Communicating and Controlling Strategy: A Study on the Effectiveness of the Balanced Scorecard

By Mary A. Malina and Frank H. Selto

Part 1 of 4

ABSTRACT

This paper reports evidence on the effectiveness of the Balanced Scorecard (BSC) as a strategy communication and management-control device. In this paper we review management control and communication literatures that identify criteria for effective control and communication of strategy. The paper analyzes empirical interview and archival data to model the use and assess the effectiveness of the BSC. The paper uses data from multiple divisions of a large, international manufacturing company. Data are from BSC designers, administrators, and North American managers whose divisions are objects of the BSC. We accumulate evidence regarding the challenges of designing and implementing the BSC faced by even a large, well-funded company. These findings may be generalizable to other companies adopting or considering adopting the BSC as a strategic and management control device.

Data indicate that this specific BSC, as designed and implemented, is an effective device for controlling corporate strategy. Results also indicate disagreement and tension between top and middle management regarding the appropriateness of specific aspects of the BSC as a communication, control and evaluation mechanism. Specific results include evidence of causal relations between effective management control, motivation, strategic alignment and beneficial effects of the BSC. These beneficial effects include changes in processes and improvements in both the BSC and customer-oriented services. In contrast, ineffective communication and management control cause poor motivation and conflict over the use of the BSC as an evaluation device.

Data availability: Use of all data collected for this study is regulated by a strict non-disclosure agreement, which requires the researchers to protect the company's identity and to obtain approval to publish any reports that might expose the company's proprietary information.

INTRODUCTION

The professional and academic strategy literatures claim that many organizations have found that traditional performance measures (e.g., ex post costs, profits, return on investment) are insufficient guides for decision making in today's rapidly changing, hyper-competitive environment. It has long been argued that sole reliance on current, financial measures of performance does not reflect the importance of current resource decisions for future financial performance [e.g., Dearden, 1969]. Though some firms have known the importance of non-financial measures of performance for many years as well (e.g., General Electric since the 1950s), growing international competition and the rise of the TQM movement have widened their appeal. Since the 1980s, authors have filled the professional and academic literature with recommendations to rely more on non-financial measures for both managing and evaluating organizations [e.g., Johnson and Kaplan, 1987; Rappaport, 1999]. A growing body of recent research has investigated empirical links between non-financial and financial measures of performance in a variety of firms and industries [for example: Amir and Lev, 1996; Banker et al., 1993, 1995, 1996, 2000; Barth et al., 1994, 1997; Behn and Riley, 1999; Foster and Gupta, 1990, 1999; Ghosh and Lusch, 2000; Hughes, 2000; Ittner and Larcker, 1997, 1998a; Perera et al., 1997]. These studies often find significant relations between non-financial measures and measures of financial performance, though studies of the performance effects of including non-financial measures in compensation plans are less consistent. Given extensive theoretical and growing empirical support, it is not surprising that many organizations report that they are turning to forward-looking, non-financial information to both guide decisions and evaluate current performance [Ittner and Larcker, 1998c].

The balanced scorecard (BSC), popularized by Kaplan and Norton [1992, 1993, 1996a, b, c] and adopted widely around the world, has been offered as a superior combination of non-financial and financial measures of performance. Because the BSC explicitly focuses on linkages among business decisions and outcomes, it is intended to guide strategy development, implementation, and communication. Furthermore, a properly constructed BSC could provide reliable feedback for management control and performance evaluation.

Atkinson et al. [1997] regard the BSC as one of the most significant developments in management accounting, deserving intense research attention. Silk [1998] estimates that 60 percent of the U.S. FORTUNE 500 companies have implemented or are experimenting with a BSC. Given its high profile, it is surprising, perhaps, that there is relatively little academic research focused on either the claims or outcomes of the BSC [Ittner and Larcker, 1998b]. It seems natural to ask whether the BSC's content, format, implementation, or use have discernable effects on business decisions and outcomes that could not be attained with existing measures, alone or in combination. In the first study of its kind, Lipe and Salterio [1999] identify decision effects associated with the format of the BSC's the arrangement of performance measures into four related categories appears to convey decision-relevant information to subjects performing a laboratory evaluation task. Most other current BSC studies, however, are relatively uncritical descriptions of BSC adoptions. One may expect a surge of empirical studies aimed at the assumptions and claims of the BSC, similar to those that focused on other recent innovations, such as economic-value added (EVATM) and activity-based costing (ABC).

