balanced scorecards report -

INSIGHT, EXPERIENCE & IDEAS FOR STR ATEGY-FOCUSED ORGANIZ ATIONS

Balanced Scorecard REPORTHARVARD BUSINESS

SCHOOL PUBLISHING

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E Part One of a Two-Part Series

Linking Strategy and Planning to BudgetsBy David P. Norton, Chairman, Balanced Scorecard Collaborative

Most organizations grapple mightily with the inherent structuralconflict between strategy (which is holistic) and organizationaldesign (which is siloed). And the stakes are high. A successfullylinked strategic planning/budgeting process depends not only onintegrating all the entities of an enterprise, but also on reconcilinglong-term goals (strategy) with short-term realities (budgeting).There is a solution, though: using strategic themes to identify a port-folio of strategic initiatives, and creating a new class of expenditure,the strategic expenditure, that’s separate from operational and capital expenses.

According to Balanced Scorecard Collaborative research, 60% of organizations do not link their strategies to their budgets. Small wonder, then, that mostorganizations cannot execute their strategies.1 Without an explicit link that identifies strategic investments, the organization has no way to distinguishbetween strategic and operational management. Predictably, the latter will preempt the former, short-term actions will preempt long-term actions, and tactics will preempt strategy. Unless strategic investments are identified explicitly and managed separately, they will simply become a piggy bank that managers can tap to meet their quarterly targets—which, while convenient in the short term, sacrifices the long-term viability of the organization.

Through our continuing research into the management practices of successfulcompanies (in particular, those companies in the Balanced Scorecard Hall ofFame), we have observed that successful organizations effectively separate strategy management from operations management. The challenge is greatestwhen it comes to the budget, as no management system has a greater impacton performance. Yet the budget is inherently biased toward the short term.Our recent research has focused on this link between strategy and budgets,with the objective of identifying the principles to be used in designing an effective planning and budgeting process. Our research has two components:strategy planning/budgeting and operational planning/budgeting. This articlewill focus on the former; we’ll address the latter in an upcoming issue of BSR.

Defining Issues

The design of a successful strategy planning/budgeting system is shaped by two issues: (1) the need for cross-business integration; and (2) the linkage of a long-term process (strategy) with a short-term process (budgeting).

The need for cross-business integration results from the structural conflictbetween strategy, which is holistic, and organization design, which is siloed.

Continued on next page

INSIDE THIS ISSUE

Case File . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7Best Buy: Putting CustomersFirst—with the BSC

How did Best Buy skyrocket to itsnumber-one place in consumerelectronics? With a rigorous customer-centric strategy andrelentless focus on employee align-ment, both enabled by the BalancedScorecard.The BSC—and perform-ance management in general—also helped employees at all levelsget past the short-term focus thatoften hamstrings retail enterprises in sustaining their success.

Performance Management . . . . 10Target Setting

In the November–December 2005BSR, Robert Kaplan argued thatbenchmarking is best limited tomeasuring commoditized processes,not those in which output is integralto strategy. Here, he takes a funda-mental look at external versus internal benchmarks across thefinancial, customer, internal process,and employee perspectives, focusingon one of the more delicate tasksexecutives face: how to determineappropriate stretch targets.

Tools & Techniques . . . . . . . . . . . . . . . . 14Choose the Right Measures,Drive the Right Strategy

Kaplan protégé and HarvardBusiness School assistant professorDennis Campbell offers a luciddemonstration of the power of goodmetrics—keeping them streamlined,ensuring their strategic relevance,and translating them into termsemployees can act upon.Toronto-Dominion Bank’s metrics overhaul,in the wake of an acquisition,actually won it more customers and higher customer satisfactionlevels—in contrast to most banks,which typically experience customerattrition following a merger.

What’s new from BSR and HarvardBusiness School Publishing?

Check out the new BalancedScorecard Hall of Fame Report 2006,which profiles the class of 2005. Andour just-released Article Index (sentto subscribers and available free viadownload) gives you the full listingof all 200-plus articles since BSR’sinception.

Visit www.harvardbusinessonline.orgfor information on these and the fullrange of BSR and HBSP publications.

M a y – J u n e 2 0 0 6

V o l u m e 8 , N u m b e r 3

Strategy, by nature, requires theintegration of money, people,customers, suppliers, processes,and so on into activities that crossthe entire business. For example,a strategic initiative typicallyrequires the simultaneous devel-opment of training programs,information systems, new prod-ucts, and new partnerships.Resource allocation, on the otherhand, tends to be organizedaround functions (or silos) likeFinance, HR, IT and/or aroundsuch divisions as products orregions. If siloed functionalresources cannot be allocatedaround holistic strategic direc-tions, then strategy cannot beexecuted. Herein lies the firststructural challenge. Budgetingsystems tend to be designedaround the architecture of theorganization (silos) in order topromote accountability withinorganizational units, and so do anotoriously poor job in promotingdesired cross-business behavior,forcing managers to resort tocomplex transfer-pricing /costingmechanisms that always seem tocomplicate the job of manage-ment. The first design challenge,then, is creating a process thatallocates resources to the strategyin a cross-business framework.

The basic structural incompatibilityof the strategic planning and thebudgeting processes also makes itdifficult to link the long-termprocess (strategy) and the short-term process (budgeting). Strategicplanning is a future-oriented,visionary, and proactive processin which accuracy and currencyof information are of secondaryimportance. Budgeting is a con-servative process, oriented towardthe present and past; accuracyand currency of information areof primary importance. The twoprocesses are structurally differentand must be managed separately,yet they must also be synchronized.So the second design challenge

is creating an effective structurallinkage between the two systems.

Six Design Principles

In “Strategic Management: AnEmerging Profession” (BSRMay–June 2004), we first identi-fied the need for an Office ofStrategy Management to manageand coordinate the various cross-business processes associated with strategy execution. One suchprocess is strategic planning—in particular, how it is linked to the budget. How does onedesign such an integrative process?Through our research of the management practices of success-ful organizations, we’ve identifiedsix principles that, we believe,should form the foundation of the strategy planning /budget-ing process. Figure 1 offers aschematic of how organizationscan integrate the strategy develop-ment, strategic planning, and budgeting processes.

Principle 1. Create the archi-tecture, or decompose thestrategy into strategic themes.A process’s design shapes theway that the process will be used. The budget, for example, is structured by the chart of accountsand the departmental structure of the organization, both of whichare hierarchical, reflecting the“chain of command” organizationalstructure of a bygone era. What,then, is the equivalent architec-ture for an organization’s strategy?We have found that the conceptsof strategy maps and BalancedScorecards provide organizationswith an effective way to representtheir strategies.

Some people refer to these tools as the “chart of accounts ofstrategy” because, like the originalterm, they provide a common lexicon the whole organizationcan understand and use. Everystrategy map contains betweenthree and five strategic themes.For example, the strategy map for

Balanced Scorecard Report

Editorial AdvisersRobert S. Kaplan

Professor, Harvard Business SchoolDavid P. Norton

Chairman, Balanced Scorecard Collaborative

Executive EditorRandall H. Russell

VP/Research Director, Balanced Scorecard Collaborative

EditorJanice Koch

Balanced Scorecard Collaborative

Consulting EditorJane Heifetz

Editorial Director–HBR Specialty Publications

PublishersRobert L. Howie Jr.

President, Balanced Scorecard CollaborativeEdward D. Crowley

Executive Director–HBR Specialty Publications

Circulation ManagerPaul Szymanski

Newsletters, HBS Publishing

DesignRobert B. Levers

Levers Advertising & Design

Letters and Reader FeedbackLetters, editorials, ideas for articles, and other contributions may be submitted to:Randall H. Russell, Balanced Scorecard Report,55 Old Bedford Road, Lincoln, MA 01773 or [email protected].

