4 The balanced scorecard

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1 SUPPLEMENT TO THE APRIL 2009 EDITION Three topics that appeared in the 2007 syllabus have been removed from the revised syllabus examinable from November If you have the April 2009 edition of the Reference Text, and are attempting the examination before November 2009, you will need to study these three topics from the text below. 4 The balanced scorecard Origins of the balanced scorecard 4.1 A problem with traditional performance measurement techniques is that whilst any particular KPI can be aligned to an overall business objective, its achievement might very well be at the expense of another part of the business. For example, there might be an overall business objective to reduce costs and in response to this purchasing source from a capable, but cheaper and untried supplier. The result is a reduction in overall purchase costs but because of poor delivery performance and repeated quality problems from the new supplier the overall total costs to the business actually increase. 4.2 In 1993, Robert Kaplan (Harvard School of Business) and David Norton (consultant) developed an alternative approach to developing business metrics called the balanced scorecard. The balanced scorecard is an approach to performance measurement that combines traditional financial measures with non-financial measures; it uses both quantitative and qualitative metrics. The balanced scorecard approach to performance measurement provides management with a more integrated and balanced framework of metrics that can be cascaded to all levels of the business and used in pursuit of overall corporate objectives. 4.3 Peter Senge (in his book The Fifth Discipline) notes that many leaders have personal visions that never get translated into shared visions that galvanise an organisation. A key cause of this problem is that the development of traditional performance metrics has been dominated by the financial perspective of the business. 4.4 As important as the financial consideration is to the business these traditional quantitative measures provide little in the way of guidance for long-term employee decision-making in the pursuit of company objectives. The balanced scorecard attempts to use measurement as a facilitating mechanism that enables organisations to translate vision into operational focus. Balanced scorecard technique 4.5 Central to the balanced scorecard approach is the vision and associated strategy of the organisation. A framework of performance measures to support this vision is developed by considering the following four business perspectives. Customer Financial Internal business processes Learning and growth

2 4.6 These four perspectives are illustrated in Figure 3.2. Figure 3.2 The balanced scorecard Financial perspectives To succeed financially, how should we appear to our shareholders? Customer perspective To achieve our vision, how should we appear to our customers? Vision and strategy Internal business processes To satisfy shareholders and customers, what business processes must we excel at? Learning and growth To achieve our vision, how will we sustain our ability to change and improve? The customer perspective 4.7 To develop measurements for this perspective two key tasks must be completed. Define the target customers Decide how to service them 4.8 The problem within many businesses is that the approach to the customer is very generic in nature: they attempt to serve all customers in the same manner. There is little or no differentiation that will provide possible competitive advantage in the market. 4.9 Typical company indicators for this perspective will normally include measures such as: Customer satisfaction Customer retention Market share The internal process perspective 4.10 From this perspective, the task is to identify those key processes the organisation must excel at in order to continue adding value in the eyes of customers and other stakeholders. Having identified these key processes the next step is to develop the most appropriate performance measures with which to track progress To satisfy customer and stakeholder expectations it may be necessary to consider more innovative solutions rather than concentrating efforts and resources on incremental improvements to existing activities. All internal supply chain activities should be considered within this perspective, including consideration of the many internal customers along the chain Increasingly, enterprises are utilising third party arrangements to achieve competitive advantage (eg by outsourcing). In these instances consideration should also be given to developing performance measures to represent the linkages within the interface with the third-party provision.

