Strategic Management Accounting – The Balanced Scorecard PDF

Strategic Management Accounting – The Balanced Scorecard Chapter 4 Management Accounting and Control Prof. Dr. Michel Charifzadeh [email protected] Introduction  This chapter explores the use of management accounting information in the...

Strategic Management Accounting – The Balanced Scorecard Chapter 4 Management Accounting and Control Prof. Dr. Michel Charifzadeh [email protected] Introduction  This chapter explores the use of management accounting information in the implementation and evaluation of an organization's strategy.  Management control systems are tools to implement the organization‘s strategies.  Management control systems should be aligned with the operations and the strategies of organizations.  Performance Measurement should be used as an instrument of strategy implementation. Prof. Dr. Charifzadeh / Management Accounting and Control 2 Objective 1 Introduce strategic management accounting. Prof. Dr. Charifzadeh / Management Accounting and Control 3 What is Strategy?  Strategy describes how an organization matches its own capabilities with the opportunities in the marketplace to accomplish its overall objectives. Internal External environment competencies Competitors Technology know-how Customers Manufacturing know-how Suppliers Marketing know-how Regulators Distribution know-how Social/Political Logistics know-how Opportunities and threats Strengths and weaknesses Match internal competencies with external opportunities Firm’s strategies: The path to reach the goals of the organization Prof. Dr. Charifzadeh / Management Accounting and Control 4 The Role of Strategic Management Accounting  To be successful, a company must (1) formulate an effective strategy and (2) implement it vigorously.  NEW view: Management accountants should have an important role to play in the formulation and implementation of strategy.  This role is providing relevant information for strategic decision making and designing reports that help managers track progress in implementing strategy. Examples are:  Collecting and using information about competitors (market intelligence)  Identifying and pursuing cost reduction opportunities  Matching accounting metrics and qualitative data with strategic intents of the firm Prof. Dr. Charifzadeh / Management Accounting and Control 6 Objective 2 Introduce the balanced scorecard. Prof. Dr. Charifzadeh / Management Accounting and Control 7 Introduction: The Balanced Scorecard  “Imagine entering the cockpit of a modern jet airplane and seeing only a single instrument there. How would you feel about boarding the plane after the following conversation with the pilot?  Q: I‘m surprised to see you operating the plane with only a single instrument. What does it measure?  A: Airspeed. I‘m really working on airspeed this flight.  Q: That‘s good. Airspeed certainly seems important. But what about altitude? Wouldn‘t an altimeter be helpful?  A: I worked on altitude for the last few flights and I‘ve gotten pretty good on it. Now I have to concentrate on proper air speed.  Q: But I notice you don’t even have a fuel gauge. Wouldn’t that be useful?  A: You’re right, fuel is significant, but I can’t concentrate on doing too many things well at the same time. So on this flight I‘m focusing on air speed. Once I get to be excellent at air speed, as well as altitude, I intend to concentrate on fuel consumption on the next set of flights.”  Would you board the plane after this discussion? Source: Kaplan/Norton (1996): Translating strategy into action: The Balanced Scorecard , p. 1. Prof. Dr. Charifzadeh / Management Accounting and Control 8 Introduction: The Balanced Scorecard  Like flying a plane, operating such a complex system as that of a company requires more than just one control instrument. Prof. Dr. Charifzadeh / Management Accounting and Control 9 Introduction: The Balanced Scorecard  In the 1980s and early 1990s traditional performance measurement systems like the ROI-system (“Du Pont”) were harshly criticized:  Mainly focused on financial performance (one- dimensional, often only 1 or 2 measures)  No link to strategy of an organization  No support of strategy implementation  In 1990 a research project team led by David P. Norton, CEO Nolan Norton Institute (research unit of KPMG), and Robert S. Kaplan, Professor Harvard Business School derived the concept of the Balanced Scorecard (BSC). Prof. Dr. Charifzadeh / Management Accounting and Control 11 Introduction: The Balanced Scorecard  The balanced scorecard (BSC) is an innovative performance measurement system and an instrument of strategic management.  Key characteristics of the BSC are:  Beyond performance measurement: A BSC consists of an integrated system of performance measures that are derived from, linked to and support the company’s strategy.  Non-monetary performance indicators: the BSC should also include non-financial measures; even though financial ratios are still very important (“balanced” approach).  