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Chapter 13

Strategic Profitability Analysis

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What is Strategy?

Strategy describes how an organization matches

its own capabilities with the opportunities in the

marketplace to accomplish its overall objectives.

Understanding the industry is key

Porter’s 5 forces: Industry analysis regarding: Competitors Potential entrants into the market Equivalent products Bargaining power of customers Bargaining power of input suppliers

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Generic Strategies

1. Product differentiationability to offer products or services perceived by its customers to be superior and unique relative to the products or services of its competitors builds on brand loyalty and the willingness of customers to pay high prices

2. Cost leadership strategic idea: ride down the experience curve faster than

competitors key strategic variable: relative market share can be enhanced preferably during the early stages of the product

life cycle Implementation of Strategy (Role of Management Accounting) :

Management accountants design reports to help managers track progress in implementing strategy.

Strategically relevant objectives Growth Price Recovery Productivity

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Growth Component

Revenue effect of growth component

= (Actual units sold current year – actual units sold

previous year) × output price (previous year) Cost effect of growth component

= (Units of input or capacity that would have been used in previous year to produce

current year’s output assuming the input-output relationship of previous year– actual units or capacity current year) × input price (previous year)

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Price-Recovery Component

Revenue effect of price-recovery component= (Output price (current year) – Output price (previous year)) × Actual units of output sold (current year)

Cost effect of price-recovery component= (Input prices (current year) – Input prices

(previous year)) × units of input or capacity that would

have been used in previous year to produce current year’s output assuming the input- output relationship of previous year

(current year)

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Productivity Component

Productivity component

= (actual units or capacity current year

– units of input or capacity that would have been used in previous year to produce

current year’s output assuming the input- output relationship of previous year)

× input prices current year)

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Change in Operating Income

Change in operating income

Growthcomponent

Price-recoverycomponent

Productivitycomponent

Revenueeffect

Costeffect

Revenueeffect

Costeffect

(productivity and pricesprevious year)

(productivity previous year volume of current year)

(prices and volume of current year)

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Managing unused capacity:Engineered Costs vs Discretionary Costs

Engineered costs result specifically from a clear cause-and-effect relationship between output and the resources needed to produce that output. They can be variable or fixed in the short run Engineered costs pertain to processes that are detailed,

physically observable, and repetitive.

Discretionary costs have two important features. They arise from periodic (usually yearly) decisions

regarding the maximum amount to be incurred. They have no measurable cause-and-effect relationship

between output and resources used. Discretionary costs are associated with processes that are

sometimes called black boxes, because they are less precise and not well understood

E.g. Advertising, executive training, R&D costs

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Managing Unused Capacity

What actions can management take when it identifies unused capacity? Attempt to eliminate the unused capacity Attempt to use the unused capacity to grow

revenue

CCs: 13-19 modified from 11th ed. (8%) 13-23 (=11.13-21) (8%) 13-27 (=11.13-25) (8%) 13-33 (=11.13-30) (9%) 13-35 (=11.13-33) (5%) 13-39 (new in 11th ed.) (9%)

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13-19

1.   OI both years

2. growth, price-recovery, and productivity components of OI change

3. comment

2006 2007Number of T-shirts purchased 200.000 250.000 Number of T-shirts discarded 2.000 3.300 Number of T-shirts sold 198.000 246.700 Average selling price $ 25,00 $ 26,00Average cost per T-shirt $ 10,00 $ 8,50Administrative capacity (number of customers) 4.000 3.750 Administrative costs $1.200.000 $1.162.500Administrative cost per customer $ 300 $ 310Design staff 5 5 Total design costs $ 250.000 $ 275.000Design cost per employee $ 50.000 $ 55.000

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3-23

2005 2006Units peroduced and sold 200 210Selling price $40 000 $42 000Direct materials (kg) 300 000 310 000Direct materials cost /kg $8 $8,50Manufacturing capacity (units of D4H) 250 250Total conversion costs $2 000 000 $2 025 000Conversion costs per unit of capacity $8 000 48 100Selling and customer service capacity (customers) 100 95Total selling and customer service costs $1 000 000 $940 500Selling and customer service capacity cost per customer $10 000 $9 900Design staff 12 12Total design costs $1 200 000 $1 212 000Design cost per employee $100 000 $101 000Number of customers 75 80

