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Balanced Scorecard Diagnostics
By Paul R. Niven
John Wiley & SonsISBN: 0-471-68123-7
Chapter OneThe Current State of the Balanced Scorecard
THE ROAD AHEAD
Note to self: Always turn off my e-mail program before working on the book. I've provided myself that reminder because my train of thought was just interrupted by a popup box in the corner of my screen. It gently notified me that a new e-mail was awaiting my immediate attention. Much like the ring of a telephone, the temptation overwhelmed me and I took a quick peek to see who had contacted me. It was a gentleman in Zimbabwe requesting additional information about the Balanced Scorecard. I'm happy to help him and will do so later in the day. Once I reply to his request, I'll file it along with those I've received from China, Fiji, South Africa, Singapore, Finland, the U.K., from small manufacturing firms in the Midwest, and large conglomerates in New York City, from civic governments in California, and nonprofits in Washington, D.C. As the roll call of nations and organization types outlined suggests, the Balanced Scorecard has become a full-fledged worldwide phenomenon. And this phenomenon knows no boundaries; it stretches around the globe and has affected virtually every type of organization known to exist.
There is little doubt that the Balanced Scorecard has joined the pantheon of successful business frameworks; that elite group possessing the dual, and highly elusive, qualities of broad-based appeal andproven effectiveness. The sheer breadth and volume of Scorecard implementations are testament to this fact. Popularity, however, does not guarantee successful outcomes for those treading this road, and in fact it has been suggested that a majority of all Balanced Scorecard initiatives fail. The most commonly cited issues derailing Scorecard implementations are poor design and difficulty of implementation. The purpose of this book is to assist you in clearing those hurdles with proven tools and techniques forged at the crucible of cutting-edge theory and practical experience. Pitfalls await those who are unprepared at any juncture in this journey, from poor planning to ineffective team design to inappropriate objective and measure selection, and many more. During our time together, we'll carefully study the essential elements of Balanced Scorecard implementation, offering tools you can use to ensure that your Balanced Scorecard will help you achieve success today and sustain that success for the long term.
Before we begin to critically examine your Scorecard implementation, however, it's important to step back and cast a trenchant eye on the tool itself. In this chapter, we'll review exactly why the Balanced Scorecard has reached an exalted position as the strategy execution choice of literally tens of thousands of organizations; what it is about this seemingly simple tool, above all others, that quickly captures the attention of senior executives and shop-floor employees alike; and finally, why it remains vitally relevant when hundreds of other potential business panaceas have come and gone.
WHY THE BALANCED SCORECARD HAS RISEN TO PROMINENCE
The reasons for the Scorecard's ascendance are many and varied, but principally I believe the tool's longevity can be traced to an ability to solve several fundamental business issues facing all organizations today. In the pages ahead, we'll look at four pervasive issues that are undoubtedly affecting your business even as we speak: (1) a traditional reliance on financial measures, (2) the rise of intangible assets, (3) the emerging pattern of reputation risk, and finally, (4) the difficulty most organizations face in executing strategy. Some of these issues are age old and have been the nemesis of organizations for decades-relying on financial measures and attempting to implement strategy. The others-a rise in intangible assets and the emergence of reputation risk-are new, and their effects are just now being perceived, evaluated, and monitored. What unites these potentially vexing agents of organizational distress, and serves as inspiration for all of us, is the proven ability of the Balanced Scorecard to overcome every one of them.
Financial Measures: Is Their Time Running Out?
When the uninitiated ask me to describe the Balanced Scorecard "in a nutshell," I get the ball rolling by asking them how most organizations measure their success. A short and reflective pause is typically followed by the confident suggestion of "revenue" or "profits." And they're right, most organizations-be they private, public, or nonprofit-gauge their success primarily by the measurement of financial yardsticks. It's been that way for literally thousands of years, and at the turn of the 20th century, financial innovations, such as the development of the return on equity formula, proved critical to the success of our earliest industrial pioneers, including DuPont and General Motors.
