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Chapter 18 - Strategic Performance Measurement: Cost Centers, Profit Centers, and the Balanced Scorecard
18-27 Research and Development: Risk Aversion and Performance
Measurement (20 min)
1. Risk aversion, the tendency to avoid actions with uncertain outcomes
(even with good probability of success), is a common trait among
managers. This leads frequently to a choice of a short-term gain that
may conflict with a long-term benefit. In the case of R&D, when
economic times are hard, very often the risk aversion and the short-
was intended to increase funding for research and development at
universities and in corporations, as well as improvements in science
education.
While managing risk aversion may mean relying in part on external
sources of funding, it can also be accomplished by a strong emphasis
Budgeting and controlling activities such as R&D is difficult. Nonetheless
some control must be exercised. The firm should attempt to track the costs
and progress of individual projects. Periodically the projects should be
evaluated by the personnel doing the research, by other scientists, and by
operating managers; the goals is to assess the progress and commercial
18-11
Chapter 18 - Strategic Performance Measurement: Cost Centers, Profit Centers, and the Balanced Scorecard
18-27 (continued -1)
spending with the spending of competitors seems reasonable.
An alternative approach, used by Hewlett-Packard’s PC division is to
increase R&D spending for products that can most benefit. To
determine how to target R&D effort, H-P uses a measure called “R&D
productivity,” which is the ratio of R&D spending on a product line to
the gross margin of the product line. Using this approach, products
with higher gross margin are allocated a higher portion of R&D
Sources: Steve Hamm, “Is Silicon Valley Losing Its Magic?: A Road Trip
Finds Risk Aversion, Short-term Thinking, and A Few Bold Ideas,”
Business Week, January 12, 2009, pp. 29-33; Cliff Edwards, “How HP Got
the Wow Back,” Business Week, December 22, 2008, pp. 60-61.
18-12
Education.
18-28 Leadership Development (20 min)
This question is intended primarily as a basis for class discussion.
The objective is to have the student consider the critical leadership
skills that successful managers must acquire. There are a number of
sources for leadership and management skills, and the following is
one representative example. The list was developed by a team at
Google. The team was code named “Project Oxygen,” and the
objective was to provide means to develop better managers. The list
included 8 key behaviors, examples of which are provided below. A
similar list could be provided by, for example, Stephen Covey’s book,
The 7 Habits of Highly Effective People (Fireside Books, 1989).
1. Be a good coach
2. Empower your team and do not micromanage
oUnderstand the strengths and weakness of your employees
3. Express interest in team members’ success and personal well-
being
oTake opportunities you have to get to know each team
member
18-13
Education.
Chapter 18 - Strategic Performance Measurement: Cost Centers, Profit Centers, and the Balanced Scorecard
18-28 (continued -1)
4. Be productive and results-oriented
oPrioritize for yourself and your team
5. Be a good communicator and listen to your team
oBe a good listener
6. Help your employees with career development
oMake available opportunities for professional development:
courses, professional meetings, …
7. Have a clear strategy for the team
oProvide direction when times are difficult
oMake sure your vision and strategy is clearly understood;
8. Develop and maintain key technical skills need by all team
members
oBe able to advise team members when they need help with
requirements of the work
18-14
Education.
Chapter 18 - Strategic Performance Measurement: Cost Centers, Profit Centers, and the Balanced Scorecard
18-28 (continued -1)
Source: Adam Bryant, “The Quest to Build a Better Boss,” The New York
Times, March 13, 2011, pp. B1-2.
18-29 Departmental Cost Allocation in Profit Centers(20 min)
1. Beef Barn: 3,000 ÷ 6,000 x $24,000 = $12,000
2. One approach would be to use the allocation approach in (1)
above, noting that total costs are now $12,000 fixed cost and unit
variable cost is still $2 ($12,000 ÷ 6,000). Thus total cost is now
$12,000 + [$2 x (2,000 + 3,000)] = $22,000. The per-table cost is
now $22,000 ÷ 5,000 = $4.40 and the allocation is:
This result is equivalent to splitting the total cost 2/5 and 3/5 to reflect
the proportion of meals served (2,000/5,000; 3,000/5,000):
In effect, this approach continues to use the percentage of
usage as a base. The manager of the Beef Barn is probably not too
happy with this result, since the Beef Barn’s sales are down 1/3, but
baking has not decreased as much. Why? The manager may need a
18-15
Education.
