Smhorngren cost accounting14e CHAPTER 13 STRATEGY, BALANCED SCORECARD, AND STRATEGIC PROFITABILITY ANALYSIS

13–1

CHAPTER 13

STRATEGY, BALANCED SCORECARD, AND

STRATEGIC PROFITABILITY ANALYSIS

13–1 Strategy specifies how an organization matches its own capabilities with the

opportunities in the marketplace to accomplish its objectives.

13–2 The five key forces to consider in industry analysis are: (a) competitors, (b) potential

entrants into the market, (c) equivalent products, (d) bargaining power of customers, and (e)

bargaining power of input suppliers.

13–3 Two generic strategies are (1) product differentiation, an organization’s ability to offer

products or services perceived by its customers to be superior and unique relative to the products

or services of its competitors and (2) cost leadership, an organization’s ability to achieve lower

costs relative to competitors through productivity and efficiency improvements, elimination of

waste, and tight cost control.

13–4 A customer preference map describes how different competitors perform across various

product attributes desired by customers, such as price, quality, customer service and product

features.

13–5 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.

13–6 The four key perspectives in the balanced scorecard are: (1) Financial perspective—this

perspective evaluates the profitability of the strategy and the creation of shareholder value, (2)

Customer perspective—this perspective identifies the targeted customer and market segments

and measures the company’s success in these segments, (3) Internal business process

perspective—this perspective focuses on internal operations that further both the customer

perspective by creating value for customers and the financial perspective by increasing

shareholder value, and (4) Learning and growth perspective—this perspective identifies the

capabilities the organization must excel at to achieve superior internal processes that create value

for customers and shareholders.

13–7 A strategy map is a diagram that describes how an organization creates value by

connecting strategic objectives in explicit cause–and–effect relationships with each other in the

financial, customer, internal business process, and learning and growth perspectives.

13–8 A good balanced scorecard design has several features:

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

relationships.

2. It helps to communicate the strategy to all members of the organization by translating the

strategy into a coherent and linked set of understandable and measurable operational

targets.

3. It places strong emphasis on financial objectives and measures in for–profit companies.

Nonfinancial measures are regarded as part of a program to achieve future financial

performance.

4. It limits the number of measures to only those that are critical to the implementation of

strategy.

13–2

5. It highlights suboptimal tradeoffs that managers may make when they fail to consider

operational and financial measures together.

13–9 Pitfalls to avoid when implementing a balanced scorecard are:

1. Don’t assume the cause–and–effect linkages are precise; they are merely hypotheses. An

organization must gather evidence of these linkages over time.

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

3. Don’t use only objective measures in the balanced scorecard.

4. Don’t fail to consider both costs and benefits of different initiatives before including

these initiatives in the balanced scorecard.

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

13–10 Three key components in doing a strategic analysis of operating income are:

1. The growth component which measures the change in operating income attributable

solely to the change in quantity of output sold from one year to the next.

2. The price–recovery component which measures the change in operating income

attributable solely to changes in the prices of inputs and outputs from one year to the

next.

3. The productivity component which measures the change in costs attributable to a change

in the quantity and mix of inputs used in the current year relative to the quantity and mix of

inputs that would have been used in the previous year to produce current year output.

13–11 An analyst can incorporate other factors such as the growth in the overall market and

reductions in selling prices resulting from productivity gains into a strategic analysis of operating

income. By doing so, the analyst can attribute the sources of operating income changes to

particular factors of interests. For example, the analyst will combine the operating income effects

of strategic price reductions and any resulting growth with the productivity component to

evaluate a company’s cost leadership strategy.

13–12 Engineered costs result from a cause–and–effect relationship between the cost driver,

output, and the (direct or indirect) resources used to produce that output. Discretionary costs

arise from periodic (usually annual) decisions regarding the maximum amount to be incurred.

They have no measurable cause–and–effect relationship between output and resources used.