The decades have come and gone, with financial measurement continuing to reach dizzying new heights as the number-crunching savvy among us introduced increasingly sophisticated metrics for the analysis of results. The corporate world readily embraced these developments and, as the prodigious growth of our generally accepted accounting principles (GAAP, in accounting parlance) will attest, financial metrics became the de facto standard of measuring business success. But, as is often the case, too much of a good thing can lead to some unintended consequences. The unrelenting drive to achieve financial success as measured by such metrics as revenue and shareholder value contributed to a round of recent corporate malfeasance unlike anything ever witnessed in the long and storied history of commerce.
Leading the ignominious pack of corporate bad boys is, of course, Enron. Once the seventh largest company in the United States, where did their insatiable thirst for growth and financial success lead them? Right into bankruptcy court, dragging thousands of suddenly poorer and justifiably angry shareholders down the path with them. If we use history as a guide, we'll find that Enron is not the first to apparently run afoul of the law in its tireless pursuit of fortune. A cautionary tale comes in the form of Samuel Insull. Upon migrating to the United States from England in 1881, Insull, through an association with Thomas Edison, co-founded the company that would eventually become General Electric. From his base in Chicago, he assembled a portfolio of holdings that would make any would-be financial impresario envious: Commonwealth Edison, People's Gas, Indiana Public Service Company, and several more. At one point, he held 65 chairmanships, 85 directorships, and 11 presidencies. Sadly, the good times were not destined to roll on forever, and the 1929 crash brought his empire down in a tumultuous thud. Humiliated, and seen as the personification of corporate greed, Insull fled the United States but was later dragged back to stand trial for securities fraud. He was ultimately, and surprisingly, acquitted, but gone were his fortune and reputation. He died, penniless, in a Paris subway station on July 16, 1938.
Since the dawn of the corporation with Sweden's Stora Enso in 1288, companies have walked the delicate line of providing prodigious societal benefits and causing immeasurable harm through questionable, and sometimes unconscionable, acts. Recognizing the need to keep corporations in check, Theodore Roosevelt, the 26th president of the United States, once remarked: "I believe in corporations. They are indispensable instruments of our modern civilization; but I believe that they should be so supervised and so regulated that they shall act for the interests of the community as a whole." As the President who took a first step toward bringing big business under federal control by ordering antitrust proceedings against the Northern Securities Company, Roosevelt would likely have welcomed the introduction of the Sarbanes-Oxley Act in 2002. The Act has set some of the toughest corporate governance standards in the world, requiring companies to report on the reliability of their financial controls, and asking CEOs and CFOs to put themselves on the line and acknowledge responsibility for internal controls, verifying their effectiveness.
All companies required to file periodic reports with the Securities and Exchange Commission (SEC) are effected by the Sarbanes-Oxley Act. The sheer magnitude of the work associated with compliance is daunting. To give you some indication, Fortune 1000 companies have earmarked more than $2.5 billion this year in investigation and initial compliance-related work. Proponents suggest that the Act represents the most far-reaching U.S. legislation dealing with securities in many years. While the Act contains many provisions, two are particularly relevant to our discussion. Section 906 of the Act requires certification by the company's chief executive officer (CEO) and chief financial officer (CFO) that reports fully comply with the requirements of securities laws and that the information in the report fairly presents, in all material respects, the financial condition and results of operations of the company. Basically, company executives must pledge that what is in their financial reports is accurate and true. The Act also requires plain English disclosure on a "rapid and current basis" of information regarding material changes in the financial condition or operations of a public company as the SEC determines is necessary or useful to investors and in the public interest.
Undoubtedly, many American investors will sleep more easily knowing the Sarbanes-Oxley Act is ever-present, threatening those even remotely considering anything outside the legal lines with the long arm (and increasingly sharp teeth) of federal prosecutors. But does the increased financial disclosure ensured by the Act really describe the value-creating mechanisms of the corporation? Does it provide us with insight as to how intangible assets are being transformed into real value for consumers and shareholders? To make an informed decision about any organization's true state of affairs, we require information that covers a broader perspective. This is the case whether we're talking about a multinational corporation, a local nonprofit health services organization, or any branch of the federal government. Ultimately, the Act makes reported financial numbers safer for our consumption and analysis, but it doesn't diminish the increasingly apparent limitations of financial metrics. Working in the early 21st century, many organizations are beginning to question the once unquestionable reliance on financial measures. Specifically, they note the following:
Financial measures are inconsistent with today's business realities. When I ask my clients what drives value in their business, it is exceedingly rare for me to hear "machinery," "facilities," or even "computers." What I do hear in near unanimity from everyone in attendance are phrases such as, "employee knowledge and skills," "relationships with customers," and "culture." Intangible assets have become the driving currency of organizations wishing to effectively compete in the modern economy. However, beyond "goodwill," you would be hard pressed to find the valuation of such intangibles on a typical corporate balance sheet. Financial metrics are ill-suited to meet the demands levied by the true value-creating mechanisms of the modern business economy-intangible assets. In the next section of this chapter, we'll take a closer look at their steep rise in prominence.
