Aligning Supply Chain Incentives Using the Balanced Scorecard

Peter C. Brewer, Ph.D., CPA

Associate Professor, Department of Accountancy Miami University, Oxford, Ohio brewerpc@muohio.edu

In recent years, much has been written about the merits of collaborative supply chain partnerships. However, this article contends that companies will fail to reap the potential rewards of collaborating with their supply chain partners unless they redefine how they measure and reward employee performance. The Balanced Scorecard is a performance measurement tool that can be used to help align the incentives of employees across organizations within a supply chain. This article explains the inter-relationship between supply chain management and the Balanced Scorecard. It also uses the Dell Computer Corporation supply chain to illustrate how the Balanced Scorecard can be used to motivate collaborative supply chain behavior.

In recent years, much has been written about the value of collaborative supply chain partnerships (Cooper, et al., 1997; Stallkamp, 1998). Yet, despite all the rhetoric, most organizations are struggling to embrace the true collaborative spirit of supply chain management (SCM) (Poirier, 1998). While managers are keenly aware of the potential benefits of coordinating their efforts across the supply chain, they are also infinitely aware of the roadblocks that impede the process of building chain-spanning partnerships (Brewer and Speh, 2001). Of course, this is not surprising given that organizations have struggled for decades to cross-functionally coordinate activities within their own companies, let alone across company boundaries. This realization begs the question - why do organizations, in spite of the theoretical appeal of crossfunctional and chain-spanning management practices, still manage within functional and intracompany silos? A big part of the answer revolves around performance m e a s u re m e n t . S i m p l y s t a t e d , people manage what gets measured and linked to their performance evaluations. Therefore, as long as the measures used to drive

pay raises and promotions are functional, financial, and intracompany in nature, people will focus their efforts accordingly. All the appeal of SCM is meaningless unless organizations redefine how they measure and reward employee performance.

The Balanced Scorecard

The Balanced Scorecard (BSC) is dramatically affecting how o rg a n i z a t i o n s a r e m e a s u r i n g intra-company performance (Kaplan and Norton, 2001). Survey research from Bain & Co. indicates that 50% of large companies in the United States and 40-45% of large companies in Europe have implemented or are considering implementing a BSC (Calabro, 2001). The appeal of the BSC rests on three principles. First, it incorporates non-financial performance measures; thus, mitigating the tendency to overemphasize short-run financial results. Second, the BSC incorporates process oriented measures ; thereby, reducing the tendency to overemphasize functional performance. Third, the BSC relies upon four categories of performance measures to map an organizations leading and lagging

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EXHIBIT 1: The Balanced Scorecard

performance indicators. More specifically, it establishes learning and growth, business processes and the customer as three classifications of leading indicators that drive results in the lagging indicator of financial performance (See Exhibit 1 for a pictorial depiction of the BSC). Mapping these lead/lag relationships enables a company to breakdown high-level strategic themes into cause-and-effect hypothesis statements that specify the interrelationships among performance metrics that are believed to drive the attainment of strategic objectives (Kaplan and Norton, 1996). These three principles justify the use of the term balanced in the sense that the BSC strikes a balance between financial and non-financial, functional and cross-functional, and leading and lagging performance measures. While the BSC has had widespread success when implemented within a single company, it has not been applied on a large scale to measure inter-company, chain-spanning performance. The primary difference between a chain-spanning approach and the more traditional

intra-company BSC approach is that the measures in an intercompany application must be chain-spanning in nature. For example, a single company may rely upon a financial measure such as return on assets. In an SCM context, the measure would become return on supply chain assets. The collective profit earned by supply chain partners would be stated as a percentage of the assets they deployed to earn that return. An example of a supply chain business process measure would be supply chain cycle time. This measure is different from each company measuring its own cycle time in the sense that it emphasizes the interdependency among supply chain partners in terms of being able to deliver products to end consumers on a timely basis. These types of chain-spanning measures seem foreign to most managers who have worked for years in supply chain environments that tend to be functional and adversarial in nature. Yet, it is these types of measures, as uncomfortable as they may be, that are needed to motivate collaborative behavior within a supply chain. Supply chains

that can motivate collaborative behavior using chain-spanning BSC measures are likely to have an edge over competing supply chains that remain mired in arms length, suboptimal relationships with their suppliers and customers.

SCM and the BSC

Exhibit 2 explains how the BSC fits within a SCM context. First, lets examine the model of SCM advocated in this article by explaining the downward flow of arrows in the column labeled SCM. The SCM Goals dimension of the model is based on the assumption that all supply chains are striving to improve themselves in terms of one or more of the following attributes: waste reduction, time compression, flexible response, and unit cost reduction (Davis, 1992; Hammel and Kopczak, 1993). Achieving these supply chain goals creates Customer Benefits in the sense that customers realize supply chain improvements in terms of product/service quality, response time, flexible or customized response capability, and overall value (Fine, 1999).

