Measuring The Performance In SMES Using Skandia Navigator Accounting Essay

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In today's globalised economy, Small-to-Medium Enterprises (SMEs) are facing ever increasing competitive pressures. They need to gain new market information and knowledge to remain competitive. To increase awareness about their performance they need to consider intellectual capital. The main aim of the article is to provide a framework to use Skandia Navigator in measuring SMEs performance and to enhance awareness of SME entrepreneurs regarding the value of intellectual capital in their companies. Paper designs a implementation framework which can be applied to SMEs.

JEL classification: M10, M21

Key words: Skandia Navigator, performance management, small and medium enterprises, intellectual capital

1. Introduction

Interest on performance measurement has notably increased in the last twenty years. Particularly, it is important to note the evolution of focusing performance from a financial perspective to a non-financial perspective.

The need for companies to align their performance measurement systems with their strategic goals is well documented in the literature [(Kaplan, 1983), (Eccles, 1991), (Kaplan and Norton, 1992), (Oliver and Palmer, 1998), (Sharma, May 2005)]. These approaches have been designed primarily for use in a medium to large company context. SMEs exhibit distinct characteristics that differentiate them from the majority of their larger counterparts (Storey, 1994). Although extensive research has been carried out to investigate the needs and characteristics of performance measurement systems in large organizations, there is a distinct lack of published research on issues related to SMEs (Hudson, Smart and Bourne, 2000). Consequently, there is a need to set up the relevance of existing performance measurement approaches for SMEs and to identify a suitable process for the design and implementation of strategic performance measurement systems in this context.

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A performance measurement system is a balanced and dynamic system that enables support of decision-making processes by gathering, elaborating and analyzing information (Neely, 2002). To identifying the features of an effective performance measurement development process, it is also vital to conceptualize the content of such a process in terms of performance measure characteristics and appropriate dimensions of performance. This is significant because a development process needs both structure and relevant content to provide value effectively to businesses.

This paper will seek to adapt the system for identifying intellectual capital Skandia Navigator to be used as a performance measurement system in the SMEs.

2. SKANDIA NAVIGATOR

Skandia regards its Navigator as a future-orientated business-planning model. The Skandia Navigator, which shows similarities with the balanced scorecard, was developed in 1994 to provide Skandia with a measuring and reporting tool. It makes provision for historical measurements (financial focus), present day measurements (customer and process focus) and the measurements required of a future organization (renewal and development focus) (Skandia, 1998).

The Skandia Navigator was developed at the Swedish financial services company Skandia by a team led by Leif Edvinsson (Edvinsson and Malone, 1997). It incorporates the presumption that intellectual capital represents the difference between market and book value of the company. Leif Edvinsson developed a dynamic and holistic intellectual report reporting model called the Navigator with five areas of focus:

Financial focus captures the financial outcome of our activities.

Customer focus gives an indication on how well the organization meets the needs of its customers via services and products.

Process focus captures the actual processes of creating the services and the products which our customers desire.

Renewal and development focus aims at reassuring the organizations long-term renewal and in part its sustainability.

Human focus is the heart of the organization and is essential in an organization that creates value. It is also essential that the employees are happy with their work situation; satisfied employees lead to satisfied customers, improving the company's sales and result.

This new accounting taxonomy sought to identify the roots of a company's value by measuring hidden dynamic factors that underlie "the visible company of buildings and products" (Edvinsson and Malone, 1997). According to Edvinsson and Malone, Intellectual capital encompasses the applied experience, organizational technology, customer relationships and professional skills that provide Skandia with a competitive advantage (Edvinsson and Malone, 1997).

Edvinsson and Malone argue that intellectual capital represents such a fundamentally new way of looking at organizational value that it will never be limited to playing a supplementary role to traditional accounting (Edvinsson and Malone, 1997). Edvinsson considers intellectual capital primarily as the hidden values constituting the gap between market value and book value. The equation is:

Market value = Book value + Intellectual capital. (1)

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In 1992, when Skandia started stock-taking of the hidden values of intellectual capital, a list consisting of more than 50 valuable items such as trade marks, concessions, customer databases, IT systems, or key persons was compiled. Since the list was perceived as too long and unmanageable, items had to be grouped into fewer but decisive categories, the human dimensions, and the structural dimension, which led to a simplified definition of intellectual capital:

Intellectual capital = Human capital + Structural capital. (2)

Fig.1. Skandia's Value Scheme

Source: Roos, Roos, Dragonetti and Edvinsson, 1997

The dimensions that are "left behind when the staff has gone home," according to Edvinsson (Roos, et al, 1997), are referred to as structural capital. He highlighted the fact that human capital cannot be owned, it can only be rented. Structural capital, on the other hand, may be owned or traded from a shareholder's point of view.