You can't see where you're going when you look in the rearview mirror. Don't try this at home: driving down the freeway with your gaze cast intently on the rearview mirror. Great view of where you've been, but what does it tell you about where you're going? Very little. Financial measures offer the same limited view of the future. A great quarter of financial success, a great six months, or even a great year are not indicative of what lies in store for you. The business pages are littered with stories of falls from grace by once-lofty companies. The legendary Fortune 500 bears witness to the inability of success to predict success. Two-thirds of the companies listed on the inaugural list in 1954 had either vanished or were no longer large enough to maintain their presence on the list's 40th anniversary.
Financial measures tend to reinforce functional silos. If you were to type "teams" into the search box of Amazon.com, how many hits do you think you'd get? Curious, I did just that and was astonished when the total popped up at over 125,000! Granted, not all of these books embrace the topic of cross-functional teams in the modern organization, but the staggering population of texts about teams lends credence to the well-known notion that in order to get anything done in today's environment, we must work together. Thus, in many respects, and in a growing number of organizations, work flows horizontally across the enterprise. Financial measures, however, are decidedly vertical in nature. A department's numbers are rolled into a business unit, and business units are consolidated into a massive corporate heap of digits. This reporting system does little to encourage cross-functional work patterns.
What's the first thing to get cut in a downturn? Easy question, right? If yours is like most businesses, the first things flung overboard when the economic seas become choppy are those that won't be missed tomorrow or the next day-items like training, employee development, and research. Their effects typically aren't seen for months or even years, and thus they become simple targets for the instant gratification, "must meet the numbers this quarter" paradigm of most publicly traded companies. Focusing on short-term financial numbers can frequently cloud our judgment as to what is going to truly distinguish our business from competitors in the long term. While training may be easy to cut today, what effect will that have on your workforce next year as you attempt to compete in ever-evolving markets?
Financial measures aren't always relevant. We're constantly bombarded with messages about the speed of change these days. I'm guilty of reminding you myself, and did so in the last sentence! Why are these disturbing missives being fired in record numbers? Because it's true. Look at the disruptive technologies we've witnessed in just the past few years that have revolutionized the way business is conducted. Today, more than ever, we need performance information we can act on. Decisions can't be debated endlessly, and the luxury of waiting for complete information is just not an option. Financial measures frequently lack the action imperative necessary to make future decisions. Let's say you pick up your company's monthly income statement and see that sales are 5% off plan. Beyond the obvious, what does that mean, and more important, what do you do? Obviously, declining sales is an important indicator, but what led to that unenviable state of affairs, what was the leading indicator? That's the information we need, and fortunately that's what the Balanced Scorecard can supply.
I've charged financial measures with a litany of offenses in the previous paragraphs, so you may be wondering if they even belong in a Balanced Scorecard. The answer is yes, because despite their limitations, no Balanced Scorecard is complete without financial measures. This is the case whether you're reading this as the CEO of a large company, the executive director of a nonprofit, or the senior manager of a state government. An old song reminds us that "money makes the world go round," and so it is with the organizational world. In many cases, the ultimate arbiter of corporate success is financial. Nonprofits and public-sector organizations must also be cognizant of the financial ramifications of their actions and steward their funds in the most efficient manner. This section simply reminds us that financial measures must be balanced with the drivers of future financial success and security. Considered alone, they offer limited value. However, when reviewed in the context of data supplied by nonfinancial measures, they are suddenly imbued with the power of information that can transform decision making and ultimately lead to even greater success.
Excerpted from Balanced Scorecard Diagnostics by Paul R. Niven Excerpted by permission.
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