19 Going Forward and Criticism (Preliminary Draft)

Risk

There is still room for improvement in the balanced scorecard. At the moment it is not obvious how to introduce risk measures and risk management in the balanced scorecard. Certainly for financial firms risk management is becoming more and more important. However, most current measures of risk such as standard deviations of recent stock
prices are at best considered to be proxies for the real thing. Some commentators argued that misinterpretation of volatility measures in  Value at Risk calculations contributed to the financial crisis (Tett 2009). Others have argued that standard deviations and volatility are more than misleading when talking about risk.

Stock prices will always be far more volatile than cash-equivalent
holdings. Over the long term, however, currency-denominated
instruments are riskier investments […] That lesson has not
customarily been taught in business schools, where volatility is
almost universally used as a proxy for risk. Though this
pedagogic assumption makes for easy teaching, it is dead wrong:
Volatility is far from synonymous with risk. — Warren Buffet

The balanced scorecard has the advantage that it does not need to include risk outcome measures to manage risk. For instance, banks can include regulators as a customer or stakeholder in their balanced scorecard. They can include “regulator satisfaction” as a subjective measure which is linked to a number of process measure of compliance with regulation.

Causal Links

A lot of criticism on the balanced scorecard has been directed at the concept of causal links between measures. For instance, the link between two measures might be non-linear. If a firm is perceived as very negative by customers, any improvement in customer satisfaction will probably lead to better financial performance. However, if the firm’s customers are already satisfied, the effect of any further improvement on profit might be very limited. Furthermore, some improvements might take time before they lead to better financial performance because human capital sometimes has an indirect effect on financial performance. For instance, hiring more capable employees might initially have a negative effect on profit because of their higher salary and only lead to higher profit when the employees come up with improvements to the production process
(Norreklit, 2000). These more complicated relations are harder to model and to visualise.

One possible solution to these kinds of problems is the introduction of new data management and data analysis methods for big data sets. The continuous improvement in IT technology and the use of web-services have led to an explosion of potential interesting data on production and communication between employees to better estimate how
the different activities in a firm are linked to each other. For instance, firms have databases on e-mail exchanges between employees which might help them to quantify the level of communication between different departments. Big retailers such as Woolworths and Coles have a vast amounts of consumer purchases based on loyalty cards. They can exploit this information to get a better idea which type of customers are affected by changes in the layout of shops and the product assortment.

Bottom-up strategies and incentives

A recurring critique on these type of performance measurement systems is that they assume that the firm, and its management, can to a large extent plan its strategy upfront. If deviations from the intended strategy are observed, managers need to give directions to the other employees how to improve their activities. Others argue that a firm’s strategy is determined by the economic circumstances and the actions of competitors and how well the firm reacts to changes in these circumstances.

The employees sometimes know better what to do or they can implement the changes faster. Therefor a grand strategic plan and a balanced scorecard is superfluous (Norreklit, 2008). The right way to manage the firm is to develop an incentive plan that forces employees to maximize firm value so that they optimally change their behavior in response to a changing environment and competitor’s decisions. In reality firms combine a strategic plan and measurement system with the appropriate incentives. The emphasis on these two systems will depend partly on how much a firm relies on a top-down or a bottom-up strategy