A century ago, at the height of the scientific management revolution, companies broke complex manufacturing jobs into sequences of simpler tasks for which industrial engineers and managers set efficient work methods and performance standards. Companies could then hire uneducated, unskilled employees and train them to do a single task. Frederick Taylor, the leader of the scientific management movement, called this “simple jobs for simple people”.
Today, this mode of work is virtually obsolete. Whatever the organisation – manufacturer or service-provider, private or public, for-profit or not-for-profit – all of its employees need to understand and be able to implement its strategy.
Much of the work done today is mental rather than physical. Automation has reduced the proportion of people in organisations who do manual work. Employees are involved in more discretionary tasks, such as product development, marketing and customer relations.
The challenge for organisations today is how to enlist the hearts and minds of all their employees. Even those employees involved in direct production and service delivery must strive for continuous improvements in quality, reducing costs and process times to meet customers’ expectations and keep up with the competition. Employees have to understand who the customers are, so they can find innovative ways to create value for them. Doing the job as it was done before is unlikely to be enough.
Dave Ulrich of the University of Michigan Business School has shown how many companies monitor employee satisfaction. But satisfaction is not the same as commitment. Employees may feel well compensated and well treated, but that does not imply that they understand the organisation’s goals and are committed to helping it achieve them.
The most successful organisations understand the importance of engaging all their employees in the strategic process. Ultimately, the they are the ones who will be implementing the strategy. Companies look to their front-line staff for new ideas and information about market opportunities, competitive threats and technological possibilities.
A decade ago we devised the balanced scorecard (see below). This offers organisations a more balanced view of how they are performing, compared with simply looking at financial indicators. Strategy-focused organisations use the balanced scorecard to align their employees to their strategy in three ways: through communication and education, personal and team objectives, and incentive and reward systems. Let’s look in more detail at reward, since this area poses some complex questions.
Employees should share in the rewards when their organisation has been successful; conversely, when it has been unsuccessful, they should feel some of the pain.
Incentive compensation is a powerful tool in getting staff to think about the objectives of the company and their business units. When Brian Baker, Mobil’s chief operations officer, North America marketing and research, first linked incentive compensation to Mobil’s balanced scorecard, his peers at the company chided him about how much time his people spent studying the scorecard results each month.
“I think it’s fabulous,” Baker responded. “For one hour each month, every employee takes out the scorecard and looks at the most important things in their business – whether we are winning or losing against the targets. They’re doing this to see how much money they are going to get. We would not have had that same focus on the scorecard and the individual business objectives if we hadn’t made the link to pay.”
The link focuses the attention of employees on the measures that the organisation felt were critical to its strategy. It also provides extrinsic motivation by rewarding employees when they and the organisation succeed in reaching their targets. But the details of how incentive pay links to compensation differed for each of the companies we studied. No single approach emerged as preferred or dominant.
Several design issues arise when tying compensation to the balanced scorecard:
Speed of implementation
It is reasonable for companies to be cautious in linking compensation to the scorecard. In fact, we have been somewhat surprised by how quickly most companies have done so. This may say more about the dysfunctionality of the companies’ previous incentive systems than anything else.
One reason for deferring the link to compensation for six to 12 months is that the initial scorecard represents only a tentative statement of the unit’s strategy. The scorecard expresses theories about the causal links between the measures for creating superior, long-term financial performance, and executives may not be completely confident at first that they have chosen the right measures. For example, one of Mobil’s initial revenue-growth measures was the year-to-year increase in gasoline sales, relative to the industry growth rate. With all its attention devoted to this measure, Mobil achieved its first-year target. But the company’s senior executives didn’t feel as successful as they had anticipated.
Subsequent discussions revealed that their market segmentation strategy was intended to increase the percentage of sales in the premium grades, rather than in the more regular products. So, in the second year, the measure was modified to emphasise the growth in sales of the higher-margin, premium grades of gasoline, distillates and lubricants.
