STRATEGY EXECUTION

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The Balanced Scorecard Applications in

Internal Auditing and Risk Management

Mark L. Frigo, PhD, CPA, CMA

Sponsored by

The Institute of Internal Auditors

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Published by The Institute of Internal Auditors Research Foundation 247 Maitland Avenue Altamonte Springs, Florida 32701-4201

No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form by any means—electronic, mechanical, photocopying, recording, or otherwise—without prior written permission of the publisher. Requests to the publisher for permission should be sent electronically to: book- [email protected] with the subject line “reprint permission request.”

Limit of Liability: The IIARF publishes this document for informational and educational purposes and is not a substitute for legal or accounting advice. The IIARF does not provide such advice and makes no warranty as to any legal or accounting results through its publication of this document. When legal or accounting issues arise, professional assistance should be sought and retained.

The Institute of Internal Auditors’ (IIA’s) International Professional Practices Framework (IPPF) comprises the full range of existing and developing practice guidance for the profession. The IPPF provides guidance to internal auditors globally and paves the way to world-class internal auditing.

The IIA and The IIARF work in partnership with researchers from around the globe who conduct valuable studies on critical issues affecting today’s business world. Much of the content presented in their final reports is a result of IIARF- funded research and prepared as a service to The IIARF and the internal audit profession. Expressed opinions, interpretations, or points of view represent a consensus of the researchers and do not necessarily reflect or represent the official position or policies of The IIA or The IIARF.

ISBN-13: 978-0-89413-876-8

18 17 16 15 14 13 1 2 3 4 5 6 7 8 9

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Executive Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . vii

Acknowledgments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ix

About the Author . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xi

Chapter 1: Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

Chapter 2: The Balanced Scorecard Framework . . . . . . . . . . . . . . . . . . . . . . . . .5

Chapter 3: Strategy Maps . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11

Chapter 4: Guidelines for Using Balanced Scorecards to Manage and Measure Performance. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15

Chapter 5: Return Driven Strategy Framework . . . . . . . . . . . . . . . . . . . . . . . . . . 19

Chapter 6: Mission Driven Strategy Framework . . . . . . . . . . . . . . . . . . . . . . . . 33

Chapter 7: A Strategic GRC Framework . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41

Chapter 8: Developing a Balanced Scorecard for the Internal Audit Function . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45

Chapter 9: Using Strategy Maps for Risk Assessment and ERM . . . . . . . . . . 63

Chapter 10: How to Conduct a Strategic Risk Assessment . . . . . . . . . . . . . . . . 71

Chapter 11: Summary and Conclusions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 83

Appendix A: The IIA’s Imperatives for Change . . . . . . . . . . . . . . . . . . . . . . . . . . . . 91

Appendix B: History of the Balanced Scorecard . . . . . . . . . . . . . . . . . . . . . . . . . 93

Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 97

Contents

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The Balanced Scorecard

Glossary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .103

Bibliography . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .105

The IIA Research Foundation Sponsor Recognition . . . . . . . . . . . . . . . . . . . . . . 113

The IIA Research Foundation Board of Trustees . . . . . . . . . . . . . . . . . . . . . . . . . . 117

The IIA Research Foundation Committee of Research and Education Advisors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 119

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Figure 3.1: Strategy Map: Cause-and-Effect Relationships Among Strategic Objectives . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12

Figure 5.1: Return Driven Strategy Framework . . . . . . . . . . . . . . . . . . . . . . . . . . 21

Exhibit 6.1: Mission Driven Strategy for Internal Audit . . . . . . . . . . . . . . . . . . . 34

Exhibit 7.1: Strategic GRC Framework . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 42

Figure 8.1: A Balanced Scorecard for Internal Audit . . . . . . . . . . . . . . . . . . . . 48

Figure 9.1: Strategic Risk Management Framework . . . . . . . . . . . . . . . . . . . . . 65

Figure 9.2: Strategy Map with Embedded Risk Management Objectives . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67

Figure 10.1: Strategic Risk Assessment Process . . . . . . . . . . . . . . . . . . . . . . . . . .72

List of Figures

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The Balanced Scorecard performance management system is widely used by organizations and has become a leading management framework for strategy execution throughout the world. A 2002 report from The Institute of Internal Auditors Research Foundation (IIARF) described early usage of Balanced Scorecards and Strategy Maps in internal auditing as a way to translate strategy into action and to manage and measure internal audit performance.

These Balanced Scorecard applications have continued as internal audit professionals have sought to develop their functions strategically. The internal audit strategy to focus on enterprise risk management (ERM) and risk assess- ment provides an opportunity to use Strategy Maps in risk assessment and risk management.

This book provides the necessary background information and terminology on the Balanced Scorecard and Strategy Maps to help ensure that internal audi- tors will gain an invaluable strategic skill set. It also describes management tools, strategy frameworks, and leading practices to assist internal auditors in applying the Balanced Scorecard framework and Strategy Maps.

Developing a Strategy for the Internal Audit Function The first step in developing a Balanced Scorecard is designing a clear strategy that can then be translated into action. The book describes frameworks that can be used to develop and refine a strategy for an internal audit function. These frameworks also can be used to connect the internal audit function’s strategy with that of the enterprise.

Executive Summary

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Developing a Balanced Scorecard for the Internal Audit Function The Balanced Scorecard framework presented provides an overview of concepts and terminology. I also discuss approaches for developing a Balanced Scorecard for an internal audit function and incorporate some general examples.

Applications of the Balanced Scorecard and Strategy Maps in Risk Assessment and ERM ERM is an excellent opportunity for internal auditors to apply Strategy Maps. The book describes the approaches for using the Balanced Scorecard and Strategy Maps in risk assessment and ERM.

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I would first like to acknowledge The IIA’s Chicago Chapter for generously sponsoring this research project and facilitating a roundtable discussion to gather insights from leading practitioners.

Many internal audit professionals and thought leaders contributed their ideas and insights to help develop this book, including:

David Landsittel, former COSO Chairman Michael Pryal, Federal Signal Corporation Jeff Perkins, TransUnion Kathy Swain, Allstate Insurance Joe Steakley, HCA Healthcare Greg Kalin, Morningstar Paul Walker, St. John’s University Larry Harrington, Raytheon Company Kathy Robinson, ADP James Alexander, Unitus Community Credit Union Edward Pitts, Avago Technologies John Covell, General Growth Properties Christy Rodriguez, Caesars Entertainment Brian Brown, PricewaterhouseCoopers (PwC)

I especially thank Dick Anderson, clinical professor at DePaul University, for his collaboration in developing many of the ideas in this book. I also give special thanks to Bob Kaplan from Harvard Business School for his thought leadership in developing the Balanced Scorecard framework (with David P. Norton).

Acknowledgments

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The project could not have been done without the help of The IIA staff, especially Deborah Poulalion, and project team members from The IIA Research Foundation’s Committee of Research and Education Advisors (CREA)—Debby Munoz, James Alexander, Michael Pryal (IIA Board of Trustees), Sabrina Hearn, and Warren Stippich.

The excellent editing by Deborah Poulalion and The IIA Research Foundation’s team was especially valuable. Research Fellows from the Center for Strategy, Execution, and Valuation and Strategic Risk Management Lab at DePaul University were instrumental in conducting the chief audit executive workshop and developing the manuscript. They include Amy Frigo, Matthew Vladika, William Scherba, John Wesley, Wei Su, and Libo (Bob) Hou.

