Summary
In this article, author, management consultant and Balanced Scorecard expert Paul Niven argues that the discipline of Cost Management must evolve to face the realities of the new economy and meet the rapidly changing information needs of today’s decision makers. Cost Management, like finance, is finding out that the new mandate calls for providing the information companies need to produce the value their customers demand.
A focus on the importance of performance measurement is an integral component of the evolution Cost Management is undergoing. In this context, the Balanced Scorecard has emerged as a proven and effective performance measurement tool as organizations seek to succeed at strategy implementation and translate intangible assets into real value for stakeholders.
The author examines how the combination of Balanced Scorecard measures and Cost Management techniques can work together in satisfying the ever-growing needs of the information consumer.
While Cost Management is a key aspect of the Financial strategic perspective of the Balanced Scorecard, it has a role to play through the entire Scorecard architecture. The author shows the relevance of Activity Based Costing in the other three strategic perspectives – Customer, Internal Process, and also Employee Learning and Growth – to identify and implement the right strategies for aspects like profitability of customer segments; quality, timeliness and cost of current processes; and investments in employee skills, tools, and alignment programs that promise to deliver a range of benefits.
Thus, the Cost Management discipline can use the Balanced Scorecard to provide critical information and facilitate many of the strategic dialogs in organizations.
Article Highlights:
- The Cost Management discipline must face the realities of the new economy or risk losing relevance
- Performance measurement is a critical component of the evolution of Cost Management
- The Balanced Scorecard is a proven tool for measuring performance and executing strategy
Cost Management & the Balanced Scorecard
In the classic film, Sunset Boulevard, Gloria Swanson portrays a long-forgotten silent movie goddess who has been unable to make the transition to “talkies.” Adamantly refusing to accept the new realities of her industry she utters: “I am big. It’s the pictures that got small.” Like our faded screen star, the discipline of Cost Management is currently facing a transitional challenge – meeting the rapidly changing information needs of today’s decision makers. This article will briefly explore a role for the Balanced Scorecard to play in the Cost Management transformation.
Clearly we live in a new world, one that features near perpetual change, global competition, tremendous customer demands, and increased shareholder expectations. Cost management must face the realities of this new economy head-on or risk losing relevance and being left behind. A focus on historical information and an inward perspective that largely ignores the entire supply chain is no longer adequate for today’s decision makers. In a transformation mirroring that of the larger discipline of Finance, the Cost Management profession is responding with a clear mandate for the 21st century: providing the information companies need in order to produce the value their customers demand. The Cost Management professional of tomorrow will be a trusted business partner, providing the vital cost information needed by management in the pursuit of an optimal mix of activities and processes to drive sustained customer value. An integral component of the Cost Management evolution is a focus on the importance of performance measurement.
The Balanced Scorecard has emerged as a proven and effective performance measurement tool in our quest to capture, describe, and translate intangible assets – the zeitgeist of the new economy – into real value for all of an organization’s stakeholders, and in the process allowing organizations to successfully implement their differentiating strategies. Developed by Robert Kaplan and David Norton, this deceptively simple methodology translates an organization’s strategy into performance objectives, measures, targets, and initiatives in four balanced perspectives: Financial, Customer, Internal Process, and Employee Learning and Growth. While many organizations have used a combination of financial and non-financial measures in the past, what sets the Balanced Scorecard apart is the concept of cause and effect linkages. A well-constructed Scorecard will tell the story of an organization’s strategy through a series of linked performance measures weaving through the four perspectives. Let’s examine how the combination of Balanced Scorecard measures and Cost Management techniques can work together in satisfying the ever-growing needs of the information consumer.
Many “traditional” Cost Management professionals may view the Financial perspective of the Scorecard as their natural home, since many cost-related insights will be revealed in that section of the tool. However, upon further reflection we discover that modern Cost Management cuts a wide swath through the entire Scorecard architecture.
In the Customer perspective organizations must determine their target customers and also devise the value proposition they will use in pursuing that group. Regardless of the value proposition a given firm pursues it relies on profitable customer relationships to drive economic success.
Sounds simple enough, but research indicates that the most profitable 20% of customers generate between 150% and 300% of total profits. The middle 70% of customers break even and the least profitable 10% of customers lose from 50% to 200% of total profits.i Activity Based Costing (ABC) can be combined with information provided in the Balanced Scorecard to assist an organization in determining the true profitability of targeted customer segments. These insights are invaluable as firms analyze current relationships and attempt to transform money-losers into future economic success stories. The Internal Process perspective of the Scorecard focuses on those processes the firm must excel at in order to add value for customers, and, ultimately, shareholders. Many organizations will closely examine the quality, timeliness, and cost of current processes. Once again ABC can be used to critically examine the true cost of current processes in an effort to determine whether the expected benefits in customer outcomes arising from the process exceed the cost of engaging in the activity. Finally, even the outcomes emanating from the Employee Learning and Growth perspective - often considered the “soft stuff” - will benefit from the discerning eye of the Cost Manager.
Measures in this perspective are often described as “enablers” of results in the other three perspectives. Investments in employee skills, tools, and alignment programs are hypothesized to drive results ranging from greater innovation to increased customer loyalty and ROE. These drivers cannot be taken for granted, however. As with any other investment, the Cost Manager must determine the true value being created from each dollar of cost.
Many organizations reaping the rewards of the Balanced Scorecard cite an increase in
“strategic conversations” as a key benefit of the effort. They note that while Scorecard results don’t always supply every answer in the firm’s quest to execute its strategy they do lead to better questions, as executives, managers, and employees alike work together to critically examine and learn from the assumptions inherent in the Scorecard. With a renewed focus on providing critical information in the drive to create customer value and a clear motivation for change, the Cost Management profession is in an enviable position of facilitating many of these strategic dialogs throughout the modern organization.
i Robert S. Kaplan and V.G. Narayanan, “Measuring and Managing Customer Profitability,” Journal of Cost Management, September/October 2001, 5-15.
QUOTE
“An integral component of the Cost Management evolution is a focus on the importance of performance measurement.”
REFERENCE TO OTHER ARTICLES
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For those of you in the public and nonprofit sectors, please consider:
Why Nonprofits Need a Balanced Scorecard
Using the Balanced Scorecard in the Public Sector
Balanced Scorecard Step by Step for Government and Nonprofit Agencies
About the author
Paul R. Niven is an author, management consultant, and noted speaker on the subject of the Balanced Scorecard. As both a practitioner and Consultant he has developed successful Balanced Scorecard systems for clients large and small in a wide variety of organizations, including Fortune 1000 companies, public sector agencies, and nonprofit organizations. The second edition of his very popular book “Balanced Scorecard Step by Step: Maximizing Performance and Maintaining Results” was released in September, 2006. The first edition has been translated into over a dozen languages. His two previous books are: “Balanced Scorecard Step by Step for Government and Nonprofit Agencies” released by John Wiley & Sons in June, 2003, and “Balanced Scorecard Diagnostics” which was released in April, 2005. He may be reached at 760.789.2449 or through his website at www.senalosa.com.
Copyright 2006 © Paul R. Niven, The Senalosa Group
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