CHAPTER 2. Theoretical Foundation. Scorecard is a new approach to strategic management. They proposed the concept of a

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1 CHAPTER 2 Theoretical Foundation 2.1 Balanced Scorecard Drs.Robert Kaplan (Harvard Business School) and David Norton has developed Balanced Scorecard (BSC) in the beginning of year 1990s, they explained that Balanced Scorecard is a new approach to strategic management. They proposed the concept of a BSC to measure a company's activities in terms of its vision and strategies, manage company performance and monitor the performance of strategic goals over time. According to Drs. Robert Kaplan and David Norton, the BSC is not only a measurement system but a management system that enables companies to clarify their vision and strategy and translate them into action. Balance Scorecard provides feedback around both the internal business processes and external outcomes in order to continuously improve the company s strategic performance and results. When the BSC is fully implemented, it transforms strategic planning from a theory into the action of a company. Kaplan and Norton (Norton and Kalpan, 1996) also describe the innovation of the balanced scorecard as follows: "The balanced scorecard retains traditional financial measures. But financial measures tell the story of past events, an adequate story for industrial age companies for which investments in long-term capabilities and customer relationships were not critical for success. These financial measures are inadequate, however, for guiding and evaluating the journey that information age companies must make to create future value through investment in customers, suppliers, employees, processes, technology, and innovation."

2 Based on article posted in DM review magazine, Balanced scorecard is a focused set of performance measures derived directly from the business strategy of an organization. (Michael J. Schroeck, 2001). He also said that no company had the same measures; a company can focus on the execution of its specific strategy, such as being the low-cost manufacturer or having better-quality customer service. Balanced Scorecard also prepares managers to have a comprehensive view of the performance of running business by measuring a business not only from a financial perspective but also from more-balanced multi-perspectives. To accomplish this, these strategic objectives are translated into performance measures categorized into four perspectives: Financial, Customer, Internal business process, and Learning and growth. These perspectives are designed to align with strategy, reflect performance across the entire enterprise, and represent cause-and-effect relationships across each dimension. Four perspectives that shown in Figure 1, balance different measures of success are:

3 In financial perspective, Kaplan and Norton do not ignore the traditional need for financial data because it reflects financial performance of a company. Timely and precise financial data will always be a main concern, and managers will do whatever necessary to provide it. In fact, often there is more than enough handling and processing of financial data. The company s database was implemented to enable centralization and automation of finance processes. But the point is that the current emphasis on financials leads to the "unbalanced" situation with regard to other perspectives. There is perhaps a need to include additional financial-related data, such as risk assessment and cost-benefit data. However, under BSC system, it does not always give good indication of what is happening in the company. Measures of customer fulfillment and satisfaction, growth and retention are the current indicator of company performance. On the other hand, internal operations (efficiency, effectiveness, speed, reducing non-value added work, minimizing quality problems) and human resource systems and development are leading indicators of company performance. Number of debtors, cash flow or return on investment and economic value added are measured in the financial perspective. The financial performance of a company is fundamental to its success. Financial figures suffer from two major disadvantages: Financial reports are historical and intangible assets are not measured by normal financial reporting. Intangible assets enable an organization to: - widen customer relationships of existing customers to retain loyalty and serve new market segments and market areas effectively and efficiently. - launch innovative products and services to targeted customer segments. - provide customized high-quality products and services at low cost and with short lead times

4 - improve employee skills and motivation for continuous improvement in process capabilities, response times, quantity and quality - set up information technology, databases and systems that would support the company s business process. Customer perspective measure has a direct impact on customers. For example, time taken to process a phone call, results of customer surveys, number of complaints or competitive rankings. Customer perspective measures satisfaction, retention, and market and account share. Recent executives belief has revealed an increasing awareness of the importance of customer focus and customer satisfaction in any business. These are leading indicators: if customers are not satisfied, they will eventually find other suppliers that will meet their necessity. Poor performance from this perspective will eventually effect the leading indicator of future decline, even though the current financial picture may look good. In developing metrics for satisfaction, customers should be analyzed in terms of preferences of customers and the kinds of processes for which the company is providing a product or service to those customer groups or market segments. Internal business process perspective reflects the performance of business internal processes. For instance, the time spent prospecting, speed and accuracy of preparing proposal needed, quality, new products introduction and number of units that required rework or process cost. Metrics based on this perspective allow the managers to know how well their business is running, and whether its products and services meet to customer requirements (the unique mission of the company). These

