THE BALANCED SCORECARD: A TOOL TO IMPLEMENT STRATEGY

THE BALANCED SCORECARD

The balanced scorecard translates an organization's mission and strategy into a set of performance
measures that provides the framework for implementing the strategy. The balanced scorecard does not
focus solely on achieving financial objectives. It also highlights the nonfinancial objectives that an
organization must achieve to meet its financial objectives. The scorecard measures an organization's
performance from four perspectives: (1) financial, (2) customer, (3) internal processes, and (4) learning
and growth. A company's strategy influences the measures it uses to track performance in each of these
perspectives.

Strategic information using critical success factors such as growth in sales and earnings, cash flow, stock
price, market share, product quality, customer satisfaction, and growth opportunities provides a road map
for a firm to chart its competitive course and serves as a benchmark for competitive success. To
emphasize the importance of using strategic information, both financial and nonfinancial, accounting
reports of a firm's performance are now often based on critical success factors in different dimensions.
Financial performance measures summarize the results of past actions and are important to a firm's
owners, creditors, employees and so forth. Nonfinancial performance measures concentrate on current
activities which will be the drivers of future financial performance. Thus, effective management requires
a balanced prospective on performance measurement, a viewpoint that some call the “balanced scorecard”
perspective. The balance scorecard integrates performance measures in four key areas:
1. financial perspective,
2. customer satisfaction,
3. internal business processes, and
4. innovation and learning.

A balanced scorecard consists of an integrated system of performance measures that are derived from and
support the company's strategy. Different companies will have different balanced scorecards because they
have different strategies. A well-constructed balanced Scorecard provides a means for guiding the
company and also provides feedback concerning the effectiveness of the company's strategy.

It is called the balanced scorecard because it balances the use of financial and nonfinancial performance
measures to evaluate short-run and long-run performance in a single report. The balanced scorecard
reduces managers; emphasis on short-run financial performance, such as quarterly earnings. That's
because the nonfinancial and operational indicators, such as product quality and customer satisfaction,
measure changes that a company is making for the long run. The financial benefits of these long-run
changes may not appear immediately in short-run earnings, but strong improvement in nonfinancial
measures is an indicator of economic value creation in the future.
The balanced scorecard is depicted in Figure 7-1.

FOUR PERSPECTIVES OF THE BALANCED SCORECARD

1. Financial Perspective. Measures of profitability and market value among others, as indicators of
how well the firm satisfies its owners and shareholders. These financial measures show the
impact of the firm's policies and procedures on the firm's current financial position and therefore
its current return to the shareholders.
2. Customer Satisfaction. Measures of quality service and low cost, among others, as indicators of
how well the firm satisfies its customers.

3. Internal Business Processes. Measures of the efficiency and effectiveness with which the firm
produces the product or service.

4. Innovation and Learning. Measures of the firm's ability to develop and utilize human resources
to meet the strategic goals now and into the future.
Features of a Good Balanced Scorecard
1. The balanced scorecard should tell the story of a company's strategy by articulating a sequence of
cause-and-effect relationships. For example, if the objective of XYZ.Manufacturing Co. is to be a
low-cost producer with emphasis on growth, the balanced scorecard describes the specific
objectives and measures in the learning and growth perspective that lead to improvements in
internal business processes. These would lead to increased customer satisfaction and market share
as well as higher operating income and shareholder wealth. Each measure in the scorecard is part
of a cause-and effect chain, a linkage from strategy formulation to financial results.
2. It helps to communicate the strategy to all members of the organization by translating the strategy
into a coherent and linked set to understandable and measurable operational targets. Managers
and employees are guided by the scorecard and take actions and make decisions that aim to
achieve the company's strategy.
3. In for-profit companies, the balanced scorecard places strong emphasis on financial objectives
and measures. When financial and nonfinancial performance measures are linked, many of the
nonfinancial measures serve as leading indicators of future financial performance.
 4. The balanced scorecard should focus only on key measures to be used by identifying only the
most critical ones.
5. The scorecard should highlight suboptimal tradeoffs that managers may make when they fail to
consider operational and financial measures together.

