Strategy, Balanced Scorecard,
and
Strategic Profitability Analysis
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1.
2.
3.
4.
5.
Recognize which of two generic strategies a
company is using
Understand what comprises reengineering
Understand the four perspectives of the
balanced scorecard
Analyze changes in operating income to
evaluate strategy
Identify unused capacity and how to
manage it
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12-2
 Strategy
specifies how an organization
matches its own capabilities with the
opportunities in the marketplace to
accomplish its objectives.
 Strategy describes how an organization can
create value for its customers while
differentiating itself from its competitors.
 A thorough understanding of the industry is
critical to implementing a successful
strategy. Industry analysis focuses on 5
forces.
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1.
2.
3.
4.
5.
Number and strength of competitors
Potential entrants to the market
Availability of equivalent products
Bargaining power of customers
Bargaining power of input suppliers
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Product differentiation—an organization’s ability to
offer products or services perceived by its
customers to be superior and unique relative to
the products or services of its competitors.
1.

Competitive advantage: brand loyalty and the
willingness of customers to pay high prices.
Cost leadership—an organization’s ability to
achieve lower costs relative to competitors
through productivity and efficiency improvements,
elimination of waste, and tight cost control.
2.

Competitive advantage: lower selling prices.
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 Reengineering
is the fundamental rethinking
and redesign of business processes to achieve
improvements in critical measures of
performance, such as cost, quality, service,
speed and customer satisfaction.
 Stated another way, reengineering is the
redesign of business processes to improve
performance by reducing cost and improving
quality.
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 Many
companies have introduced a balanced
scorecard to track progress and manage the
implementation of their strategies.
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 The
balanced scorecard translates an
organization’s mission and strategy into a set
of performance measures that provides the
framework for implementing its strategy.1
 Not only does the balanced scorecard focus
on achieving financial objectives, it also
highlights the nonfinancial objectives that an
organization must achieve to meet and
sustain its financial objectives.
 The scorecard measures an organization’s
performance from four perspectives.
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Financial - profits and value created for
shareholders
2.
Customer – the success of the company in
its target market
3.
Internal business perspective – the internal
operations that create value for customers
4.
Learning and growth – the people and
systems capabilities that support
operations
The particular measure a company uses to
track performance will depend on its strategy.
1.
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 Evaluates
the profitability of the strategy
 Uses the most objective measures in the
scorecard
 The other three perspectives eventually feed
back into this dimension
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 Identifies
targeted customer and market
segments and measures the company’s
success in these segments
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

Focuses on internal operations that create
value for customers which, in turn, will
further the financial perspective by increasing
shareholder value
Includes three subprocesses:
1.
2.
3.
Innovation
Operations
Post-sales service
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
Identifies the people and information
capabilities the organization must excel at to
achieve superior internal processes that create
value for customers and shareholders
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 Must
have commitment and leadership from
top management.
 Must be communicated to all employees.
 For the balanced scorecard to be effective,
managers must view it as a fair way to assess
and reward all important aspects of a
manager’s performance and promotion
prospects.
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12-16
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12-17
 Companies
are increasingly recognizing that
they must earn the right to operate in the
communities and countries in which they do
business.
 Failure to perform adequately on
environmental and social processes puts at
risk a company’s ability to deliver future
value to shareholders.
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12-18
 As
was discussed in Chapter 1, many
managers are promoting sustainability (the
development and implementation of
strategies) to achieve:



Long-term financial performance
Social performance (eliminating employee
injuries, improving product safety)
Environmental performance (reducing
greenhouse gas emissions)
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Managers interested in measuring environmental
and social performance are incorporating these
factors into their balanced scorecards to set
priorities for initiatives, guide decisions and
actions and fuel discussions around strategies
and business models to improve performance.
 Companies use a variety of measures including:
Cost of preventing and remediating
environmental damage (financial); brand image
(customer); energy consumption (internalbusiness); and implementation of ISO 14000
environmental standards (learning and growth).

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12-20
1. Tells the story of a firms strategy, articulating
a sequence of cause-and-effect relationships—the
links among the various perspectives that align
implementation of the strategy.
2. Helps to 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.
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12-21
3. Must motivate managers to take actions that
eventually result in improvements in financial
performance.

Applies primarily to for-profit entities, but has some
application to not-for-profit entities as well.
4. Limits the number of measures, identifying
only the most critical ones.
5. Highlights less-than-optimal trade-offs that
managers may make when they fail to consider
operational and financial measures together.
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12-22
 Managers
should not assume the cause-and-effect
linkages are precise: they are merely hypotheses.
 Managers should not seek improvements across all
of the measures all of the time.
 Managers should not use only objective measures:
subjective measures are important as well.
 Despite challenges of measurement, top
management should not ignore nonfinancial
measures when evaluating managers and other
employees.
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12-23
To evaluate how successful a company’s strategy
and implementation have been, its management
must compare the target and actual
performance columns in the balanced scorecard.
 If a company does not meet its targets on the
two perspectives that are more internally
focused (learning and growth, and internal
business processes), it may have had a problem
with strategy implementation.
 If a company performs well in the internally
focused perspectives but not customer and
financial measures, it may conclude that the
strategy was faulty because there was no effect
on customers or on long-run financial
performance and value creation.

