SMA week 6

1. Week 6
Chapter 12
Strategy, Balanced Scorecard,
and Strategic Profitability
Analysis
1

2. 4
Evaluating Strategy
5
© Neale O'Connor 2010
Strategy Reengineering Balanced Scorecard
Engineered &
Discretionary Cost
Managing Unused
Capacity
Evaluating Strategy

3. 6
4.Evaluating Strategy
 Strategic Analysis of Operating Income – three parts:
 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.
 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
 Productivity Component – measures the change in costs attributable to a
change in the quantity of inputs between the current and prior periods
Strategy Reengineering Balanced Scorecard
Engineered &
Discretionary Cost
Managing Unused
Capacity
Evaluating Strategy
Learning objective 4 :
Analyze changes in
operating income to evaluate
strategy
… growth, price, recovery,
and productivity
4How Accounting Can
Help Manage
Strategy?

4. 7
NON-FINANCIAL MEASURES
BIG DECISIONS
—ALLOCATE RESOURCES
FEEDBACK
CEO
CFO
CIO
CUSTOMER INTERNAL
PROCESS
LEARNING + GROWTH
FINANCIAL MEASURES
TRAINING
GET
ATTENTION
4. Evaluating Strategy
Decision Relevance of Financial and Non-Financial
Measures inside the Firm
INVEST
MENT

5. 8

6. 9
Strategic Analysis of Operating Income
Cost leadership Product differentiation
Growth √ √
Price √
Productivity √
Strategy Reengineering Balanced Scorecard
Engineered &
Discretionary Cost
Managing Unused
Capacity
Evaluating Strategy
Other accounting measures to support cost leadership?
Manage costs through
Value engineering, Activity based costing, Activity based budgeting
Other measures to support differentiation?
Focus on non-financial measures
Lead indicators of long term customer value
Measures of innovation for long term sustainable differentiation
How Accounting Can
Help Manage
Strategy?

7. Example: Strategic Analysis of Operating Income
2012 2013
1. Units of CX1 produced and sold 1,000,000 1,150,000
2. Selling price $23 $22
3. Direct materials (square centimeters of silicon wafers) 3,000,000 2,900,000
4. Direct material cost per square centimeter $1.40 $1.50
5. Manufacturing processing capacity (in square centimeters of silicon
wafer) 3,750,000 3,500,000
6. Conversion costs (all manufacturing costs other than direct material
costs) $16,050,000 $15,225,000
7. Conversion cost per unit of capacity (Row 6 ÷ Row 5) $4.28 $4.35
Chipset’s data for 2012 and 2013 follow:
11
Strategy Reengineering Balanced Scorecard
Engineered &
Discretionary Cost
Managing Unused
Capacity
Evaluating Strategy

8. Example: Strategic Analysis of Operating Income
2012 2013
Revenues
($23 per unit x 1,000,000 units; $22per unit x 1,150,000 units) $23,000,000 $25,300,000
Costs
Direct material costs
($1.40/sq.cm x 3,000,000 sq.cm; $1.50/sq.cm x 2,900,000 sq.cm)
4,200,000 4,350,000
Conversion costs
($4.28/sq.cm x 3,750,000 sq.cm; $4.35/sq.cm x 3,500,000 sq.cm)
16,050,000 15,225,000
Total costs 20,250,000 19,575,000
Operating income $2,750,000 $5,725,000
Change in operating income $2,975,000 F
Chipset’s asset structure is very similar in 2012 and 2013. Operating income
for each year is as follows:
12
Strategy Reengineering Balanced Scorecard
Engineered &
Discretionary Cost
Managing Unused
Capacity
Evaluating Strategy

9. 13
Example:
Strategic
Analysis of
Operating
Income
Basic
Data for
Growth

10. 14
Example: Revenue Effect of Growth
Actual Units of
Output Sold in
the Prior
Period
Actual Units of
Output Sold in
the Current
Period
X
Current
Period
Selling
Price
Revenue
Effect
Of
Growth
=
= (1,150,000 units - 1,000,000 units) X $23 per unit
Strategy Reengineering Balanced Scorecard
Engineered &
Discretionary Cost
Managing Unused
Capacity
Evaluating Strategy
Revenue Effect:
Easy!
Prior