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Mark L. Frigo, PhD, CPA, CMA, is director of The Center for Strategy, Execution, and Valuation and the Strategic Risk Management Lab in the Kellstadt Graduate School of Business at DePaul University in Chicago and Ledger & Quill Alumni Foundation Distinguished Professor of Strategy and Leadership in the Driehaus College of Business at DePaul. Author of seven books and more than 100 articles, his work is published in leading business journals, including Harvard Business Review. Dr. Frigo is a member of the Duke Corporate Education network and lead instructor for the Center for Financial Leadership. He has developed and presented education courses in strategy, strategic risk management, and leader- ship strategy programs for universities, corporate universities, and professional organizations throughout North America, Asia-Pacific, and Europe.

Dr. Frigo received his bachelor of science degree in accountancy from the University of Illinois, an MBA degree from Northern Illinois University, and completed postgraduate studies in the Kellogg Graduate School of Management at Northwestern University. He received his PhD in econometrics. He is a certified public accountant (CPA) and a certified management accoun- tant (CMA).

His professional career has included corporate strategic planning, mergers and acquisitions, and management consulting at KPMG. He is the three-time recipient of the Economos Distinguished Teaching Award in the Kellstadt Graduate School of Business, and has received numerous awards by profes- sional organizations for his executive education programs. Please visit www. markfrigo.com for his latest research and publications.

About the Author

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The Balanced Scorecard was originally introduced in 1992 to improve corpo- rate performance measurement by balancing lagging metrics of financial performance with nonfinancial metrics that drive future performance. Today, the Balanced Scorecard framework and Strategy Maps are extensively used by organizations worldwide and have become a leading management tool for strategy execution.

Many of internal auditing’s best practices in performance measurement are consistent with the Balanced Scorecard approach. As a result, leading internal audit functions are using the Balanced Scorecard approach as a strategic performance management tool to add value to the organization. The Balanced Scorecard framework and Strategy Maps can help chief audit executives (CAEs) to:

 Describe and communicate the internal audit depart- ment’s strategy

 Translate that strategy into strategic objectives and performance measures

 Develop performance measures for the internal audit function that are linked to organizational strategy

 Facilitate continuous improvement in the internal audit function

Introduction

Chapter 1

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 Showcase the role and value of the internal audit function

 More effectively conduct strategic risk assessments

Recently, applying Strategy Maps as a platform for risk assessment is an approach that can be adapted by internal audit professionals in their risk assessment and risk management activities.1

This book explains the use of various frameworks, management tools, and other leading practices, including:

 The Balanced Scorecard framework  Return Driven Strategy framework  Mission Driven Strategy framework  Strategic governance, risk, and compliance (GRC)

framework  Strategic risk management framework  Strategic risk assessment process

Building on Previous Knowledge My previous book, A Balanced Scorecard Framework for Internal Auditing, was published by The Institute of Internal Auditors Research Foundation (IIARF) in 2002. It was used by CAEs and internal auditors to develop Balanced Scorecards for internal audit functions. This book provides the latest devel- opments in Balanced Scorecards and Strategy Maps. Extensive insights have been added based on a CAE roundtable hosted by The IIA’s Chicago Chapter (December 2012) and feedback received from CAEs at leading organizations, including ADP, Allstate Insurance, Federal Signal Corporation, HCA Healthcare, Morningstar, Raytheon, St. John’s University, TransUnion, Unitus Community Credit Union, and other organizations.

Benefits for Internal Audit Functions This book will enable readers to confidently answer the following questions about strategy and performance measures for their internal audit functions:

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Introduction

Strategy

 What is the strategy of your internal audit department?

 How well is the strategy understood within the internal audit department?

 How well is the strategy of the internal audit department understood by its constituents outside the department?

 How does internal audit create value for its constituents and stakeholders (board, audit committee, management, audit customers)?

Performance Measures

 How effectively do performance measures describe the strategy of your department?

 How closely are performance measures linked to your departmental strategy?

 How well are performance measures aligned with the organization’s strategies and initiatives?

 Do performance measures include leading indicators, as well as lagging indicators?

 Are cause-and-effect linkages between performance measures clear?

 How effectively are performance measures used for continuous improvement?

 How effectively do performance measures provide a way to show the value of the department?

 How do performance measures for individuals and teams reflect the departmental strategy?

 How are departmental innovations and capabilities reflected in your existing performance measures?

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The Balanced Scorecard framework is a strategic performance measurement system for executing the strategy of an organization. It provides a pathway for translating an organization’s mission and strategy into a set of actionable stra- tegic objectives and performance measures.

Background The Balanced Scorecard performance management system was introduced in 1992 by Robert S. Kaplan, Marvin Bower Professor of Leadership Development, Emeritus at Harvard Business School, and David P. Norton, founder of a number of consulting companies, including the Nolan-Norton Company, where the original Balanced Scorecard was developed.1 They introduced the Balanced Scorecard in a January–February 1992 Harvard Business Review article, “The Balanced Scorecard: Measures that Drive Performance,” and a 1996 book, The Balanced Scorecard: Translating Strategy into Action, that has been translated into 24 languages.2 Their fifth and most recent book, The Execution Premium: Linking Strategy to Operations for Competitive Advantage (2008), captures the accumulated lessons from the previous 15 years and describes how the Balanced Scorecard has become the number one management system for strategy execu- tion.3 During the last 20 years, Kaplan and Norton have helped create a new body of knowledge, key terminology, and concepts for strategy execution that is now being used throughout the private, nonprofit, and public sectors.

The Balanced Scorecard framework comprises two powerful management tools: the Balanced Scorecard4 and Strategy Maps.5

The Balanced Scorecard Framework

Chapter 2

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Focusing on Strategy Since it was developed in the 1990s, the Balanced Scorecard framework has evolved from a performance measurement system to a strategy execution system.6 By translating strategy into actionable terms and contributing to making strategy and its execution a continual process, the Balanced Scorecard has become the centerpiece of strategy execution in many organizations. It has been broadly adopted in a wide range of industries, as well as nonprofit and public sector organizations.

The Balanced Scorecard framework has been found to be useful and robust across various industries and across firms of different sizes.7 Many organizations use this hierarchy or adapt it in some way. For nonprofit and public sector orga- nizations, the architecture is modified to focus on the Mission Driven strategy, which is also described in this book.8

The Four Perspectives of the Balanced Scorecard The strategic objectives and performance measures within the Balanced Scorecard framework are derived from the strategy of the organization. The Balanced Scorecard performance measures are generally organized in a hier- archy that considers four primary perspectives: financial, customer, internal business processes, and learning and innovation. Management can use the framework to connect the strategic business activities to the ultimate goal of creating financial value.

The four perspectives of the Balanced Scorecard framework provide the structure for addressing strategic objectives in cause-and-effect linkage with related performance measures. Linkages within the hierarchy can be powerful tools for strategy evaluation and refinement.9 Generally, the cause-and-effect linkage among strategic objectives and performance measures starts with the learning and growth perspective, which drives internal process perspective performance, which, in turn, drives customer perspective performance, and ulti- mately drives performance in the financial perspective of the scorecard.

1. Financial Perspective

This perspective focuses on key financial performance of an organization. Strategic objectives and performance measures relating to return on investment, profitability, revenue growth, and other supporting financial performance are included here. Examples of performance measures in the financial perspective

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The Balanced Scorecard Framework

include operating income, return on invested capital, and annual revenue growth. The first tenet of business strategy is to ethically maximize financial value.10

The financial perspective should provide the organization with the right objectives and metrics to achieve its financial goals. This means having specific objectives and targets for key financial metrics.

