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Strategy, Balanced Scorecard, and Strategy, Balanced Scorecard, and Strategic Profitability AnalysisStrategic Profitability Analysis

Based on Chapter 13, Based on Chapter 13, Cost Accounting, 12th ed.Cost Accounting, 12th ed.Horngren et al., Edited and Horngren et al., Edited and

Modified by C. BaileyModified by C. Bailey

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IntroductionIntroduction This topic… This topic…

– explores the use of management accounting explores the use of management accounting information for implementing and evaluating information for implementing and evaluating an organization’s strategy.an organization’s strategy.

– shows how MA information helps strategic shows how MA information helps strategic initiatives:initiatives:

• productivity improvementproductivity improvement

• reengineeringreengineering• downsizing.downsizing.

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Learning Objective 1Learning Objective 1

Recognize which of two generic Recognize which of two generic strategies a company is using strategies a company is using

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What is Strategy?What is Strategy?

Strategy describes how an organization Strategy describes how an organization matches its own capabilities with the matches its own capabilities with the opportunities in the marketplace to opportunities in the marketplace to accomplish its overall objectivesaccomplish its overall objectives..

In formulating its strategy, an organization In formulating its strategy, an organization must thoroughly must thoroughly understand the industry in understand the industry in which it operates.which it operates.

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Understanding the IndustryUnderstanding the Industry

Industry analysis focuses on five forces:Industry analysis focuses on five forces:1 CompetitorsCompetitors

– Reducing prices of products is critical for Reducing prices of products is critical for any industry to grow.any industry to grow.

– Competition today is severe along the Competition today is severe along the dimensions of price, timely delivery, and dimensions of price, timely delivery, and quality.quality.

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Understanding the IndustryUnderstanding the Industry

2 Potential entrants into the marketPotential entrants into the market– Competition usually keeps profit margins Competition usually keeps profit margins

small.small.– Existing companies probably have lower Existing companies probably have lower

costs.costs.– Existing companies also have the advantage Existing companies also have the advantage

of close relationships with customers.of close relationships with customers.

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Understanding the IndustryUnderstanding the Industry

3 Equivalent productsEquivalent products– How easily can users substitute other How easily can users substitute other

products (consider MS Windows!)products (consider MS Windows!)4 Bargaining power of customersBargaining power of customers

– Customers may obtain the products from Customers may obtain the products from other potential suppliers.other potential suppliers.

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Understanding the IndustryUnderstanding the Industry

5 Bargaining power of input suppliersBargaining power of input suppliers– Suppliers of high-quality materials can Suppliers of high-quality materials can

demand higher prices.demand higher prices.– Skilled engineers, technicians, and laborers Skilled engineers, technicians, and laborers

can demand higher wages.can demand higher wages.

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Generic StrategiesGeneric Strategies

Two generic strategies that organizations Two generic strategies that organizations use are:use are:

1 Product differentiationProduct differentiation2 Cost leadershipCost leadership

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Product DifferentiationProduct Differentiation

CustomersCustomers perceive product/service to be perceive product/service to be superior and unique relative to competitors.superior and unique relative to competitors.– Hewlett Packard in the electronics industryHewlett Packard in the electronics industry– Merck in the pharmaceutical industryMerck in the pharmaceutical industry– Coca-Cola in the soft drinks industryCoca-Cola in the soft drinks industry– Others?Others?

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Cost LeadershipCost Leadership

Achieving Achieving low costs relative to competitorslow costs relative to competitors.. How?How?

– Productivity and efficiency improvementsProductivity and efficiency improvements– Elimination of wasteElimination of waste– Tight cost controlTight cost control

– Examples? Examples? – Dell, BicDell, Bic

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Implementation of StrategyImplementation of Strategy

To be successful, a company must To be successful, a company must – formulate an effective strategyformulate an effective strategy– implement it vigorously.implement it vigorously.

Management accountantsManagement accountants play important role play important role– collecting meaningful datacollecting meaningful data– designing reports to help managers track designing reports to help managers track

progress in implementing strategy.progress in implementing strategy.

