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Scorecards
CHAPTER
5
Scorecards The previous chapters introduced different types of indicators that can be adopted for measuring performances: value-based indicators, accounting indicators, and value drivers. All three types have advantages and disadvantages, emphasizing that it is impossible to build a good performance measurement system (PMS) without a mix of indicators. This situation has led several enterprises to build indicator scorecards, which are groups of different types of indicators that together can fulfill all managerial needs. Obviously, indicators included in the scorecard must be consistent with the company’s competitive position and its organizational configuration. The correlation between the adoption of scorecards and value creation is not easy to trace, yet some studies (Evans, 2004; Davis and Albright, 2004) have shown a positive effect, in particular when the scorecard includes an integrated set of indicators consistent with the strategy (Davis and Albright, 2004). Actually, the adoption of scorecards is often linked to strategic needs (Speckbacher et al., 2003; Arena and Azzone, 2005). More generally, the adoption of indicator scorecards includes: • Defining the scorecard’s format—that is, how indicators are organized. • Defining the process by which different measures are selected. In the remaining sections of this chapter, some solutions are proposed, starting with the current most widely used application—the balanced scorecard (BSC).
5.1 BALANCED SCORECARD Among the various methodologies proposed to build an indicator scorecard, the most widely used is the BSC (Kaplan and Norton, 1992); it is so common that often the label balanced scorecard is considered a general term to specify an indicator scorecard. According to the initial proposal by Kaplan and Norton (1992), the BSC is designed as constituted by four groups of indicators related to four perspectives: 1. 2. 3. 4.
Financial Customer Internal processes Innovation (subsequently renamed “learning and growth”).
Figure 5.1 shows the graphical format of the BSC (adapted from Kaplan and Norton, 1992), where the four areas related to the strategy are in the center. The financial perspective reports indicators that are useful to analyze companies’ trends against shareholders’ expectations in terms of size (e.g., market share, revenues); profitability (e.g., ROE, ROI, EVA, EBIT); and cash generation (cash flow).
70
Performance Measurement and Management for Engineers
The customer perspective highlights performances related to the relationship between the enterprise and its market in terms of: • • • •
Range of products/services and frequency of new product introductions Customer response time Partnership with key clients Customers’ perception of the company.
These factors can be measured with both financial and nonfinancial metrics. Metrics included in the internal processes perspective are aimed at analyzing efficiency and performances of internal activities of companies; here, also, both financial and nonfinancial indicators can be included, such as: • Frequency of introduction of new products, tackling research and development processes. • Average production costs and time efficiency, addressing production performances. Time efficiency allows companies to indirectly monitor setup time and the existence of bottlenecks. Finally, metrics related to the learning and growth perspective can include indicators such as time to market or time in between the launches of two totally different products. In the first case, design and development are emphasized; in the second case, basic and applied research is stressed. Even operating activities can be addressed in this area, measuring learning phenomena, for example, with the incremental reduction of production time due to experience curves. The BSC, as shown in Figure 5.1, is very complete, including a wide range of indicators that follow the creation of enterprise value, specifically: • Metrics within the financial perspective include synthetic economic and financial indicators of the results at the enterprise or business-unit level. • The customer perspective addresses performances linked to customer relations and perception, monitoring who buys products and services.
Financial perspective How do we look to our shareholders?
Customer How do our customers see us?
Internal process Vision and strategy
Learning and growth perspective How can we continue to improve? Figure 5.1 BSC structure. Adapted by Kaplan and Norton (1992).
What must we excel at?
Scorecards
71
• Indicators in the internal processes perspective include measures monitoring the company’s processes, potentially covering all the critical success factors (CSF) (flexibility, time, productivity, etc.). • Finally, the learning and growth perspective focuses on the enterprise’s resources, encompassing indicators such as innovation, human resources, technology, and intangible assets.
