The Balanced Scorecard: Translating Strategy Into Action (14 page)
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Authors: Robert S. Kaplan,David P. Norton
Tags: #Non-Fiction, #Business
Quality was a critical competitive dimension during the 1980s and remains important to this day. By the mid-1990s, however, quality has shifted from a strategic advantage to a competitive necessity. Many organizations that could not reliably deliver defect-free products or services have ceased to be serious competitors. Because of all the attention devoted to improving quality during the past 15 years, it may offer limited opportunities for competitive advantage. It has become a hygiene factor; customers take for granted that their suppliers will execute according to product and service specifications. Nevertheless, for certain industries, regions, or market segments, excellent quality may still offer opportunities for companies to distinguish themselves from their competitors. In this case, customer-perceived quality measures would be highly appropriate to include in the BSC’s customer perspective.
Quality measures for manufactured goods could be measured by incidence of defects, say part-per-million defect rates, as measured by customers. Motorola’s famed 6σ program strives to reduce defects to fewer than
10 PPM. Frequently, third-party evaluations provide feedback on quality. The J. D. Power organization provides information and rankings on defects and perceived quality in automobiles and airlines. The Department of Transportation provides information on the frequency of late arrivals and lost baggage by airline.
Other readily available quality measures include returns by customers, warranty claims, and field service requests. Service companies have a particular problem not faced by manufacturers. When a manufacturer’s product or piece of equipment fails to work or satisfy the customer, the customer will usually return the product or call the company asking for repairs to be made. In contrast, when a quality failure occurs in a service company, the customer has nothing to return and usually no one responsive to complain to. The customer’s response is to cease patronizing the organization. The service organization may eventually note a decline in business and market share, but such a signal is delayed and almost impossible to reverse. The organization will typically not even know the identity of customers who tried the service, were poorly treated, and then decided never to use that organization’s services again. For this reason, several service firms offer service guarantees.
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This offer, to immediately refund not only the purchase price but generally a premium above the purchase price, provides several valuable benefits to a company. First, a guarantee allows it to retain a customer who otherwise might be lost forever. Second, an organization receives a signal about the incidence of defective service, enabling it to initiate a program of corrective action. And, finally, knowledge of the existence of the service guarantee provides strong motivation and incentives for the people delivering customer service to avoid defects that would trigger a request for the guarantee. Thus, companies that have service guarantee programs will likely want to include the incidence and cost of service guarantees as measures in their customer’s perspective.
Quality can also refer to performance along the time dimension. The on-time delivery measure, previously discussed, is actually a measure of the quality of the company’s performance to its promised delivery date.
With all the emphasis on time, responsiveness and quality, one might wonder whether customers still care about price. One can be assured that whether a business unit is following a low-cost or a differentiated strategy,
customers will
always
be concerned with the price they pay for the product or service. In market segments where price is a major influence on the purchasing decision, units can track their net selling price (after discounts and allowances) with that of competitors. If the product or service is sold after a competitive bidding process, the percentage of bids won, especially in targeted segments, would provide an indication of the unit’s price competitiveness.
Even price-sensitive customers, however, may favor suppliers that offer not low prices, but low costs to acquire and use the product or service. At first glance, one may think we are playing with semantics by distinguishing between low price and low cost, but real and important differences exist between them. Take a manufacturing company that is sourcing a key purchased part from a supplier. The low-price supplier may turn out to be an extremely high-cost supplier. The low-price supplier may only deliver in large quantities, thereby requiring extensive storage space, receiving, and handling resources, plus the cost of capital associated with buying and paying for the parts well in advance of when they are used. The low-price supplier may also not be a certified supplier; that is, the quality of the parts received is not guaranteed to conform to the buyer’s specifications. Therefore, the buying company has to inspect the incoming items, return those found to be defective, and arrange for replacement parts to arrive (which themselves have to inspected). The low-price supplier may also not have a stellar on-time delivery capability. Its failure to deliver reliably at scheduled times causes the buying company to order well in advance of need and hold protective stock in case delivery is not when expected. Late deliveries cause higher costs for expediting orders and rescheduling the plant around the missing items. And low-price suppliers may not be electronically connected to their customers, thereby imposing higher costs on customers when they order and pay for the purchased parts.
In contrast, a low-cost supplier may have a slightly higher purchase price but delivers defect-free products, directly to the workstation, just-in-time, as they are needed. The low-cost supplier also enables customers to order and pay electronically. The buying company incurs virtually no costs for ordering, receiving, inspecting, storing, handling, expediting, rescheduling, rework, and paying for parts purchased from this low-cost supplier. Some companies, as mentioned in the chapter, allow certain suppliers to replace their purchasing function, not taking ownership of parts until they are released, just-in-time, directly to a workstation. Suppliers should strive to
organize their production and business processes so that they can be their customers’ lowest-cost supplier. They may choose to compete along the cost (to the customer) dimension, not just by offering low prices and discounts. Such a measure requires that the supplier set an objective to minimize its customers’ total costs for acquiring parts.
