CHP 12 - Strategy, Balanced Scorecard, and Strategic Profitability (With Answers)

CHAPTER 12
Strategy, Balanced Scorecard and

Strategic Profitability Analysis
2009 Pearson Prentice Hall. All rights reserved.
Lass Class
Factors affecting pricing decision
Customers, competitors, and costs
Perfectly competitive, less competitive, and not
competitive markets
Market-based and cost-plus pricing
Competition
Target pricing and costing (market-based)
Markup percentage (cost-plus)
What is a balanced
scorecard?
A scorecard evaluates an organizations
strategy using a set of performance measures.
Learning Objectives
Recognize which of two generic strategies a
company is using
Understand the four perspectives of the balances
scorecard
Analyze changes in operating income to evaluate
strategy
Recognize which of two

generic strategies a company
is using
Strategy
Strategy specifies how an organization matches
its own capabilities with the opportunities in the

marketplace to accomplish its objectives
Wal-Mart offers low prices, a wide range of product
categories, and few choices within each product category. It

has the capability to keep costs down by aggressively
negotiating low prices with its suppliers (Cost Leadership).
Apple Inc. has successfully differentiated its products in the
consumer electronics industry(Product Differentiation).
Five Aspects of Industry

Analysis
A thorough understanding of the industry is
critical to implementing a successful strategy

Number and strength of competitors
Potential entrants to the market
Availability of equivalent products
Bargaining power of customers and input suppliers
How to chose of the two basic strategies?

Product differentiation
Cost leadership
Chipset produces a single specialized product, C1, a
standard, high-performance microchip
Competitors: severe price competition, pressure to reduce

selling price
Potential entrants into the market: small profit margins and
high capital costs discourage new entrants. Incumbent keeps

close relationship with customers and suppliers.
Equivalent products: Chipset tailors CX1 to customer needs
and lowers prices by improving design and processes. This

reduces the risk of equivalent products replacing CX1.
Bargaining power of customers: EarthLink and Verizon
negotiate aggressively with Chipset to keep prices down

Bargaining power of input suppliers: Skill-sets suppliers
and employees bring gives them bargaining power

Basic Business Strategies

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
Brand loyalty, the willingness of customers to pay high

prices
Apple, Johnson & Johnson, Coca-Cola
Cost Leadership an organizations ability to achieve
lower costs relative to competitors through productivity

and efficiency improvements, elimination of waste, and
tight cost control
Lower selling prices

Wal-Mart, IKEA
Understand the four

perspectives of the balances
scorecard
Implementation of Strategy
Many companies have introduced a
Balanced Scorecard to manage the

implementation of their strategies
Allstate Insurance, Bank of Montreal, BP, and
Dow Chemical
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
Why is this tool called a balanced scorecard?
It is called the balanced scorecard because it balances the use
of financial and nonfinancial performance measures to

evaluate short-run and long-run performance in a single
report.
Balanced Scorecard
Perspectives
Financial
profits and value created for shareholders
Customer
success of the company in its target market
Internal Business Perspective

internal operations that create value for
customers
Learning and Growth
people and system capabilities that support
operations
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

Chipsets adopts cost leadership strategy: its
financial perspective focuses on how much
operating income results from reducing costs and
selling more units of CX1
The Customer Perspective

Identifies targeted customer and market
segments and measures the companys

success in these segments
Chipset uses market share, number of new
customers, and customer-satisfaction ratings
National Customer Satisfaction

Index
The Internal Business

Prospective
Focuses on internal operations that create value for
customers that, in turn, furthers the financial

perspective by increasing shareholder value
Innovation (Product-differentiation)
Chipset focuses on improving manufacturing capability

and process controls to lower costs and improve
quality
Operations
Manufacturing quality, reducing delivery time, and

meeting specified delivery dates
Post-sales service
Service and support after sales

The Learning & Growth

Perspective
Identifies the capabilities the organization
must excel at to achieve superior internal

processes that create value for customers and
shareholders
Information-system capabilities
Employee capabilities
Motivation
The Balanced Scorecard

