Putting strategy into the balanced scorecard
Peter Brewer

01/01/2002
Strategic Finance
44
Copyright (c) 2002 ProQuest Information and Learning. All rights reserved. Copyright Institute of Management Accountants Jan 2002

Talk to any balanced scorecard consultant, and you'll find that the most important step in creating a balanced scorecard is defining your strategy. While that sounds like an easy thing to do, it's surprising how many companies struggle to define their strategy clearly, embed it into their balanced scorecard performance measurement system, and communicate it effectively throughout their organization. (See "The Balanced Scorecard at a Glance" p. 46.) The problem: Companies don't have access to structured approaches to translate high-level strategy statements into specific scorecard measures. The result: a disconnect between strategy and performance measurements.

The changing nature of value creation complicates the performance measurement process as well, especially since the New Economy has stood the world of value creation on its ear. In 1978, the average U.S. company had a book-value-to-market-value ratio of 95%, but by 1998 the ratio had plummeted to 28%! In fact, numerous highly successful companies such as AOL Time Warner, Cisco Systems, Amazon.com, Coca-Cola, Microsoft, General Electric, and Charles Schwab have all had bookvalue-to-market-value ratios in recent years of less than 10% and, in some cases, even less than 5%! Why? Intangible assets! Though Wall Street understands the value of intangible assets, the traditional financial accounting model is mired in the world of physical and financial assets that dominated value creation 20 years ago. For managers trained in Old Economy finance, the New Economy forces them to stretch their mental model of what constitutes a sustainable business model.

The Balanced Scorecard

at a Glance

The balanced scorecard offers an alternative to organizations that have historically overemphasized short-term financial performance. It measures performance from four perspectives: customer, process, learning and growth, and financial, recognizing that long-run financial success is driven by an organization's ability to continuously learn and grow and to manage the processes that deliver customer value.

A balanced scorecard should have 15 to 25 measures that support a company's strategy and are linked together in the form of cause-and-effect hypothesis statements. Forming these linkages encourages a company to specify how investments in learning and growth will drive continuous process improvement, increasing customer satisfaction and financial prosperity.

The balanced scorecard measures should cascade across divisions and down through the levels of an organization so that all employees are evaluated and rewarded using action measures that are connected to the scorecard. THE VDF FRAMEWORK

So how do you translate strategy into measures? The Value Dynamics Framework (VDF), shown in Figure 1, is a tool that can help companies interested in bridging the gap between strategy statements and balanced scorecard implementation. It enables them to disaggregate broad strategy statements into the underlying assets that are being used to deliver value to customers, thereby helping them focus the balanced scorecard metric selection process on the assets that are critical to achieving strategic objectives. The VDF recognizes that, in today's economy, physical and financial assets aren't the only types of assets used to create wealth but acknowledges that customer, organizational, and employee/supplier assets are also important. Consider how some of the assets of AOL Time Warner, Starbucks, and DaimlerChrysler AG never appear on the balance sheet.

Subscribing customers are an asset for AOL, not in terms of their subscription revenue but in terms of their ability to generate advertising revenue. Numerous companies pay AOL to gain visual exposure to the millions of customers relying on AOL for Internet access. Despite the revenue-generating ability of AOL's customers, they don't show up on AOL's balance sheet.

When Starbucks introduced its gourmet coffee-- flavored ice cream, it became a best seller in the United States within three months, thanks to the company's brand image. While brand is an organizational asset in the VDF framework, the value of Starbucks' brand isn't reflected in its balance sheet.

DaimlerChrysler AG views its relationships with suppliers as a critically important asset, yet the value of its supply chain relationships in terms of improved product quality, time compression, and lower costs isn't depicted on its balance sheet.

HOW CAN I CREATE A VDF? You can break the process of creating a Value Dynamics Framework into four steps. First, create a list of assets that supports your strategy. Include physical and financial assets such as office buildings, desks, computers, cash, and accounts receivable only if they differentiate your company from its competitors.

Second, explain how the assets in the VDF interrelate to deliver customer value. According to strategy expert Michael Porter, a competitive advantage is created when your company's activity system is difficult to replicate. Therefore, it's the combination of assets depicted in the VDF that works in unison to create an activity system leading to a competitive advantage.

Third, identify the strengths, weaknesses, opportunities, and threats (SWOT analysis) underlying the VDR The future may hold unexploited opportunities and unforeseen threats that render a current VDF and its associated activity system obsolete. Hence, the VDF is an evolving business model, not a stagnant one.