5.1.1 Choosing Indicators: Second-Generation BSC As previously discussed, the quality of the BSC depends on the indicators selected and included in each of the four quadrants, which should be linked by causal relationships and updated according to changes in the company’s strategy. To achieve this result, a tailored design is required for each company; in the second-generation BSC, Kaplan and Norton illustrate the process to follow for doing so. The first phase is the construction of a strategic map of enterprise goals. At the start, general goals are identified and then usually expressed by synthetic and financial indicators; these are positioned in the financial perspective area. Each general goal is afterward divided into subobjectives through a cascade process (refer to Figure 5.2), positioning each objective in the corresponding areas referring to the original areas of the BSC (first-generation). Usually, relations are from the top to the bottom or within the same level. The cascading process can, however, skip one or more areas.
Broaden revenue mix
Improve profitability
Increase product range
Cross selling product line
Educate salesforce
Figure 5.2 The cascading process.
Financial perspective
Improve operating efficiency
Improve delivery reliability
Customer perspective
Reduce lead time
Improve stock control
Ideas from employees
Internal perspective
Learning perspective
72
Performance Measurement and Management for Engineers
Margin Revenues from new products
ROS
Improve profitability
Broaden revenue mix
Percentage of deliveries arriving on time Improve delivery reliability
Number of new products per quarter Increase product range Percentage of products dual labeled Cross selling product line
Financial perspective
Improve operating efficiency
Lead time per customer Reduce lead time
Inventory turnover Improve stock control
Number of salespeople attending quarterly sessions Educate salesforce
Number of new ideas implemented per quarter Ideas from employees
Customer perspective
Internal perspective
Learning perspective
Figure 5.3 An example of a strategy map.
Once objectives are selected, an indicator is then assigned to each of them; the four sets of indicators defined become the indicators to be included in the BSC. Figure 5.3 shows an example of a strategy map with actions and indicators designed for a car dealership.
5.1.2 Other Types of Scorecards In addition to the approaches illustrated in the previous section, several other types of scorecards have been proposed, including: • Tableau de bord (TdB) • Third-generation BSC • Risk scorecard. TdB (Epstein and Manzoni, 1998; Bourguignon et al., 2004) was first introduced during the 1950s in France, where it had considerable success. This scorecard is designed starting with the company objectives, which are then translated into CSF. Each CSF is then associated with one or more performance indicators. The TdB structure also dictates that the company goals be disaggregated at the business-unit level and then across organizational units within business units. Both levels are hence assigned a TdB with a process similar to what was adopted for the company overall. TdB is a less structured method compared to the BSC because both the visualization format and the process for selecting indicators are less stringent. However, the differences between the two methods are minor and more often are linked to the way in which the approaches are implemented rather than their original characteristics, as defined by proponents.
Scorecards
73
The label third-generation BSC was introduced by Lawrie et al. (2004) to distinguish their proposal from the original BSC (Figure 5.1) and the strategy map (Figure 5.3). The third-generation BSC attempts to overcome two problems: 1. The difficulty in linking each indicator to a specific target; in particular, a weakness may be defined in abstract terms and then only after trying to define the target for a specific period. 2. The difficulty in defining objectives starting with the company’s BSC to create a detailed BSC for organizational units; to do this, enterprise goals must be translated to be specific to certain departments. For example, it is not easy to understand what a single organizational unit must do to increase EVA overall. To avoid these problems, two devices are introduced. First, the selection process starts with what are called destination statements, which are statements in which enterprises directly define the target values to be achieved. According to Lawrie and Cobbold (2004), this approach allows companies to more easily achieve consensus within the organization. Second, the BSC is divided into only two levels, which emphasize: (i) expected results, derived directly from the objectives in the destination statements; and (ii) the activities that will be carried out to achieve these objectives. Given that activities are easily associated with specific organizational units, this conceptualization favors the identification of goals to be assigned to each organizational unit. The set of indicators identified and their target values is the scorecard available to management. Table 5.1 gives an example of destination statements. Although this method is called a BSC, similarities with the original BSC are negligible. Instead, the freedom in structuring indicators and the emphasis on the integration among objectives of different organizational levels show that this method has more in common with TdB. Compared with TdB, the third-generation BSC is more structured and more easily implemented. Finally, there is a recent evolution of the BSC: the risk scorecard. Calandro and Lane (2006) introduced a separate scorecard based on the four areas of the traditional BSC, where different types of risks are identified and categorized. Figure 5.4 illustrates the risk scorecard.
