Plotting the Pathway to Profitability

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1 September - November 2004 Strategy Maps: Plotting the Pathway to Profitability By Dr. David Norton In today s business environment, strategy has never been more important. Yet research shows that most companies fail to execute strategy successfully. Why the poor results? In my view, the problem can be traced to a single cause; there is no generally accepted way to describe a business strategy. Unlike financial managers who have income statements and balance sheets, executives have no such frameworks or tools for describing the enterprise strategy. As a result, the description of strategy degenerates into a set of high level themes like partner with the customer, empower the people, quality first etc. The themes, while useful, tend to be too general for action, inconsistently applied, and only focus on part of the strategy. Management do a poor job executing strategy because they are trying to manage something which they can t even describe. Bob Kaplan and I developed The Balanced Scorecard over a decade ago to help companies build measurement systems to manage their strategy. As we attempted to build these systems, we faced the same problem how do you describe a strategy? Based on our experiences in hundreds of organisations, we have developed an approach which, we believe, reliably answers this question. We call it a Strategy Map. Strategy is how an organisation intends to create value for its shareholders. A strategy map describes this value creating process. The purpose of a strategy map is to facilitate discussion, debate and ultimately consensus among executives about the specifics of their strategy. It provides a visual representation of the cause-effect relationship which the executives believe to be true. The creation of a strategy map is a prelude to the creation of a Balanced Scorecard. Once the strategic objectives are agreed to in a strategy map, the measures follow directly. The strategy map template, described in Figure 1, serves as a checklist. If an organisation s strategy does not deal with each of the boxes shown there, the strategy is most likely flawed. For example, if the innovation strategy is not defined, there will be no long-term growth. If the strategy for culture and leadership is not defined, the organisation will be unable to mobilise and change. The architecture of a strategy map is based on several principles: 1. Perspective: Strategy balances long-term and short-term forces. The overarching objective of private sector organisations is the creation of long-term sustained value for the shareholders. This means that the focus must be on long-term success. Yet shareholders demand results in the short-term as well. The art of managing strategy is to deliver these short-term results without sacrificing the long-term. The financial layer of the strategy map clearly identifies these 4

2 Bringing the Process of Strategy to Life Perspective Productivity Strategy Sustained Shareholder Value Revenue Growth Strategy Improve Cost Structure Increase Asset Utilisation Enhance Value Expand Revenue Opportunities Perspective Price Value Proposition Quality Availability Selection Functionality Service Partnership Brand Product/Service Attributes Relationship Image Internal Perspective Operations Management Processes Processes that produce and deliver products and services Management Processes Processes that enhance customer value Innovation Processes Processes that create new products and services Regulatory & Social Processes Processes that improve communities and the environment CREATING ALIGNMENT Strategic Job Families Strategic IC Portfolio Organisation Change Agenda CREATING READINESS Learning & Growth Human Capital + Information Capital + Organisation Capital Skills Knowledge Values Systems Databases Networks Culture Alignment Leadership Teamwork Fig 1. A Strategy Map Describes How An Organisation Creates Value SATISFYING THOSE DIFFERENT NEEDS REQUIRES DIFFERENT STRATEGIES YET MANY ORGANISATIONS ATTEMPT TO BE ALL THINGS TO ALL PEOPLE, OFFERING HIGH SERVICE AT A LOW COST two competing thrusts and establishes the logic for their simultaneous management. Figure 2 contains the Strategy Map for Volvofinans, the vehicle financing arm of the Swedish car manufacturer Volvo. Their map illustrates the financing balancing act on which their strategy is based. They will grow (long-term) by being the market leader with fleet sales, by providing attractive financial solutions, and by increasing credit administration services. Their short-term strategy is focused on increased profitability through increased efficiency, contract administration, risk handling and synergies along their value chain. 2. Perspective: Strategy is based on a differentiated customer value proposition. The customer is the focal point of every strategy. It is the customer who evaluates the organisation s products or services and votes with his/her wallet. This is the source of value. But all customers aren t looking for the same thing some want the lowest price, others want personal relations, while yet others want product innovation. Satisfying those different needs requires different strategies. For example, you can t provide the personal service of a financial advisor or a solutions engineer and also offer the lowest price. The two strategies are incompatible. Yet many organisations attempt to be all things to all people, offering high service at a low cost. Traditional airlines have pursued this strategy over the past decade as they attempt to compete with the discounters. Many of these airlines have already declared bankruptcy. A clear unambiguous definition of the customer value proposition is the single most important element of a business strategy. The customer value proposition becomes the target at which the rest of the strategy is directed. The customer section of the Volvofinans scorecard shows several distinct customer segments which they serve. The Volvo dealers and Volvo s owned channels (VPS/VLS), with whom they 5

