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Module 9: Strategy and the Balanced Scorecard

verview

Module 9 ties all previous modules together into a method for facilitating decision-making and performance evaluation. Inhis module, you focus on the Balanced Scorecard (BSC) as a management tool for the implementation of a chosen strateou learn about the Balanced Scorecard approach to gathering financial and nonfinancial information, and how to apply th

esulting scores in strategic decision-making. The module also provides an opportunity for you to use the BSC to createolutions to performance evaluation deficiencies in a given business situation.

est your knowledge

egin your work on this module with a set oftest-your-knowledge questions designed to help you gauge the depth of studequired.

ssignment reminder

ssignment 3 is due this week (see Course Schedule). Be sure to allocate time to complete and submit the assignment by

eadline.

opic outline and learning objectives

9.1 Strategy evaluation and the Balanced Scorecard Explain how the four Balanced Scorecard perspectiare used to evaluate the success of a strategy. (Le2)

9.2 BSC application to enterprise risk management Explain how the Balanced Scorecard can be used toevaluate risk management strategy, and how goodgovernance contributes to risk management. (Leve

9.3 BSC and corporate sustainability Identify similarities between the Balanced Scorecar

measures and measures used to assess corporatesustainability. (Level 2)

9.4 Implementation of the BSC Describe the process required to implement andapply the Balanced Scorecard. (Level 1)

9.5 Evaluating outcomes of strategic initiatives Evaluate outcomes of strategic initiatives using thestoplight system. (Level 1)

9.6 Strategic analysis of operating income Evaluate change in operating income resulting fromimplementation of strategic components: growth,product differentiation, and cost leadership orproductivity. (Level 1)

9.7 Specific control strategies Analyze specific productivity and capacity controlstrategies to achieve Balanced Scorecard objective(Level 1)

Module summary

Print this module

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9.1 Strategy evaluation and the Balanced Scorecard

Learning objective

Explain how the four Balanced Scorecard perspectives are used to evaluate the success of a strategy. (Level 2)

Required reading

Chapter 13, pages 642-648 (Be sure to review the overview of strategy on pages 656-657.) Online article: The Balanced Scorecard

EVEL 2

ccording to Kaplan and Norton (2004)1, the Balanced Scorecard (BSC) translates an organizations mission and strategy comprehensive set of performance measures that provide a framework for evaluating its strategy implementation. Rathe

han the traditional financial measures of ROI, which are used to evaluate management and corporate performance, the Bses both financial and nonfinancial measures in four perspectives:

inancial Evaluates the profitability of a strategy from growth in the revenue streams or reduction of costs, and uses tmore traditional measures such as return on capital employed, operating income, and revenue growth.

ustomer Evaluates whether the company is achieving success in meeting customer needs through identifying austomer value proposition (that is, by answering the question, who are we to the customer?), and utilizes measures sus customer satisfaction, number of new customers, increase in market share, and so on.

nternal business process Evaluates the effectiveness and efficiency of managing the internal operations or valuehain. This perspective focuses on three principle sub-processes: innovation, operations, and post-sales service.

earning and growth Focuses on the area of intellectual capital, comprised of human, structural, and relational capit

his measure includes employee training and cultural attitudes.

he Balanced Scorecard aligns the organization with corporate strategy by linking strategic goals and objectives (see Exhi3-1, page 644). Exhibit 13-2 (page 647) identifies typical BSC measures that are used to determine the level of success ohe strategy implementation. A typical Balanced Scorecard identifies the objectives for each perspective, determines how t

will be measured (the measures), decides which initiatives management will implement, and defines target and actual resxhibit 9.1-1 provides an example of a BSC measure from the financial perspective. Note that the purpose of initiatives is ssist in achieving the target.

xhibit 9 .1-1: BSC measures financial perspective

Objectives Measures Initiatives Target Actua

Increased shareholder value Operating income Manage costs and unused capacity $2,000,000 $2,012,5

ompanies can use a methodology to highlight successes and areas for improvement. One such tool is as a stoplight systedescribed in detail in Topic 9.5) in which the target is broken into three categories. Green represents meeting expectationellow represents results slightly below the desired target ($1,850,000 $2,000,000 in Exhibit 9.1-1), and red represents roblem area to be addressed (income

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nstitute.

he BSC is an evolving topic. This presentation of the learning and growth perspective focuses on product development.owever, the Balanced Scorecard Institute and the 5th edition of your textbook describe learning and growth as thealuation of intellectual capital, focusing on employee training and cultural attitudes. Your knowledge of this perspectivehould be based on the material in the textbook and the module notes.

R.S. Kaplan and D. P. Norton, Strategy Maps: Converting Intangible Assets into Tangible Outcomes, Boston: Harvardusiness School Press, 2004.

