THE STRATEGY-FOCUSED ORGANIZATION
HOW BALANCED SCORECARD COMPANIES THRIVE IN THE NEW BUSINESS ENVIRONMENT
By Robert S. Kaplan - David P. Norton

HARVARD BUSINESS SCHOOL PRESS

Copyright © 2001 Harvard Business School Publishing Corporation.
All rights reserved.
ISBN: 1-57851-250-6

Chapter One

Creating the Strategy-focused
Organization

The ability to execute strategy. A study of 275 portfolio managers reported that the ability to execute strategy was more important than the quality of the strategy itself. These managers cited strategy implementation as the most important factor shaping management and corporate valuations. This finding seems surprising, as for the past two decades management theorists, consultants, and the business press have focused on how to devise strategies that will generate superior performance. Apparently, strategy formulation has never been more important.

    Yet other observers concur with the portfolio managers' opinion that the ability to execute strategy can be more important than the strategy itself. In the early 1980s, a survey of management consultants reported that fewer than 10 percent of effectively formulated strategies were successfully implemented. More recently, a 1999 Fortune cover story of prominent CEO failures concluded that the emphasis placed on strategy and vision created a mistaken belief that the right strategy was all that was needed to succeed. "In the majority of cases?we estimate 70 percent?the real problem isn't [bad strategy but] ... bad execution," asserted the authors. Thus, with failure rates reported in the 70 percent to 90 percent range, we can appreciate why sophisticated investors have come to realize that execution is more important than good vision.

    Why do organizations have difficulty implementing well-formulated strategies? One problem is that strategies?the unique and sustainable ways by which organizations create value?are changing but the tools for measuring strategies have not kept pace. In the industrial economy, companies created value with their tangible assets, by transforming raw materials into finished products. A 1982 Brookings Institute study showed that tangible book values represented 62 percent of industrial organizations' market values. Ten years later, the ratio had dropped to 38 percent. And recent studies estimated that by the end of the twentieth century, the book value of tangible assets accounted for only 10 percent to 15 percent of companies' market values. Clearly, opportunities for creating value are shifting from managing tangible assets to managing knowledge-based strategies that deploy an organization's intangible assets: customer relationships, innovative products and services, high-quality and responsive operating processes, information technology and databases, and employee capabilities, skills, and motivation.

    In an economy dominated by tangible assets, financial measurements were adequate to record investments in inventory, property, plant, and equipment on companies' balance sheets. Income statements could also capture the expenses associated with the use of these tangible assets to produce revenues and profits. But today's economy, where intangible assets have become the major sources of competitive advantage, calls for tools that describe knowledge-based assets and the value-creating strategies that these assets make possible. Lacking such tools, companies have encountered difficulties managing what they could not describe or measure.

    Companies also have had problems attempting to implement knowledge-based strategies in organizations designed for industrial-age competition. Many organizations, even until the end of the 1970s, operated under central control, through large functional departments. Strategy could be developed at the top and implemented through a centralized command-and-control culture. Change was incremental, so managers could use slow-reacting and tactical management control systems such as the budget. Such systems, however, were designed for nineteenth- and early twentieth-century industrial companies and are inadequate for today's dynamic, rapidly changing environment. Yet many organizations continue to use them. Is it any surprise that they have difficulty implementing radical new strategies that were designed for knowledge-based competition in the twenty-first century? Organizations need a new kind of management system?one explicitly designed to manage strategy, not tactics.

    Most of today's organizations operate through decentralized business units and teams that are much closer to the customer than large corporate staffs. These organizations recognize that competitive advantage comes more from the intangible knowledge, capabilities, and relationships created by employees than from investments in physical assets and access to capital. Strategy implementation therefore requires that all business units, support units, and employees be aligned and linked to the strategy. And with the rapid changes in technology, competition, and regulations, the formulation and implementation of strategy must become a continual and participative process. Organizations today need a language for communicating strategy as well as processes and systems that help them to implement strategy and gain feedback about their strategy. Success comes from having strategy become everyone's everyday job.

