CHAPTER 5
HOW TO GROW THE COMPENSATION PIE: THE BALANCED SCORECARD FACTOR1
“The general who wins the battle makes many calculations in his temple before the battle is fought. The general who loses makes but few calculations beforehand.”
—San Tzu
In Chapter 4, we discuss the critical importance of having a dynamic mission, vision, and set of values as the foundation for long-term success. After you build the foundation, you can start building and managing the firm for profits. Perhaps one of the best modern tools to help manage the firm for profits is the Balanced Scorecard.
In this chapter, we explain the Balanced Scorecard and how to use it successfully in managing a public accounting firm. We also cover how to create strategies and strategy maps.
THE BALANCED SCORECARD
The Balanced Scorecard was created in the early 1990s by Harvard Business School Professor Robert S. Kaplan and consultant David P. Norton, president of Renaissance Solutions, Inc. The Balanced Scorecard was originally developed to measure performance for corporations, especially manufacturing firms. It is now being used in accounting, consulting, and law firms as well as financial institutions and other service-related firms to help implement strategy, monitor objectives, and reward for performance.
While a great deal has been written about the Balanced Scorecard, an important thing to remember is that it measures the results of manage-ment’s efforts and the effectiveness of management’s strategies. In short, it demonstrates how well management is executing strategies and how well people in the firm are achieving their objectives. The Balanced Scorecard is an effective tool that can be used to measure a firm’s overall progress, a separate department, an industry team or individual in reaching its goals.
Creating and Selecting Strategies
For the scorecard to work in a professional services firm, owners must first agree upon the firm’s mission and vision as well as the strategy or strategies to achieve the mission and reach the vision. That’s why we talked in detail about mission, vision, and values in Chapter 4. We now discuss basic concepts of strategies and strategic development.
According to Kaplan and Norton, “An organization’s strategy describes how it intends to create value for its shareholders, customers and citizens.”2 A strategy is nothing more than a series of assumptions about what might happen in the future if certain things happen in the present. A firm may assume there are exceptional opportunities by developing a financial services arm. Its strategy may be to grow this part of the practice through acquisition of a handful of independent financial services firms in its market. Until the firm acquires these other practices and integrates them into its culture, it will not know how well the strategy will work or what changes need to be made to clarifying the strategy. The firm may also decide to use short-term strategies, such as reducing costs of service delivery by taking advantage of new technologies.
For 50 years, consumer and business-to-business firms have developed growth strategies for their products and services based on Ansoff’s Product/Market Expansion Grid.3 The following chart is adapted from Ansoff’s 1957 grid:
| Current Services | New Services | |
| Current Markets |
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| New Markets |
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Market penetration or client development strategies are based on the assumption that the firm’s growth can best be achieved by providing existing services to new clients that are similar to existing clients. These strategies involve the least amount of risk because growth depends on seeking out new clients from markets you already serve and with which you are familiar. For example, a firm with a niche in auto dealerships may decide to expand throughout the state or region.
Service development has one known and one unknown element. The known element is existing clients. The unknown element is the new service or product you plan to develop. For example, a local firm with several law firms as consulting clients may decide to start a litigation support service, or a firm may develop a valuation practice to service its closely held business clients.
Market development strategies assume firm growth will come by promoting current services to new markets. For example, a firm may develop a strong estate planning practice for physicians and believe there are also opportunities to offer these services to dentists.
The most difficult strategies to implement are the diversification strategies because there are two unknowns: the new service or product and a potential new market. The firm may be unfamiliar with the potential clients and lack the requisites to offer the service.
After developing a list of possible strategies, firms must select those that are right for the firm. When selecting strategies, consider the following four questions:
Does the strategy fit the firm?
Does the firm have sufficient resources to support the strategy?
Do the economics of the strategy make sense?
How strongly will owners and employees support the strategy?
Gaining Strategic Consensus
Just like vision and mission, it is of critical importance for owners to gain consensus on the firm’s strategy—that is, how the firm will realize its goals. Without this initial agreement, it’s almost impossible for the firm to move ahead in a unified fashion. Gaining strategic consensus is the first step in building individual owner involvement, commitment, and accountability in a firm. Once the strategic consensus is reached, owners and other key firm personnel must then develop objectives, measures, targets, and tasks since they share a common viewpoint.
Employing the Balanced Scorecard to Implement Strategy
Public accounting firm owners often leave strategic planning meetings and retreats confused about how they intend to achieve overall firm objectives.
While the Balanced Scorecard does not create the firm’s strategies, it does help owners and employees understand how they will execute their strategies by monitoring and measuring four critical areas or perspectives that create value for the firm:
▮ Financial
▮ Clients
▮ Internal systems and business processes
▮ Employee growth and learning
Some firms add areas such as marketing. The chart below shows the key objectives in a professional services firm. Let’s briefly examine these four areas and how they are interrelated. (Please see Chapter 10 for a discussion of specific objectives that firms may wish to accomplish in each of these key areas).
