LSM531 transcripts - Amazon S3 · LSM531:Choosing!the!Right!Performance!Measures!for!Your!Organization Samuel!Curtis!Johnson!GraduateSchool!of!Management,CornellUniversity!!!!

LSM531: Choosing the Right Performance Measures for Your Organization Samuel Curtis Johnson Graduate School of Management, Cornell University

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LSM531 Transcripts

Transcript: Course Introduction

Hello everyone and welcome. I’m Rob Bloomfield, professor of accounting at Cornell University’s Johnson Graduate School of Management.

In this course, we’ll be introducing you to the basics of measuring and reporting the performance of your organization, whether it’s a for-‐profit business, a not-‐for-‐profit, even a governmental organization. We’ll take a look at the different types of reporting systems these organizations use, focusing most of our attention on performance reporting systems, the systems that lay out an organization's strategy and report on how well that strategy is being executed.

We'll take a detailed look at one of the most important tools for performance reporting—the balanced scorecard. We'll look at the aims of the balanced scorecard and show how it's designed to achieve those aims. We'll show you plenty of examples, and give you opportunities to apply what you've learned. My goal is for you to walk out of this course with the ability to implement the balanced scorecard in your own organization.

Let me talk for just a minute about how I approach teaching this material. The French author Marcel Proust said, “The real voyage of discovery consists not in seeking new landscapes, but in having new eyes.” My goal in this course and throughout the series is to give you new eyes to see your organization.

Also, you may have heard the expression, "Accounting is the language of business." I take that expression very seriously. Throughout this course, I'll be giving you a precise language that you can use to talk with people in your organization about the challenges and the opportunities that you have the new eyes to see.

So I wish you all the best and I hope you find the course rewarding and enjoyable.



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Transcript: Module 1 Introduction

In this first section of the course, we’re going to define "management reporting." What is it? How does it differ from financial reporting? What are its goals and its primary challenges? We’ll talk about the five basic types of management reporting systems and the four functions that they try to achieve. We’ll spend much of our time talking about measuring performance. And we’ll introduce the balanced scorecard and show how it connects key performance measures with an organization’s overall strategy.

You’ll see examples from for-‐profit businesses, not-‐for-‐profit organizations, and governmental agencies. And we'll culminate in the first stage of your course project, in which you construct a balanced scorecard that you could implement in your own organization.

Transcript: What Do We Mean by Management Reporting?

Management reporting systems collect and distribute information throughout an organization. And they do so for four purposes. These are the four functions of management reporting systems. The first function is directing people’s attention. So you can think of this as being like sirens and flashing lights. They help people notice what needs noticing. They don’t necessarily tell them what to do, however. So some businesses—for example, a product manager will get an email first thing in the morning when they wake up, if there is a problem with their current inventory or if there’s been a drop in sales; that directs their attention to that issue. But again, it doesn’t necessarily tell them how they should react.

The second function of a management reporting system is to facilitate decisions. Once the system has gotten your attention and you’re focusing on an issue, then it needs to provide you with the information you need to make the right decision. The balanced scorecard, which we will be looking at throughout this module, is one example of such a system. It tells you how you’re performing on a variety of different dimensions. Did you do well? Did you do poorly? And if it’s a very good scorecard, it will give you clear indications of how you can change what you’re doing to improve it.



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The third function of management reporting systems is the decision-‐influencing aspect. So here it’s not just a matter of getting your attention, of giving you information that will help you make better decisions, but of influencing those decisions, of giving you rewards and, if necessary, punishments to guide the types of choices that you make. So I often use the example of a carrot and a stick. If that image doesn’t mean anything to you, think of someone who is riding a somewhat stubborn mule. They put a carrot on a piece of string and dangle it from a stick in front of the mule’s nose. And the mule, who wants to eat the carrot, will follow it whichever way you direct it.

And in much that way, organizations will use decision-‐influencing systems to guide their managers and their employees in the directions that they want to. Don’t forget, they can also take the stick and use it to give the mule a little whack if they’re going the wrong way. We don’t like to use that as often, but it can be very effective. The most important decision-‐influencing device that most organizations have is their pay-‐for-‐performance scheme. We’re going to take performance measures from a performance reporting system and we’re going to tie them to bonuses and other rewards—promotions, for example.

Finally, the fourth function of a management reporting system is the coordination-‐facilitating function. That’s a bit a mouthful, but it basically means getting all of the parts of an organization to work together in concert. So I use the image of a conductor’s baton. The most important example of a coordination-‐facilitating device in reporting systems is the budgeting process. And many of you, if you’ve ever been involved in a budgeting process, you know that they are very long and very painful. And one of the reasons for that, is that, to have a successful budget, you need to have all of the different parts of your organization aligned, get them all on the same page playing the same notes at the same time so that, if you are a car manufacturer, you are making four wheels and two axles for every car body, so that you aren't making too much of one thing and not enough of another.

Now that we understand the four functions of reporting systems, let's take a look at the five types of systems that serve these functions. The first and the one that most people know is the accounting system. This is the one that uses the dreaded double-‐entry bookkeeping to keep track of financial information, ultimately resulting in external financial reports, income statements, and balance sheets. In this course and throughout the series, we’ll be looking at much more detailed accounting reports—much more detailed than anyone outside the firm would see—that will include the margins on specific products, the efficiencies and profits of specific processes, departments, and divisions.