13–13 Downsizing (also called rightsizing) is an integrated approach configuring processes,

products, and people to match costs to the activities that need to be performed to operate

effectively and efficiently in the present and future. Downsizing is an attempt to eliminate

unused capacity.

13–14 A partial productivity measure is the quantity of output produced divided by the quantity

of an individual input used (e.g., direct materials or direct manufacturing labor).

13–15 No. Total factor productivity (TFP) and partial productivity measures work best together

because the strengths of one offset weaknesses in the other. TFP measures are comprehensive,

consider all inputs together, and explicitly consider economic substitution among inputs.

Physical partial productivity measures are easier to calculate and understand and, as in the case

of labor productivity, relate directly to employees’ tasks. Partial productivity measures are also

easier to compare across different plants and different time periods.

13–3

13–16 (15 min.) Balanced scorecard.

1. Ridgecrest’s 2012 strategy is a cost leadership strategy. Ridgecrest plans to grow by

producing high–quality boxes at a low cost delivered to customers in a timely manner.

Ridgecrest’s boxes are not differentiated, and there are many other manufacturers who produce

similar boxes. To succeed, Ridgecrest must produce high–quality boxes at lower costs relative to

competitors through productivity and efficiency improvements.

2. Solution Exhibit 13–16A shows the customer preference map for corrugated boxes for

Ridgecrest and Mesa on price, timeliness, quality and design.

SOLUTION EXHIBIT 13–16A

Customer Preference Map for Corrugated Boxes

Price

Delivery Time

Quality

Design

PoorVery good

Attribute Rating

Product Attributes

Kearney

Ridgecrest

1 2 3 4 5

13–4

3. Solution Exhibit 13–16B presents the strategy map for Ridgecrest for 2012.

SOLUTION EXHIBIT 13–16B

Strategy Map for Ridgecrest for 2012

FINANCIAL

PERSPECTIVE

CUSTOMER

PERSPECTIVE

INTERNAL–

BUSINESS–

PROCESS

PERSPECTIVE

LEARNING–

AND GROWTH–

PERSPECTIVE

Reduce

Costs

Increase

operating

income from

productivity

Improve

manufacturing

processes

Develop

process skill

Increase

market share in

corrugated

boxes market

Grow

operating

income

Increase

customer

satisfaction

Increase

new

customers

Improve

productivityImprove

quality

Deliver

on–time

Align

employee and

organization

goals

4. Measures that we would expect to see on a Ridgecrest’s balanced scorecard for 2012 are

Financial Perspective

(1) Operating income from productivity gain, (2) operating income from growth, (3) cost

reductions in key areas.

These measures evaluate whether Ridgecrest has successfully reduced costs and generated

growth through cost leadership.

Customer Perspective

(1) Market share in corrugated boxes market, (2) number of new customers, (3) customer

satisfaction index. The logic is that improvements in these customer measures are

leading indicators of whether Ridgecrest’s cost leadership strategy is succeeding with its

customers and helping it to achieve superior financial performance.

(2)

Internal Business Process Perspective

(1) Productivity, (2) order delivery time, (3) on–time delivery, (4) number of major process

improvements.

Improvements in these measures are key drivers of achieving cost leadership and are

expected to lead to more satisfied customers and in turn to superior financial performance

13–5

Learning and Growth Perspective

(1) Percentage of employees trained in process and quality management, (2) employee

satisfaction ratings.

Improvements in these measures aim to improve Ridgecrest’s ability to achieve cost

leadership and have a cause–and–effect relationship with improvements in internal business

processes, which in turn lead to customer satisfaction and financial performance.

13–17 (20 min.) Analysis of growth, price–recovery, and productivity components

(continuation of 13–16).

1. Ridgecrest’s operating income gain is consistent with the cost leadership strategy

identified in requirement 1 of Exercise 13–16. The increase in operating income in 2012 was

driven by the $150,000 gain in productivity in 2012. Ridgecrest took advantage of its

productivity gain to reduce the prices of its boxes and to fuel growth. It increased market share

by growing even though the total market size was unchanged.