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9.2 BSC application to enterprise risk management

Learning objective

Explain how the Balanced Scorecard can be used to evaluate enterprise risk management strategy, and how goodgovernance contributes to risk management.(Level 2)

Required reading

Chapter 13, pages 648-652

EVEL 2

he business landscape has changed since the 1996 advent of the Balanced Scorecard (BSC), which in turn has led tohanges in the functionality and purpose of the BSC. Originally designed solely as an advanced performance measurementystem, the BSC has come to play a deeper role in the development of corporate strategy. It now connects strategy withudgeting to establish for the first time a true link between resource needs and strategy needs.

nterprise risk management (ERM) is a fundamental issue for many organizations, especially those involved in globalperations. The BSC can be used to evaluate the effectiveness of an organization s ERM strategy, the stewardship function

management, corporate competitiveness including productivity, cost leadership, business process and capacity utilization, orporate governance (see Exhibit 13-3 on page 652). The textbook on pages 649-651 provides an illustration of how theSC can be used to assess the success of an ERM strategy to manage the corporate supply-chain.


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9.3 BSC and corporate sustainability

Learning objective

Identify the similarities between the Balanced Scorecard measures and measures used to assess corporatesustainability. (Level 2)

Required reading


he textbook on page 653 states that corporate sustainability creates long-term shareholder value by embracingpportunities and managing risks derived from economic, social, and environmental developments. The implementation ofest practices in this area has been linked to increased recognition by investors. A quantitative measure used to determinehis increased market valuation is Tobins q , measured as the sum of the balance sheet value of debt plus all equity dividy the total assets. This result is statistically different for companies found to be more sustainable than others. The findinre also associated with companies that have higher sales growth. The T-q analysis can also be used to link the earningsesponse co-efficient (ERC, studied in accounting theory), which indicates that the market reacts more strongly to news fro

ompanies with higher growth possibilities than from those rated lower on the growth scale.

he three dimensions of sustainability (economic, environmental, and social) can also be applied to the BSC. The economink lies in measures that include product protection, intellectual capital management, internal process improvement, andustomer responsiveness. Measures to control environmental risks such as hazardous waste disposal and fuel efficiency cae implemented into the BSC, as well as social measures that deal with human capital development. Each of these measuonnect the BSC with policies developed to sustain growth and manage risks.



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9.4 Implementation of the BSC

Learning objective

Describe the process required to implement and apply the Balanced Scorecard. (Level 1)

Required reading

Chapter 13, pages 656-661 (to Evaluating Strategic Success Focus on Operating Income)

uccessfully implementing a BSC requires commitment and leadership from top management. Usually, an implementationeam is put together to conduct interviews with senior managers to gather input used for developing objectives, measuresnd buy-in. The goal is to achieve consensus on objectives and to establish a cause-and-effect linkage across objectives atoth senior and middle management levels. Once the measures are developed, senior managers meet with middle-level

managers to finalize the scorecard, to determine who is responsible for each area and/or objective, and to decide how themeasures will be attained. The textbook lists features of a good BSC (page 658) and also lists pitfalls to avoid whenmplementing a BSC on pages 658-659.

ne of the advantages of implementing the BSC is that it allows management to determine the impact of initiatives onompany performance. For example, reengineering is a tool that can be used to implement initiatives that will impact anrganizations performance targets. Reengineering is a fundamental rethinking and redesign of business processes to achimprovements in critical measures of performance. It can reduce costs, increase quality, and increase customer satisfactiohis is then reflected in the BSC at the internal business process level. The training required to implement the reengineerinreflected in the learning and growth perspective and could also be mapped to show its impact on the customer perspec

When changes also reduce costs and increase revenue (for example, through increased customer satisfaction), the effectwould show up in the financial perspective.



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ed-light data for this example could be as follows:

Operating income from productivity gain: any result below $1,000,000

Operating income from growth: any result below $2,500,000

Market share in network segment: any result below 3%

Customer satisfaction rating: any result below 75%

ed-light data is set as any number below a certain measure. Amounts in the red-light range are highlighted as areas whemanagers should focus their concern.

xhibit 9.5-1 shows a printout of the section of the BSC analysis highlighted using the stoplight system.

xhibit 9.5-1: Stoplight sys tem

Objectives Measures Initiatives TargetPerformance

ActualPerformanc

Financial Perspective

ncrease shareholder value

Operating income

from productivitygain Manage costs $2,000,000.00 $2,512,500.00

Operating incomefrom growth

Build strongcustomer relations

$3,000,000.00

$2,400,000.00

Customer Perspective

ncrease market shareMarket share innetwork segment

Identify futureneeds of customers 6% 5.50%

ncrease customer satisfactionCustomer-satisfaction ratings

Increase customerfocus of salesorganization 90% 74.50%

he goal when evaluating the results of a strategy using the BSC is to isolate operating numbers related to the strategy frther causes. For example, increases in operating income could result from growth in the overall economy as opposed to uccessful implementation of the strategy. A methodology for performing a detailed analysis of operating income isddressed in the following topic.


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pdated August 18, 2010, MA2-10-IB 01

9.6 Strategic analysis of operating income

Learning objective

Evaluate change in operating income resulting from implementation of strategic components: growth, productdifferentiation, and cost leadership or productivity. (Level 1)

Required reading


EVEL 1

ach organization has a different strategy and therefore requires different sets of measures. For example, governmentrganizations do not have a profit orientation, and non-government organizations (NGOs) are required to meet the goals o

ifferent constituency groups. For an example of this type of BSC see Exhibit 13-7 on pages 669-670, which shows aalanced Scorecard used at the Canadian Institute of Health Information.

or evaluating implementation of strategies such as cost leadership, product differentiation, and growth, managers can ustrategic analysis of operating income over a minimum of two years. This is done by breaking down changes in operatingncome from one year to the next into the following components:

Revenue and cost effects of growth Revenue and cost effects of price-recovery Cost effect of productivity

xhibit 13-6 on page 664 shows the overall strategic analysis of profitability for the CXI scenario. It explains the $2,500,00ncrease in operating income by breaking it down into its component parts.