3 The learning and growth perspective 4.13 Here, the key focus initially should be on the business enablers that underpin business success. The learning and growth perspective is analogous to the enablers of the other three perspectives in that the people skills and knowledge provide the foundations for all future progress Having identified the relevant performance measures related to the goals of the customer and internal process perspectives it is necessary to undertake a gap analysis between the current business infrastructure and that required to achieve future goals and targets. This will invariably cover issues such as employee skills, information systems, organisational structures etc. The performance measures developed for this perspective are targeted to close any identified areas from the gap analysis. Financial measures 4.15 Financial measures are an important component of any organisational balanced scorecard. This is true for both profit and not-for-profit organisations. Even in the not-for-profit environment there is an absolute necessity to formulate business measurements and targets that fit within current budgetary constraints Considering the business profit environments, the measures in this perspective should be designed to inform us as to whether operational execution of the intended corporate strategy is achieving improved bottom line results. It is common for businesses to focus their resources and energy on achieving enhanced customer satisfaction etc but without an indication of their impact on the organisational bottom line such indicators are of limited value By giving due consideration to the scorecard s four perspectives, organisations develop the framework for defining, implementing and managing strategy at all levels of the business; the scorecard approach facilitates the linking of operational objectives, initiatives and metrics to the overall organisation mission However, having defined performance criteria related to the four business perspectives it is equally important not to view these developed metrics as a static list of measures, but rather a framework for implementing and aligning complex programmes of change within the business that will constantly evolve over time. Key points related to the scoreboard approach 4.19 The balanced scorecard can often act as a reality check for the developed business strategy. The scorecard should reflect the business strategy and related assumptions. However, if improvement in one area of the business does not lead to expected improvement elsewhere, there may be something wrong with the theory underlying the strategy. For example, the developed strategy might be achievable but may not be realistic within the given time frame The balanced scorecard should present a balance between lag indicators (retrospective) and lead indicators (futuristic) The scorecards developed for individual functions should contain only those performance measures they can actually influence. As the scorecard system is cascaded deeper into the organisational structure this will often mean fewer performance measures are posted The motivational potential of the balanced scorecard should not be ignored. It can be a powerful catalyst in the pursuit of continuous improvement.

4 The balanced scorecard and the supply chain 4.23 So far we have been considering the enterprise in a standalone context. However, as the focus to develop complete supply chains intensifies, can the balanced scorecard be used in a multi-enterprise application? 4.24 This is certainly possible in principle. However, research evidence to date indicates that only minimal development has been recorded in this direction. What might be the future driver of this development, if indeed it has a future? One potential major driver is where organisations are dependent upon the strength of their supply chain to gain competitive advantage The multi-enterprise scoreboard concept has future possibilities if members of a particular supply chain can agree common targets that are linked to a common strategy where all the scorecard results are being positively utilised as drivers of continuous improvement. Currently, however, many organisations will consider that successfully applying the scorecard in a single enterprise is a big enough challenge in itself. The balanced scorecard and the purchasing environment 4.26 Once the strategic level scorecard has been developed, this in turn must be cascaded through the organisation. At this stage it is essential that a structured alignment process is undertaken to ensure the appropriate level of integration is achieved at the functional level to underpin the planned enterprise objectives The strategic priorities of the enterprise will normally be incorporated into departmental or divisional business plans prior to being integrated into the functional support units, such as purchasing. At this stage, the priorities of the customer perspective proposals are communicated to the targeted customers to gain feedback and agreement. In the purchasing context these proposals, where applicable, can be further developed and cascaded to the supplier interface This structured scorecard cascading approach enables the procurement function to establish a set of strategically orientated performance metrics in support of the overall business objectives. In addition, these developed metrics provide purchasing management with a comprehensive view of the organisation's objectives and performance that in turn aids communication and the decision making process within the functional activity A typically developed scorecard for the purchasing function is illustrated in Table 3.4. Supplier balanced scorecards 4.30 The concept of the scorecard has been extended to supplier enterprises where the associated metrics are commonly referred to as supplier balanced scorecard (SBS). In this form the metrics package is constructed to measure the ongoing supply situation. In order for the supplier to meet ongoing requirements and expectations it is vital to provide them with feedback about their performance. Indeed, many companies allow their suppliers to access this measurement analysis online via the buyer s web pages The models used for this SBS formulation can range from standardised models to those that are bespoke to meet the organisational needs. A typical SBS model by which supplier performance is measured is illustrated in Table The factors and the associated weighting used in the SBS model will vary to accommodate each business requirement. The weighting for each factor used will usually have a direct alignment with the customer s strategic objectives.