3 September - November 2004 have natural partnerships, as well as the fleet customers (e.g. large corporations) and end customers, each has a specific value proposition. 3. Internal Process Perspective: Value is created through internal business processes. Organisations are made up of hundreds of processes, each creating value in some way. Collection of accounts receivable, designing new products or running an advertising campaign are examples. The art of formulating strategy is to find the critical few activities that will impact the customer value proposition and to focus on them unrelentingly. A good strategy will cover four types of processes: Operations Management producing and delivering products and services to customers. Management selecting, acquiring, retaining and growing customers. Innovation developing new products, services and relationships. Regulatory and Social conforming to regulations and building stronger communities. Within each of these categories, there will be one to three specific processes which capture the unique strategic priorities of the organisation. For example, at Volvofinans, the Innovation process objective was to be market leader in financial solutions. Three customer management processes were targeted: efficient market communications, continued education of Volvo dealers and efficient customer care. Two operations processes were identified: efficient contract administration and efficient funding. Thus, while hundreds of processes must be performed at Volvofinans, they identified the six processes which would receive special attention as the focus of their strategy. 4. Strategy consists of simultaneous, complementary themes. Each cluster of internal processes delivers benefits at different points in time. Improvements in operational processes generally deliver short-term results through cost savings and quality enhancements. Benefits from an enhanced customer relationship start to phase-in six to twelve months after the initial improvement in customer management processes. Innovation processes generally take even longer to produce higher customer revenues and operating margins, and the benefits from enhanced regulatory and social processes can occur further in the future as companies avoid litigation and enhance their reputations in the community. Strategies should be balanced, incorporating at least one strategic theme from each of the four internal clusters. By having strategic themes for enhancing processes in all four internal clusters, the organisation realises benefits that phase in over time, generating sustainable growth in shareholder value. 5. Learning & Growth Perspective: Strategic alignment and readiness determine the value of intangible assets. The intangible assets are the foundation of a modern corporation and its strategy. 75% of the value of a modern corporation is attributed to intangible assets. Yet, little structure exists in organisations to describe, measure and manage the contribution of these assets. There are three categories of assets that must be managed strategically: (1) Human capital the skills, talent and know-how to perform the activities required by the strategy; (2) Information capital the information systems and knowledge applications required to support the strategy; (3) Organisation capital the ability to mobilise and sustain the process of change required to execute the strategy. While few executives would argue that these are not important considerations, we have observed few effective structures for integrating these intangible assets with the strategy. We embarked on our own research programme a couple of years ago to try to develop some insights. We identified two properties that give value to intangible assets. 1. Alignment Investments in intangibles take on value, only in the context of a strategy. A major training program on a subject like Six Sigma would have high value in an organisation pursuing an operational excellence strategy but less value in an organisation with a customer intimacy strategy. Thus, the key to creating value with intangibles is to create alignment between the asset and the strategy. The point STRATEGY IS HOW AN ORGANISATION INTENDS TO CREATE VALUE FOR ITS SHAREHOLDERS. A STRATEGY MAP DESCRIBES THIS VALUE CREATING PROCESS 6

