Question

BUDGETING

i. what are budget design issues and solutions that may be adapted to solve these issues? [10 marks]

BALANCE SCORECARD

i. how does the balance scorecard help to deliver a manufacturing firm's mission statement using the four perspectives?

The following are the mission statements of the firm:

• Provide superior returns to our shareholders
• Continually improve our business processes
• Delight our customers
• Learn from our mistakes and work smarter in the future

[16 marks]

Answer 1

Rockwater’s senior management team transformed its vision and strategy into the balanced scorecard’s four sets of performance measures (see the chart “Rockwater’s Balanced Scorecard”):

Financial Measures:

The financial perspective included three measures of importance to the shareholder. Return-on-capital-employed and cash flow reflected preferences for short-term results, while forecast reliability signaled the corporate parent’s desire to reduce the historical uncertainty caused by unexpected variations in performance. Rockwater management added two financial measures. Project profitability provided focus on the project as the basic unit for planning and control, and sales backlog helped reduce uncertainty of performance.

Customer Satisfaction:

Rockwater wanted to recognize the distinction between its two types of customers: Tier I customers, oil companies that wanted a high value-added relationship, and Tier II customers, those that chose suppliers solely on the basis of price. A price index, incorporating the best available intelligence on competitive position, was included to ensure that Rockwater could still retain Tier II customers’ business when required by competitive conditions.

The company’s strategy, however, was to emphasize value-based business. An independent organization conducted an annual survey to rank customers’ perceptions of Rockwater’s services compared to those of its competitors. In addition, Tier I customers were asked to supply monthly satisfaction and performance ratings. Rockwater executives felt that implementing these ratings gave them a direct tie to their customers and a level of market feedback unsurpassed in most industries. Finally, market share by key accounts provided objective evidence that improvements in customer satisfaction were being translated into tangible benefits.

Internal Processes:

To develop measures of internal processes, Rockwater executives defined the life cycle of a project from launch (when a customer need was recognized) to completion (when the customer need had been satisfied). Measures were formulated for each of the five business-process phases in this project cycle (see the chart “How Rockwater Fulfills Customer Needs”):

How Rockwater Fulfills Customer Needs

• ; number of hours spent with prospects discussing new work

• ; tender success rate

• ; project performance effectiveness index, safety/loss control, rework

• . : length of project closeout cycle

The internal business measures emphasized a major shift in Rockwater’s thinking. Formerly, the company stressed performance for each functional department. The new focus emphasized measures that integrated key business processes. The development of a comprehensive and timely index of project performance effectiveness was viewed as a key core competency for the company. Rockwater felt that safety was also a major competitive factor. Internal studies had revealed that the indirect costs from an accident could be 5 to 50 times the direct costs. The scorecard included a safety index, derived from a comprehensive safety measurement system, that could identify and classify all undesired events with the potential for harm to people, property, or process.

The Rockwater team deliberated about the choice of metric for the identification stage. It recognized that hours spent with key prospects discussing new work was an input or process measure rather than an output measure. The management team wanted a metric that would clearly communicate to all members of the organization the importance of building relationships with and satisfying customers. The team believed that spending quality time with key customers was a prerequisite for influencing results. This input measure was deliberately chosen to educate employees about the importance of working closely to identify and satisfy customer needs.

Rockwater’s executives wanted a metric that would communicate the importance of building relationships with customers.

Innovation and Improvement:

The innovation and learning objectives are intended to drive improvement in financial, customer, and internal process performance. At Rockwater, such improvements came from product and service innovation that would create new sources of revenue and market expansion, as well as from continuous improvement in internal work processes. The first objective was measured by percent revenue from new services and the second objective by a continuous improvement index that represented the rate of improvement of several key operational measures, such as safety and rework. But in order to drive both product/service innovation and operational improvements, a supportive climate of empowered, motivated employees was believed necessary. A staff attitude survey and a metric for the number of employee suggestions measured whether or not such a climate was being created. Finally, revenue per employee measured the outcomes of employee commitment and training programs.

The balanced scorecard has helped Rockwater’s management emphasize a process view of operations, motivate its employees, and incorporate client feedback into its operations. It developed a consensus on the necessity of creating partnerships with key customers, the importance of order-of-magnitude reductions in safety-related incidents, and the need for improved management at every phase of multiyear projects. Chambers sees the scorecard as an invaluable tool to help his company ultimately achieve its mission: to be number one in the industry.