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The Balanced ScorecardThe Balanced Scorecard

The The balanced scorecard balanced scorecard translates an translates an organization’s mission and strategy into a organization’s mission and strategy into a comprehensive set of performance measures.comprehensive set of performance measures.

Does Does notnot focus solely on focus solely on financialfinancial objectives. objectives.– highlights nonfinancial objectives that an highlights nonfinancial objectives that an

organization must achieve to meet its [long-organization must achieve to meet its [long-term] financial objectives.term] financial objectives.

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The Balanced ScorecardThe Balanced Scorecard

Four key perspectivesFour key perspectives1 Financial [sales, cost, etc.]Financial [sales, cost, etc.]2 Customer [mkt shre, growth, satisfaction]Customer [mkt shre, growth, satisfaction]3 Internal business processes [innovation, impr]Internal business processes [innovation, impr]4 Learning and growth [skills, workforce]Learning and growth [skills, workforce]

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The Balanced ScorecardThe Balanced Scorecard

Attempts to balance Attempts to balance – financial and nonfinancial performance financial and nonfinancial performance

measures measures – short-run and long-run performance in a short-run and long-run performance in a

single report.single report. Why does the balanced scorecard reduce Why does the balanced scorecard reduce

manager’s emphasis on short-run financial manager’s emphasis on short-run financial performance?performance?

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The Balanced ScorecardThe Balanced Scorecard

Reduces short-term emphasis because:Reduces short-term emphasis because:– nonfinancial and operational indicators nonfinancial and operational indicators

measure measure fundamental changesfundamental changes – financial benefits of these changes may not financial benefits of these changes may not

appear in short-run earnings.appear in short-run earnings.– nonfinancial measures (leading indicators) nonfinancial measures (leading indicators)

signal the prospect of creating economic signal the prospect of creating economic value in the future.value in the future.

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Learning Objective 2Learning Objective 2

Identify key aspects of Identify key aspects of reengineeringreengineering

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Quality ImprovementQuality Improvement

One key element of a strategy to reduce costs One key element of a strategy to reduce costs is to improve quality, by…is to improve quality, by…– Reducing defectsReducing defects– Improving yields.Improving yields.

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Quality ImprovementQuality Improvement

What is needed to improve quality?What is needed to improve quality?– Nonfinancial data about Nonfinancial data about

– manufacturing process parameters (e.g., time)manufacturing process parameters (e.g., time)

– implementation of advanced process control methodsimplementation of advanced process control methods

– training of frontline workers in quality training of frontline workers in quality management techniquesmanagement techniques

– empowering workforce to make timely empowering workforce to make timely decisions, continuously improve processesdecisions, continuously improve processes

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ReengineeringReengineering

Example of Ford Motor Company: Example of Ford Motor Company: Reducing Reducing Ordering CostsOrdering Costs (HBR July-Aug. 1990)(HBR July-Aug. 1990)

– U.S. Accts. Payable in early 1980's U.S. Accts. Payable in early 1980's employed > 500employed > 500

– Set goal: Reduce by 20% to 400.Set goal: Reduce by 20% to 400. but . . .but . . .

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ReengineeringReengineering

Found that Mazda's AP dept had 4 people!!Found that Mazda's AP dept had 4 people!! Results of reengineering:Results of reengineering:

– "Invoiceless processing": If goods match "Invoiceless processing": If goods match PO, clerk receives them, and pmt is made. PO, clerk receives them, and pmt is made. (If don't match, reject shipment.)(If don't match, reject shipment.)

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ReengineeringReengineering

Old procedures required acctg dept to match Old procedures required acctg dept to match 14 data items on PO, receipt record, and 14 data items on PO, receipt record, and invoice.invoice.

