CASES CHADWICK, INC.: THE BALANCED SCORECARD (ABRIDGED)* The "Balanced Scorecard" article seemed to address the concems of several division managers who felt that the company was over- emphasizing short-term financial results. But the process of getting agreement on what Professor Robert 5. Kaplan prepared this case Copyright 1996 by the President and Fellows of Harvard College. Harvard Business School case 196-134 R. 5. Kaplan and D. P. Norton, "The Balanced Scorecard: Meases That Drive Performance," Harvard Business Review (January Februscy 1992). measures should be used proved a lot more difficult than I anticipated. Bill Baron, Comptroller of Chadwick, Inc. Company Background Chadwick, Inc. was a diversified producer of personal consumer products and pharmaceuti- cals. The Norwalk Division of Chadwick de- veloped, manufactured and sold ethical drugs Chapter 3 The Balanced Scorecard: Measuring Total Business Unit Performance 381 for human and animal use. It was one of five or six sizable companies competing in these mar- kets and, while it did not dominate the industry, the company was considered well-managed and was respected for the high quality of its products. Norwalk did not compete by supply- ing a full range of products. It specialized in several niches and attempted to leverage its product line by continually searching for new applications for existing compounds. Norwalk sold its products through several key distributors who supplied local markets, such as retail stores, hospitals and health ser- vice organizations, and veterinary practices. Norwalk depended on its excellent relations with the distributors who served to promote Norwalk's products to end users and also re- ceived feedback from the end users about new products desired by their customers. Chadwick knew that its long-term success depended on how much money distributors could make by promoting and selling Nor- walk's products. If the profit from selling Norwalk products was high, then these prod- ucts were promoted heavily by the distribu- tors and Norwalk received extensive commu- nication back about future customer needs. Norwalk had historically provided many highly profitable products to the marketplace, but recent inroads by generic manufacturers had been eroding distributors-sales and profit margins. Norwalk had been successful in the past because of its track record of generating a steady stream of attractive, popular products. During the second half of the 1980s, however, the approval process for new products had lengthened and fewer big winners had emerged from Norwalk's R&D laboratories. Research and Development The development of ethical drugs was a lengthy, costly, and unpredictable process. Development cycles now averaged about 12 years. The process started by screening a large number of compounds for potential benefits and use. For every drug that finally emerged as approved for use, up to 30,000 compounds had to be tested at the beginning of a new product development cycle. The de velopment and testing processes had many stages. The development cycle started with the discovery of compounds that possessed the desirable properties and ended many years later with extensive and tedious testing and documentation to demonstrate that the new drug could meet government regulations for promised benefits, reliability in produc- tion, and absence of deleterious side effects. Approved and patented drugs could gener- ate enormous revenues for Norwalk and its distributors. Norwalk's profitability during the 1980s was sustained by one key drug that had been discovered in the late 1960s. No blockbuster drug had emerged during the 1980s, however, and the existing pipeline of compounds going through development, evaluation and test was not as healthy as Nor- walk management desired. Management was placing pressure on scientists in the R&D lab to increase the yield of promising new prod- ucts and to reduce the time and costs of the product development cycle. Scientists were currently exploring new bio engineering techniques to create compounds that had the specific active properties desired rather than depending on an almost random search through thousands of possible compounds. The new techniques started with a detailed specification of the chemical properties that a new drug should have and then attempted to synthesize candidate compounds that could be tested for these properties. The bio-engi neering procedures were costly, requiring ex- tensive investment in new equipment and computer-based analysis. A less expensive approach to increase the financial yield from R&D investments was to identify new applications for existing com- pounds that had already been approved for use. While some validation still had to be 382 Chapter 8 The Balanced Scorecard: Measuring Total Business Unit Performance submitted for government approval to demonstrate the effectiveness of the drug in the new applications, the cost of extending an existing product to a new application was much, much less expensive than developing and creating an entirely new compound. Sev- eral valuable suggestions for possible new applications from existing products had come from Norwalk salesmen in the field. The salesmen were now being trained not only to sell existing products for approved applica- tions, but also to listen to end users who fre- quently had novel and interesting ideas about how Norwalk's products could be used for new applications. Manufacturing Norwalk's manufacturing processes were considered among the best in the industry. Management took pride in the ability of the manufacturing operation to quickly and effi- ciently ramp up to produce drugs once they had cleared governmental regulatory pro- cesses. Norwalk's manufacturing capabilities also had to produce the small batches of new products that were required during testing and evaluation stages. Performance Measurement Chadwick allowed its several divisions to op- erate in a decentralized fashion. Division managers had almost complete discretion in managing all the critical processes: R&D, Production, Marketing and Sales, and admin- istrative functions such as finance, human re- sources, and legal. Chadwick set challenging financial targets for divisions to meet. The targets were usually expressed as Return on Capital Employed (ROCE). As a diversified company, Chadwick wanted to be