2. Customer Perspective

Focusing on customer performance in areas that are most critical to the customer, this perspective includes broad objectives, such as improving customer satisfaction and customer retention, and other objectives related to specific customer needs and performance requirements. Customer perfor- mance will logically drive financial performance under the premise that the customer is the pathway to revenue growth.11 Examples of performance measures include customer satisfaction and customer retention.

The customer perspective is based on the customer value proposi- tion, which defines how the organization creates value for its customers and therefore how it creates financial value for its shareholders.12This means that customer performance measures must be aligned to the specific performance that customers demand, whether it is on-time delivery or a specific quality level of a product offering that the customer requires.

3. Internal Process Perspective

This perspective comprises internal business processes that drive customer performance, as well as ensure efficient and effective operations that directly support profitability and return on investment. At the heart of strategy execu- tion, it includes performance measures on cost, quality, and time for processes that are critical to customers; in other words, the “cheaper/faster/better” mantra that refers to the cost, time, and quality performance within the internal processes. Examples of performance measures include cost per unit, number of defects, and cycle time.

The Balanced Scorecard framework’s internal process perspective should consider the value chain of the organization as the sequence of business processes that add usefulness to the products or services of an organization, including innovation, operations, and post-sales processes.13

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The Balanced Scorecard

4. Learning and Innovation Perspective

Learning and innovation focus on performance objectives relating to employees, infrastructure, teaming, and capabilities necessary for internal processes. Examples of performance measures include employee satisfaction, hours of training per employee, and information technology expenditures per employee. This perspective focuses on translating intangible assets into tangible outcomes and encompasses human capital, information capital, and organization capital.14

Balanced Scorecard Terminology The terminology for Balanced Scorecard includes strategic objectives, perfor- mance measures, baseline performance, target performance, and supporting strategic initiatives.

Strategic Themes. Strategic themes generally involve growth and productivity. Both should be represented and described in the Balanced Scorecard. For example, a growth strategic theme could be to “grow revenue from international sales,” and a productivity strategic theme might be to “improve asset utilization.”

Strategic Objectives. Strategic objectives describe the strategy of the organization and are included in the four perspectives of the Balanced Scorecard. They are statements of what the strategy must achieve and what is critical to success. An example of a growth strategic initiative’s objective in the financial perspec- tive would be to “increase revenue from new product offerings.”

Performance Measures. This Balanced Scorecard component describes how success in achieving the strategy will be measured and tracked for a particular strategic objective. An example of a performance measure is “percentage of total revenue from new product offerings.”

Baseline Performance. This represents the current level of performance. An example of a baseline performance for “percentage of total revenue from new product offerings” might be 15 percent.

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Targets. The level of performance or rate of improvement needed is often represented by “stretch targets,” which provide a goal that is challenging, yet attainable. An example of a target for “percentage of total revenue from new product offerings” would be 20 percent (as opposed to the 15 percent baseline).

Strategic Initiatives. Key action programs or action plans are required to achieve strategic objectives. These describe the details of the actions needed, timelines, responsibility assign- ments for each step, and resources necessary to achieve the initiatives. In short, strategic objectives focus on what is to be achieved, strategic initiatives focus on how it will be achieved, and performance measures, baseline performance, and targets relate to measuring the progress.

Characteristics of the Balanced Scorecard

 Strategy focused. Performance measures are driven by mission, vision, and strategy.

 Balanced. Performance measures are balanced in terms of financial and nonfinancial measures, leading and lagging measures, and internal (internal processes) and external (customer) measures.

 Includes both financial and nonfinancial measures. Performance measure include traditional financial measures, as well as nonfinancial measures.

 Cause-and-effect linkages. Performance measures are connected using cause-and-effect linkages, and include performance drivers (leading indicators) and outcome performance measures (lagging indicators).

 Unique to the strategy. Performance measures are unique and customized to an organization’s strategy.

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Strategy Maps in the Balanced Scorecard framework are diagrams of the cause- and-effect relationships among strategic objectives.1 For example, the Strategy Map in figure 3.1 depicts linkage of strategic objectives across the four perspec- tives for a manufacturer. To “increase R&D and innovation investment” in the capabilities perspective drives the strategic objective to “develop new product offerings” in the internal process perspective, which in turn drives the efforts to “acquire new customers” and “increase profitability per customer” in the customer perspective, which ultimately drives “revenue growth” and “profit- ability” in the financial perspective. This can be referred to as the vertical logic of the Strategy Map.

The strategic objective to “develop new product offerings” refers to perfor- mance measures, such as “revenue from new products” and “margins from new products,” which lead to target level of performance and initiatives or action plans, which support the achievement of the strategic objective. This can be referred to as the horizontal logic of the Strategy Map.

Following are examples of key strategic objectives and related performance measures, as viewed from each of the four perspectives:

Financial Perspective

Strategic Objective Performance Measure

Increase return on investment Return on investment

Revenue growth Percent growth in revenue

Increase profitability Net income as a percentage of sales

Strategy Maps

Chapter 3

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Figure 3.1. Strategy Map: Cause-and-Effect Relationships Among Strategic Objectives

Author’s creation.

Strategy Map (Vertical Logic)

Financial

Customer

Return on investment

Internal

Increase profitability per customer

Innovation Increase R&D and

innovation investment

Revenue growth

Acquire new customers

Develop new product offerings

Profitability

Strategy Map (Horizontal Logic)

Strategic Objective

Performance Measures Target Initiative

Statement of what strategy must achieve and what is

critical to its success

How success in achieving the strategy will be measured and

tracked

The level of performance or rate of improvement needed

Key action plan required to achieve objectives

Example Develop leading edge, new product offerings

Example Revenue from new products

Profit margins from new product offerings

Example 15% of total revenue

Profitability >30%

Example New product

development initiative

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Strategy Maps

This financial perspective example relates to return on investment and the supporting measure of revenue growth and profitability.

Customer Perspective

Strategic Objective Performance Measure

Increase customer satisfaction Customer satisfaction ratings

Increase customer share Revenue per customer

Attract new customers Number of new customers Revenue from new customers

This customer perspective example includes some of the typical perfor- mance measures, including customer satisfaction and revenue per customer, as well as customer measures related to a growth strategy, such as number of new customers and resulting revenues.

Internal Business Processes Perspective

Strategic Objective Performance Measure

Improve on-time delivery Percentage of on-time deliveries

Improve quality performance Number of rejects

This internal business processes example includes on-time delivery and quality, which are traditional measures for a manufacturing firm.

Learning and Growth Perspective

Strategic Objective Performance Measure

Train employees on quality tools Hours of training on quality tools

This learning and growth perspective example reveals some possible cause- and-effect relationships. Increasing the training in quality tools may improve on-time delivery performance, which may improve customer satisfaction and

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The Balanced Scorecard

therefore increase return on investment. At some companies, the connec- tion between customer satisfaction and return on investment is based on the observation that more satisfied customers pay invoices faster, which results in increased accounts receivable turnover, which increases return on investment.

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Performance measures that are highly aligned with and linked to an organiza- tion’s business strategy are critical for communicating and executing strategy.1 Here are some guidelines for using Balanced Scorecards to measure and manage strategy.

