Balance Scorecard and Strategic Analysis of Operating Income

Strategy
- Strategy describes how an organization matches its own capabilities with the opportunities in the marketplace to accomplish its overall objectives. - A thorough understanding of the industry is critical to implementing a successful strategy

Five Aspects of Industry Analysis

1. 2. 3. 4. 5. Competitors Potential entrants into the market Equivalent products Bargaining power of customers Bargaining power of input suppliers

Basic Strategies:
1. Product Differentiation 2. Cost leadership

Basic Strategies:
1. Product Differentiation an organizations ability to offer products or services perceived by its customers to be superior and unique relative to the products or services of its competitors - Leads to brand loyalty and the willingness of customers to pay high prices Cost Leadership an organizations ability to achieve lower costs relative to competitors through productivity and efficiency improvements, elimination of waste, and tight cost control - Leads to lower selling prices

2.

Implementation of Strategy:
Many companies have introduced a Balanced Scorecard to manage the implementation of their strategies

The Balanced Scorecard

- The balanced scorecard translates an organizations mission and strategy into a set of performance measures that provides the framework for implementing its strategy - It is called the balanced scorecard because it balances the use of financial and nonfinancial performance measures to evaluate performance

The balanced scorecard is a strategic planning and management system used:

- To align business activities to the vision and strategy of the organization, - Improve internal and external communications and, -Monitor organization performance against strategic goals. The balanced scorecard automates and centralizes the issuance and tracking of objectives, targets, measures and initiatives.

The Balanced Scorecard

The scorecard measures an organizations performance from four perspectives: 1. 2. 3. 4. Financial Customer Internal Business Perspective Learning and Growth

The Financial Perspective

-Evaluates the profitability of the strategy - Uses the most objective measures in the scorecard -The other three perspectives eventually feed back into this dimension -Objective: Increase shareholder value; Measures: Increase in operating income

The Customer Perspective

-Identifies targeted customer and market segments and measures the companys success in these segments -Objectives: Increase market share and increase customer satisfaction; - Measures: Market share in communication networks segment and Customer satisfaction survey

The Internal Business Prospective

Focuses on internal operations that create value for customers that, in turn, furthers the financial perspective by increasing shareholder value. Includes three sub processes: 1. Innovation 2. Operations 3. Post-sales service

The Internal Business Prospective

- Objectives: Improve manufacturing quality and productivity; Meet specified delivery dates

- Measures: Yield; On-time delivery

The Learning & Growth Perspective

- Identifies the capabilities the organization must excel at to achieve superior internal processes that create value for customers and shareholders. - Objectives: Align employee and organization goals; Improve manufacturing processes - Measures: Employee satisfaction survey; Improvements in process controls

Aligning the Balanced Scorecard to Strategy

- Different strategies call for different scorecards. What are some of the financial perspective measures? 1. Operating income 2. Revenue growth 3. Cost reduction is some areas 4. Return on investment

Aligning the Balanced Scorecard to Strategy

What are some of the customer perspective measures?

1. Market share 2. Customer satisfaction 3. Customer retention percentage 4. Time taken to fulfill customers requests

Aligning the Balanced Scorecard to Strategy

What are some of the internal business perspective measures? Innovation Process

1. Manufacturing capabilities 2. Number of new products or services 3. New product development time 4. Number of new patents

Aligning the Balanced Scorecard to Strategy

Operations Process: 1. Yield 2. Defect rates 3. Time taken to deliver product to customers 4. Percentage of on-time delivery 5. Setup time 6. Manufacturing downtime

Aligning the Balanced Scorecard to Strategy

Post-sales service: 1. Time taken to replace or repair defective products 2. Hours of customer training for using the product

Aligning the Balanced Scorecard to Strategy

What are some of the learning and growth perspective measures? 1. Employee education and skill level 2. Employee satisfaction scores 3. Employee turnover rates 4. Information system availability 5. Percentage of processes with advanced controls

Features of a Good Balanced Scorecard

-Tells the story of a firms strategy, articulating a sequence of cause-and-effect relationships: the links among the various perspectives that describe how strategy will be implemented - Helps 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

Features of a Good Balanced Scorecard

- Must motivate managers to take actions that eventually result in improvements in financial performance Predominately applies to for-profit entities, but has some application to not-for-profit entities as well - Limits the number of measures, identifying only the most critical ones Highlights less-than-optimal tradeoffs that managers may make when they fail to consider operational and financial measures together

Drawbacks of Balanced Scorecard Implementation

- Managers should not assume the cause-andeffect linkages are precise: they are merely hypotheses -Managers should not seek improvements across all of the measures all of the time -Managers should not use only objective measures: subjective measures are important as well

Drawbacks of Balanced Scorecard Implementation

-Managers must include both costs and benefits of initiatives placed in the balanced scorecard: costs are often overlooked - Managers should not ignore nonfinancial measures when evaluating employees Managers should not use too many measures

