Knowing the score.

Does your company try every management fad under the sun? By using the balanced scorecard for planning and budgeting, you'll learn which ones advance your overall strategy - and which ones don't.

Several years ago, we introduced the concept of a balanced scorecard for measuring and motivating business-unit performance. The scorecard, with four perspectives - financial, customer, internal business processes and learning and growth - provides a balanced picture of current operating performance as well as the drivers of future performance (see box on page 31).

While some companies use their balanced scorecards just for performance measurement, some managers have begun to integrate the scorecard into their planning and budgeting processes. Used this way, the scorecard helps managers align their business units, as well as their financial and physical resources, to the company's strategy. The integrated planning and budgeting process directs capital investments, strategic initiatives and annual discretionary expenses to achieving ambitious targets for the strategic objectives and measures on the business unit's scorecard.

Companies that use the scorecard in this way can greatly strengthen the links between their overall strategy and the programs they implement to attain their goals. For example, a commercial bank, shortly after a major merger, launched more than 70 different programs. Each program was intended to produce a more competitive and successful institution, but none was integrated into an overall strategy. After building a balanced scorecard, the bank executives tried to determine the linkages between each of the 70 initiatives and the 25 scorecard measures.

Many initiatives couldn't be tied to improving any scorecard measure. These were dropped or consolidated. And, despite the plethora of initiatives, several scorecard measures were not addressed by any initiative. As a result, the bank decided to launch new initiatives directed at achieving breakthrough performance on the previously neglected scorecard measures.

But you can't achieve this level of cohesion in a hit-or-miss fashion. To embed the scorecard into an integrated long-range strategic planning and operational budgeting process, you need to take the following steps.

* Set ambitious targets for balanced-scorecard measures that all employees can accept and buy into. The cause-and-effect relationships in the scorecard help identify the critical drivers that will allow breakthrough performance on important outcome measures, particularly financial and customer measures.

* Set priorities and rationalize strategic initiatives and capital investments. The gaps between the ambitious targets for scorecard measures and the current performance on those measures enable managers to set priorities for capital investments and action programs intended to close the gaps. Managers reduce or eliminate initiatives and investments that won't have a major impact on one or more scorecard objectives.

* Link to annual resource allocation and budgets. Managers link the three-to five-year strategic plan to discretionary expenses and budgeted performance milestones for the upcoming year. The milestones enable managers to track the business unit's trajectory along its strategic journey.

EYE ON THE PRIZE

The balanced scorecard is most effective when used to drive organizational change. To communicate that need, managers should establish targets for the scorecard measures three to five years out that, if achieved, will transform the company. The targets should represent a discontinuity in business-unit performance. For example, if the business unit were a public company, target achievement should lead to a doubling or more of the stock price. Typical financial targets have included doubling the return on invested capital, or a 150-percent increase in sales during the next five years. An electronics company set a financial target to increase sales at a rate nearly double the expected growth rate of its existing customers.

The balanced scorecard has proven to be a powerful tool to gain acceptance for aggressive targets because it stresses the linkages for achieving outstanding performance in related measures, not just improving performance in isolated measures. The performance drivers and lead indicators on the scorecard identify the operational factors, such as strategic investments, market research, innovative products and services, reskilled employees and enhanced information systems, that enable companies to achieve their ambitious financial targets. Operating executives often agree on stretch targets, even beyond those senior management requests, if they can be assured of having the investment, resources and time to execute a long-term plan. Further, the scorecard provides a tool to monitor how well the strategy is being implemented.

Once you've established targets for the scorecard measures, you can assess whether your company's current initiatives are contributing to achieving these ambitious targets, or whether you require new initiatives. Currently, many organizations have a myriad of efforts underway, such as total quality management, time-based competition, employee empowerment and re-engineering.

Unfortunately, these initiatives frequently aren't linked to achieving targeted improvement for strategic objectives. As a result, the company manages these efforts independently. They're sponsored by different champions, and they compete with each other for scarce resources, including the scarcest resource of all: senior management time and attention. When you use the balanced scorecard as the cornerstone of the company's management system, you can focus all organizational initiatives on achieving stretch targets for strategic objectives and measures.