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The second reporting system is the budgeting system, which I discussed just a moment ago, that helps us plan our operations and our financial performance for the coming period.

The third management reporting system is the performance reporting system. We’re going to identify every strategic objective of our organization, and we’re going to tie to it a measure—something that we can track and report and compare to a baseline—to determine whether we’re doing well or poorly.

The fourth system is the incentive system. This is, as I said before, the carrot and the stick. This is how we guide people; we influence them to act in the interest of the organization as a whole.

And, finally, we have the control system. These are systems that we use to ensure, first, that all of the data in the other four reporting systems are accurate, and, second, that people are staying in compliance with the policies of our organization.

I’d like to take a moment to contrast management reporting with financial reporting. The most important difference is that management reports stay inside the organization. If you don’t work for an organization, you are very unlikely to see one of its management reports. In contrast, financial reports are produced to be released to outsiders. If you are a for-‐profit business, you report to investors who want to place a value on your business. If you are a nonprofit organization, you report to donors who are deciding whether they want to support you. If you are a governmental organization, you report ultimately to taxpayers, so they can assess whether you are doing your job.

This difference between internal and external reporting drives most of the differences between managerial and financial reporting. First, one thing we can see right away is that external reporting tends to be very heavily regulated. In the United States, we have Generally Accepted Accounting Principles. Outside the United States, we have International Financial Reporting Standards, IFRS. These are standards that are set by independent regulators, and enforced by governments around the world, and their goal is to limit misrepresentation and exploitation by the reporting firms, and also to improve comparability so that an investor can look at two similar types of firms and be able to compare them on an apples-‐to-‐apples basis.

It’s worth noting that neither of these motivations for regulation really applies inside the firm. First, we don’t need to worry that much about the reporter exploiting the user of the report inside the firm because, in fact, the executives who are reading the report are also the ones who are, themselves, designing the rules by which people in their organization will report to them. So we don’t have that same conflict of interest that we have outside the firm. If you lie, if you create a misleading internal report, as my mother used to say to me, you’re only really lying



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to yourself. Second, we don’t have as much need for comparability inside the firm. So if I’m an investor and I’m considering investing in an auto company, well, I want all the auto companies to report using similar rules so that I can assess their earnings, measured on the same basis, to know, “Which one is higher? Which firm seems to be doing a better job? Which one would I rather own?”

But if I’m working inside one of those auto companies, you know, my primary goal is not to compare how I’m doing to how the other company is doing. My goal is to compare my performance to what it ought to be, given my strategic objectives. So we don’t care as much about comparability.

It is also much harder for regulators to devise good rules that would apply to every firm. Every organization has slightly different needs, and they’re therefore going to need to design their reports in slightly different ways. Since no regulator can possibly know every organization’s unique needs, they tend to let organizations design their internal reporting systems with a pretty free hand. There are a few exceptions. If you have government contracts, governments will often impose restrictions on how you are tracking your costs. If you are reporting to tax authorities, they’re going to want to know that you have reliable systems to track your profits and your taxable income, and, therefore, how much tax you need to pay them.

And finally, regulators are often worried about widespread fraud and enterprise corruption. Regulators around the world, and particularly in the U.S., have been writing a number of new rules to make sure that organizations have strong and reliable control systems to make sure that their data are reliable and that employees are following organizational policy, even though control systems are primarily an internal matter.

Transcript: Strengths and Limitations of Management Reporting Systems

Now we’re going to talk about three themes that run throughout this course and throughout the entire series. The first theme is: an organization’s managerial reporting system should be matched to the challenges it faces, just as an animal’s nose must be matched to its own circumstances. So let’s take a look at an extraordinary example of a nose: the nose on the star-‐nosed mole. This nose has 22 nostrils, bright pink, very, very close to the mole’s mouth. And, why is it designed this way?



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Well, this creature lives in the mud under bogs and swamps, where it can't see anything, and actually most mammals can't smell at all underwater: the star-‐nosed mole is the only one that can. Those 22 nostrils blow out small puffs of air, and then the mole inhales immediately after. It can smell whether there is a bug or other small creature right near it. The nostrils themselves, then, will reach out and grab the food and immediately put it in the star-‐nosed mole’s mouth so that it can move on to get more food. And it must eat very quickly; otherwise it will starve to death. So this unique nose is designed for the star-‐nosed mole’s unique circumstances.

And a managerial reporting system also needs to be designed for each organization so that it can meet its unique challenges. So, for example, maybe you are in a highly competitive business with razor-‐thin margins, involved in mass production, and you have processes that you do over and over and over again. What type of reporting system do you need? You need one that will sniff out every opportunity for just a little bit of cost reduction, a little bit of extra efficiency, to help you survive in that environment.

On the other hand, maybe you’re involved in a business where every client requires something different; you’re constantly customizing. Well, what kind of nose do you need then? You need a nose that is going to help you identify which clients are going to be profitable, which are not, and what types of prices to set to get the margin that you need from the clients you do take on. So, again, theme one, your organization’s managerial reporting system—its nose—should be matched to the challenges your organization faces.

