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ACG 5065 Managerial Accounting Spring 2008 HCS: Designing a Balanced Scorecard in a Knowledge-Based Firm Requirements 1 and 2 due May 30th. Requirements 3, 4 and 5 due June 6 th. 10% of course grade.

ABSTRACT: The purpose of this case is to enable you to design a performance measurement system using a balanced scorecard. This case is based on factual issues and decisions faced by the real-world managers and employees of Holloway Consulting Services (HCS) (names and dollar amounts have been changed). HCS is a service firm that provides its customers with managed business solutions, i.e., integrating outsourcing options with systems design and support. Currently, HCS collects several financial and operational performance measures; however, Sharon Holloway, owner of HCS, is concerned that these measures are not adequate for a firm that competes using intangible assets, especially human capital. Therefore, she plans to implement a balanced scorecard in which performance measures are linked to the firm’s strategy. This case provides you with the opportunity to develop a balanced scorecard that incorporates both traditional and nontraditional performance measures within the strategic context of a knowledge-based firm. INTRODUCTION Sharon Holloway methodically tapped the desktop with her pen as she gazed out the office window. The spectacular view of the sun rising over the mountains escaped her notice. She slowly sipped her lukewarm coffee and mentally ran through the situation once again. She had achieved every goal she had set in the last six years since she started Holloway Consulting Services (HCS). The company had become a strong competitor, developing customized information system designs that effectively integrate various outsourcing options with the client’s existing internal support systems. Over the years she had helped her highly skilled, highly trained, and highly independent staff of consultants to become an exceptional team of experts, capable of handling the most arduous customer demands. Development of strong interpersonal relationships had become the defining characteristic of HCS. Thus, the company’s success depended on the internal relationships the staff maintained among themselves as much as the external relationships they built with customers. Together, Sharon and the staff had created a vibrant, knowledge-sharing, collaborative work-community that thrived on the lifelong-learning and personal-growth initiatives that had become so familiar to anyone involved with HCS. Now, HCS was growing; growing quickly—perhaps too quickly. Sharon sighed and asked herself for the thousandth time, “Is it possible to grow without sacrificing everything we’ve worked so hard to achieve? How do we grow and still be HCS?” Sharon’s main concern was how to protect HCS’ autonomous, collaborative work environment while continuing to “grow” the customer base and the staff. Sharon had told more than one new-hire, “We are not out to make as much as we can as fast as we can. We are about growing as people.” When HCS was smaller, she had been able to personally assess staff

members’ progress through individual observation and the related company results. However, the staff had grown to a size that prohibited this one-on-one type of performance measurement. Now that HCS’ corporate intellectual assets (the employees’ collective knowledge and strengths) were well established as the firm’s primary competitive advantage, Sharon was searching for a way to measure and guide the process of sustaining that advantage. She needed some answers. Sharon recalled a recent conversation she had had with HCS’ management accountant, Michael Christensen. They had briefly discussed the growth issue and he had some interesting ideas regarding performance measurement, particularly management tools that address the performance criteria typical of organizations competing with intellectual assets. Based on his expertise in the area, Michael strongly suggested that Sharon consider implementing a balanced scorecard. He explained that the balanced scorecard could be used to align an organization’s strategy with key performance measures, providing forward-looking performance management with adequate consideration of employee contributions to corporate success. Following their conversation, Michael had sent Sharon an email containing information illustrating how the balanced scorecard had been used in other, related firms. Over the past few days Sharon had reviewed the information several times. She was impressed with the potential of this new management tool. The balanced scorecard might be just what HCS needed to manage its growth and maintain its unique corporate culture. Putting down her pen, Sharon took one last sip of cold coffee and picked up the phone. “Hello, Michael? Got a minute?” COMPANY BACKGROUND Sharon established HCS in 1993 as a consulting firm under the name Holloway Consulting Services. Sharon’s background is in information technology (IT) support. She targeted HCS to provide local large manufacturers with systems support services ranging from maintenance and programming support for existing systems to complete redesign of the client’s information system. Sharon knew that the current trend within organizations was toward downsizing. Companies were redefining their core competencies, focusing on valueadded activities, and divesting themselves of support activities. Through her experience as an IT manager, Sharon was aware that the remaining information systems staff within downsized organizations was not always adequate to handle periods of peak demand. In this situation, companies with staff shortages have several options: call on a temporary service, consider outsourcing their entire systems operations, or rehire. Sharon realized that a market niche existed for a firm that could cater directly to the client’s needs without taking over the client’s entire operation. She aligned her firm in the market somewhere between a temporary services company and a large consulting firm. After analyzing the competition, Sharon decided that HCS would use a customerintimacy strategy (Treacy and Wiersema 1993), which emphasizes the value of long-standing customer relationships. This strategy seeks to create and maintain customer loyalty by continually tailoring services to the precise needs of the customer. Customer-intimacy requires flexible and responsive business processes and a highly educated, capable, and empowered

