Chapter 18 – Strategic Performance Measurement: Cost Centers, Profit Centers, and the Balanced Scorecard
18–16
18–28 Allocation of Marketing and Administrative Costs; Profit
SBUs (20 min)
1.
The 2012 and 2013 allocations using revenue as a base:
(All numbers in 000s)
Pre-School
Middle School
High School Total
Tuition revenue $1,500 $1,800 $2,200 $5,500
Marketing and administration $275 $325 $400 $1,000
In 2013, the middle and upper schools experienced no change in revenues, but the lower school’s
tuition revenue increased to $1,900
Total Marketing and administrative costs $1,250
2013 Cost allocation based on relative revenues:
Pre- Middle High
School School School Total
Tuition Revenue $1,900 $1,800 $2,200 5,900$
Relative revenue 32.2034% 30.5085% 37.2881% 100%
Cost Allocation $403 $381 $466 1,250$
Percentage Increase 46.4% 17.3% 16.5%
=(403–275)/275 =(381-325)/325 =(466-400)/400
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
18–17
18–29 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
to the apartment complexes. Each unit would in effect pay a portion
of the management fee in proportion to its rental revenue. This
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
Chapter 18 – Strategic Performance Measurement: Cost Centers, Profit Centers, and the Balanced Scorecard
18–18
18–30 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
did not have a prior agreement to handle this type of situation, then
the patients should be billed for the lesser of the two amounts, the
laboratory tests that were done, or the MRI which was not done.
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
department bear the effect of the loss of income, since it is ultimately
responsible for the repair of the machine, not the hospital
administration, and not Normed. This would provide the proper
incentive for each department in the hospital to make sure that its
suggests.
Chapter 18 – Strategic Performance Measurement: Cost Centers, Profit Centers, and the Balanced Scorecard
18–19
18–31 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,
not willing to meet these conditions, the firm would be better off to
seek another supplier.
The cost of the delay should not be charged to production or
sales, as they were not responsible for the loss. However, top
management should expect that all managers within the firm, from
production to sales, will play a role in helping to reduce the cost of the
delay, by perhaps rescheduling other orders, or using the unexpected
time to perform preventive maintenance on the machines. Each
manager should act responsibly, even though he may not have been
Chapter 18 – Strategic Performance Measurement: Cost Centers, Profit Centers, and the Balanced Scorecard
18–20
18-32 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
archived, hours of machine time, pages printed, etc …). The flexible
budget would give P&G a means to provide a greater incentive for the
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
company. A unit such as print services that cannot succeed as a
profit center as described above would then commonly become the
target for possible outsourcing. The decision to outsource indicates
that the internal unit is not as cost/effective at providing the services
as an outside provider, and so the work is outsourced. After the
flexible budget. In either case, the outsourcer (P&G) will continue to
monitor and evaluate the costs and performance of the service
provided by the outside service provider.
Chapter 18 – Strategic Performance Measurement: Cost Centers, Profit Centers, and the Balanced Scorecard
18–21
18-32 (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.
18-33 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
expected) and improving the shopping experience of its shoppers.
Source: Stephanie Simon, “Wal–Mart’s Sam’s Club Farms Out
10,000 Jobs,” The Wall Street Journal, January 25, 2010, p. B1.
Chapter 18 – Strategic Performance Measurement: Cost Centers, Profit Centers, and the Balanced Scorecard
18–22
18-34 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
possibility that the $30 is shared equally, which of course would be a
big advantage to B and C and a smaller advantage to A. Other
solutions, provided by economists and management professors, are
pointed out in the article by Carl Bailik cited below.
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
the highest for C. In effect, each would pay one-half of the cost of the
individual fare because the shared cost is one-half the total of
individual costs and the allocation is proportionate to the individual
cost.
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.
Chapter 18 – Strategic Performance Measurement: Cost Centers, Profit Centers, and the Balanced Scorecard
18–23
18–34 (continued -1)
4. Consider perhaps that these are three journalists, or professional
colleagues who look forward to the ride as an opportunity to share
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, December 8,
2005.
Chapter 18 – Strategic Performance Measurement: Cost Centers, Profit Centers, and the Balanced Scorecard
18–24
18–35 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
focused on innovation, that is, when their strategy is to emphasize
new products and services. For banks with a different strategy, the
number is a far less reliable future indicator. Innovation-oriented
banks, then, will want to keep an eye on their cross-sell metric, but
other banks may be wasting their efforts trying to capture such a
number.
18–25
18–35 (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.
Chapter 18 – Strategic Performance Measurement: Cost Centers, Profit Centers, and the Balanced Scorecard
18–26
18–36 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
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,”
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
Exercise 18-25, “Research and Development, Risk Aversion, and
Performance Measurement”)
18–27
18–36 (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.
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.
Chapter 18 – Strategic Performance Measurement: Cost Centers, Profit Centers, and the Balanced Scorecard
18–28
18–37 Financial Reporting and SBU Performance (20 min)
1. The business unit information prepared for public (external) financial
reporting purposes may not be appropriate forthe 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
Midwest, etc. ), when instead unit managers are given
responsibility for product lines including all areas in which the
product is sold.
• If business unit leaders’ performance is evaluated on the basis of
the information in the annual financial report, unit managers may
become frustrated and dissatisfied because they would be held
18–29
18–37 (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 untraceable costs, and
b) controllable and uncontrollable costs (some costs might be
traceable to a unit, but not controllable in the short term, as for example
the cost of facilities.)
The determination of whether noncontrollable costs should be charged to
division is a complex issue. For example, the managers in this case are
cost-saving join policy.
Many times it can be advantageous to compare the managers’
performance to a budget, where the budget is determined with an explicit
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
Chapter 18 – Strategic Performance Measurement: Cost Centers, Profit Centers, and the Balanced Scorecard
18–30
18–38 Financial Incentives and Auto Repair/Inspection Companies (20
min)
The findings of the research suggest that in fact the financial incentives of
the auto repair shop are to pass vehicles that fail the emissions test
because many of the owners of these vehicles are regular customers. The
auto repair shop wants to retain these customers for the more lucrative
work of replacing tires, batteries, and performing repair work. The loss of
a customer due to a failed test could be very costly to the repair shop in the
long term.
The financial incentives needed to ensure compliance with the inspection
standards require independence between the shop owner and the vehicle
owner. Independent inspection stations that only perform inspections
approach would be to reduce the cost of emission-related repairs, by
reducing or eliminating state sales tax on this type of work, by using state
income tax credits or partial reimbursements as financial incentives for the
motorist to perform the needed emissions-related work. The key issue is to
provide the financial incentives for the auto owner to keep their vehicles
emission-compliant.
The ethical issues arise clearly in this case as the shop owner and the
vehicle owner have financial incentives not to follow the state’s regulations
regarding emission controls.
quality of the environment.