4 Bringing the Process of Strategy to Life CASE STUDY: VOLVOFINANS BACKGROUND Founded in 1959 and headquartered in Göteborg, Sweden, Volvofinans is the leading vehiclefinancing company in Sweden, with total lending reaching 23.5 billion kroners ($2.7 billion) in This small but powerful lender employs about 190 people and has a highly focused mission: support sales of Volvo and Renault products in Sweden by financing products and sales. Ford Credit International owns fifty percent of the company. Swedish Volvo dealerships own the remaining 50 percent. Dealers are thus the firm s customers and its owners. Additional customers include fleets (firms operating more than 50 company cars) and individual consumers seeking attractive financing terms for their auto purchases. THE STRATEGY MAP During a series of lively seminars attended by managers and employees from a cross-section of many functions and levels up to one-third of the company s workforce the scorecard team began crafting Volvofinans' strategy map (Figure 2.). They called the document their Vägvisaren, or road map. Rank-and-file employees defined most of the map s objectives and measures an effective first step in aligning everyone behind the strategy. The company initially identified more than 35 objectives then combined several to arrive at a manageable 22. Executives also decided to emphasise product leadership and operational excellence as key to implementing Volvofinans strategy. Within the strategy map, themes such as motivated and involved co-workers, win/win with Volvo dealers, and growth and efficiency strategy along with a value chain flowing from product development to customer loyalty provided the framework for the map s cause-and-effect relationships. The team used the strategy map to communicate high-level strategy, effectively and compellingly, to all employees. ANECDOTES Volvofinans inclusive strategy map development process paid big dividends. Recent surveys revealed that employees now had a stronger grasp of department and company strategy. Morale and commitment to company goals have also soared, as has employees mastery of industry dynamics. These improvements led to tangible outcomes. In 2001, the company s share of the new-car financing market through Volvo dealerships in Sweden expanded, leading to significant increases in lending amounts and the number of contracts in force. Its emphasis on product leadership and operational excellence also yielded results. The company launched Volvo Carloan, an insurance plan that pays customers monthly auto-loan bills if they lose their job or develop a long-term illness. By mid-2002, more than 100,000 customers had signed up for the plan; Volvofinans competitors have belatedly launched similar products. And the company boasts the lowest cost per administered contract in its market. Volvofinans is a member of the Balanced Scorecard Hall of Fame. Source: Excerpt from Strategy Maps: Converting Intangible Assets into Tangible Outcomes, Robert S.Kaplan, David P. Norton, Harvard Business School Press, 2004 Reproduced with Permission. of reference in creating alignment is the set of strategic processes already identified in the strategy map. Investments in people and technology to support these processes will enable the strategy and provide the greatest returns. A different alignment vehicle is used for each class of assets: Strategic IT Portfolio (Information Capital) the IT applications and infrastructure which have the greatest impact on the strategic processes. Organisation Change Agenda (Organisation Capital) the new personal behaviours required by the strategy. Strategic Job Families (Human Capital) the one or two job families which have the greatest impact on the strategic processes. The alignment process forces an organisation to focus its attention and efforts on the critical few jobs, technologies and climate which are most 7

5 September - November 2004 Active Profitable Sales Support Growth Strategy Efficiency Strategy Growth By Attractive Solutions Market Leader Within Fleet Administration/ Finance Growth Through Increased Credit Administration Services Utilise Synergy Advantages Professional Risk Handling Market Leader in Cost Efficient Contract Administration Win / Win With Volvo Dealer VPS/VLS Fleet s End s Natural Partner for Volvo Dealers Natural Partner for VPS/VLS* Close Relations Attractive Package Solutions Professional Service Process Product Development Market Leader in Solutions & Concepts Efficient Market Communications With Active Sales Support Sales & Marketing Continued Education of Volvo Dealers Risk Handling Efficient Activity and Funding Efficient Credit Handling Efficient Contract Administration Loyalty Efficient Care Motivated and Involved Co-workers Co-workers Learning Active Participation among everyone Attractive Workplaces Quality focused co-workers Right Competence Efficient IT Support High Availability of Information Fig 2. AB Volvofinans Strategy Map * VPS/VLS: Volvo s company-owned, domestic sales network for cars (VPS) and trucks (VLS) crucial to successful strategy execution. This focus can dramatically simplify the job of managing. For example, the strategy map analysis helped a large service company identify three job families which had greatest impact on their strategy. (These were operations managers who managed current accounts, project managers who brought new services to the accounts and business development executives who helped acquire new accounts.) These three job families accounted for only 215 people, or less than 4% of the total workforce. 2. Readiness The ultimate measure of value of an intangible asset is its degree of preparation to perform its defined role in support of the strategy. Alignment insures that we have identified the correct assets for development. Readiness describes our success in preparing them. For example, a manufacturing organisation identified the job families on which it would focus. Through testing, they found that only 40% of the 30 assembly men (one of their strategic job families) were proficient in the requirements of their job. A concentrated training and development programme was put in place for the assemblymen. A year later, readiness levels increased to 84% with dramatic improvement in performance results like rework levels, cycle time, etc. The measurement of readiness is the final hurdle in converting a strategy map into a useful management tool. Human Capital readiness is measured as described above; the competency profile for the strategic job is defined and the competencies of current employees are evaluated relative to that profile. The difference between desired and actual defines a readiness gap for which a tailored training and development programme must be prepared. Information Capital readiness is measured by evaluating the level of readiness of each IT application identified in the Strategic IT Portfolio. The readiness gaps identified here provide the foundation for the IT strategic development plan, where top priority is given to bringing each of the strategic IT applications to a desired level of readiness. Organisation Capital 8