Kaplan and Norton [1996] argue that the BSC is best suited as a strategic planning and communication device to (1) provide strategic guidance to divisional managers and (2) describe links among lagging and leading measures of financial and non-financial performance. When used metaphorically, the BSC describes the steps necessary to reach financial success - invest in specific types of knowledge to improve processes, etc. If the linkages are valid reflections of a company's administrative and productive processes and economic opportunities, the BSC embodies and may communicate the company's operational strategy. Furthermore, effectively communicating these linkages throughout the organization may be crucial to implementing that strategy successfully [Tucker et al, 1996; West and Meyer, 1997].

The present paper reports research to investigate the communication and management-control effectiveness of a large, successful, international company's BSC model. The study uses archival and qualitative data from interviews of the BSC's designers, managers, and users to assess the perceived effectiveness of the BSC as both a strategic communication and control device and to find evidence of the BSC's decision impacts. To our knowledge, there are no similar empirical investigations of the BSC in the literature despite its apparent acceptance and implementation by prominent companies throughout the world. Note that the current paper does not test whether the company's BSC is a statistically valid model of the company's activities and performance. This feature of the BSC will be tested in subsequent research.

The BSC investigated in this study was explicitly designed to advance the company's strategy and has greatly affected the outlook and actions of the BSC's users. These results include both beneficial and adverse outcomes. When elements of the BSC are well designed and effectively communicated (as described in the study), the BSC appears to motivate and influence lower-level managers to conform their actions to company strategy. Furthermore, they believe that these changes will result in improved sub-unit performance. However, there also is consistent evidence that flaws in the BSC design and shortcomings in strategic communication have adversely affected relations between top and some middle managers. The BSC design exacerbates strong differences between their views of future opportunities. Shortcomings in communication generate mistrust and unwillingness to change. While the specific flaws and shortcomings may be unique to the studied company, these findings appear to be generalizable to other BSC designs and uses.

The second section of this paper provides an overview of the BSC in the context of management control of strategy and the first research question. The third section reviews the communication literature regarding characteristics of effective communication of strategy and presents a second research question. The fourth section describes the research site and the company's BSC. The fifth section describes procedures used to obtain and analyze the archival and qualitative interview data. This section also presents a theoretical model to describe BSC effectiveness. The sixth section answers the research questions and derives an empirical model of BSC effectiveness. This final section summarizes conclusions and offers recommendations for future research.

THE BSC AND MANAGEMENT CONTROL OF STRATEGY

A common criticism of traditional (typically financial) measures of performance is that they induce managers to make myopic, short-run decisions. Financial measures tend to focus on the current impacts of decisions without a clear link between short-run actions and long-run strategy [recent criticisms include McKenzie and Schilling, 1998; Luft & Shields, 1999]. Furthermore, traditional financial measures of performance may work against knowledge-based strategies by treating the enhancement of resources such as human capital, which may be critical to effecting strategy, as current expenses [e.g., Johnson, 1992]. Dixon et al. [1990] argue that traditional financial measures, by expensing costs of many improvements, also work against strategies based on quality, flexibility, and minimizing manufacturing time. For many lower-level employees, most financial performance measures are too aggregated and too far removed from their actions to provide useful guidance or feedback on their decisions. They may need measures more appropriately and accurately related to outcomes that they directly influence [McKenzie and Schilling, 1998]. A number of studies have found evidence that traditional, financial measures of performance are most useful in conditions of relative certainty and low complexity - not the conditions faced by many organizations today [e.g., Gordon and Naranyan, 1984; Govindarajan, 1984; Govindarajan and Gupta, 1985; Abernethy and Brownell, 1997].

Lynch and Cross [1995] argue that performance measures should motivate behavior leading to continuous improvement in key areas of competition, such as customer satisfaction, flexibility, and productivity. That is, they should reflect cause and effect between operational behavior and strategic outcomes [Keegan et al, 1989; Ittner and Larcker, 1998b]. Furthermore, as an organization identifies new strategic objectives, it also may realize a need for new performance measures that encourage and monitor new actions [Dixon et al., 1990]. Thus, organizations sensibly and perhaps optimally may use a diverse set of performance measures to reflect the diversity of management decisions and efforts [e.g., Holmstrom, 1979; Banker and Datar, 1989; Feltham and Xie, 1994; Ittner and Larcker, 1998c]. Empirical support for these propositions is limited but growing. For example, Banker et al. [2000] provide strong empirical support from extensive time-series data within a service firm for relations between leading non-financial measures and lagging financial performance. Furthermore, they use an event-study method to find beneficial performance effects from including non-financial measures in management performance evaluations.