Growth component

he growth component measures change in revenue and costs based on changes in units sold or produced, with all otherariables being the same as the previous year. By isolating the change in units, the analysis looks at the impact of the chan growth on revenue.

evenue effect of growth

Revenue effect of growthcomponent

=(Actual units ofoutput sold in thecurrent period

Actual units ofoutput sold in thelast period)

Selling price inthe last period

aintaining the selling price of the last period isolates the increase in revenue resulting from the change in units sold.

Cost effect of growth

Cost effect of growthcomponent

=

(Actual units of input orcapacity that would haveused to produce currentperiod output assumingthe same input-outputrelationship that existedin the last period

Actual units ofinput or capacityto produce the lastperiod output)

Input pricesthe last peri



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aintaining the input-output relationship in the last period input prices isolates the increase in cost resulting from the grown sales between the last period and the current period. Since fixed costs do not change, variable direct-material costs areolated from fixed costs (including conversion and R&D costs). This approach assumes that the company is still operating

within its relevant range.

rice-recovery component

he price-recovery component of operating income measures the change in revenues and the change in costs to produce iven level of current output resulting from the change, assuming the relationship of input-output remains constant. This

olates the change in revenue due solely to the change in selling price.

evenue effect of price recovery

Revenue effect of productdifferentiation component

=(Selling price inthe current period

Selling price inthe last period)

Actual units ofoutput sold inthe currentperiod

Cost effect of price recovery

his component focuses on the effect of changes in prices of input and also incorporates changes in fixed costs or conversosts.

Cost effect of productdifferentiation component

=(Input prices inthe currentperiod

Input prices inthe last period)

Actual units of inputs ocapacity that wouldhave been used toproduce in the currentperiod output assuminthe same input-outputrelationship that existein the last period

roductivity component

he productivity component analysis uses current-year prices to isolate the change in costs between the current and pastear caused solely by the changes in quantities, mix, and capacity of inputs.

Productivity/costeadership component

=

(Actual unitsof input orcapacity toproduce thecurrent periodinput

Actual units ofinputs or capacitythat would havebeen used toproduce the currentperiod outputassuming the sameinput-outputrelationship thatexisted in the lastperiod)

Currentperiod pric

onclusion

ompanies that have chosen a cost-leadership strategy would be more likely to focus on productivity and growthomponents, while companies following a differentiation strategy would see more changes in price-recovery and growthomponents.

urther analysis

n organization may wish to further analyze the results to factor out industry or market forces from strategic forces. Markrowth can lead to an increase in sales, regardless of whether the company implemented a successful growth strategy.


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ssume the market growth rate in the industry was 10% and total sales for the company increased from 1,000,000 to,150,000 (which is 15%). The company could factor out the impact of industry growth (1,000,000 x 10% = 100,000) frohe 150,000-unit increase in company sales (1,150,000 1,000,000). Thus the actual growth (From Exhibit 13-6, column

would yield the following:

evenue and cost effects of growth component in 2010

Revenue and cost

effects of grow thcomponent in 2010

Increase in companysales beyond theincrease due to growth)divided by (totalincrease in companysales

Growth due to increasein share of the market

$3,420,000 F 50,000 units = 1,140,000 F

150,000 units

he following computer illustration uses Excel and the stoplight method to perform a basic analysis of operating income.

Computer illustration 9.6-1: Analys is of operating income

olution


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Computer illustration 9.6-1: Analys is of operating income

his computer illustration uses conditional formatting techniques and basic analysis to communicate the organizations abio achieve target performance. Refer to the following information:

alsey and Company sells womens clothing. Halseys strategy is to offer a wide range of clothes and excellent service andharge a premium price. The following information is available for 20X9-20X10. (For simplicity, assume Halsey sells only oiece of clothing):

20X9 20X

Pieces of clothing purchased and sold 40,000 40,

Average selling price $72.00 $70

Average cost per piece of clothing $48.00 $49

Selling and customer-service capacity (customers) 51,000 43,

Selling and customer-service costs $428,400 $356,

Selling and customer-service capacity cost per customer $8.40 $8

Purchasing and administrative capacity measured by the number of distinct clothingdesigns purchased 980

Purchasing and administrative costs $294,000 $244,

Purchasing and administrative capacity cost per distinct design $300 $

otal selling and customer-service costs depend on the number of customers that Halsey has created capacity to support,he actual number of customers that Halsey services. Total purchasing and administrative costs depend on purchasing anddministrative capacity that Halsey has created (defined in terms of the number of distinct clothing designs that Halsey caurchase and administer). Purchasing and administration costs do not depend on the actual number of clothing piecesurchased. Halsey purchased 930 distinct designs in 20X9 and 820 distinct designs in 20X10. Market-wide prices for clothind the market size were unchanged in 20X9 and 20X10. At the start of 20X10, Halsey planned to increase operating incoy 10% over the operating income in 20X9.