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The arrows in the SCM column continue to flow downward because a supply chain that succeeds in satisfying its customers should realize Financial Benefits in the form of higher profit margins, improved cash flows, revenue growth, and higher return on assets (Quinn, 1997). To make the model dynamic, as opposed to static, it includes a dimension called SCM Improvement. The premise of this dimension is that a supply chain must continually improve in terms of product/process innovation, employee knowledge sharing (i.e., partnership management), and information flows management to remain competitive. A supply chains continued competitiveness also hinges upon evaluating its performance relative to potential threats and/or substitutes in the

marketplace. Notice, the SCM Improvement dimension of the model feeds back into the SCM Goals dimension, thereby creating an infinite loop of continuous improvement. The SCM column of this exhibit intuitively relates to the four categories of the BSC as shown in the BSC column. As the horizontal arrows indicate, the four dimensions of the SCM model mirror the four classifications of BSC measures. In other words, the SCM Goals are synonymous with the business process perspective of the BSC. Likewise, the Customer Benefits, Financial Benefits, and SCM Improvement dimensions of the SCM model are synonymous with the Customer, Financial, and Learning and Growth classifications of the BSC. As this exhibit demonstrates, the BSC

provides a very intuitive framework for organizing the SCM performance measurement process.

When should I use the BSC?

Supply chain partners should consider implementing a BSC when two conditions exist within their supply chain. First, the supply chain partners must be mutuallydependent on each other. In other words, a true alliance or partnership must exist between the companies in the supply chain. This is most likely to be the case for supply chain partners that view each other as strategically relevant and therefore difficult to replace. Conversely, a chain-spanning BSC is less likely to be of value when used with suppliers of non-strategic commodities and services that can be easily replaced. Furthermore, a chain-spanning BSC is less likely to be of value if one company has excessive power within the supply chain and has historically exploited that power to its advantage. While a BSC could potentially be useful in this context, the imbalance of power is likely to negate the spirit of collaboration that is needed for a chain-spanning BSC to be successful. Second, the supply chain must have mis-aligned incentives. Misalignment arises when supply chain partners rely upon traditional intracompany logistics measures that place differing amounts of emphasis on the SCM Goals shown in Exhibit 2. For example, one supply chain partner may be focused on making full truck-load shipments because cost-based logistics measures are used to reward its employees for lowering unit costs. However, the downstream partner may be focusing on just-in-time customer deliveries because time-based logistics measures are used to reward its employees for decreasing throughput time and synchronizing production to customer orders. In this example, implementing a chain-spanning BSC will enable supply chain partners to engage in a dialogue that eliminates the mis-alignment, and results in a mutually agreed upon supply chain strategy. BSC measures can then

EXHIBIT 2: The Link Between Supply Chain Management and The Balanced Scorecard

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be selected that reward supply chain partners for achieving the agreed upon strategic objectives. It is important to understand that each supply chain partner and its employees must financially benefit from the supply chain strategy chosen and the BSC measures selected. Continuing with the example above, if one supply chain partner agrees to provide less-than truckload shipments to support the supply chains strategy, employees within that companys shipping department should be rewarded for just-in-time delivery of less than truckload shipments, as opposed to being rewarded for lowering unit costs via full truckload shipments. Also, the BSC should contain financial measures that quantify the net benefit to the shipping

company of providing less-thantruckload shipments. For example, revenue growth measures would quantify the increase in end customer sales resulting from the coordinated supply chain strategy. These types of measures would enable the shipping company to quantify the increase in its profits due to the sales growth, net of the additional shipping costs.

Dell Computer Corporation: An Illustration

Dell Computer Corporation (here after called Dell) has achieved incredible success due in large part to its direct business model that has revolutionized the computer industry. By reconfiguring the supply chain to bypass

EXHIBIT 3: Dells Supply Chain Balanced Scorecard The Customer Intimacy Value Proposition

