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INTERVIEW

"Strategy Is The Basis Of The Scorecard"
He gave up a Deandom to teach and research. Thank Harvard! For, Robert S. Kaplan has, ever since, done more than any other to enhance the manager's understanding of that simple 4-letter word: cost. When the 58-year-old Marvin Bower Professor of Leadership Development at the Harvard Business School visited India for the first time in December, 1998, to deliver the keynote presentation on Integrated Cost Systems at the Confederation of Indian Industry's Second International Conference on Total Cost Management in Chennai, BT's R. Sridharan met him for 60 minutes. Excerpts from an exclusive interview about the A-B-C of the Balanced Scorecard: Q. Mr Kaplan, how has cost, as a management concept, changed in the 20th Century? A. Until just 15 years ago, all the people who handled cost-systems measured the past. We now recognise that we need to view cost from a future perspective. We have to understand the consequences of what we are doing, and how they influence future costs. Activity-Based Costing (ABC) helps us understand the decisions we can take to influence our costs. So, cost has shifted from a score-keeping function to a pro-active, influencing function. This makes the finance people more a part of the management team, a part of the value-adding process--and not just score-keepers. Right. How have costing systems evolved over the decades? From disjointed financial reporting, which I call Stage I, cost systems have moved through Stages II and III, where the quality of data and financial reporting have both improved. The best companies are in Stage III, where cost-data is customised, but is still stand-alone. In Stage IV, management reporting and control systems will be fully integrated, with information that supports both internal and external reporting. This will be able to provide performance information for operational and strategic control, and accurately measure product- and customer-profitability. ABC has become the basis of all New Age costing systems. But most companies are still unsure about how they can implement it. How do you do it? First, identify the purpose of the ABC project, and set up a team. Then, identify activities, choose the software, and analyse the product- and customer-profitability data. This will help you change your pricing, product-mix and design, and achieve process efficiencies. Ultimately, ABC must increase revenues and reduce operating expenses. Are there any pre-conditions a company must fulfil before going in for ABC? The biggest pre-conditions are dissatisfaction with your existing measurement systems, and the willingness to change. If it is as simple as that, why do organisations run into trouble while implementing ABC? Often, the problem is that CEOs do not fully understand what these techniques are, or adopt them without getting to the fundamentals. We feel that the ABC approach truly starts from the fundamental challenges of the business: what is it that the managers are trying to do? What are they trying to solve?

The Winning Edge

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Compiled by Chhaya Sehgal

ABB is simply the reverse of ABM. So. the numbers do not determine strategy. obviously. we need to know the segment's revenues and the cost of serving it. and then. yes. The Scorecard lets companies focus on customers. calculates the resources requirement. and allocates them to the various activities a company performs. They are trying to identify profitable customers. often. individuals and departments can identify the actions they should be taking to help move the numbers that the organisation is using to measure its strategy. they are trying to understand how to be more profitable with certain segments of customers. which is the ABC part. We find that measurement is a powerful way of communicating what that strategy is. they are interested not in today's or yesterday's financial performance. people hear a general idea. I really can't imagine how you can devise effective strategies without knowing your cost-structure and cost-drivers. stated in word-terms. Doesn't a pre-occupation with numbers tend to paralyse strategic action? Companies fail to execute most of the strategies they try to. and employee-related measures. The problem lies in the fact that strategies are. If you look at private companies. without being specified. they influence it. But can these numbers drive strategy? By themselves. We then associate this with the number. The only way to make them variable is to supply only those resources we need. determine the quantity of cost-drivers we plan to supply to in future. a question of understanding our capabilities--including costs--and finding out where they can be best deployed. you should optimise your longterm financial performance. and link activity demand to the supply and spending of resources. That is the real story of efficiency. And now. essentially. not everything. not better or worse. without addressing real management needs. and the kind of activities that need to be accomplished. the Scorecard is a broad performance The Winning Edge 2 Compiled by Chhaya Sehgal . and focuses on processes that deliver this value. it is ABB. Is ABB better than ABM? It is not a question of better or worse. So. It is. but in long-term performance. It identifies what customers value. How is it different from ABC? The Scorecard is different. Understanding the causality between the activities to be performed and the resources needed allows for accurate budgeting Budgeting. they are trying to make better decisions about customers. especially ones that involve a shift from the past. So. We should demonstrate how improved cost. and how companies can create value for customers. such as innovation with short lead-times. a long-term approach that measures the performance of an organisation over a period of time.and performance-measurement systems will help managers achieve their objectives. continuous cost-lowering. Then it was Activity Based Management (ABM). one year at a time. we begin with demand and. like employee capability and skills that enhance performance. it is. based on that. as is evident from the Balanced Scorecard technique that you conceptualised. What is Activity Based Budgeting (ABB)? In ABB. Virtually all the resources of a company--excluding energy and raw materials--are fixed. We have discovered that measurement can actually help companies implement strategies. That is what ABB is all about. To find out which market segment to enter. The latter begins with resources. The basic problem is that these approaches are advertised as techniques for their own sake.It is not that they want to build a measurement-system. Then. You can't get to the goal of the best long-term financials by optimising year by year. You have to get not just the senior executive team. you should have a broader set of measures--not just financials. First it was ABC. In order to drive long-term performance. and they have no way of knowing what is required. essentially. Numbers are. ABB begins with the activities that need to be performed. but everybody in the organisation to understand the new strategy.