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Copyright © 2006 by Harvard Business SchoolPublishing Corporation. Quotation is not permitted.Material may not be reproduced in whole or in part in any form whatsoever without permission from thepublisher.To order back issues or reprints of articles,please call 800.668.6705. Outside the U.S., call617.783.7474.

Harvard Business School Publishing is a not-for-profit, wholly owned subsidiary of Harvard University.The mission of Harvard Business School Publishing is to improve the practice of management and itsimpact on a changing world. We collaborate tocreate products and services in the media that bestserve our customers—individuals and organizationsthat believe in the power of ideas.

Balanced Scorecard Collaborative, a Palladium company, is dedicated to helping clients establish strat-egy execution as a core competency to achieve andsustain performance results over time. Our resourcesinclude the world’s most comprehensive database onthe new science of strategy execution, a network ofnew science thought leaders, executive workinggroups, peer-to-peer councils, research, benchmarking,best practices, education, conferences, training, andpublications. To learn more, visit www.bscol.com, or call781.259.3737.

Explore the many resources availableon the Balanced Scorecard and theStrategy-Focused Organization at BSCOnline. Join today—membership isfree. For details, visit www.bscol.com.

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B a l a n c e d S c o r e c a r d R e p o r t

M a y – J u n e 2 0 0 6

a major consumer bank containsthree strategic themes:

• Growth through innovation

• Increasing demand from customer partnerships

• Building loyalty through operational excellence

The strategy map of CanadianBlood Services (CBS), the organi-zation that manages Canada’sblood supply, also has threestrategic themes:

• Offer safe products and services

• Create an effective and efficient system

• Plan for tomorrow

A strategic theme is thus a building block of strategy.2

Strategic themes provide thearchitecture around which anintegrated strategy planning/budgeting system can bedesigned. First and foremost,themes serve to adequatelydescribe the strategy. Becausethemes are holistic, transcendingorganizational and functionalsilos, they provide a foundationfor the cross-silo management of such things as accountability,resource allocation, goal setting,monitoring, networks, and com-munities. In that respect, theyenable a new approach to organi-zational design. This approachaccepts the siloed structure of the organization as a given, andcreates an overlay that allows theorganization to focus on cross-functional issues. Strategicthemes, then, provide a bridge to the management system; the management system, basedon the strategic themes, becomesthe critical lever for motivatingbehavior.

Principle 2. Assign accounta-bility for strategic themes.Establishing accountability forperformance is the bane of com-plex enterprises. Organizations

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Balanced Scorecard

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Strategy MapStrategy

IntegratedStrategic

Plan

Portfolio ofStrategic

Initiatives(by theme)

Total Strategic Investment

• Themes

• Objectives

• Accountability

• Measures

• Targets

Strategic Initiatives

Revenue• Direct Expenses

Gross Margin• Indirect Expenses Sales Prof. Dvlpmt. G&A

Contribution• R&D

• STRATEX

EBITDA• ITDA

Net Income

$XX($XX)

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($XX)($XX)($XX)

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Rolling Forecast (Budget)

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Figure 1. Overall Mechanism for Linking Strategy Development,Strategic Planning, and Budgeting

Strategic themes provide the architecture for an integrated strategy planning/budgeting systemand enable a new category of expenditure—strategic expenditures, or STRATEX.

like DuPont or IBM must achieveaccountability for a range ofdimensions such as product,customer, region, and channel.Accountability for executing the strategy is no less complex.Because strategy is holistic,overlaying the traditional physicalstructure of the organization,accountability for strategy execu-tion cannot be linked to an existing structure. So how canaccountability be established? We have observed more andmore organizations using theirstrategic themes as a framework to establish accountability.

AT&T Canada, for example, createdfour executive councils, based on its themes, to oversee the exe-cution of the company’s strategy: (1) growth, (2) productivity,(3) professional development,and (4) management/metrics.The City of Charlotte (N.C.) created five executive-level

committees aligned to its fivestrategic themes: (1) communitysafety, (2) economic development,(3) transportation, (4) housingand neighborhood development,and (5) restructuring government.DuPont Engineering Polymersassigned accountability at theexecutive level for its five strategicthemes: (1) operations excellence,(2) supply services, (3) productportfolio management, (4) cus-tomer management, and (5) newbusiness design. In each of thesecases, the strategic themes tran-scended the organizational struc-ture. Executive team memberswere appointed sponsors of thesethemes, ensuring that lower-levelteams would receive access to thetop. At DuPont, the executiveswere told that this responsibilitywas their “night job.” Their “dayjob” was their traditional responsi-bility for line departments orfunctions. Recently, banking giantMellon Europe reorganized itself

around its strategic themes—(1) innovate products, (2) develop new and existing relationships, and (3) deliver service excellence—to ensure that its executives’ “day jobs”and “night jobs” were the same.

Thus, organizations are findingthat strategic themes provide an adequate vehicle for assigningaccountability for strategy execu-tion. With the “day-job/night-job”approach, the strategic themesoverlay the traditional organiza-tional structure, providing aframework for management and accountability. Increasingly,organizations like Mellon Europeare finding that strategic themesare an effective foundation for the organizational structure itself.

Principle 3. Set targets: definestretch targets through cause-and-effect scenarios. Target setting, the point of reference for any management system, is


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Theme Objective Balanced Scorecard Action Plan

TargetMeasure BudgetInitiative

• Revenue mix• Revenue growth

• Share of segment• Share of wallet• Customer satisfaction

• Cross-sell ratio• Hours with customer

• Human capital readiness

• Strategic application readiness

• Goals linked to BSC

• Segmentation initiative • Satisfaction survey

• Financial planning initiative• Integrated product offering

• Relationship management• Certified financial planner

• Integrated customer file• Portfolio planning application

• MBO update• Incentive compensation

New = +10%+25%

25%50%90%

2.51hr/Q

100%

100%

100%

$XX

$XX

$XX$XX

$XX$XX

$XX$XX

$XX$XX

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Broadenrevenue mix

Createorganizational

readiness

Strategic job

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Theme

Cross-sellthe product line

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By bundling initiatives into a single portfolio for each strategic theme, you can see the total investment required for achieving the theme objective, listed in order of BSC perspective. The combined budget for all portfolios equals the total STRATEX.

Figure 2. Hypothetical Portfolio of Initiatives for the Strategic Theme “Customer Partnerships”

M a y – J u n e 2 0 0 6

different for strategy and budget-ing. Targets set in the strategicplanning process should bevisionary, aggressive, and motiva-tional. President John F. Kennedy’svision of “a man on the moon bythe end of the decade” is an oft-cited example of a stretch target.On the other hand, as budgetstypically provide the foundationfor commitments to external analysts and investors, target setting for the budget should beconservative, so that there is ahigh chance of achieving goals.