5 4.33 Each supplier s performance is assessed in the following manner. For each factor, the total scores for each measurement criterion are summed (max 1.0) and multiplied by the factor weighting All the factor scores are totalled and a score out of 5.0 is recorded The factor and criterion scores are formulated via conversion tables devised by the customer. The resultant final score will enable an overall supplier rating to be established for the supplier The resultant data from the SBS analysis, if used in a positive two-way manner with the supplier, can be used to establish further improvement targets. Where deficiencies of performance are recorded these can be subjected to gap analysis with a view to setting action targets for improvement. Table 3.4 A balanced scorecard for the purchasing function Scorecard perspective Customer (internal perspective, eg production departments) Financial (cost reduction and revenue generation) Internal processes (functional efficiency improvements) Functional goal Increase number of orders delivered on time Improve internal client satisfaction Reduce number of reported stock outs Improve internal customer communication channels Achieve increased environmentally orientated focus Negotiate and award new collaborative contracts Increase purchasing leverage via collaborative partnerships Reduce purchasing administration overheads via the increased usage of vendormanaged inventory (VMI) Increase number of purchase orders placed via e- procurement Improve departmental turn time for processing requisitions Increase number of e- procurement suppliers Increase purchasing employee training in hours Purchasing measures % orders delivered on time vs. number of deliveries due Internal survey trend analysis quarterly Monthly trend of reported stockouts Number of purchasing-led internal meetings held per month Cost saving achieved per quarter via renegotiated green suppliers Number of new contracts awarded monthly Cost savings achieved per quarter Number of VMI supply partnerships created per quarter and associated overhead savings ( ) Number of e-procurement orders per quarter (%) reduction of cycle times per quarter Suppliers added per quarter (%) of training hours vs. total available hours

6 Learning and growth Performance evaluations completed annually Performance evaluations with PDP targets aligned with strategic objectives (PDP = personal development plan) (%) of evaluations completed Number of quarterly aligned personal development plan targets Table 3.5 A supplier balanced scorecard Factor Weighting (%) Points award Measurement criterion Quality PPM (0.7) Reject frequency (0.3) Delivery On-time-in-full delivery (1.0) Support systems Quality management systems, eg ISO 9000 (1.0) Commercial Cost savings (0.7) After-sales support (0.3) Total

7 2 Managing supplier relationships Defining trust: the work of Mari Sako 2.1 Many organisations are integrating components of their supply chains in an attempt to achieve competitive advantage. This integration may be achieved by mergers and acquisitions, but is increasingly the result of collaborative relationships between organisations that remain legally distinct. 2.2 Collaborative business partnerships rely significantly on trust. Professor Mari Sako has analysed the role of trust in the development of buyer-supplier relationships. She defines three possible levels of trust that may be achieved to develop an effective and lasting relationship between buyer and supplier organisations. Contractual trust Competence trust Goodwill trust 2.3 Contractual trust emerges when both buyer and supplier organisation do what they say they are going to do. This implies that trading partners are dependable and can follow through on promises. This also allows higher levels of business cooperation and reinforces trust. 2.4 This level of trust is founded on historical performance measures such as reliability and dependability. Achieving consistent business performance and behaviours leads to a foundation of familiarity between trading partners. 2.5 Competence trust refers to the ability of a supplier organisation to complete products and services to a specified standard. Competence trust is therefore underpinned by the supplier s skill and technical knowledge. A common focal point of competence based trust is that of product quality. For example, the buyer organisation develops trust in the technical ability of the supplier and therefore no longer feels the need to inspect incoming products. This level of trust provides the opportunity to achieve savings in costs and time. 2.6 Sako says that goodwill trust occurs when a trading partner believes the other trading partner is honest and dependable. Goodwill trust is an extension from both competence and contractual trust. For example, a supplier motivated by mutual benefits achieves above and beyond what was originally expected and performs beyond the contractual terms and conditions. 2.7 This level of trust is based on mutual empathy and will often lead to an increased level of cooperation, open communication, information sharing, and commitment to increased participation in innovative supply solutions. 2.8 Sako argues that trust is a cumulative process that takes time to build. Contractual trust can be established before competence trust, which in turn will lead to the development of goodwill trust. This may be a lengthy process but the time scale can be reduced by prior knowledge and mutual contacts. 2.9 Sako explores the critical relationship between trust and achieving improved business performance. In addition Sako investigates how trust can be created between businesses where there is currently none.

