Rapid changes in technology, competition and regulations means that the formulation and implementation of strategy has to be a continual and participative process.
Organisations today need processes and systems to implement strategy and gain feedback about it. "Why do organisations have difficulty implementing well-formulated strategies?" Robert Kaplan (in picture) has an answer.
Here are some cold hard statistics: fewer than 10% of effectively formulated strategies are successfully implemented.
A Fortune cover story on failures concluded that in about 70% of the cases the real problem was not bad strategy but bad execution. In India, the failure rate of the best strategies is between 70% and 90%.
"Why do organisations have difficulty implementing well-formulated strategies?" ask Kaplan and David Norton, co-authors of the best-selling The Strategy-focused Orgainzation.
The first issue is that strategies are changing but the tools for managing them have not kept pace. In the industrial economy, companies created value with tangible assets, by transforming raw material into finished products.
A 1982 study showed that tangible book values represented 62% of industrial companies' market values. Ten years later, the ratio had dropped to 38%, and by 2000 it had plummeted to under 15%.
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Opportunities to create value are shifting from managing tangible assets to managing knowledge-based strategies using intangible assets like customer relationships, innovative products and services, high quality and responsive operating processes, information technology and databases, and employee capabilities, skills and motivation.
In an economy dominated by tangible assets, financial measurements were adequate to record investments in inventory, property, plant and equipment on companies' balance sheets.
Income statements could capture expenses used by tangible assets to produce revenue and profits. Exclusive reliance on financial measures cause organisations to do the wrong things. Financial measures are lag indicators: they report outcomes or consequences of past actions. When intangible assets become major sources of competitive advantage, we need different tools, says Kaplan.
So how do you implement knowledge-based strategies in firms designed for industrial-age competition?
Many organisations operate under central control through large functional departments. Strategy is developed at the top and implemented through a centralised command-and-control culture.
This system was fine in the 19th and early 20th century when change was incremental, so managers could use slow-reacting and tactical management control systems such as the budget. These are inadequate for today's dynamic environment.
Is it any surprise that companies find it difficult to implement radical strategies designed for knowledge-based competition?
The competition is today's organisations, which operate through decentralised business units and teams that are much closer to employees than large corporate staff.
Rapid changes in technology, competition and regulations means that the formulation and implementation of strategy has to be a continual and participative process.
Organisations today need a language for communicating strategy as well as processes and systems to implement strategy and gain feedback about it. Success comes from strategy becoming everyone's everyday job.
To help meet these challenges, Kaplan and Norton designed the Balanced Scorecard (BSC). Most management systems revolve around a budget. How often is the question asked, "Is this in our strategic plan?" rather than the oft heard one, "Is this within this year's budget?"
Organisations often give up activities as the year goes by if the budget needs to be pruned without realising that some of those activities may be necessary to reach strategic objectives. Linkages between strategic objectives and action plans are often weak. When the company hits the strategic planning cycle one or more of these can happen:
- Not all key people participate in finalising strategy.
- Divisions/SBUs do not finish strategic or even action plans in time for corporate strategy to reflect all key priorities.
- The long-term strategic planning exercise does not end on time.
- The budget is treated as the strategic plan.
The issue is not that organisations can't formulate strategy, rather the task of implementing it is time consuming, and riddled with vested interests, ambiguity, even lack of acceptance of the strategic plan.
The BSC frame-work addresses these problems successfully, and focuses on shareholder, customer, internal and learning requirements of a business in order to create a system of linked objectives, measures, targets and projects which collectively describe the strategy of an organisation and how that strategy can be achieved.
In the process of creating a BSC, four perspectives --financial, customer, internal process and learning and growth -- capture the roles, tasks and priorities of the various divisions and individuals.
Three steps
1. Build a strategy map: The first output of a BSC project is a strategy map. It shows the top 20-25 objectives that the organisation needs to focus on to deliver its strategy. Financial objectives are critical to the existence of all organisations.
However, to deliver these financial outcomes, the firm must determine what customer needs have to be met, and what internal processes are critical for delivering their expectations. Finally, mangers need to work out what the organisation must learn in order to carry out the core processes efficiently and effectively.
Even though the concept of the BSC is simple, it's difficult to develop because managers are used to thinking operationally and for the short-term rather than strategically. The development of a BSC usually reveals gaps in strategy.
2. Create a BSC: The next step is to define the metrics needed to measure the success of a strategy. Both financial and non-financial measures are identified, and a significant effort is made to ensure that there are enough lead measures so that the BSC created allows the company to actively manage delivery of the strategy.
Owners are identified within the management team for collective ownership and responsibility in delivering the strategy. Actual performance is computed, and targets set.