A variety of approaches is used to establish targets in both thebudgeting and strategic planningprocesses. Budgeting targets tendto be predominantly incrementaladjustments to previous quartersor years. Benchmarking is frequently used to establish reasonable targets, although itsvalue tends to be confined tocontaining overhead costs. As rich in insights as it may be,a benchmark by definition isalmost invariably about a singleperformance parameter (e.g.,employee turnover). Strategy isabout validating the cause-and-effect hypothesis that focuses on the drivers (lead indicators)that create desired financialresults (lag indicators). To bestrategic, a target cannot stand in isolation; it must be related toother variables in a logical chainof cause and effect. Employeeturnover, for example, may impactcustomer confidence, which, inturn, will impact revenue. Target setting for strategy should thus be built around the cause-and-effect relationships defined in the strategy map.3

Principle 4. Develop a portfolio of cross-functionalinitiatives for each strategictheme. In general, strategicinvestments do not stand alone.Achieving a strategic objectiveusually involves several initiativesfrom different parts of the

organization (e.g., HR, IT,operations). So how do you prioritize the investments? Mostapproaches look at each initiativeon a stand-alone basis. Sometimesan ROI analysis or a strategicimpact analysis is used to rankthe initiatives. But such analysesignore the integrated impact ofthe multiple initiatives. The budg-eting system creates a further setof distortions, forcing each invest-ment to be assigned to a hostdepartment; for example, all ITinitiatives show up in the ITdepartment’s budget, even thoughthey will support the entire organ-ization and its strategy execution.Accounting conventions also dictatethat some initiatives be capitalizedwhile others are expensed.

Therefore, executing a strategyrequires implementing a group of complementary initiatives,including a mix of IT systems,training programs, incentive programs, change programs,and more. Initiatives should bebundled into a portfolio and associated with a strategic theme,or, as shown in Figure 2, with the various objectives within astrategic theme. The portfolioshould reflect the total investmentrequired to achieve the themeobjective. While the responsibilityfor each initiativewill belong to adifferent part ofthe organization(because of the functionally ori-ented structure of organizations),the executivesponsors of strate-gic themes must bear the overallstrategic responsibility for theseinvestments. For example, anenterprise resource planning (ERP)implementation might be theresponsibility of the ChiefTechnology Officer, while an HRexecutive would be responsiblefor specific training programs.But the senior corporate executive

who is responsible for the strategictheme that requires the ERP andthe training program would ulti-mately be accountable for both.This approach reflects the holisticnature of strategy: each initiativeis necessary to execute the strategybut not sufficient by itself. If anyinitiative is cancelled, the associatedobjective/measure/target wouldbe missed and the strategy wouldbe jeopardized.

Furthermore, ROI analysis shouldbe conducted at the level of thestrategic theme/portfolio. Forexample, if the strategic objective“Broaden revenue mix” describedin Figure 2 showed a projectedrevenue growth of $250 million,and the investment portfolio toachieve this result would cost $25 million, then an ROI of 10xshould be the economic rationalefor accepting or rejecting theinvestment. Individual initiativesshould be evaluated within the context of the strategic theme.The architecture provided by the theme allows a portfolio ofcross-business initiatives to bedefined in support of the strategy.

Principle 5. Integrate func-tional plans with the strategy.In two separate surveys, wefound that only a minority of HR and IT organizations have

their priorities aligned with theenterprise strategy4 (34% ofrespondents in one survey; amere 19% in the other). And few support units have integratedtheir planning processes with theirenterprise strategy. In general,this has been due to the lack of effective enterprise planningand, in particular, the lack of an

5

To be strategic, a target cannot stand in

isolation; it must be related to other variables

in a logical chain of cause and effect.


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effective bridge between theenterprise and the functional planning process. The portfolio of strategic initiatives describedabove provides such a bridge.As shown in Figure 2 (p. 4), theinitiatives from the various strategicobjectives provide the linkage

mechanism to the functions.For that reason, members of thefunctional departments shouldserve as members of the themeteams that both design and monitor the strategy.

Principle 6. Establish funding: create a specialbudget category—strategicexpenditures—to separatestrategic investments fromoperational investments.Since budgets are short-term,conservative, and departmental,what is the appropriate mecha-nism by which to synchronizethem with a planning process that is long-term, visionary, andholistic? The answer lies in thefunding process: what is to befunded and how it will be funded.Executing strategy is based onexecuting the initiatives tied tostrategic objectives. The methodfor funding these initiatives thusbecomes the link between strategyand budgeting.

The problem with the traditionalbudgeting process is that it does not recognize strategicinvestments as such. Rather, theseinvestments are scattered through-out departmental budgets andaccounted for through a variety ofaccounting conventions, creatingfurther confusion. (IT investments,for example, are often capitalized,while training programs are

typically expensed.) Because they lack visibility, strategicexpenditures are treated as discre-tionary and often vanish underthe pressure to meet quarterly targets by reducing costs. Elcoteq,a high-tech manufacturer locatedin Finland, developed an innova-

tive solution to this problem.Building on the traditionalaccounting convention ofOPEX (OperatingExpenses) and CAPEX(Capital

Expenses), it defined a third category, STRATEX, or StrategicExpenses. (See Figure 1, p. 3.) A broader concept than CAPEX,STRATEX involves strategicchange management. STRATEX is used to finance the various initiatives associated with Elcoteq’sstrategy. It allows intangibleexpenses such as training to betreated with the same rigor asmore tangible CAPEX expenses.At Elcoteq, STRATEX investmentsare treated with the same invest-ment discipline (e.g., net presentvalue justification) that has beenused historically for CAPEX investments.

We believe that the concept ofSTRATEX is a useful tool withwhich to build the strategy-budgetlinkage. The portfolio of cross-business investments defined foreach strategic theme should beclassified as STRATEX. These port-folios should be isolated in thebudget and treated as a separatecategory, just as research anddevelopment and general andadministrative costs are separatecategories. The STRATEX budgetshould be managed by the sameexecutive team that oversees thestrategy. Doing so will safeguard it from the invariable short-termpressures to reduce costs, allowingthe organization to balance long- and short-term managementin its budgeting process.

In Sync Through Strategic Themes

A successful strategy planning/budgeting process must overcometwo types of structural hindrances.First, it must facilitate the holistic,cross-silo nature of strategy. An organization’s strategic themesprovide an architecture that permitscross-business approaches to tar-get setting, investment portfolios,and executive accountability.Second, it must allow the synchro-nization of long-term strategy with short-term budgets. Initiativemanagement and STRATEX allowthe integration of functional plans and budgets with the strategy. Bydefining linkage mechanisms thatreflect the structural differences,we can build planning and budg-eting systems that meet the needsof two very different worlds. �

1. In a landmark Fortune article, “CorporateStrategists Under Fire” (December 27, 1982),Walter Keichel noted that 90% of organizationsfail to execute their strategy properly. Morerecently, in their June 21, 1999 Fortune coverstory, Ram Charan and Geoffrey Colvin attributedthe high rate of CEO failures to bad execution,not poor strategy or vision.

2. For a more detailed treatment of the subject,see the following BSR articles: “Using StrategicThemes to Achieve Organizational Alignment,”by Robert S. Kaplan, BSR November–December2001 (Reprint #B0111A); and “Using StrategicThemes to Achieve Inter-OrganizationalAlignment,” by Robert S. Kaplan, BSRMarch–April 2002 (Reprint #B0203A).

3. For more on this practice, see chapter 12 ofStrategy Maps: Converting Intangible Assets into Tangible Outcomes, by D.P. Norton and R.S. Kaplan (HBS Press, 2004). A six-stepmethodology begins on p. 370.

4. According to a 2002 study by BalancedScorecard Collaborative (BSCol) and CIO Insight,and another that same year by BSCol and theSociety for Human Resource Management.See D.P. Norton, “Strategic Alignment SurveysShow Misalignment of Intangible Assets,” BSRNovember–December 2002 (Reprint #B0211E).

Consult the latest BSR ArticleIndex (1999–2005) for more articles on planning and budgeting. It’s available onlineat bsr.harvardbusinessonline.orgfor free.

Reprint #B0605A

T O L E A R N M O R E

The problem with the budgeting process is

that it does not recognize strategic invest-

ments as such. Traditionally, such expenditures

are treated as discretionary and often vanish

under the pressure to meet quarterly targets.