Apple Computer: Adjusting Long-Term Performance

Apple Computer developed a balanced scorecard to focus senior management on a strategy that would expand discussions beyond gross margin, return on equity, and market share. A small steering committee, intimately familiar with the deliberations and strategic thinking of Apple’s Executive Management Team, chose to concentrate on measurement categories within each of the four perspectives and to select multiple measurements within each category. For the financial perspective, Apple emphasized shareholder value; for the customer perspective, market share and customer satisfaction; for the internal process perspective, core competencies; and, finally, for the innovation and improvement perspective, employee attitudes. Apple’s management stressed these categories in the following order:

Customer Satisfaction:

Historically, Apple had been a technology- and product-focused company that competed by designing better computers. Customer satisfaction metrics are just being introduced to orient employees toward becoming a customer-driven company. J.D. Power & Associates, a customer-survey company, now works for the computer industry. However, because it recognized that its customer base was not homogeneous, Apple felt that it had to go beyond J.D. Power & Associates and develop its own independent surveys in order to track its key market segments around the world.

Once a technology- and product-focused company, Apple has introduced measures that shift the emphasis toward customers.

Core Competencies:

Company executives wanted employees to be highly focused on a few key competencies: for example, user-friendly interfaces, powerful software architectures, and effective distribution systems. However, senior executives recognized that measuring performance along these competency dimensions could be difficult. As a result, the company is currently experimenting with obtaining quantitative measures of these hard-to-measure competencies.

Employee Commitment and Alignment:

Apple conducts a comprehensive employee survey in each of its organizations every two years; surveys of randomly selected employees are performed more frequently. The survey questions are concerned with how well employees understand the company’s strategy as well as whether or not they are asked to deliver results that are consistent with that strategy. The results of the survey are displayed in terms of both the actual level of employee responses and the overall trend of responses.

Market Share:

Achieving a critical threshold of market share was important to senior management not only for the obvious sales growth benefits but also to attract and retain software developers to Apple platforms.

Shareholder Value:

Shareholder value is included as a performance indicator, even though this measure is a result—not a driver—of performance. The measure is included to offset the previous emphasis on gross margin and sales growth, measures that ignored the investments required today to generate growth for tomorrow. In contrast, the shareholder value metric quantifies the impact of proposed investments for business creation and development. The majority of Apple’s business is organized on a functional basis—sales, product design, and worldwide manufacturing and operations—so shareholder value can be calculated only for the entire company instead of at a decentralized level. The measure, however, helps senior managers in each major organizational unit assess the impact of their activities on the entire company’s valuation and evaluate new business ventures.

While these five performance indicators have only recently been developed, they have helped Apple’s senior managers focus their strategy in a number of ways. First of all, the balanced scorecard at Apple serves primarily as a planning device, instead of as a control device. To put it another way, Apple uses the measures to adjust the “long wave” of corporate performance, not to drive operating changes. Moreover, the metrics at Apple, with the exception of shareholder value, can be driven both horizontally and vertically into each functional organization. Considered vertically, each individual measure can be broken down into its component parts in order to evaluate how each part contributes to the functioning of the whole. Thought of horizontally, the measures can identify how, for example, design and manufacturing contribute to an area such as customer satisfaction. In addition, Apple has found that its balanced scorecard has helped develop a language of measurable outputs for how to launch and leverage programs.

Apple uses the scorecard as a device to plan long-term performance, not as a device to drive operating changes.

The five performance indicators at Apple are benchmarked against best-in-class organizations. Today they are used to build business plans and are incorporated into senior executives’ compensation plans.

Advanced Micro Devices: Consolidating Strategic Information

Advanced Micro Devices (AMD), a semiconductor company, executed a quick and easy transition to a balanced scorecard. It already had a clearly defined mission, strategy statement, and shared understanding among senior executives about its competitive niche. It also had many performance measures from many different sources and information systems. The balanced scorecard consolidated and focused these diverse measures into a quarterly briefing book that contained seven sections: financial measures; customer-based measures, such as on-time delivery, lead time, and performance-to-schedule; measures of critical business processes in wafer fabrication, assembly and test, new product development, process technology development (e.g., submicron etching precision), and, finally, measures for corporate quality. In addition, organizational learning was measured by imposing targeted rates of improvements for key operating parameters, such as cycle time and yields by process.

At present, AMD sees its scorecard as a systematic repository for strategic information that facilitates long-term trend analysis for planning and performance evaluation.

Driving the Process of Change

The experiences of these companies and others reveal that the balanced scorecard is most successful when it is used to drive the process of change. Rockwater, for instance, came into existence after the merger of two different organizations. Employees came from different cultures, spoke different languages, and had different operating experiences and backgrounds. The balanced scorecard helped the company focus on what it had to do well in order to become the industry leader.