equired

1. Calculate Halseys operating income in 20X9 and 20X10.2. Calculate the growth, price-recovery, and productive components on changes in operating income between 20X9

20X10.3. Does the strategic analysis of operating income indicate Halsey was successful in implementing its premium price

product differentiation strategy in 20X10? Explain.

ource: Adapted from Horngren, 4th Canadian Edition, 13-30, p. 549

aterial provided

le MA2M9P1 containing a partially completed worksheet M9P1, the solution worksheet M9P1S, the Balanced Scorecard oworksheet called Balanced Scorecard, and the solution to the Balanced Scorecard portion on a worksheet called Balancecorecard sol

equired

nswer requirement 1 based on the information given. Then, using the spreadsheets, answer the remaining requirementsomplete the Balanced Scorecard tab by linking to M9P1S.

rocedure

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tart Excel. Open the file MA2M9P1.

1. Review the data table (A4 to I 23) and note that it replicates the information given in the question.

2. Complete a comparative income statement for Halsey and Company for the year ended December 31, 20X10, usinthe template found at A26 to I41 and the information in the data table.

3. Using the formulas given in the text on pages 664-665, complete Part 3 entitled "Revenue and Cost Effects ofGrowth" in section A43 to H54.

4. To apply conditional formatting to this section, highlight the appropriate cell or group of cells. Click Format, then

Conditional Formatting and follow the instructions. (For Excel 2007, click on the Conditional formatting icon withinHome tab.) Choose green for positive results, yellow for results that may require further research, and red for valuthat are of concern.

Judgment is required in choosing specific conditions. For example, for the variance analysis: For Revenues: values>0, choose green; values 0, choose red; valu

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omputer illustration 9.6-1

olution

he Balance Scorecard analysis shows the following with stoplight formatting.

onclusion

he analysis of operating income indicates that a significant amount of the increase in operating income resulted fromroductivity gains rather than product differentiation. The company was unable to charge a premium price for its clothes.hus, the strategic analysis of operating income indicates that Halsey has not been successful at implementing its premiumrice and product differentiation strategy, despite the fact that operating income increased by more than 10% between 20nd 20X7. Halsey could not pass on increases in purchase costs to its customers via higher prices. Halsey must eithereconsider its strategy or focus managers on increasing margins and growing market share by offering better product variend superb customer service.

he stoplight score indicates that management needs to do a more detailed analysis of the Increase in shareholder valueection and the market share numbers. These numbers show areas of concern and indicate that the company did not actuchieve their product differentiation. Have the needs of the market changed? What other issues may be indicated? The coavings on improved internal business processes were acceptable; however, given the supposed increase in quality andubsequent decline in customer service expectations, the learning and growth numbers should be analyzed further.

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9.7 Specific control strategies

Learning objective

Analyze specific productivity and capacity control strategies to achieve Balanced Scorecard objectives. (Level 1)

Required reading


EVEL 1

roductivity measures

roductivity measures the relationship between actual inputs (quantity and costs) and actual outputs produced. The lowerhe input for a given level of output, the greater the productivity achieved.

artial productivity focuses on one productivity component, such as direct materials. The following ratio measures the leveutput to the level of input used.

artial productivity = Quantity of output producedQuantity of input used

he higher the ratio, the greater the productivity achieved.

valuating changes in partial productivity

t is important to separate variable from fixed productivity changes. A reduction in variable costs immediately lowers overaost, while fixed costs tend to be based on a minimum capacity, so lowering the capacity used does not necessarily reduce

otal costs. Changes from the previous year can be used to determine percentage change for the current year as in Exhibi3-8 on page 671.

ercentage change = Partial productivity current year Partial productivity previous yearPartial productivity previous year

otal-factor productivity (TFP )

artial productivity measures individual inputs and isolates relevant factors of importance to managers, but fails to determhe overall impact on productivity by the mix of inputs.

otal-factor productivity = Quantity of output produced

Costs of all inputs used

otal-factor productivity considers all inputs simultaneously and assesses the tradeoffs made based on current input priceo compare the changes over time, TFP benchmarks against the company for the previous year but maintains the currentear prices to control for changes in price.

otal factor productivity = Quantity of output produced in current year

or current year using current year pricesCost of inputs used in current year based on currentyear prices

his is compared to the previous years input required to produce the the current level of output.