THE MANAGEMENT-CONTROL CASE FOR THE BALANCED SCORECARD

It seems a short leap of normative logic from an awareness of the potential usefulness of multiple measures of performance to the selection and arrangement of performance measures that Kaplan and Norton [1992] have dubbed the Balanced Scorecard. Indeed, the BSC may have spread widely throughout industry on the strength of its intuition and internal logic. Kaplan and Norton claim that the BSC offers two significant improvements over traditional financial or even non-financial measures of performance.

First, the BSC identifies four related areas of activity that may be critical to nearly all organizations and all levels within organizations:

  • Investing in learning and growth capability

  • Improving efficiency of internal processes

  • Providing customer value

  • Increasing financial success

Following the logic of the BSC and ignoring cost-benefit considerations, most organizations could use measures in all four areas to encourage and monitor actions appropriate to organizational strategy. In its most basic use, a properly configured BSC could provide a comprehensive picture of the state of the organization, much as an automobile's dashboard shows fuel level, oil pressure, coolant temperature, engine RPM, and velocity.

Second and significantly, the BSC seeks to link these measures into a model that accurately reflects cause and effect relations among categories and individual measures. Using the automobile analogy, a BSC would simulate the car's performance given a planned increase in fuel consumption and engine RPM (and perhaps other factors). Such a model could support operational decisions, make predictions of outcomes given decisions and environmental conditions, and provide reliable feedback for learning and performance evaluation.

While the first claim for the value of multiple measures of performance borders on common sense and likely would generate little controversy beyond considerations of costs and benefits, the second claim is a bold and rigorous hypothesis. A literal and potentially testable description of the BSC is that it describes contemporaneous, leading, or lagging relations among performance measures. For example, improvements in learning and growth such as increased training should be reflected in predictable improvements in internal processes, such as reduced cycle time [e.g., Luft and Shields, 1999]. Likewise, improvements in internal processes would result predictably in improved customer value (e.g., satisfaction and market share). Finally, improvements in customer value would lead to predictable increases in financial success (e.g., profits). Creating such a comprehensive and coherent model is an ambitious objective that is akin to simulating the important features of the organization itself. Note that accomplishing such an empirical result may not establish causality among BSC elements because (1) some proposed measures may not be independent and (2) causes of profitability may not be generalizable beyond the context of a specific firm [Norreklit, 2000].

THE ROLE OF THE BSC FOR STRATEGY IMPLEMENTATION AND PERFORMANCE MEASUREMENT

Proponents of the BSC stress its alignment of critical measures with strategy and linkages of the measures to valued outcomes. In addition, the management control literature identifies other characteristics of control systems that may be critical to the successful implementation of strategy and should apply to the BSC. Briefly, to be effective, BSC measures should be accurate, objective, and verifiable. Otherwise, measures will not reflect performance and may be manipulated, or managers could in good faith achieve good measured performance but cause the organization harm. If managers can achieve good measured performance by cheating, the system quickly will lose credibility and desired motivational effect. Furthermore, the set of BSC measures should completely describe the organization's critical performance variables, but should be limited in number to keep the measurement system cognitively and administratively simple. An exhaustive set of performance measures may accurately reflect the complexity of the organization's tasks, but too many measures may be distracting, confusing, and costly to administer. However, Lipe and Salterio [1999] did not find evidence of information overload from multiple measures in their experimental study of the BSC. To obtain motivational impact, at least some of the BSC measures should reflect managers' actions, which does not negate the possible importance of informative but not controllable performance measures. That is, relative performance evaluation may be an important component of the BSC [e.g. Antle and Demski, 1988], but it may not be sufficient by itself. Extensive goal-setting literature confirms that performance should be keyed to challenging but attainable targets [e.g., Locke and Latham, 1990]. Without such explicit BSC targets, performance likely would be lower than could be reasonably achieved. Finally, the BSC should be linked with prompt and well-understood rewards and penalties. Rewards that are delayed, uncertain, or ambiguous may be ineffective motivational devices.

Therefore, even though an organization's BSC reflects its critical performance variables and linkages to valued outcomes, it may fail as an effective management control device if it lacks other attributes. To summarize, a BSC should have the following management control characteristics to, first, attain strategic alignment:

  • A comprehensive but parsimonious set of measures of critical performance variables

  • Critical performance measures causally linked to valued outcomes

  • Effective - accurate, objective, and verifiable - performance measures

Second, to further promote effective motivation, the BSC should have:

  • Performance measures that reflect managers' controllable actions and/or relative performance

  • Performance targets or appropriate benchmarks that are challenging but attainable

  • Performance measures that are related to meaningful rewards

Therefore, the first research question is:

Does the evidence support causal paths from (in)effective BSC management control to strategic (non)alignment, (in)effective motivation, and (poor)good performance?

This ends Part 1 of 4