Capital Budgeting in the Context of the Balanced Score Card
Thomas D. Corrigan, Bridget Lyons, Andra Gumbus, Sacred Heart University
The Balanced Scorecard concept has been successfully employed by many companies in recent years to better measure their financial results. According to one study, fully 40% of Fortune 500 companies were using this system to evaluate performance at the end of 2000. In essence, the Balanced Scorecard was developed because it was becoming increasingly apparent to many executives that traditional financial measures of performance were not allowing companies to relate financial measures of performance to long-term company objectives. For example, traditional financial analysis fails to take into account such key variables as levels of customer service, employee morale, market share by segment and other important factors that influence an organization=s ultimate success.
The single most important criticism of traditional financial analysis is that standard measures of performance focus on an organization=s past performance and fail to incorporate drivers of future performance. To date, most of the literature on the Balanced Scorecard measurement system has focused on how a company can tie traditional measures of financial performance to strategic goals, which, in many cases, include such difficult to measure objectives as becoming more customer focused, developing the best service record in the industry, being a leader in bringing new and innovative products to market, to name just a few.
However, very little research has been done in applying the Balanced Scorecard approach of firm performance to the capital budgeting process. The potential shortfall of a narrow focus on resource allocation is that decision making based on traditional metrics such as net present value and internal rate of return may lead a company to stray from its strategic mission. Supplementing these traditional resource allocation techniques with non-traditional measures B the Balanced Scorecard approach B holds out the promise of improving a company=s prospects of more closely matching its capital investments to its strategic goals and objectives.
The objective of this study is to design a set of Balanced Scorecard criteria for capital budgeting and show where and how they should be included in the process. The working assumption of the study is that projects evaluated under the Balanced Scorecard approach improve an organization=s chances of long-term success as opposed to the traditional decision-making techniques of net present value, internal rate of return and other cash-flow valuation techniques.
Robert S. Kaplan, Harvard Business School, and David P. Norton, Nolan, Norton & Company, introduced the concept of the Balanced Scorecard in the January-February 1992 issue of the Harvard Business Review. The authors were concerned that traditional measures of company performance failed to provide adequate guidance to management operating in a rapidly changing and increasing competitive business world. Through their study of twelve large corporations, Kaplan and Norton realized that companies, while recognizing the importance of such hard-to-measure variables as customer satisfaction, were having great difficulty in measuring key aspects of their businesses for which hard data were inadequate or completely lacking. Kaplan and Norton designed a generic system through the Balanced Scorecard that supplements traditional financial metrics with less tangible strategic objectives, enabling companies to develop a more balanced view of their operations and to better match all operating and investment activities to long-term strategic objectives.
The Balanced Scorecard, as it has been applied, typically measures data in four distinct areas: Financial, Customers, Internal Business Processes and Learning and Growth. In the Financial area, the Balanced Scorecard includes such non-traditional aspects of performance as 1) the number of products introduced over a given time span, 2) the number of new markets opened, 3) the number of innovative pricing strategies, 4) the number of customer complaints and the severity of the complaints. Customer measures include data on 1) market share and 2) increases in sales to the existing customer base. Internal Business Processes incorporate such items as 1) profitability by market segment, 2) the length of time it takes to bring out a new product, 3) customer delivery performance including data on stock-outs and the number of defective products delivered to customers. Learning and Growth measures include data on 1) staff turnover, 2) employee morale and 3) the accuracy and availability of data on customer preferences.
The focus of this study is to incorporate as many of the Kaplan/Norton variables as appropriate to the traditional capital budgeting process. The study will attempt to do this from two directions. First, a generic model of the Balanced Scorecard for Capital Budgeting will be developed. Second, several large companies will be analyzed via the generic model. This second part will compare how the capital budgeting process has been traditionally implemented in a sample group of companies and how those processes compare to a Balanced Scorecard approach. The study will also attempt to project the actual performance of selected capital projects from the sample group under the traditional approach and the Balanced Scorecard approach.