A second reason for delaying is that companies may not have reliable data for many of the measures at the early stages of their programme. Companies’ initial balanced scorecards often have several missing measurements, typically in the areas of learning and growth. Companies have to develop new processes that will generate the data for these new measures.
Third, there could be unintended or unexpected consequences in how the targets for the measures are achieved. Gerry Isom at Cigna, who was among the fastest to tie incentive pay to his organisation’s new scorecards, made it known to everyone that he was prepared to override the reward linked to any measure if he felt that the underlying process had been manipulated or poorly managed.
Objective measures versus subjective measures
Several executives told to us it was important that compensation-based measures were objective and based on results, rather than tasks and activities. For example, they didn’t want to reward staff for completing initiatives and projects on time, or by counting the number of customer visits or phone calls they made.
Instead they wanted compensation to be tied to the outcomes of these efforts: the number of new customers signed up, the amount of new products and services sold to existing customers and the volume of sales from new products.
Many organisations tie commissions and compensation to customer satisfaction. This leads salespeople and others with direct customer contact to coach their customers about how to respond to surveys and interviews. It is better to measure the actual behaviour of these customers – repeat purchases, purchases of new products and services and referrals to new customers – rather than their attitudes.
Number of measures
Another design issue concerns the simplicity of the compensation plan. Many executives want the compensation plan to be simple, having, say, no more than four to seven measures, because they feel that employees wouldn’t understand a system with many more measures than this.
Often, companies use only a subset of their scorecard for this reason – to increase focus and reduce confusion. But we are impressed with Mobil’s success in getting employees to understand and influence more than two dozen measures on both their business-unit and divisional scorecards. A well-constructed strategy scorecard will not be as confusing as an ad hoc collection of two dozen measures that might arise from a stakeholder or KPI scorecard.
The measures derived from an integrated strategy map should reflect a single strategy with only two or three themes – for example, revenue growth, cost reduction and new product development. Employees can then picture the cause-and-effect links.
Individual versus team
These measures involve managing several trade-offs and tensions. Mobil adopted a system that had no individual rewards, while several other companies used a mixture of organisational and individual rewards. Organisational team-based rewards encourage co-operation and problem-solving, but can lead to the “free-rider problem”. This is where individuals do not get the full benefit from their own initiatives and actions, but can benefit from the good ideas and hard work of others.
This can often be mitigated if employees are allowed to observe and evaluate individuals’ contributions. And when sanctions other than pay can be used, the consequences of the free-rider problem can be minimised.
On the other hand, tasks such as personal selling or breakthrough product innovation may require individual dedication and brilliance. In this case, organisations may wish to provide explicit incentives that reward successful results.
Frequency of updates
compensation in rapidly evolving environments. An explicit, formula-based compensation plan that is tied to many non-financial measures from a balanced scorecard may be too inflexible. Consider companies operating in “internet time”, where tactics and action plans may have to change rapidly because of technological innovation, unexpected initiatives by existing competitors, new competitors and shifts in consumer preferences.
While the basic strategies of these companies may not change, the internal processes, critical skills and IT that are required to implement these strategies may need to be updated regularly. If a compensation system gets tied to non-financial measurements based on obsolete processes, companies can find it difficult to adapt quickly enough.
Organisations in rapidly changing environments can base their incentive pay on outcomes and long-term financial performance, such as stock price or economic value added over three to five years. In this way, their reward systems are focused on long-term value creation and they retain the option of changing their balanced scorecard measures – particularly the performance drivers and leading indicators – without having to adjust their compensation plans.
In conclusion, the balanced scorecard has become the framework for linking employees’ everyday actions to company-wide strategic objectives. For this to occur, companies must communicate and educate employees about their strategy. Balanced scorecards and strategy maps provide a new language that helps employees to understand the organisational objectives and the cause-and-effect links among them.
Once employees understand business-unit and company objectives, they can set personal objectives that, if met, help to achieve the organisation’s strategy. And aligning incentive pay with strategic objectives provides both the motivation and the feedback for successful strategy implementation.
