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Putting strategy into the balanced scorecard

The value dynamics framework provides companies with an asset-driven approach to strategy. By Peter Brewer, associate professor in accountancy at Miami University, Ohio.

This is the first in a series of articles about global accounting issues taken from the IFAC Articles of Merit 2003

Talk to any consultant and they'll tell you that the most important step in creating a balanced scorecard is defining your strategy. While that may sound easy, it's surprising how many companies struggle to define their strategy clearly, embed it into their balanced scorecard performance measurement system, and communicate it effectively throughout their organisation. Companies don't have structured approaches to translate high-level strategy statements into specific scorecard measures. The result? A lack of connection between strategy and performance measurements.

The changing nature of value creation complicates the performance measurement process, especially since the so-called new (knowledge-based) economy has stood the world of value creation on its ear. In 1978, the average US company had a book-value-to-market-value ratio of 95 per cent but by 1998 that had plummeted to 28 per cent. In fact, many successful companies such as AOL Time Warner, Cisco Systems, Amazon.com, Coca-Cola, Microsoft, General Electric, and Charles Schwab have all had recent book-value-to-market-value ratios of less than 10 per cent and, in some cases, less than five per cent. Why? Intangible assets. Though Wall Street understands the value of intangible assets, the traditional financial accounting model is mired in the world of physical and financial assets that dominated value creation 20 years ago. For managers trained in so-called old economy finance, the new economy forces them to stretch their mental image of what constitutes a sustainable business model.

So how do you translate strategy into measures? The value dynamics framework (VDF), shown in figure 1, is a tool that can help companies bridge the gap between strategy statements and balanced scorecard implementation. It enables them to disaggregate broad strategy statements into the underlying assets that are being used to deliver value to customers. This helps them focus the balanced scorecard metric selection process on the assets that are critical to achieving strategic objectives. The VDF recognises that, in today's economy, physical and financial assets aren't the only types of assets used to create wealth but acknowledges that customer, organisational and employee/supplier assets are also important.

Consider how some of the assets of AOL Time Warner, Starbucks, and DaimlerChrysler AG never appear on the balance sheet. Subscribing customers are an asset for AOL, not in terms of their subscription revenue but in terms of their ability to generate advertising revenue. Numerous companies pay AOL to gain visual exposure to the millions of customers relying on AOL for internet access. Despite the revenue-generating ability of AOL's customers, they don't show up on AOL's balance sheet. When Starbucks introduced its gourmet coffee-flavoured ice cream, it became a best-seller in the US within three months, thanks to the company's brand image. While brand is an organisational asset in the VDF framework, the value of Starbucks' brand isn't reflected in its balance sheet. DaimlerChrysler AG views its relationships with suppliers as a critically important asset, yet the value of its supply chain relationships in terms of improved product quality, time compression, and lower costs, isn't depicted on its balance sheet.

You can break down the process of creating a VDF into four steps. First, create a list of assets that supports your strategy. Include physical and financial assets, such as office buildings, desks, computers, cash, and accounts receivable only if they differentiate your company from its competitors. Second, explain how the assets in the VDF interrelate to deliver customer value. According to strategy expert Michael Porter, a competitive advantage is created when your company's activity system is difficult to replicate. Therefore, it's the combination of assets depicted in the VDF that works in unison to create an activity system, leading to a competitive advantage.

Third, identify the strengths, weaknesses, opportunities, and threats (SWOT analysis) underlying the VDF. The future may hold unexploited opportunities or unforeseen threats that render a current VDF and its associated activity system obsolete. Fourth, define the critical success factors underlying the strategy, and identify particular combinations of assets as being supportive of each critical success factor. Creating a VDF in this manner will focus your balanced scorecard metric selection process on the assets and critical success factors most important to achieving your strategic objectives.

Building Dell's VDF
To illustrate the application of the VDF, we'll use Dell Computer Corporation. Dell's mission statement is "to be the most successful computer company in the world at delivering the best customer experience in markets we serve". While this statement provides an expression of Dell's strategy and goals, it doesn't specify the combination of assets that Dell relies on to meet customer expectations. It would take a substantial leap of unstructured thought processes to get from this mission statement to the process of choosing measures for a balanced scorecard. Here's where the VDF can help.