The Skandia Navigator report uses up to 91 new intellectual capital metrics plus 73 traditional metrics to calculate the five areas of focus making up the Navigator model. Edvinsson and Malone concede that various indices may be redundant or of varying importance (Edvinsson and Malone, 1997). The following table summarize some of these metrics.

Edvinsson and Malone support direct counts to be compared with other direct counts to generate ratios or be transformed into money leaving only two types of measurement (Edvinsson and Malone, 1997). Monetary measures are combined using a pre-determined weighting to create an overall intellectual capital value (C) for the organization. Percentages, that can be considered measures of incompleteness, can be combined to produce the coefficient of IC efficiency (i) that captures the organization's "velocity, position, and direction". An organization's IC represents a multiplicative function of the two sums, C and i.

Organizational Intellectual Capital = i x C (3)

When trying to come up with a monetary value of an organization's IC, Edvinsson and Malone recommend reducing the number of indices available to create a more parsimonious measure (Edvinsson and Malone, 1997). They note that Navigator's five "focuses" have 36 monetary measures that cross-reference each other. They also recommend multiplying out the denominators in those that are ratios e.g., "value added/employee", and excluding from a final list any redundancies and entries that are found on the traditional balance sheet Their examination leaves them with 21 indices which they believe can act as intellectual capital measurements for a fiscal year.

Skandia's model is particularly impressive in recognizing the role of customer capital in creating value for an organization and how the very nature of customer relationships has changed. Skandia also provides a broad coverage of organizational structural and process factors with its focus on process and renewal and development contributions to organizational value that has not been attempted before. Lynn (1998) points out that Skandia assigns no value to its intellectual capital, but uses proxy measures of intellectual capital to track trends in the assumed value added.

Leibowitz and Wright (1999) and Kaes (1999) criticise the Navigator for the following reasons:

There is an amalgam of both quantitative and descriptive measures without a common basis of measurement.

The measures are infused with subjectivity that is difficult to generalize over organizations. Kaes goes as far as to say that the use is limited because of the unstandardized approach that underlies the index.

There is an inadequate treatment of the external environment, i.e. the exclusive focus on customers.

The static intellectual capital flows are not incorporated.

The index was designed specifically for a service company which limits its applicability to other industries.

In addition to the criticism expressed by Kaes and Leibowitz and Wright, it is also necessary to add that, although the Navigator is seen as the benchmark in measuring intangible assets, the multitude of measuring elements is not appropriate in the given environment. It also does not appear to make provision for the full picture within the context of this research, which is in all probability due to the fact that the company backgrounds differ to the extent that they do.

Compared to the Balanced Score Card model, where the measures are more or less prescribed, the Navigator's highlighting philosophy allows for multiple variations. The underlying philosophy is to provide the highest level of flexibility within a defined framework. Skandia wants the Navigator to be a tool for plotting a way rather than a detailed guideline. The details can be filled in later as management steers the business toward meeting its strategic goals. Being flexible and idiosyncratic to the needs of the measuring unit, the Navigator ensures that the entire business talks intellectual capital, while at the same time allowing each measuring unit to develop its own understanding. (Bontis, 1998)

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3. IMPLEMENTING SKANDIA NAVIGATOR AS MEASURING PERFORMANCE TOOL AT SMES LEVEL

To implement Skandia Navigator at SMEs level I propose an instrument that would give top-management of the companies a tool for measuring performance in a dynamic and holistic way. Based on a literature review, I developed a procedure for implementing Skandia navigator in small to medium sized companies. The procedure prescribes a top down approach that derives indicators from the strategic model of the firm. Fig. 2 shows the four phases described by methodology.

In the strategic modeling phase, top management will traces business goals and key success factors following a mutual workshop setting. These business goals and key success factors will be communicated to operational management who then select the suitable indicators for company to make the theoretical concepts measurable. In the measurement phase, data will be then collected for the chosen indicators. After a measurement cycle had been completed, the data will be analyzed, presented to top management and interpreted providing feedback.

4. CONCLUSION

Although there was widespread acceptance of the value of strategic performance measurement evident among the managers of the SMEs studied, none had taken steps to redesign or update their current performance measurement systems. This suggests that there are substantial barriers to strategic performance measurement system development in SMEs.

The Skandia Navigator is a collection of intangibles measurements methods, pioneered by Leif Edvinsson at Skandia. The Navigator comprises a holistic view of performance and goal achievement. The architecture of the Skandia Navigator is simple yet very sophisticated. Therefore I consider that it can be used to measure performance at the SMEs level, highlighting the entire value of the company. SMEs managers must select indicators relevant to their domain and their size.