Measuring performance in financial services organizations

The Balance Scorecard is a strategic planning and management system that is used extensively in business organizations worldwide to align business activities to the vision and strategy of the organization. The Balance Scorecard improves internal and external communication, and monitors organizations’ performance against strategic goals.

B W S Premaratne Chartered Marketeer CIM (UK)

Balance Scorecard is a multi-source business performance management system based on the most critical organizational measures. These major components are named as ‘Key Performance Indicators’ (KPIs) and include the following: financial perspective, customer perspective, internal business process, and learning and growth measures.

Traditional performance evaluation systems provided information about past financial performance, and were incapable of offering information about future performance. BSC (Balance Scorecard) gives attention to the importance of strategic measurement systems including both non financial and financial measures. BSC also lets managers see whether they have improved in one area at the expense of another.

Perspectives

The BSC suggests that there are four perspectives in measuring organizational performance. They are:

Customer perspective: How do customers see us? Recent management philosophy has shown an increasing realization of the importance of customer focus and customer satisfaction in any business. The customer is the most valuable asset in the business organization. If the customers are not satisfied, they will eventually find other organizations that will meet their needs. These are leading indicators (performance drivers). Poor performance from this customer perspective is thus an indicator of future decline; even though the current financial position of the company may look healthy. Customer satisfaction, the customer retention ratio, the size of the customer base, and the frequency of complaints are some of the indicators of the customer perspective.

The learning and growth perspective: Through learning and growth, we can continue to improve and create value for the customer. This perspective includes employee training and corporate cultural attitudes related to both individual and corporate self improvement. In a knowledge-worker organization, people are the main repository and resource of knowledge and skills.

In the current climate of rapid technological change. It is becoming necessary for workers to be in a continuous state of learning and growth.

‘Learning is more than training’. It also includes on-going mentoring and tutorship within the organization, as well as ease of communication among workers that allows them to readily get help on a problem when it is needed.

Business process perspective: This prospective facilitates business performance through internal processing improvement. Customer-based measures are important , but they must be translated into measures of what the company must do internally to meet its customers’ expectations. Afterwards, excellent customer performance -derives from process, decisions, and actions occurring throughout an organization (Kaplan and Norton, 1992). Metrics based on this perspective allow the Managers to know how well their business is running , and whether its products and services conform to customer requirements. These metrics should be carefully designed by those who know these processes .

Financial perspective: How do we look to shareholders? Financial performance measures indicate whether the company’s strategy, implementation and execution are contributing to the bottom-line improvement. Financial objectives are typically related to profitability measures, for example, by operating income, Return On Capital Employed (ROCE), or more recently EVA (Economic Value Added). Alternative financial objectives can be rapid sales growth or generation of cash.

Balance scorecard framework for financial services organisations

Objectives: Within each perspective, objectives identify what needs to be done in order to achieve the overall mission. They answer the following questions: 1What must we do (from each perspective) to achieve the overall mission? 2.What is most important (from each perspective) to achieving the overall mission? Measures: Measures provide a way to determine how an organization is doing in achieving the objectives within the perspectives, and in turn the overall mission (Hubbard, 2007). They are the most ‘actionable’ component in the Scorecard. These measures help answer the question: How do we know how well we’re doing in achieving our objectives, and in turn our overall mission?

Targets: Targets are set for each measure to monitor and evaluate the progress towards the objective (Hubbard, 2007).

Initiatives: These are the set of activities that are planned within each perspective in order to achieve the targets set for each measure.

Application of BSC in financial services organizations

Most of the financial organizations in Sri Lanka are still using only the traditional financial measures such as return on capital employed (ROCE), earning per share (EPS), and budgeted versus actual in measuring organizational performance.

A company could measure performance based on how much money the company makes. To a certain extent, it is right. Financial measures are the critical ‘bottom-line results’ that companies must deliver to survive. But, if the top management of the company only focuses on the financial health of the organization, several unfortunate consequences may arise. One of these is that financial measures are ‘lagging indicators (outcomes)’ rather than ‘leading indicators (performance drivers)’. This means that these indicators may have happened months or years before, and may not be controllable in the present. Being in a plane falling from the sky is not the time to realize that you should have done routine maintenance. Another of the consequences of just focusing on financial measures is that the company is not customer-oriented. Decisions may be made that help your organization financially, but hurt the long-term relationships with customers; the customers may eventually reduce purchases or leave all together. As an example: you may have gone to get your car serviced, but later found out that you have paid too much. The outcome is you may never go back to that service station again.

The management of a financial organization needs to be aware of inter-play of numerous factors that can impact the organization’s performance. An organization is required to take care of these numerous factors and devise a plan to attain a ‘balance growth’. Key performance indicators are set on two major aspects in a financial organization - lending and borrowing, The key performance indicators are instituted to streamline the operations and goals of the company.

Various factors can be tracked by the company’s BSC: financial indicators such as the ROCE, capital adequacy, the movement of profit and cost margins can all be used to measure the success of the company. Financial organizations need to keep track of their assets and risks. A financial organization’s Balance Scorecard could be used to assess whether or not the company is maximizing their resources or taking too much risk. BSC could provide this information easily.