1. Remember, strategy and performance measures are inseparable.

At many organizations, there are serious gaps between strategy and perfor- mance measures. This is often the result of the separation between strategy development processes and performance measurement (strategy execu- tion) processes. Instead, organizations should treat strategy development and strategy execution as parallel, interrelated processes. Strategy-focused performance measures are driven by a process that encompasses the ongoing reevaluation and redesign of business strategy, and ensures that strategy execution through performance measurement is part and parcel of the strategy design itself. This approach leads naturally to the types of performance measures the Balanced Scorecard and other strategic performance measure- ment systems encourage.

2. Always begin with strategy.

Ignoring this guideline is a common problem. The first question some managers ask when embarking on a performance measurement initiative is, “What should we measure?” or “How should we measure performance in a given area?” or “How many performance measures should we have in our scorecard?” In fact, any of these questions is the last thing management should focus on. Strategic performance measurement systems, such as the Balanced Scorecard, are first

Guidelines for Using Balanced Scorecards to Manage and Measure Performance

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The Balanced Scorecard

and foremost about strategy. This requires the development of a business strategy with execution in mind. Once the strategy is well developed, perfor- mance metrics can be identified.

3. Align strategy and performance measures with the right goal.

The highest tenet of business strategy is to ethically manage for the creation of maximum financial value. This goal provides the anchor that will help management make the right decisions in developing and executing the busi- ness strategy. Strategic performance measures must be focused on maximizing financial value creation, although many companies fail to do this because of misaligned compensation plans and/or misdirected motivations. As recent events have dramatically shown, the use of stock options can have quite the problematic incentive effects. Are the performance measures used in your organization truly leading to managing for maximum financial value creation? Or are flawed financial metrics leading in the wrong direction? Increases in revenues and earnings per share (EPS) are still widely reported as primary metrics of determining value creation. When business decisions are based on those metrics, however, the results can be disastrous, such as value-destroying mergers and acquisitions, growth at the expense of return on investment, and harvesting of assets, which may increase accounting profits, but actually destroy value.

4. Metrics should change as strategy changes.

Too often, organizations use performance measures that are no longer rele- vant to their business strategy. Existing strategy can become outdated because products and services are less needed by the marketplace, the market segment may be shrinking in size, or the way the organization creates or delivers the product or service offerings may become outmoded as new technologies become available or laws and regulations restrict or allow activities to change. It is critical that organizations consider how forces of change affect the entire value chain and how those changes can affect the interrelationships of accom- panying activities. All of this affects performance measures.

During the late 1990s, technology took center stage, reshaping the way companies conduct business and the demands consumers place on the goods and services they receive, as companies like Dell have proven. Dell’s initial strategy and performance metrics differed from competitors like Compaq. Dell initially focused on operating effectively and efficiently, which, in part, involved

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Guidelines for Using Balanced Scorecards to Manage and Measure Performance

shortening its cash conversion cycle by managing days’ sales outstanding, days in inventory, and days’ payables outstanding. But when the market demanded more innovation of offerings in product and post-sales service, Dell needed to adjust its strategy and performance metrics accordingly.

5. Use performance measures that help synchronize strategic activities.

How well do existing performance measures enable your organization to synchronize the combination of strategic competencies and supporting activi- ties to fulfill customer needs in large, growing market segments? In successful companies, all strategic activities are closely aligned and synchronized to create the right kinds of offerings.

Strategic performance measures should be closely focused and driven from the strategy. Michael Porter of Harvard Business School puts it this way, “Measure how various parts of your value chain actually fit together to lead to an overarching advantage, rather than using process-by-process metrics.”2 Are your performance measures truly unique and relevant to the strategy of the organization?

These guidelines can provide an alternative to the endless performance metric debates that have plagued corporate management over the past decade. Strategic performance measurement begins with a sound philosophy pertaining to, and a sound judgment surrounding, how strategic decisions will be made and how performance measurement will be used to make decisions and execute the strategy. Management must be vigilant in aligning performance measures with the strategy of the organization and in ensuring the strategy is executable and viable.

The Six-Stage Management System The six-stage strategy execution system developed by Kaplan and Norton provides an excellent perspective on how performance measures and results are used in executing and refining strategy.3

1. Develop the strategy. Establish the organization’s mission, vision, and strategy.

2. Translate the strategy. Include the strategy in Strategy Maps and Balanced Scorecard performance measures.

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The Balanced Scorecard

3. Align the organization. Align organizational units through the use of the Balanced Scorecard.

4. Plan operations. Develop operational plans and budgets.

5. Monitor and learn. Use strategy reviews and opera- tional reviews to learn and refine the strategy and its execution.

6. Test and adapt. Set the stage for strategy refinement and development.

This six-stage management system (most importantly, stages 1 and 2) can be adapted in developing Balanced Scorecards and Strategy Maps for internal audit departments.

Departmental Scorecards When developing performance measures, department heads should consider key strategy-related questions:

 How aligned are departmental performance measures to departmental and corporate strategies?

 How well does the departmental budget link to depart- mental and corporate strategies?

 How should we prioritize strategic initiatives?

 How well are individuals/teams in the department aligned to strategy?

Summary The last two chapters presented an overview of the Balanced Scorecard and Strategy Maps to provide perspective on the way organizations manage and measure performance. In the next two chapters, I describe strategy frameworks for developing a strategy and strategic objectives for an internal audit function, which is the first step for developing a Balanced Scorecard for internal audit.

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Prior to developing a Balanced Scorecard and Strategy Map for an internal audit function, the strategy and strategic objectives must be defined before the accompanying performance measures can be developed in a Balanced Scorecard. The next three chapters describe the Return Driven Strategy framework (introduced in the 2002 report) and the Mission Driven Strategy framework, and the importance of building a strategic internal audit function with a business perspective.1 I also discuss the importance of linking internal audit strategy with the strategy of the enterprise, and introduce the strategic governance, risk, and compliance (GRC) framework to help CAEs develop stra- tegic objectives that relate to risk assessment and risk management.2

The Return Driven Strategy framework is a way to think about internal audit as a business and to help connect its strategy with that of the enterprise. It can help CAEs to understand the enterprise’s strategy and develop a rele- vant strategy for internal audit. It describes the pattern of strategic activities of high-performance companies, regardless of industry or geographic loca- tion, and includes the strategic activities of high-performance companies, as described in the book, DRIVEN: Business Strategy, Humans Actions, and the Creation of Wealth.3

The Return Driven Strategy framework is based on extensive research of the financial performance data of more than 20,000 companies for more than 30 years of data, along with detailed study of the pattern of strategic activities in those that met stringent criteria for sustainable high performance. These compa- nies showed superior performance for ten consecutive years or more in three key performance measures: return on investment (ROI), growth, and total share- holder returns. Cash flow ROI was at least twice that of the corporate average for at least ten consecutive years, growth rates in investments made in the business

Return Driven Strategy Framework

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The Balanced Scorecard

exceeded average market growth, and total shareholder returns outperformed the market for at least a ten-year period. Approximately 100 Return Driven companies that are currently publicly traded met this set of criteria.

The Return Driven Strategy framework includes 11 tenets that represent the path to ethically create wealth. (The tenets are shown in the 11 rectangular boxes in figure 5.1.4) Tenets are arranged in a pyramid from top to bottom in order of impact on long-term financial results and valuations.

Each level in the pyramid represents a type of tenet. These levels are:

 Commitment tenet  Goal tenets  Competency tenets  Supporting tenets

Finally, the pyramid rests on three foundations, which summarize key factors of business strategy that apply to each of the 11 tenets. These foun- dations are (1) genuine assets, (2) vigilance to forces of change, and (3) disciplined performance measure and valuation.