Similarly, Joseph De Feo, chief executive of Service Businesses, one of the three operating divisions of Barclays Bank, had to transform what had been a captive, internal supplier of services into a global competitor. The scorecard highlighted areas where, despite apparent consensus on strategy, there still was considerable disagreement about how to make the strategy operational. With the help of the scorecard, the division eventually achieved consensus concerning the highest priority areas for achievement and improvement and identified additional areas that needed attention, such as quality and productivity. De Feo assessed the impact of the scorecard, saying, “It helped us to drive major change, to become more market oriented, throughout our organization. It provided a shared understanding of our goals and what it took to achieve them.”

Analog Devices, a semiconductor company, served as the prototype for the balanced scorecard and now uses it each year to update the targets and goals for division managers. Jerry Fishman, president of Analog, said, “At the beginning, the scorecard drove significant and considerable change. It still does when we focus attention on particular areas, such as the gross margins on new products. But its main impact today is to help sustain programs that our people have been working on for years.” Recently, the company has been attempting to integrate the scorecard metrics with hoshin planning, a procedure that concentrates an entire company on achieving one or two key objectives each year. Analog’s hoshin objectives have included customer service and new product development, for which measures already exist on the company’s scorecard.

But the scorecard isn’t always the impetus for such dramatic change. For example, AMD’s scorecard has yet to have a significant impact because company management didn’t use it to drive the change process. Before turning to the scorecard, senior managers had already formulated and gained consensus for the company’s mission, strategy, and key performance measures. AMD competes in a single industry segment. The top 12 managers are intimately familiar with the markets, engineering, technology, and other key levers in this segment. The summary and aggregate information in the scorecard were neither new nor surprising to them. And managers of decentralized production units also already had a significant amount of information about their own operations. The scorecard did enable them to see the breadth and totality of company operations, enhancing their ability to become better managers for the entire company. But, on balance, the scorecard could only encapsulate knowledge that managers in general had already learned.

The scorecard enables managers to see the breadth and totality of company operations.

At Advanced Micro Devices, the scorecard only encapsulated knowledge that managers had already learned.

AMD’s limited success with the balanced scorecard demonstrates that the scorecard has its greatest impact when used to drive a change process. Some companies link compensation of senior executives to achieving stretch targets for the scorecard measures. Most are attempting to translate the scorecard into operational measures that become the focus for improvement activities in local units. The scorecard is not just a measurement system; it is a management system to motivate breakthrough competitive performance.

Implementing the Balanced Scorecard at FMC Corporation: An Interview with Larry D. Brady

FMC Corporation is one of the most diversified companies in the United States, producing more than 300 product lines in 21 divisions organized into 5 business segments: industrial chemicals, performance chemicals, precious metals, defense systems, and machinery and equipment. Based in Chicago, FMC has worldwide revenues in excess of $4 billion.

Since 1984, the company has realized annual returns-on-investment of greater than 15%. Coupled with a major recapitalization in 1986, these returns resulted in an increasing shareholder value that significantly exceeded industrial averages. In 1992, the company completed a strategic review to determine the best future course to maximize shareholder value. As a result of that review, FMC adopted a growth strategy to complement its strong operating performance. This strategy required a greater external focus and appreciation of operating trade-offs.

To help make the shift, the company decided to use the balanced scorecard. In this interview conducted by Robert S. Kaplan, Larry D. Brady, executive vice president of FMC, talks about the company’s experience implementing the scorecard.

Robert S. Kaplan: What’s the status of the balanced scorecard at FMC?

Larry D. Brady: Although we are just completing the pilot phase of implementation, I think that the balanced scorecard is likely to become the cornerstone of the management system at FMC. It enables us to translate business unit strategies into a measurement system that meshes with our entire system of management.

For instance, one manager reported that while his division had measured many operating variables in the past, now, because of the scorecard, it had chosen 12 parameters as the key to its strategy implementation. Seven of these strategic variables were entirely new measurements for the division. The manager interpreted this finding as verifying what many other managers were reporting: the scorecard improved the understanding and consistency of strategy implementation. Another manager reported that, unlike monthly financial statements or even his strategic plan, if a rival were to see his scorecard, he would lose his competitive edge.

It’s rare to get that much enthusiasm among divisional managers for a corporate initiative. What led you and them to the balanced scorecard?

FMC had a clearly defined mission: to become our customers’ most valued supplier. We had initiated many of the popular improvement programs: total quality, managing by objectives, organizational effectiveness, building a high-performance organization. But these efforts had not been effective. Every time we promoted a new program, people in each division would sit back and ask, “How is that supposed to fit in with the six other things we’re supposed to be doing?’’