Pitfalls in Implementing a Balanced Scorecard

Pitfalls to avoid in implementing a balanced scorecard include the following:
1. Don't assume the cause-and-effect linkages are precise. They are merely hypotheses. Over time, a
company must gather evidence of the strength and speed of the linkages among the nonfinancial
and financial measures.
2. Don't seek improvements across all of the measures all of the time. Tradeoff may need to be
made across various strategic goals. For example, strive for quality and on-time performance but
not beyond a point at which further improvement in these objectives may be inconsistent with
long-run profit maximization.
3. Don't use only objective measures in the balanced scorecard. The balanced scorecard should
include both objective measures (such as operating income from cost leadership, market share
and manufacturing yield) and subjective measures (such as customer and employee satisfaction
ratings). When using subjective measures, though, management must be careful to trade off the
benefits of the richer information these measures provide against the imprecision and potential for
manipulation.
4. Don't fail to consider both costs and benefits of initiatives such as spending on information
technology and R&D before including these objectives in the balanced scorecard. Otherwise,
management may focus the organization on measures that will not result in overall long-run
financial benefits.
5. Don't ignore nonfinancial measures when evaluating managers and employees. Managers tend to
focus on what their performance is measured by. Excluding nonfinancial measures when
evaluating performance will reduce the significance and importance that managers give
nonfinancial measures.
6. Don't use too many measures. It clutters the balanced scorecard and takes attention away from the
measures that are critical for implementing strategy.

Internal Business Process Performance

Most of the performance measures are self-explanatory. However, three are not - delivery cycle time,
throughput time, and manufacturing cycle efficiency (MCE). These three important performance
measures are discussed below.
Figure 7-3: Delivery Cycle Time and Throughput

Delivery Cycle Time. The amount of time from when an order is received from a customer to when the
completed order is shipped is called delivery time cycle. This time is clearly a key concern to many
customers, who would like the delivery cycle time to be as short as possible. Cutting the delivery cycle
time may give a company a key competitive advantage - and may be necessary for survival.
Consequently, many companies would include this performance measure on their balanced scorecard.

Throughput (Manufacturing Cycle) Time. The amount of time required to turn raw materials into
completed products is called throughput time, or manufacturing cycle time. The relation between the
delivery cycle time and the throughput (manufacturing cycle) time is illustrated in the diagram above.

As shown in the diagram, the throughput time, or manufacturing cycle time, is made up of process time,
inspection time, move time, and queue time. Process time is the amount of time work is actually done on
the product. Inspection time is the amount of time spent ensuring that the product is not defective. Move
time is the time required to move materials or partially completed products from workstation to
workstation. Queue time is the amount of time a product spends waiting to be worked on, to be moved, to
be inspected, or to be shipped.

As shown at the bottom of the diagram, only one of these four activities adds value to the product -
process time. The other three activities - inspecting, moving, and queuing - add no value and should be
eliminated as much as possible.

Manufacturing Cycle Efficiency (MCE). Through concerted efforts to eliminate the non-value-added
activities of inspecting, moving, and queuing, some companies have reduced their throughput time to only
a fraction of previous levels. In turn, this has helped to reduce the delivery cycle time from months to
only weeks or hours. Throughput time, which is considered to be a key measure in delivery performance,
can be put into better perspective by computing the manufacturing cycle efficiency (MCE). The MCE is
computed by, relating the value-added time to the throughput time. The formula is:

MCE = Value-added time .

Throughput (manufacturing cycle) time

If the MCE is less than 1, then non-value-added time is present in the production process. An MCE of 0.5,
for example, would mean that half of the total production time consisted of inspection, moving, and
similar non-value-added activities. In many manufacturing companies, the MCE is less than 0.1 (10%),
which means that 90% of the time a unit is in process is spent on activities that do not add value to the
product. By monitoring the MCE, companies are able to reduce non-value added activities and thus get
products into the hands of customers more quickly and at a lower cost.

Illustrative Problem 7-1: Measures of Internal Business Process Performance

Southwest Company keeps careful track of the time relating to orders and their production. During the
most recent quarter, the following average times were recorded for each unit or order:
Days
Wait time 17.0
Inspection time 0.4
Process time 2.0
Move time 0.6
Queue time 5.0

Goods are shipped as soon as production is completed.

REQUIRED:
1. Compute the throughput time, or velocity of production.
2. Compute the manufacturing cycle efficiency (MCE).
3. What percentage of the production time is spent in non-value-added activities?
4. Compute the delivery cycle time.