Flowchart
Infosys Technologies
Infosys: an Indianmultinational corporation
providesbusiness consulting
information technology
software engineering
outsourcingservices
In 2000s, Infosys turned to the balanced scorecard to
formulate and monitor its strategy. The management team

used the scorecard to guide discussion; the scorecard
helped the team respond to its clients evolving needs.
The scorecard helped successfully steer the transformation
of Infosys from a technology outsourcer to a leading
business consultancy.
Balanced Scorecard
Illustration
PPT Slides
Strategy
and the
Balance
d
Scorecar
d,
Illustrate
d
Common Balanced Scorecard

Measures
Balanced Scorecard
Implementation
Must have commitment and leadership from
top management
Must be communicated to all employees
Surveys indicate that companies assign 55% weight to
the financial perspective, 19% on customer, 12% on

internal business process, and 14% on learning and
growth
Features of a Good Balanced

Scorecard
Tells the story of a firms strategy, articulating a
sequence of cause-and-effect relationships

For-profit and not-for-profit organiztions
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
Tailored to distinct strategic business units

Scorecard
Must motivate managers to take actions that
eventually result in improvements in financial

performance
Managers sometimes tend to focus too much on
innovation, quality, and customer satisfaction as ends in

themselves
Limits the number of measures, identifying only
the most critical ones
Focus managers attention on those that most affect
strategy implementation

Scorecard
Highlights less-than-optimal tradeoffs that
managers may make when they fail to consider

operational and financial measures together
Cutting R&D increases short-run financial performance
but hurts the firm in the long-run
A good balanced scorecard would signal that the short-
run financial performance might have been achieved by

taking actions that hurt future financial performance
R&D spending as a leading indicator
Cutting R&D
PfizerInc. is feeling continued sales pressure from
generic competition for top-selling drugs, which

contributed to a 19% profit decline for the third
quarter, while the drug maker signaled its researchand-development spending cuts would ease.
To bolster profits, the company has cut costs,
including sales-force layoffs, manufacturing-plant

closings, and steep reductions in R&D spending since
2011.
Oct. 29, 2013, Wall Street
Journal
Balanced Scorecard
Implementation
Managers should not Pitfalls
assume the cause-andeffect linkages are precise
They are merely hypotheses
Scorecard evolves over time
Managers should not seek improvements across
all of the measures all of the time

Cost-benefit considerations
Managers should not use only objective
measures
Subjective measures are important as well

Customer- and employee-satisfaction ratings
Balanced Scorecard
Implementation Pitfalls
Managers should not ignore nonfinancial
measures when evaluating employees
Analyze changes in
operating income to
evaluate strategy
Conversioncosts(laborandoverheadcosts)foreachyeardependon
productionprocessingcapacitydefinedintermsofthequantityofsquare
centimetersofsiliconwafersthatChipsetcanprocess
ChipsetincursnoR&Dcosts
Chipsetsassetstructureisverysimilarin2010and2011
Chipsetsdatafor2010and2011follow:
1.UnitsofCX1producedandsold
2.Sellingprice
3.Directmaterials(squarecentimetersofsiliconwafers)
4.Directmaterialcostpersquarecentimeter
5.Manufacturingprocessingcapacity(insquarecentimetersofsiliconwafer)
6.Conversioncosts(allmanufacturingcostsotherthandirectmaterialcosts)
7.Conversioncostperunitofcapacity(row6row5)
2010
1,000,000
2011
1,150,000
$23
$22
3,000,000
2,900,000
$1.40
$1.50
3,750,000
$16,050,000
$4.28
3,500,000
$15,225,000
$4.35
How much of the $2,975,000 increase in operating income

was caused by the successful implementation of the
companys cost-leadership strategy?
Growth, price recovery, and productivity
2010
2011
Revenues
($23perunit1,000,000units;$22perunit1,150,000units)
Costs
Directmaterialcosts
($1.40/sq.cm.3,000,000sq.cm.;$1.50/sq.cm.2,900,000sqcm)
Conversioncosts
($4.28/sq.cm.3,750,000sq.cm.;$4.35/sq.cm.3,500,000sq.cm.)
23,000,000
25,300,000
4,200,00
4,350,000
16,050,000
15,225,000
Totalcosts
20,250,000
19,575,000
Operatingincome
2,750,000
5,725,000
Changeinoperatingincome
2,975,000F
Evaluating Strategy
Strategic Analysis of Operating Income three
parts:
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
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
Productivity Component measures the

