Strategy, Balanced Scorecard, and Strategic Profitability Analysis

Strategic Alignment and the Balanced Scorecard

  • Definition of Strategy: Strategy describes how an organization matches its own capabilities with the opportunities in the marketplace to accomplish its overall objectives.
  • Industry Analysis Focus: Organizations must analyze the following five factors to understand their competitive environment:     * Competitors currently in the market.     * Potential entrants into the market.     * Equivalent (substitute) products.     * Bargaining power of customers.     * Bargaining power of input suppliers.
  • Generic Strategies: Companies typically choose between two primary paths:     * Product Differentiation: Offering unique products or services that customers perceive as superior to those of competitors.     * Cost Leadership: Becoming the lowest-cost producer in the industry.
  • Implementation: Management accountants play a critical role by designing reports and systems to help managers track the progress of strategy implementation.

Reengineering Business Processes

  • Definition: Reengineering is the fundamental rethinking of business processes delivery to achieve improvements in critical measures of performance. Focus areas include:     * Cost     * Quality     * Service     * Speed     * Customer satisfaction
  • Case Study: Dallas Co. Order Delivery System Analysis:     * Original Process Workflow:         1. Customer needs identified.         2. Purchase order issued.         3. Production scheduled.         4. Manufacturing completed.         5. Finished goods sent to inventory.         6. Quantities to be shipped matched against the purchase order.         7. Shipping documents sent to the Billing Department.         8. Invoice issued.         9. Customer payment follow-up.     * Identified Inefficiencies:         * Frequent long waiting times before production begins in the manufacturing department.         * Items are sometimes held in inventory until a truck is available for shipment.         * Quantity mismatches between shipped items and customer requests require special, unplanned shipments.         * Excessive transfers across departments slow down the process and create delays.     * Reengineered Process Solution:         * Establishment of a Multifunctional Team.         * Assignment of a dedicated Customer Relationship Manager for each customer.         * Implementation of long-term contracts specifying quantities and prices.         * Collaborative scheduling between the relationship manager, the customer, and manufacturing at least one month in advance.         * Electronic transmission of order schedules to manufacturing.         * Direct shipment from the manufacturing plant to customer sites (bypassing inventory storage).         * Automated electronic invoicing triggered by the shipment.

The Balanced Scorecard Framework

  • The Balanced Scorecard (BSC) measures performance from four distinct perspectives to ensure alignment with strategy:
1. Financial Perspective
  • Objective: Increase shareholder value.
  • Primary Measure: Increase in operating income.
  • Other Measures: Revenue growth, cost reduction in specific areas, and Return on Investment (ROI).
  • Example Initiatives (Dallas Co.):     * Managing costs and unused capacity: Target Performance of $2,000,000\$2,000,000 vs. Actual Performance of $2,100,000\$2,100,000.     * Building strong customer relationships: Target Performance of $3,000,000\$3,000,000 (Operating Income) and 6%6\% vs. Actual Performance of $3,420,000\$3,420,000 and 6.48%6.48\%.
2. Customer Perspective
  • Objectives: Increase market share and customer satisfaction.
  • Measures: Market share in communication networks segment, customer satisfaction surveys, customer retention percentage, and time taken to fulfill requests.
  • Example Initiatives (Dallas Co.):     * Identify future needs of customers and new target segments (Target: 6%6\% vs. Actual: 7%7\%; Target: 77 vs. Actual: 88).     * Increase customer focus of sales organization: Target of 90%90\% giving top two ratings vs. Actual of 87%87\%.
3. Internal Business Process Perspective
  • Objectives: Improve manufacturing quality and productivity.
  • Sub-processes and Measures:     * Innovation Process: Manufacturing capabilities, number of new products/services, new product development time, and number of new patents.     * Operations Process: Yield, defect rates, time taken to deliver products, percentage of on-time delivery, setup time, and manufacturing downtime.     * Post-sales Service: Time taken to replace or repair defective products, and hours of customer training for product use.
  • Example Initiatives (Dallas Co.):     * Identify problems and improve quality: Target yield of 78%78\% vs. Actual of 79.3%79.3\%.     * Reengineer order delivery process: Target on-time delivery of 92%92\% vs. Actual of 90%90\%.
4. Learning and Growth Perspective
  • Objective: Align employee and organizational goals.
  • Measures: Employee education and skill levels, employee satisfaction scores, employee turnover rates, information system availability, and percentage of processes with advanced controls.
  • Example Initiatives (Dallas Co.):     * Employee participation and suggestion programs to build teamwork (Target: 80%80\% top ratings vs. Actual: 88%88\%).     * Organizing R&D/manufacturing teams to modify processes (Target and Actual value of 55).

Pitfalls in Balanced Scorecard Implementation

  1. Assuming cause-and-effect linkages are precise.
  2. Seeking improvements across all measures simultaneously at all times.
  3. Using only objective measures (ignoring subjective/qualitative data).
  4. Failing to consider both costs and benefits of initiatives like IT spending or R&D.
  5. Ignoring nonfinancial measures when evaluating managers and employees.
  6. Using too many measures, which can dilute focus.