1.   OI both years2. growth, price-recovery, and productivity components of OI change3. comment

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13-33

2007 2008Pieces of clothing purchased and sold 40 000 40 000Average selling price $60 $59Average cost per piece $40 $41Selling and customer serv ice capacity (customers) 51 000 43 000Selling and customer serv ice costs $357 000 $296 700Selling and customer serv ice capacity cost / customer $7 $6.90Purchasing and administrative capacity (dist designs) 980 850Purchasing and administrative costs $245 000 $204 000Purchasing and administrative capacity cost per dist. design $250 $240

1. Strategy?2. OI both years3. growth, price-recovery, and productivity components of OI

change4. comment

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13-35

750 000 subscribers in 2005 5 customer help desks 8 hrs/day, 250 days per year fixed salary: $36 000 45 000 customer calls @ 10 minutes (average)

1. help call costs: engineered or discretionary?

2. cost of unused capacity in each case

3. 2006: 900 000 subscribers, same percentage calling help as in 2005; requirement as in 2.

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13-39

Cafeteria employees' annual wages $150.000 $75.000

Additional benefits (% of salary) 25% 25%

Days of cafeteria operation 250 250 250

Annual cost of utilities and maintenance (paid by Mayfair) $ 40.000 $40.000 $40.000

Daily sales:

Entrees 120 at $4,00 each 75 at $5,00 each

Sandwiches 100 at $3,00 each 150 at $3,50 each 95 at $4,00 each

Beverages/desserts 250 at $1,00 each 280 at $1,50 each 230 at $1,50 each

Cost of supplies (% of revenues) 60% 50% 70%

Annual rent (paid to Mayfair) $18.000

Percent of revenues above breakeven (paid to Mayfair) 5,00%

Wilco's revenues and costs:

Current Operation Downsized Operation Wilco Foods' Proposal

1. Downsizing acceptable?

2. Breakeven level of revenues fo Wilco? Preferred alternative?

3. other factors to be considered

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3-27

2005 2006Units of work performed 60 70Selling price $50,000 $48 000Software implementation, labor hrs 30 000 32 000Cost per software implementation labor hr. $60 $63Software-implementation support capacity (units of work) 90 90Total cost of software implementation support $360 000 $369 000Software-implementation support capacity cost/ unit of work $4 000 $4 100Number of emloyees doing software development 3 3Total software developmant costs $375 000 $390 000Software development cost per employee $125 000 $130 000

1.   OI both years2. growth, price-recovery, and productivity

components of OI change3. comment

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Quiz

1.       Reengineering is a key element ina. cost leadership strategy.b. price recovery strategy.c. product differentiation strategy.d. productivity measures. 2.       Which of the following is not a key aspect of

reengineering?a. Eliminating unnecessary activities and tasksb. Developing employee skillsc. Changing roles and responsibilitiesd. Working on one activity at a time to improve

production processes 

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Quiz

3.       The analysis used for evaluating the success of a strategy through changes in operating income components uses actual results of the current year compared to

a.       budgeted results for the current year.b.       actual results for the previous year.c.       target amounts for the current year.d.       budgeted results for the previous year.

 4.       The growth in market share is used in calculating the net income effect

a.       of industry growth.b.       of product differentiation.c.       of cost leadership.

d. of either cost leadership or product differentiation, depending upon the strategy chosen.

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5. The following strategic analysis of profitability was prepared for the Corum Company: Revenue and Revenue and Income Cost Effects Cost Effects of Cost Effect of Income Statement of Growth Price-Recovery Productivity Statement Amounts Component Component Component Amounts in 2004 in 2005 in 2005 in 2005 in 2005 (1) (2) (3) (4) (5) Revenues $300,000 $40,000 F $85,000 F $425,000 Costs 240,000 24,000 U 34,000 U $8,000 U 306,000 Operating income $ 60,000 $16,000 F $51,000 F $8,000 U $119,000

$59,000 F

Change in operating income The market growth rate in the industry is 9% in 2005. Sales in 2005 were 17,000 units at $25 each. Corum sold 15,000 units at a unit-selling price of $20 in 2004. The effect of the industry market size factor for Corum Company in 2005 was

a. $5,200. b. $10,800. c. $12,240. d. $13,500.

Quiz