Commitment Tenet 1. Ethically Maximize Wealth

The first tenet, which appears at the top of the Return Driven Strategy pyramid, focuses on the commitment of companies to create the most value with their resources and to do so within the ethical parameters of their constituents and communities.

More important than any other tenet, management must:

 Be committed and focused on maximizing shareholder value (achieving long-term and sustainable ROI) as its primary objective

 Manage the drivers of wealth creation—ROI and strategic growth

 Always function within the ethical boundaries and parameters set by its constituents and the communities in which the business operates (or hopes to operate in the future)

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Return Driven Strategy Framework

Ethically Maximize Wealth

Fulfill Otherwise Unmet Customer

Needs

Innovative Offerings

Map and Redesign

Processes

Partner Deliberately

Deliver Offerings

Engage Employees and

Others

Brand Offerings

Balance Focus and Options

Communicate Holistically

Target Appropriate

Customer Groups

Disciplined Performance Measurement and Valuation

Vigilance to Forces of Change

Genuine Assets

Return Driven Strategy

Figure 5.1. Return Driven Strategy Framework

Described by Kathy Apple, CEO of the National Council of State Boards of Nursing (NCSBN) as “doing the right things for the right reasons,” this tenet also includes the controls and governance necessary to conduct business within the ethical parameters of constituents and communities. Internal audi- tors provide a valuable resource for supporting this tenet of strategy.

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Goal Tenets 2. Fulfill Otherwise Unmet Customer Needs and 3. Target Appropriate Customer Groups

The two goal tenets are the second level from the top of the Return Driven Strategy pyramid. The goal tenets focus on the path to maximizing shareholder value by creating value for customers—lots of customers.

This is done by:

 Targeting economically profitable customer groups

 Targeting customer groups with growth opportunities

 Identifying otherwise unmet needs of customers

 Creating (innovating) and delivering offerings that fulfill those needs without a close substitute

 Being the dominant fulfiller of that customer group’s needs

The goal tenets focus attention on customer needs and customer groups (markets) where the organization has the unique and valuable capabilities and resources, or genuine assets. These tenets can help internal auditors understand how the business creates value for its customers, which, in turn, drives finan- cial results. They also can apply to the internal audit process in terms of fulfilling otherwise unmet customer needs and serving the right customer groups.

Competency Tenets 4. Deliver Offerings, 5. Innovate Offerings, and 6. Brand Offerings

The competency tenets, which are the third level from the top of the pyramid, focus on the offerings that the organization provides for the customer. The business must effectively deliver need-answering offerings, while balancing convenience and cost to the customer. Given scarce resources of time and money, a customer’s needs are never really fulfilled—meanwhile, profit- able offerings quickly attract substitutes. Therefore, continuous innovation (changing) of offerings) is necessary. Finally, the consumer’s mind must be

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Return Driven Strategy Framework

branded with an indelible connection between an explicit understanding of need and the offering that uniquely fulfills it. Branding is defined as making the connection between your offering and the customer’s unmet need in the mind and heart of the customer. The executability of plans must be tackled at the outset of strategy evaluation.

The competency tenets help internal auditors understand how internal processes drive customer performance, which, in turn, drives financial perfor- mance. Internal auditors can think about their own competency tenets in terms of how well they innovate, deliver, and brand their offerings.

Supporting Tenets 7. – 11. Activities to Better Achieve the Higher Tenets of the Pyramid

Five overlapping groups of activities (tenets 7-11) serve to enhance a busi- ness’s strategy and execution (see figure 5.1, the third level from the top of the pyramid). They include:

7. Partner deliberately 8. Map and redesign processes 9. Engage employees and others 10. Balance focus and options 11. Communicate holistically

Great performance is evident when these activities are focused on driving innovation, operational superiority, and branding in order to achieve the goal tenets and maximize shareholder wealth. Poor performance follows firms that engage in these supporting tenets indiscriminately.

The supporting tenets can help internal auditors understand the strategic activities that support the competency tenets and the role the internal audit function plays in these activities. The internal auditors also can think about the supporting tenets in terms of partnering deliberately with internal and external partners, understanding and improving the internal audit value chain, balancing the focus on current internal audit activities while considering innovation and growth options, communicating holistically to ensure internal audit effective- ness, and developing the internal audit brand.

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Three Foundations of Business Strategy As shown in figure 5.1, the three foundations of business strategy are (1) genuine assets, (2) vigilance to forces of change, and (3) disciplined perfor- mance measure and valuation. The following section explains these foundations and the questions that CAEs should ask about them.

1. Genuine Assets

As the 11 tenets are the verbs of strategy, the genuine assets are the nouns. Over time, activities are copied by competitors and followed by price compe- tition, and returns are reduced. By leveraging un-copiable assets (which are assets that cannot be copied, such as proprietary customer information, unique capabilities, patents, leading economies of scale and scope, distribution chain monopolies, etc.), a business can create un-substitutable offerings (offerings for which the customer cannot find a substitute). With that comes the potential for pricing premiums, higher margins and/or asset efficiency, and above-average returns and valuation. Coupled with activities described in the 11 tenets, genuine assets are the building blocks of a sustainable competitive advantage.

Questions CAEs Should Ask about the Organization’s Genuine Assets

 What are the most important genuine assets of the organization?

 How are they leveraged in the strategy?

 What are the missing genuine assets that would allow the organization to create more value?

 Which genuine assets are at risk and how can they be protected?

 What role does internal audit play in protecting the organization’s genuine assets?

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Questions CAEs Should Ask about the Internal Audit Function’s Genuine Assets

 What are the most important genuine assets of internal audit?

 How are they leveraged in the internal audit function’s strategy?

 What are the missing genuine assets that would allow the function to create more value?

2. Vigilance to Forces of Change

The Greek letter and symbol for change in mathematics (delta, ∆) forms the backdrop of the pyramid. Because business environments are so dynamic, management must leverage opportunities and avoid or manage threats arising in pursuit of each of the tenets. Major areas for vigilance include:

 Government, legal, and regulatory change  Demographic and cultural shifts and trends  Scientific and technological breakthroughs  Industry and competition

This foundation relates to the risks and opportunities in forces of change.

Questions CAEs Should Ask about the Organization’s Vigilance to Forces of Change

 What forces of change will create the most risk for the organization?

 What forces of change will create the most opportuni- ties for the organization?

Questions CAEs Should Ask about the Internal Audit Function’s Vigilance to Forces of Change

 What forces of change will create the most risk for internal audit?

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 What forces of change will create the most opportuni- ties for internal audit?

3. Disciplined Performance Measurement and Valuation

This is the bedrock foundation of the framework. Performance measures must be aligned with the tenets and foundations of the Return Driven Strategy. Performance measures should also be highly aligned with superior long-term ROI. And performance measures should include some key risk indicators for effective strategic risk management.

Questions CAEs Should Ask About Disciplined Performance Measurement and Valuation

 Does the organization have the right metrics that are aligned with long-term wealth creation?

 Does the internal audit function have the right metrics that reflect its strategic vision and value?