11. 15
Example: Cost Effect of Growth for Variable Costs
Actual Units of
Input used
to produce
Prior Period
Output
Units of Input
required to
produce Current
Output in the
Prior Period
X
Current
Period
Input
Price
Cost
Effect
Of
Growth
For
Variable
Costs
=
Cost effect of
growth for
direct materials
= (3,000,000 sq.cm. x
1,150,000 units
- 3,000,000 sq.cm.)
X $1.40 per
sq.cm.
1,000,000 units
= (3,450,000sq.cm. - 3,000,000 sq.cm.) X $1.40 per sq.cm. = $630,000 U
Strategy Reengineering Balanced Scorecard
Engineered &
Discretionary Cost
Managing Unused
Capacity
Evaluating Strategy
Cost Effect:
Keeping productivity constant – what should DM cost you in the
second period?
Prior

12. Example: Cost Effect of Growth for Fixed Costs
 Assuming 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
Cost
Effect
Of
Growth
For
Fixed
Costs
=
Cost effect of
growth for
conversion cost
= (3,750,000 sq.cm. - 3,750,000 sq.cm.) X $4.28 per sq.cm. = $0
Strategy Reengineering Balanced Scorecard
Engineered &
Discretionary Cost
Managing Unused
Capacity
Evaluating Strategy
16
16
Cost Effect:
Doesn’t change because no additional capacity (eg employees) were
needed to produce the current period output

13. 17
Example: Cost Effect of Growth for Fixed Costs
 Assuming Inadequate Current Capacity:
Actual
Units
of Capacity
in the
Prior
Period
Units of
Capacity
required to
produce Current
Period Output in
the Prior Period
X
Prior
Period
Price
per unit
of
capacity
Cost
Effect
Of
Growth
For
Fixed
Costs
=
Strategy Reengineering Balanced Scorecard
Engineered &
Discretionary Cost
Managing Unused
Capacity
Evaluating Strategy
Inadequate Capacity Effect:
Fixed Costs don’t change because no additional capacity (eg
employees) were needed to produce the current period output

14. 18
Example:
Strategic
Analysis of
Operating
Income
Basic
Data for
Price

15. 19
Example: Revenue Effect of Price Recovery
Prior Period
Selling Price
Current Period
Selling Price
X
Current
Period
Units
Sold
Revenue
Effect
Of
Price-
Recovery
=
= ($22 per units - $23 per unit) X 1,150,000 units
= $1,150,000 U
Strategy Reengineering Balanced Scorecard
Engineered &
Discretionary Cost
Managing Unused
Capacity
Evaluating Strategy
Price recovery:
How good is your
negotiation/pricing power?

16. 20
Example: Cost Effect of Price Recovery
 Variable Costs:
Prior Period
Input Price
Current Period
Input Price
X
Units of
Input
required to
produce
Current
Period’s
Output in
the Prior
Period
Cost
Effect
Of
Price-
Recovery
for
Variable
Costs
=
Cost effect of
price
recovery for
direct
materials
= ($1.50 per sq.cm. - $1.40 per sq.cm.) X 3,450,000 sq. = $345,000U
Strategy Reengineering Balanced Scorecard
Engineered &
Discretionary Cost
Managing Unused
Capacity
Evaluating Strategy
Price recovery:
How good is your negotiation/pricing power?
This is the unit price effect due to increase in unit costs?

17. 21
 Fixed 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
Cost
Effect
Of
Price-
Recovery
for Fixed
Costs
=
Example: Cost Effect of Price Recovery
Conversion costs: ($4.35 per sq.cm. - $4.28 per sq.cm.) X 3,750,000 sq. cm. = $262,500 U
Strategy Reengineering Balanced Scorecard
Engineered &
Discretionary Cost
Managing Unused
Capacity
Evaluating Strategy
Price recovery:
How good is your negotiation/pricing power?
This is the unit price effect due to increase in unit costs?