Fourth, define the critical success factors underlying the strategy, and identify particular combinations of assets as being supportive of each critical success factor. Creating a VDF in this manner will focus your balanced scorecard metric selection process on the assets and critical success factors most important to achieving your strategic objectives.

BUILDING DELL'S VDF

To illustrate the application of the VDF, I'll use Dell Computer Corporation. Dell's mission statement, which appears on its website, is "to be the most successful computer company in the world at delivering the best customer experience in markets we serve." While this mission statement provides a high-level expression of Dell's strategy and goals, it doesn't specify the combination of assets that Dell relies on to meet customer expectations. It would be a substantial leap of unstructured thought processes to jump directly from this mission statement to the process of choosing measures for a balanced scorecard. Here's where the VDF can help.

Figure 2 provides a VDF for Dell. It breaks down Dell's high-level mission statement into the assets that drive the attainment of strategic objectives. Dell's two biggest assets are classified under organizational assets, namely the leadership of Michael Dell and the business processes underlying the direct business model. Other organizational assets include:

* Patents related to Dell's direct business model,

* Corporate consumers' perception of brand stability,

* Individual consumers' perception of first-to-market technology leadership, and

* A segmented organizational structure that enables managers to get intimately acquainted with customers' needs within a business segment.

Dell's physical assets provide a classic example of "less is more.' As a result of bypassing distributors and selling directly to customers, Dell minimizes the need to maintain inventory. Also, Dell maximizes its flexible-response capabilities by outsourcing component-part manufacturing. Dell doesn't have substantial resources tied up in physical facilities dedicated to winning the first-to-market battle for each successive generation of technology. But Dell invests in the information technology infrastructure that supports real-time communication among its customers, its own manufacturing facilities, component suppliers, and airfreight carriers.

The policy of outsourcing component manufacturing leads to a discussion of supplier and employee assets. By maintaining partnerships with as few highly reliable suppliers as possible, Dell streamlines its operations and relies on its computer monitor suppliers to ship directly to the customer. As long as a supplier retains its leadership position, Dell will collaborate with it to achieve mutual success, but if a particular supplier loses its edge, Dell has the flexibility to respond quickly. Another asset? Employees. Direct salespeople, help-desk operators, engineers, and the like all have to be knowledgeable and customer focused to ensure Dell's continued competitiveness.

In addition, customers are critically important assets to Dell. When Dell introduced the direct model, all of its competitors were selling computers to end consumers via distributors and detaching themselves from end consumers. Dell, on the other hand, sells directly to consumers and is continuously communicating with them and benefiting, especially in two areas: seeing sales trends and learning about unmet customer needs.

The sales trend data helps Dell match supply with demand, and information related to unmet customer needs translates into opportunities for innovation of products and services. The company also relies on customers' knowledge of what they want to purchase and when they want to complete the transaction to drive the direct business model. Dell leverages this source of customer knowledge by making it as easy as possible for a customer to place a customized order electronically. In fact, Dell has set up about 7,000 customized versions of dell.com for various customers. Electronic ordering is hassle free for the customer and cost effective for Dell.

Finally, financial assets appear in the VDR The primary financial assets for Dell include minimal accounts receivable and a strong cash position. Dell's cash conversion cycle (e.g., days accounts receivable outstanding + days inventory on hand - days accounts payable outstanding) is minus five days, which means customers pay Dell before it has to pay suppliers. This minimization of working capital provides not only a cost advantage, but cash availability to support necessary investments to stay on the forefront of technology.

LINKING DELL'S VDF TO THE BALANCED SCORECARD

Dell's Value Dynamics Framework provides a richer body of information to support the balanced scorecard metric selection process than the mission statement alone

because it specifies the assets that deliver customer value and profits. It provides a structure that facilitates the underlying thought process involved with transitioning from the high-level mission statement to selecting measures for each of the four balanced scorecard perspectives: learning and growth, process, customer, and financial.

Let's look at Dell's assets that relate to its customer intimacy and operational efficiency value propositions. Figure 3 suggests that Dell's leadership, structure, customer, brand, and employee assets play a pivotal role in delivering on the customer intimacy value proposition. Likewise, Figure 4 suggests that customers and employees, as well as the remaining assets from Dell's VDF, support its operational efficiency value proposition. Here's an analysis of the underlying logic of the links between Dell's customer intimacy assets and the balanced scorecard measures shown in Figure 3.