Cause-and-effect relationships: the BSC shows how non-financial measures drive financial performance indicators.  Adaptability: the BSC is not a pre-defined set of performance measures. Rather it has to be adapted to an organisation’s specific situation. Prof. Dr. Charifzadeh / Management Accounting and Control 12 Structure of The Balanced Scorecard  The original concept focused on providing measures for goals along four perspectives to get a balanced view of the performance (supplementing these four with a number of customized perspectives as needed). Financial perspective How do we look to our shareholders? Vision Internal process perspective Customer perspective and At what business practices How do customers see us? Strategy must we excel at? Innovation and learning perspective Can we continue to improve and create value? Prof. Dr. Charifzadeh / Management Accounting and Control 13 The Four Dimensions of the Balanced Scorecard  The four perspectives can be seen as either leading indicators or lagging indicators.  Leading indicators provide information about current performance on key aspects that drive future performance.  Lagging indicators report on past performance and are a result of the leading factors.  Financial (perspective) measures are typically lagging indicators; the other perspectives contain rather leading indicators. Prof. Dr. Charifzadeh / Management Accounting and Control 14 Operationalizing the Balanced Scorecard  Under each perspective the BSC defines (1) objectives, (2) measures, (3) targets, and (4) initiatives.  Kaplan and Norton suggest that each perspective should not have more than 4-6 measures. Financial perspective Objectives Measures Targets Initiatives Customer perspective Internal process perspective Vision Objectives Measures Targets Initiatives Objectives Measures Targets Initiatives and Strategy Innovation and learning perspective Objectives Measures Targets Initiatives Prof. Dr. Charifzadeh / Management Accounting and Control 15 The Financial Perspective  This perspective evaluates the financial performance of a strategy.  Indication whether the company‘s strategy, implementation, and execution are contributing to the bottom-line improvement. Frequently cited Frequently cited financial objectives (e.g.) financial measures (e.g.) Operating profit, gross margin percentage, cost Increase profitability reductions in key areas revenue growth, revenues from new Growth products Increase shareholder value EVA, ROCE, FCF  Financial goals should have a cause and effect relationship with the goals of the other three BSC dimensions (financial performance is a lagging indicator). Prof. Dr. Charifzadeh / Management Accounting and Control 16 The Customer Perspective  This perspective identifies the targeted market segments and measures the company‘s success in these segments.  Leading factor to the financial perspective: a company’s financial success depends heavily on fulfillment of customer needs. Frequently cited Frequently cited customer objectives (e.g.) customer measures (e.g.) Increase market share Market share in specific segment Delivery times, number of complaint letters, Increase customer satisfaction customer churn rate Build customer relationship Customer retention rate, repeat purchases  The customer perspective enables/forces business managers to articulate their unique customer and market-based strategy for producing superior financial returns. Prof. Dr. Charifzadeh / Management Accounting and Control 17 The Internal Business Process Perspective  This perspective depicts the value chain and focuses on internal operations that further both the customer perspective and the financial perspective (i.e., a leading factor to the customer and the financial objectives).  The internal business process comprises 3 areas (value chain): Customer Customer Innovation Operations After-sales wish wish process process services fulfilled Create new Produce and deliver Service and support products, services existing products, after the sale Anticipate customer services Invoicing needs Time, quality, cost Frequently cited Frequently cited internal process objectives (e.g.) internal process measures (e.g.) number of new products or services, Increase number of innovations development cycle times, number of patents Improve product quality Defect rates, reject rate, throughput time Improve customer service Time taken to repair or replace products Prof. Dr. Charifzadeh / Management Accounting and Control 18 The Learning and Growth Perspective  An organization cannot succeed long-term if it only maintains its current level of capabilities and technologies.  This perspective comprises a company‘s ability to innovate, improve, and learn.  It identifies the infrastructure for creating the ground for long-term learning, growth and improvement.  A company’s infrastructure comprises 3 areas: employees, systems and organizational procedures.  