived from a business unit's vision and strategy and provides a benchmark for employees in all levels of the organization. A well crafted BSC should tell the story of the business unit's strategy (Kaplan & Norton, 1996). The process begins by translating strategy into specific objectives, including long-run financial objectives. Specific operational measures are selected and then linked to the strategy in a cause and effect manner. The cause and effect linkage runs through all perspectives in the scorecard. Kaplan and Norton (1996) provide an example of this concept. Assume return on capital employed is an outcome measure in the financial perspective and is the result of repeat and expanded sales. It is then determined that customer loyalty is the driver of increased sales, and what customers value is on-time delivery; therefore, customer loyalty and on-time delivery become part of the customer perspective. The next question is what internal processes are needed to accomplish on-time delivery. The answer could be improved quality and shorter cycle times. If so, these measures would be part of the internal process perspective. Improving these processes will require training and improved skills; the specific measures of these activities are naturally part of the learning and growth perspective. The primary insight which differentiates this system from a mere collection of additional measures, and the key to its success as emphasized by its proponents, is this explicit focus on linking performance measures in each perspective to the firm's strategy (Kaplan & Norton, 1996). This design concept creates a framework in which the scorecard provides tactical feedback and control of current operations. Kaplan (1996) also argue that the methodology can act as a strategic management system which clarifies and translates strategy, communicates and links strategic objectives and measures, aligns strategic initiatives, aligns incentives at lower organizational levels, and provides feedback. To say this idea is popular is something of an understatement. The Harvard Business Review has identified the BSC as one of five "breakthrough ideas" which "take hold and change how we think and work...concepts that are shaping management now" (The 2001 HBR List, 2001, p. 123). Anecdotal evidence supports this claim. A quick search for "balanced scorecard" on the Internet results in tens of thousands of references, including software vendors, consultants, seminars, and user group websites. A wide range of practitioner journals contain BSC descriptions, case studies, methodological issues, implementation issues and experiential accounts in a wide variety of settings. Representative examples of this type of work include BSC implementation issues, BSC applications to the non-profit sector, case studies in BSC development, linking BSC to a JIT environment, BSC applications to human resources, information technology, supply chain management, municipal government (Meisinger, 2003). Balanced Scorecards and Non-financial Performance Measures Compared to this backdrop of practitioner interest in balanced performance measures, empirical research by academics can perhaps be characterized as being in its infancy. Several streams of research on the subject of balanced performance measures can be identified in the literature (Ittner & Larcker, 1998). One area of research investigates the link between the use of non-financial performance measures and the level of future financial performance. The premise of this research is that financial measures are "backward looking" and therefore are not reliable gauges to guide day-to-day decision-making (Kaplan & Norton, 1992; Banker, Potter, & Srinivasan, 2000). In a longitudinal case study of hotels, positive association was found between customer satisfaction measures and future financial performance (Banker et al., 2000). Ittner and Larcker (1998) found that stock portfolios composed of firms identified as having superior customer satisfaction outperformed the stock market in later periods. The same authors showed that customer satisfaction measures are associated with future customer purchase behavior, customer growth, and financial performance. However, at the firm level (as opposed to the business unit level) results were mixed and appeared to be contingent on industry membership. In a study of the airline industry, Behn and Riley (1999) developed a customer satisfaction metric. Their results showed that non-financial performance information, in the form of customer satisfaction, is useful in predicting quarterly accounting results. A second avenue of research focuses on the implications of non-financial performance measures used in organizations which have adopted some form of advanced manufacturing practice, such as TQM or JIT. Studies consistently find a positive association between the emphasis placed on TQM, JIT, or manufacturing flexibility and the use of non-financial performance measures (Banker, Potter, & Schroeder, 1993). Problematically, the expected benefits from such measurement practices have much less empirical support (Ittner & Larcker, 1998). For example, some researchers did not find significant evidence that giving operational measures to workers in a JIT environment improved manufacturing performance or performance ratings. Perera, Harrison, and Poole (1997) did not find significant evidence of an association between the use of non-financial measures and perceived