Friday, March 19, 2010

Developing a Balanced Scorecard for Commercial Banking

In recent months HBV has been working with a large regional Bank on a Business Transformation exercise.   Essentially the purpose of the engagement is to transform the current practices of the client to more closely comply with an industry best practices model.  The results of this should include increased productivity, improved performance, increased customer satisfaction, enterprise growth, and improved utilisation of human resources.  The Bank we have been working with expects rapid growth in the next several years both from organic growth and an aggressive acquisition strategy.  This exercise will prepare the enterprise to better manage this growth as well as provide a better platform for the integration of future acquisitions.

One of the topics we have spent time with our Banking client on is the importance of a Balanced Scorecard to track and measure performance of the enterprise.

When implementing a Performance Management system for any enterprise, it is important to make certain to appropriately balance all competing priorities and imperatives of the business.  The Balanced Scorecard approach is an effective methodology for accomplishing this balance.

We felt that while the below comments were developed for our banking client, followers of the HBV Blog would be able to easily understand how to apply the same approach to their own enterprise using the below described approach as a model.

Developing a Balanced Scorecard

When considering the strategic process, this provides an opportunity to consider the set of performance measures adopted by the Bank to measure the success of its strategy.  To assess the effectiveness of any set of performance measures it is most appropriate to use the Balanced Scorecard concept.

What is a Balanced Scorecard?

A new approach to strategic management was developed in the early 1990's by Drs. Robert Kaplan (Harvard Business School) and David Norton. They named this system the 'balanced scorecard'.  Recognising some of the weaknesses and vagueness of previous management approaches, the balanced scorecard approach provides a clear prescription as to what companies should measure in order to 'balance' the financial perspective.

The balanced scorecard is a management system (not only a measurement system) that enables organisations to clarify their vision and strategy and translate them into action. It provides feedback around both the internal business processes and external outcomes in order to continuously improve strategic performance and results. When fully deployed, the balanced scorecard transforms strategic planning from an academic exercise into the nerve center of an enterprise.

Kaplan and Norton describe the innovation of the balanced scorecard as follows:

"The balanced scorecard retains traditional financial measures. But financial measures tell the story of past events, an adequate story for industrial age companies for which investments in long-term capabilities and customer relationships were not critical for success. These financial measures are inadequate, however, for guiding and evaluating the journey that information age companies must make to create future value through investment in customers, suppliers, employees, processes, technology, and innovation."

The balanced scorecard suggests that we view the organisation from four perspectives, and to develop metrics, collect data and analyze it relative to each of these perspectives:
  • The Financial Perspective
  • The Customer Perspective
  • The Business Process Perspective
  • The Learning and Growth Perspective

Figure 1

The Balanced Scorecard approach is designed to address some of the weaknesses of other performance management systems that tend to create conflicting goals or objectives within an entity.  This frequently results when objectives for organisational units are too closely tied to business unit goals rather than set to align with higher Entity level objectives.  When the Bank’s objectives are established, measured, and managed across the four dimensions of the Balanced Scorecard this tends to “balance” the perspectives of the managing the enterprise to optimise both short term and long performance through the balanced considerations.  Additionally, all organisational units should similarly take a balanced scorecard approach to business unit objectives making certain to focus on their ability to contribute to accomplishment of all of the Bank’s entity level objectives and measures.

The Balanced Scorecard and Measurement-Based Management

The balanced scorecard methodology builds on some key concepts of previous management ideas such as Total Quality Management (TQM), including customer-defined quality, continuous improvement, employee empowerment, and -- primarily -- measurement-based management and feedback.

Double-Loop Feedback 

In traditional industrial activity, "quality control" and "zero defects" were the watchwords. In order to shield the customer from receiving poor quality products, aggressive efforts were focused on inspection and testing at the end of the production line.  The problem with this approach -- as pointed out by Deming -- is that the true causes of defects could never be identified, and there would always be inefficiencies due to the rejection of defects.  What Deming saw was that variation is created at every step in a production process, and the causes of variation need to be identified and fixed. If this can be done, then there is a way to reduce the defects and improve product quality indefinitely.  To establish such a process, Deming emphasized that all business processes should be part of a system with feedback loops.  The feedback data should be examined by managers to determine the causes of variation, what are the processes with significant problems, and then they can focus attention on fixing that subset of processes.

The balanced scorecard incorporates feedback around internal business process outputs, as in TQM, but also adds a feedback loop around the outcomes of business strategies.   This creates a "double-loop feedback" process in the balanced scorecard.

Outcome Metrics

You can't improve what you can't measure.  So metrics must be developed based on the priorities of the strategic plan, which provides the key business drivers and criteria for metrics that managers most desire to watch.  Processes are then designed to collect information relevant to these metrics and reduce it to numerical form for storage, display, and analysis. Decision makers examine the outcomes of various measured processes and strategies and track the results to guide the company and provide feedback.

So the value of metrics is in their ability to provide a factual basis for defining:

  • Strategic feedback to show the present status of the organization from many perspectives for decision makers
  • Diagnostic feedback into various processes to guide improvements on a continuous basis
  • Trends in performance over time as the metrics are tracked
  • Feedback around the measurement methods themselves, and which metrics should be tracked
  • Quantitative inputs to forecasting methods and models for decision support systems
Management by Fact 

The goal of making measurements is to permit managers to see their company more clearly -- from many perspectives -- and hence to make wiser long-term decisions.  The Baldrige Criteria (1997) booklet reiterates this concept of fact-based management:

"Modern businesses depend upon measurement and analysis of performance. Measurements must derive from the company's strategy and provide critical data and information about key processes, outputs and results.  Data and information needed for performance measurement and improvement are of many types, including: customer, product and service performance, operations, market, competitive comparisons, supplier, employee-related, and cost and financial. Analysis entails using data to determine trends, projections, and cause and effect -- that might not be evident without analysis.  Data and analysis support a variety of company purposes, such as planning, reviewing company performance, improving operations, and comparing company performance with competitors' or with 'best practices' benchmarks."

