978-0077733773 Chapter 1 Solution Manual Part 4

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Chapter 01 – Cost Management and Strategy

PROBLEMS

1-45 Strategy; Downsizing Luxury (15 min)

BMW, Tiffany, Audi and Mercedes-Benz are-well known luxury brands and

their products are know to be among the most highly-regarded and

expensive in their respective product markets. So it is clear that their

competitive strategy is differentiation.

Does the the move into downmarket products mean the firms are

moving to a cost leadership strategy? Not likely, as the reason for the

popularity of the new, less expensive products is the attachment to the

luxury brand. So the question arises, can this new strategy lead to what

Michael Porter calls ”getting stuck in the middle.” As explained in the text,

Porter’s view is that a company cannot succed at both cost leadership and

differentiation. That is, the customer is attracted to the products becuase

of the low price or the differentiation, and a mixing of the two will lead to

confusion in the market and loss of the differentiation. Will the less

expensive products dilute the luxury brand?

So, the expansion of the these companies to the downmarket creates

a risk for these companies that the brand can be dilulted, and of less value.

However, as Mark Del Rosso (chief operating officer of Audi of America)

notes in a recent BloombergBusinessweek article (“The Downside of Low-

End Luxury Cars”), “Consumers ultimately choose the products that best

suit their lifestyle, and what we are seeing is that the (Audi) A4 has not

faced any lost volume, and that A3 sales have provided incremental gains.”

Whether the more expensive products of the Audi brand will continue to be

unaffected is a question that will be answered in the coming years.

Source: “The Downside of Low-End Luxury Cars,” Mark Clothier,

BloombergBusinessweek, July 21, 2014; “Tiffany Moves Down Market and

Makes a Mint,” Kyle Stock, Bloomberg Businessweek, May 21, 2014.

In a similar manner, the motorcycle maker Buell which is known as one of

the best and most expensive bikes in the world, and having a proud racing

tradition, is now testing the waters of entering the market for low-price

motorcycles. Source: “High-End Motorcycles Meet India’s Mopeds,”

Bloomberg Businessweek, August 25, 1914, pp 52-53.

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Chapter 01 – Cost Management and Strategy

1-46 Current Economic Information; Use of the Internet (30 min)

Information obtained from the Federal Reserve Board site, in March 2015:

http://www.federalreserve.gov/apps/fof/FOFTables.aspx

Gross Domestic Product (Table F6)

Gross domestic product gained 12% from the period 2011 to 2014, rising

from $15,517 billion in 2011 to $17,418 billion in 2014. Overall this is a

sign of a economic recovery. This can be compared to the 2007-2009

period of the recession in which there was virtually no gain in GDP. GDP

is an important measure of economic activity, so this is clearly a positive

sign for the recovery.

Home Mortgages (Table F218)

On almost every dimension, home mortgage assets fell from 2011 to 2014,

continuing the pattern of 2007 to 2010. Despite a small increase in 2014,

all sectors were down a total $139 billion during the 2011-2014 period, a

five percent decline over the period. Media reports during this time have

explained that the housing bust was a key factor in the slow economic

recovery, and this data is consistent with that.

Overall, these figures reflect an economy slowly recovering from recession

at the time the data was obtained.

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Education.

1.47 Strategy; Innovation (15 min)

The rate of innovation is higher in software and services, semiconductors,

pharmaceuticals, biotech, and technology hardware because the firms in

these industries compete largely on innovation. For example, a drug firm

is successful to the extent it is able to develop new drugs; cost efficiency

is not a key to its success, and it is unlikely to be a cost leader. The only

exception to this might be a manufacturer of generic drugs, where quality

as well as cost leadership would be important.

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Education.

Chapter 01 – Cost Management and Strategy

1-48 Enterprise Risk Management (20 min)

The risk factors in the UHG (United Health Group) ERM appear to be

relatively comprehensive. A manufacturer will have different risk factors

than a service firm such as UHG, so the ERM of the auto parts

manufacturer would recognize these differences. For example, while the

auto manufacturer will likely have a risk category for the external

environment, under this category it would have a risk factor of, for

example, trend in input prices or in auto demand instead of trend in medical

loss/utilization.

Also, an auto parts manufacturer will likely place much more

emphasis on risk factors in the category, business process execution. As a

manufacturer, most of the cost and risk lies in this category –

manufacturing costs, warranty liability, raw materials costs and availability,

etc, will be important risk factors in this category.

