He gave up a Deandom to teach and research. Thank Harvard! For, Robert S. Kaplan has, ever since, done more than any other to enhance the manager's understanding of that simple 4-letter word: cost. When the 58-year-old Marvin Bower Professor of Leadership Development at the Harvard Business School visited India for the first time in December, 1998, to deliver the keynote presentation on Integrated Cost Systems at the Confederation of Indian Industry's Second International Conference on Total Cost Management in Chennai, BT's R. Sridharan met him for 60 minutes. Excerpts from an exclusive interview about the A-B-C of the Balanced Scorecard:

Q. Mr Kaplan, how has cost, as a management concept, changed in the 20th Century?

A. Until just 15 years ago, all the people who handled cost-systems measured the past. We now recognise that we need to view cost from a future perspective. We have to understand the consequences of what we are doing, and how they influence future costs. Activity-Based Costing (ABC) helps us understand the decisions we can take to influence our costs. So, cost has shifted from a score-keeping function to a pro-active, influencing function. This makes the finance people more a part of the management team, a part of the value-adding process--and not just score-keepers.

Right. How have costing systems evolved over the decades?

From disjointed financial reporting, which I call Stage I, cost systems have moved through Stages II and III, where the quality of data and financial reporting have both improved. The best companies are in Stage III, where cost-data is customised, but is still stand-alone. In Stage IV, management reporting and control systems will be fully integrated, with information that supports both internal and external reporting. This will be able to provide performance information for operational and strategic control, and accurately measure product- and customer-profitability.

ABC has become the basis of all New Age costing systems. But most companies are still unsure about how they can implement it. How do you do it?

First, identify the purpose of the ABC project, and set up a team. Then, identify activities, choose the software, and analyse the product- and customer-profitability data. This will help you change your pricing, product-mix and design, and achieve process efficiencies. Ultimately, ABC must increase revenues and reduce operating expenses.

Are there any pre-conditions a company must fulfil before going in for ABC?

The biggest pre-conditions are dissatisfaction with your existing measurement systems, and the willingness to change.

If it is as simple as that, why do organisations run into trouble while implementing ABC?

Often, the problem is that CEOs do not fully understand what these techniques are, or adopt them without getting to the fundamentals. We feel that the ABC approach truly starts from the fundamental challenges of the business: what is it that the managers are trying to do? What are they trying to solve?

It is not that they want to build a measurement-system; they are trying to make better decisions about customers. They are trying to identify profitable customers; they are trying to understand how to be more profitable with certain segments of customers. We should demonstrate how improved cost- and performance-measurement systems will help managers achieve their objectives. The basic problem is that these approaches are advertised as techniques for their own sake, without addressing real management needs.

First it was ABC. Then it was Activity Based Management (ABM). And now, it is ABB. What is Activity Based Budgeting (ABB)?

In ABB, we begin with demand and, based on that, determine the quantity of cost-drivers we plan to supply to in future. We then associate this with the number, and the kind of activities that need to be accomplished, and link activity demand to the supply and spending of resources. That is the real story of efficiency. Virtually all the resources of a company--excluding energy and raw materials--are fixed. The only way to make them variable is to supply only those resources we need. That is what ABB is all about.

Is ABB better than ABM?

It is not a question of better or worse. ABB is simply the reverse of ABM. The latter begins with resources, and allocates them to the various activities a company performs; ABB begins with the activities that need to be performed, and then, calculates the resources requirement. Understanding the causality between the activities to be performed and the resources needed allows for accurate budgeting

Budgeting, yes. But can these numbers drive strategy?

By themselves, the numbers do not determine strategy; they influence it. To find out which market segment to enter, we need to know the segment's revenues and the cost of serving it. So, it is, essentially, a question of understanding our capabilities--including costs--and finding out where they can be best deployed. I really can't imagine how you can devise effective strategies without knowing your cost-structure and cost-drivers.

Doesn't a pre-occupation with numbers tend to paralyse strategic action?

Companies fail to execute most of the strategies they try to. The problem lies in the fact that strategies are, often, stated in word-terms, without being specified. So, people hear a general idea, and they have no way of knowing what is required. We have discovered that measurement can actually help companies implement strategies, especially ones that involve a shift from the past.

You have to get not just the senior executive team, but everybody in the organisation to understand the new strategy. We find that measurement is a powerful way of communicating what that strategy is. Then, individuals and departments can identify the actions they should be taking to help move the numbers that the organisation is using to measure its strategy.

Numbers are, obviously, not everything, as is evident from the Balanced Scorecard technique that you conceptualised. How is it different from ABC?

The Scorecard is different; not better or worse. It is, essentially, a long-term approach that measures the performance of an organisation over a period of time. If you look at private companies, they are interested not in today's or yesterday's financial performance, but in long-term performance. In order to drive long-term performance, you should have a broader set of measures--not just financials. You can't get to the goal of the best long-term financials by optimising year by year, one year at a time; you should optimise your long-term financial performance.

The Scorecard lets companies focus on customers, and how companies can create value for customers. It identifies what customers value, and focuses on processes that deliver this value, such as innovation with short lead-times; continuous cost-lowering, which is the ABC part; and employee-related measures, like employee capability and skills that enhance performance. So, the Scorecard is a broad performance measurement and management approach, and ABC is one element which tells us the cost of the processes.

How does an organisation validate its Scorecard once it has one? Are there any benchmarks?