The second theme is that managerial reporting systems mitigate, and are compromised by, intra-‐firm conflict. Organizations are filled with conflict. There is conflict between managers and the people they manage. Economists call these agency frictions. They talk about the boss who is directing an employee as the principal and the employee who is being directed as the agent. And of course the principal and the agent have their own distinct needs. The principal is usually looking out for the broader needs of the organization, while the agent is going to be looking out for their own needs. And those conflicts between the principal and the agent are going to require a very good reporting system, especially a good pay-‐for-‐performance system that is going to influence the agent to act in the interest of the organization, while from their own perspective they are just pursuing their own interests.

Now, we also have conflicts not between the superior and the subordinate, but between two people at the same level of the organization. Economics is often described as the study of the allocation of scarce resources, and every organization has scarce resources. So you’ll see people at equal levels of the organization who are going head-‐to-‐head trying to increase their own budget allocations so that they can meet their own performance goals. They’re going head-‐to-‐



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head to get the attention of the people above them, to get the loyalty of the agents below them in the organization. Again, we need reporting systems that are going to mitigate the costs of this type of conflict and help us make the right decisions of how to allocate resources among peers.

We also have the problem of perquisites, sometimes called "perks." Perks are the incidental benefits of a position that you have at the organization and everyone wants more of them, and they can be very difficult to track. We might know who’s using the company jet, which is one type of perk, but it’s a little harder to assess who got the slightly better assistant and who is being able to go out to more pleasant business dinners and trips. Again, we need a reporting system that will help us track this and understand what perquisites are appropriate and when people are going over the line.

Finally, we have the issue of rent seeking. So first let’s just talk for a moment about rent. A landlord who owns a building will earn some profit by renting out their building. Well, as a person in an organization, employees also have forms of capital, but they are not necessarily something you can hold in your hand or touch like a building. They have authority to make decisions, they have information, and they have expertise. All of these are forms of capital that they can earn profit on, often at the expense of the organization itself.

Let me just share one example of rent seeking that compromised a firm’s managerial reporting system. A firm that shall remain nameless made thousands of different products. And there was one man who headed up a major unit in the division. One man who knew the costs of all of the different types of products that they make. What did this man do? He used his authority over being able to set the managerial reporting system to thwart any efforts to get a highly informative detailed public report of the costs of all those different products.

Why would he do this? Well, because as the only person who knew all of that cost information, his informational capital became even more valuable. By distorting the reporting system, he made himself indispensable. He was able to protect his position and increase his power at the expense of the organization. This story is a great illustration of the second theme of this course: that managerial reporting systems mitigate but are also compromised by intra-‐firm conflict.

The third theme is a simple one. No system is perfect. This applies to all of the types of managerial reporting systems we will see in this course. And they are imperfect for many different reasons. Some of those reasons come directly from the first two themes.

So if every organization needs a reporting system designed to its challenges, then what are they going to want to do? They are going to want to highlight some information and suppress other



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information so they don’t overload the employees in the organization with information. So think for a minute about what you learned about two-‐dimensional maps of our three-‐dimensional earth. There is no way to get a perfect map into two dimensions that represents all aspects of the earth accurately. You can look at different—what are called “map projections.” You can cut the map in different places. You can stretch it in different places, and there are many different ways to do this.

What do map makers do? They need to decide which parts of the world they want to get a very close accurate representation of, and which parts they are willing to give up. You can't make a perfect two-‐dimensional map and you can't provide information simple enough that people in your organization are going to understand it without suppressing and distorting other information. So the choice of which type of nose you want your business to have is as much about the imperfections you are willing to accept as it is about the information that you want to highlight.

Here is another reason that reporting systems are imperfect: they are filled with legacy systems. Legacy systems are old solutions to old problems. Very likely, your firm still uses a long-‐outdated software program. There are much better programs out there today. But you know what? No one wants to change that program. It’s simply not worth the cost because it would be so disruptive to the business. Sometimes the technology is fine, but the system was designed to solve problems that we no longer have. But we keep them on as a legacy because it’s just too difficult to change them.

Finally, managerial reporting systems are bureaucratic systems. And bureaucratic systems by definition are one-‐size-‐fits-‐all systems—they set policies that apply to every circumstance that fits a relatively simple set of rules. For example, at many organizations every purchase over a certain dollar amount has to be approved by a series of people, no matter how obvious and urgent the need for the purchase. Now, everyone knows when they shop, that one-‐size-‐fits-‐all clothing doesn’t fit anyone perfectly. So when we impose a bureaucratic system, we’re going to find that there are occasional gaps and puckers in the fabric of our system because it’s just not cost effective to tailor it to every possible circumstance.



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Transcript: Yes, There Is Such a Thing as a Free Lunch

Like so many business courses, this one is full of lists: we’ve got our three themes and our four categories of the balanced scorecard, and you’ll see more and more lists as the course and series go on. Underlying all of these, though, there is one unifying principle. “Yes, there is a free lunch.”

Now if you’ve studied some economics that probably sounds like heresy to you. Milton Friedman, a Nobel laureate in economics and one of the great economists of the 20thcentury, popularized the phrase, “There ain’t no such thing as a free lunch.” And that is a unifying principle of all of economics. Economists assume that people are extracting every last bit of value they possibly can from the economy that they’re in, so they are pushing up against their constraints. And as a result, there’s no free lunch left. If it seems like you can get something for nothing, you're probably wrong. Now the popularity of this no free lunch perspective leads to an old joke in economics. Two economists are walking down the street and one says, “Hey, is that a twenty-‐dollar bill I see on the ground?” And the other says, “No, it couldn’t possibly be, because someone would have picked it up.” And so they walk on and leave the twenty-‐dollar bill to be picked up by the next passerby.