Thinking of Internal Audit as a Business One way to develop a strategic internal audit function is to use the Return Driven Strategy framework in thinking of internal audit as a business. For example, tenet 2 of the Return Driven Strategy framework, which focuses on identifying and fulfilling a customer’s unmet needs, can help CAEs develop a strategy that, first and foremost, addresses stakeholder needs. Tenet 3 (targeting and serving appropriate customer groups) can help CAEs develop a strategy to identify new stakeholder groups and create additional value. Tenet 5, which refers to fulfilling otherwise unmet needs, can help CAEs develop a strategy driven by changing customer needs. Strategic partnering (tenet 7) suggests including internal and external partnering as part of the internal audit strategy. CAEs can identify genuine assets and how they are (or could be) leveraged in the strategy of an internal audit function. The framework’s disci- plined performance measurement and valuation can serve as the foundation for developing strategic internal audit objectives and performance measures for an internal audit Balanced Scorecard.

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Return Driven Strategy Framework

Balanced Scorecard and Strategy Map Integration The architecture of the Return Driven Strategy is consistent with that of the Balanced Scorecard. The Balanced Scorecard architecture comprises financial, customer, internal processes, and innovation and growth perspectives.

Tenet 1 of the Return Driven Strategy framework (to ethically create wealth) represents the financial perspective of the Balanced Scorecard architec- ture. Tenets 2 and 3 (to fulfill otherwise unmet needs and target appropriate customer groups) represent the customer perspective. The competency tenets (4, 5, and 6) and the supporting tenets represent the internal processes perspective and the innovation and growth perspective. The genuine assets, which are unique (tangible and intangible) resources and capabilities, fall under the Balanced Scorecard’s innovation and growth perspective. Vigilance to forces of change is relevant to monitoring economic factors, technological factors, social factors, and laws and regulations, which also drive innovation and growth. Disciplined performance measures and valuation naturally fit well within the Balanced Scorecard approach.

Insight from Internal Audit Leaders The following question-and-answer features provide insight and perspective for applying the Return Driven Strategy framework to an internal audit func- tion. Dick Anderson, clinical professor of strategic risk management at DePaul University, discusses how key tenets of the framework help CAEs and internal auditors to develop a strategy by thinking of internal audit as a business. Paul Walker, from St. John’s University School of Risk Management, discusses keys to success for developing a strategic internal audit function.

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Thinking of Internal Audit as a Business

Richard J. (Dick) Anderson, Partner (retired) PricewaterhouseCoopers LLP, Clinical Professor of Strategic Risk Management, DePaul University

Note: Although the entire Return Driven Strategy framework can be used to develop an internal audit strategy, Dick Anderson focuses here on the aspects he believes are most critical for the internal audit function.

Focus on Internal Audit Customer Needs (Tenet 2)

My experience is that this tenet is the key to both internal audit’s strategy and how the function will add value to the organization. Explicitly understanding and then exceeding the expectations of key stakeholders is how internal audit becomes viewed as a value- adding function. While internal audit can have multiple stakeholders, the audit committee and executive management are the drivers and their expectations are the ones that matter most. At PwC, we referred to these expectations as “value drivers,” as they are the stakehold- er’s proxy for the value they expect from internal audit. Internal audit must explicitly understand these expectations and also vali- date them back to the stakeholders to ensure that there is clarity and agreement.

Deliver Offerings (Tenet 4)

Internal audit needs to follow the example of many of its businesses and seek the most efficient and effective operating processes. It must constantly challenge itself to be highly effective in its operations and consider how to improve and innovate delivery of its services. This can entail activities such as reviews and comparisons with leading practices and the deployment of new audit approaches and tools. Similar to most businesses, technology offers significant opportuni- ties to improve both efficiency and effectiveness of audit operations.

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Return Driven Strategy Framework

Strategic Partnering (Tenet 7)

One of the valuable lessons learned during the financial crisis was the need for organizations to move away from “siloed” risk and control units to increase the amount of collaboration and information sharing. This is especially the case with the organization’s risks. Accordingly, internal audit needs to consider how effectively they partner with their related risk and control functions as a core part of their strategy. This is not an organizational structure or reporting line issue, but rather a mindset issue. All the risk and control functions are serving and protecting the same organization and, therefore, need to be open to information sharing and seeking opportunities for better collabora- tion. This partnering and sharing can be done without any impairment of internal audit independence.

Engage Employees and Others (Tenet 9)

Few, if any, internal audit functions have all the skills and knowl- edge that they need to keep up with today’s fast-paced environment. Therefore, internal audit’s strategy should consider what skills it needs to address the risk profile of the organization, which of these skills it has or can reasonably develop, and which it might need from third- party support.

Vigilant to the Forces of Change (Foundation 2)

Probably the greatest challenge facing most internal audit organi- zations today is understanding and keeping up with changing risks. Internal audit must then challenge its own processes for risk assess- ment, risk monitoring, and risk identification. This must include both the internal risks related to the strategy of its business and the external and systemic risks that could impact the organization’s ability to meet its business objectives. Accordingly, a CAE must have a stra- tegic view of the organization and its businesses and be attuned to changes—both internal and external—and then ensure that the audit coverage is appropriately revised to keep pace with those changes.

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Disciplined Performance Measurement and Valuation (Foundation 3)

The best advice I can give a CAE is to ensure that performance measures clearly align with and address the expectations of the key stakeholders, and then to periodically report on performance related to each of those expectations. Too often, I observed internal audit functions diligently tracking and reporting on internally focused performance measures that, unfortunately, did not reflect or measure performance against the specific expectations of their key stake- holders. That misalignment is a recipe for disaster.

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Developing a Strategic Internal Audit Function

Dr. Paul L. Walker, James J. Schiro/Zurich Chair in Enterprise Risk Management at St. John’s University, Center for Excellence in ERM at St. John’s School of Risk Management

How would you describe the keys to success for developing a strategic internal audit function and becoming a more strategic internal auditor?

Internal auditors have to learn to think differently. That means under- standing the business, the strategy, and the related risks. It will require that they adopt a different view of the company—a view that may stretch their thinking way beyond auditing. My study describes several CAEs that have altered their thinking and become more strategic.

One of the themes of this book is “Developing a Strategy for an Internal Audit Function,” which includes “The Importance of Linking Internal Audit Strategy with the Strategy of the Enterprise.” Based on your research, what are some of the keys to success for doing this?

Our study shows the key is to first understand the business and then to take the initiative and get involved. In some cases, you’ve got to be ready to show you’ve got skills that are valuable to the board and C-suite.

What advice would you give CAEs to help them develop strategic internal audit functions?

After changing their thinking about how they can contribute, auditors may need more training. This can include business acumen, busi- ness modeling, strategy, and enterprise risk management. Additional training and skills may be critical thinking, consulting, listening, and facilitation.

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Chapter 1: Introduction

1. Mark L. Frigo, “The Balanced Scorecard: Twenty Years and Counting,” Strategic Finance, October 2012, 49–53.

Chapter 2: The Balanced Scorecard Framework

1. Mark L. Frigo, “The Balanced Scorecard: 20 Years and Counting,” Strategic Finance, October 2012, 49–53.

2. Robert S. Kaplan and David P. Norton, “The Balanced Scorecard: Measures that Drive Performance,” Harvard Business Review 70, no 1 (January–February 1992): 71–79. Robert S. Kaplan and David P. Norton, The Balanced Scorecard: Translating Strategy into Action (Boston: Harvard Business Review Press, 1996).

3. Robert S. Kaplan and David P. Norton, The Execution Premium: Linking Strategy to Operations for Competitive Advantage (Boston, MA: Harvard Business Review Press, 2008).