From its modest beginnings in1966 as a small music store in St. Paul, Minnesota, the Richfield,Minnesota–based Best Buy todayreigns as the king of consumerelectronics. Boasting more than900 stores across the United States and Canada, Best Buy isthe largest consumer electronicsretailer in America and employs a global workforce of 120,000people. In 2004 Fortune ranked it 77th of the 500 largest U.S.corporations according to rev-enues. In Best Buy’s fiscal 2005,the organization posted revenuestopping $27.4 billion.

Besides consumer electronics,Best Buy sells home office products, entertainment software,and appliances. In recent years,it has acquired Magnolia AudioVideo (a Seattle-based retailer ofhigh-end consumer electronics)and Future Shop (a chain ofCanadian stores). Its Geek Squad,operating in every Best Buy storein North America, offers 24/7computer services for customersat work or at home.

But competition in retailing is cutthroat, and even the mostremarkable success can provefleeting if companies make themistake of resting on their laurels.Besides facing off against directcompetitors such as onetime category leader Circuit City, BestBuy has encountered new, non-traditional competitors—includingDell, Wal-Mart, and Amazon.

Furthermore, Best Buy’s spate of acquisitions has exposed the need to improve the cross-functional coordination of business lines and enhanceprocess efficiencies. To sustain the company’s impressive growth,executives at Best Buy took abold step: shifting from a product-focused strategy to a customer-intimacy strategy that Best Buydubbed Customer Centricity.Launched in 2003, CustomerCentricity has an ambitious intent:to differentiate the company fromits competition in no uncertainterms in the minds of NorthAmerican consumers. As SusanGrafton, vice president of finance,explains, “Retail stores have analarmingly high rate of failure. Wecan never be satisfied with whatwe’ve achieved.”

The Five Faces of Best BuyCustomers

To carry out its Customer Centricitystrategy, Best Buy identified its most profitable customer segments, whom it personifiedthrough these specific, vividdescriptions:

• Affluent professional malesdesiring top-of-the-line products and service

• Young entertainment enthusiasts who appreciate a digital lifestyle

• Busy moms

• Families that are practical-minded technology adopters

• Small businesses with fewerthan 20 employees

The company then began tailoringits store environments and offer-ings to better satisfy these cus-tomers’ needs. For example,small-business owners needingcustomized solutions can getadvice and assistance from busi-ness pros in Best Buy stores whounderstand their particular needs.Customers who want only top-of-the-line products and personalservice can visit Magnolia HomeTheater boutiques located insideBest Buy stores. And busy familiescan enlist personal shoppingassistants to help them betterunderstand product benefits andnavigate stores quickly.

Activating the Employee-Customer Connection

Through Customer Centricity,Best Buy has successfully reachedits five targeted customer segmentswhile improving customer satis-faction and loyalty—two key drivers of financial performance.Executives are betting that thestrategy will help Best Buy reacha particularly important goal:increasing the company’s annualoperating income rate to 7% ofrevenue in 2008 and raising the

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E Best Buy: Putting CustomersFirst—with the BSCBy Lauren Keller Johnson, Contributing Writer

How to shift your focus from putting products first to puttingcustomers first? Consumer electronics retailing giant BestBuy did it with help from the BSC. Fending off rivals, the company has positioned itself to achieve aggressive newgoals—including dramatically increasing its number of stores and enhancing annual operating income. Its dazzlingresults—financial and nonfinancial—won it a place in theBSC Hall of Fame in 2005.

A T A G L A N C E

Best BuyRichfield, Minnesota

(All figures 2005)

Industry: consumer electronics

Total revenues: $27.4 billion

Employees: 120,000

Operations: 900-plus stores in theUnited States and Canada; recentlyopened an office in China dedicatedto purchasing in that country

BSC adopted: 2002; corporate-levelBSC developed in 2003

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number of its stores in NorthAmerica to 1,000 over the nextseveral years.

Best Buy has also trained itsemployees to think and behave asbusiness owners/operators. Thistraining includes extensive onlinelearning, as well as presentationsin which general managers andsupervisors share best practices.These experiences empoweremployees to decide how to satisfy customers at all touchpoints—store visits, phone calls,online visits, and in-home visits.In addition, Best Buy has created“lab stores,” in which managersand employees develop and test strategies for better servingcustomers.

All of these efforts have a com-mon aim: to enhance employeeengagement. Indeed, engagementis Best Buy CEO Brad Anderson’smost crucial performance metric.He is convinced that when people are excited by their work,they provide better service to customers. Twice a year, the company assesses employeeengagement through a 12-question survey designed byGallup. Questions include “Doyou know what’s expected of youeach day?” “Do you have the toolsand equipment you need to doyour job?” and “Do you have abest friend at work?”

Driving Customer Centricity

In 2002, Executive Vice Presidentand CFO Darren Jackson, alongwith Director of ManagementReporting Kirk Geadelmann,investigated the possibility ofusing the Balanced Scorecard to serve two ends for Best Buy:(1) providing visibility on perfor-mance against the CustomerCentricity strategy in a consistentway, and (2) providing seniormanagement with timely, conciseinformation on key performancemeasures. By April 2003, a score-card team led by Susan Grafton

had developed the corporate-level BSC.

Defining metrics and setting targets proved challenging,Grafton says. The team askedfunctional area leaders to identifykey metrics, and “many came with a bushel basket…We had to whittle them down.” Butinstead of aiming for perfection,the scorecard team took a prag-matic approach. “We used theeighty-twenty rule,” Graftonexplains. “If you can get 80% ofthese right—enough to move theeffort forward—you can alwaysmodify things later.” Yet the teamalso strove to balance flexibilitywith stability in its choice of metrics. “Retail culture is charac-terized by constant change,”Grafton notes. “So people assumethat performance metrics shouldkeep changing. They want toknow, ‘What’s the big metric forthis year?’ Our message is that theimportant metrics stay the same.”

Each metric on the scorecard hasa dedicated “business owner”—the executive who owns the relevant data and is accountablefor performance against target.Business leaders throughout thecompany see key metrics monthlyvia the company’s BalancedScorecard package. And twice a year, Best Buy’s 900-plus storemanagers and several hundredcorporate leaders gather to discuss strategy and define supporting initiatives.

Rather than use cascaded score-cards, Best Buy has developedtwo documents designed toachieve organizational alignment:

1. The company’s BusinessOperating Blueprint definescapabilities (such as tailoredmarket assortments and price optimization) needed toexecute Best Buy’s strategyover a rolling three-year period.

2. The National MarginEnhancement (ME) StoreScorecard is updated by

7:00 a.m. local time every dayto each store. General managers(GMs) use the scorecard dailyto check the prior day’s per-formance and discuss ways inwhich their stores can contributeto improved performance.As a result, the National MEstore scorecard has become the essential tool of every retail manager. Each week, thisscorecard gets 600,000 informa-tion hits from GMs and otherexecutives systemwide.

Best Buy has also resisted takingon complex reporting technologyto manage its scorecard program,preferring to work with low-techsolutions first. As Grafton explains,“We like to take a ‘crawl, walk,run’ approach. It’s more importantto ‘land the principles’ first, beforeyou adopt complex technology—to get the strategy down, chooseyour metrics, [and] ensure that you have the data to inform themetrics.” Best Buy initially usedelectronic spreadsheets for score-card reporting, and then moved toWeb-based PDFs. The companyintends to develop more interac-tive, higher-tech tools, thoughGrafton notes that obtaining funding “isn’t always easy.” Still,as the company has grown morecomplex, and with the rise of its Customer Centricity strategy,its performance management system requirements have grown.Grafton believes Best Buy needsto revamp its BSC and providesenior management more high-tech tools to dissect and drilldown performance data.