Head count cut 75%Head count cut 75%

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Learning Objective 3Learning Objective 3

Present the four perspectives Present the four perspectives of the balanced scorecardof the balanced scorecard

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Perspectives of the Perspectives of the Balanced ScorecardBalanced Scorecard

There are four perspectives of the balanced There are four perspectives of the balanced scorecard:scorecard:

1 Financial perspectiveFinancial perspective2 Customer perspectiveCustomer perspective3 Internal business process perspectiveInternal business process perspective4 Learning and growth perspective Learning and growth perspective

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Financial PerspectiveFinancial Perspective

Evaluates the profitability of the strategy.Evaluates the profitability of the strategy. Focuses on how factors affect income:Focuses on how factors affect income:

– Growth (units sold, inputs need)Growth (units sold, inputs need)– Price Recovery (higher prices, lower costs)Price Recovery (higher prices, lower costs)– Productivity (efficiency of resource use)Productivity (efficiency of resource use)

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Financial PerspectiveFinancial Perspective

Objective: Objective: – Increase shareholder valueIncrease shareholder value Sample Measures: Sample Measures: – Increase in operating incomeIncrease in operating income– Revenue growth,Revenue growth,

SALES

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Aligning the Balanced Aligning the Balanced Scorecard to StrategyScorecard to Strategy

What are some of the financial perspective What are some of the financial perspective measures?measures?

– Operating incomeOperating income– Revenue growthRevenue growth– Cost reduction is some areasCost reduction is some areas– Return on investmentReturn on investment

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Customer PerspectiveCustomer Perspective

Identifies the targeted market segment and Identifies the targeted market segment and measures the company’s success in these measures the company’s success in these segments.segments.

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What are some of the customer What are some of the customer perspective measures?perspective measures?

– Market shareMarket share– Customer satisfactionCustomer satisfaction– Customer retention percentageCustomer retention percentage– Time taken to fulfill customers requestsTime taken to fulfill customers requests

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Internal Business Internal Business Process PerspectiveProcess Perspective

Focuses on internal operationsFocuses on internal operations– Create value for customersCreate value for customers– Further the financial perspective by increasing Further the financial perspective by increasing

shareholder wealth.shareholder wealth. Typical Objectives: Typical Objectives:

– Improve manufacturing capabilityImprove manufacturing capability– Reduce delivery time to customersReduce delivery time to customers– Meet specified delivery datesMeet specified delivery dates

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What are some of the internal What are some of the internal business perspective measures?business perspective measures?

– Innovation ProcessInnovation Process Manufacturing capabilitiesManufacturing capabilities Number of new products or servicesNumber of new products or services New product development timeNew product development time Number of new patentsNumber of new patents

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Internal business perspective Internal business perspective measures cont’d.measures cont’d.

– Operations ProcessOperations Process YieldYield Defect ratesDefect rates Time taken to deliver product to customersTime taken to deliver product to customers Percentage of on-time deliveryPercentage of on-time delivery Setup timeSetup time Manufacturing downtimeManufacturing downtime

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Internal business perspective Internal business perspective measures cont’d.measures cont’d.

– Post-sales servicePost-sales service Time taken to replace or repair defective Time taken to replace or repair defective

productsproducts Hours of customer training for using the Hours of customer training for using the

productproduct

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Learning and Growth PerspectiveLearning and Growth Perspective

Emphasizes capabilities ofEmphasizes capabilities of– EmployeesEmployees

• empowerment, trainingempowerment, training

– Info systemsInfo systems Typical Objectives:Typical Objectives:

» Develop process skillDevelop process skill

» Empower work forceEmpower work force

» Enhance information system capabilitiesEnhance information system capabilities

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Some Learning and Growth Perspective Some Learning and Growth Perspective MeasuresMeasures

– Employee education and skill levelEmployee education and skill level– Employee satisfaction scoresEmployee satisfaction scores– Employee turnover ratesEmployee turnover rates– Information system availabilityInformation system availability– Percentage of processes with advanced Percentage of processes with advanced

controlscontrols

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Features of a Good Features of a Good Balanced ScorecardBalanced Scorecard

1 It tells the story of a company’s strategy by It tells the story of a company’s strategy by articulating a sequence of cause-and-effect articulating a sequence of cause-and-effect relationships.relationships.

