Bob Kaplan, Distinguished AdvocateBy
Never one to rest, this pioneer is now tackling issues such as healthcare costs.
Robert S. Kaplan, senior fellow and Marvin Bower Professor Emeritus of Leadership Development at Harvard Business School, recently received the IMA Distinguished Advocate Award for his successes, exceptional achievements, dedication, and professionalism. An IMA member since 1989, Bob is the codeveloper of activity-based costing (ABC) and the balanced scorecard (BSC), and he is renowned for his work in management accounting and other areas. A few weeks ago, he and I sat down to catch up on his latest activities.
Q. Your books The Balanced Scorecard: Translating Strategy into Action, Strategy Maps: Converting Intangible Assets into Tangible Outcomes, and The Execution Premium: Linking Strategy to Operations for Competitive Advantage focused on putting strategy into action. How have your thoughts on these topics evolved over time?
In our original 1992 Harvard Business Review article, David Norton and I described the balanced scorecard as a multidimensional performance measurement system designed to quantify the improvement or degradation in a company’s intangible assets: customer relationships and loyalty, quality and process capabilities, innovation, employees, and information systems. As we helped companies apply this framework, we began to explore the causal relationships among the measures in the four perspectives [Learning & Growth, Business Process, Customer, Financial]. For example, a simple causal chain of strategic BSC measures would be: Employees who were better trained in quality management tools would reduce process cycle times and process defects. The improved process performance would lead to shorter customer lead times, improved on-time delivery, and fewer defects experienced by customers, leading to higher customer satisfaction and retention, eventually leading to higher revenues and margins. All the metrics are linked in cause-and-effect relationships, starting with employees, continuing through processes and customers, and culminating in higher financial performance. We also realized that we needed an intermediate step, strategic objectives, between a company’s strategy and its performance metrics. Strategic objectives are short word statements of what the company wanted to achieve in each of the four BSC perspectives. It turned out that once a company could describe linked strategic objectives, it was far simpler to choose one or more metrics (or indicators) for the BSC. Causal relationship and strategic objectives soon led to the invention of the strategy map, which may have been as important an innovation as the original BSC. Today, all BSC projects build a strategy map of linked strategic objectives first, and only afterward do they select metrics for each objective.
For many years, the weakest link was the Learning & Growth perspective. One executive described it as “the black hole of the Balanced Scorecard.” While companies had some generic measures for employees, none had metrics that linked their employee capabilities to the strategy. Dave Norton led a research project that developed the concepts of strategic human capital readiness and strategic job families and, by extension, the linkages to information capital and organizational capital. These important extensions to measure the capabilities of a company’s most important intangible assets were described in an HBR article and the Strategy Maps book.
Another major learning was how to extend the strategy map and BSC to nonprofit and public sector enterprises (NPSEs). Prior to the development of the balanced scorecard, the performance reports of NPSEs focused only on financial measures, such as budgets, funds appropriated, donations, expenditures, and operating expense ratios. Clearly, however, NPSEs’ performance has to be measured by their effectiveness in providing benefits to constituents, not by financial indicators. We adapted the BSC by replacing the financial perspective with the “customer” or citizen/constituent perspective at the top of the NPSEs’ strategy map and scorecard.
Perhaps the largest change was the shift from designing the BSC as an enhanced performance measurement system to a strategy execution system. We identified this transformation in a 1996 HBR article and Part II of the Balanced Scorecard book. It reached its full culmination with our articulation of a six-stage closed-loop strategy execution system in our fifth book, The Execution Premium, published in 2008:
- Develop the strategy
- Translate the strategy
- Align the organization
- Plan operations
- Monitor and learn
- Test and adapt the strategy
Finally, we identified the need for a new organizational function, which we call the Office of Strategy Management (OSM), to be the process owner of the strategy execution system and its component processes. The OSM, which I might add is a great role for management accountants, keeps all the diverse organizational players—executive team, business units, regional units, support units, and, ultimately, employees—aligned with each other to execute the enterprise’s strategy.
Q. You’ve recently taken on a pilot project to explore time-driven activity-based costing (TDABC) to measure and manage the costs of healthcare delivery. What have you found most interesting to date?
This has been a fascinating and exciting project, which I have conducted with my HBS strategy colleague, Michael Porter. Michael has identified that the best way to improve healthcare delivery is to mobilize the powerful force of competition to offer higher value—better outcomes at lower costs—to patients. But healthcare, a $3 trillion industry (18% of GDP) in the United States, wasn’t measuring its outcomes nor did it know its costs at the medical condition level. Michael helped establish the International Consortium for Health Outcomes Measurement (ICHOM) to develop outcome metrics for all principal medical conditions. My role has been to introduce TDABC to healthcare. We have projects completed or under way for measuring costs for several dozen medical conditions and more than 100 provider organizations in the U.S. and Europe. The most interesting finding is the large variation in healthcare costs. The ratio of the most highly paid to least highly paid person involved in a patient’s care cycle varies by a factor of 12:1 to 15:1, the highest ratio of any industry I have seen except for professional sports teams. So who does what over a cycle of care makes a huge difference in the overall cost of care.