Another difference is in the analysis and reporting category. It is

much more likely that a manufacturer will also have a sustainability report

as part of its reporting process. Investors and regulators are likely to

expect this. UHG’s operations do not have the environmental impact of an

auto manufacturer.

The risk category, business strategies and policies, is likely to look

somewhat similar for a manufacturer. While the strategies and policies will

be different, the types of risks listed by UHG are likely to be similar to those

faced by a manufacturer.

The risk category, people, will likely differ somewhat for a

manufacturer. Rather than a focus on fraud and abuse and leadership, the

manufacturer will likely be more focused on productivity and people who

are able to adapt and perform in a very cost leadership type of competition

that is common to this type of manufacturing.

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Education.

Chapter 01 – Cost Management and Strategy

1-48 (continued -1)

The category, technology and data, is also likely to be different for a

manufacturer. While data management is critical for a health insurance

and health services company like UHG that has many customers, the data

management issues will likely be less challenging for the manufacturer.

The manufacturer needs effective systems to track production costs,

operating performance, sustainability measures, and financial performance;

this is likely to be a simpler technology than for UHG.

For a broad example of the risks that CFOs from many industries are

concerned about, a 2012 survey by CFO magazine finds that CFOs find

the following to be the most important risks in their firms (and percentage of

CFOs indicating the risk is important to their firm):

Customer demand/profitability (66%)

Workforce capabilities/talent management (41%)

Recent or pending regulatory requirement (35%)

Commodity costs (27%)

Technology/data security(22%)

Risks in markets overseas (14%)

Availability of credit/bank relationships (13%)

Inflation (9%)

Natural disasters (7%)

Tax policies (5%)

Source: Patrick H. Stroh, “Enterprise Risk Management at United Health

Group (UHG),” Strategic Finance, July 2005, pp 27-35; Kate O. Sullivan,

“Keeping Cool in the Hot Seat,” CFO Magazine, March 2012, pp 39-424

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Education.

Chapter 01 – Cost Management and Strategy

1-49 Strategy; Service Company (20 min)

1. Full Frame employs the cost leadership strategy by focusing primarily

on low price and profitability through growth. This is consistent with

Clyde’s description of the business as one that is difficult to

differentiate.

2. Clyde’s pricing and employee-incentive policies are consistent with

the cost leadership strategy. The fact that the business has grown

from one to five stores in the past seven years is an indication that

the strategy is working.

Potential problems:

a. While the growth strategy should work for a time, there is likely to

be a limit to the total demand, within Clyde’s community for the

framing type of service that Full Frame provides. Clyde may have

to franchise the business or expand it beyond his current family –

adding stores in other communities or perhaps other cities and

states. This will require a professional level of management that

Clyde will have to adopt if he wants the business to continue to

grow.

b. Managing a company with the help of family members has its own

set of rewards and potential problems. It may be more difficult to

resolve disputes and to effectively employ performance

management.

c. Clyde’s current incentive plan rewards all employees for stores

where efficiency has improved. The incentive might be more fair

and effective if it could be targeted to each employee; however,

there might be difficulty in measuring performance at the individual

employee level.

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Education.

Chapter 01 – Cost Management and Strategy

1-50 Strategy: Brand Value (15 min)

This question is intended for class discussion. Some students will be

surprised by some of the firms on the two lists, and also by firms that are

missing from the lists. The major point of the exercise is to discuss the

nature of the differentiation strategy and how firms that have developed

valuable brands have succeeded in making this differentiation. Ask the

class if they themselves, or they expect others, would pay more for

products of the firms on the top brands list. Those that say yes will be

acknowledging the “earnings premium” that Interbrand Corp. refers to in its

analysis.

As an aside, the list of top 10 brands for 2014 has 7 of the 10 companies

in both the 2014 and the 2010 list, with Toyota and Samsung entering the

list in 2012 and Mercedes-Benz entering the list in 2014. The lists each

year from 2010-2014 are otherwise quite similar. Many of these firms have

been on the list for several years.

Note however, that as the recession has potentially changed consumer

buying behaviors, some suggest that the strength of brands is weakening,

and that cost-conscious consumers will look for savings and avoid the

higher priced branded products. See Ellen Byron, “At the Supermarket

Checkout, Frugality Trumps Brand Loyalty,” The Wall Street Journal,

November 6, 2008, p D1. On this point, also consider the discussion of

BMW, Mercedes, Audi, and Tiffany in problem 1-45.