Table 5.1 An Example of Destination Statements Financial results
• Achieve an EVA of 100 million h • Reduce time for collecting trade receivable to 20 days
Internal processes
• Improve manufacturing productivity by 15% • Reduce defective products by 10%
Innovation
• Reduce time to market to 1 month
Clients
• Reduce delivery time to 5 days • Increase customer satisfaction
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Performance Measurement and Management for Engineers
Financial Risk Perspective
Customer Risk Perspective
Risk
Risk
Measure
Portfolio
% customers satisfied # of customer complaints Purchase frequency variance Receivables’ quality Bad debt reserve fluctuations
Measure
Financial Market Weighted Average Cost of Capital Capital Asset Pricing Model Solvency
Debt-to-Equity Cost of Debt Value-at-Risk
Tax
Expected-to-actual affective tex rate
Competition # of new entrants % share lost Marketing
Actual-to-Expected Revenue
Internal Risk Perspective Risk
Measure
Learning & Growth Risk Perspective
Technological
# of help tickets issued # of security breaches
Risk
Measure
Learning
Productivity or trained employees % of employees sent for training that are promoted % of suggestions implemented
Growth
Expected-to-actual growth M&A synergy variance Trend of the expected-to-actual process improvement benefits
Human Resource Employee turnover Employee morale/satisfaction # (or %) of top performers who leave Process
# of unsatisfactory internal audit findings # of positive controls rationalizations % of manual-to-automated processes
Organizational
# of regulatory complaints Price of insurance
Figure 5.4 Risk scorecard. Calandro and Lane (2006, p. 35).
5
Scorecards The previous chapters introduced different types of indicators that can be adopted for measuring performances: value-based indicators, accounting indicators, and value drivers. All three types have advantages and disadvantages, emphasizing that it is impossible to build a good performance measurement system (PMS) without a mix of indicators. This situation has led several enterprises to build indicator scorecards, which are groups of different types of indicators that together can fulfill all managerial needs. Obviously, indicators included in the scorecard must be consistent with the company’s competitive position and its organizational configuration. The correlation between the adoption of scorecards and value creation is not easy to trace, yet some studies (Evans, 2004; Davis and Albright, 2004) have shown a positive effect, in particular when the scorecard includes an integrated set of indicators consistent with the strategy (Davis and Albright, 2004). Actually, the adoption of scorecards is often linked to strategic needs (Speckbacher et al., 2003; Arena and Azzone, 2005). More generally, the adoption of indicator scorecards includes: • Defining the scorecard’s format—that is, how indicators are organized. • Defining the process by which different measures are selected. In the remaining sections of this chapter, some solutions are proposed, starting with the current most widely used application—the balanced scorecard (BSC).
5.1 BALANCED SCORECARD Among the various methodologies proposed to build an indicator scorecard, the most widely used is the BSC (Kaplan and Norton, 1992); it is so common that often the label balanced scorecard is considered a general term to specify an indicator scorecard. According to the initial proposal by Kaplan and Norton (1992), the BSC is designed as constituted by four groups of indicators related to four perspectives: 1. 2. 3. 4.
Financial Customer Internal processes Innovation (subsequently renamed “learning and growth”).
Figure 5.1 shows the graphical format of the BSC (adapted from Kaplan and Norton, 1992), where the four areas related to the strategy are in the center. The financial perspective reports indicators that are useful to analyze companies’ trends against shareholders’ expectations in terms of size (e.g., market share, revenues); profitability (e.g., ROE, ROI, EVA, EBIT); and cash generation (cash flow).