distributors, Dell has built a multibillion dollar business predicated on selling direct to end customers. Upstream, Dell has forged partnerships with a select number of high quality suppliers to create what Michael Dell calls virtual integration. Virtual integration relies upon a tightly coordinated supply chain to provide the integration of effort and knowledge that has traditionally been achieved through vertical integration. Yet, at the same time, virtually integrated organizations achieve a degree of specialization and nimbleness that is not achievable in large vertically integrated organizations (Dell and Fredman, 1999). Dells virtually integrated supply chain offers a useful context for providing a simplified illustration of how the BSC could be applied within an SCM environment. To facilitate the discussion, Dells strategy is disaggregated into two value propositions, namely customer intimacy and operational efficiency. The Customer Intimacy Value Proposition For Dell, customer intimacy is defined as relying upon the voice of the customer to drive technology innovations and solutions. Indeed, Michael Dell has stated that looking for value shifts in his companys customer base is perhaps his most important leadership responsibility (Magretta, 1998). Moreover, Dell relies upon a segmented organizational structure to enable its managers to build intimate relationships with segments of customers. However, delivering on the customer intimacy value proposition does not stop with Dell and its customers. Dells suppliers are critically important to producing customer driven business solutions in a timely manner. In fact, engineers employed by Dells suppliers work with Dells engineers to create new products that respond to the voice of customer. Dell relies upon its suppliers to actually translate the voice of the customer into manufactured product. In summary, Dells customer intimacy

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value proposition is based on a view of the supply chain that defines the customer as the trigger of innovation, and that relies heavily upon suppliers for engineering and manufacturing expertise (Dell and Fredman, 1999). Exhibit 3 contains examples of chain-spanning BSC measures that could be used by Dell and its supply chain partners to motivate the achievement of the customer intimacy value proposition. For the learning and growth perspective, the first two measures are number of collaborative customer solution teams, and percent increase in customer collaboration contact time. These measures motivate Dell to build points of contact with the customer and to actually commit time to collaborating with its network of contacts. The remaining learning and growth measures include number of collaborative supplier product solution teams, and percent increase in supplier collaboration contact time. These measures motivate Dell to work with its suppliers to efficiently and effectively manufacture innovative products that satisfy customer needs. The business process perspective has three measures. The first measure number of customized solutions delivered by the supply chain motivates the supply chain to translate customer ideas into reality. Notice from the arrows in Exhibit 3 that the first two measures from the learning and growth perspective are intended to drive improvement in this business process measure. The second measure average customer idea supply chain ramp-up time motivates the supply chain to translate customer-driven innovations into deliverable product as efficiently as possible. After all, the customer will only value innovation if it can be delivered in a timely manner. This measure drives improvement in the number of customized solutions delivered by the supply chain. It ensures that the ideas generated by the collaborative customer solution teams are translated into actual solutions in a timely manner. The third measure supply chain

EXHIBIT 4: Dells Supply Chain Balanced Scorecard The Operational Efficiency Value Proposition

first pass defect rate motivates the supply chain to not only deliver customer-driven innovations to the marketplace quickly, but also in a high quality manner. Notice the last two business process measures are driven by the supplier-oriented measures from the learning and growth perspective. The customer perspective has three measures. The first metric customer perception of supply chains customer-driven response capability measures the customers view of how successful the supply chain is at translating its voice into new product innovations. This measure focuses on flexible response and timely delivery. The measure titled customer perception of value delivered by the supply chain evaluates the customers perception of flexible response and timely delivery with respect to quality and price. Notice the first measure from the business process perspective

(number of customized solutions delivered by the supply chain) drives improvement in the first customer perspective measure. The third business process measure (supply chain first pass defect rate) drives improvement in the customer perception of value delivered by the supply chain. The second measure from the business process perspective (average customer idea supply chain ramp-up time) drives improvement in both customer measures discussed so far. The connection to the timely delivery component of the first customer measure is clear because of the common emphasis on time. The connection to the value delivered component of the other customer measure relates to the impact of price on the perception of value. If the supply chain can shrink the amount of time and human resources committed to effectively generating customer-driven

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innovations, it in effect lowers its cost. Lowering costs increases the likelihood of establishing a price that is perceived as a good value by the customer, but nonetheless, is profitable for the supply chain. The final measure in the customer perspective customer retention is driven by the other customer measures within the BSC. In other words, customers will remain loyal if they believe that the supply chain responds to their needs in a timely, high-quality, and cost effective manner. Each customer measure focuses on the perception of the end consumer. While admittedly the customer measures are not chain-spanning in the sense that they do not incorporate feedback from anyone other than the end consumer, the feedback from the customer would be shared throughout the supply chain to identify the root causes of exceptional or unsatisfactory performance. The first financial measure captures gross margin by supply chain partner. It is driven by the measures from the customer perspective. If the supply chain succeeds in responding to the voice of the customer by delivering customized solutions in a high quality and timely manner, it should be rewarded with strong gross margins. The gross margin is measured for each supply chain partner to determine if a mutually beneficial, cooperative relationship exists. If one company uses its leverage to extract disproportionately high returns, it suggests a lack of partnership. The potential long-run effects of the adversarial approach include supplier turnover, lower quality product, and lower innovation response capability. The second financial measure evaluates increase in customized solution gross profit relative to the increase in supply chain research and development and sales expenses. It ensures that the supply chain strives to widen the gap between increasing gross margins and prudent, efficient use of the research and development and sales human resources consumed supporting the new business. The measure is driven by

