Chapter 18 – Strategic Performance Measurement: Cost Centers, Profit Centers, and the Balanced Scorecard
18-34 Outsourcing; Choice of Strategic Business Unit (15min)
1. P&G probably used a cost center to manage the print services unit,
which would be a common approach for managing this department.
Commonly it is viewed as a service department, subject to oversight
with a focus on meeting budgeted cost. When a company like P&G
considers that the print/document services is not providing a
strategically important role in the organization (while it is certainly an
print unit’s managers to reduce cost.
While a discretionary budget provides an incentive to keep
costs within budget, a flexible budget approach targets efficiency in
meeting operating demands. A final in-house management approach
would be to evaluate the print services unit as a profit center, that is,
each job request from within the company is priced at near market
rates, and typically the managers of divisions that use print services
have the opportunity to purchase these services outside the
company. A unit such as print services that cannot succeed as a
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Chapter 18 – Strategic Performance Measurement: Cost Centers, Profit Centers, and the Balanced Scorecard
18-34 (continued -1)
2. The decision to outsource will likely advance the firm’s sustainability
objectives, since it is likely that the service provider can provide the
services needed by P&G in a more efficient manner, saving energy,
paper, and other environmental resources.
Source: William M. Bulkeley, “Print Outsourcing Gives Boost to Xerox, H-
P,” The Wall Street Journal, December 22, 2009, p. B5.
18-35 Outsourcing: Link to Strategy (15 min)
1. Sam’s Club and Walmart are very much associated with the cost
leadership strategy. Walmart’s slogan says it all: “Save Money –
Live Better.” The introduction to Chapter 1 provides more detail on
the strategies of Walmart and Target.
2. The decision to outsource looks consistent with the company’s
strategy of cost leadership, to find a way to reduce cost and lower
prices. The greater efficiency of outsourcing will help Sam’s Club
become more profitable. As noted in the Wall Street Journal article
cited below, Sam’s Club has had lower profit margins than some of
its key competitors such as Costco.
In what may be a strategic shift, Sam’s Club’s President, Brian
Source: Stephanie Simon, “Wal-Mart’s Sam’s Club Farms Out
10,000 Jobs,” The Wall Street Journal, January 25, 2010, p. B1.
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Education.
Chapter 18 – Strategic Performance Measurement: Cost Centers, Profit Centers, and the Balanced Scorecard
18-36 Cost Allocation; Sharing Cab Fare (15 min)
The objective of this exercise is to introduce a brief discussion of the
complexities of achieving a fair cost allocation in a setting which
otherwise might seem relatively simple.
There are numerous solutions for this exercise, beginning with the
1. Split up the $30 savings proportionally based on how much A, B, and
C would have paid individually, assuming they each took a separate
cab. Then A would pay $ 12 – [($12 ÷ $60) x $30] = $6; B would
save 18/60 of the $30 and would pay $18 – [(18 ÷ 60) x $30] = $9,
2. Another method takes a game theory approach and says that the
sharing of the cab can be viewed as a negotiation or contract, and the
3. Other methods could be based on the amount of time in the cab; for
example, B and C presumably have a longer cab ride because of A.
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Education.
Chapter 18 – Strategic Performance Measurement: Cost Centers, Profit Centers, and the Balanced Scorecard
18-36 (continued -1)
4. Consider perhaps that these are three journalists, or professional
colleagues who look forward to the ride as an opportunity to share
more attractive and fair.
5. A final possibility is that rider C may offer to pay the entire fare of $30
Source: Carl Bailik, “How to Split a Shared Cab Ride? Very
Carefully, Say Economists,” The Wall Street Journal Online,
December 8, 2005,
http://www.wsj.com/articles/SB113279169439805647.
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Education.
Chapter 18 – Strategic Performance Measurement: Cost Centers, Profit Centers, and the Balanced Scorecard
18-37 Intangibles; Validating the Balanced Scorecard (15 min)
The Findings of the Study (cited below):
The key finding of the study is that no single customer relationship
metric can be used to predict future earnings. Rather, when
considered in relationship to other measures, such metrics can lead
to a financial profitability number 15 percent closer to the actual figure
for the coming year than is otherwise possible.
The authors note that “Looking at a customer satisfaction number
alone doesn’t do you much good unless you know the costs involved
in achieving it. Customers might be satisfied because you’re giving
them everything for free, but this doesn’t say much about what your
future profitability will be.”
In other words, a bank must compare customer satisfaction to a cost
such as the amount of interest it pays. What the authors found was
that high customer satisfaction and low interest costs push
profitability significantly. The bottom line: a bank can rely on the
customer service metric as a predictor of profitability only when its
interest or “deposit” costs are low.
Similarly, the number of additional goods and services cross-sold to
customers becomes predictive depending on the bank’s business
strategy. Thus, the cross-sell figure is valuable only when banks are
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Education.
Chapter 18 – Strategic Performance Measurement: Cost Centers, Profit Centers, and the Balanced Scorecard
18-37 (continued -1)
Comments on the Study:
The implication of the study is that it is important in using a balanced
scorecard to understand the causal linkages between the scorecard
measures and desired outcomes such as profits. The measures
(customer satisfaction-related measures in this case) were found to
be interlinked in a complex way, and the authors of the study devised
a causal model including the interactive effects to explain these
linkages. The point: looking at the measures individually is unlikely
to produce the desired results. The message to managers using the
balanced scorecard: it is important to develop a casual model, based
on actual data in your firm, to understand how the individual
scorecard measures contribute individually, and interactively, to the
desired outcomes.