18. 22
 Fixed Costs without Adequate Capacity
Prior Period
Price per Unit
of Capacity
Current Period
Price per Unit
of Capacity
X
Units of
Capacity
Required to
Produce Current
Period’s Output
in the Prior
Period
Cost
Effect
Of
Price-
Recovery
for Fixed
Costs
=
Example: Cost Effect of Price Recovery
Strategy Reengineering Balanced Scorecard
Engineered &
Discretionary Cost
Managing Unused
Capacity
Evaluating Strategy

19. 23
Example:
Strategic
Analysis of
Operating
Income
Basic
Data for
Producti-
vity

20. 24
Example: 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
Cost
Effect
Of
Productivity
for Variable
Costs
=
Cost effect of
productivity of
direct materials
= (2,900,000 sq.cm. - 3,450,000 sq.cm.) X $1.50 per sq.cm.
= 550,000 sq.cm. x $1.50 per sq.cm. = $825,000 F
Strategy Reengineering Balanced Scorecard
Engineered &
Discretionary Cost
Managing Unused
Capacity
Evaluating Strategy
Efficiency:
How good is your
production process?

21. 25
Example: Cost Effect of Productivity for Fixed Costs
 With Adequate Capacity
Actual Units of
Capacity in Prior
Period to
Produce Current
Period’s Output
Actual
Units of
Capacity in
Current
Period
X
Price Per Unit of
Capacity in
Current Period
Cost
Effect
Of
Productivity
for Fixed
Costs
=
Conversion costs: (3,500,000 sq.cm. - 3,750,000sq.cm.) X $4.35 per sq. cm. = $1,087,500 F
Strategy Reengineering Balanced Scorecard
Engineered &
Discretionary Cost
Managing Unused
Capacity
Evaluating Strategy
Efficiency:
How efficient is your
capacity?

22. 26
Example: Cost Effect of Productivity for Fixed Costs
 Without Adequate Capacity
Units of Capacity
Required to
Produce Current
Period’s Output in
the Prior Period
Actual
Units of
Capacity in
Current
Period
X
Price Per Unit of
Capacity in
Current Period
Cost
Effect
Of
Productivity
for Fixed
Costs
=
Strategy Reengineering Balanced Scorecard
Engineered &
Discretionary Cost
Managing Unused
Capacity
Evaluating Strategy

23. 27
Strategic Analysis of Operating Income
Cost leadership Product differentiation
Growth √ √
Price √
Productivity √
Strategy Reengineering Balanced Scorecard
Engineered &
Discretionary Cost
Managing Unused
Capacity
Evaluating Strategy

24. 28
Example: Strategic Analysis of Profitability - Chipset
Strategy Reengineering Balanced Scorecard
Engineered &
Discretionary Cost
Managing Unused
Capacity
Evaluating Strategy

25. Strategy Reengineering Balanced Scorecard
Engineered &
Discretionary Cost
Managing Unused
Capacity
Evaluating Strategy
Example: Strategic Analysis of Profitability - Chipset
Revenues 2012 G 2013 P E 2013
= growth of 15% Units produced
Units produced 1,000,000 1,150,000 1,150,000
27 27 25
27,000,000 31,050,000 28,750,000
4,050,000 (2,300,000)
1. What are the
two types of
variances for
revenues?
What are the
variances telling
management?

26. Strategy Reengineering Balanced Scorecard
Engineered &
Discretionary Cost
Managing Unused
Capacity
Evaluating Strategy
Example: Strategic Analysis of Profitability - Chipset
Costs 2012 G 2013 P E 2013
For growth of 15% should have req 3450000 sq cm Actual
Materials costs 3,000,000 3,450,000 3,450,000 2,900,000
1.40 1.40 1.50 1.50
4,200,000 4,830,000 5,175,000 4,350,000
630,000 345,000 (825,000)
1. What are the two
types of variances for
ordinary standard
costing analysis?
2. Where does the
third variance come
from?
Growth Price Productivity

