Strategy, Balanced Scorecard, andStrategic Profitability Analysis

Chapter 13

Learning Objective 1

Recognize which of two generic

strategies a company is using.

What is Strategy?

Strategy describes how an organization matches

its own capabilities with the opportunities in the

marketplace to accomplish its overall objectives.

What is the focus of industry analysis?• Competitors• Potential entrants into the market• Equivalent products• Bargaining power of customers• Bargaining power of input suppliers

Basic Strategies

Implementation of Strategy :

Management accountants design reports to help managers track progress in implementing strategy.

1. Product differentiation

2. Cost leadership

The Balanced Scorecard

The scorecard measures an organization’s

performance from four perspectives:

1. Financial

2. Customer

3. Internal business processes

4. Learning and growth

Learning Objective 2

Identify what comprises

reengineering.

Reengineering

Definition:

Reengineering is the fundamental rethinking and redesign of business processes to achieve improvements in critical measures of performance such as cost, quality, service,

speed, and customer satisfaction.

Reengineering Example

Customers needs identified

Purchase order issued

Production scheduled

Manufacturing completed

Finished goods to inventory

Quantities to be shippedmatched against purchase order

Shipping documents sentto Billing Department

Invoice issued

Customer payment follow up

Dallas Co. order delivery system:

Reengineering Example

The following was determined: Frequently, there is a long waiting time before production begins in the

manufacturing department. Sometimes items are held in inventory until a truck is available for

shipment. If the quantity shipped does not match the number of items requested by

the customer, a special shipment must be scheduled. Dallas discovered that the many transfers across departments slowed

down the process and created delays. A multifunctional team reengineered the order delivery process.

Reengineering Example

A customer relationship manager is responsible for each customer. Dallas will enter into long-term contracts with customers specifying

quantities and prices. The customer relationship manager will work with the customer and

manufacturing to specify delivery schedules one month in advance. The schedule of customer orders will be sent electronically to

manufacturing. Completed items will be shipped directly from the manufacturing plant to

customer sites. Each shipment will automatically trigger an invoice to be sent

electronically to the customer.

Learning Objective 3

Present the four perspectives

of the balanced scorecard.

Perspectives of Performance

1. Financial

2. Customer

3. Internal business process

4. Learning and growth

Financial Perspective

Objective: Increase shareholder value Measures: Increase in operating income

Initiatives: Target

PerformanceActual

PerformanceManage costs ofunused capacity

Build strong customerrelationships

$2,000,000

$3,000,000

6%Build strong customerrelationships

$2,100,000

$3,420,000

6.48%

Customer Perspective

Objectives: • Increase market share & Increase customer satisfaction

Measures: • Market share & Customer satisfaction survey

Initiatives: TargetPerformance

ActualPerformance

Identify future needsof customer

Identify new targetcustomer segments

6%

7

90% give toptwo ratings

Increase customer focusof sales organization

7%

8

87% give toptwo ratings

Internal Business Process Perspective

Objectives: Improve manufacturing quality and productivity, Meet specified delivery dates

Measures: Yield, On-time delivery

Initiatives: TargetPerformance

ActualPerformance

Identify problems andimprove quality

Reengineer orderdelivery process

78%

92%

79.3%

90%

Learning and Growth Perspective

Objectives: • Align employee and organization goals, Improve manufacturing

processes

Measures: • Employee satisfaction survey, Improvements in process controls

Initiatives: TargetPerformance

ActualPerformance

Employeeparticipation and

suggestion programto build teamwork

Organize R&D/manufacturing teamsto modify processes

80% ofemployees

give toptwo ratings

5

88% ofemployees

give toptwo ratings

5

Aligning the Balanced Scorecard to Strategy

Different strategies call for different scorecards. What are some of the financial perspective measures?

• Operating income• Revenue growth• Cost reduction is some areas• Return on investment

What are some of the customer perspective measures?• Market share• Customer satisfaction• Customer retention percentage• Time taken to fulfill customers requests

Aligning the Balanced Scorecard to Strategy

What are some of the internal business perspective measures?

Innovation Process:• Manufacturing capabilities, Number of new products or services,

New product development time, Number of new patents Operations Process:

• Yield Defect rates, Time taken to deliver product to customers, Percentage of on-time delivery, Percentage of on-time delivery, Setup time, Manufacturing downtime

Post-sales service:• Time taken to replace or repair defective products, Hours of

customer training for using the product

Aligning the Balanced Scorecard to Strategy

What are some of the learning and growth perspective measures?• Employee education and skill level• Employee satisfaction scores• Employee turnover rates• Information system availability• Percentage of processes with advanced controls

Pitfalls When Implementinga Balanced Scorecard

What pitfalls should be avoided when implementing a balanced scorecard?