staff who partner closely with customers to develop and implement solutions that work. Within HCS, effective and efficient development and implementation of system solutions for customers depended on knowledge sharing 1 among the employees. To support HCS’ strategy, Sharon developed four specific strategic objectives: (1) to “grow” the company; (2) to know and understand customers’ needs; (3) to encourage and promote knowledge sharing; and (4) to maintain an open and collaborative culture in order to attract and retain employees. HCS worked hard to ensure that all of its systems, structures, and values were about sharing and working together as a group: a structure well suited to the customer-intimacy strategy. Sharon found herself in the fortunate situation of being in a high-demand, low-supply market. HCS has been able to attract experienced employees who are complex problem solvers capable of dealing with very diverse, dynamic situations. Sharon recognized that these talented, motivated employees could easily find employment elsewhere, potentially at a higher salary. To succeed with a customer intimacy strategy, HCS had to retain its expert staff. These highly skilled consultants needed a collaborative, supportive environment with considerable freedom at the point of customer contact in order to make effective decisions in a timely manner. For example, a staff member might negotiate an equipment purchase from a third-party vendor, guarantee a price on an outsourcing contract, or alter an implementation schedule to meet customer needs. Sharon is convinced that the key to retaining her staff rests in the continuance of HCS’ work environment and value system. Accordingly, a group of core employees documented HCS’ commitment to the work-community environment by developing a statement of purpose (Figure 1) and a set of five core values (Figure 2). These core values provide HCS with the foundation and infrastructure to accomplish its customer-intimate mission by building the necessary internal relationships. 1

Knowledge is a conclusion based upon relevant data and information (Stewart 1997). Knowledge sharing is the process by which individuals communicate knowledge to one another. Knowledge sharing in a knowledge-based firm requires that employees openly communicate to others knowledge that has been gained individually so that a collective, corporate body of knowledge may be built. The five values are summarized as: 1. balance: “balance gives us the ongoing energy to be efficient and effective;” 2. authenticity: “authenticity ensures timely, honest, and accurate communication;” 3. service over self-interest: “service over self-interest guarantees…(the) client partner comes first;” 4. empowerment: “empowerment enables each of our consultants to make decisions that benefit the client;” and 5. diversity: “diversity means we respect and appreciate the unique gifts and needs of each of our consultants and our client-partners.” FIGURE 1 Statement of Purpose Our purpose is to build a work community that is:

Values-Based: We honor each other’s rights to our values. We hold each other accountable for practicing our values. Collaborative: We seek to distribute authority and responsibility outwards. We have a bias toward consultative over autocratic decisions. We practice accountability to internal as well as external customers. Focused on Personal and Technical Growth: We build a vibrant, growing, learning community. We seek clients that offer technical growth opportunities. Financially Viable Each of these values is accompanied by a set of behaviors, rights, and responsibilities. These five values have successfully served HCS as tools for helping teams resolve differences and make difficult decisions, thereby empowering employees to become the type of problem solvers essential to succeed with a customer-intimacy strategy. Growth Brings Change When HCS reached 30 employees, everyone realized that annual meetings on Sharon’s back patio were not sufficient for comprehensive management of HCS. At 60 employees, Sharon recognized that not only were managers needed but a core support infrastructure was needed as well. Up to this point, Sharon had been able to perform a general oversight function while depending on her employees to operate autonomously and to make sound decisions on a daily basis. The supportive culture along with the ability of the employees to successfully manage their work had allowed HCS to grow with minimal investment in management structure. HCS also needed to develop its accounting function, specifically its accounting information system, cost accounting, and performance measurement system. HCS began to focus on developing a system of cost allocations and implemented several performance measures. Recently HCS switched its accounting software from a small accounting program to a much larger, more comprehensive system to meet its rapidly growing management needs. HCS’ recognition of its lack of necessary infrastructure led the firm to purposely slow down growth the last 12 to 18 months. Sharon believed that more growth without adequate infrastructure would be damaging to the organization. Performance Measures HCS currently uses several financial ratios and other metrics in an effort to track operational alignment with strategic goals. To gauge financial performance, HCS compares quarterly revenue and expense numbers to management’s expectations derived from the annual budget. Management investigates any “significant” differences between budgeted and actual revenue and expenses. Additionally, HCS tracks hours billed and hours paid by quarter and compares