To reinforce the CustomerCentricity strategy, Best Buymakes savvy use of a broad range of communication vehicles.For example, store managers hold daily morning “chalk talks”with employees to discuss strategyand teach workers about business.Additional communications includeannual strategy addresses deliveredby the CEO to all employees, aswell as monthly newsletters that

leaders discuss with employees atteam meetings. Another vehiclefor conveying information aboutstrategy is “Donuts with Darren,”a quarterly event attended by corporate employees and hostedby Jackson. At each session,Jackson translates quarterly earnings releases and analysts’responses and discusses theimpact of strategic priorities oncompany performance.

Pay-for-Performance Predicament

Best Buy has also consideredtying compensation to scorecardperformance, but as Graftonpoints out, this step requires careful thought. “Retailing has alower base-pay-to-variable-payratio, because margins are sothin,” she explains. “The higher up in the organization you go,the heavier the percentage of your pay is variable.” For this reason, any attempt to link pay tostrategic performance must ensurethat performance is measuredonly against goals that support the company’s strategy of putting customers first. Otherwise, unin-tended consequences can result,as people “game” the system.

Grafton cites the example ofestablishing goals and metricsrelated to increasing sales ofextended warranty programs.“If people think they’re going to get a bonus by selling more of these programs, they’ll keeppushing them on customers—andthat doesn’t enhance the customerexperience when they’re in ourstores. Customers don’t want tobe asked three times if they’reinterested in extended warranties.”By contrast, defining and reward-ing performance on goals andmetrics related to customer loyalty—such as the speed with whichcustomers go through the check-out line or receive refunds—encourages people to behave inways that improve the customerexperience. And a satisfying expe-rience with Best Buy links directlyto increased customer loyalty.

Racking Up Results

Best Buy’s successful execution of its Customer Centricity strategyhas paid big dividends. For exam-ple, during the months in 2005when the company applied thestrategy to 67 customer-segmentedU.S. stores, those stores reportedan 8.2% comparable-store increasein sales. Meanwhile, stores thathad not been converted to thestrategy reported comparable-store sales gains of just 1.9%.As Jackson explains, “Linking ourstrategy with metrics and publish-ing this information in a timely,balanced, and relevant fashion has enhanced our performanceculture by shaping behavior andreinforcing positive strategic out-comes.”

In addition to a rise in customer-segmented store sales, Best Buy’scompounded revenue grew 17%from 2001 to 2005. And its U.S.market share increased from 13%in 2001 to 17% in 2004. From2003 to 2005, the company’s stockprice jumped from $19.38 to$34.46, and from 2001 to 2005,earnings per share increased 21%.Equally devoted to its intangibleassets, Best Buy also saw employeeengagement (measured on a scalefrom 1 to 5) improve from 3.8 in2003 to 4.1 in 2005.

The BSC has helped teach Best Buy executives, managers,and employees the importance of looking beyond just the hereand now. “Most retailers don’tthink past the next holiday season,”acknowledges Grafton. By linkingthe BSC to its financial plans, inwhich all strategic initiatives werescheduled for execution duringparticular quarters that looked outover three years, Best Buy openedstore managers’ eyes to a longertime horizon than they were previously used to.

Eyeing the Future

Of course, success is always amoving target, and Best Buy hasno intention of sitting back and

relaxing just because it has scoredimpressive results. The companyhas major plans to continue movingits strategy and BSC program forward. Within three years, itintends to convert all remainingU.S. Best Buy stores to theCustomer Centricity operatingmodel. Scorecard team membersalso plan to revisit functional area metrics and revise them asnecessary to ensure that theydirectly support corporate-levelobjectives. To further sharpen thefocus on the employee-customerlink, Best Buy will also strengthenemployee retention efforts andlink incentive compensation toimprovements in customer loyalty.

And Best Buy is considering introducing the BSC to its nearly100 stores in Canada, as well asinitiating the opening of retailstores in China. According toGrafton, such expansion effortswill pose special challenges. Forexample, thanks to the briskgrowth Best Buy is experiencingin Canada, “no one has time to dealwith the BSC,” Grafton says. “Ourchallenge will be to get leaders’attention”—always a foundationalstep in any BSC program.

Comparing performance manage-ment to a Rubik’s Cube, Graftonnotes that the real challenge is in aligning strategy and metricsacross the organization. The BSC “must send the message toother parts of the company abouthow to create synergy”—a pointon which “we still have work to do.” �

Best Buy, a 2005 BSC Hall of Fameinductee, is featured in the BSCHall of Fame Report 2006, availableat bsr.harvardbusinessonline.org(type “Hall of Fame Report” in thesearch window).

Reprint #B0605B


M a y – J u n e 2 0 0 6

9


10

Target setting is central to theeffective implementation ofBalanced Scorecard–based strategymanagement. Targets for financialmetrics should ideally come fromexternal benchmarks as companiesstrive for performance that willmake them among the best intheir industry in metrics such asreturn on capital, revenue growth,and productivity. They shouldstrive to be number one or two in such measures, or at least to achieve top-quartile or top-quintile performance, especially if their current performance isbelow the industry median.

Some customer outcome metrics,such as improvements in marketshare or growth in account share,1

are by definition benchmarkedagainst competitors. Companiescan also ask key customers torank their performance relative to competitive suppliers. Thestretch target for that metricwould be “to become (or remain)our customers’ number-oneranked supplier.”

Once a high-level stretch financialor customer target has beenestablished, it can often bedecomposed into more manage-able subtargets for each strategictheme. Consider a financial institution whose CEO sets a

stretch target of doubling monthlyoperating income from $1 millionto $2 million over the next threeyears. At first, this seems like animpossible target to achieve. Butthe company can decompose thisstretch target into somewhat moremodest and achievable perform-ance targets for each of its threestrategic themes shown in Figure 1.The ambitious income-doublingtarget can be achieved if: the

number of new customersincreases by 25%, the average revenue per customer increasesby 33% (perhaps by increasingthe number of products used bythe average customer from threeto four), and the cost to serve isdecreased by 20%. The targets for the three themes combine toproduce the desired doubling of net income.

After selecting subtargets forstrategic themes, companies identify a portfolio of strategic initiatives designed to achieve the theme targets. For example,for the theme “Add and RetainHigh-Value Customers,” the com-pany instituted several initiatives,among them: a targeted telemar-keting campaign (to grow revenuesfrom new customers) and a rela-tionship management program (to increase revenue per existingcustomer).

Companies with large numbers ofhomogeneous outlets, such asretail-store chains, hotels, banks,and quick-service restaurants,can use statistical analysis to

Target SettingBy Robert S. Kaplan

Articulating strategy and identifying strategic objectivesoften get the spotlight as major scorecard-building challenges. But defining measures and setting targets are no less challenging—for different reasons. And unlike themore stable BSC elements, targets must, by definition,be continually revised. One of the most delicate tasks is setting effective stretch targets—those that are ambitious,yet achievable without being demoralizing. The implicationsare great, not just for company performance but for individualperformance and morale. Here, Robert Kaplan discussesexternal and internal benchmarks across the four BSC performance perspectives, presenting proven methods forsetting stretch targets that deliver the results leaders wantwithout incentivizing the wrong behavior.