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12-24

Strategic analysis of operating income—
three parts:
1.
2.
Growth component—measures the increase in
revenues minus the increase in costs from
selling more units in the current year than in
the prior year, assuming nothing else has
changed.
Price-recovery component—measures solely
the effect of price changes on revenues and
costs to produce and sell the current year
quantity.
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12-25

Strategic analysis of operating income
3.
Productivity component—measures how costs
have changed as a result of using fewer/more
inputs, a better/worse mix of inputs, and/or
more/less capacity to produce current year
output compared with the inputs and capacity
that would have been used to produce this
output in the prior year.
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12-26
Revenue
Effect
=
of
Growth
Actual Units of
Output Sold in _
the Current
Period
Actual Units of
Output Sold in
the Prior
Period
Prior
X Period
Selling
Price
Throughout these slides, we’ll use values from the textbook example
to illustrate the formulas:
Here, actual units of output sold in the current period are 1,150,000;
Actual units of output sold in the prior period are 1,000,000, and
The selling price in the prior period was $23/unit, therefore:
(1,150,000 – 1,000,000) x $23 = $3,450,000F Revenue Effect of Growth
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12-27
Cost Effect
of Growth
for Variable
Costs
=
Units of Input
Required to Produce _
Current Output in the
Prior Period
Actual Units of
Input Used to
Produce Prior
Period Output
X
Prior
Period
Input
Price
3,000,000 sq cm x (1,150,000/1,000,000) – 3,000,000 sq cm x $1.40
input price = $630,000 Unfavorable
The cost effect of growth measures how much costs would have changed
in the prior year if production would have been at current year levels.
This is done separately for Variable and Fixed costs.
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12-28
 Assuming
Cost
Effect
Of
Growth
For
Fixed
Costs
=
adequate current capacity:
Actual Units of
capacity in
Prior Period to
Produce Current
Period Output
Actual Units
of Capacity
in the
Prior
Period
X
Prior
Period
Price
per unit
of
capacity
(3,750,000 sq cm – 3,750,000 sq cm) X $4.28 per sq cm = $0.00
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12-29
Revenue
Effect
Of
PriceRecovery
=
Current Period
Selling Price
Prior Period
Selling Price
X
Current
Period
Units
Sold
($22 per unit current year - $23 per unit prior year) X 1,150,000 actual
units of output sold in current year = $1,150,000 Unfavorable
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Cost
Effect
Of
PriceRecovery
for
Variable
Costs
=
Current Period
Input Price
Prior Period
Input Price
X
Units of
Input
required to
produce
Current
Period’s
Output in
the Prior
Period
($1.50 per sq cm current year - $1.40 per sq cm prior year) X 3,450,000 sq cm
required for current year output in prior year = $345,000 Unfavorable
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12-31
 Assuming
Cost
Effect
Of
PriceRecovery
for Fixed
Costs
=
adequate current capacity:
Current Period
Price per Unit
of Capacity
Prior Period
Price per Unit
of Capacity
X
Actual Units of
Capacity on
Prior Period to
Produce
Current
Period’s Output
$4.35 per sq cm - $4.28 per sq cm) X 3,750,000 sq cm = $262,500 Unfavorable
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12-32
Cost
Effect
Of
Productivity
for Variable
Costs
=
Actual Units of
Input used to
Produce
Current Period
Output
Units of Input
Required to
Produce Current X
Period’s Output
in Prior Period
Input Price in
Current Period
(2,900,000 sq cm for current period output – 3,450,000 sq cm for current
period output in prior period) X $1.50 per sq cm = $825,000 Favorable
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12-33
 Assuming
Cost
Effect
Of
Productivity
for Fixed
Costs
=
adequate current capacity:
Actual
Units of
Capacity in
Current
Period
Actual Units of
Capacity in Prior
Price Per Unit of
Period to X
Capacity in
Produce Current
Current Period
Period’s Output
(3,500,000 sq cm – 3,750,000 sq cm) X $4.35 per sq cm = $1,087,500 Favorable
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Consistent with a cost-leadership strategy, the productivity gains of
$1,912,500 in 2013 were a big part of the increase in operating income
for prior year to current year.
Under different assumptions about the change in selling price, the
analysis will attribute different amounts to the different strategies.
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12-35
 Managers
can reduce capacity-based fixed
costs by measuring and managing unused
capacity.
 Unused capacity is the amount of productive
capacity available over and above the
productive capacity employed to meet
consumer demand in the current period.
 To better understand this concept of unused
capacity, it is necessary to distinguish
engineered costs from discretionary costs.
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12-36
1.
2.
Engineered costs result from a cause-and-effect
relationship between the cost driver (output)
and the (direct or indirect) resources used to
produce that output. Engineered costs have a
detailed, physically observable and repetitive
relationship with output.
Discretionary costs have two important
features:
1.
2.
They arise from periodic (usually annual) decisions
regarding the maximum amount to be incurred.
They have no measurable cause-and-effect
relationship between output and resources used.
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12-37
 Downsizing
(rightsizing) is an integrated
approach of configuring processes, products,
and people to match costs to the activities
that need to be performed to operate
effectively and efficiently in the present and
future.
 Downsizing often means eliminating jobs,
which can adversely affect employee morale
and the culture of a company.
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12-38
TERMS TO LEARN
PAGE NUMBER REFERENCE
Balanced scorecard
Page 476
Cost leadership
Page 474
Discretionary costs
Page 496
Downsizing
Page 497
Engineered costs
Page 496
Growth component
Page 489
Partial productivity
Page 503
Price-recovery component
Page 489
Product differentiation
Page 474
Productivity
Page 503
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12-39
TERMS TO LEARN
PAGE NUMBER REFERENCE
Productivity component
Page 489
Reengineering
Page 475
Rightsizing
Page 497
Strategy map
Page 477
Total factor productivity
Page 504
Unused capacity
Page 496
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12-40
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