Companies in several industries have the opportunity to do even better than become their customers’ lowest-cost supplier. If the customer is an organization that resells purchased items to its own customers and consumers, like a distributor, wholesaler, or retailer, the supplier can strive to become its customers’ most profitable supplier. Using activity-based costing techniques, the supplier can work with its customers to build an ABC model that enables the customer to calculate the profitability by supplier. For example, Maplehurst, a frozen bakery goods company, works directly with its customers—in-store bakeries in supermarkets—to calculate the profitability by different classes of products: purchased bread, cakes, and muffins; in-store prepared goods; and in-store heated frozen bakery products (Maplehurst’s product line). Maplehurst has been able to demonstrate to customers that the frozen (and subsequently in-store heated) goods are among the most profitable in the product line, a discovery that invariably leads to increased business for Maplehurst.
The current battle between national branded beverages, such as Coca-Cola and Pepsi-Cola, versus retail-branded private labels, like President’s Choice and Safeway Select, is being fought on both sides by calculations for the retail grocery store about which product is more profitable for the store to stock and sell. The calculation is more complex than the traditional gross margin (net selling price less purchase price) used by most distributors, wholesalers, and retailers to calculate their profitability by product line or supplier. For example, the national-branded beverage companies deliver their product directly to the store and have their delivery people stock the product on the shelves. The retail-branded beverage companies deliver their product to warehouses and require the store to spend its resources for receiving, handling, storing, delivery, and merchandising. But the national brands also tend to occupy some of the most visible and valuable space in the stores, whereas the retail-branded products occupy normal shelf space. So care must be taken to correctly and fully account for all costs when comparing the profitability of alternative suppliers.
The benefits, to the excellent supplier, from a customer’s profitability calculation are enormous. What more powerful message can a company
deliver to its customers than a demonstration that it is the most profitable supplier the customer has? Thus, a company supplying customers that stock and re-sell their products or services, can drive customer satisfaction, loyalty, and retention by measuring its customers’ profitability and striving to become a highly profitable supplier. Of course, the supplier must also balance this measure by calculating its own profitability of supplying each of its customers. Decreasing its own profitability to increase its customers’ may lead to satisfied and loyal customers but not happy shareholders and bankers.
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. See discussion of boundary systems in R. Simons,
Levers of Control: How Managers Use Innovative Control Systems to Drive Strategic Renewal
(Boston: Harvard Business School Press, 1995), 47–55, 156.
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. J. Heskett, T. Jones, G. Loveman, E. Sasser, and L. Schlesinger, “Putting the Service Profit Chain to Work,”
Harvard Business Review
(March–April 1994): 164–174.
3
. T. O. Jones and W. E. Sasser, “Why Satisfied Customers Defect,”
Harvard Business Review
(November–December 1995): 88–99.
4
. R. Cooper and R. S. Kaplan, “Profit Priorities from Activity-Based Costing,”
Harvard Business Review
(May–June 1991): 130–135.
5
. C. Hart, “The Power of Unconditional Service Guarantees,”
Harvard Business Review
(July–August 1988): 54–62; and J. Heskett, E. Sasser, and C. Hart,
Service Breakthroughs: Changing the Rules of the Game
(New York: Free Press, 1990).
C h a p t e r F i v eInternal-Business-Process Perspective
F
OR THE INTERNAL-BUSINESS-PROCESS PERSPECTIVE
, managers identify the processes that are most critical for achieving customer and shareholder objectives. Companies typically develop their objectives and measures for this perspective after formulating objectives and measures for the financial and customer perspectives. This sequence enables companies to focus their internal-business-process metrics on those processes that will deliver the objectives established for customers and shareholders.
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Most organizations’ existing performance measurement systems focus on improving existing operating processes. For the Balanced Scorecard, we recommend that managers define a complete internal-process value chain that starts with the innovation process—identifying current and future customers’ needs and developing new solutions for these needs—proceeds through the operations process—delivering existing products and services to existing customers—and ends with postsale service—offering services after the sale that add to the value customers receive from a company’s product and service offerings.
The process of deriving objectives and measures for the internal-business-process perspective represents one of the sharpest distinctions between the Balanced Scorecard and traditional performance measurement systems. Traditional performance measurement systems focus on controlling and improving existing responsibility centers and departments. The limitations of relying exclusively on financial measurements and monthly variance reports for controlling such departmental operations are, of course, well
known.
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Fortunately, most organizations today have moved well beyond using variance analysis of financial results as their primary method for evaluation and control. They are supplementing financial measurements with measures of quality, yield, throughput, and cycle time.
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These more comprehensive performance measurement systems are certainly an improvement over exclusive reliance on monthly variance reports, but they still attempt to improve performance of individual departments rather than of integrated business processes. So more recent trends encourage companies to measure performance of business processes like order fulfillment, procurement, and production planning and control that span several organizational departments. Typically, cost, quality, throughput, and time measures would be defined and measured for these processes.