Care is taken to set breakthrough and stretch targets in select areas where benefits could be significant, balancing it with more realistic targets for other objectives.
Lastly, internal projects that tend to often lose sight of what business objectives they need to achieve are identified, prioritised and aligned to the business objectives they will help deliver.
BSCs are created at the corporate level but organisations that want to ensure detailed strategy at the operational level will build cascaded scorecards for all business units, and some or all support functions.
3. Use the BSC: Once a scorecard is designed, it takes about 60-90 days to take it 'live'. Actuals and targets need to be set, and internal BSC coordinators need to get organised for monthly reporting of the scorecards.
The BSC is then used actively in the monthly management meetings to find solutions and improve performance in areas where business targets are not being met.
In some cases, automation software is purchased to improve the ease and quality of reporting, but for the initial period, simple excel formats are preferred. Abbreviated versions can be created for quarterly reports. The BSC should be reviewed yearly, in the third quarter.
BSC, planning and the budget
Managers use budgets for vital functions: performance targets; allocating resources to achieve targets; assessing performance relative to targets; updating the targets based on new information and learning.
Companies can overcome important barriers to strategy implementation using the BSC to integrate planning and budgeting processes. The operational budget, handled through an activity-based budgeting process, authorises resource supply and spending based on anticipated demand for work and forecasted process efficiencies.
This budget can be dynamic, allowing for changes in the environment, new opportunities and competitor actions. The strategic budget focuses on decisions about new discretionary funding and the assignment of critical human and capital resources to new initiatives.
The decisions are taken in rigorous reviews using the BSC as the lens by which initiatives are proposed, ranked and selected. The process generates short-term performance targets across BSC measures, holding employees accountable and compensating them in upcoming periods.
Like the BSC, conceptually activity-based budgeting is simple to understand. However, it is not as simple to implement. The organisation has to specify far more detailed estimates than it would in conventional budgeting.
When done successfully, it is truly bottom-up, giving managers an opportunity to identify where excess resource capacity already exists and to take steps to redeploy or dispose resources (equipment, facilities, people) that are no longer needed in forthcoming periods. Many spending decisions can be determined by using the following sequence of steps.
- Estimate production and sales volumes for the next period: Activity-based budgeting starts, as in the conventional budget process, with estimates of production, sales volume and mix of products and customers. The sales estimates must include not only products to be sold but also the customers expected to buy them.
Production and sales budgets need to be far more detailed than conventional ones. For example, they must include information about the processes that will be used to achieve the total production volumes such as the expected number of runs for each product, the frequency of materials ordered and receipts, and the method of shipment.
For customers, estimates of number of orders placed, average order size, and number and intensity of customer contacts are important inputs to forecast demanded level of customer support activities.
- Forecast demand for activities: Conventionally companies have detailed budgets only for activities such as materials purchasing, labor times and machine times. Activity-based budgeting extends this analysis by estimating the demand for all activities required to produce, market, sell and deliver products. It forecasts demand, for example, for ordering, receiving or handling materials, developing new pro-ducts, selling and maintaining relationships with customers.
- Calculate resource demands: Once the types of resources needed are known, the next step is to use this information for the following period's activity and process. If it forecasts process improvements, the demand for resources will be modified downward.
- Determine the actual resource supply: Activity-based budgeting process concludes by converting the demand for resources into an estimate of the total resources to be supplied.
In generally, each resource has a particular profile, ranging from very flexible (e.g. hourly rate), to committed and fixed (e.g. plant floor space). For most companies it is a complex, iterative calculation.
Establishing an activity's capacity requires looking into sales-order patterns; production, purchasing and shipping schedules; resources that can perform multiple activities; and seasonal demands for activities.
A battle half won
Focus on achieving the strategy defines priorities across multiple entities and suitably allocates resources. Divisions, SBUs and departments can retain their individual priorities yet know their contribution and role in the overall strategic framework.
Some divisions would contribute to revenues, some to profits, and some to long term growth and hence their financial/customer/ process/organisational focus can be defined more clearly.
It is not uncommon for a divisional head to ask for funds to grow though even doubling of that division's turnover would not help significantly in overall revenue growth. Prioritisation is always necessary and the BSC framework allows this to be done strategically.
Thus successful strategy implementation is driven by a strong alignment of people, activities, functions, information and infrastructure.
The roadmap must address all these elements comprehensively, in order to track steps towards achievement of the strategy, appropriate mid-course corrections taken and the contribution of the entire organisation to be well integrated.
The achievement of the strategy is owned by all and not just by the senior management. Hence an aligned approach is half the battle won, assures Kaplan.
Sanjiv Anand is Global Balanced Scorecard Practice Head, Cedar Consulting Pvt Ltd.
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