PE

RF

OR

MA

NC

E

MA

NA

GE

ME

NT

Add andRetain

High-ValueCustomers

StrategicTheme

Target forImprovement +25%

IncreaseRevenue

perCustomer

DecreaseCostper

Customer

+33% –20%

CurrentQuantity

100,000customers

Revenue of $15 percustomer

per month

Cost of$5 per

customerper month

Growrevenue

Improveproductivity

Enhanceshareholder

value

TargetedQuantity

125,000customers

Revenue of $20 percustomer

per month

Cost of$4 per

customerper month

Profit$1 million/month

Profit$2 million/month

The ambitious stretch target of doubling monthly operating income becomes more easily achievedwhen it is decomposed across the strategic themes that affect financial performance.

Figure 1. Decomposing a Stretch Target into Manageable Subtargets

M a y – J u n e 2 0 0 6

determine their targets forprocesses and employee capabili-ties. For example, a Canadianbank does multiple regressionanalysis on a data set consistingof monthly performance measuresfrom its hundreds of branches.The coefficients from the regres-sion analysis measure the rate ofincrease in profitability, customersatisfaction, and loyalty that areassociated with improvements inprocess performance and employ-ee satisfaction. The bank thenuses these coefficients proactivelyto estimate the levels of processand employee performance thatare required to yield desired levels of customer and financialperformance.

External and Internal Targets

Companies also use external,best-in-class benchmarks as targets for their process metrics,especially those related to thecost, quality, and cycle times ofkey processes. For example, aretail bank may have identifiedthe approval of mortgages orloans as a key process. The bankmay set a target to offer the short-est response time from customerapplication to credit approval inthe industry. Another bank maystrive to match or exceed the lowest ATM downtime percentagein the industry. Or a bank maywish to have the highest yield ofnew customers acquired throughits promotional activities. For aninnovation process, a manufactur-ing company may strive to havethe shortest product developmenttimes in its industry, measuredfrom the time of idea generationto the time of commercial productavailability. To use such externalbenchmarks, the company must,of course, have access to industryor trade association data, subscribeto a benchmarking service, orlead or participate in benchmark-ing studies.

Companies may also set internaltargets for improving their

process performance. Twentyyears ago, when it launched itstotal quality management initia-tive, the Milliken Corporationestablished a “10-4” program (the name came from truck-drivers’ familiar CB radio sign-off code). The 10-4 programexpressed the target of achievinga tenfold reduction in the defectrate for each of its processes overa four-year period.

Art Schneiderman, as vice presi-dent for quality and productivityimprovements at Analog Devices,developed the “half-life” methodfor targeting improvement rates inrepetitive processes.2 Inspired byscientists’ half-life calculation forradioactive materials, the half-lifeprocess measures the length oftime required to reduce a processdefect rate by half (50%). Themetric assumes that formal qualityimprovement processes should be able to reduce defects at aconstant rate so that each reductionin defects by 50% should takeabout the same number ofmonths. For example, supposethe organization has identified on-time delivery as a critical customer objective. Currently, thebusiness unit may be missingpromised delivery dates on 30%of orders. If its goal is to reducethe missed delivery percentage to1% over a four-year (48-month)period, a thirtyfold improvement,then it can reach (and actuallyexceed) this target by a continu-ous improvement process thatreduces missed deliveries by 50%every nine months, as shownbelow:

Month Missed Delivery %

0 30

9 15

18 7.5

27 3.8

36 1.9

45 1.0

By establishing the rate at whichdefects are expected to be elimi-nated from the system, managerscan validate whether they are on a trajectory that will yield thedesired performance over thespecified time period. While theChinese proverb tells us that avoyage of a 1,000 miles startswith a single step, the half-lifemetric tells us whether we arestepping in the correct direction,and at a rate that will enable usto reach our ambitious target inthe requisite time period.Companies can start from astretch target, such as Milliken’s10-4 program, and calculate theprocess’s half-life. For example,the tenfold improvement impliesabout three-and-a-half “half-life”cycles during the 48-month period,or a half-life of about 14.5 months.If defects drop by half every 14.5months, the defect rate after fouryears will be only 10% of its original rate.

Hilton Hotels uses an internalbenchmarking procedure to establish targets for its individualproperties. It expects each prop-erty to close the gap every yearbetween its current performance and that of one of Hilton’s top-tier(or “green zone”) hotels. Supposea low-performing hotel has a cur-rent score of 45 on a particularmetric, whereas the best perform-ance score for a comparableproperty is 89. Hilton would set a target for its properties to closethe gap by, say, 25% each year.In this case, next year’s target forthe low-performing hotel wouldbe: 45 + [.25 x (89 – 45)] = 56.This approach acknowledges that“Rome was not built in a day”;properties have stretch, but stillachievable, goals. The Hiltonapproach to targets also recognizesthat improvements may be moredifficult to realize as propertiesapproach performance “perfection.”Next year’s target for a propertywith a current rating of 75 would be 78.5, a much lower

11

percentage improvement than the low-performing hotel wouldbe asked to achieve.

Motivating Stretch TargetPerformance

Setting stretch targets is one thing.Having managers internalize thestretch target and strive to achieveit is quite another task—perhaps a

stretch target in its own right.Several companies have motivatedmanagers to buy into stretch targets by linking performancebonus percentages to the degree of “stretch” in the target.Beyond establishing targets foreach scorecard measure, MobilNorth America Marketing &Refining’s business units alsoassigned a performance factorthat represented the perceiveddegree of difficulty of targetachievement. The maximum index score of 1.25 occurredwhen the target represented best-in-class industry perform-ance. An average target received a performance factor of 1.00, anda factor score as low as 0.7 wouldbe applied when the target repre-sented poor performance, or wasdeemed very easy to achieve.

Executives in the individual busi-ness units proposed the perform-ance factors for each measure,and had to explain and defendthem in a meeting attended bythe executive leadership team and shared service unit heads.Collectively, this group had agreat deal of knowledge abouteach business and the degree ofstretch in any proposed target,which served to discipline theoptimism that managers might

otherwise have built into theirperformance factors.

The performance factor was multiplied by the actual value ofthe measure to arrive at a totalperformance amount, in much the way a diving competition isscored. In a diving competition,someone who attempts an easydive may execute it flawlessly and

be awarded thetop score of “10” on merit.But because the degree of difficulty waslow (say 0.8),the total amountof points award-

ed to the dive will be low (8). Another competi-tor may try an extremely difficultdive (triple reverse with two anda half spins, a difficulty factor of2.8), do it satisfactorily but notperfectly (be awarded a 7.1), yetearn a much higher total score(19.9) for the dive. This perform-ance amount ensures that man-agers in all units are compensatedon a level playing field, with the targets’ degree of difficultymade comparable across diversegeographical and product units.

Another option in setting a stretchtarget is to reward managers even

if they fall a little short of achievingthe target. Otherwise, managersmay “sandbag” the target, select-ing one that they are quite confi-dent they can achieve, rather than risk falling a little short of thestretch target. The payoff shouldbe nonlinear—a 10% shortfallfrom the target may result in a30% to 50% reduction in the payoff to managers—but enoughso that when they perceive thattheir performance will not reachthe target, they are still motivatedto come as close to it as possible.

