Balanced Scorecard: Traditional Performance Measurement

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Balanced Scorecard
Traditional Performance Measurement
Historically, the measurement system for business has been financial. Activities of companies were measured and monitored through the traditional financial accounting model. However, the extensive, even exclusive use of financial measurements in business has been criticized primarily because an overemphasis on achieving and maintaining short-term financial results can cause companies to overinvest in short-term fixes and to underinvest in long-term value creation, particularly in the intangible and intellectual assets that generate future growth. Indeed, the Harvard Business School Council on Competitiveness project in 1992 identified the following systematic differences between investments made by U.S. corporations and those made in Japan and Germany: The U.S. system is less supportive of long-term corporate investment because of the overemphasis on improving short-term returns to influence current share prices. The U.S. system favors those forms of investment for which returns are most readily measurable; this leads to underinvestment in intangible assets – product and process innovation, employee skills, customer satisfaction – whose short-term returns are more difficult to measure. Inevitably, as managers are pressured to deliverconsistent and excellent short-term financial performance, trade-offs are made that limit the search for investments in growth opportunities. Even worse, the pressure for short-term financial performance can cause companies to reduce spending on new product development, process improvements, human resource development, information technology, data bases, and systems as well as customer and market development. In the short run, the financial accounting model reports these spending cutbacks as increases in reported income, even when reductions have cannibalized a company’s stock of assetsand its capabilities for creating future economic value. Alternatively, a company could maximize short-term financial results by exploiting customers through high prices or lower service. In the short run, these actions enhance reported profitability, but the lack of customer loyalty and satisfaction will leave the company highly vulnerable to competitive inroads. The concern with the overemphasis on financial performance measures has also permeated the U.S. professional association of public accountants as a high-level special committee on financial reporting of the American Institute of Certified Public Accountants reinforced concerns with exclusive reliance on financial reporting for measuring business performance: “Users focus on the future while today’s business reporting focuses on the past. Although information about the past is a useful indicator of future performance, users also need forward-looking information.” The committee acknowledged the importance of reporting on how well companies are creating value for the future, and recommended linking business performance reporting to management’s strategic vision: “Many users want to see a company through the eyes of management to help them understand management’s perspective and predict where management will lead the company.” It went on to say that nonfinancial measurement must play a key role: “Management should disclose the financial and nonfinancial measurements it uses in managing the business that quantify the effects of key activities and events.” The committee concluded by recommending that companies adopt a more “balanced” and forward-looking approach: To meet users’ changing needs, business reporting must:

Provide more information about plans, opportunities, risks and uncertainties Focus more on the factors that create longer-term value, including nonfinancial measures indicating how key business processes are performing Origins of the Balanced Scorecard

By the mid-1990s other organizational theorists had taken up Kaplan...
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