I will be frank. I am heartily sick of articles attacking the balanced scorecard written from an incorrect premise, by authors that have failed to read any of the literature since 1992 and usually have their own axe to grind. Most have never had any training in modern balanced  and can’t be bothered to find out either.  (You know precisely the sort of article I mean)

I am sure you are different. I am sure you would love to understand the  approach better and be clear about its conceptual foundations (as well as practical experiences).

So, it was a delight to read a recent paper that Prof Bob Kaplan wrote.  A paper that should be compulsory reading for all these cynics, naysayers and “not invented here” critics.  More importantly Kaplan’s conceptual foundations paper should be compulsory reading for anyone thinking about a balanced scorecard for their organisation.

In this article I summarise the main points Kaplan makes in the paper.

The conceptual foundations of the balanced scorecard

In 2010, Professor Bob Kaplan put together a paper called “The conceptual foundations of the balanced scorecard”. It is a tour de force in both explaining the basis on which it is based AND, importantly, how it was subsequently developed over nearly twenty years. As Bob puts it,

“This paper describes the roots and motivation for the original Balanced Scorecard article as well as the subsequent innovations that connected it to a larger management literature.”

In this article I intend to summarise the main points that Kaplan makes, emphasise their importance and link them to the more recent developments I have developed with our clients at Excitant.

Influencing  approaches prior to 1992

In the first section Kaplan reviews the literature from the 1950’s to the mid 1970’s with Drucker, Simon and Anthony demonstrating that “the  roots of management planning and control systems encompassing both financial and non-financial measurement can be seen in these early writings”.

He then explores the Japanese management movement showing how the US were obsession, even in the 1980’s with short-term results and measurement.  Yet at the same time others were looking at the intangible assets that actually drove performance.  Also how  “Improvements in intangible assets effect financial outcomes through chains of cause-and-effect relationships involving two or three intermediate stages.”  (In effect hinting at and predicting the balanced scorecard’s cause and effect model).

He also noted that in the late 80’s several articles and books “recommended that companies integrate non-financial indicators of their operating performance into their management accounting and control systems”

Not just Analog Devices, of course

One criticism that you occasionally see is that Kaplan and Norton stole the idea for the balanced scorecard from Arthur Schneiderman of Analog Devices, without even acknowledging it.  This is of course nonsense on both counts.  Art and Analog Devices are acknowledged in the preface to their first book, and this article also explains that several other case studies in companies at the  same time also influenced the  approach.

As Kaplan described it, these cases showed,

“…how front-line employees could benefit from seeing financial metrics, while senior executive teams benefited from supplementing their financial view of the world with metrics about customers, quality, and employees. Thus the stage was set for thinking about a general framework by which both senior-level executive teams and front-line production workers would receive financial and non-financial information.”

The stage was set for the balanced scorecard framework.

There is also a revealing story about Analog Devices.  Kaplan describes how Art was asked about how the company was doing with its quality improvement metrics and corporate scorecard.  He  reported that every quality measure on its corporate scorecard had experienced dramatic improvements.  However, he also reported that the company’s stock price had decreased by nearly 70% during the past three years!  Analog Devices had failed to translate its improved manufacturing and delivery performance into increased sales and margins: the stock price reflected this shortcoming.  They had failed to establish a link between quality improvements on Analog’s quality scorecard and any customer value proposition or customer outcomes that were likely to contribute  to the shareholder value.  As a consequence they lost value!

A Kaplan says.

“Norton and I recognized that any comprehensive measurement and management system had to link operational performance improvements to customer and financial performance. Our Balanced Scorecard, while incorporating Analog’s operational improvement metrics, also incorporated metrics for innovation, employee capabilities, technology, organizational learning, and customer success.  … we did place shareholder value as the highest-level metric, with all the other stakeholders reflected in how they contributed to the company’s success in maximizing long-term shareholder value.”

Fighting the principal-agent model

One fight Kaplan had was with academics who still believed in the principal agent model.  Adherents of this model urged companies to provide more financial incentives to senior executive teams, (And even today, many still do).  These incentives would be based on  financial performance:  the typical “outcome” measure assumed in principal-agent models.

One academic (Jensen) wrote in 1991,

“Balanced Scorecard theory is flawed because it presents managers with a scorecard which gives no score – that is no single-valued measure how they have performed. Thus managers evaluated with such a system […] have no way to make principled or purposeful decisions.”

This is an argument that still appears on forums put there by advocates of weighted scorecards leading to a single overall score.  In my opinion (and Kaplan’s) these people are  wasting their time.