This little joke points out the big irony of believing that there ain’t no such thing as a free lunch. The only reason that economists can assume there ain’t no such thing as a free lunch, is because all of the people within the economy are assuming that there is and they’re doing everything they can to seek them out, to seek free lunches out wherever they can. So you’ll see this as a principle underlying everything we do in this course, that we are constantly on a search for the free lunch that is being left behind by our own organization, by others within our organization, and by our competitors.

So my job, I believe, will be a success if by the end of this course and this series, you’re able to use your new eyes and a more refined language to describe organizational challenges that will help you design a better reporting system, and have that reporting system serve as a better nose for your organization to help it sniff out the free lunches that indeed are all around.



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Transcript: Introduction to the Balanced Scorecard

We now introduce one of the most important tools in managerial reporting, and specifically in performance reporting, and that’s the balanced scorecard. The balanced scorecard provides us with a framework in which we can put the indicators that are most important to the success of our business. Our starting point might surprise you. One of the key goals of the balanced scorecard is not to give more information to the people in our organization, but to give less information, to give people only the information that they need to solve the most important problems, to direct their attention to what they need to pay attention to and guide them in finding the solution.

I’d like to emphasize the value of less information by sharing some advice my brother, a political strategist, often gives to his clients. My brother works with politicians running relatively small campaigns—not running for the president of the United States, but running for the mayor of a city, or governor of a small state. And he often has a candidate with grandiose ideas about all of the messages that they want to communicate to the voters. And my brother has to tell them, “You have enough money to get voters to remember two things about you. And one of them is your name.” So what’s the challenge that a candidate faces? They’ve got to figure out that one most important thing, that they want voters to remember, other than their name.

Within the organization, the problem is similar. There is just too much information that we could give our managers, and they don’t have time to deal with it all. So we’re going to use a balanced scorecard to discipline the set of performance indicators that we’re going to focus on, so that we can tailor our reporting system to the specific challenges our organization faces.

The second very important function that the balanced scorecard provides is that it helps give us balance in our measures. And actually, here now, I’m going to speak to the second theme that runs throughout this course and the series: that we devise systems to mitigate intra-‐firm conflict, but we also have to recognize that the systems that we create are compromised by that conflict.

Many businesses have performance indicators that are distorted because there are some groups within the organization that have a lot of power and other groups that don’t have much power. So it may be that it’s very important for your organization to have everyone, even at the top levels, focusing on marketing and branding initiatives. However, the marketing and



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branding departments, the people working there don’t have enough power to incorporate that information into the high profile performance reports. Instead, and this sadly is very frequent, because the reports are compiled by the finance and accounting groups, what the reports end up including is a lot of finance and accounting information.

The balanced scorecard is a framework that will help ensure that at least we’re checking whether we're providing a balanced set of measures that matches the strategy of the organization, even if we have some power imbalances that put too much emphasis on some measures and too little emphasis on others.

Transcript: Balanced Scorecard 1.0

Now we focus on two particularly useful features of the balanced scorecard that allow us to put all of our objectives into a meaningful framework, to let us achieve balance and reduce the amount of information we force the people in our organization to deal with. First, the balanced scorecard organizes our objectives into four categories. Second, it links every objective to a measure, a target, and an initiative. So let’s take a look first at the categories.

You can think of the categories as being very similar to the four food groups that the United States Department of Agriculture used to try to encourage everyone in the United States to have a better diet from the fifties up until about the nineties. They identified four different groups of foods: vegetables and fruit, milk, meat, and cereals and bread. And while, as I understand it, the dietary science in this day and age doesn’t support the way the U.S.D.A went about this, the idea is a reasonable one. Make sure you’re getting a little bit of food from each of four different groups every day to have a balanced diet.

Well, the balanced scorecard does a very similar thing, but it makes sure that our diet of information and performance measures is also balanced. The four groups in the balanced scorecard are financial, customer, internal processes, and learning and growth. Let’s take a look at each of these. We’ll start with the financial perspective. Now the people who really crafted and popularized the balanced scorecard are Robert Kaplan and David Norton. And they have a question for each category. So for the financial perspective, the question that they think objectives in this category should answer is: “To succeed financially, how should we appear to our shareholders, or, for a nonprofit, our funders?”

So for-‐profit organizations, you might think about an objective like returning a lot of money to our shareholders that you might measure with return on equity. It could be a cash flow



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measure making sure that we’re bringing enough cash in the door every day to keep the lights on. For a nonprofit organization, it might be to make sure that we are serving our target audience of recipients of our services at the lowest possible cost. Okay, so that’s the financial perspective.

We then move onto the customer perspective. The question associated with this category is: “To achieve our vision, how should we appear to our customers?” Objectives in this category could be anything from customer satisfaction to brand recognition to market share. All of these are going to be ways to identify whether customers know who we are, whether they like what we’re doing, whether we’ve become more popular; retention of customers, growth of customers, also very common popular measures in the customer perspective.

The third category is the internal processes perspective. And Kaplan and Norton ask: “To satisfy our shareholders and customers, at what business processes must we excel?”