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enchmark TFP = Quantity of output produced in current yearCost of inputs that would have been used inprevious year to produce current year output

rom this, you can compute the percentage change in total factor productivity

ercentage change in TFP = TFP (current year) TFP (previous year)TFP (previous year)

sing both total-factor and partial productivity measures

hese measures work well together, as the strengths of one are the weaknesses of the other. While partial productivitymeasures identify changes in specific factors, they fail to identify the impact on overall productivity. Total-factor productivmeasures provide numbers across the company. However, increased productivity in one area can cause decreasedroductivity in another, which can remain hidden when the total-factor number is used. The total-factor number is more lisnapshot, and usually needs further analysis to provide useable information. Both measures can be used across time as

hey both measure physical inputs that can be tracked. This allows the organization to identify improvements over time, ahe results can ultimately be tied to productivity-based bonus and compensation systems.

thical considerations

ince productivity measures can be used in productivity-based compensation systems, they can create incentives forndividual managers to manipulate information for their own gain, and this would be counterproductive to achieving therganizational goals. Both the Balanced Scorecard and productivity measures must be designed and implemented in such

way that managers are not able to manipulate the system. This problem is often solved by ensuring transparency ofnformation and process. The steps in creating the BSC should be designed to demonstrate openness and to incorporateeedback, allowing each manager to have a say in developing the BSC measures and goals.

Capacity control measures

nlike variable costs, fixed costs are tied to capacity. Managers can control capacity by understanding engineered costs aniscretionary costs.

ngineered costs result from cause-and-effect relationships between output (cost driver) and direct or indirect resources uo produce that output. Direct materials are an example of direct engineered costs. Conversion costs include factory overh

eeded to produce a given level of output and are an example of indirect engineered costs, which are tied to capacity in thort-run.

iscretionary costs arise from periodic (usually yearly) decisions regarding maximum amounts to be incurred, and have nomeasurable cause-and-effect relationship between output and resources consumed. Discretionary costs are undermanagements discretion to incur or not in the short-run and can usually be eliminated in the short-run without hurting sa

elationships between inputs and outputs

ngineered costs are related to processes that are detailed, physically observable, and repetitive (such as manufacturing oustomer service activities), while discretionary costs are less precise and not as tied to processes. Further, discretionaryosts are less certain. As defined in the text, uncertainty refers to the possibility that an actual amount will deviate from axpected amount. The higher the level of uncertainty, the less likely a cause-and-effect relationship will exist. See Exhibit on page 675 for a summary of engineered and discretionary costs.

nused capacity for engineered and discretionary overhead costs

ngineered unused manufacturing capacity costs can be calculated by taking the maximum capacity and subtracting curreutput, then multiplying by the conversion cost rate. Using the example in the text, the maximum capacity is 1,875,000 und current production is 1,450,000, resulting in unused capacity cost as follows:

Maximum capacity Current production) x Indirect engineered cost1,875,000 1,450,000) x $6.20 = $2,635,000.00

he absence of cause-and-effect relationships make discretionary costs more difficult to relate to used or unused capacity


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anaging unused capacity

anagers prefer to operate close to capacity in order to allocate fixed costs over more units. When the organization isntperating at capacity, fixed costs are higher per unit. A company has two options for managing unused capacity it caniminate the unused capacity by downsizing (also known as rightsizing) or attempt to use the unused capacity by growing

evenues.

any companies have focused on the first approach to reduce costs and increase efficiency by reconfiguring processes any reducing products and human resources. Before downsizing, an organization must consider future growth expectationsnd the impact of reductions on quality and efficiencies. For example, if Air Canada reduced its workforce by 30%, aomplete analysis would involve all aspects of the Balanced Scorecard, which also considers the impact of such a staff

eduction on internal business processes, employee morale, and customer satisfaction. The reduction in workforce couldncrease the wait-time for ticket processing and baggage claim, leading to decreased efficiencies, less customer satisfactiond decreased morale of remaining employees.

he second approach, growing revenues, can be accomplished by decreasing selling prices and increasing sales or byeveloping new products. For example, unused space can be rented out to achieve higher revenues.

thical issues and downsizing

When considering options regarding unused capacity and downsizing, it is important to ensure that all effects of suchecisions have been taken into account, including effects on all stakeholders. Downsizing can have a profound effect on

workers and communities. People living in small, one-industry towns are particularly vulnerable to the negative effects ofownsizing. Care must be taken to mitigate negative effects these events may have on workers. For example, havemployees been given fair notice? Has the company provided counseling and training for new opportunities? Has theompany ensured that workers have the opportunity to qualify for the appropriate pension or unemployment insurance?

he organization also needs to make sure that it has lived up to any previous commitments. For example, often when a lamployer comes into a small community, that community provides tax incentives to the company in exchange for themployment opportunities for the townspeople. Also, the company may have provided certain employees with employmenommitments in order to obtain their skills. While not all of these commitments are legally enforceable, they do createegitimate expectations regarding the subsequent actions of the organization.


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Module 9 self-test

Question 1

xercise 13-18, pages 686-687

olution

Question 2

a. Exercise 13-16, page 686b. Exercise 13-17, page 686

olution

Question 3

roblem 13-22, pages 687-688

olution

Question 4

roblem 13-30, page 690



olution

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Self-test 9

Solution 1

13-18 Strategy, Balanced Scorecard

1. Meredith Corporation follows a product differentiation strategy in 2009. MeredithsD4H machine is distinct from its competitors and generally regarded as superior tocompetitors products. To succeed, Meredith must continue to differentiate itsproduct and charge a premium price.

2. Balanced Scorecard measures for 2009 follow:


(1) Increase in operating income from charging higher margins, (2) price premiumearned on products.These measures indicate whether Meredith has been able to charge premium pricesand achieve operating income increases through product differentiation.