The perspective is the ultimate leading indicator for the other three perspectives. Frequently cited Frequently cited learning and growth objectives (e.g.) learning and growth measures (e.g.) Increase employee skills Number of employee trainings Enhance information system capabilities Real-time system availability Employee satisfaction survey, employee Align employee and organization goals retention (fluctuation), incentive systems Prof. Dr. Charifzadeh / Management Accounting and Control 19 Cause-and-Effect Relationships  A correctly constructed BSC consists of a linked series of objectives and measures.  The four perspectives and the 16-24 measures therein must be linked by cause-and-effect relationships. Learning Process Customer Financial Skills Technologies Loyalty Shareholder Training Process quality Satisfaction Value Alignment Service Reputation Profit … … … …  “A strategy is a set of hypothesis about cause and effect” (R. Kaplan)  The cause-and-effect relationships may be hypothesized only. A validated proof is not necessary. Prof. Dr. Charifzadeh / Management Accounting and Control 20  Cause-and-Effect Relationships – “A Strategy Map”  Exemplary cause-and-effect chain at a car manufacturer („strategy map“).  In contrast to Du Pont or Financial ROCE + + Profit value-based - Accounts + driver trees, receivable Contribution margin per car the BSC does not include any + Customer mathematical Number of cars sold + Customer surveys: links between + satisfaction with options indicators. available Internal +  Instead there - business Number of options are logical process available Time to install an option links (cause- and effect Learning + relationships) and growth Employee skills in + postulated. installing options + Employees‘ morale + Source: adapted from Seal, W., Garrison, R.H., Noreen, E. W. (2015): Management Prof. Dr. Charifzadeh / Management Accounting and Control 21 Accounting, 5th edition, p. 709. Objective 3 Understand the features of a good balanced scorecard. Prof. Dr. Charifzadeh / Management Accounting and Control 22 Features of a Good Balanced Scorecard (I) 1. It tells the story of a company’s strategy by articulating a sequence of cause-and-effect relationships. Each measure in the scorecard is part of a cause-and-effect chain, a linkage from strategy formulation to financial outcomes. 2. It helps to communicate the strategy to all members of the organization by translating the strategy into a coherent and linked set of understandable and measurable operational targets.  Guided by the scorecard, managers and employees take actions and make decisions that aim to achieve the company’s strategy.  Some companies have pushed down developed scorecards at the division and departments level. Prof. Dr. Charifzadeh / Management Accounting and Control 23 Features of a Good Balanced Scorecard (II) 3. In for-profit organizations, the BSC places strong emphasis on financial objectives and measures.  Sometimes, managers tend to have too much emphasis on non-financial initiatives.  A BSC emphasises non-financial measures as a part of a programme to achieve the future financial performance. 4. The BSC limits the number of measures used by identifying only the most critical ones.  Focuses management’s attention on those that are key to the implementation of strategy.  Choose only measures that can be influenced by management.  Normally not more than 4-6 measures per perspective. Prof. Dr. Charifzadeh / Management Accounting and Control 24 Features of a Good Balanced Scorecard (III) 5. The BSC highlights suboptimal trade-offs that managers may make when they fail to consider operational and financial measures together.  The BSC will reveal trade-offs if pursuing the objectives in one perspective is to the detriment of another perspective. 6. In every organization the BSC will look different – it has to be customized to meet the needs of the different markets, strategies, and environments. Prof. Dr. Charifzadeh / Management Accounting and Control 25 Features of a Good Balanced Scorecard (IV) 7. The BSC is “balanced”: External perspectives Internal perspectives - Shareholders - Processes - Customers - Employees Short-term goals Long-term goals Non-financial Financial measures measures Lagging indicators Leading indicators Business specific Generic measures (customized) measures Objective measures Subjective measures (easily quantifiable) (requires judgement) Tactical feedback Strategic Feedback Prof. Dr. Charifzadeh / Management Accounting and Control 26 Objective 4 Understand the process of developing a BSC. Prof. Dr. Charifzadeh / Management Accounting and Control 29 Developing a Balanced Scorecard  Step 1: A BSC-project starts with clarifying the strategic objectives along the four perspectives within the top management team.  