performance in facilities following a "customer-focused" strategy. A third avenue of research has focused on the use of non-financial performance measures as incentives in compensation plans. Ittner and Larcker (1998) have shed some light on the factors which influence the importance of non-financial measures in executive compensation plans. These factors include strategic posture, regulation, "noise" in financial measures, use of quality initiatives, length of product development and stage in product life cycle. Govindarajan and Gupta (1985) explored the fit between non-financial performance measures contained in incentive compensation plans with firm characteristics and the resulting impact on performance. Results showed that the benefits of non-financial measures as incentives are contingent on whether the business unit is following a build mission or a harvest mission. Empirical evidence on the implementation and performance issues of the BSC concept is beginning to emerge. Malina and Selto (2001) concluded from their field research that BSC implementation can improve the communication and control of corporate strategy. Schiff and Bento (2000) utilized attribution theory in their study of how executives use nonfinancial information in evaluating department and management performance. Youngblood and Collins (2003) developed an analytic model using multi-attribute utility theory to investigate the issue of trade-offs between performance measures in the balanced scorecard. Hoque and James (2000) studied the impact of contextual variables, such as organizational size, market position and product life cycle on BSC usage and its impact on performance. Their survey of Australian manufacturers suggested that higher BSC usage was associated with higher performance, regardless of business unit size, product life cycle or market position. Olson and Slater (2002) studied the relationship between strategy, balanced scorecard usage, and performance. Their results showed that higher performance was generally associated with greater emphasis on BSC measures; however there was some variation in emphasis among strategy types. For example, prospectors emphasized the innovation and growth perspective more than the other strategy types, while high performing low-cost defenders placed the least emphasis on the innovation and growth and customer perspectives. The Balanced Scorecard in Hospitality Industry: Hilton Case. Hilton Hotels Corp. is an internationally recognized hospitality company The company develops, manages or franchises more than 1,800 hotels, resorts and vacation ownership properties Their hotel brands include: Hilton, Doubletree, Hampton Inn, Hampton Inn & Suites, Embassy Suites, Harrison Conference Centers, Hilton Garden, Homewood Suites by Hilton, and Conrad International. (http://www.hilton.com) The company instituted a Balanced Scorecard and incentive compensation system based on BSC metrics in 1996 stated that the incentive compensation system is predominantly awarded on an individual basis for property-specific metrics. Each hotel or property has a set of goals or objectives that are included on its Balanced Scorecard and are the value drivers based on the strategic objectives of the corporation. The incentive bonuses, merit-based salary increases, and stock-option grants are awarded to employees from the corporate office to the department heads at each property but is not extended to the frontline employees The performance incentives are usually rewarded annually. (http://www.hilton.com) Front-line team members are extremely cognizant of the BSC measures and their property's score on the metrics. The entire organization is aligned to the objectives of the firm, "People at every level of the organization, from the president to front-line team members, know what is expected of them and how they are doing." (Huckestein and Duboff, 1999) Hilton's philosophy on performance measurement is that people should be measured and evaluated based on goals over which they have control and authority to improve. Furthermore, Hilton offers rewards that are achievable by front-line employees as members of the property team. The company offers the Hilton Million $ Team Pride Award, the Hilton Pride Innovation Award, and the Hilton Pride Awards for customer satisfaction. These awards are available to single properties and individuals for their contribution towards value-creating ideas and the value-proposition measurements that appear on their BSC. These are both monetary awards and recognition awards based on clear measurable performance criteria. The corporate officers of Hilton Hotels do not have their incentive compensation packages tied directly to the Balanced Scorecard. They are rewarded based on improvements in EPS (earnings-per-share). However, earnings is one of the financial metrics on Hilton's Scorecard. The Balanced Scorecard and performance incentive system yielded immediate dividends for the company. Smith Travel Research, reported in the article "A Comprehensive Approach to Delivering Value for Stakeholders" (Huckestein and Duboff, 1999), that Hilton's owned and managed hotels in the United States improved their RevPAR index (index gauging the extent to which a hotel is capturing or exceeding its fair market share) as compared to their competitors Similarly, their franchised hotels, which were previously operating below their fair market share, are now capturing more than their fair