8 2.10 In linking trust to business performance, she argues that there should be a move away from the framework based on minimising transaction costs towards one with a focus on learning and innovation. Her main hypothesis is that among the three types of trust, goodwill trust would have the strongest impact on performance In relation to the creation of trust Sako recommends a move away from a framework which focuses on safeguards against the abuse of trust towards thinking about enhancers of trust. The latter are like gift exchanges based on loose reciprocal arrangements over time.

9 4 Cross-functional negotiation Roles and responsibilities 4.1 The basic concept of cross-functional working within organisations is gaining momentum in business environments. The thinking behind the technique is to harness the core competencies within the organisation to maximum effect. Internal cross-functional negotiation 4.2 It is often stated that the majority of the product or service cost is fixed before the moment when the purchasing function begin negotiations with suppliers. The specification developed internally often remains unchallenged. In reality, however, the costs that can possibly be negotiated are often far greater during the specification phase than during negotiation with suppliers. 4.3 The role of purchasing can be focused internally to engage in a cross-functional negotiation process. The same negotiation skills can be used internally to challenge the status quo and promote alternative solutions. The basic approach to negotiation is the same when applied to internal applications as we have already seen with external negotiations. 4.4 Buddress and Raedels (Negotiating With Engineers and Other Internal Customers) suggest the following sequence of activities for internal negotiations. Recognition of negotiation opportunity Recognition of negotiation environment Determination of true needs and wants of the internal customer Determination of methods to meet customer needs Execution of methods Measurement and analysis of results Continuous improvement 4.5 Buddress and Raedels suggest that the first four steps in the above sequence can be collectively grouped together under the process of negotiation planning. They argue that the success or failure of any negotiation is largely the result of the planning process. Carefully conceived, thoroughly researched and developed negotiation plans usually yield superior results. 4.6 The authors further argue that often the opportunity to internally negotiate is overlooked. Even if it is noticed, plans are often not developed for internal negotiations because of the lack of time. Even if they are prepared, this may not be with the same diligence as for external negotiations. 4.7 The negotiating skill base can therefore be used in both internal and external applications. The function of purchasing can add significant value to organisational supply chain processes. This multi-directional negotiation activity remains largely undeveloped within many organisations.

10 4.8 Buddress and Raedels suggest that the development and application of the internal negotiation process should not be confined to the purchasing department. With developed negotiation skills other intra-functional activities can also benefit from questioning and negotiating business requirements. The authors propose that successful internal negotiations must reflect other factors: establishing internal credibility; artful questioning; developing alternative solutions. 4.9 Establishing internal credibility Try to be fluent in the technical jargon of the business and specifically the internal party Have a clear understanding of the overall functionality of the business not just your function Apply communication skills and professional behaviour 4.10 Artful questioning Well thought-out questions help improve knowledge of important issues such as technical specifications and requirements. Meaningful questioning can often develop empathy with the negotiation party Develop alternative solutions Prior to the negotiation process try to develop a number of alternative solutions that are acceptable to both parties; avoid, if possible, the mentality of a one best way solution to a situation. Spending time to explore alternatives often yields significant results There is frequent opportunity for the purchasing function to engage in internal business negotiations. Engaging in internal cross-functional negotiations can often yield substantive value and cost savings. These internal savings can often be more significant than the buyer might achieve via the external negotiation process. In addition, this internal process fine tunes buyer negotiation skills as well as providing the opportunity to develop internal relationships.