5 metrics have to be carefully built by those who know these processes most familiarly. Learning and growth perspective describing the company s learning curve, for example, employees satisfaction, information system availability, number of employee suggestions or total hours spent on staff training and the company s cultural attitudes related to both individual and corporate self-improvement. In a knowledge-worker organization, human resource which is the only repository of knowledge are the main resource. The rapid technological changes in the current century makes the knowledge-worker feels the necessity to be in a continuous learning progress. For the company that often find themselves unable to hire new technical workers, and at the same time there is a decline in training of existing employees. According to Kaplan and Norton, this is a leading indicator of 'brain drain' that must be reversed. Metrics can be put into place to guide managers in focusing training funds where they can help the most. This is the reason why in any case, learning and growth become the essential foundation for success of any knowledge-worker organization. Kaplan and Norton emphasize that 'learning' is more than 'training'; it also includes things like mentors and tutors within the company, as well as that ease of communication among workers that allows them to readily get help on a problem when it is needed. As a result, Kaplan and Norton suggested that financial measures be supplemented with data that would reflect customer satisfaction, internal business processes, and the ability to learn and grow. Their scorecard evaluates corporate performance from four

6 perspectives (as shown in Figure 2). Then, to develop metrics, collect data and analyze it relative to each of these perspectives. Figure 2. Balanced Scorecard provides a framework to translate a strategy into operational terms. (Adapted from Robert S. Kaplan and David P. Norton, Translate Strategy Into Action (1996:9)) Balanced Scorecard (BSC) methodology translates strategy into action. Working through the balanced scorecard process enables management to define those key perspectives that will drive the business to success, as well as to define how to measure them. The balanced scorecard helps companies align multiple strategies, from various units, to the organizational strategy by linking their deliverables to those key perspectives that drive the business. Balanced scorecard provides a clear understanding

7 of the company strategy as well as how it is supported by the various divisions and functional units of the company to achieve the objectives. The balanced scorecard has been a very attractive concept. Thousands of managers all over the world have implemented this concept in one form or another. On the positive side, the balanced scorecard has help managers to recognize that financial measurements are necessary but not enough. Perhaps most importantly, they do not fully account for intangible assets and especially knowledge-based assets. Business success in traditional industries is often based on economies of scale and/or scope and thus closely linked to the efficient allocation of financial and physical capital. This type of resource allocation can be monitored and controlled fairly well by using financial measures. However, the ability to mobilize and exploit softer and less tangible knowledge resources is increasingly important in information industries. Unfortunately, traditional financial measures are poorly suited to manage a knowledge-intensive company. Depending too much on financial indicators can also promote efforts to maximize short-term results. The management bonuses and stock options tied to quarterly revenue and income, managers had a strong incentive to make the numbers even if that means sacrificing longer-term value. The balanced scorecard retains financial measures, but supplements them with leading indicators that reflect the drivers of future financial performance. With the scorecard, top managers can keep a close eye different aspects of their organisation and its environment. According to Kaplan and Norton, the research indicates that there is a

8 significant positive relationship between the leading indicators of corporate performance from one year and the lagging indicators - financial measures - in the next year. This means that the financial future of a company can be forecast reliably, and investor expectations managed ahead of time, by monitoring certain non-financial indicators. A few key indicators provide a reliable guide to corporate health. A balanced scorecard that is carefully designed will encourage a laser like focus on those key indicators. After managers communicate their envisioned future for the company, the stakeholders can work together and focus their daily efforts on realizing the vision by striving to improve key performance dimensions, such as retaining customers or lowering production costs. The balanced scorecard can help to align the interests of people at various levels of the organisation by drawing their attention to a common set of indicators. In some cases, this alignment has been made explicit by developing departmental and even individual scorecards that are based upon the corporate scorecard. Ideally, a balanced scorecard will indicate whether a company has a motivated and prepared workforce (learning and growth perspective), effective processes (operational perspective), and delighted customers (customer perspective). Positive leading indicators should result in superior long-term financial performance. Unfortunately, the balanced scorecard also has a negative side. As with almost any management technology, it must be adapted to the context. For example, industry specifics and the cultural differences between West and East mean that the scorecard used by a company in America cannot be transplanted directly to an import/export firm in Asia.

9 Benefits of applying balanced scorecard: Balanced scorecard provides a framework to focus on key perspectives that will lead to success, and provides a framework to assess performance constantly aligned with targets. Balanced scorecard assists align key performance measures with strategy at all levels in the company. Balanced scorecard provides management with a comprehensive picture of business goals and strategies at all levels in the company. 2.2 SWOT analysis and SWOT Matrix Tool Definition of SWOT: SWOT is an abbreviation for Strengths, Weaknesses, Opportunities and Threats. The SWOT framework was first illustrated in the late 1960 s by Edmund P. Learned, C. Roland Christiansen, Kenneth Andrews, and William D. Guth in Business Policy, Text and Cases (Homewood, IL: Irwin, 1969). SWOT analysis is a simple framework for generating strategic alternatives from a situation analysis. It is also an important tool for auditing the overall strategic position of a business and its environment. This tool provides a systematic approach to identifying strengths, weaknesses, opportunities and threats (SWOT) to assist the strategic planning process. The SWOT analysis is useful to address a complex strategic situation especially when there is a time limit. Once key strategic issues have been identified, they feed into business objectives, particularly marketing objectives. SWOT analysis can be used in conjunction with other tools for audit and analysis, such as Porter's Five Forces analysis.