change in costs attributable to a change
in the quantity of inputs between the
current and prior periods
Growth Component
Revenue effect of growth
(actual units of output sold in 2011- actual units of output sold in
2010)selling price in 2010 = (1,150,000 units 1,000,000

units) $23 = $ 3,450,000 F
Cost effect of growth

Cost effect of growth for variable costs
(units of input required to produce 2011 output in 2010 -actual
units of input used to produce 2010 output) input price in

2010=
[(3,000,000 sq.cm *(1,150,000/1,000,000))-3,000,000 sq.cm ]
$1.40 per sq. cm

=(3,450,000 sq.cm 3,000,000 sq.cm) $1.40 per sq.cm=
$630,000 U
Cost effect of growth for fixed costs= (actual units
of capacity in 2010 because adequate capacity

exists to produce 2011 output in 2010 - actual
units of capacity in 2010)price per unit of
capacity in 2010
=( 3,750,000 sq. cm - 3,750,000 sq.cm ) $4.28
per sq.cm= $0
Net increase in operating income

attributable to growth equals
Revenue effect of growth
Cost effect of growth
Direct material costs
Conversion costs
Change in operating income due to
growth
630,000 U
0
$3,450,000
F
630,000 U
$2,820,000
F
Price-Recovery Component of Change in

Operating Income
Revenue effect of price recovery
(selling price in 2011 selling price in 2010)actual units of
output sold in 2011

($22 per unit - $23 per unit) 1,150,000 units = $1,150,000 U
Cost effect of price recovery

Cost effect of price recovery for variable costs=(input price in
2011 input price in 2010) Units of input required to

produce 2011 output in 2010= ($1.50 per sq. cm - $1.40 per
sq. cm) 3,450,000 sq.cm = $ 345, 000 U
Cost effect of price recovery for fixed costs =(price per unit of
capacity in 2011 price per unit of capacity in 2010) Actual
units of capacity in 2010 (because adequate capacity =
( $4.35 per sq.cm - $4.28 per sq.cm. ) 3,750,000 sq.cm= $
262,500 U
Cost effect of productivity for variable costs=(actual units of
input used to produce 2011 output units of input required

to produce 2011 output in 2010) input price in 2011=
(2,900,000 sq.cm 3,450,000 sq.cm ) $ 1.50 per sq.cm =
$ 8,250,000 F Component of Change in
Productivity
Operating Income
Cost effect of productivity for fixed costs= (actual units of
capacity in 2011 actual units of capacity in 2010 (because

adequate capacity)) price per unit of capacity in 2011=
(3,5000,000 sq.cm 3,750,000 sq. cm) $4.35 per sq. cm=
$ 1,087, 500 F
Net increase in operating income

attributable to price recovery
Revenue effect of price recovery
Cost effect of price recovery
Conversion costs
Change in operating income due to price
recovery
Strategic Analysis of
Profitability Illustrated
Income
statement
Amounts in
2010
Revenue
and Cost
Effects of
Growth
Component
in 2011
Revenues
(1)
$23,000,00
0
(2)
$3,450,000
F
630,000
U
$
2,820,000
F
Costs
Operating
income
20,250,000
$
2,750,000
Revenue
and Cost
Effects of
PriceRecovery
Component
in 2011
(3)
$1,150,00
0U
607,500
U
$ 1,757,500
U
Cost Effect
of
Productivity
Component
in 2011
Income
Statement
Amounts in 2011
(4)
---
(1)+(2)+(3)+(4)
$25,300,000
$1,912,000
F
$1,912,50
0F
$ 2,975,000 F
Change in operating income
19,575,000
$ 5,725,000
Further Analysis of Growth,

