ROI Guide: Balanced Scorecard

Definition: A set of principles and analytic techniques for improving an organization's performance in four general areas: financials, customers, learning and internal processes.

What it means: Long-term organizational excellence can be achieved only by taking a broad and holistic approach, not by focusing solely on financials.

Strengths: This approach is potentially all-encompassing, combining financial and nonfinancial goals and measures. It can encompass the performance of entire companies or business units, not just individual investments or projects. Balanced scorecard is future-oriented, not a rearview mirror on performance.

Weaknesses: This method is potentially so broad that it may divert resources from those few areas that really are vital to shareholder return. It doesn't readily weight the relative importance of the different metrics it uses.

Credit for the balanced scorecard idea most often goes to Robert S. Kaplan and David Norton, who wrote an article about it for the Harvard Business Review in 1992. Certainly, many of the underlying ideas go back much further, and today, many companies use one or more of its principles without having adopted the balanced scorecard methodology in any formal sense.

"There are many different balanced scorecards, and they serve many different purposes," says Arthur Schneiderman, an independent business-process management consultant in Boxford, Mass. "But most organizations will say its purpose is to link strategy to action."

Regardless of how one defines it, the balanced scorecard is based on several underlying notions. The first is that financial measures alone aren't sufficient to size up the health of a company and that a single-minded pursuit of financial objectives could lead your company to ruin in the long run.

The second is that balanced scorecard focuses on process, not metrics. As such, it's forward-looking (How can I retain my best customers?) rather than backward-looking (What were my earnings per share last quarter?).

The scorecard is an analytic framework for translating a company's visions and high-level business strategies into specific, quantifiable goals and for monitoring performance against those goals. The methodology breaks high-level strategies into objectives, measurements, targets and initiatives.

For example, Southwest Airlines Co. employs a number of scorecards, one of which relates ground-crew performance to company profitability (see chart). It arranges the four quadrants of the balanced scorecard—learning, internal, customer and financial—in a hierarchy that shows how objectives relate to one another.

Directly relating a financial measure such as "lower costs" with an operations metric like "fast ground turnaround" is a relatively new idea at the Dallas-based airline, says Mike Van de Ven, vice president of financial planning and analysis. "Historically, the budget system was the primary system to monitor costs, and if you were an accountant, you got it," he says. "But if you were an operations person, and you weren't used to cost centers and general ledgers and budget-to-actual variances, it didn't make any sense to you."

The operations people had hundreds of metrics dealing with things such as on-time performance or baggage delivery, but they weren't linked directly to the financial measures or the budget system, Van de Ven says. "So what we have been doing over the past several years is putting these things together, and that neatly rolls into this balanced scorecard concept," he says.

Another advantage of this integrated scorecard approach is that it retains the hundreds of detailed metrics for front-line supervisors but gives top management a "dashboard" displaying a few key measures. "We are trying to get more focused on key measurements that we want to stay on top of," Van de Ven says.

Although nearly everyone applauds the broad view that the balanced scorecard encourages and its proactive, forward-looking thrust, some critics say the scorecard is often misused. "Most of the time, the balanced scorecard will help you identify the wrong things to measure," Schneiderman says. That can waste a lot of corporate resources, he adds.

There's a danger that use of the balanced scorecard can divert management attention away from the most important goals, which are financial, says Ray Trotta, co-founder of iValue LLC, an IT valuation consultancy in Barrington, Ill. "We like the way the Street does things; they talk about dollars and cents," he says. "The balanced scorecard talks about customer relationships, internal processes, learning and growth. I mean, those things are good, but where's the money?"

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Southwest Airlines’ Balanced Scorecard:What It Looks Like

Southwest Airlines' Balanced Scorecard: What It Looks Like

Please click on image above to view a readable version.

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