all three of the measures from the customer perspective. The final financial measure is new customer acquisition revenue. It is included in the BSC based on the assumption that delivering results in the two aforementioned customer perspective measures should lead to word-of-mouth new customer acquisitions. The Operational Efficiency Value Proposition Operational efficiency is a function of getting high quality product to market in a timely and cost effective manner. The two pillars of operational efficiency for Dell are information and inventory velocity. Customers and suppliers play a critical role in this process. The customer is the order trigger point who possesses knowledge of it purchase requirements. This information needs to be transferred as quickly as possible through Dell to its suppliers to enable timely customer delivery. Similar to the customer intimacy value proposition, Dells success in terms of operational efficiency hinges upon its supply chain partners, namely the customer and suppliers. Exhibit 4 contains examples of chain-spanning BSC measures that could be used by Dell and its supply chain partners to motivate the achievement of the operational efficiency value proposition. For the learning and growth perspective, the measure supply chain investment in information sharing technology motivates Dell and its suppliers to invest in the technology that will enable continuous improvement in customer order response time. The measure number of shared data sets with suppliers motivates Dell to share information, such as demand forecasts, with suppliers to enable quick response with minimal inventory carrying costs and markdown costs. The measure number of supply chain process improvement teams motivates Dell to work with its suppliers to eliminate non-valueadded activities in the supply chain and to perform value-added activities more efficiently. The

measure number of collaborative supplier product solution teams from the learning and growth section of the customer intimacy portion of the BSC is different from this measure because the focus of the operational efficiency portion of the BSC is on process improvement as opposed to product innovation. The business process measures focus on information and inventory velocity. Indeed, the first two interrelated measures are percent improvement in customerto-supplier information cycle time and supply chain inventory velocity. Decreasing the amount of time it takes to communicate customer order information to suppliers helps synchronize production with customer demand thereby shrinking the amount of time inventory resides within the supply chain. The third business process measure supply chain quality defect resolution cycle time monitors how quickly Dell and its suppliers can redesign components to rectify customeridentified defects. Notice, each learning and growth measure drives improvement in the business process measures. More specifically, investing in information transfer technology, creating collaborative process improvement teams, and sharing data sets with suppliers enables information and inventory velocity improvements as well as quality improvements within the supply chain. The customer perspective includes a total of three measures. Two of these measures are customer perception of order-to-delivery cycle time and customer perception of service resolution response time. These measures are driven by the time-based measures from the business process perspective. They account for three components of time-based performance. First, they capture the amount of time it takes to communicate information from the customer back to the suppliers. Second, they capture the amount of time it takes to manufacture the product, or to create a solution to a quality problem. Third, they capture the amount of time it takes

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to transport a completed product, or quality improvement solution, to the customers door. These measures also control for the risk that Dell and its suppliers may be improving their time-based response capabilities, but nonetheless are not meeting customer expectations. The final customer measure is customer perception of value delivered. It is intended to capture the customers perception of quality and timely delivery relative to the sales price. Similar to the value-based customer measure in the customer intimacy portion of the BSC, this measure acknowledges that the operational efficiency value proposition must also be evaluated relative to price. Notice, the customer perception of value delivered is driven by the other two customer measures within the scorecard. The financial measures include supply chain cash-to-cash cycle, supply chain profit margin, and new customer acquisition revenue. The supply chain cashto-cash cycle is measured by adding the number of days accounts receivable outstanding for Dell to the number of days that inventory is in the supply chain, and then subtracting the number of days Dells suppliers accounts payable are outstanding. This measure can be translated into dollars by multiplying the number of days in the cash-to-cash cycle by the average dollar amount of one days worth of inventory. The measure is driven by the customers perception of order-todelivery cycle time, which is driven by the time-based measures from the business process perspective. Supply chain profit margin should be measured for the entire supply chain as well as each partner. If the supply chain satisfies the customers expectations, as stated and tracked in the customer perspective, it should drive healthy profit margins. Finally, if Dells operationally efficient supply chain provides a competitive advantage in the marketplace it should attract new customers as measured by new customer acquisition revenue.

Conclusion
In todays turbulent, fast-paced business environment, it is difficult for companies to establish a sustainable source of competitive advantage. SCM offers a promising vehicle for overcoming this problem. Companies that can work together to establish collaborative chain-spanning and non-replicable activity systems are likely to realize a sustainable advantage over their competitors that squander resources and waste time due to poor communication and lack of cooperation. This article has suggested that the key to SCM success is aligning the incentives of supply chain partners. The BSC offers a performance measurement framework that can help align supply chains by synchronizing inter-organizational efforts to learn and grow, improve business processes, deliver customer value, and achieve financial prosperity.

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References
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