As Kaplan puts it,:

“Ultimately, if a company wants to set bonuses based on measured performance, it must reward based on a single measure (either a stock market or accounting based metric) or provide a weighting among the multiple measures a manager has been instructed to improve. But linking performance to pay is only one component of a comprehensive management system.”

“…Incentives are important, but so also are information, communication, and alignment.”

 Uncertainty and multi-period optimisation

Many of the principal-agent models are single time period where results are revealed at the end and no further management intervention is required.   This is in dramatic contrast to how managers actually manage.

Managers are adjusting their choices as the strategy develops and even updating and refining their strategy.  Managers invest in intangible assets often unclear the extent of the benefits they will get.  Many investments are never exposed to stakeholder or shareholder scrutiny, remaining internal to the organisation.

So, “The Balanced Scorecard recognizes the limitation of managing to financial targets alone in short-time horizons, when managers are following a long-term strategy of enhancing the capabilities of their customer
and supplier relationships, operating and innovation processes, human resources, information  resources, and organizational climate and culture. But because the links from process improvements and investments in intangible assets to customer and financial outcomes are uncertain… the Balanced Scorecard includes the outcome metrics as well to signal when the long-term strategy appears to be delivering the expected and desired results.”

In other words the Balanced Scorecard approach is looking at both short-term changes and their longer term effects.  This often gets referred to as lead and lag effects (or measures) but is in effect (when incorporated into the cause and effect model between objectives on a strategy maps, shows how the managers  believe their strategy will succeed.   The strategy map and balanced scorecard are, in essence, capturing the strategy, its drivers and anticipated results.

Stakeholder theory

Kaplan addresses stakeholder theory by starting with a simple premise:

“Just as Chandler articulated that strategy precedes structure, I strongly believe that strategy also precedes stakeholders.”

As soon as you read this it become clear why so few “stakeholders” should actually appear on a strategy map or scorecard.    Also, why those advocating an expansive stakeholder perspective should be more restrained in their thinking.  There is a simple answer, simply include these few that matter alongside customers in that perspective (but don’t assume they will give you money for your services).

As Kaplan explains, The stakeholder movement developed to counter the narrow shareholder value maximization view articulated by Milton Friedman and, subsequently, financial economists, such as Jensen.  Stakeholder theory helped us appreciate the value from nurturing multiple relationships that drive long-term and sustainable value creation.

Yet at the same time, (as Porter says), Strategy is about choice. Companies cannot meet the expectations of all their possible customers and stakeholders.  Especially as many such cited stakeholders actually hold no stake in the company.  Kaplan puts this to bed very nicely.  He says:

“The determination of strategy must come before defining measures of customer satisfaction and loyalty. Otherwise, following the recommendations of the stakeholder theorists, the company would attempt to meet the expectations of all the existing and potential customers it could serve, getting stuck “in the middle,” as described by Michael Porter, with both a high cost and a non-differentiated approach, a recipe for strategy failure.”

 Perfect.  He is clearly saying that, yes include those stakeholders that are critical to the strategy, but exclude those that are not.  Do not try to be all things to everyone and top please all of the people all of the time.  Make explicit choices in your strategy: reflect those choices in the tools that capture, describe  measure and manage your strategy, your balanced scorecards.

 Supplier perspective

Stakeholder theorists also criticize the Balanced Scorecard for not having a separate perspective for suppliers, one of their five essential stakeholder groups. But as with employees, suppliers get on the scorecard (typically in the Process perspective) when they are essential to the strategy.

An organisation may not feature suppliers on their balanced scorecards simply because those suppliers do not contribute to the differentiation and sustainability of their strategies. Strategy precedes stakeholders so this might reveal that a particular stakeholder category is not decisive for the strategy.  If so, it should NOT appear on the strategy map and the scorecard.

Where is the “people” perspective

Just as Kaplan explains why suppliers don’t get a specific perspective, he explains why the learning and growth perspective is not called the people perspective.  He says.

“The Balanced Scorecard deliberately did not (my italics)  label its fourth perspective the “employees” or “people” perspective… (instead)…  choosing a more generic name, “learning and growth,” to signal that we were not taking a pure stakeholder approach.

Under the BSC approach, employee objectives always appear (in the learning and growth perspective) but they get there because they are necessary for the strategy, not because someone has labelled them as a “stakeholder.”

 This is really important.  The question is not

“Do these employees hold a stake?”

but

“Are these employees contributing to strategy?” and “How are they contributing to the strategy?”