As a first step, determine whether you can achieve your stretch targets by continuous improvement, such as a total-quality management approach to business processes, or whether you need discontinuous improvement, such as a re-engineering or transformation program. The continuous improvement model works within existing processes and applies a systematic problem-solving approach to reduce and eventually eliminate defects in the processes (such as late deliveries, defective products, process errors and unskilled employees).

Frequently, however, managers conclude that local problem-solving to continuously improve critical processes will not enable them to achieve their three- to five-year stretch targets for strategic objectives. This gap signals that the existing processes for accomplishing work are fundamentally flawed. The organization needs a re-engineering approach to completely redesign these processes to improve their performance.

Whether you implement a continuous or a discontinuous improvement process, the balanced scorecard provides the front-end justification and focus for your company's TQM and re-engineering programs. Rather than just apply process improvement or redesign to any local process, to obtain easy but inconsequential gains, managers direct their efforts to improve processes critical for the organization's strategic success.

Most important, when you use the balanced scorecard to drive strategic initiatives, you can focus on the issues that create growth, not just those that reduce costs and increase efficiency. Some re-engineering programs focus only on massive cost-cutting. TQM and re-engineering programs can be evaluated not just by dollars saved but by a dramatic time reduction in the order fulfillment cycle, a shorter time-to-market in the product development process and enhanced employee skills. You can use these nonfinancial targets to justify and monitor strategic initiatives because the balanced scorecard has established the linkage between achieving these targets and dramatic improvements in future financial performance.

Organizations should link their investment decisions, as well as their strategic initiatives, to achieving ambitious targets for scorecard measures. While this principle seems obvious and is part of the rhetoric of most strategic planning exercises, many organizations, in practice, fail to incorporate the development of long-term capabilities into their resource allocation processes and decisions. The justification for most capital investments remains tied to narrow financial measures, such as payback and discounted cash flow. With these metrics, the investments aren't linked to developing strategic capabilities, or even tactical improvements in nonfinancial variables like quality, customer satisfaction and organizational and employee capabilities. The balanced scorecard overcomes this gap by providing executives with a mechanism to incorporate strategic considerations into the resource allocation process.

For example, one organization developed a weighted index of its balanced-scorecard measures for evaluating capital investments. The index gave significant emphasis to financial measures, such as return on capital and profitability, but gave equal emphasis to the drivers of future financial performance, such as quality, service and customer retention. The company ranked individual investments based on their overall impact on the balanced-scorecard formula. Then it selected the top-ranked investments that fit within the available capital budget.

After seeing this process function for the first time, one member of the executive committee described his impressions. "In the past, we had unfocused activities occurring everywhere. A lot of effort was counterproductive, and much of it wasn't cumulative," he reports. Now, he says, "The balanced scorecard is like a prism through which all of our investments are focused. Instead of a thousand points of light, we have a laser. All of our energies are now directed at a critical few targets."

GETTING IT TOGETHER

Most organizations have separate processes and separate organizational units for strategic planning and operational budgeting. The strategic planning process operates on an annual cycle. In the middle of each fiscal year, senior executives go off-site and, for several days, engage in active discussion, facilitated by planning and development managers and occasionally external consultants. The outcome of this exercise is a strategic plan for where the company expects (or hopes, or prays) to be in three, five and 10 years. Typically, the company codifies these expectations into documents that sit on executives' bookshelves for the next 12 months.

Ongoing during the year is a separate budgeting process run by the finance staff. This process culminates in month 10 or 11 of the year with an approved budget for the upcoming year, consisting of detailed short-term (monthly, quarterly and annual) targets for financial measures. The measures include sales, operating expenses, gross margin, general and administrative expenses, operating margin, net profit, cash flow and return on investment.

The annual budget also establishes authorized spending levels for capital investments, research and development, and marketing and promotional activities. Unfortunately, the budgeted financial targets typically bear little relation to the five-year targets in the now-hibernating strategic plan.

