Comparing Balanced Scorecard(BSC) with Traditional Performance Measurement

Traditional Performance Measurement Systems

Traditional Performance measurement system tracks only the financial performance of the organization relating to profit earned from selling to the capital required. They focus solely on financial measures based on internal accounting reports such as profitability, revenue, cash flows, earnings per share (EPS), return on assets (ROA),economic value added, etc. These measures are known as lag indicators as they only reflect the past data and represent historical performance (Kaplan and Norton 1992, 1996). Even-though such quantitative performance metrics can control and improve the internal performance of the organization, they can result in incorrect decision-making in the long-term.

First, relying solely on financial metrics can motivate managers to make decisions that sacrifice long-term value creation for the benefit of short term performance (Anthony & Govindarajan, 2007; Porter, 1996). For example; cost reduction can increase profit in the short-run, but only at the expense of loss of quality, loss of expertise and/or loss of customer base which all have long-term impacts. The traditional performance measurement systems were designed and appropriate to be used in the industrial age, a case of 50 years ago where the majority of companies were mass-production based having tangible assets like plant, property, equipment. In such cased financial performance based on past historical data was sufficient for decision making purposes. However, the modern business environment has moved from mass-production based industrial era to knowledge based era. This transformation has brought about a shift from relying solely on measuring tangible assets towards the valuing of intangible assets such as customer relationship, human capital, intellectual capital,etc. So, in today's competitive environment, sole reliance on the financial measures is inappropriate as these quantitative measures do not measure intangible assets, do not address the issue of competitive rivalry, are too aggregate, not timely and are backward looking to help managers to root cause performance problem and initiate timely corrective actions .

Secondly, traditional performance measures are not linked to the organizational strategy. Strategy is relates to the long-term goals of the organization, the scope of the organization’s activities, the allocation and matching of organizational activities to its resource capabilities and business needs, and consideration of the organization’s stakeholders' values and expectations (Anthony & Govindarajan, 2007 ; Porter, 1996). Traditional performance systems focus on short-term financial performance, resulting in a disconnect between organizations' long-term strategy and its short-term actions. Organizations must measure performance in ways that not only replicate past positive performance, but also encourage positive future results. Today's business environment is characterized by intense competitive rivalry and as a result businesses have to be flexible and adaptable to gain and sustain a competitive advantage (Porter, 1996). Organization must excel in other critical areas such as product or service quality, organizational flexibility, customers relationships, relationships with suppliers, relationships with employees, processes and technology know-hows, and innovation in order to survive in the current competitive environment. Therefore, modern organization must invest in intangible assets that create future value such as Customer relationship, employee development and intellectual capital. These intangible assets drive value creation, are linked to the long term growth of the company and have become a major source of competitive advantage (Kaplan and Norton, 1996). Therefore, it is critical that these intangible assets are measured as they are leading indicators of organizational performance. However, traditional performance systems do not measure such non-financial performance. By focusing only on lag indicators and ignoring lead indicators, managers tend to have the problem of shortsightedness at the expense of long term benefits.

Therefore, traditional performance measures which predominately focusses on financial performance measures are not appropriate in this dynamic and changing environment. Focussing just on financial-measures is inadequate because one-type of performance metric, cannot realistically capture the entire organization's performance. Organizations need to link performance measurement to strategy, and therefore, the performance measurement system must include both financial and non-financial measures in order to get a complete snapshot of organizational performance to succeed in the modern dynamic environment. A performance measurement system that aligns performance measurement to strategy by linking short-term actions with long-term goals such as customer relationships, employee and organizational capabilities are critical for success.

Balanced Scorecard

The Balanced Scorecard (BSC) is a performance measurement system that addresses the weaknesses of the traditional performance measurement systems. It has added strategic non-financial performance metrics to traditional financial metrics, thus, providing a ‘balanced’ view of an organizational performance (Anthony & Govindarajan, 2007; Kaplan and Norton 1992;1996). BSC reflects changes in the modern competitive environment by taking into account the intangible assets that have became a major source of competitive advantage (Kaplan and Norton, 1996).

BSC is an integrated strategic management system that aligns business activities to the strategy of the organization by linking performance measurement with the company’s strategic objectives. It provides a framework to translate the organization's strategy into specific quantifiable performance objectives that can be measured (Kaplan & Norton,1996).The performance objectives are measured using the four inter-connected perspectives, i.e., the financial perspective, customer perspective, learning and growth perspective and internal business processes perspective (Kaplan and Norton, 1996).