Financial Area
The financial area is one with which all accountants are familiar and have traditionally stressed. The firm’s performance in terms of sustainable growth is perhaps the ultimate definition of success from a financial perspective. Financial results, however, tell the firm what has happened rather than what will happen. This is why the Balanced Scorecard approach requires the firm to consider other areas (clients, internal systems, and employee growth and learning).
Clients Area
Without satisfied and loyal clients, the firm will be unable to achieve its financial objectives of sustainable growth. “The customer perspective,” according to Norton and Kaplan, “defines the value proposition for targeted customer segments.”4
Internal Systems/Business Processes Area
The firm needs to determine which internal systems and business processes must be developed, improved, or modified to better serve internal and external clients. Such processes may include marketing, work flow, decision-making, internal and external communication, recruitment, orientation, performance management, and of course, compensation. Many of these systems are technology-based or, at a minimum, require technology support.
Employee Growth and Learning Area
Unless employees (including owners) develop technical, conceptual, and relationship competencies, it is difficult to elevate the level and depth of service to clients. The employee perspective describes how the people will be trained and organized to support the firm’s strategy.
The following table captures how a firm’s strategy and the four key areas flow into one another:
BUILDING THE SCORECARD
In Chapter 4, we discuss mission (why we exist), vision (what we want to become), and values (what behaviors are important to us). The Balanced Scorecard takes us one step further toward implementing the mission, with emphasis on strategy development and the use of strategy maps which visually translate the strategy.
The next step is for the firm or practice unit to develop the actual scorecard, which consists of a set of objectives, various types of measures, success targets for each measure, and specific action steps or tasks for each objective. A word of warning: Most firms initially try to capture too many measures. With four or more areas, you want no more than two or three measures per area. The following is a typical scorecard template.
Scorecard Template
| Area | Objective | Measures (Lagging, Leading, and Real Time) |
Target | Task(s) |
| Financial | ||||
| Clients | ||||
| Internal system/business process | ||||
| Employee growth/learning | ||||
| (For additional areas) |
Objectives
Objectives tell you what you must do to execute your strategy. Paul Niven, in Balanced Scorecard Step-by-Step: Maximizing Performance and Maintaining Results, notes, “The best way to create performance objectives is to examine each perspective [area] of the Balanced Scorecard in the form of a question.”5
▮ What financial steps are necessary to ensure the execution of our strategy?
▮ Who are our targeted customers and what is our value proposition in serving them?
▮ To satisfy our customers and shareholders, at what processes must we excel?
▮ What capabilities and tools do our employees require to help them execute our strategy?6
Performance Measures
Performance measures, as Paul Niven describes, are used to determine whether the firm is meeting its objectives and moving toward successful implementation of its strategy.7 This section discusses performance measure types and performance measure selection, including the appropriate number of measures.
Types of Performance Measure
There are three types of measures firms can select: lagging, leading, and real time. A lagging measure depicts the results of previous efforts. Traditionally, accountants have relied on lagging measures that are usually financial measures, such as revenue, net income per owner (NIPO), margins, realization, and utilization. These measures, however, don’t tell you what to do to improve financial results. They only tell you what happened. Most financial measures are lagging measures. Last month revenues were “X,” expenses were “Y,” and profit or loss was “Z.”
A leading measure, which is generally behavioral, predicts what might happen in the future. For example, you may track the number of sales appointments you attend each month. Let’s say there are five in the first month, five more in the second month, and eight in the third month. Let’s also say your goal was four per month. Such a measure tells you that revenues over the next several months could increase, provided these were qualified prospects and your professionals know how to develop and close. Leading measures are often called performance drivers. Unlike lagging measures, leading measures are often behavioral and useful in telling you how well you will likely do in the future.
A real-time measure tells you what is happening right now. Think about the gas gauge in your car. It tells you in real time how much gas you have left. At the same time, the speedometer tells you how fast the car is going. While real-time measures in an accounting firm may be more difficult to capture, they are still important. Employees could enter their time every hour. The internal accounting department could post cash throughout the day. The firm could track daily the number of hours spent face-to-face with a client or track weekly the number of proposals delivered.
For accounting firms, it may be best to focus on lagging and leading indicators. Imagine for a moment that you focus only on lagging measures. What real control or impact would you have on performance? Now imagine that you focus on leading measures, as well, such as:
▮ Building new niche areas.
▮ Creating new services.
▮ Prospecting specific clients.
▮ Making new business presentations.
▮ Asking for referrals from your key clients.
▮ Prospecting for leads and appointments during client seminars and conferences and symposia.
