© 2012 Pearson Prentice Hall. All rights reserved. Strategy, Balanced Scorecard, and Strategic...

© 2012 Pearson Prentice Hall. All rights reserved.

Strategy, Balanced Scorecard,and

Strategic Profitability Analysis


StrategyStrategy specifies how an organization

matches its own capabilities with the opportunities in the marketplace to accomplish its objectives.

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


Five Aspects of Industry Analysis1. Number and strength of competitors2. Potential entrants to the market3. Availability of equivalent products4. Bargaining power of customers5. Bargaining power of input suppliers


Basic Business Strategies1. 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

Leads to brand loyalty and the willingness of customers to pay high prices

2. 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

Leads to lower selling prices


Implementation of StrategyMany companies have introduced a balanced

scorecard to manage the implementation of their strategies.


The Balanced ScorecardThe balanced scorecard translates an

organization’s mission and strategy into a set of performance measures that provides the framework for implementing its strategy.

It is called the balanced scorecard because it balances the use of financial and nonfinancial performance measures to evaluate performance.


Balanced Scorecard Perspectives1. Financial2. Customer3. Internal business perspective4. Learning and growth


The Financial PerspectiveEvaluates the profitability of the strategyUses the most objective measures in the

scorecardThe other three perspectives eventually feed

back into this dimension


The Customer PerspectiveIdentifies targeted customer and market

segments and measures the company’s success in these segments


The Internal Business Prospective Focuses on internal operations that create

value for customers that, in turn, furthers the financial perspective by increasing shareholder value

Includes three subprocesses:1. Innovation2. Operations3. Post-sales service


The Learning and Growth PerspectiveIdentifies the capabilities the organization

must excel at to achieve superior internal processes that create value for customers and shareholders


The Balanced Scorecard Flowchart

Financial CustomerInternal

BusinessProcess

Learning&

Growth


BalancedScorecardIllustrated


Strategy and the Balanced Scorecard, Illustrated


Common Balanced Scorecard Measures


Balanced Scorecard ImplementationMust have commitment and leadership from

top managementMust be communicated to all employees


Features of a Good Balanced ScorecardTells the story of a firms strategy, articulating

a sequence of cause-and-effect relationships—the links among the various perspectives that describe how strategy will be implemented

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


Features of a Good Balanced ScorecardMust motivate managers to take actions

that eventually result in improvements in financial performancePredominately applies to for-profit entities, but has

some application to not-for-profit entities as wellLimits the number of measures, identifying

only the most critical onesHighlights less-than-optimal trade-offs that

managers may make when they fail to consider operational and financial measures together


Balanced Scorecard Implementation PitfallsManagers 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.


Balanced Scorecard Implementation PitfallsManagers must include both costs and

benefits of initiatives placed in the balanced scorecard: costs are often overlooked.

Managers should not ignore nonfinancial measures when evaluating employees.

Managers should not use too many measures.


Evaluating Strategy Strategic analysis of operating income—

three parts:1. 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

2. 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

3. Productivity component—measures the change in costs attributable to a change in the quantity of inputs between the current and prior periods


Revenue Effect of Growth

RevenueEffect

ofGrowth

Actual Units of Output Sold in the Current Period

Actual Units of Output Sold in

the Prior Period

= X_Prior Period Selling Price


Cost Effect of Growth for Variable Costs

Cost Effectof Growth

for VariableCosts

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

(c) 2012 Pearson Prentice Hall. All rights reserved.

Cost Effect of Growth for Fixed CostsAssuming adequate current capacity:

Actual Units of Capacity

in the Prior

Period

Actual Units of capacity in Prior Period to Produce Current Period Output

X

Prior Period Price

per unit of

capacity

CostEffect

OfGrowth

For FixedCosts

=


Revenue Effect of Price Recovery

Prior Period Selling Price

Current Period Selling Price X

CurrentPeriod Units Sold

RevenueEffect

OfPrice-

Recovery

=


Cost Effect of Price RecoveryVariable costs:

Prior Period Input Price

Current Period Input Price X

Units of Input

required to produce Current Period’s Output in the Prior Period

CostEffect

OfPrice-

Recovery for

Variable Costs

=


Cost Effect of Price RecoveryFixed costs with adequate capacity

Prior Period Price per Unit

of Capacity

Current Period Price per Unit of Capacity

X

Actual Units of Capacity on

Prior Period to Produce Current

Period’s Output

CostEffect

OfPrice-

Recovery for Fixed

Costs

=


Cost Effect of Productivity for Variable Costs

Units of Input Required to

Produce Current Period’s Output

in Prior Period

Actual Units of Input used to Produce Current Period Output

X Input Price in Current Period

CostEffect

OfProductivity for Variable

Costs

=


Cost Effect of Productivity for Fixed CostsWith adequate capacity

Actual Units of Capacity in Prior

Period to Produce Current Period’s Output

Actual Units of Capacity in Current Period

XPrice Per Unit of

Capacity in Current Period

CostEffect

OfProductivity

for Fixed Costs

=


Strategic Analysis of Profitability Illustrated


The Management of CapacityManagers 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.


Analysis of Unused Capacity Two important features:

1. Engineered costs result from a cause-and-effect relationship between the cost driver and the resources used to produce that output.

2. Discretionary costs have two parts:1. They arise from periodic (annual) decisions

regarding the maximum amount to be incurred.2. They have no measurable cause-and-effect

relationship between output and resources used.


Differences Between Engineered and Discretionary Costs Illustrated


Managing Unused CapacityDownsizing (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.


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