6 Bringing the Process of Strategy to Life readiness is measured through employee surveys and 360 degree feedback programmes, which assess the extent to which the cultural values and leadership behaviours identified in the Organisation Change Agenda are understood and being practised. The gaps between desired and actual provide the foundation for the Organisation Development plan, generally administered by the HR organisation. chain and outsourcers as well as with boards of directors and shareholders. The strategy map becomes the focal point of the governance process. Management meetings use the strategy map as their agenda and point of reference. Planning, budgeting and capital allocation are linked to the priorities of the map. In effect, the strategy map and the Balanced Scorecard which it precipitates can become the focal point of every THE PROCESS OF DESIGNING A STRATEGY MAP REQUIRES A LEADERSHIP TEAM TO DEBATE AND ACHIEVE CONSENSUS ON THE STRATEGY IN A HOLISTIC MANNER. GETTING THE EXECUTIVE TEAM ON THE SAME PAGE HAS ENORMOUS VALUE IN AND OF ITSELF Thus, by identifying the intangible assets required to support the strategic processes on the strategy map (alignment) and focusing resources on their development (readiness), the organisation is now ready to mobilise and drive the execution of its strategy from the grass roots of the organisation. Because the processes are aligned with the customer value proposition and the intangible assets are aligned with the processes, all of the activities are focused on executing the strategy in the marketplace, which will ultimately create shareholder value. Developing a strategy map allows you to move from the levels of non-actionable generalities to a level of granularity that can be managed. The strategy map forces you to identify specific processes, jobs, technologies and values on which the organisation can focus its attention. In this article I have concentrated my comments on the architecture of a strategy map, the real value comes from its use. The process of designing a strategy map requires a leadership team to debate and achieve consensus on the strategy in a holistic manner. Getting the executive team on the same page has enormous value in and of itself. The completed strategy map becomes a powerful communications vehicle to bring the strategy to all corners of the enterprise. Many organisations will build multi-faceted communication and education programmes around their Strategy Maps to build a deep understanding of each phrase on the map. Once understood, the strategy map becomes a powerful tool for alignment. Each person can look at the enterprise strategy map, determine how they can personally contribute and align their personal goals to the strategy. Strategy maps are being used to align organisations with external partners such as supply management process that drives change in an organisation, thus assuring that all change is focused on the strategy. When we first developed the Balanced Scorecard, over a decade ago, our mantra was you can t manage what you can t measure. The Balanced Scorecard introduced a measurement framework to help organisations focus on their strategies. However, we quickly uncovered the real barrier to strategic execution you can t measure what you can t describe. Strategy maps eliminate this barrier, providing a reliable, consistent way to describe enterprise strategy. In our experience, the ability to visually represent and communicate the components of an organisation s strategy is as big an insight to executives as is the Balanced Scorecard itself. David is the President of the Balanced Scorecard Collaborative, Inc. David and his co-creator Dr Robert Kaplan were ranked by the Times among the 15 business world s most important practical and intellectual influences. David can be contacted at mcriticaleye Publications Ltd

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