Strategic Profitability Analysis

  • To evaluate the success of a strategy, changes in operating income are decomposed into three components: Growth, Price-Recovery, and Productivity.
  • Example Comparison (Dallas Co.):     * 2003 Data: Revenues of $26,000,000\$26,000,000 (1,000,0001,000,000 units ×$26\times \$26/unit); Materials cost of $4,050,000\$4,050,000; Other expenses of $16,000,000\$16,000,000.     * 2004 Data: Revenues of $26,400,000\$26,400,000 (1,100,0001,100,000 units ×$24\times \$24/unit); Materials cost of $3,631,320\$3,631,320.     * Total Change in Operating Income: Increase of $818,680\$818,680.
1. Growth Component
  • Calculates the change in operating income caused solely by a change in quantity of output sold.
  • Revenue Effect of Growth:     * (Actual units in 2004−Actual units in 2003)×Output price in 2003(\text{Actual units in 2004} - \text{Actual units in 2003}) \times \text{Output price in 2003}     * (1,100,000−1,000,000)×$26=$2,600,000 F(1,100,000 - 1,000,000) \times \$26 = \$2,600,000 \text{ F}
  • Cost Effect of Growth:     * (Input units for 2004 output at 2003 efficiency−Actual input for 2003 output)×Input prices in 2003(\text{Input units for 2004 output at 2003 efficiency} - \text{Actual input for 2003 output}) \times \text{Input prices in 2003}     * Given 3,000,000 cm23,000,000\,cm^2 materials for 1,000,0001,000,000 units in 2003, a 10%10\% increase in output expects $3,300,000 cm2\$3,300,000\,cm^2.     * (3,300,000−3,000,000)×$1.35=$405,000 U(3,300,000 - 3,000,000) \times \$1.35 = \$405,000 \text{ U}
  • Net Growth Component: $2,600,000 F−$405,000 U=$2,195,000 F\$2,600,000 \text{ F} - \$405,000 \text{ U} = \$2,195,000 \text{ F}.
2. Price-Recovery Component
  • Calculates the effect of changes in output and input prices on operating income.
  • Revenue Effect of Price-Recovery:     * (Output price in 2004−Output price in 2003)×Actual units sold in 2004(\text{Output price in 2004} - \text{Output price in 2003}) \times \text{Actual units sold in 2004}     * ($24−$26)×1,100,000=$2,200,000 U(\$24 - \$26) \times 1,100,000 = \$2,200,000 \text{ U}
  • Cost Effect of Price-Recovery:     * (Input price in 2004−Input price in 2003)×Input units for 2004 output at 2003 efficiency(\text{Input price in 2004} - \text{Input price in 2003}) \times \text{Input units for 2004 output at 2003 efficiency}     * ($1.31−$1.35)×3,300,000=$132,000 F(\$1.31 - \$1.35) \times 3,300,000 = \$132,000 \text{ F}
  • Net Price-Recovery Component: $2,200,000 U−$132,000 F=$2,068,000 U\$2,200,000 \text{ U} - \$132,000 \text{ F} = \$2,068,000 \text{ U}.
3. Productivity Component
  • Measures how much operating income changed because the company used fewer inputs to produce 2004 output compared to 2003 efficiency.
  • Formula: (Actual inputs for 2004 output−Input units for 2004 output at 2003 efficiency)×Input price in 2004(\text{Actual inputs for 2004 output} - \text{Input units for 2004 output at 2003 efficiency}) \times \text{Input price in 2004}
  • Calculation:     * (2,772,000−3,300,000)×$1.31=$691,680 F(2,772,000 - 3,300,000) \times \$1.31 = \$691,680 \text{ F}
Summary Table of Operating Income Change
  • Increase in Operating Income: $818,680\$818,680
  • Growth Component: $2,195,000 F\$2,195,000 \text{ F}
  • Price-recovery Component: $2,068,000 U\$2,068,000 \text{ U}
  • Productivity Component: $691,680 F\$691,680 \text{ F}

Engineered vs. Discretionary Costs

  • Engineered Costs:     * Result from a clear cause-and-effect relationship between output and resources.     * Can be variable or fixed in the short run.     * Pertain to processes that are detailed, physically observable, and repetitive.
  • Discretionary Costs:     * Arise from periodic (yearly) decisions regarding maximum spending.     * No measurable cause-and-effect relationship between output and resources.     * Associated with "black box" processes that are less precise and not well understood.
  • Key Dimensions of Difference: Type of process and level of uncertainty.

Managing Unused Capacity

  • When unused capacity is identified, management can take two primary actions:     1. Attempt to eliminate the unused capacity to reduce costs.     2. Attempt to use the unused capacity to grow revenue.