>> Now we're going to talk about systems that firms use to incorporate and connect nonfinancial performance measures and financial performance measures. Generically, these systems are referred to as strategic performance measurement system. So what is this really? Well, it's a model or a framework that the firm uses that explicitly strategy to the related performance measure. In other words, it's a map. The purpose of a strategic performance measurement system is usually threefold. First, it communicates strategy to the managers and employees throughout the firm. Second, it enables and evaluation of strategy. It lets the firm know whether or not the strategy being implemented is being effective. And this, ultimately allows for the strategy to he evolve over time, for the firm to improve or change its strategy in the future. Now there are many different types of strategic performance measurement systems. This comes from practitioner reading and consultants. One very famous type is referred to as the balance score card. There are many different types, as well beyond the balance score card, specifically, performance prism and the performance pyramid, value-chain scoreboard, the customer equity model, and the performance dashboard. These are just a few of the strategic performance measurement systems that consultants and practitioners have suggested would benefit firms. We're going to focus on what is arguably the most popular version of the strategic performance measurement system. Specifically, the balance score card. This is a very popular strategic performance measurement system. It establishes objectives and measures and links them to the strategy of the firm or the business unit. Oftentimes, a firm with multiple business units will have multiple versions of a balance score card that are specific to each of its major divisions. The evolution of the balance score card is actually quite interesting. It started off by just offering a more balanced view of the firm. Historically, firms overemphasized financial performance, and it's kind of odd to say now, but somebody needs to tell them that they're overly focused on financial performance measures and that non-financial per performance measures and other aspects of their business are just as important. Then the being score card evolved into adopting more strategic perspectives, and from there, the balance score card incorporated strategy maps and more explications about linking objectives, initiatives, and measures. Just recently, firms are evolving to incorporate the balance score card into their incentive compensation system, and some interesting research focuses and that. Basically, the balance score card is comprised of four perspectives. There is the age-old tradition of focusing on something that is more financial. Financial-oriented goals and accompanying measures are developed, and the questions inside of that perspective are how should we look to our shareholders? What are goals in terms of financial returns? There are also internal perspective. On the right-hand side, the right box of this diamond, talks about goals and measures that ask what must we excel at? This is more of an internal perspective and has to do with the operations and processes that allow the firm to implement and pursue its strategy. There's also a customer perspective, seen on the left-hand side of this depiction. There are goals and measures that are adopting the customer perspective, which asks, how should we look to our customers? Common measures inside of this per perspective are customer satisfaction and the percentage of customers that return. And finally, there's more of a long-term perspective. One that's invasion or development or learning. The questions asked there are how can we continue improve and create value. Different measures correspond to each of these individual perspectives, but ideally, they're all linked to facilitate the compilation of non-financial and financial performance metrics and facilitate the development and pursuit of the firm's strategy. Here's an example, which I wouldn't take the time to walk through every ultimate detail here, but you can see along the left-hand side, SMDC, is company in the real world that has adopted the balance score card. They have a mission statement that reads, "SMKC is a values-driven integrated organization which will be recognized for excellence in customer service, quality patient care, financial strength, and support of community health." You can see the multiple perspectives right inside their mission statement, but the balance score card extends well beyond this. On the left-hand side you can see the financial, customer, internal and learning and growth or innovation perspectives, and they have incorporated somewhat of a strategy map, as depicted by the arrows that connect different levels or different perspectives and cross those dotted lines that separate them. So this slide will be available for you to review, as well as you can look to the original resource for this slide, a book by Robert Kaplan and David Norton. Now question is how well are firms using this tool? Well, there is some research on balance score card, actually quite a bit that is performed by academics so see the implications and the consequences associated with the firm adopting the balance score card. This research, or an example of it, has shown a few mixed results first of all, firms, long before it was suggested, tie compensation to the balance score card. Eighty percent of firms that were surveyed do this in some form or fashion. Less than 30% of the firm's implementing the balance score card explicitly define a causal chain. That is, they don't necessarily connect the perspectives with explicit arrows, like we saw in SDMC's example. Only 21% of those with a causal chain actually test its validity. Most of the firms just rely on what they feel is the right strategy in how these things can be connected, but very few actually do the testing. But research suggests that when a firm does actually test the causal linkages between non-financial performance measures and financial performance measures, they actually earn better financial performance. Of the 21% that tested its validity, they had an average of 2.95% higher return on assets and over 5% higher return on equity than those that did not test the causal chain. So implemented appropriately, the balance score card can actually yield very significant returns. There are some challenges with the balance score card, however. First of all, it incorporates many different measures. Again, when we open the door to the non-financial view of the firm and these alternatives of customer, internal, or innovation or learning and growth, it's difficult to deal with all of those individual measures and it's difficult to evaluate the relative importance of those measures. Quantifying qualitative data is oftentimes difficult, as well. So just to create those nonfinancial metrics and incorporate them and find connections between them can be very taxing. It's very time consuming and expensive to implement the balance score card, and there can be some gaming of the system. The more measures you put in front of managers and employees, the more likely they'll try to manipulate those measures, and of course, will are problems with the causal chain. Firms never really know for sure about the link between non-financial measures and financial measures Again, oftentimes, due to a variety of factors, one, the linkages might be nonlinear or they may not be unidirectional. The causal linkages between nonfinancial measures and financial measures may actually be looped. There also may be more noisy measures, especially when we're talking about nonfinancial metrics, and of course, there is the time lag, and testing causal chains over multiple years when it takes a nonfinancial metric to ultimate transform into financial performance can be very difficult and taxing, as well.