share of RevPAR. Hilton tracks customer loyalty measures closely and the measures include overall customer satisfaction, their likelihood of recommending Hilton hotels, and their likelihood to return to a given hotel After implementation of the BSC, their customer loyalty measures were the highest ever Furthermore, the article reported that a major syndicated research project conducted by J D Power and Associates, showed Hilton decisively improving during the three years prior to the article's publishing in 1999. Conclusion The existing body of research confirms the basic utility of the balanced scorecard concept; however, the methodology is not above criticism. Some observers question the meaning of the term "balance." For example, Olson and Slater (2002) suggest that the scorecard should be "unbalanced," in that different strategies should emphasize different perspectives. A typical BSC can consist of four measures in each of the four perspectives (Otley, 1999). It has been questioned whether this complex information system will result in "information overload" (Ittner & Larcker, 1998). Additionally, there is little guidance as to how effective trade-offs should be made among the perspectives, how the scorecard should be linked to other systems like budgeting, and how incentives should be tied to the scorecard (Otley, 1999). There is also the question of cost. Norrelkit (2000) argued that the cause and effect chain linking the perspectives is problematic. A more fundamental criticism is that it is logically impossible to maximize along more than one dimension, and the multiple perspectives of a BSC can detract from the firm's ultimate goal of maximizing shareholder profits (Jensen, 2001). Despite these criticisms, existing evidence suggests that using balanced performance measures can be an effective means of translating strategy into action and maintaining management control over organizational efforts. However, the more fundamental question of what factors shape the need for organizational control in the first place is beyond its scope. Bibliography Atkinson, A. A., Waterhouse, J. H., & Wells, R. B. Sloan management review, 38 (3) (1997): 25-37. Behn, B. K., & Riley, R. A., Jr. Using nonfinancial information to predict financial performance: The case of the U.S. airline industry. Journal of Accounting, Auditing & Finance 14 (11) (1999): 29-55. Biddle, G. C, Bowen, R. M., & Wallace, J. S. Does EVA beat earnings Evidence on associations with stock returns and firm values. Journal of Accounting and Economics 24 (3) (1998): 301-336. Govindarajan, V., & Gupta, A. K. Linking control systems to business unit strategy: Impact on performance. Accounting, Organizations & Society 10 (1) (1985): 51-66. Huckestein, D and Duboff, R. Hilton Hotels: a comprehensive approach to delivering, value for all stakeholders. Cornell Hotel and Restaurant Administration Quarterly 40 (4) (1999): 28. Ittner, C. D., & Larcker, D. F. Innovations in performance measurement: Trends and research implicaitons. Journal of Management Accounting Research 10 (1998): 205-238. Jensen, M. C. Value maximisation, stakeholder theory, and the corporate objective function. European Financial Management 7 (3) (2001): 297-317. Kaplan, R. S., & Norton, D. P. The balanced scorecard-Measures that drive performance. Harvard Business Review 70 (1) (1992): 71-79. Kaplan, R. S., & Norton, D. P. Linking the balanced scorecard to strategy. California Management Review 39 (1) (1996): 53-79. Lingle, J. H., & Schiemann, W. A. From balanced scorecard to strategic gauges: Is measurement worth it Management Review (1996): 56-61. Malina, M.A., & Selto, F.H. Communicating and controlling strategy: An empirical study of the effectiveness of the balanced scorecard. Journal of Management Accounting Research 13 (2001): 47-90. Meisinger, S. Taking the measure of human capital. HR Magazine 48 (1) (2003): 10. Myers, R., & Welch, B. Measure for measure. CFO: The Magazine for Chief Financial Officers 13 (11) (1997): 45-51. Norreklet, H. The balance on the balanced scorecard - A critical analysis of some of its assumptions. Management Accounting Research 11 (2000): 65-88. Olson, E. M., & Slater, S. F.. The balanced scorecard, competitive strategy, and performance. Business Horizons. 45 (3) (2002): 11-16. Otley, D. Performance management: A framework for management control systems research. Management Accounting Research 10 (1999): 363-382. Perera, S. G., Harrison, & Poole, M. Customer-focused manufacturing strategy and the use of operations-based non-financial performance measures: A research note. Accounting. Organizations and Society 22 (6) (1997): 557-572. Schiff, A. D., & Bento, R. F. The use of financial and nonfinancial information for evaluating performance: An attributional perspective. The Journal of Applied Business Research 16 (4) (2000): 47-62. Stivers, B. P., & Joyce, T. Building a Balanced Performance Management System. SAM Advanced Management Journal 65 (21) (2000): 22-29. The 2001 HBR list: Breakthrough ideas for today's business agenda. Harvard Business Review (2001, April): 123-128. Wallace, J. S. Adopting residual income-based compensation plans: Do you get what you pay for Journal of Accounting & Economics 24 (3) (1997): 275-300. Youngblood, A. D., & Collins, T. R. Addressing balanced scorecard trade-off issues between performance metrics using multi-attribute utility theory. Engineering Management Journal 15 (1) (2003): 11-17. . Read More