• Financial Perspective
  The financial perspective focuses primarily on the financial objectives of the organization. It deals with the tracking and monitoring of financial success and how the company look to the shareholders (Kaplan and Norton, 1996). The typical financial measures are the profitability, revenue, Return on Investments, Return on Capital Employed ,cash flows, and sales growth.
• Customer Perspective
  The Customer Perspective perspective deals with how the customers see the company (Kaplan and Norton, 1992). This perspective focuses primarily on customer satisfaction since customer satisfaction and retention is linked to the long term growth and survival of the company. This perspective helps in the long-term planning of the company. The goal is to measure the value delivered to the customers by meeting customer demands and needs. Measures selected for this perspective include customer satisfaction rate, customer retention rate, delivery performance, quality performance, existing market share, and percentage sales to new customers, and so forth.

• Learning and Growth Perspective
  Learning and Growth Perspective focuses primarily on intangible drivers of future growth such as human capital and operational capital . This perspective deals with objectives such as the capability of the company to continue to grow, improve and create value (Kaplan and Norton, 1992). In the modern dynamic and intensely competitive business environment, the organization must constantly change, adapt, learn, improve and innovate to create future value and survival. Measures selected for this perspective include Job satisfaction, employee turnover, employee training, and development,the rate of innovation, etc.

• Internal Business Processes Perspective
  Internal Process Perspective focuses primarily into the area of internal operational objectives that the company must achieve at in order to survive (Kaplan and Norton, 1992). This internal focus perspective gives an understanding of how well the organization is operating and helps to determine which activities are meeting the real needs of the customers. Organization will have to excel in the key processes necessary to deliver the customer’s need such as producing value adding products or services, improving internal resource and asset utilization.The measures that are used to assess Internal Business Processes Perspective include efficiency levels, value analysis of unit costs, and process alignment.

BSC analyzes the company performance from the above four perspectives where performance metrics are designed, collected and analyzed relative to each of these four perspectives. The measurements of the four perspectives have inter-dependent relationship between them (Kaplan and Norton, 1996). The learning and growth perspectives leads to delivering high quality internal business processes as employees would have developed right competencies. By having good internal business processes, the company would be able to meet their customer’s needs and will gain market share and customer loyalty for future business. The higher customer’s satisfaction can lead to improvement in the company’s financial performance. This highlights that the objectives in the four perspectives are inter-linked. Therefore, if an organization can excel in all the perspectives of the BSC scorecard, the organization would have a better long-term financial success (Kaplan and Norton,1992).

Thus, the BSC measures organization performance by balancing between financial and non-financial measures. Progress is measured with traditional financial measures, such as profit and loss, along with contemporary non-financial measures such as customer satisfaction, employee retention, brand equity, intellectual capital and market share. BSC includes both lag indicators and lead indicators in the four perspectives and links the strategic objectives of an organization to the day-to-day actions of managers

Conclusion

In conclusion, organizations need to link performance measurement to strategy. Strategic decisions occur at many levels of managerial activity. Therefore, it is crucial that the organization’s performance measurement system must be linked to the objectives of business units, functional units, groups and individuals (Kaplan and Norton ,1996). The traditional performance measurement systems are said to be no longer appropriate in this dynamic and changing environment, as they do not reflect the organization strategy, nor the uncertainty in the competitive environmental, nor addresses organization improvement and capabilities. Organizations need to link performance measurement to strategy, and must measure performance such that they encourage both, positive future results and replicate past positive performance .

Balanced scorecard is an integrated strategic management system, which has overcome the limitations of the traditional performance measurement systems. The BSC provides a balanced view of the company’s overall performance by aligning organizational activities with the company's strategy and vision. The main advantage of the balanced scorecard methodology is that it created the basis for forward-thinking performance measurement by linking “what the organizations wants to achieve” (financial and customer objectives) with “ How the organizations can achieve this” (internal process and learning and growth objectives). In order to successfully execute organization vision and strategy organizations must monitor and control that all business units, functional units, groups and individuals are all pursuing strategic goals. BSC links strategy to operational activities and creates a strategy focused organization. It monitors different business processes to determine which metrics are most effective in measuring performance and provides feedback to internal business & external business process in order to continuously track and improve strategic performance and results. Performance issues are discovered early, giving managers opportunity to take corrective action, identify the company’s value drivers and ensure correct strategies have been adopted. Thus, the BSC aids managers to shift from a reactive management approach to a proactive management approach. By linking strategy to operational objectives to organization strategy, BSC enforces managers to look at the long-term view of the organization, promoting managers to think about the future and not focus on the past. This is in contrast to the drawbacks of the traditional performance measurement systems, which are too aggregate, not timely and are backward looking to help managers to root cause performance problem and initiate timely corrective actions.