Evaluating Strategy
Strategic Analysis of Operating Income three parts: 1. Growth Component measures the change in operating income attributable solely to the change in the quantity of output sold between the current and prior periods. 2. Price-Recovery Component measures the change in operating income attributable solely to changes in prices of inputs and outputs between the current and prior periods

Evaluating Strategy
Strategic Analysis of Operating Income 3. Productivity Component measures the change in costs attributable to a change in the quantity of inputs between the current and prior periods

Evaluating the Success of a Strategy

Assume the following operating incomes: Year 2012 Year 2013
Revenues: (1,000,000 $26) $26,000,000 (1,100,000 $24) Expenses: Materials Other

$26,400,000

4,050,000 16,000,000 ---------------Operating Income $5,950,000

3,631,320 16,000,000 ----------------$ 6,768,680

Increase in operating income: $ 818,680

Assume that for 2012, FWB produced and sold 1,000,000 units at $26 per unit. During the year 2013, FWB produced and sold 1,100,000 units at $24 per unit. What is the revenue effect of growth?

Growth Component
Revenue effect of growth component = (Actual units of output sold in 2013 Actual units of output sold in 2012) Output price in 2012 (1,100,000 1,000,000) $26 = $2,600,000 F This component is favorable because it increases operating income.

Growth Component
Cost effect of growth component = Actual units of input or capacity that have been used in 2012 to produce year 2013 output assuming the same input-output relationship that existed in 2012 Actual units or capacity to produce 2012 output X Input prices in 2012

Growth Component
To produce 1,100,000 units in 2013 compared with the 1,000,000 units produced in 2012 (a 10% increase), Dallas would require a proportional increase in direct materials. Assume that 3,000,000 square centimeters of materials were used to produce the 1,000,000 units in 2003 at a cost of $1.35 per square centimeter.

Growth Component
Assume that manufacturing conversion costs, selling and customer service costs and research and development costs were $16,000,000 and remained stable during 2013. What is the cost effect of the growth component? 3,000,000 110% = 3,300,000 centimeters (3,300,000 3,000,000) $1.35 = $405,000 U

Operating Income and Growth

What is the net increase in operating income as a result of growth? Revenue effect of growth component $2,600,000 F Cost effect of growth component 405,000 U Increase in operating income due to growth component $2,195,000 F

Price-Recovery Component
Revenue effect of price-recovery component = (Output price in 2013 Output price in 2012) Actual units of output sold in 2013 What is the revenue effect of the price-recovery component? ($24 $26) 1,100,000 = $2,200,000 U

Price-Recovery Component
Cost effect of price-recovery component = (Input prices in 2013 Input prices in 2012) X Actual units of inputs or capacity that would have been used to produce year 2013 output assuming the same input-output relationship that existed in 2012 * Assume that in the year 2013, direct materials costs were $1.31 per square centimeter.

Price-Recovery Component
What is the cost effect of the price-recovery component? ($1.31 $1.35) 3,300,000 = $132,000 F

Operating Income and Price-Recovery Component

What is the total effect on operating income of the pricerecovery component?

Revenue effect of price-recovery component $2,200,000 U Cost effect of price-recovery component 132,000 F Decrease in operating income due to price-recovery component $2,068,000 U

Productivity Component
Productivity component = Actual units of inputs or capacity to produce year 2013 output - Actual units of inputs or capacity to produce year 2013 output X Input prices in 2013

Productivity Component
Assume that 2,772,000 actual square centimeters of direct materials were used in the year 2013. Actual price was $1.31/square centimeter.

Productivity Component
What is the productivity component of cost changes?

(2,772,000 3,300,000) $1.31 = $691,680 F

There is a $691,680 increase in operating income due to the productivity component.

Change in Operating Income

Increase in operating income $818,680

Growth component $2,195,000 F

Price-recovery component $2,068,000 U

Productivity component $691,680 F

The Management of Capacity

- Managers can reduce capacity-based fixed costs by measuring and managing unused capacity - Unused Capacity is the amount of productive capacity available over and above the productive capacity employed to meet consumer demand in the current period

Analysis of Unused Capacity

Two Important Features: 1. Engineered Costs result from a cause-andeffect relationship between the cost driver and the resources used to produce that output 2. Discretionary Costs have two parts: They arise from periodic (annual) decisions regarding the maximum amount to be incurred They have no measurable cause-andeffect relationship between output and resources used

Relationships Between Inputs and Outputs

- Engineered costs pertain to processes that are detailed, physically observable, and repetitive. - Discretionary costs are associated with processes that are sometimes called black boxes, because they are less precise and not well understood.

Managing Unused Capacity

Downsizing (Rightsizing) is an integrated approach of 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.

Members:

JUGALBOT MELENDRES NAVARRA OPPUS PABELLO URGEL VERGARAY COY