The Balanced Scorecard: Historical Development and Context, As Developed by Robert Kaplan & David Norton

The Balanced Scorecard: Historical Development and Context, As Developed by Robert Kaplan & David Norton

Karl R. Knapp

Anderson University – Anderson IN

ABSTRACT

This paper discusses the general theory of the Balanced Scorecard and traces its historical origins. The Balanced Scorecard is based on three main areas: Measurement, Human Relations, and Customer Value Disciplines. The basis in measurement draws on Management by Objectives. The human relations school of management and open-book management theories are influential. The customer value discipline links the scorecard to the strategy of the firm.

The Balanced Scorecard

The Balanced Scorecard is a theory and management approach first proposed in the Harvard Business Review by Robert S. Kaplan & David P. Norton (1995). A subsequent book, The Balanced Scorecard, was published following this article (1996). The most recent refinement of this theory and management approach appears in Kaplan & Norton’s book, The Strategy-Focused Organization (2001). This paper attempts to present a high-level overview of this management theory, along with a description of its historical foundation and development.

As defined by Kaplan and Norton (1996), “The Balanced Scorecard translates an organization’s mission and strategy into a comprehensive set of performance measures that provides the framework for a strategic measurement and management system”. This strategic management system measures organizational performance in four ‘balanced’ perspectives:

·        Financial – summarizes “the readily measurable economic consequences of actions already taken”.

·        Customer – contains measures that “identify the customer and market segments in which the business unit will compete and the measures of the business unit’s performance in these targeted segments”.

·        Internal Business Process – measures the “critical internal processes in which the organization must excel”.

·        Learning & Growth – measures the “infrastructure that the organization must build to create long-term growth and improvement”.

To create a Balanced Scorecard an organization’s management team translates the mission, vision, and strategy of the firm into a scorecard. The scorecard measures should represent both long-term and short-term success in the execution of the strategy. The measures are arranged in the four perspectives. The scorecard should contain both outcome measures that indicate excellent prior performance, along with the performance-drivers that create successful future performance.

This ‘balanced’ framework enables a management team to execute the following four strategic management processes:

·        Clarify and translate vision and strategy.

·        Communicate and link strategic objectives and measures.

·        Plan, set targets, and align strategic initiatives.

·        Enhance strategic feedback and learning.

These four strategic management processes are the keys to the Balanced Scorecard theory.

Strategy-Focused Organization

The latest refinement of this concept developed from the experiences of companies implementing the Balanced Scorecard into their strategic management processes. Kaplan and Norton found that implementation of strategy is as important as the development of strategy. They propose that successful strategy implementation incorporates the following five strategic management principles (Kaplan & Norton, 2001):

·        Translate the strategy to operational terms.

·        Align the organization to the strategy.

·        Make strategy everyone’s everyday job.

·        Make strategy a continual process.

·        Mobilize change through executive leadership.

Within the five principles there are several elements. These new elements add the following new sections to the theory:

·        Strategy Maps – Strategy aligned with the value proposition (see figure 1).

·        Personal Scorecards – Strategy aligned with personal objectives.

·        Balanced Paychecks – Incentive compensation aligned with team-based goals (scorecard).

·        Strategic & Operational Budgeting – Strategy funded.

·        Open Reporting – All employees get the information and management meetings held to discuss performance.

·        Change Management – The Balanced Scorecard is a change management program, enabled by the scorecard.

One of the most useful additions to the Balanced Scorecard theory is the Balanced Scorecard Strategy Map (Kaplan & Norton, 2001). A well-developed strategy map clearly illustrates the company’s strategy and the measures of success for the strategy. A template for a strategy map is illustrated on the following page.

Balanced Scorecard Strategy Map

Historical Analysis

The Balanced Scorecard is based on three general management concepts:

·        Measurement and Goal Setting.

·        Communication, Motivation and Human Relations.

·        Business Strategy.

The remainder of this paper discusses the historical evolution of each of these management concepts.

Measurement & Goal Setting

The Balanced Scorecard concept uses a “strategic measurement system” at the root of the theory. One of the most widely used measurement and management practices is Management by Objectives.