Read More

Comparing Strategic Management Accounting with Traditional Management Accounting

“Strategy is the direction in which the organization plans to move to attain its long-term goal” (Anthony & Govindarajan, 2007). Strategy is concerned with the long-term direction of the business organization, the scope of its operational activities, the matching of operational activities to its resource capabilities and its competitive environment, giving consideration its stakeholders values and expectations (Porter, 1996 ; Anthony & Govindarajan, 2007).

Traditional Management Accounting has tended to concentrate on the tactical and operational decisions in the organization by focussing strictly on financial measures for monitoring and controlling short term activities. It predominately emphasizes on allocating business costs to goods or services and prepare accounting reports using historical and quantitative financial data for internal management business decisions. It is inward-looking with short-term outlook and focussing too much on internal organizational efficiency. In the new competitive environment, for a business to remain healthy there are other aspects that need to be considered such as information on competitors, human resources, customers, suppliers and technologies for developing and monitoring a business strategy.

By focussing only on the cost side of things more heavily than other aspects of the business,traditional management accounting has tended to neglect to provide information to support and attain strategic goals of organizations. Therefore traditional management accounting is considered to be inadequate due to its failure to generate relevant and futuristic non-financial information required to support strategic decision-making (Bromwich, 1990).

Strategic management accounting (SMA) is a newer version of management accounting which adds the strategic perspective to traditional management accounting. SMA is defined as “The provision and analysis of financial information on the firm’s markets ,competitors’ costs, cost structures and the monitoring of the organization's strategies and those of its competitors in these markets over a number of periods” (Bromwich, 1990) . SMA attempts to rectify the weakness of Traditional management Accounting by including (i) Both financial and non-financial indicators and (ii) Both internal and external information.

According to Porter (1996) business strategy, involves (i) Competitive advantage, which focusses on choices and trade-offs between alternatives based on external industry analysis , and (ii) “operational effectiveness,” which focuses on cost minimization based on internal value chain analysis. Thus, SMA can be compared to Traditional Management Accounting from these two perspectives of external competitive environment and internal strategic costing ;

External competitive environment perspective

For an organization to be successful, it is important to gain or sustain its competitive advantage. According to Porter 's (1996) strategy framework, for businesses to generate a sustainable competitive advantage, they have three strategies to choose from. They are the low cost leadership strategy, product or service differentiation strategy, and focussed strategy. A low cost leadership strategy involves seeking to become the lowest cost producer of a product or service in order to earn above-average profits. A differentiation strategy seeks to create a customer perception that a product or service is superior compared to that of the competitor's products or services, based on brand, quality, and performance. A focus strategy involves either a differentiation or cost leadership strategy, but seeks to provide a high perceived value product or service to customers in a niche segment of the market, justifying a price premium. In order to gain competitive advantage, an organization requires constant monitoring of the external competitive environment and must be flexible, adaptable and needs continuous improvement (Porter, 1996).

SMA incorporates strategic thinking into management accounting by including non-financial measures to capture the qualitative attributes and aspects of competitive management. A key component of SMA is analyzing and incorporating external factors such as industry competition to determine the organization's biggest competitors, competitor's positions in the market, threat of new competition in the market, and the cost of entering the market, the threat of substitute products or services which can obsolete the existing product. SMA conveys an externally oriented perspective and helps in the development of long-term plans by collecting and analyzing information on competitors costs, market shares, sales volumes, and resource utilization for comparison against its own internal information. Such competitor data helps business to protect its strategic position or make strategic changes to improve future competitiveness. Thus , SMA looks to the future by measuring trends in the external environment and supports positive longer-term decision makings rather than short-term reactive ones.

Traditional Management Accounting does not offer a full understanding of the external competitive situation. Its focus is on determining costs and financial control, by using methodologies such as budgeting and cost accounting, thus making the organization rigid and not adaptable to the dynamic nature of the external competitive markets. Traditional Management Accounting is inward looking as it focuses largely on accounting functions within internal business units to meet the requirements of the business unit managers. While greater emphasis is given to the internal operations side of the organization, it overlooks potential external competitive threats and external opportunities. Traditional Management Accounting excludes information about competitors, without the information of competition taking advantage of them is impossible. By focussing purely on financial information, Traditional Management Accounting coveys on short-term outlook. Thus, traditional management accounting is considered to be too limited to provide necessary and meaningful information for long-term planning .

Compared to Traditional Management Accounting, Strategic Management Accounting (SMA) is outward looking and helps businesses to evaluate its relative competitive position in industry it operates in. By providing strategic competitive data, SMA helps businesses to analyze the actions of its customers and competitors. In the absence of such information, businesses will be incapacitated in formulation and implementation of business strategies for competitive advantage. Therefore, Strategic Management Accounting (SMA) entails providing management accounting in the context of planning and implementing business strategies.