Table 1: The value dynamics framework includes the following:

Physical assets
land
buildings
equipment
inventory
Customer assets
customers
channels
affiliates

Organisational assets
leadership
structure
culture
brand
systems
processes
intellectual property

Financial assets
cash
accounts receivable
debt
investments
equity
Employee and Supplier assets
employees
suppliers
partners

Table 2: Dell Computer's value dynamics framework

Physical assets
inventory (minimal)
manufacturing facilities (outsource)
other equipment (IT infrastructure)
Customer assets
customers (institutional/ consumer)

Organisational assets
leadership (Michael Dell)
process (the direct model)
structure (segmented approach)
brand (institutional/ consumer)
intellectual property (patents)

Financial assets
cash
accounts receivable (minimal)
Employee and Supplier assets
suppliers (as few as possible)
employees (sales, engineering, help desk, etc)

(Adapted from Cracking the value code: how successful businesses are creating wealth in the new economy by Richard Boulton, Barry Libert, and Steve Samek.)

Table 2 provides a VDF for Dell. It breaks down Dell's high-level mission statement into the assets that drive the attainment of strategic objectives. Dell's two biggest assets are classified under organisational assets, namely the leadership of CEO Michael Dell and the business processes underlying the direct business model. Other assets include:

patents related to Dell's direct business model;
corporate consumers' perception of brand stability;
individual consumers' perception of first-to-market technology leadership; and
a segmented organisational structure that enables managers to get intimately acquainted with customers' needs within a business segment.
Dell's physical assets provide a classic example of "less is more". As a result of bypassing distributors and selling direct to customers, Dell minimises the need to maintain inventory. It also maximises its flexible-response capabilities by outsourcing component-part manufacturing. Dell doesn't have substantial resources tied up in physical facilities dedicated to winning the first-to-market battle for each successive generation of technology. But it invests in the information technology infrastructure that supports real-time communication among its customers, its own manufacturing facilities, component suppliers and airfreight carriers.

The policy of outsourcing component manufacturing leads us to supplier and employee assets. By maintaining partnerships with as few highly reliable suppliers as possible, Dell streamlines its operations and relies on its computer monitor suppliers to ship direct to the customer. As long as a supplier retains its leadership position, Dell will collaborate with it to achieve mutual success. But if a particular supplier loses its edge, Dell has the flexibility to respond quickly. Another asset? Employees. Direct salespeople, help-desk operators, engineers and the like all have to be knowledgeable and customer focused to ensure Dell's continued competitiveness.

Customers are also critically important assets to Dell. When Dell introduced the direct model, all of its competitors were selling computers via distributors and so were detached from their end consumers. Dell, on the other hand, sells direct to consumers and is continually communicating with them. This is useful in two areas in particular - monitoring sales trends and learning about un-met customer needs. The sales trend data helps Dell match supply with demand, and information related to un-met customer needs translates into opportunities for innovation.

The company also relies on customers' knowledge of what they want to purchase and when they want to complete the transaction to drive the direct business model. Dell leverages this source of customer knowledge by making it as easy as possible for a customer to place a customised order electronically. In fact, Dell has set up about 7,000 customised versions of dell.com for various customers. Electronic ordering is hassle free for the customer and cost effective for Dell.

Finally, financial assets appear in the VDF. The primary financial assets for Dell include minimal accounts receivable and a strong cash position. Dell's cash conversion cycle (for example, day's accounts receivable outstanding + day's inventory on hand - day's accounts payable outstanding) is minus five days, which means customers pay Dell before it has to pay suppliers. This minimising of working capital provides not only a cost advantage but frees up cash to support necessary investments to stay at the forefront of technology.

Table 3: Linking the VDF to the balanced scorecard: Dell's customer intimacy value proposition

CUSTOMER MEASURES
Leadership Organisational structure Customer Brand Employees

|

LEARNING AND GROWTH MEASURES
Training dollars spent per FTE by customer segment Number of collaborative customer-solution teams Number of emerging technologies evaluated

|

BUSINESS PROCESS MEASURES
Percent of total hours spent in contact with customer Number of customer initiated product innovations Average customer idea ramp-up time

|

CUSTOMER MEASURES
Customer perception of customised response capability Customer perception of stability and first-to market capability Customer retention

|

FINANCIAL MEASURES
Revenue growth by customer segment Gross margin by customer segment

Table 4: Linking the VDF to the balanced scorecard: Dell's operational efficiency value proposition