Good strategy map and scorecard design entails asking questions about the strategy and the drivers of that strategy and change.  You are after the few things that will make the biggest difference.  You are not after everything.  By asking how they contribute to the strategy (Or in actual fact you ask, “To achieve this, what do we need these employees to contribute?”) you get to strategic contribution rather than mere employment and existence as a stakeholder .

So, there is NO people perspective.  Only the Learning and growth perspective which includes (amongst other things) some employee objectives.

What if I don’t want profit and shareholder return at the top

Having worked on over sixty implementations of strategic balanced scorecards I frequently come across organisations who don’t see profit or shareholder value as their defining objective.  Kaplan also sees these and explains to those who reject the approach as ONLY addressing profit and shareholder value, by saying,

“Some companies do not want shareholder value to be their unifying paradigm for its strategy. That’s ok; it’s their choice. They don’t have to abandon the Balanced Scorecard approach and switch to the stakeholder view. They can use a strategy map and Balanced Scorecard to articulate their strategy that attempts to simultaneously create economic, environmental and social value, and to balance and manage the tensions among them.”

This is precisely the approach we use in the richer fourth generation balanced scorecard framework.  A framework that works for both commercial and nor for profit organisations (such as public sector bodies and charities).

All you do is to create parallel perspectives alongside the customer and customer and financial perspectives: Ones that capture CSR or environmental impact.  Then you clearly establish the causal relationships to these new perspectives from the lower ones.  You can see this in our “Environmental Balanced Scorecard” paper.

Strategic objectives, and their wording

Kaplan explains how merely using measures was not adequate for capturing strategy and so the definition of objectives before measures was introduced very early.

I can testify to this.  I joined Norton and Kaplan’s organisation, Renaissance in 1995 and even by then we were using strategy maps with objectives, before defining any measures on scorecards.  The idea of going straight to measures was dropped by 1994/5.  Kaplan’s story backs this up.

As Kaplan says,

“Thus, while our initial article had a subtitle, “Measures that Drive Performance,” we soon learned that we had to start not with measures but with descriptions of what the company wanted to accomplish. It turned out that selection of measures was much simpler after company executives described their strategies through the multiple strategic objectives in the four balanced scorecard perspectives.”

Kaplan also explains that this is about avoiding metric benchmarking where organisations adopt metrics from a company with a different strategy: a situation that would confuse the organisation were these inconsistent metrics  adopted.

If you are every to define measures, Kaplan provides some useful wording guidelines for customer and learning and growth perspective objectives.  You can find a more detailed guide to wording objectives in my 2011 book, “Strategy Mapping for Learning Organizations”.

Strategy Maps

As Kaplan put it, “It soon became natural to describe the causal relationships between strategic objectives” and these diagrams became known as “Strategy Maps”.  These strategy maps captured the causal relationship between objectives.  Measures are only established once these strategy maps are complete.

It is their fundamental role in Balanced Scorecard design that caused me to, as David Norton put it in the foreword to my book, “..use strategy maps as the jumping off point” to explain much of the Excitant Fourth Generation Balanced Scorecard approach.

 Supporting not for profit organisations

Finally, in this part, I want to cover how Kaplan extends the approach to nor for profit and public sector organisations.   Many try to abuse the approach or say it does not work.  On the contrary, it is extremely powerful in these organisations, when the cause and effect model is suitably adapted.

Kaplan says you simply add two developments:

1) Because Not for Profit and Public sector organisations cannot use the standard architecture of the Balanced Scorecard strategy map where financial objectives are the ultimate, you simply place an objective related to their social impact and mission, at the top of the strategy map. This represents  their social impact and mission,

2) Expand the customer perspective. Donors or taxpayers provide the financial resources: they pay for the service.  Another group, the citizens and beneficiaries, receive the service. Both constituents and resource suppliers should be the placed at the top of a not for profit or public sector strategy map.

Both of these are incorporated into our fourth generation not for profit strategy map framework and there are examples here:

Conclusion so far

Kaplan clearly explains how the balanced scorecard evolved and developed.  He also cleverly knocks down the nay-sayers and cynics most common criticisms.

However this is only half of the paper.  In the second half, he explains the balanced scorecard as a system of strategy management and execution.

That I shall cover in a separate article.

(Oh, and if you want to know how to do modern strategy focused balanced scorecards, then give me a call.)

References

Kaplan 2010, The Conceptual Foundation of the Balanced Scorecard Harvard Business School Accounting & Management Unit Working Paper No. 10-074 The original paper can be downloaded from the Social Sciences research Network website,