Gaining consensus: Senior executives need to agree on their own given strategy and need to develop a common understanding of their goals. Increase Financial profitability Reduce Increase revenues fixed costs Customer Generate new Become Increase customers preferred supplier market share Example Decrease admin Process tasks for sales force Utilize new Streamline distribution admin processes channels Reduce fluctuation Recruit Learning among sales force high potentials Use social media Increase number Improve image of quality circles Prof. Dr. Charifzadeh / Management Accounting and Control 30 Developing a Balanced Scorecard  Step 2: Set up a “strategy map” by linking the objectives with cause-and-effect relationships. Increase Financial profitability Reduce Increase revenues fixed costs Customer Generate new customers Become Increase preferred supplier market share Decrease admin Process tasks for sales force Utilize new Streamline distribution admin processes channels Reduce fluctuation Learning Recruit among sales force high potentials Use social media Increase number Improve image of quality circles Prof. Dr. Charifzadeh / Management Accounting and Control 31 Developing a Balanced Scorecard  Step 3: Define performance measures for each objective.  For each performance measure, define a target value (budget) that is supposed to be reached within a specified time period. Financial Target Perofrmance Definition of Customer Objectives Measure Measure (Budget) Actual 2023 2012 Target Perofrmance Improve image Definition of (2019) Actual 2023 Internal Business Objectives Process Measure Measure 2012 Increase number Improve image of Perofrmance quality circlesTarget Definition Objectives of (Budget) Actual 2011 LearningIncrease and Measure Growth number Use new media, 2012 Measure of quality circles esp. internet Decrease admin Performance Definition of Target Objectives Actual 2023 tasks for sales force Use new media, Measure Measure 2026 Streamline esp. Improve internet image admin process Increase number Utilize new of quality circles distr. channels Use social media Prof. Dr. Charifzadeh / Management Accounting and Control 32 Developing a Balanced Scorecard  Example for specification of the customer perspective: Customer Performance Frequency Target Objectives Actual 2023 Measure of reporting 2026 Generate new Revenue with monthly +25% 500,000 customers new customers EUR Number of monthly 30 15 customers with first contract Become preferred Average % of quarterly 35% 30% supplier customers’ budget spent with us Increase Market share in quarterly 7% 5% market share relevant market segment Prof. Dr. Charifzadeh / Management Accounting and Control 33 Developing a Balanced Scorecard  Step 4: Define initiatives for reaching the targets.  The more precise the initiatives are formulated the higher the chance of reaching the targets.  Example for defining initiatives for the customer perspective: Customer Performance Target Actual Objectives Initiatives Measure 2026 2023 Generate Revenue with +25% 500,000 Train sales force new new customers EUR Revise print and online customers Number of 30 15 marketing customers with Start social media first contract marketing Become Average % of 35% 30% Train sales force preferred customers’ Introduce new voucher supplier budget spent system with us Increase Market share in 7% 5% Buy marketing study market share relevant market “Central Europe”) segment Install task force Prof. Dr. Charifzadeh / Management Accounting and Control 34 Developing a Balanced Scorecard  Step 5: Feedback and continuous improvement of the BSC.  Feedback: The BSC continually tests the hypotheses and theories underlying management's strategy. If a strategy is not working it will become evident when some of the predicted results don’t occur. Prof. Dr. Charifzadeh / Management Accounting and Control 35 Example of a Balanced Scorecard – Lufthansa Strategic objectives Measures Operating targets Strategic initiatives Shareholders Profitability Return on investment x% after tax Derive business-specific hurdle rates Required return by DCF return Rise in foreign sales by x% shareholders Screen potential foreign Sales growth Growth in Region A by x% partners Sustained growth Expansion of market Acquire a company in share Region A Customer loyalty Customer service index Increase of CSI by x Develop scenarios of (CSI) percentage points future customer Image for quality expectations and Image repair Expansion of the share of Customer Internationality suitable offers foreign customers by x% Share of foreign Anticipative customers development of new products Internationalize external communication Commitment of Employee commitment Increase of ECI by x Project “Employees in employees index (ECI) percentage points the Focus“ Employees Leadership Leadership potential Increase of decentralized Introduce job-rotation leadership competence by program (across Service culture Industry-wide x% hierarchies) comparison from the customer's point of Amongst the 5 providers Incorporate service- view with the utmost focus on relevant criteria for service employment Source: Weber / Schäffer, Balanced Scorecard & Controlling (2000), p. 84. Prof. Dr. Charifzadeh / Management Accounting and Control 36 Example of a Balanced Scorecard – McDonalds  McDonald‘s Deutschland has introduced a customized 4 Quality of financial planning Guest perspective dimensional BSC for “Plan thoroughly and “Be a great