Corporate staff groups were perceived by operating managers as pushing their pet programs on divisions. The diversity of initiatives, each with its own slogan, created confusion and mixed signals about where to concentrate and how the various programs interrelated. At the end of the day, with all these new initiatives, we were still asking division managers to deliver consistent short-term financial performance.

“The diversity of initiatives, each with its own slogan, created confusion and mixed signals.”

What kinds of measures were you using?

The FMC corporate executive team, like most corporate offices, reviews the financial performance of each operating division monthly. As a highly diversified company that redeploys assets from mature cash generators to divisions with significant growth opportunities, the return-on-capital-employed (ROCE) measure was especially important for us. We were one of the few companies to inflation-adjust our internal financial measures so that we could get a more accurate picture of a division’s economic profitability.

At year-end, we rewarded division managers who delivered predictable financial performance. We had run the company tightly for the past 20 years and had been successful. But it was becoming less clear where future growth would come from and where the company should look for breakthroughs into new areas. We had become a high return-on-investment company but had less potential for further growth. It was also not at all clear from our financial reports what progress we were making in implementing long-term initiatives. Questions from the corporate office about spending versus budget also reinforced a focus on the short-term and on internal operations.

But the problem went even deeper than that. Think about it. What is the value added of a corporate office that concentrates on making division managers accountable for financial results that can be added up across divisions? We combine a business that’s doing well with a business that’s doing poorly and have a total business that performs at an average level. Why not split the company up into independent companies and let the market reallocate capital? If we were going to create value by managing a group of diversified companies, we had to understand and provide strategic focus to their operations. We had to be sure that each division had a strategy that would give it sustainable competitive advantage. In addition, we had to be able to assess, through measurement of their operations, whether or not the divisions were meeting their strategic objectives.

If you’re going to ask a division or the corporation to change its strategy, you had better change the system of measurement to be consistent with the new strategy.

“If you’re going to ask a division or the corporation to change its strategy, you had better change the system of measurement.”

How did the balanced scorecard emerge as the remedy to the limitations of measuring only short-term financial results?

In early 1992, we assembled a task force to integrate our various corporate initiatives. We wanted to understand what had to be done differently to achieve dramatic improvements in overall organizational effectiveness. We acknowledged that the company may have become too short-term and too internally focused in its business measures. Defining what should replace the financial focus was more difficult. We wanted managers to sustain their search for continuous improvement, but we also wanted them to identify the opportunities for breakthrough performance.

When divisions missed financial targets, the reasons were generally not internal. Typically, division management had inaccurately estimated market demands or had failed to forecast competitive reactions. A new measurement system was needed to lead operating managers beyond achieving internal goals to searching for competitive breakthroughs in the global marketplace. The system would have to focus on measures of customer service, market position, and new products that could generate long-term value for the business. We used the scorecard as the focal point for the discussion. It forced division managers to answer these questions: How do we become our customers’ most valued supplier? How do we become more externally focused? What is my division’s competitive advantage? What is its competitive vulnerability?

How did you launch the scorecard effort at FMC?

We decided to try a pilot program. We selected six division managers to develop prototype scorecards for their operations. Each division had to perform a strategic analysis to identify its sources of competitive advantage. The 15 to 20 measures in the balanced scorecard had to be organization-specific and had to communicate clearly what short-term measures of operating performance were consistent with a long-term trajectory of strategic success.

Were the six division managers free to develop their own scorecard?

We definitely wanted the division managers to perform their own strategic analysis and to develop their own measures. That was an essential part of creating a consensus between senior and divisional management on operating objectives. Senior management did, however, place some conditions on the outcomes.

First of all, we wanted the measures to be objective and quantifiable. Division managers were to be just as accountable for improving scorecard measures as they had been for using monthly financial reviews. Second, we wanted output measures not process-oriented measures. Many of the improvement programs under way were emphasizing time, quality, and cost measurements. Focusing on T-Q-C measurements, however, encourages managers to seek narrow process improvements instead of breakthrough output targets. Focusing on achieving outputs forces division managers to understand their industry and strategy and help them to quantify strategic success through specific output targets.

Could you illustrate the distinction between process measures and output measures?

You have to understand your industry well to develop the connection between process improvements and outputs achieved. Take three divisional examples of cycle-time measurement, a common process measure.

For much of our defense business, no premium is earned for early delivery. And the contracts allow for reimbursement of inventory holding costs. Therefore, attempts to reduce inventory or cycle times in this business produce no benefit for which the customer is willing to pay. The only benefits from cycle time or inventory reduction occur when reduction in factory-floor complexity leads to real reductions in product cost. The output performance targets must be real cash savings, not reduced inventory levels or cycle times.

Thank You,