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CHAPTER 12
STRATEGY, BALANCED SCORECARD, AND
STRATEGIC PROFITABILITY ANALYSIS
12-1 Strategy specifies how an organization matches its own capabilities with the opportunities
in the marketplace to accomplish its objectives.
12-2 The five key forces to consider in industry analysis are: (1) competitors, (2) potential
entrants into the market, (3) equivalent products, (4) bargaining power of customers, and (5)
bargaining power of input suppliers.
12-3 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.
12-4 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.
12-5 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.
12-6 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 at
which the organization must excel to achieve superior internal processes that create value for
customers and shareholders.
12-7 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.
12-8 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.
5. It highlights suboptimal trade-offs that managers may make when they fail to consider
operational and financial measures together.
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12-9 Pitfalls to avoid when implementing a balanced scorecard are the following:
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.
12-10 Three key components in doing a strategic analysis of operating income are the following:
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.
12-11 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.
12-12 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.
12-13 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.
12-14 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).
12-15 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.
12-16 (15 min.) Balanced scorecard.
Ridgecrest Electric manufactures electric motors. It competes and plans to grow by selling high–
quality motors at a low price and by delivering them to customers quickly after receiving
customers’ orders. There are many other manufacturers who produce similar motors. Ridgecrest
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believes that continuously improving its manufacturing processes and having satisfied employees
are critical to implementing its strategy in 2013.
Required:
1. Is Ridgecrest’s 2013 strategy one of product differentiation or cost leadership? Explain briefly.
2. Kearney Corporation, a competitor of Ridgecrest, manufactures electric motors with more
sizes and features than Ridgecrest at a higher price. Kearney’s motors are of high quality but
require more time to produce and so have longer delivery times. Draw a simple customer
preference map as in Exhibit 12-1 for Ridgecrest and Kearney using the attributes of price,
delivery time, quality, and design features.
3. Draw a strategy map as in Exhibit 12-2 with two strategic objectives you would expect to see
under each balanced scorecard perspective.
4. For each strategic objective indicate a measure you would expect to see in Ridgecrest’s
balanced scorecard for 2013.
SOLUTION
1. Ridgecrest’s 2013 strategy is a cost leadership strategy. Ridgecrest plans to grow by
producing high-quality boxes at a low cost delivered to customers at a low price and 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 12-16A shows the customer preference map for electric motors for
Ridgecrest and Kearney on price, timeliness, quality, and design.
SOLUTION EXHIBIT 12-16A
Customer Preference Map for Electric Motors
Price
Delivery Time
Quality
Design
Poor Very good
Attribute Rating
Product Attributes
Kearney
Ridgecrest
1 2 3 4 5
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3. Solution Exhibit 12-16B presents the strategy map for Ridgecrest for 2013.
SOLUTION EXHIBIT 12-16B
Strategy Map for Ridgecrest for 2013
4. Measures that we would expect to see on a Ridgecrest’s balanced scorecard for 2013 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 electric motors 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.
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
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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.
12-17 (20 min.) Analysis of growth, price-recovery, and productivity components
(continuation of 12-16).
An analysis of Ridgecrest’s operating-income changes between 2012 and 2013 shows the
following:
The industry market size for electric motors did not grow in 2013, input prices did not change, and
Ridgecrest reduced the prices of its motors.
Required:
1. Was Ridgecrest’s gain in operating income in 2013 consistent with the strategy you identified
in requirement 1 of Exercise 12-16?
2. Explain the productivity component. In general, does it represent savings in only variable costs,
only fixed costs, or both variable and fixed costs?
SOLUTION
1. Ridgecrest’s operating income gain is consistent with the cost leadership strategy identified
in requirement 1 of Exercise 12-16. The increase in operating income in 2013 was driven by the
$160,000 gain in productivity in 2013. Ridgecrest took advantage of its productivity gain to reduce
the prices of its motors 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,
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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.
12-18 (20 min.) Strategy, balanced scorecard, merchandising operation.
Ramiro & Sons buys T-shirts in bulk, applies its own trendsetting silk-screen designs, and then
sells the T-shirts to a number of retailers. Ramiro wants to be known for its trendsetting designs,
and it wants every teenager to be seen in a distinctive Ramiro T-shirt. Ramiro presents the
following data for its first two years of operations, 2012 and 2013.
Administrative costs depend on the number of customers Ramiro has created capacity to support,
not on the actual number of customers served. Ramiro had 4,300 customers in 2012 and 4,200
customers in 2013.
Required:
1. Is Ramiro’s strategy one of product differentiation or cost leadership? Explain briefly.
2. Describe briefly the key measures Ramiro should include in its balanced scorecard and the
reasons for doing so.
SOLUTION
(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. Ramiro & Sons follows a product differentiation strategy. Ramiro’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,
Ramiro must continue to innovate and be able to charge a premium price for its product.
2. Possible key elements of Ramiro’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
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These measures will indicate whether Ramiro 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 Ramiro’s T-shirts in the leading fashion magazines
Ramiro’s strategy should result in improvements in these customer measures that help
evaluate whether Ramiro’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 Ramiro’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.
12-19 (25–30 min.) Strategic analysis of operating income (continuation of 12-18).
Refer to Exercise 12-18.
Required:
1. Calculate Ramiro‘s operating income in both 2012 and 2013.
2. Calculate the growth, price-recovery, and productivity components that explain the change in
operating income from 2012 to 2013.
3. Comment on your answers in requirement 2. What does each of these components indicate?
SOLUTION
1. Operating Income Statement
2012
Revenues ($32
205,000; $33
233,000)
$6,560,000
Costs
T-shirts purchased ($17
225,500; $15
257,000)
3,833,500
Administrative costs
1,739,000
Total costs
5,572,500
Operating income
$ 987,500
Change in operating income
$1,155,500 F
2. The Growth Component
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Revenue effect
of growth
=
Actual units of Actual units of
output sold output sold
in 2013 in 2012
−