Which document gets discussed during the next year when business unit and corporate managers meet in monthly and quarterly meetings? It's usually only the budget, since the periodic reviews focus on comparing actual with budgeted financial results, line item by line item, with explanations demanded for large variances from the budget. But when does the company discuss the strategic plan? Probably during the next off-site annual strategic planning meeting, when it formulates a new set of three-, five-, and 10-year plans.

Strategic planning and operational budgeting processes are too important to be treated as independent processes. The company must link strategic planning to operational budgeting if it's going to tie vision to action. The target-setting process described earlier sets aspirations for what the business unit must achieve for breakthrough performance, according to the strategic measures in the four balanced-scorecard perspectives. The company deploys resources and initiatives to start the journey along this path, to close the gap between current performance and the stretch targets it wants to achieve during the next three to five years.

But managers can't wait three to five years to determine whether their strategy is valid and feasible. Managers need to continually test both the theory underlying their strategy and the way that the strategy is being implemented. They can perform such tests of strategic hypotheses by formulating specific short-term targets for their balanced-scorecard measures. These short-term targets, or milestones, become the tangible expression of managers' beliefs about how the speed and impact of their current programs affect strategic measures.

You must expand your traditional budgeting process beyond financial targeting to encompass short-term targets for all balanced-scorecard measures. The budgeting process should translate the first year of a five-year plan into operational budgets for strategic objectives and measures in all four balanced-scorecard perspectives. That is, as part of the integrated planning and budgeting process, you should establish short-term targets for where you expect to be, monthly and quarterly, on the outcome and performance driver measures for customers and consumers; innovation; operational processes; and employees, systems and organizational alignment. The monthly and quarterly targets represent the milestones your company expects to achieve as it travels along its long-term strategic journey.

Many business units emphasize the early stages of the new balanced-scorecard management process: translating vision and strategy into objectives and measures, and communicating these objectives and measures to participants inside and outside of the unit. Unless, however, your company directs real resources toward achieving these objectives, they'll remain distant goals, not tangible targets to which everyone is committed. By establishing long-term targets for strategic measures, directing strategic initiatives and significant resources toward achieving them and specifying short-term milestones, you become committed to and accountable for achieving the organizational vision.

This article is adapted from the authors' book, The Balanced Scorecard, published by Harvard Business School Press. Copyright [C] 1996 by the President and Fellows of Harvard College; all rights reserved. To order, call [phone], or send an e-mail message to [e-mail].

THE SCORECARD

SOME EXAMPLES

You've got the balanced scorecard. Here are a few ideas on how to flesh it out.

Financial

"To succeed financially, how should we appear to our shareholders?"

Objective               Measure                Target

Increase                Return on              16%
profitability           capital used
Customer

"To achieve our vision, how should we appear to customers?"

Objective              Measure                 Target

Partner with           Account share           60%
targeted               of targeted
customers              customers
Internal business process

"To satisfy our shareholders and customers what business processes
must we excel at?"

Objective              Measure                Target

Find innovative        % sales from           25%
solutions for          new services
new customer
markets
Learning and growth

"To achieve our vision, how will we sustain our ability to change
and improve?"

Objective           Measure                 Target

Reskill             Strategic job           100%
employees           coverage ratio

RELATED ARTICLE: WHO'S WALKING THE TALK

This is a partial list of the organizations using the balanced-scorecard concept.

Amoco Corp. Analog Devices BellSouth caterpillar Chase Manhattan Cigna Property & Casualty Dept. of Energy Fannie Mae Fleet Bank FMC Corp. Hewlett-Packard Interhealth Key Corp. McNeil Consumer Products Corp. Mellon Bank Metropolitan Life Michigan Consolidated Gas Mobil PNC Bank Rich Products Rockwell International Sears Texaco

Source: International Quality and Productivity Center.

Mr. Kaplan is a professor at Harvard Business School. You can reach him at [phone], or online at [e-mail]. Mr. Norton is founder and president of Renaissance Solutions in Lincoln, Mass. You can reach him at [phone], or at [e-mail].