▮ Reducing work in progress.
If the number of new leads per month (a lagging measure) declines, you could increase your business development activities (leading measure). If the number of referrals from lawyers or bankers (a lagging measure) falls, you could increase the amount of time you spend with them or educate them more completely about what a good referral looks like (leading measure). Now that is proactive management!
Selecting Performance Measures
Every firm needs to identify what performance measures to track to achieve its desired objectives. This is not a “boilerplate” exercise. Selecting the right performance measures is critical in helping management make better decisions and motivating team members to behave in ways that support the firm’s objectives. Choosing the right performance measures helps firms gain a competitive edge, both now and into the future.
The following guidelines may help you select the appropriate performance measures for your firm:
▮ Measures must tie into the firm’s strategies. If, for example, the firm wants to be profitable the first year of its entry into the biotech market, one of the performance measures could be profitability per new engagement. If the objective is to build market share and not worry about current year profitability, the measure may be the number of new clients acquired.
▮ Measures should tie into owner and employee performance. For example, an owner who focuses on business development supports the firm’s goal of bringing in new business. A possible measure could be the number of qualified appointments he or she is able to set. A tax preparer’s measure could deal with the amount of time he or she takes to complete returns and whether the returns are completed by the agreed-upon deadlines. For staff accountants or new associates, it could be the number of times a project needs rework.
▮ While setting measures is necessary, team members and owners need to understand the strategy and measures, and buy into their importance. If they are unclear about what they are asked to accomplish, all the knowledge and skill in the world doesn’t matter. They must understand how and why to apply them in their everyday activities.
▮ Finally, the measures need to be useful to management. Leading indicators cannot be faulty. Let’s say you attempt to measure client satisfaction based on the number of complaints you receive from clients. Anecdotal evidence tells you, however, that clients don’t complain, they just walk away. In this case, you have selected a faulty measure. (See Chapter 10 for a comprehensive list of measures.)
Number of Performance Measures
Most firms that undertake the Balanced Scorecard start with too many measures. We hear this from firms with revenue of less than $5 million and from firms with revenue of more than $100 million.
Considering that you may have four or five interrelated areas in which to develop measures, we believe you should have no more than two or three measures for each area. Tracking too many measures will surely cause you and your fellow owners to lose focus on what’s truly important. A lot of money can be spent developing a tracking system with little return. It’s best to go slowly until you understand what it takes to track your measures. Too much of a good thing, or in this case too many measures, is not healthy or wise.
Targets
According to Paul Niven, “A target can be defined as a quantitative representation of the performance measure at some point in the future (i.e., our desired future level of performance).”8
While there are financial benchmarks for the accounting and legal professions (examples include the Annual PCPS/Texas State Society Survey, the Rosenberg Survey, Inside Public Accounting’s Annual Accounting Survey, and Of Counsel Annual Survey), firms need to determine their own targets or points of arrival (POA). Determining targets is nothing new for professional services firms. Firms generally set annual financial goals, set targets for accounts receivable days outstanding and work in progress, and assign billable hour targets for professionals and paraprofessionals. Firms have not been as diligent in setting goals in the other three areas of the Balanced Scorecard.
Without targets, firm management will never know how well it’s achieving its objectives or implementing its strategies. Targets can be set for a month, quarter, year, or longer. Recall President Kennedy’s 1961 target to put a man on the moon by the end of the decade. Whether your targets are long-term, mid-term, or short-term, they need to be specific. And while targets can be determined by senior management, you will get more buy-in if they are determined by the practice areas, niche groups, and others with final approval from senior management.
Tasks or Action Steps
After determining goals, measures, and targets, the final step is to develop specific action steps or tasks. These identify who will do what by when.
Sample Balanced Scorecard Templates
The following table shows a completed template for employee progress. The objective is to develop team member and owner marketing skills. The leading measures are the number of team members and owners who attend training and acquire marketing skills. The lagging measure is the amount of new billings as a result of developing the skills. Our example includes three targets that measure success. The first is having 80 percent of staff and owners trained by 2008. The second is having 100 percent trained by 2009. The third is $10,000 in billings for each individual who completed the training.
Employee Growth and Learning
| Area | Objective | Measure(s) (Lagging, Leading, And Real Time) | Target | Tasks |
| Employee Growth and Learning | Develop employee and owner marketing skills |
|
|
Tom to contract with outside sales training professionals who design a program that exactly meets our needs by June 30. |
STRATEGY MAPS
Recall that a strategy is an assumption of what may happen if everything goes right. If I do “A” and the result is “B,” then I should expect “C” to happen. The Balanced Scorecard requires firms to develop more than a list of independent objectives. It requires firms to determine how the various objectives in each of the key areas interrelate. In other words, how are the objectives interdependent? How do one area’s objectives affect and support another area’s objectives?