Price-Recovery, and Productivity
Market size vs. share
Components
Market growth rate= 8 %
How many units are due to an increase in industry market
size and share? (1,150,000-1,000,000)*8%=80,000

Change in operating income due to growth in industry
market size? 2,820,000*(80,000/150,000)=1,504,000
F
Lacking a differentiated product, Chipset could have
maintained the price of CX1 at $23 per unit even while the
prices of its inputs increased
prices of inputs (cost effect of price recovery) 607,500 U

operating income due to product differentiation 607,500 U
Chipset cuts the price of CX1 by $1
A summary of the change in operating income
between 2010 and 2011
due to industry market size

due to product differentiation
due to cost leadership
in operating income
In class-exercise: product
differentiation
Units of KE8 produced and sold

Selling price
Direct materials (square feet)
Direct material cost per square foot
Manufacturing capacity for KE8
Conversion costs
Conversion cost per unit of capacity (row 6 / row 5)
Selling and customer-service capacity
Selling and customer-service costs

Cost per customer of selling and customer-service
capacity (row 9 /row 8)
2012
40,000
$100
120,000
$10
50,000
units
$1,000,00
0
$20
30
customer
s
$720,000
$24,000
2013
42,000
$110
123,000
$11
50,000
units
$1,100,00
0
$22
29
customer
s
$725,000
$25,000
In class-exercise
In 2011, Westwood produced no defective units
and reduced direct material usage per unit of KE8.

Conversion costs in each year are tied to
manufacturing capacity. Selling and customer
service costs are related to the number of
customers that are selling and service functions
are designed to support. Westwood has 23
customers (wholesalers) in 2010 and 25
customers in 2011.
Calculatethegrowth,price-recovery,andproductivitycomponents
thatexplainthechangeinoperatingincomefrom2010to2011.
Revenues
($100 per unit *40,000 units; $110 per unit * 42,000
units)
Costs
($10 per sq. ft. *120,000 sq. ft; $ 11 per sq. ft. *
123,000 sq. ft.)
Conversion costs
($20 per unit * 50,000 units; $22 per unit * 50,000
units)
Selling and customer-service cost
($24,000 per customer * 30 customers;
$25,000 per customer * 29 customers )
Total costs
Operating income
Change in operating income
2012
$4,000,00
0
1,200,000
2013
$4,620,0
00
1,353,00
0
1,000,000 1,100,00
0
720,000
725,000
2,920,000 3,178,00
0
$1,080,00 $1,442,0
0
00
$362,000 F
Growth Component of Operating

Income Change
Revenue effect of growth = (actual units of output sold in 2013 -
actual units of output sold in 2012) Selling price in 2012 =

(42,000 units 40,000 units) $100 per unit = $200,000 F
Cost effect of growth for variable costs = (Units of input required
to produce 2013 output in 2012 actual units of input used to

produce 2012 output) input price in 2012 = ( 120,000 sq .ft
42,000 /40,000 120,000 sq. ft ) $ 10 per sq. ft= $60,000 U
Cost effect of growth for fixed costs = (Actual units of capacity in
2012 because adequate capacity exists to produce 2013 output in

2012 Actual units of capacity in 2012 ) Price per unit of
capacity in 2012 = (50,000 units 50,000 units) $20 per unit=
$0
Price-Recovery Component of
Operating-Income Change
Revenue effect of price recovery = (selling price in 2013 Selling price
in 2012) Actual units of output sold in 2013 = ($ 110 per unit - $ 100
per unit) 42,000 units= $420.000 F
Cost effect of price recovery for variable costs= (Input price in 2013
Input price in 2012) Units of input required to produce 2013 output in

2012 = ($11 per sq. ft - $10 per sq.ft) 126,000 sq.ft. = $126,000 U
Cost effect of price recovery for fixed costs= (price per unit of capacity
in 2013 price per unit of capacity in 2012) Actual units of capacity in

2012 because adequate capacity exists to produce 2013 output in 2012
= ($22 per sq. ft - $20 per sq.ft) 50,000 units = $100,000 U
Cost effect of price recovery for customer service = ( $25,000 per
customer - $ 24,000 per customer) 30 customers= $30,000 U
Productivity Component of OperatingIncome Change