Is there also an “earnings premium” for the firms on the Boston Consulting

Group’s most-innovative list? Note that Apple, Toyota, IBM, Google,

Microsoft, and Samsung are on both lists. Note also that none of the

ten on this list are clear cost leaders. These firms succeed by providing

new and attractive products, such as Apple’s iPad. So they are arguably all

differentiators as well.

To further the analysis, Bloomberg ranks countries on innovation, and the

2014 rankings, in order, are: 1. South Korea, 2. Japan, 3. Germany, 4.

Finland, 5. Israel, 6. United States, 7. Sweden, 8. Singapore, 9. France,

and 10. United Kingdom.

“What’s in the Innovation Sandwich,” Bloomberg Businessweek, January

19, 2015, pp 49-51.

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Education.

Chapter 01 – Cost Management and Strategy

1-50 (continued -1)

The top ten firms to receive technology patents from the U.S. Patent Office

in 2013 (www.uspto.gov):

Company 2013

IBM 6,788

Samsung Electronics 4,652

Canon 3,820

Sony 3,073

Microsoft 2,659

Panasonic 2,582

Toshiba 2,365

Qualcomm 2,103

LG Electronics 1,945

Google 1,851

Notice that there are some differences between the list of innovative

companies as measured by the number of patents and the list as measured

by the survey of senior executives. In both cases, for both lists, an

examination of the company’s products suggests that the firms on both lists

are primarily differentiators. However, the survey by executives is

probably a more reliable measure of innovation in a strategic sense

because it reflects not just the number of patents, but also the company’s

effectiveness at marketing and promoting its new products.

Some of the firms on the list are differentiated on innovation and style, such

as Apple, which enjoys a 30% gross margin, far higher than other firms in

its industry. See Arik Hesseldahl, “Why the Mac is Still a Rock Star for

Apple,” Bloomberg Business Week, June 28-July 4, 2010, p 28.

1-38

Chapter 01 – Cost Management and Strategy

1-51 Strategy; Customer Service (15 min)

Note: A 2014 JD Power survey lists 50 “Customer Champions” which

include many firms on the 2010 list (www.jdpower.com); because of the

length of the list, it is not included in the problem for the students, but is

included for your review below.

Most of the companies are well-known and the students will likely

recognize them as differentiators based on customer service and a number

of other factors including product quality and brand. The articles cited

below explain for each firm how it goes about achieving world–class

customer service. For some, like LL Bean, it is the attention toward

satisfying employees so they are happier to provide better customer

service. For USAA, it is employing military veterans and extensive training.

For Ace Hardware, it is the use of technology.

Source: Jena McGregor, “Customer Service Champs,” Bloomberg

Business Week, March 1, 2010, p 44; Jena McGregor, “Customer Service

Champs,” Business Week, March 5, 2009, pp 32-34.

J.D. Power Customer Champions, 2014

Amazon.com

Amica Mutual

Apple

AvMed Health Plans

Bangor Savings Bank

Beneficial Mutual Savings Bank

Boost Mobile

Cadillac

Capital District Physicians

Clark Public Utilities

Clay Electric Cooperative

Drury Hotels

Enterprise First Citizens Bancorp

Four Seasons

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Education.

Chapter 01 – Cost Management and Strategy

1-51 (continued – 1)

Frost Bank

Good Neighbor Pharmacy

HealthPartners

Homewood Suites

Independent Health Association

Jackson EMC

Jaguar

JetBlue Airways

Lexus

Lincoln

MetroPCS

National

Neiman Marcus

NJM Insurance Co.

Publix (Retail and Pharmacy)

Quicken Loans

The Ritz-Carlton

Saks Fifth Avenue

Sawnee EMC

Scottrade

SECO Energy

SelectHealth

Southern Maryland Electric Cooperative

Southwest Airlines

SRP

Staybridge Suites

Straight Talk

Tennessee Farm Bureau

Texas Farm Bureau

TracFone

U.S. Cellular

Union First Market Bank

United Community Bank

(See more at: http://www.jdpower.com/press-releases/jd-power-

recognizes-50-brands-2014-customer-champions#sthash.h0Ca15z7.dpuf).

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Education.