4. See Robert S. Kaplan and David P. Norton, “The Balanced Scorecard: Measures that Drive Performance.” Robert S. Kaplan and David P. Norton, “Putting the Balanced Scorecard to Work,” Harvard Business Review 71, no. 5 (September–October 1993): 134–142. Robert S. Kaplan and David P. Norton, “Using the Balanced Scorecard as a Strategic Management System,” Harvard Business Review 74, no. 1 (January–February 1996): 75–85. Robert S. Kaplan and David P. Norton, The Balanced Scorecard: Translating Strategy into Action (Boston, MA: Harvard Business School Press, 1996).

5. Robert S. Kaplan and David P. Norton, “Having Trouble with Your Strategy? Then Map It,” Harvard Business Review 78, no. 5 (September–October 2000): 167–176. Robert S. Kaplan and David P. Norton, Strategy Maps: Converting Intangible Assets into Tangible Outcomes (Boston, MA: Harvard Business School Press, 2004).

Notes

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6. See Robert S. Kaplan and David P. Norton, “The Balanced Scorecard: Measures That Drive Performance.” Robert S. Kaplan and David P. Norton, “Putting the Balanced Scorecard to Work,” 134–147. Robert S. Kaplan and David P. Norton, “Using the Balanced Scorecard as a Strategic Management System,” Harvard Business Review 74, no. 1 (January–February 1996): 75–85. Robert S. Kaplan and David P. Norton, The Balanced Scorecard: Translating Strategy into Action. Robert S. Kaplan and David P. Norton, The Strategy-Focused Organization: How Balanced Scorecard Companies Thrive in the New Business Environment (Boston, MA: Harvard Business School Publishing, 2001). Robert S. Kaplan and David P. Norton. “Having Trouble with Your Strategy? Then Map It.” Robert S. Kaplan and David P. Norton, Strategy Maps: Converting Intangible Assets into Tangible Outcomes.

7. Robert S. Kaplan and David P. Norton, Strategy Maps: Converting Intangible Assets into Tangible Outcomes.

8. Robert S. Kaplan and David P. Norton, “The Balanced Scorecard and Nonprofit Organizations” Balanced Scorecard Report, November–December 2002. Chapter 5 in Robert S. Kaplan and David P. Norton, The Strategy-Focused Organization: How Balanced Scorecard Companies Thrive in the New Business Environment. P. R. Niven, Balanced Scorecard Step by Step for Government and Nonprofit Agencies (New York: John Wiley & Sons, 2002).

9. Robert S. Kaplan and David P. Norton, Strategy Maps: Converting Intangible Assets into Tangible Outcomes, xii–xiii.

10. Mark L. Frigo, “Performance Measures that Drive the First Tenet of Business Strategy,” Strategic Finance, September 2003, 8–11.

11. Mark L. Frigo, “Performance Measures that Drive the Goal Tenets of Strategy,” Strategic Finance, October 2003, 9–11.

12. Robert S. Kaplan and David P. Norton, Strategy Maps: Converting Intangible Assets into Tangible Outcomes, 379–381.

13. Michael E. Porter, Competitive Advantage: Creating and Sustaining Superior Performance (New York: The Free Press, 1985).

14. Robert S. Kaplan and David P. Norton, Strategy Maps: Converting Intangible Assets into Tangible Outcomes, 203.

Chapter 3: Strategy Maps

1. Robert S. Kaplan and David P. Norton, Strategy Maps: Converting Intangible Assets into Tangible Outcomes (Boston, MA: Harvard Business School Press, 2004). Mark L. Frigo, “The Value of Strategy Maps,” Strategic Finance, March 2004, 23–25.

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Notes

Chapter 4: Guidelines for Using Balanced Scorecards to Manage and Measure Performance

1. Mark L. Frigo, “Strategy-Focused Performance Measures,” Strategic Finance, September 2002, 10–15.

2. Michael Porter, “The Importance of Being Strategic,” Balanced Scorecard Report (March–April 2002).

3. Robert S. Kaplan and David P. Norton, The Execution Premium (Boston, MA: Harvard Business School Press, 2008).

Chapter 5: Return Driven Strategy Framework

1. This chapter is adapted from the book by Mark L. Frigo and Joel Litman, DRIVEN: Business Strategy, Human Actions, and the Creation of Wealth (Chicago: Strategy & Execution, 2007). The Return Driven Strategy framework is copyrighted by Mark L. Frigo and Joel Litman. Return Driven Strategy is the registered service mark of Mark L. Frigo, PhD, in the United States Patent and Trademark Office.

2. Mark L. Frigo and Richard J. Anderson, “10 Steps to Implement the Strategic GRC Framework,” Internal Auditor, June 2009, 33–37. Used by permission.

3. Mark L. Frigo and Joel Litman, DRIVEN: Business Strategy, Human Actions, and the Creation of Wealth.

4. Ibid.

Chapter 6: Mission Driven Strategy Framework

1. Mark L. Frigo, Mission Driven Strategy: A Primer for Management Teams, 2011. Mark. L. Frigo “Mission Driven Strategy,” Strategic Finance, August 2003, 8–11.

2. Gary Hamel and C. K. Prahalad, “Strategic Intent,” Harvard Business Review 67, no. 3 (May–June 1989): 63–78.

3. Jim Collins, Good to Great: Why Some Companies Make the Leap . . . And Others Don’t (New York: Harper Business, 2001).

4. Jim Collins, “Best New Year’s Resolution? A ‘Stop Doing’ List,” USA Today, December 30, 2003.

Chapter 7: A Strategic GRC Framework

1. This chapter is adapted from Mark L. Frigo and Richard J. Anderson, “Strategic GRC: 10 Steps to Implementation,” Internal Auditor, June 2009, 33–37.

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Chapter 8: Developing a Balanced Scorecard for the Internal Audit Function

1. Porter, Michael. “What Is Strategy?” Harvard Business Review, November–December, 1996.

2. The discussion of the Balanced Scorecard for internal audit is based on Mark L. Frigo, A Balanced Scorecard Framework for Internal Auditing Departments (Altamonte Springs, FL: The Institute of Internal Auditors Research Foundation, 2000), 46–53.

3. W. Edwards Deming, Out of the Crisis (Boston, MA: The MIT Press, 2000).

4. IIA Practice Guide, Developing the Internal Audit Strategic Plan (Altamonte Springs, FL: The Institute of Internal Auditors, 2012).

Chapter 9: Using Strategy Maps for Risk Assessment and ERM

1. Portions of this chapter are based on material drawn from the following sources: Mark L. Frigo and Richard J. Anderson, “Strategic Risk Assessment: A First Step for Improving Risk Management and Governance,” Strategic Finance, December 2009, 25–33. Mark L. Frigo and Richard J. Anderson, “Strategic Risk Management: A Primer for Directors,” Director Notes (The Conference Board), July 2012. Mark L. Frigo and Richard J. Anderson, Strategic Risk Management: A Primer for Directors and Management Teams, 2010.

2. Mark L. Frigo and Mark Beasley, “Strategic Risk Management: Creating and Preserving Value,” Strategic Finance, May 2007.

3. Mark L. Frigo and Richard J. Anderson, Strategic Risk Management: A Primer for Directors and Management Teams.

4. This section is adapted from Mark L. Frigo and Richard J. Anderson, “Strategic Risk Assessment: A First Step for Improving Risk Management and Governance.”

Chapter 10: How to Conduct a Strategic Risk Assessment

1. This chapter was adapted from Mark L. Frigo and Richard J. Anderson, “Strategic Risk Assessment: A First Step for Improving Risk Management and Governance,” Strategic Finance, December 2009, with the permission of Strategic Finance and the Institute of Management Accountants, www.imanet.org.