THE CUSTOMER INTIMACY VALUE PROPOSITION

Michael Dell says his most important leadership responsibility is looking for "value shifts" in his company's customer base. To identify the shifting needs of customers, he has to stay in close contact with them. The segmented organizational structure and the employees who work within that structure are two other assets that enable Dell to focus on building intimate relationships with its segments of customers. To build customer intimacy and loyalty, Dell leverages its customers' knowledge of their own unmet needs. Dell's brand image was and is shaped by customer feedback.

Identifying this linked set of assets enables Dell to select strategy-focused, asset-based balanced scorecard measures that support the customer intimacy value proposition. For example, the balanced scorecard's learning and growth measures might include:

* Training dollars spent per full-time equivalent by customer segment to ensure that well-educated business segment managers provide state-of-the art advice to customers.

* Number of collaborative customer-solution teams that motivate Dell to collaborate with its customers and jointly create technology solutions that fulfill any unmet customer needs.

* Number of emerging technologies evaluated inspires Dell's leaders to stay abreast of technology threats and opportunities that may alter the competitive landscape in the future.

Business process measures might include:

* Percentage of total hours spent in contact with the customer,

* Number of customer-initiated product innovations, and

* Average customer idea ramp-up time.

The first measure-hours spent with the customer-- would be evaluated at the executive as well as managerial levels. This would motivate Dell's highest-level leaders, as well as its segmented management teams, to stay in touch with the customer. The second business process measure-- customer--initiated product innovations-should motivate Dell employees to listen to and collaborate with customers. The first two measures from the learning and growth perspective would support this process-oriented measure. The third measure-ramp-up time-assesses how long it takes Dell to translate a customer's idea into reality because creating innovative ideas is one thing, but delivering results in a timely manner is another.

The three customer measures are customer perception of customized response capability, customer perception of stability and first-to-market capability, and customer retention. If the learning and growth and business process outcomes are being achieved, then as the first customer perspective measure suggests, customers should perceive that their individual needs are being met in a timely manner. The second measure focuses on brand image. If Dell stays in touch with customers and delivers solutions consistent with their needs, then its brand image of stability in the institutional segment and "first-to-market with the latest technology" in the consumer segment should remain strong. Finally, if customer perception regarding the prior two measures is positive, Dell should be able to retain customers and grow the business.

Pursuing the value proposition of customer intimacy should lead to revenue growth, so the financial measures are revenue growth by segment and gross margin by segment. Since the growth needs to be profitable growth, gross margin is included as a financial measure to ensure profitable growth.

KEY TO SUCCESS

Bain & Company's research suggests that 50% of the Fortune 1,000 and 40% to 45% of larger companies in Europe use the balanced scorecard. Many more companies, large and small, are likely to implement the balanced scorecard in the near future. The Value Dynamics Framework is the key to balanced scorecard success because it helps translate broad strategy statements into strategy-focused, asset-based measures.

BY PETER BREWER, CPA

Peter Brewer, CPA, is associate professor in the department of accountancy at Miami University in Oxford, Ohio, You can reach him at (513) 529-6271 or brewerp@muochio edu.

---

For More Insight

Many books and articles provide information on issues related to the VDF The book Cracking the Value Code: How Successful Businesses Are Creating Wealth in the New Economy offers a wealth of information on the VDF framework. Michael Porter's article, "What Is Strategy?," in the November-December 1996 issue of the Harvard Business Review provides a deeper understanding of strategy.

If you'd like insight on interorganizational, supply chain-oriented balanced scorecard performance measures, see the article, "Using the Balanced Scorecard to Measure Supply Chain Performance," which appeared in the Spring 2000 issue of the Journal of Business Logistics, and "Adapting the Balanced Scorecard to Supply Chain Management" in the March-April 2001 Supply Chain Management Review. Both articles were written by Peter C. Brewer and Thomas W. Speh.

To learn more about customer intimacy and operational efficiency as value propositions, see Michael Treacy and Fred Wiersema's article titled "Customer Intimacy and Other Value Disciplines" in the JanuaryFebruary 1993 Harvard Business Review. And to obtain further information on how these value propositions relate to the balanced scorecard, read Robert S. Kaplan and David P Norton's book titled The StrategyFocused Organization: How Balanced Scorecard Companies Thrive in the New Business Environment.