In The Practice of Management, Peter Drucker (1954) introduced a concept called Management by Objectives (MBO). As defined by George Odiorne (1965), Management by Objectives is “a process whereby the superior and subordinate managers of an organization jointly identify its common goals, define each individual’s major areas of responsibility in terms of the results expected of him, and use these measures as guides for operating the unit and assessing the contribution of each of its members”. In this definition, the key is that subordinates participate in the goal setting process. It is the involvement of subordinates that allows Drucker the credit for development of Management by Objectives. “This would dismiss many of the claims made for previous use of MBO by such people as McKinsey, Barnard, Fayol, or by such corporations as DuPont, General Motors, and Standard of New Jersey – firms that Odiorne claims used an early objective-based management style of organization” (Greenwood, 1981).

Prior objective based management research and implementation clearly influenced the development of Management by Objectives.

Henri Fayol founded the earliest thinking about the functions of management. In his work, Administration industrielle et générale, Fayol founded the fourteen principles of management (Fayol, 1916):

·        Division of labor (job specialization).

·        Authority & responsibility (authority derived from expertise, leadership, skill, and knowledge).

·        Unity of command (everyone has one manager and only one manager).

·        Line of authority (chain of command).

·        Centralization (preferred less centralized).

·        Unity of direction (singleness of purpose).

·        Initiative (causes creativity & innovation).

·        Equity (fair treatment for employees).

·        Order (efficiency & career opportunity).

·        Discipline (enforce rules to achieve goals).

·        Remuneration of Personnel (bonuses and profit sharing).

·        Stability & Tenure of Employees (encouraged long-term employees).

·        Subordination of Individual Interests to the Common Interest (employees need to understand how their performance affects the entire organization).

·        Esprit de Corp.

Management by Objectives and The Balanced Scorecard are greatly influenced by Fayol’s four functions of management (Fayol, 1916):

·        Planning.

·        Organizing.

·        Leading.

·        Controlling.

Communication, Motivation & Human Relations

One of the key foundational concepts of The Balanced Scorecard is that employees are motivated by a clear ‘line of sight’ from their activities to the strategy of the organization. Employees want to understand the linkage between what they do, and what the organization’s mission, vision, values and strategy are. These ideas are based mainly on the Human Relations School of management theory.

Open-Book Management

A major premise that the Balanced Scorecard is constructed upon is that employees need to understand the business strategy, and have information available to them that enables them to execute and adapt their actions to successfully execute the strategy. This idea is clearly influenced by the theory of Open-Book Management.

Jack Stack introduced the concept of Open-Book Management The Great Game of Business (1992).  In this book Stack argues that “the best, most efficient, most profitable way to operate a business is to give everybody in the company a voice in saying how the company is run and a stake in the financial outcome, good or bad” (Stack, 1992). John Case has further developed this basic concept in several books and articles.

Open-book management is revolutionary because conventional business operates under two assumptions (Case, 1995):

·        A job must be defined as narrowly as possible.

·        Workers need close, direct supervision.

The key steps to the development of this archaic management paradigm are (Case, 1995):

·        The rise of engineering, and of the engineering-inspired movement known as scientific management.

·        The professionalization of management – the creation, in effect, of a separate managerial class.

·        The rise of the adversarial union.

Changes in the organizational and social environment have prompted changes in the approach to management.

According to Case (1995), “open-book management is a way of running a company that gets everyone to focus on helping the business make money”. Case further argues that open-book management “takes those trendy new management ideas – empowerment, TQM, teams and so on – and gives them a business logic. In an open-book company, employees understand why they’re being called upon to solve problems, cut costs, reduce defects, and give the customer better service”.

In open-book management there are three essential differences to a conventional business (Case, 1995):

·        Every employee sees – and learns to understand – the company’s financials, along with all the other numbers that are critical to tracking the business’s performance.

·        Employees learn that, whatever else they do, part of their job is to move those numbers in the right direction.

·        Employees have a direct stake in the company’s success.

The implementation of the open-book management concept is very similar to the implementation of a Balanced Scorecard strategic management system. Case posits that there are four steps to implementing open-book management (Case, 1995):

1.      Get the information out there.

2.      Teach the basics of business.

3.      Empower people to make decisions based on what they know.

4.      Make sure everyone – everyone! – shares directly in the company’s success, and in the risk of failure.

These four steps have been refined and organized in the following four management practices (McCoy, 1996):

·        Educate.