So you might think here about anything from defect rates, quality, uptime of our machines, make sure that they are running efficiently, on-‐time delivery, all of these are internal processes, they are the things that we need to do well—in fact, excellently—in order to succeed as an organization.

Finally, we have the learning and growth perspective. The question for this one: “To achieve our vision, how will we sustain our ability to change and to improve?” Now there are many measures in this category, but you might think about it from the perspective of human resources. Just like our customers need to be happy with us, so do our employees. If we are going to learn and grow and respond to changes, we need well-‐trained, well-‐informed, well-‐motivated employees who have good morale. So any measures dealing with those features would fall in learning and growth.

Now, it’s also worth pointing out that the very topic of this course, managerial reporting systems, also would fall into the learning and growth perspective. If you’re going to achieve your vision, especially in the face of changing circumstances, well, you’re going to need to have a reporting system that gives your employees the right information at the right time that directs their attention to the changes, that guides them like a compass to the appropriate responses. You’re going to need to have a system that influences their decisions and gets them to do what is in the organization’s interest, and you’re going to need everyone to coordinate to respond to the new challenges. So any objective you have at improving management reporting systems would fall into the learning and growth perspective.



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Like with the four food groups, we have four different information groups: financial, customer, internal processes, and learning and growth, and the balanced scorecard, by creating these four categories, encourages us to make sure we have a balanced diet of objectives and information.

Now let’s break down a single objective—say, customer satisfaction. How are we going to make sure that that’s a meaningful and useful objective for us?

Well, what we do in the balanced scorecard is each objective actually is a set of four different things. It’s an objective tied to a measure of that objective, a target, which is a level of performance on that measure that we’re trying to achieve, and an initiative, which is a way that we’re going to go about achieving that target. So let me just elaborate a little on each of these and then we will look at an example in the nonprofit sector. We’ll start with the objectives. Now an objective should be specific in the sense that there is one thing you’re trying to do, but an objective should be vague in the sense that you’re not saying you want 7 percent of something, you are just stating the basic goal you’re trying to achieve.

It’s the measure that is very specific and concrete. The measure is what is going to allow us to assess how well we are doing on our objective, which is necessarily fairly vague. The target is a specific numerical level of achievement that we want the measure to hit, which we will define as success, or if we don’t hit it, as failure. And, finally, an initiative is a set of actions that you’ve devised in your organization that you believe will help improve your performance on that objective, as shown by the measure, and improve enough that you’ll be able to hit your target.

Let’s take a look at an example. This is a not-‐for-‐profit organization based in New York called the Pajama Program. And their overall mission is to provide, and I’m quoting from their Web site here, “To provide new warm pajamas and books to children in need in the United States and around the world.” Now, let’s talk about objectives, measures, initiatives, and targets.

So, first, we might think of a customer objective, which is that they “provide as many children as possible with bedtime comfort.” So you can see that’s fairly vague with that objective. They just want to provide a lot of children; they are not saying explicitly how they are going to count them. They are not saying explicitly how they’re going to define what "bedtime comfort" means.

So then to get that level of specificity, we need to take a look at the measure, and we can talk about, for example, “the number of children who are provided with flannel pajamas and at least three books.” So that’s something that is specific and concrete enough that the people working with the reporting system can make sure that they track that number, that they funnel all the data to a central location, and then that they report it on a balanced scorecard.



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Now we turn to the target. So we have our measure, we’ve spelled out specifically what it means to provide bedtime comfort to a child, and now we can talk about a target. For example, we’d like that measured number to “increase by 40 percent over the next three years.” So that is a specific level of achievement that allows us to say whether we have failed or succeeded at improving the measure.

Finally, we get to the initiative. It’s not enough simply to say, well, we want 40 percent growth. Our balanced scorecard needs to link the objective, the measure, and especially the target, to an initiative—to a plan of action that’s going to allow us to reasonably hit our target. So this might be, for example, a “nationwide advertising campaign at toy stores intended to increase donations of the pajamas and books we’re going to distribute.” That would be an initiative.

To wrap up, the balanced scorecard, in its attempt to impose structure on our objectives, does two things. One, it organizes our objectives into four categories: financial, customer, internal processes, and learning and growth, and, two, it forces us to link each objective to a specific measure, a target, and an initiative.

Transcript: Choosing Objectives

As you set to work building your own balanced scorecard, here is a little bit of advice. Now, I’m not going to tell you what your organization’s strategy should be. That’s your job. But I will give you a little insight into how to make it easier to transform that strategy into a set of useful objectives and measures.

First, make each objective as specific as you possibly can. Remember, ultimately, you’re going to have to link it to a measure and you are going to have to know whether they succeeded or failed by linking it to a target. And you’ll want to link it to an initiative as well, and that’s going to force you to be pretty specific on the objective.

Also, think about crafting your measures narrowly enough that you could say that there’s a single person at your organization who’s responsible for that measure. We often say that they "own" the measure. Now ownership doesn’t mean that if a measure looks good or bad, it’s their fault; blame and credit is very different from responsibility. Someone is responsible if it is their duty to know the state of that measure, to be able to explain why the measure is showing good or bad performance, and to propose a way to respond. If you craft your measure too broadly, it will be hard for a single person to do that.



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Finally, make sure that when you look at a single objective that you have a sense of how it’s integrating with other objectives. Remember that in a large organization, every unit is going to have their own objectives. Within a unit or a division, every individual will be responsible for different objectives. So make sure that you’re tying those objectives together in a way that’s going to allow everyone to coordinate.