The benchmark is the Scorecard itself. The Scorecard defines sets of cause-and-effect relationships. You collect the data, and you see whether you are getting the results you expect: if you improve the operating processes and offer new products and services, does customer satisfaction go up? If that happens, is there an increase in marketshare, and then, an improvement in financial performance? We have a whole set of linkages built into the Scorecard. By collecting data over time, and measuring how well you are doing on the various sets of measures, you will get insights into the validity of the model.

Isn't it possible for a company to achieve such improvements by measuring itself against the best-in-class benchmarks, and deploying operational improvement techniques? Why use the Scorecard?

You could do that, but that would be a limited approach. Because, if you start benchmarking, you are starting off with assumptions about your most important processes. In fact, we feel that each organisation has to first decide what its strategy is. And the importance of your processes is a function of this strategy. Now, for a company whose strategy is innovation, trying to improve manufacturing processes--even if the objective is only to become best-in-class--is a sub-optimal approach.

So, pharmaceutical companies, which are efficient in operating processes but lousy in innovation, may end up benchmarking the wrong process. It is more important for them to be good in innovation, and rapidly introduce new products and services than it is to manufacture efficiently. Given that their gross margins could be 70 or 80 per cent, a few extra expenses in manufacturing are much less consequential than being a year late to market a new product.

So, with the Scorecard, you start with your strategy and how you compete, and then decide on the critical processes. Only then does it make any sense to start benchmarking.

Your article in the Harvard Business Review (September-October, 1993) had case studies on Advanced Micro Devices (AMD), Rockwater, and Apple as practitioners of the Scorecard. Both AMD and Apple are under tremendous pressure today. What went wrong with their implementation of the Scorecard?

In both Apple and AMD, the Scorecard was done by one person; in one case, the CFO, and, in the other, the Chief Business Development Officer. It was not a group process. As we now understand it, after 5 years of dealing with the Scorecard, the critical issue in developing it is that it should be an exercise carried out by the senior executive team. I know of companies that started with the Scorecard in 1993, and, in 2 years, moved from almost the last position in their industry in terms of profitability to the first. Companies like Mobil, Chemical Bank, and Rockwater have achieved millions of dollars of operational improvements in a few years. In each case, the project was led by the CEO himself, and he engaged his executive leadership team in his efforts to create, and manage with a Scorecard. In Apple and AMD, the project was led by a staff person, not by the CEO. It was interesting to see the contrast.

Besides the lack of top management involvement, are there other threats to implementing the Scorecard?

The problem most organisations face is that their infotech group is not linked to their strategy group. Let me give you an example that we haven't written about. In 1998, the colleague whom I do most of my work on the Scorecard with, Dave Norton, was visiting a large European bank, which we knew to be an early adopter of the model. They were not one of our clients, but they had read the articles and the books, and implemented it. Dave showed the head of the bank the financial improvements in Mobil, Chemical Bank, and Rockwater--and this person kind of slumped in his chair. Dave said: "What's the matter?" And he said: "We must be the black sheep of the Scorecard family. We haven't got anything like those results you just showed me. In fact, our results have been terrible."

The chairman said that they had a great strategy, which was to offer sophisticated financial products and services to global corporations on a global basis so that they could access them anywhere in the world. But, he said, they could never get the infotech group to do these financial products and offer them in a convenient, user-friendly interface. So, the whole effort failed, and they had to sell off the unit, and lose a lot of money. Dave said: "What about your infotech group? How do they think they are doing?" The chairman said: "They think they are doing great. I asked all the units to build Scorecards, and the infotech group went off and did some benchmarking against other infotech organisations which they felt were world-class, found out what measures they employed, and, according to those measures, they are doing very well."

What went wrong? What was wrong is that the infotech group benchmarked its processes against the processes of other organisations, but did not understand the critical role it had to play in its organisation to implement strategy. That can't happen if you follow the Scorecard correctly. You start with the strategy of the organisation, and move to the strategies of the individual groups. And the strategies of these groups get linked to help the business units implement their strategies. When you get that alignment throughout the organisation, you get the leverage and the focus that yields breakthrough performance.

You have always maintained that the Scorecard should be used as a change-driver. What kind of change do you really mean?

A change is usually a change in strategy; particularly a strategy to become more customer-focused. So, you see companies shifting from product-focused organisations--focused on product-development, and processes to make products--to customer-focused organisations, which are more responsive to customer needs, and deliver products that customers want. Part of the change also involves the ability to follow a segmentation strategy. If you look at their old strategies, companies have always tried to be all things to all people, trying to satisfy customers in different segments. So, one approach involves being much more focused on a particular customer segment. The Scorecard helps articulate that, and to focus the organisation's attention on the targeted customer segments.

ABC, ABB, the Scorecardwhat next? Are there any new accounting techniques you are working on?

In its fundamental form, the ABC model helps you identify cost-drivers, and arrive at an organisation's cost-structure. One under-explored area is short-term operational control systems that give employees information on a day-to-day basis about how they can work on improving their costs. ABC is not good at that; it focuses more on strategic control. So, the Japanese use kaizen costing, but what I like best is something I have seen in a few Japanese and American companies. It is called pseudo cognoscentis, and can actually tell employees the value they create by putting a price on the output they produce. This is not a real transfer price--it is what you call a pseudo price--but it lets employees see the revenues they create in the production process, measure the costs, and find out how much profits they have generated in that period. We've seen organisations put penalties when the output produced is off-spec; we've actually seen them report losses when they produce below-quality items. And you can extend the idea to cover other things, like delivery, too.

Professor Kaplan, thank you very much for your time.

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