One such target-setting scheme,proposed in the academic litera-ture but rarely implemented inpractice, is to tie compensationjointly to an aggressive forecastand to the performance relative tothe forecast. Consider the payofftable for salesman Gary Jones,shown in Figure 2. The payofftable has some interesting anddesirable properties. SupposeJones believes that by workingharder and smarter, he canachieve a sales level of 100, for abonus of $5,000. With this belief,he should set his sales target forthe year at 100; for if he sets asomewhat lower target, say 90,and achieves 100, his payoffwould be $4,900 rather than the$5,000 he would have achieved


12

80 90 100 110 120 130

80 4,400 4,100 3,600 2,900 2,000 900

90 4,500 4,600 4,300 3,800 3,100 2,200

100 4,600 4,900 5,000 4,700 4,200 3,500

110 4,700 5,200 5,500 5,600 5,300 4,800

120 4,800 5,500 6,000 6,300 6,400 6,100

130 4,900 5,800 6,500 7,000 7,300 7,400

Targeted Performance (Level)

Act

ual

Per

form

ance

(Lev

el)

$

Such a target-setting scheme offers greater rewards for striving toward—or exceeding—stretch targets rather than for playing it safe.

Figure 2. Payoff for Setting Truthful Stretch Targets

Another aspect of setting a stretch target

is to reward managers even if they fall a

little short of achieving the target. Otherwise,

managers may “sandbag” the target.

M a y – J u n e 2 0 0 6

by setting 100 as his annual target. You can see in Figure 2that for any given level of actualperformance (specified by therow headings), Jones’s best policyis to choose the “column” or tar-geted performance that equals theactual performance (see bold-faced number in each row). Oncethe target has been established,however, Jones is still better offoutperforming the target if thatproves feasible. If Jones chooses100 as his target, for example,his payoff for selling 110 wouldbe $5,500, or $500 more than just hitting targeted performance.Conversely, if he falls short of tar-geted performance, say by sellingonly 90 units, he would receiveonly $4,300 (a loss of $700), sohe has a strong incentive to atleast achieve targeted perform-ance. The numbers are selectedso that the gains from exceedingtargeted performance by a givenamount are less than the lossesfrom falling short by that amount(called an asymmetric reward byeconomists).

The “truth-revealing” incentivescheme in Figure 2 is expensive,since the company is paying

managers both for their forecastsand their performance; for anygiven level of actual performance,the payment is higher if that performance had been forecastedaccurately, than if the forecast was inaccurate. Therefore, thismethod should be restricted tothose measures for which forecastaccuracy is especially valuable to the company. I would use it primarily for a sales target,rather than for targeting internalprocesses, since sales targets arethe basis for resource allocation,capacity supply, and coordinationbetween sales and operations.If managers generate more salesthan they had forecasted, thecompany may run out of capacityand be unable to fulfill all poten-tial orders without backlogs anddelivery delays. Conversely, ifactual sales are below the fore-cast, the company will have spenttoo much to provide productioncapacity for the period. When somuch rides on choosing an accu-rate target, it becomes worthwhileto provide incentives both fortruthful, stretch forecasts as wellas excellent execution against the plan. �

Author’s note: This article haspresented various ideas for target-setting, but candidly, this processis one of the less developed aspectsof the Balanced Scorecard strategymanagement system. Moreresearch, experimentation, andinformation sharing on this subject is definitely warranted. Ihope the article stimulates severalof our readers to share their bestpractices with us.

1. Account share is the percentage of customers’spending in the company’s industry category thatthe company captures. For example, an accountshare of 90% for Cisco Systems means that Ciscocaptures 90% of the total amount its customersspend on networking and routing equipment.

2. Analog Devices, Inc.: The Half-Life System:Harvard Business School Case, by Robert S.Kaplan (March 16, 1990; revised June 29, 1993:9-190-061).

See “The Limits of Benchmarking,”by Robert S. Kaplan, BSRNovember–December 2005(Reprint #B0511C).

Also see “Considerations onCascading BSC Measures,” byAntosh Nirmul, BSR September–October 2003 (Reprint #B0309E)

Reprint #B0605C


13

I N T H E N E W S

Honoring a pioneer: FirstCommonwealth FinancialCorporation, the Pennsylvania-based bank that pioneered the useof the Balanced Scorecard with theboard of directors, won the 2006Governance Award from BankDirector for having “instituted andpracticed corporate governance in a superlative manner.”The bank,highlighted in Kaplan and Norton’sMarch–April On Balance (“Aligningthe Board of Directors”) as well as in their latest book, Alignment,was also the subject of a HarvardBusiness School case study byKaplan…More and more BSC usersare explicitly referring to their BSC in their annual reports, particularlythose from countries in which

corporate social responsibility is big.Recently, BSR learned of yet anotherexample: TrygVesta, the Denmark-based insurer (and a strategic part-ner of BSC Hall of Fame winnerNordea). TrygVesta structures itsannual report according to the fourperspectives of the BSC…MaverickBritish retail magnate Sir TerryLeahy, whose Tesco supermarketchain has redefined its industry category, credits Robert Kaplanand the Balanced Scorecard withinspiring his thinking about the customer relationship—and aboutthe role of intangibles in growth.(The Sunday Times [London], March12, 2006 profile.) Tesco’s BSC naturallyhas its own private label (“the steer-ing wheel”)…The three most critical

issues in HR for 2006, according to IOMA’s annual survey, are:talent management, including staff retention and development and succession planning; employeeengagement and enhanced pro-ductivity; and leadership trainingand development at all organiza-tional levels. (See Hrfocus, HumanResources magazine, December2005.)…In a November 2005 article,Advertising Age, the leading voice of the advertising industry, notes the importance of using multiplemetrics to measure marketing effectiveness—and thus the value of the BSC for marketers.

BR

IE

FS

Could someone who has neverheard of your company pick up your Balanced Scorecard andarticulate your strategy? Howabout someone within your com-pany who is actually responsiblefor implementing your strategy atan operational level? A hallmarkof a good Balanced Scorecard isthat it translates strategy intounderstandable operational terms.Scorecards can fail to achieve thisobjective if they include too manyor potentially irrelevant metrics.Too many metrics can dilute thefocus on your strategic objectives,making it difficult to communicatea coherent implementation planto the employees responsible for achieving those objectives.Moreover, an abundance of metrics that do not have clearlinkages to your overall strategicobjectives may be symptomatic of a larger problem: the lack ofstrategic focus at the top of theorganization.

Measures selected for inclusion in your scorecard should haveclear and demonstrable links to your overall customer andfinancial performance objectives.Understanding the relative importance of different metrics in driving these objectives is anecessary condition for providinggood, actionable information at the operational level, wherestrategy is actually implemented.

Consider the case of Toronto-Dominion Bank (TD Bank). In a banking market where consumersand regulators were typically hostile to mergers and acquisi-tions, TD Bank, one of the largestbanks in Canada, undertook amerger with a relatively smalltrust company, Canada Trust (CT),which was known for exceptional

customer service. To assuage theconcerns of regulators, consumergroups, and the customers newlyacquired through the acquisitionof CT, the bank made severalpublic pronouncements promisingto maintain its high customerservice standards and deliver a“comfortable” and convenientbanking experience.

Executives at the bank took thispromise seriously, but were nowfaced with the task of translatingtheir service strategy of “comfort-able banking” into operationalterms. To appreciate their chal-lenge, consider the customer satisfaction tracking report inFigure 1. This periodic report was meant to provide informationto tellers and branch managementabout their performance againstvarious service attributes that areregarded as drivers of the overallbranchwide objectives of high


14

TO

OL

S

&

TE

CH

NI

QU

ES Choose the Right Measures,

Drive the Right StrategyBy Dennis Campbell, Assistant Professor, Harvard Business School

Metrics overload is a common problem that can have serious consequences: specifically, it can make it difficult foremployees to see what actions they should take to executestrategic objectives. Having too many metrics dilutes the focusand invariably means many are irrelevant. Here, accountingand performance measurement expert Dennis Campbelltraces a major Canadian bank’s experience in overhauling itscustomer satisfaction metrics to make them meaningful—and actionable—to frontline employees. The results say it all.