Customer Perspective(1) Market share in high-end special-purpose textile machines, (2) customersatisfaction, (3) new customers.Merediths strategy should result in improvements in these customer measures thathelp evaluate whether Merediths product differentiation strategy is succeeding with

its customers. These measures are leading indicators of superior financialperformance.

Internal Business Process Perspective(1) Manufacturing quality, (2) new product features added, (3) order delivery time.Improvements in these measures are expected to result in more distinctive productsdelivered to its customers and in turn superior financial performance.

Learning and Growth Perspective

(1) Development time for designing new machines, (2) improvements inmanufacturing processes, (3) employee education and skill levels, (4) employeesatisfaction.Improvements in these measures are likely to improve Merediths capabilities toproduce distinctive products that have a cause-and-effect relationship withimprovements in internal business processes, which in turn lead to customersatisfaction and financial performance.

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Self-test 9

Solution 2

13-16 Balanced Scorecard.

1. La Quintas 2009 strategy is a cost leadership strategy. La Quinta plans to grow byproducing high-quality boxes at a low cost delivered to customers in a timelymanner. La Quintas boxes are not differentiated, and there are many othermanufacturers who produce similar boxes. To succeed, La Quinta must achievelower costs relative to competitors through productivity and efficiencyimprovements.

2. Measures that we would expect to see on La Quintas Balanced Scorecard for 2009are


(1) Operating income from productivity gain, (2) operating income from growth, (3) costreductions in key areas.These measures evaluate whether La Quinta has successfully reduced costs andgenerated growth through cost leadership.

Customer Perspective(1) Market share, (2) new customers, (3) customer satisfaction index, (4) customerretention,The logic is that improvements in these customer measures are leading indicators ofsuperior financial performance.

Internal Business Process Perspective(1) Yield, (2) productivity, (3) order delivery time, (4) on-time delivery.Improvements in these measures are expected to lead to more satisfied customers and inturn to superior financial performance.

Learning and Growth Perspective(1) Percentage of employees trained in process and quality management, (2) employeesatisfaction, (3) number of major process improvements.

Improvements in these measures have a cause-and-effect relationship withimprovements in internal business processes, which in turn lead to customer satisfactionand financial performance.

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13-17 Analysis of growth, price-recovery, and productivitycomponents (continuation of 13-16)

1. La Quintas operating income gain is consistent with the cost leadership strategyidentified in requirement 1 of Exercise 13-16. The increase in operating income in

2009 was driven by the $140,000 gain in productivity in 2009. La Quinta tookadvantage of its productivity gain to reduce the prices of its boxes and to fuelgrowth. It increased market share by growing even though the total market sizewas unchanged.

2. The productivity component measures the change in costs attributable to achange in the quantity and mix of inputs used in a year relative to the quantityand mix of inputs that would have been used in a previous year to produce thecurrent year output. It measures the amount by which operating incomeincreases and costs decrease through the productive use of input quantities.

When comparing productivities across years, the productivity calculations usecurrent year input prices in all calculations. Hence, the productivity componentis 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 improvementsimmediately translate into cost savings. In the case of fixed costs, such as fixedmanufacturing conversion costs, productivity gains result only if management takesactions to reduce unused capacity. For example, reengineering manufacturing processeswill decrease the capacity needed to produce a given level of output, but it will lead to aproductivity gain only if management reduces the unused capacity by, say, selling off

the excess capacity.

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Self-test 9

Solution 3

13-22 Balanced Scorecard

Perspectives

Strategic

Objectives

Performance

Measures

Financial

Customer

Internal Business Process

Learning and Growth

Increase shareholdervalue

Increase profit generated

by each salesperson

Acquire new customers

Retain customers

Develop profitablecustomers

Improve manufacturing

quality Introduce new products Minimize invoice error

rate

On-time delivery bysuppliers

Increase proprietaryproducts

Increase informationsystem capabilities

Enhance employee skills

Earnings per share Net income Return on assets Return on sales Return on equity Product cost per unit Customer cost per unit

Profit per salesperson

Number of newcustomers

Percentage of customersretained

Customer profitability

Percentage of defective

product units

Percentage of error-freeinvoices

Percentage of on-timedeliveries by suppliers

Number of patents

Percentage of processeswith real-time feedback

Average job-relatedtraining hours peremployee

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Self-test 9

Solution 4

13-30 Balanced Scorecard and strategy

1. Dransfield currently follows a cost leadership strategy, which is reflected in its lowerprice compared to Yorunt Manufacturing. The electronic component ZP98 is similarto products offered by competitors.