"A major consideration in performance improvement involves the creation and use of performance measures or indicators. Performance measures or indicators are measurable characteristics of products, services, processes, and operations the company uses to track and improve performance. The measures or indicators should be selected to best represent the factors that lead to improved customer, operational, and financial performance.  A comprehensive set of measures or indicators tied to customer and/or company performance requirements represents a clear basis for aligning all activities with the company's goals. Through the analysis of data from the tracking processes, the measures or indicators themselves may be evaluated and changed to better support such goals.

Balanced Scorecard Perspectives 

The Balanced Scorecard is a framework for translating an entity’s strategic objectives into a set of four linked performance components.  The Balanced Scorecard concept includes the following:

  • Financial perspective - how does the Bank look to stakeholders?
  • Customer or market perspective - how do customers see the Bank?
  • Process perspective - what must the Bank excel at to succeed?
  • Learning and growth perspective - can the Bank continue to improve and create value?
The Financial Perspective 

Kaplan and Norton do not disregard the traditional need for financial data. Timely and accurate funding data will always be a priority, and managers will do whatever necessary to provide it.  In fact, often there is more than enough handling and processing of financial data. With the implementation of a corporate database, it is hoped that more of the processing can be centralized and automated.  But the point is that the frequent emphasis on financials leads to the "unbalanced" situation with regard to other perspectives.

There is perhaps a need to include additional financial-related data, such as risk assessment and cost-benefit data, in this category.

The Customer or Market Perspective 

Recent management philosophy has shown an increasing realization of the importance of customer focus and customer satisfaction in any business.  These are leading indicators: if customers are not satisfied, they will eventually find other suppliers that will meet their needs. Poor performance from this perspective is thus a leading indicator of future decline, even though the current financial picture may look good.

In developing metrics for satisfaction, customers should be analyzed in terms of kinds of customers and the kinds of processes for which the Bank is providing a product or service to those customer groups.

The Business Process Perspective 

This perspective refers to internal business processes.  Metrics based on this perspective allow managers to know how well the Bank is running, and whether its products and services conform to customer requirements (the mission).  These metrics have to be carefully designed by those who know these processes most intimately; with Bank’s unique missions these are not something that can be developed by outside consultants.

In addition to the strategic management process, two kinds of business processes may be identified: a) resource management processes, and b) core business processes.  Resource management processes are business processes that both acquire and provide appropriate and sufficient resources to the other business processes.  By their nature resource management processes are the province of management.  They are also often more difficult to measure directly or to find appropriate peer group comparisons.  Core business processes are the processes that develop, produce, sell, and distribute an entity’s products and services.  These processes do not follow traditional organisational or functional lines, but reflect the grouping of related business activities.  Core business processes because of their often more repetitive nature are easier to measure and benchmark using generic measurements and peer group comparisons.

Mission-oriented processes are the special functions of executive management, and many unique problems are encountered in these processes.   The support processes which  are more repetitive in nature, and hence easier to measure and benchmark using generic metrics.

The Learning and Growth Perspective 

This perspective includes employee training and corporate cultural attitudes related to both individual and corporate self-improvement.  In a knowledge-worker organization such as a Bank, people -- the only repository of knowledge -- are the main resource.  In the current climate of rapid technological change, it is becoming necessary for knowledge workers to be in a continuous learning mode.  Banks sometimes find themselves unable to identify, recruit, and hire new qualified knowledge workers, and at the same time there is sometimes a lack of training of existing employees.  This is a leading indicator of 'brain drain' that must be reversed.  Metrics can be put into place to guide managers in focusing training funds where they can help the most. In any case, learning and growth constitute the essential foundation for success of any knowledge-worker organization.

Kaplan and Norton emphasize that 'learning' is more than 'training'; it also includes things like mentors and tutors within the organization, as well as that ease of communication among workers that allows them to readily get help on a problem when it is needed.  It also includes technological tools; what the Baldrige criteria call "high performance work systems."

A Balanced Scorecard for a Bank - at the Strategic Level

Customer or Market

Return on Equity

Return on Assets
Net Interest Margin
Revenue Mix
Revenue Growth
Return on Equity Growth

Market Share (by Segment)

Customer Retention
Customer Satisfaction Survey
Customer Acquisition
Learning and Growth

Error Rates
Investment in Technology
Number of complaints
Cross sell ratio

Revenues from New Products
Product Development Cycle
Employee Survey
Revenue per Employee
Employee Turnover
Training Hours per Employee

Figure 2

A Best Practice Bank will typically have from 15 to 20 Key Performance Indicators (KPI’s) to measure the success of its strategy.

Summary: A Good Balanced Scorecard Tells the Story of Your Strategy
  • Every measure is part of a chain of cause and effect linkages
  • Every measure ultimately ties to financial results
  • A balance exists between outcome measures (lagging indicators) and performance drivers (leading indicators)
  • It includes performance drivers which will redefine a process or change behaviour

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