For example, you cannot expect to enter a new market unless your firm’s employees develop better knowledge about how to attract and serve its clients. Your owners and employees won’t spend “quality” time with clients unless they know what quality time is. They won’t deliver timely services until you have processes in place that reduce redundancies and other inefficient activities. They won’t likely bring in new business unless they have business development and listening skills and are measured and compensated for doing so.
We call this the “gas pedal/brake pedal” theory. As much as you apply your collective feet to the gas pedals (for example, strategies for attracting new clients, spending quality time with clients, timely services, and new business development), there are always brake pedals pushing back just as hard. As we mentioned previously, these brake pedals usually come in the form of people not knowing what to do, how to do it, or why to do it. This compels you to change the systems (for example, recruitment and selection, orientation, training and development, mentoring and coaching, performance management, and compensation) that either cause or allow these brake pedals.
Here’s another example. Assume under the “Client” area in the “Employee Growth and Learning” table your objective is to “establish long-term client relationships.” Your measures are (1) the amount of quality time (nonbillable) spent with key clients to understand their business and needs, and (2) key client retention rates. A target for quality time spent with clients could be 16 hours per year with key clients. The target for key client retention rate might be 98 percent.
There is one more thing you need to do. In addition to setting an objective of establishing long-term client relationships, you must consider what else needs to be done to make that objective a reality. From an internal processing perspective you will need some sort of client relationship management (CRM) system to support your efforts. It could be as simple as a three-ring binder, an Excel spreadsheet, Microsoft Outlook, Gold-mine, or a more sophisticated CRM (client relationship management) program. If you don’t have a system in place, you won’t be able to keep track of client contact and the nature of your discussions, methodology for follow-up, and ultimate outcomes.
In addition, your owners and team members are not likely to spend time with clients and talk about their business needs unless you help them develop specific competencies so they can prepare for, structure, and follow up these meetings. We trust you see how these areas are becoming interrelated and how a strategy map helps you visualize the interdependence of objectives.
Kaplan and Norton describe four ways in which creating value from intangible assets is different from creating value by managing tangible and financial assets.
Value creation is indirect. Intangible assets, such as competencies, training, and knowledge, usually don’t have a direct effect on the financial outcome of a firm. Rather, there is a cause and effect relationship. As employees and owners become more highly skilled, they provide higher value services to clients, which in turn generate higher fees and better profits for the firm.
Value is contextual. “The value,” according to Kaplan and Norton, “of an intangible asset depends on its alignment with the strategy.” If your firm’s strategy is to grow, but your training does not provide the necessary skills in business development, it won’t have as much value for the firm as a training program that provides the firm with these skills. If your strategy is to grow, but owners and employees are not compensated for engaging in business development, little value can be created—even though they may have business development skills.
Value is potential. Kaplan and Norton note that, “The cost of investing in an intangible asset represents a poor estimate of its value to the organization.” We cannot tell you how many firm leaders we have talked with who do not understand this point. What is the potential value of a lateral hire with specialized knowledge in one of your niches? What is the potential value of an internal process that tracks client satisfaction and loyalty on a real time basis?
Assets are bundled. An accounting firm’s biggest asset is its people. If your people are not aligned behind the firm’s mission and vision (see Chapter 3), maximum value will not be created. Individual owners and employees bring more value to an organization when they work together interdependently rather than when they work in isolation or independently.
The strategy map that follows is for a mid-sized accounting firm and shows how strategy links the intangible assets to value-creating processes. We have found firms as small as $3 million using strategy maps, and we consistently help firms, regardless of size, create them.
FINAL THOUGHTS
While the Balanced Scorecard process focuses on key measures necessary to achieve stated objectives, the process is really more about strategy implementation. It’s only by focusing on measures and targets that a firm can determine how well its strategy is working, how effective its processes are, and how well people are producing.
When applied properly in professional services firms, the Balanced Scorecard creates the following organizational benefits:
▮ Defines specific objectives for both the firm and for each aspect of its practice units
▮ Builds consensus on what should be measured at the firm, department, niche, engagement, or individual level
▮ Identifies targets or successes at each stage of the process (milestones)
▮ Shows how different objectives interrelate through the use of strategy maps
▮ Defines the process for successfully meeting objectives
▮ Improves internal communications among the owners and between owners and employees
▮ Places emphasis on both financial and non-financial (client, employee growth and learning, and internal systems and business processes) measures
▮ Produces greater owner and employee accountability
▮ Generates superior financial results for shareholders
To keep the Balanced Scorecard from becoming overwhelming, we suggest you start with only a few measures you can track without fail. Based on your experience, you can then expand the process and create separate scorecards for each department, niche, and service area.