Don’t assume the cause-and-effect linkages to be precise. Don’t seek improvements across all measures all the time. Don’t use only objective measures on the scorecard. Don’t fail to consider both costs and benefits of initiatives

such as spending on information technology and research and development.

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

Don’t use too many measures.

Learning Objective 4

Analyze changes in operating

income to evaluate strategy.

Evaluating the Successof a Strategy

Assume the following operating incomes:

Year 2003 Year 2004Revenues:

(1,000,000 × $26) $26,000,000(1,100,000 × $24) $26,400,000

Expenses:Materials 4,050,000 3,631,320Other 16,000,000 16,000,000

Operating income $ 5,950,000 $ 6,768,680

Evaluating the Success of a Strategy

How can the increase in operating income of $818,680 be evaluated?

Growth Price recovery Productivity

Growth Component:• For 2003, Dallas produced and sold 1,000,000 units at $26 per unit.• During the year 2004, Dallas produced and sold 1,100,000 units at

$24 per unit.• What is the revenue effect of growth?

Growth Component

Revenue effect of growth component

Actual units of output sold in 2004

Actual units of output sold in 2003

Output price in 2003

(1,100,000 – 1,000,000) × $26 = $2,600,000 F

This component is favorable becauseit increases operating income.

=

–

×

Growth Component

Cost effect of growth component

Actual units of input or capacity that would have been used in 2003 to produce year 2004

output assuming the same input-output relationship that existed in 2003

Actual units or capacity to produce 2003 output

Input prices in 2003

=

–

×

Growth Component

To produce 1,100,000 units in 2004 compared with the 1,000,000 units produced in 2003 (a 10% increase), Dallas would require a proportional increase in direct materials.

Assume that 3,000,000 square centimeters of materials were used to produce the 1,000,000 units in 2003 at a cost of $1.35 per square centimeter. Assume that manufacturing conversion costs, selling and customer service costs and research and development costs were $16,000,000 and remained stable during 2004.

Growth Component

What is the cost effect of the growth component?• 3,000,000 × 110% = 3,300,000 square centimeters• (3,300,000 – 3,000,000) × $1.35 = $405,000 U

What is the net increase in operating income as a result of growth?• Revenue effect of growth component $2,600,000 F• Cost effect of growth component 405,000

U• Increase in operating income due

to growth component $2,195,000 F

Price-Recovery Component

Revenue effect of price-recovery component

= (Output price in 2004 – Output price in 2003)

× Actual units of output sold in 2004

What is the revenue effect of the price-recovery component?

($24 – $26) × 1,100,000 = $2,200,000 U

Price-Recovery Component

Cost effect of price-recovery component

(Input prices in 2004 – Input prices in 2003)

Actual units of inputs or capacity that wouldhave been used to produce year 2004 outputassuming the same input-output relationship

that existed in 2003

Assume that in the year 2004, direct materialscosts were $1.31 per square centimeter.

=

×

Price-Recovery Component

What is the cost effect of the price-recovery component?

($1.31 – $1.35) × 3,300,000 = $132,000 F What is the total effect on operating income of the price-

recovery component?

Revenue effect of price-recovery component $2,200,000 UCost effect of price-recovery component 132,000 FDecrease in operating income due to price-recovery component $2,068,000 U

Productivity Component

Productivity component

Actual units of inputs or capacity toproduce year 2004 output

Input prices in 2004

=

×

Actual units of inputs or capacitythat would have been used to produceyear 2004 output assuming the same

input-output relationship that existed in 2003

–

Productivity Component

Assume that 2,772,000 actual square centimeters of direct materials were used in the year 2004.

Actual price was $1.31/square centimeter. What is the productivity component of cost changes?

(2,772,000 – 3,300,000) × $1.31 = $691,680 F

There is a $691,680 increase in operating income due to the productivity component.

Change in Operating Income

Increase in operating income$818,680

Growthcomponent

$2,195,000 F

Price-recoverycomponent

$2,068,000 U

Productivitycomponent$691,680 F

Learning Objective 5

Distinguish between engineered

and discretionary costs.

Engineered Costs vs Discretionary Costs

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

They can be variable or fixed in the short run.

Discretionary costs have two important features. They arise from periodic (usually yearly) decisions regarding

the maximum amount to be incurred. They have no measurable cause-and-effect relationship

between output and resources used.

Relationships Between Inputs and Outputs

Engineered costs differ from discretionary costs along two key dimensions:

Type of process Level of uncertainty Engineered costs pertain to processes that are detailed,

physically observable, and repetitive. Discretionary costs are associated with processes that are

sometimes called black boxes, because they are less precise and not well understood.

Learning Objective 6

Identify unused capacity

and how to manage it.

Managing Unused Capacity

What actions can management takewhen it identifies unused capacity?

Attempt to eliminate the unused capacity

Attempt to use the unused capacity to grow revenue