2. The productivity component measures the change in costs attributable to a change in the

quantity and mix of inputs used in a year relative to the quantity and mix of inputs that would

have been used in a previous year to produce the current year output. It measures the amount by

which operating income increases and costs decrease through the productive use of input

quantities. When comparing productivities across years, the productivity calculations use current

year input prices in all calculations. Hence, the productivity component is unaffected by input

price changes.

The productivity component represents savings in both variable costs and fixed costs.

With respect to variable costs, such as direct materials, productivity improvements immediately

translate into cost savings. In the case of fixed costs, such as fixed manufacturing conversion

costs, productivity gains result only if management takes actions to reduce unused capacity. For

example, reengineering manufacturing processes will decrease the capacity needed to produce a

given level of output, but it will lead to a productivity gain only if management reduces the

unused capacity by, say, selling off the excess capacity.

13–6

13–18 (20 min.) Strategy, balanced scorecard, merchandising operation.

(Please alert students that in some printed versions of the book there is a typographical

error in line 8 of the table. It should read “Administrative cost per customer (Row 7 Row

6)” and not “(Row 8 Row 7).”

1. Roberto & Sons follows a product differentiation strategy. Roberto’s designs are

―trendsetting,‖ its T–shirts are distinctive, and it aims to make its T–shirts a ―must have‖ for each

and every teenager. These are all clear signs of a product differentiation strategy, and, to

succeed, Roberto must continue to innovate and be able to charge a premium price for its

product.

2. Possible key elements of Roberto’s balance scorecard, given its product differentiation

strategy:

Financial Perspective

(1) Increase in operating income from charging higher margins, (2) price premium earned on

products.

These measures will indicate whether Roberto has been able to charge premium prices and

achieve operating income increases through product differentiation.

Customer Perspective

(1) Market share in distinctive, name–brand T–shirts, (2) customer satisfaction, (3) new

customers, (4) number of mentions of Roberto’s T–shirts in the leading fashion magazines

Roberto’s strategy should result in improvements in these customer measures that help

evaluate whether Roberto’s product differentiation strategy is succeeding with its customers.

These measures are, in turn, leading indicators of superior financial performance.

Internal Business Process Perspective

(1) Quality of silk–screening (number of colors, use of glitter, durability of the design), (2)

frequency of new designs, (3) time between concept and delivery of design

Improvements in these measures are expected to result in more distinctive and trendsetting

designs delivered to its customers and in turn, superior financial performance.

Learning and Growth Perspective

(1) Ability to attract and retain talented designers (2) improvements in silk–screening processes,

(3) continuous education and skill levels of marketing and sales staff, (4) employee satisfaction.

Improvements in these measures are expected to improve Roberto’s capabilities to

produce distinctive designs that have a cause–and–effect relationship with improvements in

internal business processes, which in turn lead to customer satisfaction and financial

performance.

13–19 (25–30 min.) Strategic analysis of operating income (continuation of 13–18).

1. Operating Income Statement

2010

2011

Revenues ($25 198,000; $26 246,700)

$4,950,000

$6,414,200

Costs

T-shirts purchased ($10 200,000; $8.50 250,000)

2,000,000

2,125,000

Administrative costs

1,200,000

1,162,500

Total costs

3,200,000

3,287,500

Operating income

$1,750,000

$3,126,700

Change in operating income

$1,376,700 F

2. The Growth Component

Revenue effect

of growth

=

Actual units ofActual units of

output sold output sold

in 2011 in 2010

×

Selling

price

in 2010

= (246,700 198,000) $25 = $1,217,500 F

Cost effect of

growth for

variable costs

=

Units of inputActual units of

required to input used

produce 2011 to produce

×

Input

price

in 2010