Transcript: Tips for Building Your Balanced Scorecard

Here is some advice on how to make your scorecard and your scorecard development project as manageable as possible. First, follow the advice given to every young author: write what you know. Don’t choose your entire company or a large federal agency; choose a single division, a department, or even a process within that department. Crafting the scope of your balanced scorecard narrowly will make everything a lot easier.

Feel free to choose departments that are not necessarily for-‐profit organizations. Even if your day job is at a for-‐profit company, maybe you work with nonprofits in your spare time: a religious organization, a school, a charity, a political group. Maybe on the weekends, you play football. Your football team is an organization too and might well benefit from a coherent set of objectives, measures, targets, and initiatives.

Finally, keep it simple. Remember in most organizations, the problem is too many measures, not too few. And when thinking about objectives, think about people, think about individuals. Whose objective is this?

Transcript: The Role of Causation

We’ve spoken before about the four-‐food-‐groups view of the balanced scorecard, which is very useful in organizing our objectives and their associated measures, targets and initiatives into four groups that represent, really, four major functions of any organization. And so the four-‐food-‐group view gives us the balance that we need to make sure that we have a system that helps us respond to all the challenges our organization faces. But the original designers of the balanced scorecard, Kaplan and Norton, quickly realized that that wasn’t quite enough.

The balanced scorecard is an essential decision-‐influencing tool-‐-‐we use it to evaluate and reward our employees. And it’s not enough just to tell them what we define as success or failure in our target. What we need to do is give the people who are responsible for measures a



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way to explain, “why did they do well or poorly on their measure?” Explanation leads directly to a response: “how can they respond to, in particular, poor performance?” So Kaplan and Norton transformed the balanced scorecard into something I call balanced scorecard 2.0, a major revision that is going to incorporate causal linkages between the objectives. And this fits very well with the four food groups that we already have: financial, customer, internal processes, and learning & growth, because we can tell a pretty simple story connecting those categories. I’m going to start by doing it in reverse.

If you’re a for-‐profit company, how do you make sure you’re going to look good to your investors? Well, you’re going to look good to your investors by giving them lots of money-‐-‐a high return on their investment. And where is that money going to come from? It’s going to come from your customers. So you’re only going to look good to your investors if your customers like the way they’re being treated. How are you going to treat your customers w ell? Well, you’re going to have to get your internal processes running smoothly and perform well on those metrics. How are you going to make sure that your internal processes are always running smoothly despite the fact that circumstances are always changing? Well, you’re going to have to do well in the “learning and growth” category. And to give another plug for managerial reporting systems, you’re going to have to give your business a good nose to sniff out any possible improvements in ways to reduce costs and add value.

So, again, we have – we’ve linked together, with this little story, the four categories into a natural system of cause and effect. Now, running through forward, do well on the learning and growth objectives and that is going to help you keep your internal processes smooth, which in turn, will help you make your customers happy, which in turn will give you the money to make your investors happy.

So the big innovation in balanced scorecard 2.0 is that we are emphasizing the causal linkages between objectives. And many of those linkages go in a natural path from learning and growth to internal processes, to customer, finally to financial.

Balanced scorecard 2.0, with its causal linkages, is also going to help us come up with a new definition of what a strategy is: a strategy is really a hypothesis about cause-‐and-‐effect relationships between your objectives.

So if you believe, for example, that getting better information to your sales group is going to improve on-‐time delivery, which in turn will improve customer satisfaction, then that is going to be a strategy. And you’re making a conjecture about how an improvement on one objective will cause improvement in another. This perspective of strategy is also going to allow us to talk about leading and lagging measures. If you believe that improving the information to your



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sales group is going to improve on-‐time delivery, then you would expect to see those improvements on the information side occur first, followed by the improvement in on-‐time delivery. It’s not going to work the other way if your strategy-‐-‐if your hypothesis about cause and effect-‐-‐ is correct. So we can then talk about measures as being leading or lagging, that we will in this case talk about the learning and growth measure, about the information you’re providing to your sales group as leading information about on-‐time delivery, which in turn is going to lead information about customer satisfaction and ultimately growth in your customer base.

So you can see that we have so many connections in a typical – what is called a strategy map, that most measures are leading one measure and lagging another. So like most strategy maps, this one moves from bottom to top. You can see that there are many arrows pointing from learning and growth into internal processes, and from internal processes into customer, and then on into financial. So in general, the arrows go upward. You’ll see that not every objective or measure in one category affects every objective of measure in another one because we’re trying to craft our measures as narrowly as we can, so that one person is responsible for each measure usually associated with a particular type of process or function.

Now this definition of strategy as a set of cause-‐and-‐effect relationships gives us yet one more rule for picking a good and small set of objectives. Every objective that is in your balanced scorecard needs to be integrated into your strategy, which means that it should be, either, an end in itself, such as profit, or if you’re not-‐for-‐profit “achieving your mission”. Or if it’s not an end in itself, it better be linked causally to something that is. If improving that objective doesn’t cause something else good to happen, why are you including it?

Transcript: Module 2 Introduction

Now we’re going to refine our understanding of the strategic linkages at the heart of balanced scorecard 2.0, and give you the tools that you need to pull together a scorecard and integrate it into your organization. Our first step will be to distinguish between two very different types of measures: outputs and outcomes.