27. Strategy Reengineering Balanced Scorecard
Engineered &
Discretionary Cost
Managing Unused
Capacity
Evaluating Strategy
Example: Strategic Analysis of Profitability - Chipset
Costs 2012 G 2013 P E 2013
Actual units of capacity in prior period to produce current periods output
Fixed Conversion costs 3,750,000 3,750,000 3,750,000 3,500,000
Processing capacity - 4.28 4.28 4.35 4.35
sq cm of silicon wafer 16,050,000 16,050,000 16,312,500 15,225,000
- 262,500 (1,087,500)
Actual units of capacity in prior period to produce current periods output
R & D Costs 40 40 40 39
Employees 100,000 100,000 100,000 100,000
4,000,000 4,000,000 4,000,000 3,900,000
- - (100,000)
24,250,000 24,880,000 25,487,500 23,475,000
630,000 607,500 (2,012,500)
Growth Price Productivity
1. What are the two
types of variances for
ordinary standard
costing analysis?
2. Where does the
third variance come
from?

28. Strategy Reengineering Balanced Scorecard
Engineered &
Discretionary Cost
Managing Unused
Capacity
Evaluating Strategy
Example: Strategic Analysis of Profitability - Chipset
Revenues 2012 G 2013 P E 2013
= growth of 15% Units produced
Units produced 1,000,000 1,150,000 1,150,000
27 27 25
27,000,000 31,050,000 28,750,000
4,050,000 (2,300,000)
Costs 2012 G 2013 P E 2013
For growth of 15% should have req 3450000 sq cm Actual
Materials costs 3,000,000 3,450,000 3,450,000 2,900,000
1.40 1.40 1.50 1.50
4,200,000 4,830,000 5,175,000 4,350,000
630,000 345,000 (825,000)
Actual units of capacity in prior period to produce current periods output
Fixed Conversion costs 3,750,000 3,750,000 3,750,000 3,500,000
Processing capacity - 4.28 4.28 4.35 4.35
sq cm of silicon wafer 16,050,000 16,050,000 16,312,500 15,225,000
- 262,500 (1,087,500)
Actual units of capacity in prior period to produce current periods output
R & D Costs 40 40 40 39
Employees 100,000 100,000 100,000 100,000
4,000,000 4,000,000 4,000,000 3,900,000
- - (100,000)
24,250,000 24,880,000 25,487,500 23,475,000
630,000 607,500 (2,012,500)

29. Revenues 2012 G 2013 P E 2013
= growth of 15% Units produced
Units produced 1,000,000 1,150,000 1,150,000
27 27 25
27,000,000 31,050,000 28,750,000
4,050,000 (2,300,000)
Costs 2012 G 2013 P E 2013
For growth of 15% should have req 3450000 sq cm Actual
Materials costs 3,000,000 3,450,000 3,450,000 2,900,000
1.40 1.40 1.50 1.50
4,200,000 4,830,000 5,175,000 4,350,000
630,000 345,000 (825,000)
Actual units of capacity in prior period to produce current periods output
Fixed Conversion costs 3,750,000 3,750,000 3,750,000 3,500,000
Processing capacity - 4.28 4.28 4.35 4.35
sq cm of silicon wafer 16,050,000 16,050,000 16,312,500 15,225,000
- 262,500 (1,087,500)
Actual units of capacity in prior period to produce current periods output
R & D Costs 40 40 40 39
Employees 100,000 100,000 100,000 100,000
4,000,000 4,000,000 4,000,000 3,900,000
- - (100,000)
24,250,000 24,880,000 25,487,500 23,475,000
630,000 607,500 (2,012,500)
Strategy Reengineering Balanced Scorecard
Engineered &
Discretionary Cost
Managing Unused
Capacity
Evaluating Strategy
Example: Strategic Analysis of Profitability - Chipset

30. 5
Analysis of Unused Capacity
34
© Neale O'Connor 2010
Strategy Reengineering Balanced Scorecard
Engineered &
Discretionary Cost
Managing Unused
Capacity
Evaluating Strategy

31. 35
5. 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
Strategy Reengineering Balanced Scorecard
Engineered &
Discretionary Cost
Managing Unused
Capacity
Evaluating Strategy
Learning objective 5 :
Distinguish engineered costs
… a cause-and-effect relationship exists between
output produced and costs incurred
from discretionary costs
… no cause-and-effect relationship exists between
output
Produced and costs incurred
5