    Several years ago, we introduced the Balanced Scorecard. At the time, we thought the Balanced Scorecard was about measurement, not about strategy. We began with the premise that an exclusive reliance on financial measures in a management system was causing organizations to do the wrong things. Financial measures are lag indicators; they report on outcomes, the consequences of past actions. Exclusive reliance on financial indicators promoted short-term behavior that sacrificed long-term value creation for short-term performance. The Balanced Scorecard approach retained measures of financial performance, the lagging indicators, but supplemented them with measures on the drivers, the lead indicators, of future financial performance.

    But what were the appropriate measures of future performance? If financial measures were causing organizations to do the wrong things, what measures would prompt them to do the right things? The answer turned out to be obvious: Measure the strategy! Thus all of the objectives and measures on a Balanced Scorecard?financial and nonfinancial?should be derived from the organization's vision and strategy. Although we may not have appreciated the implications at the time, the Balanced Scorecard soon became a tool for managing strategy?a tool for dealing with the 90 percent failure rates.

    Several of the first companies that asked us to help them adopt the Balanced Scorecard?Mobil Oil Corporation's North America Marketing and Refining Division, CIGNA Corporation's Property & Casualty Division, Chemical Retail Bank, and Brown & Root Energy Services' Rockwater Division?were underperforming; they were losing money and trailing the industry. Each organization had recently brought in a new management team to turn performance around. Each new management team introduced fundamentally new strategies in an effort to make their organizations more customer-driven. The strategies did not simply rely on cost reduction and downsizing; rather, they required repositioning the organization in its competitive market space. More important, the new strategies required that the entire organization adopt a new set of cultural values and priorities. In retrospect, we had been asked to introduce the Balanced Scorecard into four worst-case scenarios: failing, demoralized organizations that needed their workforces of up to 10,000 employees to learn and understand a new strategy and change behavior that had been imbedded for decades.

Mobil North America Marketing and Refining

In 1992, Mobil North America Marketing and Refining Division, a $15 billion per year division of Mobil Oil Corporation, ranked last among its industry peers in profitability, producing an unacceptably low return on investment and requiring a cash infusion of about $500 million from the parent company just to maintain and upgrade facilities. A new management team developed a new customer-focused strategy. The team decentralized the organization into eighteen market-facing business units with P&L accountability and restructured central staff functions into fourteen shared service groups. The Balanced Scorecard was introduced in 1994 to communicate and manage the rollout of the new strategy.

    Results came quickly. After years of below-average performance, including ranking at the bottom of its peer group in 1992 and 1993, Mobil moved to the number one position in 1995, with profits 56 percent above the industry average (see Figure 1-1). This turnaround was accomplished within two years of introducing a new strategy, a new organization, and the Balanced Scorecard performance management process. What is more impressive, Mobil maintained industry leadership for the next four consecutive years. Brian Baker, executive vice president of the division in early 1998, commented on the organization's success: "In 1997 we hit the number 1 ranking for our third consecutive year, which is unprecedented for a major oil company.... The Scorecard gets the lion's share of the credit. We created a performance mind-set with the Balanced Scorecard."

CIGNA Property & Casualty Insurance

In 1993, the Property & Casualty Division of CIGNA lost nearly $275 million, making its performance the worst in the industry. The division was near bankruptcy. Although its poor performance was due in part to a few major catastrophes, almost all of its lines of business were marginal. The new turnaround management team developed a new strategy?to become a "specialist"?by focusing on niches in which it had an informational comparative advantage. The management team deployed the new strategy to its twenty-one business units in 1994, using the Balanced Scorecard as the core management process.

    The results were rapid and dramatic. Within two years, CIGNA Property & Casualty had returned to profitability and sustained and improved its performance during each of the next four years. By 1998, the company's profitability positioned it strongly within the industry with many of its businesses exhibiting top quartile performance. At the end of 1998, the parent company spun off the Property & Casualty Division for $3.45 billion. According to Gerald Isom, president of CIGNA Property & Casualty, the Balanced Scorecard played an important role in this success story: "CIGNA used the Balanced Scorecard to manage its transformation from a generalist company to a top-quartile specialist."