host“ manage your financials“ restaurant Customer service index Guest complaints managers. Profit after controllable Staff assignment costs (PAC)  With only 12 Revenue planning index e.g. customer planning index experience Service capability index indicators McDonald‘s measures all e.g. economic efficiency relevant “Manage and control “Satisfy your employees“ Total score = success factors your systems“ 120% for managing a Restaurant Operations People care restaurant. Training Improvement Process (ROIP)  The BSC Crew structure Reduce overtime and Retention vacation focusses on the quality of ROIP / Process perspective Employee perspective planning. Source: Adapted from Sagadin, H., Hirsch, B. (2016): Die Balanced Scorecard als operatives Steuerungsinstrument, in: Controlling & Management Review, Vol. 60, No. 6, pp. 52-57. Prof. Dr. Charifzadeh / Management Accounting and Control 38 Example of a Balanced Scorecard – VFB Stuttgart Source: Presentation by Erwin Staudt:Prof. Das Management eines Dr. Charifzadeh Fußballvereins / Management über dieand Accounting Balanced ControlScorecard, Stuttgart, 20. Dezember 2004 39 Software Solutions for a Balanced Scorecard  QPR Software Plc (listed on Nasdaq Helsinki) is a Helsinki based consulting firm and provides solutions for strategy execution, performance and process management, process mining and enterprise architecture in over 50 countries. https://www.qpr.com/solutions/ balanced-scorecard Prof. Dr. Charifzadeh / Management Accounting and Control 40 Examples of Balanced Scorecards  For a list of more adopters of the Balanced Scorecard visit the website balancedscorecard.org: https://balancedscorecard.org/bsc-basics/about-the- balanced-scorecard/balanced-scorecard-adopters/ Prof. Dr. Charifzadeh / Management Accounting and Control 41 Objective 6 Outline the use of the BSC in practice and its major points of criticism. Prof. Dr. Charifzadeh / Management Accounting and Control 49 Different Types of the Balanced Scorecard  In practice, we can observe 3 different types of Balanced Scorecards in action.  Only type III fulfils all intentions of the originators Kaplan and Norton. Type I BSC Type II BSC Type III BSC „minimum-standard „medium-developed „fully-developed BSC“ BSC“ BSC“ “KPI-BSC” as a pure BSC as a strategic BSC as a strategic performance performance management system measurement system measurement system Type II BSC that with no or few links Type I BSC that additionally Includes financial and additionally describes implements strategy non-financial strategy by using by defining objectives, measures cause-effect action plans, results KPIs structured relationships and connecting according to incentives with BSC perspectives Source: Speckbacher, Bischof, Pfeiffer (2003): A descriptive analysis on the implementation of Balanced Scorecards in German-speaking countries; in: Management Accounting Research, Vol. 14 (2003), pp. 361-38. Prof. Dr. Charifzadeh / Management Accounting and Control 50 Criticism of the Balanced Scorecard  Often, the BSC is not applied as the original concept suggests. As opposed to a systematically developed BSC a so called KPI-BSC just rearranges existing KPIs (see also “BSC type I”).  The implementation of a full-fledged BSC ties up lots of resources and is extremely time-consuming.  Cause-and-effect links are only hypothesized – however, managers usually demand validated proofs instead of fuzzy plausibilities.  The BSC is primarily oriented towards internal processes. An analysis of the external environment (opportunities and threats), especially the competition, is missing. New perspectives, such as sustainability, are not included.  When including more perspectives the BSC may become cluttered or too complex. Prof. Dr. Charifzadeh / Management Accounting and Control 53 Quick Quiz 1. Explain the role of Management Accounting in strategic management (i.e., Strategic Management Accounting). 2. Describe the features of a good balanced scorecard! 3. What are the original four perspectives of the Balanced Scorecard? 4. The BSC receives positive feedback from companies as well as from academics who believe it to be a superior instrument of performance measurement. What are some downsides of the BSC? Prof. Dr. Charifzadeh / Management Accounting and Control 54 Required Reading  Anthony / Govindarajan: Management Control Systems, 1st Edition, Chapters 4, 10.  Charifzadeh / Taschner: Management Accounting and Control, Chapter, Chapter 9.  Kaplan / Atkinson: Advanced Management Accounting, 3rd Edition, Chapter 8.  Kaplan, R.S. / Norton, D.P.: The Balanced Scorecard – measures that drive performance, in: Harvard Business Review, Vol. 70 (1992), No. 1 (January-February), pp. 71-79  Kaplan, R.S. / Norton, D.P.: Using the Balanced Scorecard as a strategic management system, in: Harvard Business Review, Vol. 74 (1996), No. 1 (January-February), pp. 75-85.  Seal, W., Rohde, C., Garrison, R. H., Noreen, E. W. (2024): Management Accounting, 7th edition, Chapter 16. Prof. Dr. Charifzadeh / Management Accounting and Control 55