70
Performance Measurement and Management for Engineers
The customer perspective highlights performances related to the relationship between the enterprise and its market in terms of: • • • •
Range of products/services and frequency of new product introductions Customer response time Partnership with key clients Customers’ perception of the company.
These factors can be measured with both financial and nonfinancial metrics. Metrics included in the internal processes perspective are aimed at analyzing efficiency and performances of internal activities of companies; here, also, both financial and nonfinancial indicators can be included, such as: • Frequency of introduction of new products, tackling research and development processes. • Average production costs and time efficiency, addressing production performances. Time efficiency allows companies to indirectly monitor setup time and the existence of bottlenecks. Finally, metrics related to the learning and growth perspective can include indicators such as time to market or time in between the launches of two totally different products. In the first case, design and development are emphasized; in the second case, basic and applied research is stressed. Even operating activities can be addressed in this area, measuring learning phenomena, for example, with the incremental reduction of production time due to experience curves. The BSC, as shown in Figure 5.1, is very complete, including a wide range of indicators that follow the creation of enterprise value, specifically: • Metrics within the financial perspective include synthetic economic and financial indicators of the results at the enterprise or business-unit level. • The customer perspective addresses performances linked to customer relations and perception, monitoring who buys products and services.
Financial perspective How do we look to our shareholders?
Customer How do our customers see us?
Internal process Vision and strategy
Learning and growth perspective How can we continue to improve? Figure 5.1 BSC structure. Adapted by Kaplan and Norton (1992).
What must we excel at?
Scorecards
71
• Indicators in the internal processes perspective include measures monitoring the company’s processes, potentially covering all the critical success factors (CSF) (flexibility, time, productivity, etc.). • Finally, the learning and growth perspective focuses on the enterprise’s resources, encompassing indicators such as innovation, human resources, technology, and intangible assets.
5.1.1 Choosing Indicators: Second-Generation BSC As previously discussed, the quality of the BSC depends on the indicators selected and included in each of the four quadrants, which should be linked by causal relationships and updated according to changes in the company’s strategy. To achieve this result, a tailored design is required for each company; in the second-generation BSC, Kaplan and Norton illustrate the process to follow for doing so. The first phase is the construction of a strategic map of enterprise goals. At the start, general goals are identified and then usually expressed by synthetic and financial indicators; these are positioned in the financial perspective area. Each general goal is afterward divided into subobjectives through a cascade process (refer to Figure 5.2), positioning each objective in the corresponding areas referring to the original areas of the BSC (first-generation). Usually, relations are from the top to the bottom or within the same level. The cascading process can, however, skip one or more areas.
Broaden revenue mix
Improve profitability
Increase product range
Cross selling product line
Educate salesforce
Figure 5.2 The cascading process.
Financial perspective
Improve operating efficiency
Improve delivery reliability
Customer perspective
Reduce lead time
Improve stock control
Ideas from employees
Internal perspective
Learning perspective
72
Performance Measurement and Management for Engineers
Margin Revenues from new products
ROS
Improve profitability
Broaden revenue mix
Percentage of deliveries arriving on time Improve delivery reliability
Number of new products per quarter Increase product range Percentage of products dual labeled Cross selling product line
Financial perspective
Improve operating efficiency
Lead time per customer Reduce lead time
Inventory turnover Improve stock control
Number of salespeople attending quarterly sessions Educate salesforce
Number of new ideas implemented per quarter Ideas from employees
Customer perspective
Internal perspective
Learning perspective
Figure 5.3 An example of a strategy map.
Once objectives are selected, an indicator is then assigned to each of them; the four sets of indicators defined become the indicators to be included in the BSC. Figure 5.3 shows an example of a strategy map with actions and indicators designed for a car dealership.