·        Big picture education.

·        Customer education.

·        Operating process education.

·        Financial results education.

·        Enable.

·        Information sharing.

·        Information exchange systems.

·        Employee participation and involvement systems.

·        Empower.

·        Convincing employees they have the right and responsibility to make decisions and take action.

·        Engage (reward systems).

After reviewing the basic fundamentals of open-book management, it is easy to see the linkages to the Balanced Scorecard. The Balanced Scorecard shares the basic fundamentals of open communication and the engagement of employees through incentive-based pay. The Balanced Scorecard refines this approach by going beyond financial measurements using a balanced four-perspective approach, highlighting the cause-and-effect relationships between business drivers and outcome measures (financial). It also links the business strategy to the strategic measurement and management system.

Assumptions About Human Nature

Assumptions about human nature and motivation underlie both the Balanced Scorecard and Open-Book management. Douglass McGregor’s influential work on managerial assumptions about human nature was influential to the development of these modern management theories.

The Balanced Scorecard and Open-Book management are based on Theory Y assumptions about human nature.

According to McGregor (1960), the Theory Y assumptions are:

1.      Expending physical and mental effort at work is as natural as play and rest. The average human being does not inherently dislike work.

2.      External control and the threat of punishment are not the only means to direct effort toward organizational objectives. People will exercise self-direction and self-control in the service of objectives to which they feel committed.

3.      Commitment to objectives is a function of the rewards associated with their achievement. The most significant rewards – the satisfaction of ego and self-actualization needs – can be direct products of effort directed toward organizational objectives.

4.      Avoidance of responsibility, lack of ambition, and emphasis on security are not inherent human characteristics. Under proper conditions, the average human being learns not only to accept but to seek responsibility.

5.      Imagination, ingenuity, creativity, and the ability to use these qualities to solve organizational problems are widely distributed among people.

In accordance with the approach to the Balanced Scorecard and Open-Book management, Theory Y assumptions would view the task of management as follows (McGregor, 1960):

1.      Managers are responsible for organizing the elements of productive enterprise – money, materials, equipment, people – in the interest of economic ends.

2.      Because people are motivated to perform, have potential for development, can assume responsibility, and are willing to work toward organizational goals, managers are responsible for enabling people to recognize and develop these basic capabilities.

3.      The essential task of management is to arrange organizational conditions and methods of operation so that working toward organizational objectives is also the best way for people to achieve their own personal goals.

Proponents of the Balanced Scorecard and Open Book management would certainly argue that point 3 above is the essential task of management.

Theory Y assumptions about people was heavily influenced by the human relations perspective of management thought. The development of this perspective was influenced by Eldon Mayo and Abraham Maslow.

Eldon Mayo’s research in the famous Hawthorne studies provided empirical evidence on theories of human motivation. Mayo was heavily influenced by the work of Abraham Maslow.

Maslow (1998) believed that “people sought meaning in their work, wanted to commit to causes larger than themselves, and were capable of ‘roaring off the face of the earth’ when engaged with a task, role, or responsibility that was worth doing”.

Maslow introduced the hierarchy of needs or self-actualization theory. This theory was based on the assumption that people are inherently seeking ‘self-actualization’, as they move up the hierarchy of needs.

Maslow’s (1962) Hierarchy of Needs

To move up the hierarchy of needs, the needs below must be generally satisfied.

The Balanced Scorecard is an extension of the concept of open-book management, based on Theory Y assumptions about people, who seek self-actualization. The Balanced Scorecard is also a tool for organizational change. Kaplan and Norton borrow heavily from the work of  John Kotter on change management.

Leading Change

If successfully used, the Balanced Scorecard will identify areas where the firm’s strategy is successful and where it needs improvement. These areas of improvement will undoubtedly require change. John Kotter developed a highly regarded approach to the implementation of change recommended by Kaplan and Norton (2001). Kotter argues that the successful implementation of change should follow an eight-step process (Kotter, 1996):

1.      Establishing a sense of urgency.

·        Create a crisis.

·        Eliminate obvious examples of excess.

·        Set targets so high that they can’t be reached by conducting business as usual.