With so many uses for a BSC, the company would be able to track its own progress and focus on giving better service. Once the company knows where to concentrate their strengths, and lessen their weaknesses, it is much easier for the management and marketing of target opportunities.

BSC framework will guide the company to set the four perspectives, measures and criteria, in order to assess measuring the organization’s performance. Unlike other organizations, a financial organization is required to ‘watch their steps’ in an extremely careful manner. This is to keep an account of the way things and operations have been progressing in the company.

Building a balanced scorecard

The process of building a Balanced Scorecard can be divided into seven steps that can be categorized into three phases:

Phase 1: The Strategic Foundation

Step 1: The organization must be aligned around a clear and concise strategy. The strategy is what feeds the Balanced Scorecard. Therefore a strategic plan needs to be constructed at this stage. This includes the identification of the specific objectives that tell people what to do and a set of targets to convey what is expected. For example, a strategic objective may be to decrease the loan/lease cycle time by 20% over the next 12 months through more decentralized approval systems. This step is at the heart of Balanced Scorecards as the whole organization needs to be aligned and rallied around strategic objectives and targets set at this stage.

Step 2: The major strategic areas on which the organization must focus are then determined. It is important to restrict the organization to select areas of key importance for strategic success; otherwise it can find itself over-extended, doing too many things. Most organizations’ strategic focus is on the stakeholder groups such as customers, shareholders, and employees. Most public limited companies, for example will have “shareholder value” as a major strategic area. The strategic areas should be linked to the strategic goals defined in step 1. For example the strategic goal of having the most innovative ‘minor’s savings account’ at a commercial bank by the year 2012, means that the strategic area for the bank is to focus on ‘product innovation’.

Step 3: A strategic grid is built for each major strategic area of the business. Having devised the strategy in step 1 and identified the strategic areas in step 2, these are now translated into a set of grids. As described earlier, Balanced Scorecards are structured over four perspectives: Financial, Customer, Internal Processes, and Learning and Growth. Strategic grids include these four layers. Within each layer, the strategic objectives are placed, making sure everything links back. Trying to develop strategic objectives and placing them into the correct layers for all strategic grids is probably the most difficult step in building the Balanced Scorecard (Kaplan and Norton, 1996).

Phase 2: Three critical components

Step 4: Measurements are established for each strategic objective in the areas identified (Hubbard, 2007). The measurement criteria provide the targets which can then be used to measure the level of success in achieving them. For each strategic objective on the strategic grid, at least one measurement is required. If there are several measurements for a strategic objective, then chances are that there is more than one strategic objective. Is it possible to have an objective without a measurement? Yes, it is possible, but not having a measurement makes it difficult to manage the objective.

It’s best to revisit this objective and ask the question: Why is this objective without a measurement? Measurement makes it easy to quantify the strategic objectives, asking the question: How well are we doing? (Niven, 2006).

Step 5: Targets are set for each measurement. Measurement alone is not good enough. We must drive behavioural changes within the organization if we expect to execute strategy. This requires establishing a target for each measurement within the Balanced Scorecard.

Targets are designed to stretch and push the organization in meeting its strategic objectives. For example, suppose the strategic objective is to improve customer satisfaction and the measurement is based on the number of customer complaints.

If the average number of monthly complaints is 50 for the last 12 months, then a target of no more than 35 complaints could be established.

Targets need to be realistic so that people feel comfortable about trying to execute on the target. Therefore, targets should be mutually agreed upon between management and the person held responsible for hitting the target. One good place to start in setting a target is to look at past performance. Past trends can be extended for modest improvement.

Step 6: At this step, formal programs, activities, initiatives or projects are designed and launched to achieve the targets set for each area.

This is perhaps the trickiest part in the entire process. Some typical examples of programs include quality improvement programs, marketing initiatives, enterprise resource planning, customer relations management and supply chain management. These programs usually have certain characteristics such as: * Support by top level management. * Utilization of designated leaders and cross-functional teams. * Presence of deliverables, milestones and a timeline. * Requiring resources (people, facilities, allocated budget, etc.)

Phase 3: Development

Step 7: The entire process of building a Balanced Scorecard is repeated in other parts of the organization to construct a single coherent management system. This integrates all parts of the organization and allows successful execution of the strategy.

Budgeting and Balance Scorecard

BSC should work in conjunction with budgetary system for performance measurement.

The budget which represents a set of financial targets is constantly monitored through monthly performance reviews and remedial steps are taken in order to rectify any significant variance.

BSC could be linked with the corporate plan of the company. Corporate plan is a long-term plan that maps out the long-term goals of an organization in line with its vision, mission and objectives. In this case of measuring, it is easier to measure quantitative rather than qualitative measures.

Balance scorecard can be used to look at a financial organization in broader prospects under four main categories of financial, customer, learning and growth and internal process to set organizational strategic directions, evaluation and monitor actual performance.

No manager can ignore the bottom-line. What has happened is the key indicator, but you need a ‘Balance Scorecard’ to measure, not just how you’ve been doing, but also how well you can expect to do in the future. Then the company will have a clear picture of reality, and can proceed with confidence and success.