Figure 1. The Bank’s Original Customer Satisfaction Tracking Report

With an abundance of data but little information on the relative importance of these 25-plus metrics, this report was not very helpful to branch-level employees.

customer satisfaction and loyalty.1

But were there too many meas-ures? And were they the rightmeasures to include in the branchscorecard? Without the answer to these questions, how wouldoperational-level employees knowwhich service attributes to focustheir efforts on to achieve highercustomer satisfaction? The score-card in Figure 1 contains a lot of data, but very little informationthat would help branch-levelemployees implement the bank’scustomer service strategy. Thereare more than 25 performancemetrics included in this scorecardand no information on their relative importance in driving customer satisfaction.

Overhauling CustomerSatisfaction Metrics

The EVP of marketing, ChrisArmstrong, and his team under-took a rigorous and systematic

approach to analyzing whichdimensions of service warrantedfurther investment and whichshould be de-emphasized. Theirapproach began with ensuringhigh-quality data and metrics.Surveys of customers’ experienceswith each dimension of servicewere taken shortly after a cus-tomer’s actual service interactionat a branch. Individual customersurveys were aggregated up to the branch level to form averagebranch satisfaction scores witheach dimension of service onlyafter a sufficient number of customers had been surveyed for each branch.

Statistical analysis was then used to estimate the impact of measures of each service attribute on customer satisfactionand branch profitability.2 Forexample, the analysis revealed,among other things, that:

• Each increase of 1% in meas-ures related to “comfortablebanking” (e.g., the percentageof customers who were satisfiedthat the teller made them feeltheir business was appreciated)led to a 1.7% increase in customer satisfaction, which in turn led to a 0.4% increase in branch profitability.

• Similarly, a 1% increase inmeasures related to “speed of service” (e.g., the percentageof customers satisfied that their transaction was processedquickly) led to only a 0.8%increase in customer satisfaction,which in turn led to a 0.2%increase in branch profitability.

• Many service attributes tracked in the branch scorecard showedonly a marginal or even norelationship to overall customersatisfaction and branch prof-itability.

Armstrong and his team werenow able to understand preciselyhow much it was worth toincrease performance in eachdimension of service; they knewwhich aspects of service weremost important and which ones could be de-emphasized.Moreover, they found that mostservice measures showed a highly nonlinear “S”-shaped rela-tionship to customer satisfaction.Improvements in service did notyield incremental increases in customer satisfaction until meas-ured service levels were aboveminimum thresholds, after which they yielded dramatic increases in customer satisfaction. However,once service levels climbed aboveupper thresholds, further improve-ments in service yielded smallerand smaller increases in customersatisfaction.

Armed with these insights, execu-tives at the bank were now in a position to provide high-qualityinformation and feedback to operating units in the form of thecustomer satisfaction tracking

M a y – J u n e 2 0 0 6

15

1. CSI score

2. Satisfied (bottom 3 box)

3. Likely to recommend

4. Likely to continue

5. Make you feel like they appreciate your business

6. Process your transaction quickly

7. Have the ability to handle your request

8. Wait time acceptable

9. Greet you pleasantly

10. Address you by your name

11. Give you his or her undivided attention

12. Thank you for your business

13. Process your transactions accurately

14. Treat you in a respectful manner

15. Conduct your banking privately

86.9

1.9

79.8

90.7

91.6

96.3

96.3

91.6

97.2

77.6

96.3

86.9

97.2

98.1

93.5

Teller CSI YTDPerformance

levels

1 2 3

1= Need to improve; 2 = Room to improve; 3 = Maintain

Figure 2. Post-Analysis Customer Satisfaction Tracking Report

By streamlining metrics, presenting them in order of relative importance, and coding performance, this new report helped employees be more effective in their customer satisfaction

efforts. The bank also gained customers and boosted customer satisfaction—a rare achievement following a merger.

report shown in Figure 2. Severalfeatures distinguish this new reportfrom that shown in Figure 1:

• The number of metrics trackedwas reduced from 26 to 15.Eleven performance metrics that showed either a marginalor no relationship to the objec-tives of customer satisfactionand branch profitability weredropped. The remaining metricswere identified as strong driversof these objectives.

• Measures of service performanceare listed on the scorecard inorder of their relative impor-tance in driving customer satis-faction and branch profitability,starting with the attribute “appre-ciate your business,” which wasfound to be the strongest driver.

• Current performance againsteach of these metrics is nowcoded as red, yellow, or greencorresponding to whether that metric is in immediateneed of improvement, has room to improve, or is at anacceptable level. Targets indicat-ing red, yellow, and green levels of performance (in Figure 2, indicated in numberedcolumns) were established foreach individual metric based onthe thresholds identified in the“S”-curve analysis. Performancebelow the lower threshold,which needed to be crossedbefore service improvementscould yield incremental benefits,was coded red; performanceabove the upper threshold,where service improvementsbegan yielding diminishingreturns, was coded green; andperformance between thesethresholds was coded yellow.

This new reporting tool and the measurement and analysis it was built on served as thelinchpin for translating the bank’sservice strategy into operations.Branch-level employees, whosecompensation was linked to customer satisfaction, now had

high-quality information aboutwhere to focus their efforts toachieve the largest gains in cus-tomer satisfaction and, ultimately,branch profitability. Fewer meas-ures kept the focus on those that mattered most in driving the bank’s strategic objectives of increasing satisfaction and profitability in its branch network.Targets that indicated where service improvements would havethe largest impact on satisfactionand profitability allowed branch-level employees to allocate theireffort more effectively among theremaining metrics included in thescorecard. The net result? Thebank was able to deliver on itspromise of high customer service.Better yet, in its post-merger climate, where many banks experience customer attrition ratesof 5% to 10%, the bank increased its net customer acquisitions. Itscustomer satisfaction index rosefrom 81.5% to 84.5%.

The type of statistical analysisdescribed here requires data onperformance measures acrosscomparable operating units,across time, or both. Banks areparticularly amenable to this type of analysis because they aredecentralized and have multiplecomparable branches. But otheroptions exist. You can wait untilyou have amassed enough per-formance measurement data overtime, although you may need 20 to 30 periods’ worth to ensurevalid results. A second option: be creative about how you defineyour unit of analysis. Many impor-tant performance measures aredefined at the individual customeror employee level. The key tofocusing on measures that matter,and avoiding metric overload, isto take a systematic approach toselecting measures that have clearand demonstrable links to youroverall customer and financialperformance objectives. If thedata is just not available to makethese links “demonstrable,” then

managers across organizationalunits and at different organiza-tional levels should have exten-sive discussions and come tosome consensus on which ofthese links are at least most“defensible.” Putting this kind ofeffort into the design of yourscorecard can provide strategicclarity at the top of the organiza-tion and allow you to providegood, actionable information atthe operational level where strategyis actually implemented. �

1. Customer satisfaction was measured as the percentage of customers rating themselves as “satisfied” or “highly satisfied.” Similarly,performance on each service attribute was measured as the percentage of customers ratingthemselves as “satisfied” or “highly satisfied”with that particular aspect of service. For example, the measure corresponding to the service attribute “appreciate your business”captured the percentage of customers ratingthemselves as “satisfied” or “highly satisfied”with the tellers’ making them feel appreciated.

2. A combination of factor analysis and multipleregressions were used to estimate the relation-ships between measures of service attributes,customer satisfaction, and branch profitability.

Dennis Campbell is author of“Putting Strategy Hypotheses to the Test with Cause-and-EffectAnalysis,” BSR September–October2002 (Reprint #B0209E).

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