When individuals understand how their pay is linked to achieving strategic objectives, strategy truly becomes everyone’s everyday job.
What is the balanced scorecard?
For those who didn’t read the book, missed the video or aren’t going to the CIPD’s national conference, this is how Kaplan and Norton defined the balanced scorecard 10 years ago:
“The balanced scorecard retains financial measurement as a critical summary of business performance, but it also highlights a more general, integrated set of measurements that link customers, internal processes, employees and systems to long-term financial success.”
The scorecard itself is a list of performance measures set out in a series of tables, along with a “high-level strategy map” showing how these measures relate to each other and the firm’s strategic objectives. These help top managers to communicate to everyone else in the organisation what their strategy is – and how they expect it to be achieved.
The scorecard’s measures are grouped under four “perspectives”: customer; financial; internal business process; and learning and growth.
- The financial perspective: measures are usually of profitability, but they can cover areas such as sales growth or cash flow.
- The customer perspective: core measures generally cover customer satisfaction and retention, the number of new customers gained and the company’s market share in various segments. This should also include measures of an organisation’s “value propositions” – for instance, “short lead times” and “timely delivery”.
- The internal business process perspective: covering the critical processes where the organisation must excel. Unlike traditional methods of improving existing processes, the scorecard will usually identify entirely new processes that an organisation must master to meet its financial and customer objectives. It also includes ways of measuring a company’s long-term cycle of innovation.
- The learning and growth perspective: identifying the structures an organisation must build to create long-term growth and improvement. The other three perspectives will typically reveal gaps between a firm’s existing capabilities and those that it needs to achieve “breakthrough performance”. To close these gaps, a business will have to retrain employees, improve its systems and align all of its procedures properly. These all come under the learning and growth perspective. Measures include employee satisfaction, retention and skills.
In this section, the authors suggest that businesses examine how well their employee incentives are aligned with the overall organisational success factors.
All four perspectives should be linked, consistent and mutually reinforcing.
Turing the tide
Yorkshire Water is changing its approach to HR after a top-to-bottom review using the balanced scorecard. Managers believe it is the first UK company to apply the scorecard to the HR function.
The beleaguered utility has emerged from a bad few years, in which drought was followed by industrial conflict and redundancies. Its HR director left last autumn and her post was eventually given to one of the company’s most successful general managers, Mike Smith, who brought with him a reputation for skilful people management.
“The feeling was that we had to get the people agenda firmly back on track,” he says. “So I was looking for a way to move this forward. I decided to think in terms of cause and effect.
“I wanted to connect the people strategy to the business strategy. I was also looking for a balance between the hard processes of change management and something quite soft in terms of working with the HR team to move it forward. The balanced scorecard, combined with more general change management techniques, seemed to be the right approach.”
Working through the scorecard with Jacki McCartney from the Syat consultancy, Smith and his colleagues developed a set of questions for the HR team and their customers. Each member of the executive team, along with the union convener and some junior managers, were interviewed. Focus groups were also held with the HR team.
Smith and McCartney then made a “strategy map” to show how HR’s activities related to business objectives.
This led to a series of projects where Smith worked with his colleagues to set up a partnership agreement with the unions and to alter the company’s performance management process so it linked more clearly to the business objectives.
“In the interviews, customers were saying that HR was too complex and that they wanted something that was more fitted to the business need,” says Smith, who thinks that the process has clearly motivated his HR team. “It’s been a huge investment for them and they really got stuck in. It’s also been a way to tell them that they are highly valued.”
- Smith and McCartney are taking questions at the Syat stand (Q33) during the CIPD’s national exhibition, 24-26 October.
- Robert Kaplan is professor of leadership development at Harvard Business School. David Norton is president of Balanced Scorecard Collaborative Inc. This article is an edited extract from their book, The Strategy-Focused Organization (Harvard Business School Press, 2001). Kaplan gives the opening keynote address, “The strategy-focused organisation”, on Wednesday 24 October at the CIPD’s national conference.