2. In the internal business process perspective, Dransfield needs to set targets fordecreasing the percentage of defective products sold and then identify measures thatwould be leading indicators of achieving this goal. For example, in the learning andgrowth perspective, Dransfield may want to measure the percentage of employees

trained in quality management and the percentage of manufacturing processes withreal-time feedback. The logic is that improvements in these measures will drivequality improvements and so reduce the percentage of defective products sold. Toachieve its goals, items that Dransfield could include under each perspective of theBalanced Scorecard follow:

FinancialPerspective OperatingincomefromproductivityandqualityimprovementOperatingincomefromgrowth

Revenuegrowth

CustomerPerspective MarketshareinelectroniccomponentsNumberofadditionalcustomers

Customersatisfactionratings

InternalBusinessProcessPerspective PercentageofdefectiveproductssoldOrderdeliverytime

Ontimedelivery

Numberofmajorimprovementsinmanufacturingprocess

LearningandGrowthPerspective EmployeesatisfactionratingsPercentageofemployeestrainedinqualitymanagement

Percentage

of

line

workers

empowered

to

manage

processes

Percentageofmanufacturingprocesseswithrealtimefeedback

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13-31 Strategic analysis of operating income (continuation of 13-30)

1. Operating income for each year is as follows:2008 2009

Revenue

($44

5,000;

$50

6,250)

$220,000

$312,500

Less:Salesreturns($44500;$50225) 22,000 11,250Netrevenue 198,000 301,250

Costs

Directmaterialscosts($102,500;$103,125) 25,000 31,250Conversioncosts 128,000 184,000

Sellingandcustomerservicecosts 4,000 4,180

Advertisingcosts 20,000 24,000

Totalcosts 177,000 243,430

Operatingincome $21,000 $57,820

Changeinoperatingincome $36,820F

2. The Growth Component

Revenue effectof growth

=Actual units of Actual units of Selling

output sold output sold pricein 2009 in 2008 in 2008

= (6,025 4,500) $44 = $67,100 F

Units of inputrequired Actual units of

Cost effect Inputto produce inputs

of growth price2009 output used to produce

for variable costs in 2008in 2008 2008 output

=

Cost effect ofgrowth forfixed costs

=

Actual units of capacity in2008 if adequate to produce

2009 output in 2008 ActOR

If 2008 capacity inadequateto produce 2009 output in 2008,

units of capacity requiredto produce 2009 output in 2008

ual unitsof capacity

in 2008

Price per unitof capacity

in 2008

Direct materials costs that would be required in 2009 to produce 6,025 units instead

of the 4,500 units produced in 2008, assuming the 2008 input-output relationship

continued into 2009, equal 3,347.22 kilograms (2,500 6,025

4,500

). Conversion costs and

selling and customer-service costs will not change since adequate capacity exists in2008 to support year 2009 output and customers.

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Advertising costs are discretionary costs and would not change in 2008 if Dransfieldhad to produce and sell the higher 2009 volume in 2008.

The cost effects of growth component are:Direct materials costs (3,374.22 2,500) $10 = $ 8,472 UConversion costs (8,000 8,000) $16 = 0

Selling & cust.-serv. costs (60 60) $66.67 = 0Advertising costs (1-1) $20,000 = 0Cost effect of growth $ 8,472 U

In summary, the net increase in operating income as a result of the growthcomponent equals:Revenue effect of growth $67,100 FCost effect of growth 8,472 UChange in operating income due to growth $58,628 F

The Price-Recovery ComponentRevenue effect of

price-recovery ( )Actual units

Selling price Selling price= of output

in 2009 in 2008sold in 2009

= ($50 $44) 6,025 = $36,150 F

Cost effect ofprice-recovery for

variable costs =

Input Inputprice in price in

2009 2008

Units of inputrequired to

produce 2009 outputin 2008

Cost effect ofprice-recovery for

fixed costs =

Price per Price perunit of unit of capacity capacityin 2009 in 2008

Actual units of capacity in2008, if adequate to produce

2009 output in 2008ORIf 2008 capacity inadequate toproduce 2009 output in 2008,units of capacity required toproduce 2009 output in 2008

Direct materials costs ($10 $10) 3,347.22 = $ 0Conversion costs ($23 $16) 8,000 = 56,000 USelling and customer-service costs ($69.67 $66.67) 60 = 180 UAdvertising costs ($24,000 $20,000) 1 = 4,000 UCost effect of price-recovery $60,180 U

In summary, the net increase in operating income as a result of the price-recoverycomponent equals:

Revenue effect of price recovery $36,150 FCost effect of price recovery 60,180 UChange in operating income due to price recovery 24,030 U

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The Productivity Component

Cost effect ofproductivity forvariable costs

=

Actual units of Units of inputinput used required toto produce produce 2009

2009 output ouput in 2008

Inputprice

in 2009

Cost effect ofproductivity for

fixed costs =

Actual units of capacity in2008, if adequate to produce

Actual units of 2009 output in 2008capacity in OR

2009 If 2008 capacity inadequateto produce 2009 output in 2008,

units of capacity required t

oproduce 2009 output in 2008

Price perunit of

capacityin 2009

The productivity component of cost changes areDirect materials costs (3,125 3,347.22) $10 = $2,222 FConversion costs (8,000 8,000) $23 = 0Selling and customer-service costs (60 60) $69.67 = 0Advertising costs (1 1) $24,000 = 0Change in operating income due to productivity $2,222 F

The change in operating income between 2008 and 2009 can be analyzed as follows:

Income

Statement

Amounts

in2008

(1)

Revenueand

CostEffects

ofGrowth

Component

in2009

(2)

Revenueand

CostEffectsof

PriceRecovery

Component

in2009

(3)