2 It assists in communicating the strategy to all It assists in communicating the strategy to all members of the organization by translating members of the organization by translating the strategy into a coherent and linked set of the strategy into a coherent and linked set of measurable operational targets.measurable operational targets.

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Features of a Good Features of a Good Balanced ScorecardBalanced Scorecard

3 In for-profit companies, the balanced In for-profit companies, the balanced scorecard places strong emphasis on financial scorecard places strong emphasis on financial objectives and measures.objectives and measures.

4 The scorecard limits the number of measures The scorecard limits the number of measures used by identifying only the most critical ones.used by identifying only the most critical ones.

5 The scorecard highlights suboptimal tradeoffs The scorecard highlights suboptimal tradeoffs that managers may make.that managers may make.

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Pitfalls When Implementing Pitfalls When Implementing a Balanced Scorecarda Balanced Scorecard

1 Don’t assume the cause-and-effect linkages Don’t assume the cause-and-effect linkages to be precise.to be precise.

2 Don’t seek improvements across all measures Don’t seek improvements across all measures all the time.all the time.

3 Don’t use only objective measures on the Don’t use only objective measures on the scorecard.scorecard.

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Pitfalls When Implementing Pitfalls When Implementing a Balanced Scorecarda Balanced Scorecard

4 Don’t fail to consider both costs and benefits Don’t fail to consider both costs and benefits of initiatives such as spending on information of initiatives such as spending on information technology and research and development.technology and research and development.

5 Don’t ignore nonfinancial measures when Don’t ignore nonfinancial measures when evaluating managers and employees.evaluating managers and employees.

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Learning Objective 4Learning Objective 4

Analyze changes in operatingAnalyze changes in operating

income to evaluate strategyincome to evaluate strategy

[We may do a case next week.][We may do a case next week.]

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Learning Objective 5Learning Objective 5

Distinguish between engineeredDistinguish between engineered

and discretionary costsand discretionary costs

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Engineered and Engineered and Discretionary CostsDiscretionary Costs

Fixed costs are tied to capacity.Fixed costs are tied to capacity. Fixed costs do not change automatically with Fixed costs do not change automatically with

changes in the level of the cost driver.changes in the level of the cost driver. How can managers reduce capacity-based How can managers reduce capacity-based

fixed costs?fixed costs? The key is understanding and managing The key is understanding and managing

unused capacity.unused capacity.

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Engineered CostsEngineered Costs

Engineered costs result specifically from a Engineered costs result specifically from a clear cause-and effect relationshipclear cause-and effect relationship between between output and the resources needed to produce output and the resources needed to produce that output.that output.

Engineered costs can be variable or fixed in Engineered costs can be variable or fixed in the short run.the short run.– Selling & customer-service costs are Selling & customer-service costs are

engineered, engineered, fixedfixed in the short run. in the short run.

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Discretionary CostsDiscretionary Costs

Two important features of discretionary costs:Two important features of discretionary costs:1 They arise from periodic (usually yearly) They arise from periodic (usually yearly)

decisions regarding the maximum amount to decisions regarding the maximum amount to be incurred.be incurred.

2 They have no clearly measurable cause-and They have no clearly measurable cause-and effect relationship between output and effect relationship between output and resources used.resources used.

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Discretionary CostsDiscretionary Costs

Discretionary costs include:Discretionary costs include:– AdvertisingAdvertising– Executive trainingExecutive training– Research and developmentResearch and development– Health careHealth care– Legal resourcesLegal resources– Public relationsPublic relations

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Relationships between Relationships between Inputs and OutputsInputs and Outputs

Engineered costs differ from discretionary costs Engineered costs differ from discretionary costs along two key dimensionalong two key dimension– Type of processType of process

» detailed, physically observable, and repetitivedetailed, physically observable, and repetitive

– Level of uncertaintyLevel of uncertainty» higher level of uncertainty about the relationship means less higher level of uncertainty about the relationship means less

likely cause-and-effect existslikely cause-and-effect exists

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End of BSC PresentationEnd of BSC Presentation