Outputs are the aspects of performance that you as an organization largely control on your own—it’s really how much you are doing. In contrast, outcomes are what’s happening as a result of what you are doing. Then we’re going to move onto some implementation challenges. Organizations have many different units all working together. We’re going to look at how



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organizations cascade the balanced scorecard from the highest levels that are setting overall strategy down to individual units, aligning from top to bottom, and also aligning horizontally, across similar units.

Finally, we’ll look at how we need to integrate a balanced scorecard into a report that people are going to be able to use and interpret. It’s not enough just to throw a bunch of numbers at people. You have to put them in context. Ideally, they form a narrative, a story that helps people understand why the organization is performing as it does.

Transcript: What's the Difference?

Now we’re going to talk about a particularly important distinction in the types of objectives and measures we include in a balanced scorecard. Are they measures of output or are they measures of outcome? An OUTPUT is a quantity of the amount of some type of product or service that we provide. It’s very much under our control. In contrast, an OUTCOME is the goal that we accomplish as a result of providing the output. And that is almost always a little out of our control.

As an example, let me use this course and eCornell. Here we are producing many minutes of video and many pages and words of Web content and discussion. That’s all output. We create that. It’s very much under our control; if we want another minute of video, we just record it. But what’s the outcome that we care about? The outcome that we care about is that our students learn the material-‐-‐that they walk out of the course knowing more than when they came in. That isn’t entirely under our control—we have to rely on you, our students, to do your part, and we have to hope that circumstances make it possible for you to devote time to the course. So it’s easy for us to focus on output and we need to, but we also have to keep our eyes on what really matters: the outcomes that are caused partly by our outputs.

Now this distinction between output and outcome, actually got its start in the governmental sector. And the reason is because taxpayers are paying a great deal of money for output and aren't always thinking that they’re getting the outcomes that they actually desire.

So it’s easy to build schools, that’s something you control once you get it through the – get the funding for it, you can build the school. You can put computers in it. You can put teachers in it. You can hold many, many hours of class. All of that is output and it is very expensive. But of course what the populace cares about is the outcome. Are more students getting a better education? Now this all began – the output/outcome distinction, in the governmental sector,



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but it’s been applied with great success in the for-‐profit sector as well. And one of the classic examples is Rolls-‐Royce.

As well as making incredibly expensive cars, Rolls-‐Royce makes airplane engines that they sell to commercial airliners. So they also, in addition to selling the engine, they provide a service contract that they will keep that engine up and running. Now that’s the outcome that the commercial airliner cares about. But most service contracts are output contracts. So the airliner under an output-‐based contract, an airliner would pay Rolls-‐Royce for every hour Rolls-‐Royce has to spend fixing the engines. But the output is not actually what the airline cares about. They want their engines to be running reliably with little downtime for many, many years.

Rolls-‐Royce understood this problem; they understood that customers would be worried that Rolls-‐Royce would try to beef up their service revenues by doing a lot of ineffective work and charging for a lot of hours of service. So they created what is called an outcome-‐based contract. Commercial airlines pay Rolls-‐Royce for servicing not according to the output -‐-‐ hours of servicing-‐-‐but according to the outcome, how many hours are the planes up and running with reliable engines; how many hours of successful reliable performance does a single engine give? The better the outcome, the more Rolls-‐Royce gets from its customers for servicing.

So you can see this distinction between output and outcome is very important in governmental agencies, in for-‐profit contracting. It’s equally important WITHIN the organization. In most organizations, one unit is creating an output, but hoping for the outcome that is going to be to another unit's benefit. Make sure your balanced scorecard emphasizes outcome measures because that is what, by definition, the organization ultimately cares about. Of course, it’ll have to include output measures as well. Why? Because the way you get the outcome is by first providing the output. So an output is a leading measure of its outcome.

Transcript: The Importance of Alignment

So you’ve already had some experience pulling together a single balanced scorecard. Now we’re going to look at some of the challenges in integrating that scorecard into the organization as a whole. So here’s the first rule to remember. Every unit within the organization should have its own scorecard. Every unit should be able to assess whether it is achieving its various output and outcome objectives, having measures, targets, and initiatives to help them do so. So that’s rule number one. Now how you are going to link all of those scorecards together? Remember



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that managerial reporting systems, and especially the balanced scorecard, serve a coordination-‐facilitating function that they get us all on the same page playing the same notes at the same time.

And remember that we have causal linkages that will often move across units. So you’ll have causal linkages within a single balanced scorecard, but an objective of one unit may be to help the performance of another. So you’re going to have to make sure that you understand how the objectives of each unit are integrated with the objectives of the other ones. So you’ll need to link those, and keep those causal connections in mind.

You’ll also want to make sure that every unit is achieving the goals of the overall organization. So we’ll just call “HQ,” headquarters, we’ll refer to that overall top-‐level balanced scorecard as being HQ’s balanced scorecard. Now, every objective that they have should be traceable to something that must be achieved by some unit below them. So we’re going to want to make sure that for every objective at HQ, we’re going to be able to identify the most relevant units, and we’d better make sure that those units are placing a lot of emphasis on those measures and that they are reflected in their scorecards. Now, also, every unit has some measures that are particularly important for its own success. And because the performance of one unit may be influenced by the performance of another unit, you’ll want to make sure that the most important objectives of each unit are reflected in HQ’s overall scorecard.