10 2.2.1 Internal and External Issues Strengths and weaknesses are internal factors. Some factors that should be recognized across the company such as company s culture, organizational structure, key staffs, operational efficiency as well as the capacity, brand awareness, market share, financial resources, etc. For example, strength could be the company s specialist marketing expertise and can be served as a foundation for building a competitive advantage. While a weakness, could be the lack of a new product or services and should be eliminated. On the other hand, opportunities and threats are external factors. Some factors that should be aware such as customer s preferences or customer s lifestyles, market trends, competitors, suppliers, partner, technology, economic, political, regulatory, etc. For instance, an opportunity could be the development of new channel distribution through the Internet web, or consumer changes of lifestyles that potentially increase demand for a company's products. A threat could be a new competitor that enters to the existing market or changes in technology that makes existing products potentially obsolete. Both of internal and external situations analysis can create a large amount of information for the company. By recognizing and understanding these four aspects of its situation, the company can better leverage its strengths, correct and improve its weakness, exploit on opportunities, and prevent destructive threats.

11 The following diagram (Figure 3) illustrates how a SWOT analysis fits into a strategic situation analysis. Situation Analysis Internal Analysis External Analysis Strength s Weaknesses Opportunities Threats SWOT Profile Figure 3 SWOT Analysis fits into Situation Analysis It is necessarily pointing out that SWOT analysis can be very subjective. It is because two people rarely come-up with the same version of a SWOT analysis even when given the same information about the same business and its environment. Consequently, SWOT analysis is best used as a guide and not a prescription. Adding and weighing criteria to each factor increases the validity of the analysis. Information revealed in a SWOT analysis can be used to generate new/better strategies for the company. By using a SWOT Matrix, you are able to formally analyze and make your strengths, weaknesses, opportunities and threats, a key component of your strategy. There are some of the key areas to consider when identifying and evaluating Strengths, Weaknesses, Opportunities and Threats are listed in the example SWOT analysis below:

12 Positive Negative Internal Factors Strengths Weaknesses > Technological skills > Absence of important skills > Leading Brands > Weak brands > Distribution channels > Poor access to distribution > Customer Loyalty/ Relationship > Low customer retention > Production Quality > Unreliable product/ service > Scale > Sub-scale > Management > Management External Factors Opportunities Threats > Changing customer tastes > Changing customer tastes > Technological Advances > Changes in government politics > New distribution channels > Technological advances > Lower personal taxes > Tax increases > Change in population age-structure > Change in population age-structure > Liberalization of geographic markets > New distribution channels > Closing of geographical markets Table 1 Example of SWOT analysis When done formulating the SWOT list, do not leave it on a draft chart or in some reports never to be analyzed formally. The list needs to be generated, and yet many companies do not adequately concentrate on the findings. 2.3 Porter s Five Forces The Porter s five forces tool is an uncomplicated yet powerful tool for assessing the potential for profitability in an organization. With a little adjustment, it is also useful as a way of assessing the balance of power lies in any business situation. This is helpful,

13 because it facilitates to recognize both the strength of the companies current competitive position, and the strength of a position the companies are looking in the future. The company can take reasonable advantage of a situation of strength, improve a situation of weakness, and avoid taking wrong steps based on the better understanding of where power lies. This makes it an important part of your planning toolkit. In fact, the tool is used to identify whether new products, services or businesses have the potential to be profitable in the market. Nonetheless, it can be very illuminating when used to understand the balance of power in other situations. Five Forces analysis consist of five important forces that determine competitive power in a business situation. The five forces are: I. Threat of New Entry: This power is also affected by the ability of people to enter the company s market. If only little time or money is needed to enter the market and it can compete effectively, few economies of scale, or if the company have low protection in technologies, then new competitors can hastily come into the market and weaken the company s position. On the other condition, if the company has strong and durable barriers to entry, then the company can maintain a favorable position and take fair benefit of it. II. Supplier Power: It is the power for suppliers to increase prices. This is determined by the number of suppliers of each key input, limitation of the product, the uniqueness of the product or service offers, the strength and control over the company, the switching cost, and so on. The fewer the supplier choices the company have, and the more the company needs suppliers' help, the more powerful the suppliers are.