" The Winning Edge 3 Compiled by Chhaya Sehgal . the critical issue in developing it is that it should be an exercise carried out by the senior executive team. Given that their gross margins could be 70 or 80 per cent. trying to improve manufacturing processes--even if the objective is only to become best-in-class--is a sub-optimal approach. Only then does it make any sense to start benchmarking. but that would be a limited approach. the colleague whom I do most of my work on the Scorecard with. a few extra expenses in manufacturing are much less consequential than being a year late to market a new product. We haven't got anything like those results you just showed me. It was not a group process. They were not one of our clients. may end up benchmarking the wrong process. is there an increase in marketshare. which we knew to be an early adopter of the model. Let me give you an example that we haven't written about. It was interesting to see the contrast. which are efficient in operating processes but lousy in innovation. the CFO. and then. moved from almost the last position in their industry in terms of profitability to the first. and measuring how well you are doing on the various sets of measures. the project was led by a staff person. It is more important for them to be good in innovation. Your article in the Harvard Business Review (September-October. and he engaged his executive leadership team in his efforts to create. but they had read the articles and the books. You collect the data. pharmaceutical companies. not by the CEO. our results have been terrible. Dave Norton. and. and you see whether you are getting the results you expect: if you improve the operating processes and offer new products and services. after 5 years of dealing with the Scorecard. the Chief Business Development Officer. and deploying operational improvement techniques? Why use the Scorecard? You could do that. By collecting data over time. and Rockwater--and this person kind of slumped in his chair. you are starting off with assumptions about your most important processes. As we now understand it. was visiting a large European bank. and Rockwater have achieved millions of dollars of operational improvements in a few years. Besides the lack of top management involvement. Because. the project was led by the CEO himself. in one case. and ABC is one element which tells us the cost of the processes. you will get insights into the validity of the model. So. In fact. The Scorecard defines sets of cause-and-effect relationships. for a company whose strategy is innovation. and rapidly introduce new products and services than it is to manufacture efficiently. In 1998. Both AMD and Apple are under tremendous pressure today. and implemented it. you start with your strategy and how you compete. with the Scorecard. and manage with a Scorecard. we feel that each organisation has to first decide what its strategy is. Isn't it possible for a company to achieve such improvements by measuring itself against the bestin-class benchmarks. the Scorecard was done by one person. What went wrong with their implementation of the Scorecard? In both Apple and AMD. Companies like Mobil. So. 1993) had case studies on Advanced Micro Devices (AMD). In each case. and then decide on the critical processes. Dave said: "What's the matter?" And he said: "We must be the black sheep of the Scorecard family. Chemical Bank. in the other. and. In Apple and AMD. an improvement in financial performance? We have a whole set of linkages built into the Scorecard. Rockwater. In fact. and Apple as practitioners of the Scorecard.measurement and management approach. Chemical Bank. does customer satisfaction go up? If that happens. I know of companies that started with the Scorecard in 1993. are there other threats to implementing the Scorecard? The problem most organisations face is that their infotech group is not linked to their strategy group. if you start benchmarking. Dave showed the head of the bank the financial improvements in Mobil. How does an organisation validate its Scorecard once it has one? Are there any benchmarks? The benchmark is the Scorecard itself. Now. in 2 years. And the importance of your processes is a function of this strategy.

The chairman said that they had a great strategy. you see companies shifting from product-focused organisations--focused on product-development. too. user-friendly interface. and can actually tell employees the value they create by putting a price on the output they produce. That can't happen if you follow the Scorecard correctly. and they had to sell off the unit. which was to offer sophisticated financial products and services to global corporations on a global basis so that they could access them anywhere in the world. and lose a lot of money. The Winning Edge 4 Compiled by Chhaya Sehgal . trying to satisfy customers in different segments. but did not understand the critical role it had to play in its organisation to implement strategy. and deliver products that customers want. Professor Kaplan. measure the costs. So. This is not a real transfer price--it is what you call a pseudo price--but it lets employees see the revenues they create in the production process. and the infotech group went off and did some benchmarking against other infotech organisations which they felt were world-class. the ABC model helps you identify cost-drivers. You start with the strategy of the organisation. he said. If you look at their old strategies. the Scorecard what next? Are there any new accounting techniques you are working on? In its fundamental form. We've seen organisations put penalties when the output produced is off-spec. So. and processes to make products--to customer-focused organisations. companies have always tried to be all things to all people. Part of the change also involves the ability to follow a segmentation strategy. But. the whole effort failed. and move to the strategies of the individual groups. particularly a strategy to become more customer-focused. it focuses more on strategic control. It is called pseudo cognoscentis. one approach involves being much more focused on a particular customer segment. thank you very much for your time. and. but what I like best is something I have seen in a few Japanese and American companies. and find out how much profits they have generated in that period. So. ABB. You have always maintained that the Scorecard should be used as a change-driver. Dave said: "What about your infotech group? How do they think they are doing?" The chairman said: "They think they are doing great. they are doing very well. and arrive at an organisation's coststructure. One under-explored area is short-term operational control systems that give employees information on a day-to-day basis about how they can work on improving their costs. which are more responsive to customer needs. When you get that alignment throughout the organisation. and to focus the organisation's attention on the targeted customer segments. And the strategies of these groups get linked to help the business units implement their strategies. What kind of change do you really mean? A change is usually a change in strategy. you get the leverage and the focus that yields breakthrough performance. ABC is not good at that. So. the Japanese use kaizen costing. I asked all the units to build Scorecards. according to those measures. we've actually seen them report losses when they produce below-quality items. ABC. The Scorecard helps articulate that. And you can extend the idea to cover other things. like delivery. found out what measures they employed. they could never get the infotech group to do these financial products and offer them in a convenient." What went wrong? What was wrong is that the infotech group benchmarked its processes against the processes of other organisations.