What you’ll learn to do: explain the need for a balanced scorecard

Just as humans have different systems that interact to make up a person’s overall health, organizations have many different components that contribute to organizational health. Though we tend to focus on symptoms to know whether we’re healthy or not, it’s a good idea to have regular physical exams to make sure we’re not missing any health red flags. In the case of an organization, this is where a balanced scorecard comes in. A balanced scorecard is the health checklist, monitoring and measuring the health of the company.

The Gartner Group has found that more than 50 percent of large US firms use a balanced scorecard (BSC). Moreover, many large firms all over the world use the balanced scorecard in business operations.^[1] The scorecard system is a reaction to earlier mistakes driven by a narrow focus on financial results. The balanced scorecard adds goals for a company’s customers, internal quality, and learning and growth.

The following video helps explain the purpose of the balanced scorecard:

Balanced Scorecard Components

Bain & Company, a global consulting firm, ranks the balanced scorecard fifth of the top 10 management tools used around the world. The balanced scorecard is a system used by organizations to do the following:

• communicate goals
• align daily tasks with strategies
• prioritize projects
• measure performance
• monitor progress

Traditionally, companies have used financial measures to determine their health. The term “balanced scorecard” comes from looking at strategic measures in addition to financial measures for a balanced view of performance. The BSC typically looks at the company from four different perspectives to measure learning and growth, internal business processes, customers’ perspective, and financials.

Learning and growth

The learning and growth perspective involves the culture of a company. When managers look at their company from this perspective, they ask themselves questions such as: Are the employees learning? Is the company growing in its capacities? Are we using the latest and best technology and software? Do employees have access to continuing education, and if so, are they taking advantage of the opportunities? Is the company staying ahead of the competition regarding employee talent?

If a company is not learning and growing, it is dying. Learning and growth are necessary to ensure a company maintains or gains a competitive edge. Without it, a company is not sustainable.

Internal business processes

This perspective focuses on how well the company is running. Managers measure quality and efficiency and how to adapt to changing conditions.

Customer’s perspective

The customer’s view is often measured by surveying existing customers directly. Less obvious is talking to customers who defected, or switched to another brand or product. Harvard Business Review says, “acquiring a new customer is anywhere from five to 25 times more expensive than retaining an existing one.”^[2] The company must determine whether it is competitive in meeting customers’ needs. Without the customer, there is no business.

Financial

Companies need to succeed financially to continue operating. Focusing on other aspects of a company while ignoring its financial state leads to disaster. Measures such as revenue, profit, and ratios such as return-on-equity (ROE) show performance. Other measures are asset turnover, liquidity, gross profit margin, and the current ratio.

Why a BSC Is Needed

Fannie Mae is a financial services company. Before 1992, Fannie Mae’s compensation structure was linked to a wide range of performance measures. Beginning in 1992, earnings-per-share growth and growth were the only measures used to set incentive pay for Fannie executives. The incentive pay handed to Fannie executives more than quadrupled after this change, rising from $8.5 million to $35.2 million (1993 to 2000). In 2003, the regulator overseeing Fannie Mae found accounting fraud.

Without a balanced scorecard, executives focus on only one or a few aspects of the organization. A company may be doing well financially but performing poorly in another area. Even if a company is doing extremely well in one area and outperforming the competition, the area that needs the most improvement may destroy the company. For example, a company may exceed customer expectations related to product quality, corporate social responsibility, and customer service; however, its gross profit margin could be low. With a low gross profit margin, the company may not be able to grow, compete, or overcome obstacles.

A BSC forces managers to look at the company as a whole to measure performance and thus more accurately determine the company’s overall state. Managers can then work to improve in areas in which it is lacking.

Check Your Understanding

Answer the question(s) below to see how well you understand the topics covered in the previous section. This short quiz does not count toward your grade in the class, and you can retake it an unlimited number of times.

Use this quiz to check your understanding and decide whether to (1) study the previous section further or (2) move on to the next section.