Cost effect of productivity for variable costs = (Actual units of input
used to produce 2013 output Units of input required to produce

2013 output in 2012 ) Input price in 2013
(123,000 sq. ft 126,000 sq.ft) $11 per sq.ft= $33,000 F
Cost effect of productivity for fixed costs= (Actual units of capacity
in 2013 Actual units of capacity in 2012 because adequate

capacity exists to produce 2013 output in 2012) price per unit of
capacity in 2013= (50,000 units 50,000 units ) $22 per unit=
$0
Selling and customer-service costs : (29 customers 30 customers)
$25,000/customer = $25,000 F
Suppose during 2011, the market size for high-
end kitchen range hoods grew 3% in terms of

number of units and all increases in market share
(that is, increases in the number of units sold
greater than 3%) are due to Westwoods productdifferentiation strategy. Calculate how much of the
change in operating income from 2012 to 2013 is
due to the (1)industry-market-size factor,
(2)cost leadership, and (3)product
differentiation.
Industry-Market=Size factor $140,000 1,200 /2,000=
$84,000 F; 3% 40,000 units =1,200 units

Effect of Product Differentiation on Operating Income:
A. Increase in selling price of KE8 (revenue effect of the
price recovery component): $420,000 F
B. Cost effect of price recovery component: 256,000 U
C. Growth in market share due to product differentiation
$140,000 800 / 2,000 = 56,000 F
Effect of Cost leadership in Operating income
Productivity component: $ 58,000 F

CHP 12 - Strategy, Balanced Scorecard, and Strategic Profitability (With Answers)

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CHP 12 - Strategy, Balanced Scorecard, and Strategic Profitability (With Answers)

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CHAPTER 12

Strategy, Balanced Scorecard and

2009 Pearson Prentice Hall. All rights reserved.

2009 Pearson Prentice Hall. All rights reserved.

A scorecard evaluates an organizations

strategy using a set of performance measures.

2009 Pearson Prentice Hall. All rights reserved.

2009 Pearson Prentice Hall. All rights reserved.

Recognize which of two

2009 Pearson Prentice Hall. All rights reserved.

its own capabilities with the opportunities in the

categories, and few choices within each product category. It

consumer electronics industry(Product Differentiation).

2009 Pearson Prentice Hall. All rights reserved.

Five Aspects of Industry

critical to implementing a successful strategy

How to chose of the two basic strategies?

Chipset produces a single specialized product, C1, a

standard, high-performance microchip

Competitors: severe price competition, pressure to reduce

Potential entrants into the market: small profit margins and

high capital costs discourage new entrants. Incumbent keeps

and lowers prices by improving design and processes. This

negotiate aggressively with Chipset to keep prices down

and employees bring gives them bargaining power

Basic Business Strategies

offer products or services perceived by its customers to

Brand loyalty, the willingness of customers to pay high

Cost Leadership an organizations ability to achieve

lower costs relative to competitors through productivity

Lower selling prices

Understand the four

2009 Pearson Prentice Hall. All rights reserved.

Balanced Scorecard to manage the

2009 Pearson Prentice Hall. All rights reserved.

The Balanced Scorecard

organizations mission and strategy into a set of

of financial and nonfinancial performance measures to

Internal Business Perspective

The Financial Perspective

into this dimension

2009 Pearson Prentice Hall. All rights reserved.

The Customer Perspective

segments and measures the companys

customers, and customer-satisfaction ratings

2009 Pearson Prentice Hall. All rights reserved.

National Customer Satisfaction

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2009 Pearson Prentice Hall. All rights reserved.

The Internal Business

customers that, in turn, furthers the financial

Chipset focuses on improving manufacturing capability

Manufacturing quality, reducing delivery time, and

Service and support after sales

The Learning & Growth

must excel at to achieve superior internal

2009 Pearson Prentice Hall. All rights reserved.

The Balanced Scorecard

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formulate and monitor its strategy. The management team

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Common Balanced Scorecard

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