Since its introduction in the early 1990s as a simple performance measurement framework, the balanced score card has practically become the standard tool with which businesses and industries, governments and nongovernmental organizations around the world align their activities to their visions and strategies.
The success of the balanced scorecard approach lies in wedding non-financial aspects – the learning and growth perspective, the business process perspective, and the customer perspective – to the traditional financial metrics, providing an organization with the tools to plan, measure and monitor performance at all levels. It takes into account not just revenues and profits, but also measures customer satisfaction, operations, employees’ skills, data and information systems and even corporate culture.
However, the recent financial crisis showed how many companies that were otherwise performing well found themselves affected because their risk management mechanisms were either too dispersed or isolated from their overall strategy.
It is not hard to see why. Most companies will always want to close as many deals as possible and will be reluctant to turn down a transaction. Even if risks are identified, these are often described as “minimal” or easy to “mitigate.” Thus, a lot of risk management is confined to keeping strict controls over financial reporting and many top executives only recognize the risks when it starts affecting the financial figures.
But just as the non-financial aspects are as important indicators as financial metrics, they are also where most of the risks to a company start out and are often more important to risk management. As the balanced scorecard approach teaches, non-financial indicators are leading, financial indicators are often lagging.
In effect, for a risk management system to be effective, it should not be laid aside as a mere contingency plan but integrated into the day-to-day functions of all aspects of an organization’s operations as well as its overall goals.
The classic balanced score card lays out the four perspectives – financial, internal business processes, learning and growth, and customer – as four equal spokes, each with its objectives, measures, targets and initiatives to achieve, or the so-called Key Performance Indicators (KPIs). To make risk management part of the balanced scorecard approach, risk indicators can be introduced to each of the perspectives to be analysed and measured along with the KPIs.
For example, if a goal is to open a branch in a Third World country, the company could risk exposing itself to political instability or to unfamiliar legal systems.
Or if a company decides to downsize its labor force to bring down costs and offers financial incentives to those willing to go, it might risk good employees who might take the separation packages and leave for the competition.
When applied to the customer perspective, this could impact on a company’s decision to for example, shift its focus to a younger market. The possible risks would be the traditional customers abandoning the company at an unexpected rate and the new clientele not staying for long.
At the very least, including risk indicators in the balanced score card ensures that possible risks are recognized and considered. This will allow executives to weigh KPIs against the risk indicators at all levels of an organization, giving them the comprehensive and balanced information they need to plan and decide company strategy, objectives or procedures or if these need to be modified.
Just as the balanced scorecard approach allows a company to clearly define and prioritize goals that everyone at all levels of the organization could achieve to improve performance, integrating risk indicators into the balanced score card will allow it to formulate and implement a strategic development risk management system.