Chapter 18 - Strategic Performance Measurement: Cost Centers, Profit Centers, and the Balanced Scorecard
18-29 (continued -1)
A way to solve this deficiency is to use a different approach,
based upon dual allocation, where variable costs are traced directly
to the user, and fixed costs are allocated on some logical basis. In
this case, suppose we split fixed costs evenly, because, on the
average, the Bowl and the Barn have approximately equal activity
levels.
Fish Bowl: 3,000 x $2 + ($6,000) = $12,000
This result is much more motivating, since the variable costs are
traced directly, and the fixed costs are fairly allocated.
Now, what happens if the average activity levels are quite
different?
Then the fixed costs should be allocated on the basis of the
proportion of the long-run average usage. For example, if the average
long-run usage of the Fish Bowl is 4,000 tables, and the long-run
usage of the Beef Barn is 2,000, then the fixed costs should be
allocated as follows:
18-16
Education.
18-30 Allocation of Marketing and Administrative Costs; Profit
SBUs (20 min)
1. The prior and current year allocations using revenue as a base:
(All numbers in 000s)
Preschool Middle
School
High School Total
Tuition revenue $1,500 $1,800 $2,200 $5,500
Marketing and administration $275 $325 $400 $1,000
In the current year the middle and high schools experienced no change in revenues, but
Current year cost allocation based on relative revenues:
Middle High
Preschool School School Total
Tuition Revenue $1,900 $1,800 $2,200 $ 5,900
Relative revenue 32.2034% 30.5085% 37.2881% 100%
Cost Allocation $402.54 $381.36 $466.10 $ 1,250
2. Allocating costs solely on the basis of revenue can penalize
growing units, or units which have a temporary, unusually high activity
level. In this example, the pre-school’s increased volume probably
had little effect on its actual per-student usage of marketing and
Chapter 18 - Strategic Performance Measurement: Cost Centers, Profit Centers, and the Balanced Scorecard
18-31 Allocation of Administrative Costs (20 min)
1. The solution shown below uses total revenues for the four apartment
buildings as the basis for the allocation. Total revenue takes into
account both the number of units and average rent, and therefore
would provide a reasonable basis for allocating the costs to be billed
2. The potential ethical issue in this case is the fairness to the four
different apartment building owners in determining the allocation of
the management fee. It is likely that the allocation method is stated
clearly in the management contact, so the ethical issue is likely to be
18-18
Education.
Chapter 18 - Strategic Performance Measurement: Cost Centers, Profit Centers, and the Balanced Scorecard
18-32 Responsibility for Inefficiency; Ethics (15 min)
The best approach would have been for the hospital and
Normed to arrive at an agreement about the repair of the machine,
and the use of alternative methods while the machine was out of use.
A logical approach would have been for Normed to agree in advance
to pay for the laboratory tests if the machine was out of use, and the
Another issue is the loss of revenue to the MRI (radiology)
department in the hospital, due to the loss of the MRI machine. If the
radiology department is a profit center, the loss of the MRI machine
will result in a loss of revenue which will affect its profitability for the
period. The hospital should determine in advance, how such matters
are to be handled. A logical approach is to have the radiology
One ethical issue is to place the primary focus on patient care.
It would be unethical of General Hospital to delay diagnosis of patient
problems until the less expensive machine is repaired, as Normed
suggests. Also there is an ethical issue of charging the patients for
the more expensive lab tests if Normed will not reimburse General
Hospital for the extra costs. It would be unethical for General
18-19
Education.
18-33 Assigning Responsibility (10 min)
Ultimately, the responsibility for having the parts on the
production line at the desired time is that of the purchasing
department. Even if the purchasing department has done its part,
and the supplier fails, the purchaser should be held responsible. This
would provide the appropriate incentive for the purchasing
department to develop contingency plans for situations such as this,
and for the purchasing department to draw up contracts with
suppliers which in effect have the supplier bear the cost of the
delayed shipment.
In this case, the supplier appears to have not paid any of the
cost of the delay. In practice, it would be advisable for the purchasing
agent not to rely on any supplier, but to make each supplier
at fault. Moreover, it is also top management’s role to make sure that
each of the functions has adequate plans to avoid problems such as
this. Top management should be concerned that it failed to require
the proper planning within the purchasing department.
18-20
Education.