Brown & Root Energy Services' Rockwater Division

Rockwater, an undersea construction company of Brown & Root Energy Services (part of the Halliburton Corporation) headquartered in Aberdeen, Scotland, served major offshore oil and gas producers. Rockwater was losing money in 1992. Norm Chambers, the new division president, introduced the Balanced Scorecard to his management team in 1993 to help clarify and gain consensus for a new strategy based on developing customer value-added relationships rather than offering customers the lowest price. By 1996, Rockwater was first in its niche in both growth and profitability. Chambers noted: "The Balanced Scorecard helped us improve our communication and increase our profitability."

Chemical (Chase) Retail Bank

Chemical Retail Bank's implementation started shortly after the merger of Manufacturers Hanover and Chemical Bank in 1992. Michael Hegarty, president of the Retail Bank, deployed the scorecard as part of a new strategy: to diversify the bank's business away from the increasingly commodity-oriented checking and savings accounts delivered through expensive branches in the New York metropolitan area. Chemical, as a newly merged bank, would have to close hundreds of now-redundant branches. By using the scorecard to communicate an intense focus on targeted customers, the retail bank was able to accomplish the cost savings expected from the merger while minimizing the losses of targeted customers, and, in fact, simultaneously expanding its revenue base with the targeted customer base. Chemical's retail profits evolved as shown:

Year 1993 (base year) 1994 1995 1996

Profits  x 8x 13x 19x

    The improvement represented hundreds of millions of dollars annually during the bank's first three years of managing with the Balanced Scorecard. Hegarty noted: "The Balanced Scorecard has become an integral part of our change management process. The Scorecard has allowed us to look beyond financial measures and concentrate on factors that create economic value."

    In contrast with the difficulty most organizations experience in implementing strategy, these four early adopters all used the scorecard to support major strategic and organizational changes. And the "long run" came quite soon. The companies enjoyed substantial benefits from their new strategies early in their implementation activities.

    The Balanced Scorecard made the difference. Each organization executed strategies using the same physical and human resources that had previously produced failing performance. The strategies were executed with the same products, the same facilities, the same employees, and the same customers. The difference was a new senior management team using the Balanced Scorecard to focus all organizational resources on a new strategy. The scorecard allowed these successful organizations to build a new kind of management system?one designed to manage strategy. This new management system had three distinct dimensions:

1. Strategy. Make strategy the central organizational agenda. The Balanced Scorecard allowed organizations, for the first time, to describe and communicate their strategy in a way that could be understood and acted on.

2. Focus. Create incredible focus. With the Balanced Scorecard as a "navigation" aide, every resource and activity in the organization was aligned to the strategy.

3. Organization. Mobilize all employees to act in fundamentally different ways. The Balanced Scorecard provided the logic and architecture to establish new organization linkages across business units, shared services, and individual employees.

    These organizations used the Balanced Scorecard to create Strategy-Focused Organizations. They beat the long odds against successful strategy execution.

THE PRINCIPLES OF STRATEGY-FOCUSED
ORGANIZATIONS

When talking about how they achieved these breakthrough results, the executives continually mention two words: alignment and focus. How does focus create breakthrough performance? Think of the diffuse light produced in a well-lit room by thousands of watts of incandescent and fluorescent lamps. Compare that warm, diffuse light with the brilliant beam of light that comes from the tiny battery in a handheld laser pointer. Despite its limited resources (two 1.5 volt batteries), the pointer produces a blinding light by emitting all the laser's photons and light waves in phase and coherent. The laser operates nonlinearly; it leverages its limited power source to produce an incredibly bright and focused beam of light. Similarly, a well-crafted and well-understood strategy can, through alignment and coherence of the organization's limited resources, produce a nonlinear performance breakthrough.

    The Balanced Scorecard enabled the early-adopting companies to focus and align their executive teams, business units, human resources, information technology, and financial resources to their organization's strategy (see Figure 1-2).

    Our research of successful Balanced Scorecard companies has revealed a consistent pattern of achieving such strategic focus and alignment. Although each organization approached the challenge in different ways, at different paces, and in different sequences, we observed five common principles at work. We refer to these as the principles of a Strategy-Focused Organization (see Figure 1-3).

(Continues...)

Excerpted from THE STRATEGY-FOCUSED ORGANIZATION by Robert S. Kaplan - David P. Norton. Copyright © 2001 by Harvard Business School Publishing Corporation. Excerpted by permission. All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.