This section addresses two approaches to use when evaluating a firm’s performance. The
first is financial ratio analysis, which, generally speaking, identifies how a firm is performing according to its balance sheet, income statement, and market valuation. As we will
discuss, when performing a financial ratio analysis, you must take into account the firm’s
performance from a historical perspective (not just at one point in time) as well as how it
compares with both industry norms and key competitors.61
The second perspective takes a broader stakeholder view. Firms must satisfy a broad
range of stakeholders, including employees, customers, and owners, to ensure their longterm viability. Central to our discussion will be a well-known approach—the balanced
scorecard—that has been popularized by Robert Kaplan and David Norton.
Financial Ratio Analysis
The beginning point in analyzing the financial position of a firm is to compute and analyze
five different types of financial ratios:
• Short-term solvency or liquidity
• Long-term solvency measures
• Asset management (or turnover)
• Profitability
• Market value
The Balanced Scorecard: Description and Benefits To provide a meaningful integration of
the many issues that come into evaluating a firm’s performance, Kaplan and Norton developed a “balanced scorecard.”66 This provides top managers with a fast but comprehensive
view of the business. In a nutshell, it includes financial measures that reflect the results of
actions already taken, but it complements these indicators with measures of customer satisfaction, internal processes, and the organization’s innovation and improvement activities—
operational measures that drive future financial performance.
The balanced scorecard enables managers to consider their business from four key
perspectives: customer, internal, innovation and learning, and financial.
Customer Perspective Clearly, how a company is performing from its customers’ perspective is a top priority for management. The balanced scorecard requires that managers translate their general mission statements on customer service into specific measures that reflect
the factors that really matter to customers. For the balanced scorecard to work, managers
must articulate goals for four key categories of customer concerns: time, quality, performance and service, and cost.
Internal Business Perspective Customer-based measures are important. However, they must
be translated into indicators of what the firm must do internally to meet customers’ expectations. Excellent customer performance results from processes, decisions, and actions that
occur throughout organizations in a coordinated fashion, and managers must focus on those
critical internal operations that enable them to satisfy customer needs. The internal measures
should reflect business processes that have the greatest impact on customer satisfaction.
These include factors that affect cycle time, quality, employee skills, and productivity.
Innovation and Learning Perspective Given the rapid rate of markets, technologies, and
global competition, the criteria for success are constantly changing. To survive and prosper,
managers must make frequent changes to existing products and services as well as introduce
entirely new products with expanded capabilities. A firm’s ability to do well from an innovation and learning perspective is more dependent on its intangible than tangible assets. Three
categories of intangible assets are critically important: human capital (skills, talent, and
knowledge), information capital (information systems, networks), and organization capital
(culture, leadership).
Financial Perspective Measures of financial performance indicate whether the company’s
strategy, implementation, and execution are indeed contributing to bottom-line improvement. Typical financial goals include profitability, growth, and shareholder value. Periodic
financial statements remind managers that improved quality, response time, productivity,
and innovative products benefit the firm only when they result in improved sales, increased
market share, reduced operating expenses, or higher asset turnover.67
A key implication is that managers do not need to look at their job as balancing stakeholder demands. They must avoid the following mind-set: “How many units in employee
satisfaction do I have to give up to get some additional units of customer satisfaction or
profits?” Instead, the balanced scorecard provides a win–win approach—increasing satisfaction among a wide variety of organizational stakeholders, including employees (at all
levels), customers, and stockholders.
Limitations and Potential Downsides of the Balanced Scorecard
There is general agreement
that there is nothing inherently wrong with the concept of the balanced scorecard.68 The key
limitation is that some executives may view it as a “quick fix” that can be easily installed. If
managers do not recognize this from the beginning and fail to commit to it long term, the
organization will be disappointed. Poor execution becomes the cause of such performance
outcomes. And organizational scorecards must be aligned with individuals’ scorecards to
turn the balanced scorecards into a powerful tool for sustained performance.
In a study of 50 Canadian medium-size and large organizations, the number of users
expressing skepticism about scorecard performance was much greater than the number claiming positive results. A large number of respondents agreed with the statement
“Balanced scorecards don’t really work.” Some representative comments included: “It
became just a number-crunching exercise by accountants after the first year,” “It is just the
latest management fad and is already dropping lower on management’s list of priorities as
all fads eventually do,” and “If scorecards are supposed to be a measurement tool, why is it
so hard to measure their results?” There is much work to do before scorecards can become
a viable framework to measure sustained strategic performance.
Problems often occur in the balanced scorecard implementation efforts when the
commitment to learning is insufficient and employees’ personal ambitions are included.
Without a set of rules for employees that address continuous process improvement and the
personal improvement of individual employees, there will be limited employee buy-in and
insufficient cultural change. Thus, many improvements may be temporary and superficial.
Often, scorecards that failed to attain alignment and improvements dissipated very quickly.
And, in many cases, management’s efforts to improve performance were seen as divisive
and were viewed by employees as aimed at benefiting senior management compensation.
This fostered a “what’s in it for me?” attitude.
SUMMARY REVIEW QUESTIONS
- SWOT analysis is a technique to analyze the internal
and external environments of a firm. What are its
advantages and disadvantages? - Briefly describe the primary and support activities in
a firm’s value chain. - How can managers create value by establishing
important relationships among the value-chain
activities both within their firm and between the firm
and its customers and suppliers? - Briefly explain the four criteria for sustainability of
competitive advantages. - Under what conditions are employees and managers able
to appropriate some of the value created by their firm? - What are the advantages and disadvantages of
conducting a financial ratio analysis of a firm? - Summarize the concept of the balanced scorecard.
What are its main advantages?
Using published reports, select two CEOs who have
recently made public statements regarding a major
change in their firm’s strategy. Discuss how the
successful implementation of such strategies requires
changes in the firm’s primary and support activities.
- Select a firm that competes in an industry in which
you are interested. Drawing upon published financial
reports, complete a financial ratio analysis. Based on
changes over time and a comparison with industry
norms, evaluate the firm’s strengths and weaknesses
in terms of its financial position. - How might exemplary human resource practices
enhance and strengthen a firm’s value-chain activities?
- What are some of the ethical issues that arise when
a firm becomes overly zealous in advertising its
products? - What are some of the ethical issues that may arise
from a firm’s procurement activities? Are you aware
of any of these issues from your personal experience
or businesses you are familiar with?