able to de- ploy the returns from the most profitable divi- sions to those divisions that held out the high- est promise for profitable growth. Monthly financial summaries were submitted by each division to corporate headquarters. The Chadwick executive committee, consisting of the chief executive officer, the chief operat- ing officer, two executive vice presidents, and the chief financial officer met monthly with each division manager to review ROCE performance and backup financial informa- tion for the preceding month. The Balanced Scorecard Project Bill Baron, Comptroller of Chadwick, had been searching for improved methods for eval uating the performance of the various divi- sions. Division managers complained about the continual pressure to meet short-tenn financial objectives in businesses that required extensive investments in risky projects to yield long-term returns, The idea of a Balanced Scorecard ap- pealed to him as a constructive way to balance short-run financial objectives with the long- tem performance of the company. Baron brought the article and concept to Dan Daniels, the President and Chief Operat- ing officer of Chadwick. Daniels shared Baron's enthusiasm for the concept, feeling that a Balanced Scorecard would allow Chad- wick divisional managers more flexibility in how they measured and presented their re- sults of operations to corporate management. He also liked the idea of holding managers accountable for improving the long-term per- formance of their division. After several days of reflection, Daniels issued a memorandum to all Chadwick divi- sion managers. The memo had a simple and direct message: Read the Balanced Scorecard article, develop a scorecard for your division, and be prepared to come to corporate head- quarters in 90 days to present and defend the divisional scorecard to Chadwick's Executive Committee. John Greenfield, the Division Manager at Norwalk, received Daniel's memorandum with some concem and apprehension. In prin- Chapter 8 The Balanced Scorecard: Measuring Total Business Unit Performance 383 ciple, Greenfield liked the idea of developing a scorecard that would be more responsive to his operations, but he was distrustful of how much freedom he had to develop and use such a scorecard. Greenfield recalled: This seemed like just another way for corporate to claim that they have decentralized decision making and authority while still retaining ul- timate control at headquarters. Greenfield knew that he would have to de- velop a plan of action to meet corporate's re- quest but lacking a clear sense of how com- mitted Chadwick was to the concept, he was not prepared to take much time from his or his subordinates' existing responsibilities for the project. The next day, at the weekly meeting of the Divisional Operating Committee, Greenfield distributed the Daniels memo and appointed a three man committee, headed by Divisional Controller, Wil Wagner, to facilitate the process for creating the Norwalk Balanced Scorecard. Wagner approached Greenfield later that day: I read the Balanced Scorecard article. Based on my understanding of the concept, we must start with a clearly defined business vision. I'm not sure I have a clear understanding of the vision and business strategy for Norwalk. How can I start to build the scorecard without this understanding? Greenfield admitted: "That's a valid point. Let me see what I can do to get you started." Greenfield picked up a pad of paper and started to write. Several minutes later he had produced a short business strategy statement for Norwalk (see Exhibit 1). Wagner and his group took Greenfield's strategy statement and started to formulate scorecard measures for the division. EXHIBIT I Norwalk Pharmaceutical Division-Business Strategy 1. Manage Norwalk portfolio of investments Minimize cost to executing our existing business base Maximize return/yield on all development spending Invest in discovery of new compounds 2. Satisfy customer needs 3. Drive responsibility to the lowest level Minimize centralized staff overhead 4. People development Industry training Unique mix of technical and commercial skills CHEMICAL BANK: IMPLEMENTING THE BALANCED SCORECARD* In early 1995, Michael Hegarty, Head of the Retail Bank of Chemical Banking Corpora- tion, was overseeing a transformation in his organization. The process had begun with the merger of Chemical and the Manufacturers Hanover Corporation at year-end 1991. The "This case was prepared by Norman Klein and Professor Robert S. Kaplan Copyright 1995 by the President and Fellows of Harvard College. Harvard Business School case 125-210. new, larger banking company was better po- sitioned to compete in a marketplace charac- terized by intense pricing competition, an outflow of deposits to mutual funds, rapidly evolving technology, and increased customer demand for value. Hegarty commented on just one indicator of the future competitive environment for retail banking: At the time of the merger, the old Chemical Banking Corporation with assets of $75 Balanced Scorecard Chadwick Inc. Read the article entitled The Balanced Scorecard: Measures that drive performance by Kaplan and Norton (Harvard Business Review Jan-Feb 1992), which has been uploaded to myelearning as background reading. Answer the following questions on the case: 1) How does the Balanced Scorecard approach differ from traditional approaches to performance measurement. What, if anything, distinguishes the balanced scorecard approach from a "measure everything, and you might get what you want" philosophy? 2) Develop the Balanced Scorecard for the Norwalk Pharmaceutical Division of Chadwick, Inc. What parts of the business strategy that John Greenfield sketched out should be included? Are there any parts that should be excluded or cannot be made operational? What are the scorecard measures you would use to implement your scorecard in the Norwalk Pharmaceutical Division? What are the new measures that need to be developed, and how would you go about developing them? 3) 3. How would a Balanced Scorecard for Chadwick, Inc. differ from ones developed in its divisions, such as the Norwalk Pharmaceutical Division? Do you anticipate that there might be major conflicts between divisional scorecards and those of the corporation? If so, should those conflicts be resolved, and if so, how should they be resolved