Also, when comparing costs for the same treatment and outcomes across multiple institutions, we see ratios of more than 2:1 from the 90th to the 10th percentile. Just enabling those institutions currently above the cost median to move down to the median would produce enormous cost savings. We’ve seen clinicians produce short-term cost savings of 20%-40% once they understood the true costs of delivering care at the medical condition level and across the entire cycle of care. In a July 2016 Harvard Business Review article, Michael and I describe how accurate outcomes and cost measurements enable us to shift to an entirely new payment mechanism—bundled payments—to motivate providers to become far more effective and efficient. All this new measurement work is a huge opportunity for management accountants to pursue.
Q. As outlined in your foreword for the book Advancing Innovation: Galvanizing, Enabling & Measuring for Innovation Value! companies have recently begun measuring and managing innovation. How can the balanced scorecard apply to this area of business?
Innovation has always been a key component in the balanced scorecard and strategy maps. It’s one of the major themes in the BSC’s Process perspective and is one of the major differences between the BSC and the quality management/Lean movement. TQM and Lean enable you to eliminate waste so that existing processes will be better, faster, and cheaper. But companies must also identify entirely new products, services, customers, and processes. From the beginning, we have emphasized that companies need metrics for the innovation processes as much as they need them for their operating processes. If you don’t measure, you can’t manage. With innovation being important, as it certainly is, you must have metrics and accountability for your innovation processes.
Q. You’ve also conducted research on risk management systems. What does an effective risk management system entail?
Risk management, as we learned in 2008, was, like cost management and performance management in the 1980s, being done poorly by most companies. This is another fascinating and complex subject in which much conventional wisdom and practice is inadequate, if not misguided. One insight is that the risk management department should not be “the Department that Says No.” Effective risk management should enable companies to take on more risk. If you want higher returns, you generally need to take on more risk.
Some risks, which I call preventable, should be driven to zero; these are the risks of noncompliance and illegal and unethical behavior. This is a proper and important role for internal audit and internal controls. But any strategy involves some degree of risk, and most strategy risks can’t be eliminated entirely. The proper role of risk management for strategy risks is to identify the principal risks associated with it, assess magnitude and likelihood, set priorities about which risks need to be mitigated and managed, and then allocate resources and management attention to reduce the likelihood and impact of the principal risk events.
One can also develop a risk scorecard that gives visibility to the early detection of emerging strategy risks. Managing strategy risks can’t be done via software and checklists. It requires active and intrusive dialogue and debate among managers and employees. Strong behavioral biases—identified by scholars such as Daniel Kahneman—prevent people and organizations from thinking deeply and analytically about risk. Effective risk management must overcome these individual and organizational biases so that deep (slow) thinking can be conducted to identify, assess, mitigate, and manage strategy risks.
Several organizations, such as ISO (International Organization for Standardization) and COSO (Committee of Sponsoring Organizations of the Treadway Commission), have issued standards for risk management. We are still early on the journey to developing comprehensive, effective, and integrated risk management systems. Standardization in a field as immature as strategy risk management is dangerous. We don’t know a great deal about effective and efficient strategy risk management systems; our immediate need is for experimentation and innovation, not standardization. One size definitely does not fit all, and we need to learn more about a contingency theory of risk management in which design and implementation can be far better customized to a particular company’s strategy and context.
Q. Looking ahead, what do you see as the critical issues facing the management accounting profession?
The critical issue, I believe, is for management accounting to stay focused on its basic function: to provide valid, mostly quantitative, data that informs decisions, control, and governance of the enterprise. I continue to see large global companies operating with cost and performance measurement systems that Tom Johnson and I, in Relevance Lost, described as obsolete 30 years ago. The lack of valid data on outcomes and costs in healthcare has led to massive inefficiencies and inadequate competition in that sector. If management accountants fall down in their basic responsibility to provide their organizations with accurate information and internal systems for costs, margins, performance, and risk, no other group in the organization can correct for these deficiencies. Clearly, technology and Big Data provide enormous opportunities for management accountants to do their jobs more easily and more powerfully. But technology and information must be used within coherent frameworks that help organizations create current and future value.
Financial accounting is important for reporting on the near-term results from a company’s strategy. Management accounting is even more important for helping companies describe, communicate, implement, and adapt their strategies. Providing the requisite information and systems to help companies execute on their strategies should remain the fundamental mission for management accounting.