Governance Award: First Commonwealth Financial Corp., Indiana, PA

In 2000, after a companywide reorganization and an acquisition had failed to boost his bank’s sagging profitability, First Commonwealth Financial Corp. Chairman James Trimarchi was casting about for some way of reintroducing a performance culture at the Indiana, Pennsylvania-based regional bank. And that’s when he had a conversation with one of his own executives that would turn the company on its head.

Vice Chairman David S. Dahlmann, previously the president and chief executive officer at Southwest National Corp. in nearby Greensburg, Pennsylvania, which First Commonwealth had acquired in 1998, suggested that Trimarchi use something called a balanced scorecard to manage the company’s performance. Trimarchi read a couple of Harvard Business Review articles on the subject and decided that the highly focused, systematicu00e2u20ac”one might even say methodicalu00e2u20ac”approach might be just the thing to revive First Commonwealth’s financial performance.

Today, $6.2 billion First Commonwealth uses the balanced scorecard approach to manage all of its businessesu00e2u20ac”as well as the performance of its 13-member board of directors and members of its senior management team. Dahlmann, who has since stepped down as vice chairman but remains on the board, is an enthusiastic supporter of the scorecard approach. “It identifies those areas where it is important for us to perform well as a board,” he explains. Another director, Laurie Stern Singer, who previously had been a director at Southwest, goes even further in her assessment of the impact the scorecard has had on the board’s governance practices. “It has been a paradigm shift,” she says.

First Commonwealth has since launched a new business strategy that focuses on building profitable customer relationships rather than just pushing product, and the board is using its own scorecard to monitor the company’s progress and also to evaluate its own performance. Because it took the bold step of reengineering its governing practices in such a revolutionary way, First Commonwealth has earned Bank Director magazine’s Corporate Governance Award for 2005.

The Balanced Scorecard was introduced in 1992 by Robert S. Kaplan, a professor at the Harvard Business School, and management consultant David P. Norton. The two men cofounded a consulting firm, Lincoln, Massachusetts-based Balanced Scorecard Collaborative Inc., which helps businesses, educational institutions, and nonprofit organizations apply their concepts.

Put simply, the Balanced Scorecard is a highly systematic approach to running an organization that uses linked performance measurements across separate domainsu00e2u20ac”financial, customers, internal processes, and employee learning and growthu00e2u20ac”and enables managers and directors to focus their attention on strategy. The method is forward looking in its application since it requires the organization to define its strategy, establish a set of metrics that will be used to measure its effectiveness across those four domains, and then review its progress on an ongoing basis.

In effect, the scorecard approach forces companies to identify their strategic goals and then review their progress on a regular basis in each of the domains. At most companies, for example, strategic planning is something that occurs once a year when senior management and the board retire to a conference room for their annual planning retreat. The management team then goes back to the office and develops an annual budget for the company, after which the board measures the team’s performance against the budget and rarely looks beyond the numbers. Strategy usually isn’t dealt with again until the next planning retreat. Managers and directors at companies using the scorecard approach, on the other hand, review their strategy on an ongoing basisu00e2u20ac”and are expected to modify it as they go along if the strategy isn’t working.

Once Trimarchi decided to adopt the scorecard approach, First Commonwealth’s executive team laid out its strategic goals. For example, it wanted the bank to consistently perform in the top quartile of its peer group. The team also proposed to turn First Commonwealth into a “world-class” sales organization that could grow organically. And the team wanted all of the bank’s employees to understand the strategy and be fully committed to its implementation. (First Commonwealth’s early experience with the scorecard approach was detailed by Kaplan in a Harvard Business School case study dated Nov. 4, 2003.) In 2001, Jerry Thomchick, the company’s senior executive vice president and chief operating officer, took the first whack at designing a scorecard for the bank and its various businesses, which include retail banking and investment advisory and insurance brokerage services. The scorecard was later refined with the assistance of the Balanced Scorecard Collaborative and went into use in early 2003.

From the beginning, Trimarchi had also wanted to extend the scorecard approach to the company’s board, and as Thomchick and First Commonwealth President and Chief Executive Officer Joseph E. O’Dell rolled out the “enterprise” scorecard, Kaplan’s consulting firm started devising one for directors. Among other things, this scorecard would, as Kaplan explained in his HRB case study, “define the strategic contributions of the board, provide the board with a tool to manage its performance and that of its committees, and clarify the strategic information required by the board.” Kaplan’s firm also devised a third scorecard for the bank’s senior executives, which is linked to the company’s strategic objectives.

How does the scorecard approach work at First Commonwealth? At the enterprise level, the bank created a “strategy map” that identifies a number of key objectives in each of the four domainsu00e2u20ac”financial, customer, internal processes, and employeesu00e2u20ac”along with a set of metrics to determine whether each objective is being met. O’Dell, Thomchick, and their executive team use this analytic framework to measure their performance against the company’s strategic goals. “We think it’s a simple way to set targets and monitor progress,” says O’Dell. First Commonwealth also uses a rolling six-quarter forecast instead of a traditional one-year budget, and the scorecard metrics are reforecasted each month. This keeps the management team and board much closer to the company’s strategic plan. “This gives us a tool to focus on long-term strategy rather than just reacting to history,” O’Dell says. “That really appealed to us.”

At the board level, the strategy map for directors includes the same financial objectives as the enterprise map so that they measure the company’s performance in the same way. The directors’ map also includes several individual objectives for internal processes, although the customer domain is focused more broadly on “stakeholders,” reflecting the board’s more expansive responsibility to shareholders, regulators, and the communities the institution serves. Also, the learning and growth domain has been focused on the board’s own knowledge, skill level, and participation. Each director completes a survey after every board meeting rating the quality of the meeting and the board processes overall, and they also fill out semiannual self-evaluations of their board performance.

At each board meeting, the directors receive a scorecard report that takes the four domains and their various objectivesu00e2u20ac”there are about 13u00e2u20ac”and rates how well they are being obtained. The scorecard uses a color-coding system with green signifying that an objective is being attained ahead of plan; yellow means that an area is performing according to plan; red means the area is falling short of plan and requires immediate attention.

This approach has already provided several important benefits to First Commonwealth’s board. First, it isolates those areas where it is important for the board to perform well, including a variety of governance issues. While the company was developing its directors’ scorecard, it was also complying with both the Sarbanes-Oxley Act and a new set of listing standards from the New York Stock Exchange, which imposed significant requirements on the audit, governance, and compensation committees.

Singer, who is president of the Allegheny Valley Development Corp. and, unlike Dahlmann, does not have a banking background, says the scorecard has made it easier for her to understand what’s really going on inside the company. “I get much clearer access to operational issues and strategy than I would from a packet of financials,” she says. “It enhances your ability to understand and monitor.”

Indeed, the board used to monitor the company almost solely through its financial reports, which are historical in nature. Directors would rarely talk about the bank’s strategy, which is forward-looking by definition. “This has really pulled the organization together around strategy,” says Dahlmann.

Since adopting the scorecard approach in 2003, the company has changed a significant aspect of its business strategy. Instead of emphasizing volume and production for its own sake, First Commonwealth wants to focus on building customer relationships that are profitable over the long term and has made changes to the enterprise scorecard to reflect this strategic shift.

Although First Commonwealth directors still receive a large stack of financial reports prior to every board meetingu00e2u20ac”and are expected to digest them fullyu00e2u20ac”discussions now focus on strategic issues rather than the minutia of the numbers. “But we think that’s the role of the board,” says Thomchick. “Is the management strategy correct? And is the management team implementing it as it should? We’re trying to put our focus on what’s really important for the shareholders in the long run.”