CostEffectof

Productivity

Component

in2009

(4)

Income

Statement

Amounts

in2009

(5)=

(1)

+

(2)

+

(3)

+

(4)

Revenues $198,000 $67,100F $36,150F $301,250Costs 177,000 8,472U 60,180U $2,222F 243,430

Operatingincome $ 21,000 $58,628F $24,030U $2,222F $57,820

$36,820 F

Change in operating income

3. The analysis of operating income indicates that a significant amount of the increasein operating income resulted from Dransfields cost leadership strategy. Thecompany was able to improve quality and grow sales. The price recovery component

indicates that selling prices increased in line with the market but Dransfields costsincreased even faster, particularly the price of conversion cost capacity, as Dransfieldfocused on improving quality. The benefit of this improved quality came in the formof higher sales that more than offset the spending on quality.

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13-32 Analysis of growth, price-recovery, and productivitycomponents (continuation of 13-31)

Effect of the industry market-size factor on operating income

Of the 1,525 increase in sales from 4,500 to 6,025 units, 8% or 360 (8% 4,500) units aredue to growth in market size, and 1,165 (1,525 360) units are due to an increase inmarket share.

The change in Dransfields operating income from the industry-market size factor ratherthan from specific strategic actions is:

$58,628 (the growth component in Exercise 13-31) 360

1,525$13,840 F

Effect of product differentiation on operating incomeThe change in operating income due to:

Increase in the selling price of ZP98 (revenue effect of price recovery) $36,150 FIncrease in price of inputs (cost effect of price recovery) 60,180 UChange in operating income due to product differentiation $24,030 U

Effect of cost leadership on operating income

The change in operating income from cost leadership is:

Productivity component $ 2,222 F

Growth in market share due to cost leadership

$58,628 (the growth component in Exercise 13-31) 1,165

1,52544,788 F

Change in operating income due to cost leadership $47,010 F

The change in operating income between 2008 and 2009 can be summarized as follows:Change due to industry market size $13,840 FChange due to product differentiation 24,030 UChange due to cost leadership 47,010 FChange in operating income $36,820 F

A thoughtful student might argue that the $24,030 U price-recovery variance could alsobe thought of as part of the productivity variance. Why? Because a large component ofthis cost is from conversion costs incurred to improve quality, which is more closelyassociated with productivity and process improvement rather than product developmentand product differentiation. Under this assumption, the change in operating incomebetween 2008 and 2009 can be summarized as follows:

Change due to market industry size $13,840 FChange due to product differentiation 0Change due to cost leadership ($47,010 $24,030) 22,980 FChange in operating income $36,820 F

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Dransfield has been successful in implementing its cost leadership strategy. The increasein operating income during 2009 was due to quality improvements and sales growth.Dransfields operating income increase in 2009 was also helped by a growth in the overallmarket size.

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Module 9 summary

xplain how the four Balanced Scorecard perspectives are used to evaluate the successf a strategy.

he four perspectives are: financial, customer, internal business processes, and learning and growth.

xplain how the Balanced Scorecard can be used to evaluate risk management strategynd how good governance contributes to risk management

he BSC can be used to evaluate the effectiveness of an organizations ERM strategy.

dentify similarities between the Balanced Scorecard measures and measures used tossess corporate sustainability

orporate sustainability creates long-term shareholder value by embracing opportunities and managing risks derived fromconomic, social, and environmental developments.

Describe the process required to implement and apply the Balanced Scorecard

uccessfully implementing a BSC requires commitment and leadership from top management

valuate the outcomes of strategic initiatives using the stoplight system

he target stoplight system is a method of evaluating the results of the Balanced Scorecard effort that isolates areas forurther analysis.

valuate change in operating income resulting from implementation of strategicomponents: grow th, product differentiation, and cost leadership or productivity

rowth

evenue effect of growth = (Actual units sold in current year Actual units sold in previous year) x Previous year sellingrice.

ost effect of growth = (Actual units of input that would have been used in current year based on previous years relationActual units of input to produce previous years output) x Previous years prices.

rice-recovery

evenue effect of product differentiation = (Selling price in current year Selling price in previous year) x Actual units solurrent year.

ost effect of product differentiation = (Input price in current year Input price in previous year) x Actual units of input/utput that would have been used to produce current year output assuming the same relationship as previous year.

roductivity

roductivity/cost leadership component = (Actual units input/capacity to produce for current year Actual units of inputs/apacity that would have been used to produce current year assuming same relationship as previous year) x Current yearrices.

dentify unused capacity, and design recommendations to deal w ith that capacity

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le:///F|/Courses/2010-11/CGA/MA2/06course/m09summary.htm

Fixed costs are tied to capacity. There are two types of fixed costs engineered and discretionary. Engineered costs have a direct relationship with outputs. Discretionary costs are periodic costs with no measurable cause-effect relationship to output. Manage unused capacity by downsizing. Use unused capacity to increase revenues.

Analyze specific productivity and capacity control strategies to achieve Balancedcorecard objectives

Partial productivity = Quantity of output producedQuantity of input used

he higher the ratio, the greater the productivity achieved.

Total factor productivity = Quantity of output producedCosts of all inputs used

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