Foundations of the Balanced Scorecard, Part 3

(Third part of three part series. See post one and post two.)

Managerial accounting and its sub-field of activity-based costing both look inward at the firm to explain costs and profits. The methodology of Balanced Scorecard (BSC) looks both inward—at costs, processes, employee skills—and outward, at how internal capabilities affect customer value and competitive position. And while managerial accounting provides support for specific capital budgeting decisions, BSC looks beyond immediate decisions—beyond the tactical—to the big picture of the firm’s strategic objectives. In shaping BSC to look beyond the walls of the firm and toward the future, Robert Kaplan and David Norton built on the ideas of Michael Porter on competitive strategy.

Porter warns in Competitive Strategy (1980) that “concentrating only on resources/competencies and ignoring competitive position runs the risk of becoming inward looking” and advises firms to devise strategies that “maximize the value of the capabilities that distinguish it from its competitors.”

As opposed an accounting perspective, Porter begins his reasoning with an insight from economics—that competition in any industry will drive down prices until profits just suffice to compensate for the risk of investment. Asking what enables a firm to earn higher than this minimal profit, Porter identifies five competitive forces: industry entry barriers, threat of substitution, buyer bargaining power, seller bargaining power, and rivalry among current competitors.

By analyzing these competitive forces and by understanding its own strengths and weaknesses, Porter argues that a firm may exploit market inefficiencies to achieve greater profits. To achieve greater profits on a sustainable basis, Porter states that a firm must choose from among three broad competitive strategies: cost leadership, differentiation, or focus on a niche. Failing to make such a choice, or attempting to be all things to all people, Porter writes in Competitive Advantage (1985), condemns an organization to “strategic mediocrity and below-average performance.”

In Competitive Advantage, Porter drills into what he refers to as a firm’s value chain, which “disaggregates a firm into its strategically relevant activities.” While these activities refer to internal processes, Porter emphasizes that it is customers who determine what makes an activity valuable. And he walks through how internal processes such as research and development may contribute to strategic advantage in the marketplace.

As the sub-title of The Balanced Scorecard: Translating Strategy into Action (1996) spells out, strategy is the driver of BSC; in the words of Kaplan and Norton, “the scorecard should be based on a series of cause-and-effect relationships derived from the strategy.”

In Strategy Maps (2004), Kaplan and Norton write, “we base our approach on the general framework articulated by Michael Porter.” BSC, according to this passage, is based on Porter’s definition of strategy: “strategy is about selecting the set of activities in which an organization will excel to create a sustainable difference in the market.”

In summary, Kaplan and Norton creatively synthesized three schools of management thought—managerial accounting, activity-based costing, and strategy—to elaborate and popularize BSC, which for me makes it all the richer.

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I’m a solution engineer for Shape Security, an awesome web security startup in Mountain View that defends some of the worlds largest web sites from bot attacks. I see this blog as a learning tool. It gives me a chance to collect my thoughts on topics of interest and to share with others. If you see a mistake or think I’m on the wrong track, please let me know. I appreciate comments. See my LinkedIn profile at http://www.linkedin.com/in/jamesdowney and follow me on Twitter at http://twitter.com/james_downey.

Posted in Balanced Scorecard
One comment on “Foundations of the Balanced Scorecard, Part 3
  1. kalpana says:

    I Like this very much…. I never get the information like this.

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