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For most companies today, having multiple measurements for cross-functional and integrated business processes represents a significant improvement over their existing performance measurement systems. Indeed, this is the goal we set for ourselves when we launched, back in 1990, a one-year performance measurement project with a dozen companies. This project, building on the experience of Analog Devices and other companies, led to our formulation of the Balanced Scorecard as a new corporate measurement system.
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Subsequent work with innovating companies has revealed to us the limitations of even these improved performance-measurement systems. We believe that simply using financial and nonfinancial performance measures for existing business processes will not lead companies to make major improvements in their economic performance. Merely slapping performance measures on existing or even reengineered processes can drive local improvements, but are unlikely to produce ambitious objectives for customers and shareholders.
All companies are now attempting to improve quality, reduce cycle times, increase yields, maximize throughput, and lower costs for their business processes. Therefore, an exclusive focus on improving the cycle time, throughput, quality, and cost of existing processes may not lead to unique competencies. Unless one can outperform competitors across the board on all business processes, in quality, time, productivity, and cost, such improvements will facilitate survival, but will not lead to distinctive and sustainable competitive advantages.
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In the Balanced Scorecard, the objectives and measures for the internal-business-process perspective are derived from explicit strategies to meet
shareholder and targeted customer expectations. This sequential, top-down process will usually reveal entirely new business processes at which an organization must excel.
Rockwater’s experience provides two vivid examples of why entirely new business processes may be required if companies are to achieve their financial and customer objectives. Recall, from
Chapter 3
, that Rockwater was plagued by long closeout cycles at the end of many of its construction projects. Some customers delayed their final payment by more than 100 days, leading to high accounts receivable and low return-on-capital-employed. Rockwater executives specified, as one of their financial objectives, to reduce the length of this closeout cycle so that ROCE would improve. In constructing the Rockwater scorecard, managers linked this financial objective to an internal process to collect end-of-project payments faster. A simplistic analysis would have directed attention to the existing accounts receivable process and attempted to identify the problems in that process, which led to 110-day collection periods. But the root cause of 110-day collection periods was not to be found in the accounts receivable department. No amount of quality improvement or reengineering of the accounts receivable process would do much to reduce the long closeout cycles. Customers were delaying paying their bills not because they were unaware of the invoice or because they needed more reminders and coaxing from accounts receivable clerks to pay their bill. The customers were not paying on time because, from their point of view, the project had yet to be successfully completed.
Anyone who has been involved with contractors, particularly in home construction or renovation projects, has learned that the contractor’s definition of when a project has been successfully completed often differs considerably from the customer’s definition of a successful completion. Thus, although Rockwater’s engineers had completed the last scheduled weld on the pipeline, and had already moved on to their next project, the customer may have been less than completely satisfied with the results. One of the few ways that customers have of communicating the difference in opinion they have with contractors about the definition of project completion is to withhold the final payment until the additional work is done so that both parties agree that the project is indeed completed.
The solution for Rockwater’s long closeout cycle did not lie with additional training, education, or even technology in the accounts receivable department. The solution had to come from greatly improved communication
between Rockwater’s on-site project manager and the customer’s representative. Such communication would reveal, much earlier, any concerns that the customer had about the work already performed and the progress of the project. Ideally, if communication occurred on a continual basis throughout the project, with the customer kept satisfied during every stage, the final payment should be made promptly. So Rockwater identified, as an entirely new internal process, that project managers should continually be communicating with the customer about the progress and expected completion of the project, and asking the customer for prompt payment at every scheduled milestone, especially the final payment upon project completion. The process stressed that project engineers needed to focus on the commercial success of a project, not just technical success. This new internal process for project engineers and managers was revealed and derived from the financial objective to increase return-on-capital-employed.
A second example of a new internal process arose from Rockwater’s customer objective to become a preferred supplier to its Tier 1 customers. Rockwater executives recognized that if they were to win business from Tier 1 customers, they would have to offer services that those customers valued. The problem was how to determine what those services were. Rather than take a large one-time survey of customers, Rockwater executives wanted their managers, as part of their day-to-day activities, to continually learn about customers’ evolving needs. The services could include innovative technologies for operating in hostile undersea environments, increased concern about management of safety, new project financing methods, or enhanced project-management methodologies. Rockwater established an internal process objective, to be able to anticipate and influence its customers’ future needs. This was an entirely new process for the company. In the past, Rockwater responded reactively—waiting for a customer’s request for tender, and then preparing a work plan and a bid price. In the future, it would act proactively, by influencing the content of their customers’ requests for tenders.
Thus, the process of linking internal-business-process objectives to financial and customer objectives revealed to Rockwater executives two entirely new internal processes at which they must excel:
- Manage existing project relationships to facilitate a fast closeout cycle
- Anticipate and influence customers’ future requests