2. Mark L. Frigo and Richard J. Anderson, “Strategic Risk Assessment: A First Step for Improving Risk Management and Governance,” 25–33.

3. Mark L. Frigo, “The Balanced Scorecard: Twenty Years and Counting,” Strategic Finance, October 2012, 49–53.

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Notes

4. Mark L. Frigo, “When Strategy and ERM Meet,” Strategic Finance, January 2008. Mark S. Beasley and Mark L. Frigo, “Strategic Risk Management: Creating and Protecting Value,” Strategic Finance, May 2007.

5. Mark L. Frigo and Venkat Ramaswamy, “Co-Creating Strategic Risk-Return Management,” Strategic Finance, May 2009.

6. For more information about co-creation see C. K. Prahalad and Venkat Ramaswamy, The Future of Competition: Co-Creating Unique Value with Customers (Boston, MA: Harvard Business School Press, 2004). Venkat Ramaswamy and Francis Gouillart, The Power of Co-Creation: Build It with Them to Boost Growth, Productivity, and Profits (New York: Free Press, 2010). Venkat Ramaswamy and K. Ozcan, “The Co-Creation Paradigm” (Palo Alto, CA: Stanford University Press, 2014, forthcoming).

7. For more information about the Strategic Risk Maturity Diagnostic and the Strategic Risk Alignment Guide, see Mark L. Frigo and Richard J. Anderson, Strategic Risk Management: A Primer for Directors and Management Teams, 2010.

8. Robert S. Kaplan and David P. Norton, The Execution Premium: Linking Strategy to Operations for Competitive Advantage (Boston, MA: Harvard Business School Press, 2008).

9. Mark L. Frigo, “Return Driven: Lessons for High Performance Companies,” Strategic Finance, July 2008. Mark L. Frigo and Joel Litman, DRIVEN: Business Strategy, Human Actions, and the Creation of Wealth (Strategy & Execution, 2007).

10. Mark L. Frigo and Richard J. Anderson, Strategic Risk Management: A Primer for Directors and Management Teams.

11. Mark L. Frigo and Richard J. Anderson, “A Strategic Framework for GRC,” Strategic Finance, February 2009.

Appendix A: The IIA’s Imperatives for Change

1. Imperatives for Change: The IIA’s Global Internal Audit Survey in Action: A Component of the CBOK Study (Altamonte Springs, FL: The Institute of Internal Auditors Research Foundation, 2011).

Appendix B: History of the Balanced Scorecard

1. Robert S. Kaplan and David P. Norton, “The Balanced Scorecard–Measures that Drive Performance,” Harvard Business Review, January–February 1992, 71–79.

2. Robert S. Kaplan and David P. Norton, The Balanced Scorecard: Translating Strategy into Action (Boston, MA: Harvard Business School Press, 1996).

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3. Mark L. Frigo, “The State of Strategic Performance Measurement: The IMA 2001 Survey,” The Balanced Scorecard Report (Boston, MA: Harvard Business School Press, November–December 2001), 13–14.

4. Darrell Rigby, Management Tools and Techniques (Bain & Company, 1999).

5. Robert S. Kaplan and David P. Norton, The Strategy-Focused Organization: How Balanced Scorecard Companies Thrive in the New Business Environment (Boston, MA: Harvard Business School Publishing, 2001).

6. Robert S. Kaplan and David P. Norton, Strategy Maps: Converting Intangible Assets into Tangible Outcomes (Boston, MA: Harvard Business School Press, 2004).

7. Robert S. Kaplan and David P. Norton, Alignment: Using the Balanced Scorecard to Create Corporate Synergies (Boston, MA: Harvard Business School Press, 2006).

8. Ibid.

9. Ibid, chapter 3.

10. Ibid, chapter 4.

11. Ibid, chapter 5.

12. Brian E. Becker, Mark A. Huselid, and Dave Ulrich, The HR Scorecard: Linking People, Strategy, and Performance (Boston, MA: Harvard Business School Press, 2001).

13. M. J. Epstein and M. J. Roy, “How Does Your Board Rate?” Strategic Finance, February 2004, 25–31. M. J. Epstein and M. J. Roy, Measuring and Improving the Performance of Corporate Boards (The Society of Management Accountants of Canada, 2001).

14. Mark L. Frigo, A Balanced Scorecard for Internal Auditing Departments (Altamonte Springs, FL: The Institute of Internal Auditors Research Foundation, 2002).

15. Mark L. Frigo, “The Balanced Scorecard: 20 Years and Counting,” Strategic Finance, 2012, 49–53.

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Balanced Scorecards. Include strategic objectives and performance measures in a hierarchy that includes financial, customer, internal process, and learning and growth perspectives.

Baseline Performance. The current level of performance for the performance measure. An example of a baseline performance for “Percentage of Total Revenue from New Product Offerings” would be 15 percent.

Cause-and-Effect Linkages. Performance measures are connected using cause-and-effect linkages. Performance measures include Performance Drivers (leading indicators) and Outcome Performance Measures (lagging indicators).

Four Perspectives of the Balanced Scorecard. The four perspectives of the Balanced Scorecard include:

Customer Perspective. This perspective focuses on customer performance in areas that are most critical to the customer. Examples of performance measures include customer satisfaction and customer retention.

Financial Perspective. This perspective focuses on return on investment and other supporting financial performance measures. Examples of perfor- mance measures include profitability, return on invested capital, and revenue growth.

Internal Business Processes Perspective. This perspective focuses on oper- ating effectively and efficiently and includes performance measures on cost, quality, and time for processes that are critical to the customers. Examples of performance measures include number of defects and cycle time.

Glossary

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Learning and Growth Perspective. This perspective focuses on perfor- mance measures relating to employees, infrastructure, teaming, and capabilities necessary for the internal processes to achieve customer performance and financial results. Examples of performance measures include employee satisfaction, employee engagement, hours of training per employee, and information technology expenditures per employee.

Performance Measures. Describe how success in achieving the strategy will be measured and tracked for a particular strategic objective. An example of a performance measure would be “percentage of total revenue from new product offerings.”

Strategic Initiatives (Action Plans). Key action programs or action plans required to achieve strategic objectives. They describe the details of what actions need to be taken, timelines for the actions, responsibility of taking the action steps, and resources for getting the action plan done.

Strategic Objectives. These are word statements of what the strategy must achieve and what is critical to success. Strategic objectives describe the strategy of the organization and are included in the four perspectives of the Balanced Scorecard. An example of a strategic objective in the financial perspective for a growth strategic initiative would be “increase revenue from new product offerings.”

Strategic Risks. Those risks that are most consequential to the organization’s ability to execute its strategies and achieve its business objectives.

Strategic Themes. Strategic themes generally involve growth and productivity themes. Both should be represented in a Balanced Scorecard framework. For example, a strategic theme could be “grow revenue from international sales” for a growth strategic theme, or “improve asset utilization” for a productivity stra- tegic theme. A Balanced Scorecard should have both growth and productivity strategic themes represented and described.

Strategy Maps. Describe the strategy of the organization and the cause-and-ef- fect linkages between the strategic objectives.

Targets. The level of performance or rate of improvement needed in the perfor- mance measure often using “stretch targets,” which provide a target that is challenging yet attainable. An example of a target performance for “percentage of total revenue from new product offerings” would be 20 percent (versus 15 percent baseline performance).

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