these with quarterly revenue and expenses. HCS also tracks some generic nonfinancial measures related to customer satisfaction and employee attitudes. These are captured through a measure of employee response time and an employee morale survey. BALANCED SCORECARD—BACKGROUND The balanced scorecard is an innovative performance measurement process that builds on the notion that reliance on traditional (particularly short-term) financial measures is no longer adequate for firms competing under knowledge-based strategies that derive value from the management of intangible assets (Kaplan and Norton 2001a, 2001b). Financial measures are outcome measures based on historical results. As such, these lag indicators generally focus management’s attention on past actions and short-term performance related to the management of tangible assets. In contrast, nonfinancial measures, categorized as lead indicators, tend to focus attention on actions that drive future results, creating value for the long-term from such intangible assets as human capital, customer relations, innovation in products, and highly efficient operating systems (Kaplan and Norton 1996, 2001a). A balanced scorecard combines measures in such a way that management has access to key financial and nonfinancial information that they need, while not being inundated with an abundance of information. A firm’s strategy and vision are the center of the balanced scorecard. The strategic objectives are translated into measures that managers use to track how they create value for customers, how internal business processes can be enhanced, and how the investment in people supports improved future performance (Kaplan and Norton 1996, 2001a). Since aligning actions with strategy is central to the balanced scorecard, the scorecard assists firms in effectively implementing the strategic shifts needed to remain competitive in the context of today’s technology-driven economy. The scorecard combines both financial and nonfinancial performance measures along four perspectives: a. Customer Perspective—Focuses on the external environment to understand, discover, and emphasize customer needs. Common measures: customer satisfaction, customer loyalty, and customer retention. b. Internal Business Processes Perspective—Focuses internally along a value chain comprising innovation, operations, and post-sale service processes. Common measures: research and development expenditures, sales from new products, productivity, cycle time, and throughput efficiency. c. Learning and Growth Perspective—Provides the foundation, or infrastructure, needed to meet the objectives from the other two operational perspectives. Common measures: employee satisfaction, dollars spent on training, and voluntary turnover. d. Financial Perspective—Focuses on shareholders. Every measure in the balanced scorecard should be part of a causal link that ends in financial measures (Kaplan and Norton 1996). Common measures: economic value added EVA, return on investment, and net income.

CONCLUSION HCS is in transition. The relaxed management style that has proven successful so far verges on becoming ineffective because of the growth it has produced. For years Sharon has relied on a handful of financial ratios, limited survey data, personal observation, and her own good business sense to manage HCS. Sharon has now come to the conclusion that a more sophisticated management system would allow HCS to grow without sacrificing its value-based culture. Sharon thinks that the balanced scorecard may be the right tool to link performance measurement to the essential internal elements that have led to HCS’ success with a customerintimacy strategy. To investigate the possibility further, she diagrammed the relationships between HCS’ strategic objectives, statement of purpose, core values, and the four perspectives of the balanced scorecard (see Figure 3). Although Sharon is satisfied that the balanced scorecard provides an effective mechanism to conceptually link performance measurement with strategy, she struggles with which metrics to use. Sharon is aware that “what you measure is what you get” and wants to ensure that the measures selected send a clear message regarding HCS’ values and goals; thus, the phone call to Michael. Michael has patiently awaited his opportunity to put his ideas about the balanced scorecard into action. In Sharon’s opinion, the time is now.

REQUIREMENTS 1. With HCS’ strategy as the core of the balanced scorecard, develop at least one performance measure for each of the strategic objectives and core values found within the four perspectives of the scorecard (that is, complete column (2) of Figure 4). 2. Suggest how to report and monitor your indicated performance measures by completing Figure 5. List each measure, define the measure, and describe how it would be collected and monitored. In other words, perform the following: a. In column (1) list the measure (e.g., employee satisfaction). b. In column (2) define the measure (e.g., rating by each employee on a seven point scale) c. In column (3) discuss how the measure will be collected. Will the data be collected from surveys, the financial information system, or some other data source? Will the data be collected on an ongoing basis, daily, monthly, or at some other interval? d. In column (4) describe how management would monitor the performance measures. Specifically, will they only monitor exceptions, and, if so, how often? Will management use benchmarking or continuous improvement? 3. Describe a plan that will align the balanced scorecard with compensation. Would you recommend that Sharon link the balanced scorecard to compensation? Why or why not? Describe both “benefits” and “costs” of linking the balanced scorecard to compensation.



How has the emergence of a “knowledge-based economy” influenced performance measurement? How does the development and continued use of the balanced scorecard address the problems faced by knowledge-based firms such as HCS? HCS’ primary performance measurement issue is management’s inability to assess its efforts to sustain its primary strategic resource: human capital. How do unrecorded assets such as HCS’ intellectual capital affect management decision processes?


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