·        Stop measuring subunit performance based only on functional goals. Insist on broader measures of performance.

·        Send more data to more employees.

·        Insist that people talk regularly to unsatisfied customers.

·        Use consultants and other means to force more relevant data and honest discussion into management meetings.

·        Put more honest discussions of the firm’s problems in company newspapers and senior management speeches. Stop senior management ‘happy talk’.

·        Bombard people with information on future opportunities, on the wonderful rewards for capitalizing on those opportunities, and on the organization’s current inability to pursue those opportunities.

2.      Creating the guiding coalition.

·        Position power: Are enough key players on board, especially the main line managers, so that those left out cannot easily block progress?

·        Expertise: Are the various points of view relevant to the task at hand adequately represented so that informed, intelligent decisions will be made?

·        Credibility: Does the group have enough people with good reputations in the firm so that its pronouncements will be taken seriously by other employees?

·        Leadership: Does the group include enough proven leaders to be able to drive the change process?

3.      Developing a vision and strategy.

·        Vision: a sensible and appealing picture of the future.

·        Strategies: a logic for how the vision can be achieved.

·        Plans: specific steps and timetables to implement the strategies.

·        Budgets: plans converted into financial projections and goals.

4.      Communicating the change vision.

5.      Empowering employees for broad-based action.

6.      Generating short-term wins.

7.      Consolidating gains and producing more change.

8.      Anchoring new approaches in the culture.

Kotter’s eight-step process can be applied both to the implementation of change identified as a result of the Balanced Scorecard, and to the implementation of the Balanced Scorecard itself.

Customer Value Discipline

The subject of business strategy is deep and wide. The Balanced Scorecard, especially the latest version of the theory presented in The Strategy-Focused Organization (2001), is heavily based on the concepts presented by Michael Treacy and Fred Wiersema (1995) in Discipline of Market Leaders.

The formulation of strategy is not specially addressed in either of the works on the Balanced Scorecard. What the authors propose is that the customer perspective of a company’s scorecard and strategy map, must match the company’s strategy towards its customers. It must match its customer ‘value discipline’.

Treacy and Wiersema (1996) propose that, to accomplish maximum effectiveness, a company must pursue one of three customer value disciplines (Treacy & Wiersema, 1996).

The Three Customer Value Disciplines

·        Operational excellence: providing customers with reliable products or services at competitive prices, delivered with minimal difficulty or inconvenience.

·        Product leadership: providing products that continually redefine the state of the art.

·        Customer intimacy: selling the customer a total solution, not just a product or service.

One of the keys to formulating a successful Balanced Scorecard is the linkage between the measures in the customer perspective and the company’s value discipline. The measures in the customer perspective should indicate the success or failure of the company’s value discipline.

The customer value discipline also has a great effect on the other measures in the company’s scorecard. Measures in the business process perspective for instance, should directly support the company’s customer value discipline. For example, a company that pursues a product leadership value discipline should have a focus on innovation. This focus on innovation should be reflected as measures in the business process perspective of their scorecard. The lack of these innovation measures identifies a weak link between the stated value discipline and the operational processes of the company that execute the strategy.

Summary & Next Steps

The Balanced Scorecard management approach developed by Kaplan & Norton (1995) is based upon several foundational management theories, including:

·        Management by objectives (Drucker, 1954).

·        Principles of management (Fayol, 1916).

·        Open-book management (Case, 1995).

·        Leading change (Kotter, 1996).

·        Theory Y (McGregor, 1960).

·        Hierarchy of needs (Maslow, 1962).

·        Value disciplines (Treacy & Wiersema, 1995).

The Balanced Scorecard is a strategic management tool that is gaining in popularity. Initial results from companies using the Balanced Scorecard have been favorable. The concept fits with current management thinking and is enabled by technological and social changes in the current work environment.

The next step in the development of the Balanced Scorecard management theory should be an analysis of successful (and unsuccessful) implementations of this approach. As with the concept of customer value disciplines (Treacy & Wiersema, 1995), common threads for successful implementations might be identified. Successful companies may prove to use similar scorecards, or fall into specific categories of similarity. Once identified, these common ‘themes’ could be used to develop best practice scorecards matched to specific types of business strategies.

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