×
Selling
price
in 2012
= (233,000 − 205,000) $32 = $896,000 F
Cost effect of
growth for
variable costs
=
Units of input Actual units of
required to input used
produce 2013 to produce
output in 2012 2012 ouput
−




×
Input
price
in 2012
Cost effect of
growth for
fixed costs
=
Actual units of capacity in Actual
2012 because adequate units of
capacity exists to produce capacity
2013 output in 2012 in 2012
−




×
Price per unit
of capacity
in 2012
Direct materials (purchased T-shirts) that would be required in 2013 to sell 233,000 T-shirts
instead of the 205,000 sold in 2012, assuming the 2012 input-output relationship continued into
2013, equal 256,300 purchased T-shirts
233,000 225,500
205,000



. Administrative capacity will not
change because adequate capacity exists in 2012 to support year 2013 output and customers.
The cost effects of growth component are
Direct materials costs (256,300 − 225,500) $17 = $523,600 U
Administrative costs (4,700 – 4,700) $370 = 0
Cost effect of growth $523,600 U
In summary, the net increase in operating income as a result of the growth component equals:
Revenue effect of growth $896,000 F
Cost effect of growth 523,600 U
Change in operating income due to growth $372,400 F
The Price-Recovery Component
Revenue effect of
price-recovery
( )
Actual units
Selling price Selling price
= of output
in 2013 in 2012 sold in 2013
−
= ($33− $32) 233,000 = $233,000 F
Cost effect of
price-recovery for
variable costs
=
Input Input
price in price in
2013 2012


−


×
Units of input required
to produce 2013
output in 2012
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Cost effect of
price-recovery for
fixed costs
=
Price per Price per
unit of unit of
capacity capacity
in 2013 in 2012
−





×
Actual units of capacity in
2012 because adequate
capacity exists to produce
2013 output in 2012
Direct materials costs ($15 − $17) 256,300 = $512,600 F
Administrative costs ($380 − $370) 4,700 = 47,000 U
Total cost effect of price-recovery component $465,600 F
In summary, the net increase in operating income as a result of the price-recovery component
equals: Revenue effect of price-recovery $233,000 F
Cost effect of price-recovery 465,600 F
Change in operating income due to price-recovery $698,600 F
The Productivity Component
Cost effect of
productivity for
variable costs
=
Actual units of Units of input
input used required to
to produce produce 2013
2013 output ouput in 2012
−




Input
price
in 2013
Cost effect of
productivity for
fixed costs
=
Actual Actual units of capacity in
units of 2012 because adequate
capacity capacity exists to produce
in 2013 2013 output in 2012
−




Price per
unit of
capacity
in 2013
The productivity component of cost changes are
Direct materials costs (257,000 − 256,300) $15 = $10,500U
Administrative costs (4,450 − 4,700) $380 = 95,000 F
Change in operating income due to productivity $84,500 F
The change in operating income between 2012 and 2013 can be analyzed as follows:
Income
Statement
Amounts
in 2012
(1)
Revenue and
Cost Effects
of Growth
in 2013
(2)
Revenue and
Cost Effects of
Price-Recovery
in 2013
(3)
Cost Effect
of
Productivity
in 2013
(4)
Income
Statement
Amounts
in 2013
(5) =
(1) + (2) + (3) + (4)
Revenues
$6,560,000
$896,000 F
$233,000 F
−−
$7,689,000
Costs
5,572,500
523,600 U
465,600 F
$84,500 F
5,546,000
Operating income
$ 987,500
$372,400 F
$698,600 F
$84,500 F
$2,143,000
$1,155,500 F
Change in operating income
3. The analysis of operating income indicates that growth, price-recovery, and productivity
all resulted in favorable changes in operating income in 2013. Further, a significant amount of the
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increase in operating income resulted from Ramiro’s product differentiation strategy. The
company was able to continue to charge a premium price while growing sales even as the cost of
shirts decreased. It was also able to earn additional operating income by improving its productivity.
12-20 (20 min.) Analysis of growth, price-recovery, and productivity components
(continuation of 12-19).
Refer to Exercise 12-19. Suppose that the market for silk-screened T-shirts grew by 10% during
2013. All increases in sales greater than 10% are the result of Ramiro’s strategic actions.
Calculate the change in operating income from 2012 to 2013 due to growth in market size,
product differentiation, and cost leadership. How successful has Ramiro been in implementing its
strategy? Explain.
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