When the history of the financial scandals and subsequent bankruptcies of firms such as Enron and WorldCom is finally written, it will no doubt be a story of greed, fraud, corruption, and the “irrational exuberance” of the stock market.  However, there is one theme that probably will not get very much attention, which, in many ways, contributed to an environment that allowed investors, employees, and other stakeholders in these businesses to be taken advantage of.  This theme … an incomplete view of corporate performance – an over reliance on financial measures.

Now, I’m sure many of you are thinking “wait a minute, if the financial measures had been correct, rather than fraudulent, none of this would have happened.”  This may be correct, but consider the following thought experiment involving two pharmaceutical companies:  The first company, in an effort to impress investors, quietly cuts back on R&D and marketing in order to show a profit, inflate the stock price, and allow senior managers to execute options thereby enriching themselves; while the second firm reduced short-term earnings and continued to invest in R&D and marketing in an effort to ensure the long-term success of the firm.  Now I ask you … for what firm would you want to be an investor – or for that matter – an employee?

Financial measures alone are incomplete.  They simply don’t give us enough information to make judgments about the long-term potential of a business, and in the case of firms such as Enron and WorldCom give corrupt managers too much room to maneuver in falsifying their books.  Certainly almost anyone who was a customer of MCI/WorldCom in the last five years would have questioned the hype surrounding how well they were integrating their acquisitions.

From a management prospective, managing by financial measures alone is like trying to coach a football team by solely looking at the scoreboard.

Now, don’t get me wrong, financial measures – like the score of a game – are important, and arguably supremely important…but clearly a more comprehensive view of corporate performance is needed to manage a modern business.

So what are the managers of a firm to do?

A couple of business researchers pose an answer: The Balanced Score Card.  In a number of articles published in the Harvard Business Review in the last decade Robert Kaplan and David Norton propose managing a business with not only financial measures, but also with metrics which yield information from the customer, internal business, and innovation perspectives.  These four metrics constitute the basis of the Balanced Score Card concept.

Financial Metrics: Like the score of a game, financial measures (Revenue, Cash Flow, ROE) are very important, but they only tell the result of action already taken. They look backwards, rather than predicting the future, as the disclaimer on mutual funds says: “past performance does not predict future returns.” A Balanced Score Card compliments financial statements with measures of customer satisfaction, internal process and the organization’s ability to learn and improve.

Customer Metrics:  The customer is the primary building block to profitability. Without customers there can be no revenue:  as a result, it is important to look at a business from a customer’s perspective.   Measurements of customer satisfaction, customer expectations and service quality are typically included as customer metrics on a company’s Balanced Score Card.

Internal Business Metrics: Once the customer has delivered the top-line revenue, businesses need to deliver on their value proposition.  Internal business metrics such as, cycle time, productivity, employee satisfaction, and cost of goods sold, provide insight into internal business processes, which effect the business’ ability to perform and the bottom line.

Innovation and Learning Metrics:  No company will survive in the long-term without innovation.  The fourth set of metrics in a Balanced Score Card measures innovation.  These metrics vary greatly from company-to-company, but generally they measure: technology leadership, manufacturing learning, product focus and time to market.

Within these four broad categories of measurement, Kaplan and Norton recommend managers select the specific metrics (such as ROI, customer satisfaction and cycle time), which will best measure performance relative to company goals.  Management is free to select the individual metrics which will be most meaningful to the organization.  Discipline should be used, however, in selecting metrics.  Too many can be difficult to absorb. Rather, a few metrics of key significance to the organization should be collected and tracked.

Moreover, the Balanced Score Card concept not only provides a clearer picture of corporate performance, it can also serve as a catalyst for strategy definition, translating what you measure into corporate strategy.  Not only do you tend to become what you measure, but the concept of looking at a business from financial, customer, internal and learning/development perspectives gives a context from which to define business strategy.  To develop such a balanced strategy, ask yourself the questions below:

At times, it seems our understanding of corporate measurement seems incomplete – particularly if we over focus on the financial measures.  The Balanced Score Card is an excellent tool to provide a more complete picture of corporate performance and strategy.