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20Strategy,
Balanced Scorecards, and
Incentive Systems
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LeadFinancial
performanceLead
Customervalue
Lead
Business andproduction
processefficiency
Using Leading and Lagging Indicatorsin Balanced Scorecards
Leading indicators are measures that identifyfuture nonfinancial and financial outcomes to
guide management decision making.
Organizationallearning and
growth
Leading Indicators
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Using Leading and Lagging Indicatorsin Balanced Scorecards
LeadLeadLead
Organizationallearning and
growth
Business andproduction
processefficiency
Customervalue
Financialperformance
Lagging indicators are measures of the finaloutcomes of earlier management plans and
their execution.
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Balanced Scorecard
Balanced scorecards areperformance measurementsystems or business models
that tie together knowledge of
strategy, processes,activities, and operationaland strategic performance
measures.
An incentive systemcommunicates strategy,
motivates employees, andreinforces achievement of
organizational goals.
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Communicating Strategy toEmployees
Many employees do not understand the impactsof their activities on customer value and
profitability because their jobs are narrow or they
do not interact directly with customers.Communicating leading indicators in a balanced
scorecard can make the effects of employeesmore visible.
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Motivating Employees andEvaluating Performance
Visible leading indicators can contribute toemployees improved motivation and
commitment. At a commercial bank the
following sequence may be effective.
Increasedemployeetraining
Fasterloan
processingLeads to
Increasedcustomer
satisfactionLeads to
Moreloyal
customers
Leads to
Betterfinancialresults
Leads to
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A Balanced Scorecards StrategicPerformance Measures
Vision
and
Strategy
Business and production
process performanceAt what business practices
must we excel?
Customer performanceHow should be appear to
our customers
Financial performanceHow should we appear to
our shareholders?
Learning and growth performance
Howshould we sustain our abilityto change and improve?
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LeadCustomer
valueLead
Businessand
productionprocess
efficiency
Implementation of a BalancedScorecard
1. Organizational Learning and Growth
a) Employee Training and Education.
b) Employee Satisfaction.
Organizationlearning and growth1. Employee training.2. Employee satisfaction.3. Employee turnover.4. Innovativeness.
5. Opportunities forimprovement.
Financialperformance
L
ead
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Evaluation of Measures ofOrganizational Learning and Growth
Consider the information in this table:
Incremental profit = Total benefits Total costsBreak-even profit = 0 = 9X - $240,000
9X = $240,000
Break-even benefit level, X = $26,667 per year
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Evaluation of Measures ofOrganizational Learning and Growth
Information in this table considers the time value of money
Break-even profit = .909X + .826(2X) + .751(3X) + .683(2X) + .621(X) -1.000($80,000) - .909($80,000) - .826($80,000)
Break-even benefit level, X = $32,170 per year rounded
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Business and Production ProcessesEfficiency
Organizationallearning and
growthLead
Business andProduction
Process Efficiency1. New service development.
2. Employee productivity anderror rates.
3. Service costs.4. Process improvements.5. Supplier relations.
Customervalue
Lead
Financialperformance
Lead
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Customer Value
Organizationallearning and
growth
LeadBusiness and
production process
efficiency
Customer Value1. Customer satisfaction.2. Customer retention and
loyalty.3. Market share.4. Customer risk.
Lead
Financialperformance
Lead
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Evaluation of Measures of CustomerValue
0
0.5
1
1.5
2
2.5
3
3.5
4
4.5
5
Services meet
customer needs
Service superior to
competitors' service
Employees respond
to special requests
Employees give
prompt service
Employees superior
to competitors'
Customer satisfaction survey scale 1 to 5
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Financial Performance
Organizationallearning andgrowth
Lead Business andproduction processefficiency
Lead Customervalue
Financial Performance1. New interest margin.2. Revenue growth.3. Customer profitability.4. Overall return on assets.
Lead
Financial measures of performance tend to be the most
objective measures because most organizations havededicated significant resources to ensure the validity of
their financial performance measures.
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Benefits and Costs of a BalancedScorecard
Benefits of a balanced scorecard
1. Encourages all employees toconsider the impacts of their
decisions on profitability.
2. Appears to work in various types oforganizations.
Costs of a balanced scorecard1. Measurement costs.
2. Education costs.
3. Use costs.
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Fundamental Principles of IncentiveSystems
Pay for performance means that at leastsome portion of a managers income is not
guaranteed but depends on measure(s) of
organizational performance.
An effective incentive system should motivateemployees to achieve the organizations goals and
objectives and reward them if they do.
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A Role for Theories of Incentivesand Behavior
Theory and Practice Guideline
Most individuals are motivated by
self-interest
Performance-based rewards must
be greater than alternative rewards
from nonperformance
Organizations get the behavior they
reward
Performance measures and related
rewards must reflect organizational
goals
Effort follows rewards Employees must believe that their efforts influence performance
Difficult but attainable goals
motivate best
Impossible goals are de-motivators,
and so are easy goals. Make goals
difficult but not impossible
Fairness is a basis for sustained
motivation
Rewards must be linked to desired
performance in a fair manner
Manipulation undermines fairnessand effort
Performance measures must beobservable and verifiable
Different rewards can motivate effort Rewards must meet market
conditions, and rewards must be
available
Incentive systems involve trade-offs Minimizing the overall costs of
aligning goals and monitoring
behavior is a goal of incentive
system design
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Features of Performance BasedIncentive Systems
Performance-basedmanagement incentive
system
1. Absolute orrelativeperformance?
2. Formula-basedor subjectiveperformance?
3. Financial ornonfinancialperformance?
4. Narrow or broadresponsibility ofperformance?
5. Current ordeferredrewards?
6. Salary orbonusrewards?
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Absolute or Relative Performance
Absolute performance evaluation comparesindividual performance to set objectives orexpectations.
Relative performance evaluation compares anindividuals performance to that of others.
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Formula-Based or SubjectivePerformance
A performance evaluation formula computesrewards earned for specific achievements.
Subjective performance evaluation uses non-
quantified criteria not captured by formulas.
Evaluation
Group
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Financial or NonfinancialPerformance
Financial performance reflects the achievement offinancial goals, such as . . .
Cost control.
Revenue growth. Earnings.
Residual income.
Adding nonfinancial measures to the incentive system,
Gets managers to focus on the leading indicators ofprofit.
Gives recognition of the time lags betweennonfinancial and financial performance.
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Narrow or Broad Responsibility ofPerformance
Incentives work best when individuals see astrong link between their actions and
performance results. Many companies reward
division managers for both business-unit andcompanywide performance.
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Salary, Bonus, or Stock Rewards
Some companies stress salary while others stress
performance-based compensation. Somecommon performance-based compensation
plans include:
1. Cash bonuses.2. Stock awards.
3. Stock appreciations rights confers a bonus toemployees based on increases in stock price for a
predetermined number of shares.4. Stock options gives an individual the right to
purchase a number of shares at a specified priceover a specified time period.
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Ethical Aspects of Incentives andCompensation
A mismatch of executive pay and firm performance hasbeen widely observed in many types of organizations. In
some cases, the mismatch is the result of poorlydesigned incentive systems that generate high rewards
even when stockholders lose money.
It is likely that regulatory actions will more closely
align executive pay and performance, but itultimately it is difficult to mandate integrity or
ethical behavior.
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Incentive Plans in NonprofitOrganizations
Despite differences between for-profit andnonprofit organizations, nonprofit organizationsincreasingly use features of executive incentive
plans developed in the private sector.
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End of Chapter 20