CUSTOMER MEASURES
Suppliers Process Employees Customers
Working capital/pp&e IT infrastructure Intellectual property

|

LEARNING AND GROWTH MEASURES
Number of data sets shared with suppliers Number of patents that improve direct model Training dollars committed to building forecasting skills
Number of customer-focused process innovations Per cent improvement in customer-to-supplier information cycle time

|

BUSINESS PROCESS MEASURES
Per cent defect rate by supplier and within Dell Cash conversion cycle time Margin of error in sales forecasting

|

CUSTOMER MEASURES
Order-to-delivery cycle time Customer perception of value (ie, quality relative to cost) Customer perception of ease of interacting with Dell

|

FINANCIAL MEASURES
Cash flow Economic value added

Linking Dell's VDF to the balanced scorecard

Dell's VDF provides a richer body of information to support the balanced scorecard metric selection process than the mission statement alone because it specifies the assets that deliver customer value and profits. It provides a structure that allows you to move from the high-level mission statement to selecting measures for each of the four balanced scorecard perspectives: learning and growth, process, customer, and financial.

Let's look at Dell's assets that relate to its customer intimacy and operational efficiency value propositions. Figure 3 suggests that Dell's leadership, structure, customer, brand, and employee assets play a pivotal role in delivering on the customer intimacy value proposition. Likewise, figure 4 suggests that customers and employees, as well as the remaining assets from Dell's VDF, support its operational efficiency value proposition. Here's an analysis of the underlying logic of the links between Dell's customer intimacy assets and the balanced scorecard measures shown in Figure 3.

The customer intimacy value proposition
Michael Dell says his most important leadership responsibility is looking for "value shifts" in his company's customer base. To identify the shifting needs of customers, he has to stay in close contact with them. The segmented organisational structure and the employees who work within that are two other assets that enable Dell to focus on building intimate relationships with its segments of customers.

To build customer intimacy and loyalty, Dell exploits its customers' knowledge of their own un-met needs. Dell's brand image was and is shaped by customer feedback. Identifying this linked set of assets enables Dell to select strategy-focused, asset-based balanced scorecard measures that support the customer intimacy value proposition. For example, the balanced scorecard's learning and growth measures might include:

training dollars spent per full-time equivalent by customer segment to ensure that well-educated business segment managers provide state-of-the art advice to customers;
number of collaborative customer-solution teams that motivate Dell to collaborate with its customers and jointly create technology solutions that fulfil any un-met customer needs;
number of emerging technologies evaluated inspiring Dell's leaders to stay abreast of technology threats and opportunities that may alter the competitive landscape.

Business process measures might include:
percentage of total hours spent in contact with the customer;
number of customer-initiated product innovations; and
average customer idea ramp-up time.

The first measure - hours spent with the customer - would be evaluated at the executive as well as managerial level. The second business process measure - customer-initiated product innovations - should motivate Dell employees to listen to and collaborate with customers. The first two measures from the learning and growth perspective would support this process-oriented measure. The third measure - ramp-up time - assesses how long it takes Dell to translate a customer's idea into reality because creating innovative ideas is one thing, but delivering results in a timely manner is quite another.

The three customer measures are customer perception of customised response capability, customer perception of stability and first-to-market capability, and customer retention. If the learning and growth and business process outcomes are being achieved, then as the first customer perspective measure suggests, customers should perceive that their individual needs are being met in a timely manner.

The second measure focuses on brand image. If Dell stays in touch with customers and delivers solutions consistent with their needs, then its brand image of stability in the institutional segment and "first-to-market with the latest technology" in the consumer segment should remain strong. Finally, if customer perception regarding these two measures is positive, Dell should be able to retain customers and grow the business. Pursuing the value proposition of customer intimacy should lead to revenue growth, so the financial measures are revenue growth by segment and gross margin by segment. Since the growth needs to be profitable growth, gross margin is included as a financial measure to ensure profitable growth.

Research by Bain & Company suggests that 50 per cent of the Fortune 1,000 and 40 to 45 per cent of larger companies in Europe use the balanced scorecard. Many more companies are likely to implement the balanced scorecard in the near future. The value dynamics framework is the key to balanced scorecard success because it helps translate broad strategy statements into strategy-focused, asset-based measures.

Email Peter Brewer

This article was a 2003 International Federation of Accountants article of merit winner. http://www.ifac.com/

February 2004