Internal Strategic Costing perspective

From Porter's (1996) strategy framework, businesses have three strategies at their disposal : product or service differentiation, low-cost leadership and focus strategy . However, to implement any of these strategies , the management must manage costs strictly . Therefore cost management system is a critical source of building a competitive advantage. The 21^st century business environment is characterized by intense competitive rivalry and as a result, businesses have to constantly adapt and change their internal operations in order to maintain or gain a competitive advantage . Successful organizations are those that are able to (i) lower costs and (ii) improve the quality and efficiency of operations. Therefore, an organization's internal cost management system must be aligned to its business strategy

Traditional Management accounting features management control techniques such as budget control and standard costing. Such costing models incorporates arbitrary allocation instead of the cause-and-effect allocations of indirect costs, and they do not provide accurate product cost information in a multi-product organization. Such techniques could lead to accurate product costs in mass-production organizations where direct costs are considerably high and indirect costs are typically low. This was appropriate in mass-production industries which were dominant around 50 years ago, however, the current organizations are characterized with having lower direct costs and higher indirect costs. This makes accurate calculation of product profitability in a modern organization not possible. It is impossible to establish and/or sustain competitiveness without an actual cost calculation mechanism. Also, traditional management accounting has failed to adapt to the modern competitive environment that requires continuous improvement in the entire value chain. The value chain is the set of all the activities involved in the product, from the beginning with the extraction of raw materials to the end with the post-delivery customer support activities (Anthony & Govindarajan, 2007).Traditional Management Accounting does not analyze non-manufacturing costs or the costs of pre-conversion and post-conversion activities. Thus, it fails to evaluate the relative cost positions of competitors as it is concerned more with the internal cost position of the company such as focussing on existing activities and managing the internal resources of the organization. This makes traditionally management accounting backward-looking and reactive to competitive pressure.

For this reason management accounting processes shifted to using costing models under SMA such as activity-based costing methodology. The Activity-Based Costing (ABC) is costing system methodology that reflects the modern complex business environment and facilitates the organization to allocate costs more accurately. ABC assesses and identifies activities in the value chain of the organization and assigns the cost of each activity with resources to all products and services according to the actual consumption by each of them (Anthony and Govindarajan, 2007). Therefore, an organization can accurately estimate the cost elements of the entire range of its product and/or service and to help in management decisions. By identifying and allocating costs to each activity, ABC helps the company to determine whether to lower or raise the activities cost based on the relative cost position. Also, ABC model offers valuable insights toward the strategic planning process (Anthony and Govindarajan, 2007) . ABC focus is not just on the costs of the activities but also value added by these activities from both internal and external positions. SMA views cost drivers by looking at the value they provide to achieve the company's strategic/long-term objectives. In areas where opportunities for lowering costs exists, the long-term impact are addressed, such as the possibility of declining market demand and/or quality. In areas where investment opportunities exists, long-term advantages and/or disadvantages are evaluated, such as whether increasing value-adding activities or eliminating non-value adding activities will raise the profit margin in the future. By integrating costs into strategy, SMA enhances the strategic position of the firm through the exploitation of the linkages in the value chain and optimizing cost drivers. Thus, compared to Traditional Management accounting, SMA uses cost information to formulate strategies and carry out tactics to implement those strategies (Anthony and Govindarajan, 2007).

In conclusion, today's organizations face a lot of competition due to the rapidly changing, complex and uncertain economic environment. For an organization to be successful, it is critical for it to maintain or improve its competitive advantage. By focussing too much on internal organizational efficiency , Traditional Management Accounting does not offer a full understanding of the external competitive situation. It is considered inward-looking aiming to fulfill short-term objectives rather than long-term objectives of the business. Strategic Management Accounting (SMA) looks not only at the internal efficiency of the organization in terms of its resources and operations, but also on the external business environment . SMA aims to provide relevant and both financial and non-financial information on competitors, customers, suppliers, and the external environment to the organization’s management. With such information, organizations can monitor and evaluate the changes in the external environment in which the company operates and enable them to make strategic plans and strategic decisions. SMA also integrates costing into strategy. SMA uses the cost information to improve the strategic cost position of the business and carry out long-term strategic objectives by using cost management as a tool to improve productivity, increase customer satisfactions and increase revenues. Thus, the approach of SMA is in line with the business strategy objectives that produces long-term objectives for the business, taking into consideration competitor's plans and their possible actions, as well as analyzing and improving the value chain to align with the strategic objectives of the organization.

Read More