5.1.2 Other Types of Scorecards In addition to the approaches illustrated in the previous section, several other types of scorecards have been proposed, including: • Tableau de bord (TdB) • Third-generation BSC • Risk scorecard. TdB (Epstein and Manzoni, 1998; Bourguignon et al., 2004) was first introduced during the 1950s in France, where it had considerable success. This scorecard is designed starting with the company objectives, which are then translated into CSF. Each CSF is then associated with one or more performance indicators. The TdB structure also dictates that the company goals be disaggregated at the business-unit level and then across organizational units within business units. Both levels are hence assigned a TdB with a process similar to what was adopted for the company overall. TdB is a less structured method compared to the BSC because both the visualization format and the process for selecting indicators are less stringent. However, the differences between the two methods are minor and more often are linked to the way in which the approaches are implemented rather than their original characteristics, as defined by proponents.
Scorecards
73
The label third-generation BSC was introduced by Lawrie et al. (2004) to distinguish their proposal from the original BSC (Figure 5.1) and the strategy map (Figure 5.3). The third-generation BSC attempts to overcome two problems: 1. The difficulty in linking each indicator to a specific target; in particular, a weakness may be defined in abstract terms and then only after trying to define the target for a specific period. 2. The difficulty in defining objectives starting with the company’s BSC to create a detailed BSC for organizational units; to do this, enterprise goals must be translated to be specific to certain departments. For example, it is not easy to understand what a single organizational unit must do to increase EVA overall. To avoid these problems, two devices are introduced. First, the selection process starts with what are called destination statements, which are statements in which enterprises directly define the target values to be achieved. According to Lawrie and Cobbold (2004), this approach allows companies to more easily achieve consensus within the organization. Second, the BSC is divided into only two levels, which emphasize: (i) expected results, derived directly from the objectives in the destination statements; and (ii) the activities that will be carried out to achieve these objectives. Given that activities are easily associated with specific organizational units, this conceptualization favors the identification of goals to be assigned to each organizational unit. The set of indicators identified and their target values is the scorecard available to management. Table 5.1 gives an example of destination statements. Although this method is called a BSC, similarities with the original BSC are negligible. Instead, the freedom in structuring indicators and the emphasis on the integration among objectives of different organizational levels show that this method has more in common with TdB. Compared with TdB, the third-generation BSC is more structured and more easily implemented. Finally, there is a recent evolution of the BSC: the risk scorecard. Calandro and Lane (2006) introduced a separate scorecard based on the four areas of the traditional BSC, where different types of risks are identified and categorized. Figure 5.4 illustrates the risk scorecard.
Table 5.1 An Example of Destination Statements Financial results
• Achieve an EVA of 100 million h • Reduce time for collecting trade receivable to 20 days
Internal processes
• Improve manufacturing productivity by 15% • Reduce defective products by 10%
Innovation
• Reduce time to market to 1 month
Clients
• Reduce delivery time to 5 days • Increase customer satisfaction
74
Performance Measurement and Management for Engineers
Financial Risk Perspective
Customer Risk Perspective
Risk
Risk
Measure
Portfolio
% customers satisfied # of customer complaints Purchase frequency variance Receivables’ quality Bad debt reserve fluctuations
Measure
Financial Market Weighted Average Cost of Capital Capital Asset Pricing Model Solvency
Debt-to-Equity Cost of Debt Value-at-Risk
Tax
Expected-to-actual affective tex rate
Competition # of new entrants % share lost Marketing
Actual-to-Expected Revenue
Internal Risk Perspective Risk
Measure
Learning & Growth Risk Perspective
Technological
# of help tickets issued # of security breaches
Risk
Measure
Learning
Productivity or trained employees % of employees sent for training that are promoted % of suggestions implemented
Growth
Expected-to-actual growth M&A synergy variance Trend of the expected-to-actual process improvement benefits
Human Resource Employee turnover Employee morale/satisfaction # (or %) of top performers who leave Process
# of unsatisfactory internal audit findings # of positive controls rationalizations % of manual-to-automated processes
Organizational
# of regulatory complaints Price of insurance
Figure 5.4 Risk scorecard. Calandro and Lane (2006, p. 35).