Fortifying Your Financial Perspective
In most writing on the Balanced Scorecard, you will find substantially less ink devoted to the Financial perspective than to the Customer, Internal Process, and Employee Learning and Growth dimensions. This is certainly not a surprise to people familiar with the Scorecard model, as it was created with the goal of supplementing lagging financial measures of performance with the drivers of future financial success. Anyone who has worked in the field of business has undoubtedly been exposed to the standard toolkit of financial metrics, but what drives financial success is often a mysterious black box of many possibilities. Thanks to the Scorecard system with its inclusion of non-financial perspectives of performance firms are in a much better position to solve the value-creation mystery and discover what does, in fact, drive future financial results.
Most private sector organizations operating in a competitive environment consider results from the Financial perspective to represent the ultimate arbiter of absolute success. The key word in that last sentence is absolute. The measures they employ provide an outstanding view of the company’s absolute performance, meaning the actual dollars in sales they’ve generated, the exact percentage of growth, the precise ratio of profits to sales, etc. What they don’t tell us, however, is how well the firm has performed relative to its competition.
Michael Porter reminds us repeatedly that “Competitive advantage is a relative concept”[i] meaning that results must be stacked up against those of other companies operating in the same industry who face a similar competitive environment. Without this comparison, absolute performance is meaningless. If your company achieved sales growth of 20 percent last year that might be cause for cheers and back slapping all around until you learn that your key competitors all surpassed 30 percent. Knowing that you quickly realize how much economic value you’ve left on the table.
What we’re ultimately attempting to capture in the Financial perspective is a verdict on the company’s success in achieving competitive advantage over its rivals. Since most companies track only their absolute performance on financial yardsticks, they’re unable to gauge their success when judged against peers. I would argue that virtually all financial metrics must be compared to industry averages or other key benchmarks in order to prove effective in judging competitive success. So, rather than raw sales growth, you would calculate sales growth percentage versus the industry average. Instead of Return on Equity, its return on equity versus the industry average. Perhaps the most important metric in this perspective will be Return on Invested Capital (ROIC). This fundamental measure examines a company’s profits versus all the funds it has invested to generate those profits; both operating expenses and capital. Returning to Porter, he cogently argues this is the only metric that reflects the true economic purpose of every profit-seeking enterprise: to produce goods or services whose value exceeds the sum of the costs of all the inputs, thereby ensuring resources have been used effectively. And once again, to ensure efficacy, ROIC should be compared to others in your industry.
We must never lose sight of the fact that for-profit businesses are attempting to achieve a competitive advantage that leads to superior profitability. All industries have defined ‘profit pools’ and therefore, it’s vital that when assessing financial results we do so in the context of performance versus rivals. Only then does a firm possess a true and meaningful picture of the competitive advantage it does or does not enjoy.
[i] Joan Magretta, Understanding Michael Porter (Boston, MA, Harvard Business Review Press, 2012).