Source: VenkyNajar and Madhav V. Rajan, Management Science, June
2005, Vol 51, pp. 904-919.
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Chapter 18 – Strategic Performance Measurement: Cost Centers, Profit Centers, and the Balanced Scorecard
18-38 Managing the Research and Development Department (20 min)
Management of any R&D project is difficult, but breakthrough projects
are especially difficult to evaluate because of the extensive uncertainty
surrounding them. It is clear, however, that breakthrough projects must be
evaluated differently than the incremental projects. They require more
patience, and the pressure of short-term cost reports is inappropriate. Nor
can these projects be evaluated by comparing the amount spent on
research (say, relative to total sales) to that of other firms in the industry.
Emphasis must be on the researchers’ skills, the funding levels, and other
factors that can aid the progress of the research. For example, academic
research at Rensselaer Polytechnic Institute shows that the most
successful R&D researchers have wide-ranging networks in the research
community. The skills of the researchers, the funding level, and the other
factors can be evaluated in a balanced scorecard approach.
In the case of both types of R&D departments, the best SBU choice is
likely to be the cost center, and specifically, the discretionary-cost type of
cost center. The discretionary cost center is appropriate because it is
difficult to measure the output of an R&D department, particularly one that
is focused on long-term, breakthrough types of projects. The case could be
made that the incrementalist type of department could be evaluated on
using the engineered-cost approach, since the incrementalist department is
more likely to have well-defined goals that have measureable outputs.
Hewlett-Packard’s PC division, under the leadership of Todd Bradley,
began a strong focus on research and innovation in the PC group which
helped HP increase its market share in this competitive market. Bradley’s
focus was striking the right balance between the cost of product and the
investment in innovation. A key metric he used was “R&D productivity,”
which measures R&D spending as a percentage of gross margin
percentage for each product line. A standard desktop with low margins will
be allocated less R&D effort, while a high-end laptop with higher margins
will receive greater R&D effort. In effect, what Bradley is doing is treating
R&D as a discretionary cost center in which the costs of R&D are not
evaluated ex post, but are allocated, ex ante, in a budget plan. (See also
Chapter 18 – Strategic Performance Measurement: Cost Centers, Profit Centers, and the Balanced Scorecard
18-38 (continued -1)
Also, research involving 75 industrial design managers reported that the
firms surveyed use various financial and nonfinancial measures to evaluate
new product development, although managers in these firms reported that
relatively few of these measures reflect the key aspects of their firms’
strategies. Clearly, R&D activities are difficult to evaluate, although they are
critical to the strategies of many firms.
Other firms choose a different approach; Valent Pharmaceutical
chose to outsource R&D because of the high risk of the investment in
R&D (“..we fail more often than we succeed.”) and the difficulty in
evaluating performance there.
Productivity of R&D can also be a function of the company’s product
development platform. For example, Apple is able to introduce innovative
new products at a lower cost of R&D relative to sales because it has the
MAC OS software platform that has produced many hits in the past. Other
competitors in the mobile products industry, such as Microsoft, Google, and
Research in Motion, have far higher ratios of R&D expenditures to sales
than Apple, in part because these competitors do not have the productive
platform that Apple has.
Sources: Julie Hertenstein and Marjorie B. Platt, “Performance Measures and
Management Control in New Product Development,” Accounting Horizons,
September 2000, pp. 303–23; Jonathan D. Rockoff, “Drug Firm Leaves R&D to
Others,” The Wall Street Journal, March 2, 2009, p. B6; Cliff Edwards, “How HP
Got the Wow! Back,” Business Week, December 22, 2008, pp. 60-61; “Mobile
Wars: Bang for the R&D Buck,” BloombergBusinessweek, February 21, 2011, p.
38.
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Chapter 18 – Strategic Performance Measurement: Cost Centers, Profit Centers, and the Balanced Scorecard
18-39 Financial Reporting and SBU Performance (20 min)
1. The business unit information prepared for public (external) financial
reporting purposes may not be appropriate for the evaluation of
business unit management performance because:
an allocation of common costs incurred for the benefit of more
than one business unit must be included for public reporting
purposes,
in external financial reports, common costs are often allocated on
annual report may group operations into geographical-based
categories (foreign versus domestic; western states versus
Midwest, etc. ), when instead unit managers are given
responsible for an earnings figure that includes the arbitrary
allocation of common costs and costs traceable to but not
controllable by them. This type of performance evaluation is unfair
to managers and does little to motivate them. As a result of this
dissatisfaction, the best managers may seek employment
elsewhere.
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Education.
18-39 (continued -1)
2. The company should consider establishing profit centers for its
business units. The contribution income statement should be used to
evaluate Samentech Inc.’s business unit managers. The contribution
income statement is the best measure of performance because it
distinguishes both:
a) traceable and nontraceable costs, and
The determination of whether noncontrollable costs should be charged to
division is a complex issue. For example, the managers in this case are
choosing a higher cost insurance coverage in order to maintain some
local flexibility. If insurance costs are not charged to the unit managers,
there is no incentive for them to choose a cost–saving insurance plan. In
consideration of conditions in the industry for that unit. This way
managers are not rewarded or penalized for favorable or unfavorable
conditions within the market place that are beyond their control.
Also, the company should consider using the balanced scorecard, in
order to include in the performance measurement all of the critical
success factors that managers should attend to in order to align their
performance with the company’s strategic goals.
3. Using the BSC and the contribution income statement should help
Samentech Inc. bring its managers’ decision making more in line with