14 III. Buyer Power: It is the power for buyers to decrease prices. Again, this is determined by the number of buyers, the significance of each individual buyer to the business, the cost to the company of switching from current products and services to somebody else, and so on. If the company contracts with few yet powerful buyers, the buyers are often able to state terms to the company. IV. Threat of Substitution: This is influenced by the capability of the company s customers to discover a different way of doing what the company does. For instance, if the company supplies a unique and complicated software invention that computerizes an important process, people may substitute by doing the process manually or by outsourcing it. If substitution is effortless and substitution is practicable, then the company s power is deteriorated. V. Competitive Rivalry: The importance in competitive rivalry is the number and capability of the company s competitors. If the company has many competitors that can offer equally attractive products and most likely services, then the company has little power in the situation. If suppliers and buyers do not get a good deal from the company, the suppliers and buyers will go and find other companies. On the other hand, if no one else can offer what the company provides, then the company can often have tremendous strength.

15 All these forces can be efficiently brought together in a diagram below: Figure 4 Porter s Five Forces Diagram By thinking through how each force affects the company, and by identifying the strength and direction of each force, the company should quickly evaluate the strength of the position and the company s ability to make a sustained profit in the industry.

16 2.4 Key Performance Indicators (KPI) Key Performance Indicators (KPI), also recognized as Critical Success Factors are financial or non-financial metrics used to reflect the critical success factors of a company. These are used to assess the current state of business and to specify the path of accomplishment. The KPIs vary depending on the nature of the company. They help a company to measure progress towards their company s goals. A key performance indicator (KPI) is a specific measure of a company's performance in various area of its business. It is a very general concept, with different implementations depending on the variety of business and goals stated in the company. For examples, KPIs may include the percentage of on-time policy deliveries, total outsource marketing agents needed in a period time, distribution as well as training costs as a percentage of total sales, accuracy of insurance policy sent to clients, or lead-time for issuing a policy, numbers of clients or employees complaints. There are some KPIs calculations in finance such as: ELR (Earned Lost Ratio) = Net Claim Incurred Net Premium Earned WCR (Written Commission Ratio) = Net Commission Net Premium Written WER (Written Expense Ratio) = Management Expense Net Premium Written

17 The purpose of KPIs is to give business quantifiable measurements for the company to attain its long-term goals. Identifying the most important KPIs is the first step towards realizing increased profitability and efficiency for most businesses. Useful KPIs must be consistently quantifiable, have an established connection to the area of the business that need to be improved, and give accurate readings. For example, an insurance company may notice that the volume of its profits come from repeat customers. They wish to move more of their business towards repeat customers and more stable, long-term cash flow they represent. One of the most important KPIs for this insurance company is therefore the number of repeat customers buy the insurance policy. By tracking the customers request for the policy by name, type of insurance and history, they are able to calculate accurately the KPI. They may then set a specific goal for their KPIs, such as 50% of customers are repeat purchasers, and track how the marketing agents meet this KPI. Marketing agents that meet or exceed the target are rewarded, while others that fall short are given further training in order to achieve the KPI target. Talented and outstanding marketing agents come through several processes such as recruitment, enrollment process, learning process, and proper practices in the working area. Knowing the employee (marketing agents and the internal employee) capability does not adequate if only depends on the process recruitment, because junior and senior employees always need to be trained and improved so that the employability also can be improved gradually. The employability can be calculated by the increment of employee competence.

18 Talented employees (achieve their KPI target set for them) are retained by offering them competitive reward. As stated by Watson Wyatt, (Wyatt, 2000), reward can be classified into monetary reward and non-monetary reward. Survey that had been done by Watson Wyatt shows that bonus and stock options still become the preferences on the top level of the monetary reward. However, the chances to improve, learn, develop in career, flexible working hour and chances to learn new skill are settled on the top level of non-monetary reward. Table below shows the examples of monetary and non-monetary reward. Monetary reward Non monetary reward 1. Sign on bonus 1. Advancement opportunities 2. Stock grant/options 2. Flexible work schedule 3. Spot bonus 3. Opportunities to learn new skill 4. Group incentives 4. Career development (non promotion) 5. Project incentives 5.Work at home 6.Paying above market 6. Use of competencies for career development 7.Exempt overtime (cash) 7. Reduced work week 8. Technical pay premiums 8. Job redesign 9. Exempt overtime (compensatory time 9. Sabbaticals off) Table 2: Monetary and Non-monetary rewards KPIs may be differentiated in many ways: Directional KPI give a simple better-or-worse rating for a specific area in the business and evaluate whether the business is improving or not. Quantifiable KPI rating is represented as a number and allow for more accurate data analysis. Non-numeric KPI non-numeric form that may be translated into numbers. Usually, user rating system of Poor, Fair, Good, and Excellent is translated to a number scale of one to four.

19 Lastly, it is critical to recognize whether KPIs are still within the ability of the business to change or not. Customer reduction due to inflation is not actionable for the company, and is thus less important than KPIs, which may be directly acted ahead by the business. Overall, KPI has offered an outstanding opportunity for businesses to target specific areas of desired growth and achieve maximum results.

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