So, finally, I just want to point out that when I use the word “unit,” this doesn’t necessarily mean department or division, it could mean a function within a department or a division. You may have some accountants working closely together with some people on the production floor, you may have marketing and operations group working closely together, even within a department. They may each need their own balanced scorecard because they have distinct objectives.

Transcript: Measuring and Reporting Performance

As you look forward to implementing a balanced scorecard, remember that a balanced scorecard is not just a report, a page on paper or on the Web with a lot of numbers. It’s actually a reporting system. It is a system that is going to entail data collection, reporting, and response. And it’s a system that is not going to make everyone happy. If you’re doing your job, you’re going to find that some people maybe were not really represented in the report. There weren’t



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any objectives pertaining to much of what they were doing in your old system, and they may well have been happy with that, because it allowed them to operate safely out of view.

There may be other people who were very happy having a large presence in the performance-‐reporting scheme because it made them so visible to the people at the top of the organization. As you balance out the report then, you’re going to be making people unhappy. As you shift toward more actionable measures, as you shift also from outputs to outcomes, you’re going to be holding people’s feet to the fire a little more effectively, and again, there is going to be some resistance.

So as you turn to implementing a balanced scorecard, keep in mind that there's quite a bit of persuasion involved, and really, persuasion of two types. First, you have to persuade people that the changes in the system are appropriate and helpful. Second, you need to persuade people that the output of an individual report gives them a way to respond and improve. This second type of persuasion leads us to the final topic of this module, which is placing the numbers in context. Not just giving people a set of performance measures and listing which targets they hit and didn't hit. We’re crafting a more comprehensive narrative that will allow people to understand what happened, why it happened, and how everyone needs to respond.

Transcript: Best Practices in Reporting: Lessons from the U.S. Government

Now we’re going to look at the components of a good, comprehensive balanced scorecard report. We’ll start by following the framework of SERVICE EFFORT AND ACCOMPLISHMENT reporting, and this starts with the basics: our objectives, measures, targets and initiatives for how much effort it takes us, and how we accomplished our outputs and our outcome goals. Then we want to do a little bit of simple math with the inputs and outputs and outcomes, so we can assess our efficiency. How much input did it take to get our outputs and our outcomes?

And then we’re going to place all of those numbers in context, and this is the part I really want to emphasize now. First, there are many comparisons that we want to make that go far beyond just looking at cost versus benefit. We also want to look at baselines. So how did we do relative to last period? How did we do relative to our competitors or our peers? So, many comparisons should be emphasized in a useful, effective report. We also need to discuss unintended effects. So every time we have an initiative, every time we work to improve our performance on one objective, we may well alter outputs and outcomes on other objectives, measured or



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unmeasured. They might not even be part of our balanced scorecard, but we should discuss those.

We also need to be talking about the various effects outside of our firm and inside of our firm, the influences that are altering the outputs and outcomes we are able to achieve. So how did the economy change? Were there changes, maybe a new competitor came in and made it much harder for us to retain market share. We’ll want to talk about those as well. Maybe there is a big new demand for our services.

And then finally and most importantly, we need to have a narrative, a story that ties together all of the information. A good report tells a story. Now storytelling can get a bad name because your story may not really be a faithful representation of what happened. But I’m assuming that you are sincerely trying to craft a careful explanation and a persuasive document that will convince people that your understanding of what happened, why it happened, and how you should respond, is correct.

Now, the framework I just talked about came from SEAGov.org, an independent, nonprofit organization that really is dedicated to improving government reporting from the inside, from people closely associated with government and government reporting. But we can also look at some additional advice that comes more from the outside, from a government watchdog group, called the Mercatus Center at George Mason University. And they emphasize a few more points that are very useful to keep in mind as you think about what makes an effective report. It should be accessible and readable. Can people find the report? Do they have to hunt it down? And when they get it, does it speak simply and directly, or does it obfuscate? Are the data verifiable, and more importantly than that, does the report discuss the limitations of the data?

We also need to remember that every system imperfect; we’ve discussed that as a running theme of this course. And you need to think about what limitations in the data are making your measures imperfect. Hey, if you don’t talk about that in the report, people will wonder what you’re hiding. And finally, the report should tell a story that links inputs to outputs, and outputs to outcomes. It isn't just, “what happened?” but, “how did what people in the organization did affect what happened?” Without that story, you’ll never get people to respond and improve the organization.



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Transcript: Thank You and Farewell

Thank you for taking this course on the balanced scorecard and performance reporting. I've got some pretty clear outcome objectives for this course.

First, I hope I've given you new eyes with which to see the world, and a new, more precise language that will allow you to discuss the challenges your organization faces and the reporting systems that can serve as solutions. The terms we've introduced should help you to see that some things you thought were similar are actually different. For example, a measure is not the same as an objective, and an output is not the same as an outcome.

The terms should also help you see that things that seemed different to you before are now rather similar. So, for example, you may not have thought of a managerial reporting system as being like the nose of a star-‐nosed mole, but indeed it is. I also hope I've given you a number of memorable examples that will allow all of these ideas to stick in your head and given you enough guidance that you can put all of this to work in your own organization. Mostly, I hope you've seen this as a good investment of your time and I hope you come back for more. I'll be here.

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