32. 36
Example: Differences Between Engineered and
Discretionary Costs - Chipset
Strategy Reengineering Balanced Scorecard
Engineered &
Discretionary Cost
Managing Unused
Capacity
Evaluating Strategy

33. 6
Managing Unused Capacity
37
© Neale O'Connor 2010
Strategy Reengineering Balanced Scorecard
Engineered &
Discretionary Cost
Managing Unused
Capacity
Evaluating Strategy

34. 38
Managing Unused Capacity
 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
Strategy Reengineering Balanced Scorecard
Engineered &
Discretionary Cost
Managing Unused
Capacity
Evaluating Strategy
Learning objective 6 :
Identify unused capacity
… capacity available minus
capacity used
and how to manage it
…downsize to reduce
capacity
6

35. 39
Example: Differences Between Engineered and
Discretionary Costs - Chipset
Strategy Reengineering Balanced Scorecard
Engineered &
Discretionary Cost
Managing Unused
Capacity
Evaluating Strategy

36. 40
Managing Unused Capacity
 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
Strategy Reengineering Balanced Scorecard
Engineered &
Discretionary Cost
Managing Unused
Capacity
Evaluating Strategy

37. 41
Summary
 Strategy
 Learning objective 1: Recognize which of two generic strategies a company is using
 Reengineering
 Learning objective 2: Understand what comprises reengineering
 Balanced Scorecard
 Learning objective 3: Understand the four perspectives of the balanced scorecard
 Evaluating Strategy
 Learning objective 4: Analyze changes in operating income to evaluate strategy
 Engineered & Discretionary Cost
 Learning objective 5: Distinguish engineered costs from discretionary costs
 Managing Unused Capacity
 Learning objective 6: Identify unused capacity and how to manage it
Strategy Reengineering Balanced Scorecard
Engineered &
Discretionary Cost
Managing Unused
Capacity
Evaluating Strategy

38. APPENDIX
42

39. 4343
In Practice: Framework for thinking and deciding on strategy
Strategic objectives
What is the basis for success?
What is the Sustainable Competitive Advantage (SCA)?
Why? - Direction of effort
How?
Learn how to beat competitors and provide value to customer
Develop consensus as to the priorities and initiatives to undertake in the short term
(next 12 months)
Strategy Reengineering Balanced Scorecard
Engineered &
Discretionary Cost
Managing Unused
Capacity
Evaluating Strategy
HOW?

40. In Practice: Framework for thinking and deciding on strategy
Sustainable Competitive Advantage (SCA)
Source: Aaker (1995) Strategic Market Management (Fourth Edition) New York: Wiley.
44
Strategy Reengineering Balanced Scorecard
Engineered &
Discretionary Cost
Managing Unused
Capacity
Evaluating Strategy
SCA
The Way You Compete
- Product strategy
- Position strategy
- Manufacturing strategy
- Distribution strategy, etc.
Basics of Competition
- Assets and skills
Where You Compete
- Product-market selection
Whom You Compete Against
- Competitor selection
HOW?

41. 45
In Practice: Framework for thinking and deciding on strategy
Recently Identified Sustainable Competitive Advantages (SCA) of 248 Firms
AAKER (1995) Strategic Market Management (Fourth Edition) New York: Wiley.
• Reputation for quality
• Customer service/product support
• Retain good management & engineering staff
• Low-cost production
• Financial resources
• Customer orientation/feedback/market research
• Product-line breadth
• Technical superiority
• Installed base of satisfied customers
• Segmentation/focus
• Product characteristics/differentiation
• Continuing product innovation
• Market share
• Size/location of distribution
Strategy Reengineering Balanced Scorecard
Engineered &
Discretionary Cost
Managing Unused
Capacity
Evaluating Strategy
HOW?

42. In Practice: Framework for thinking and deciding on strategy
Your Sustainable Competitive Advantage
Ability to beat competitors
10 High5Low 0
5
High 10
ValuetoCustomer
Top Five Issues
1
2
3
4
5
© Neale O’Connor 2005
T
46
Strategy Reengineering Balanced Scorecard
Engineered &
Discretionary Cost
Managing Unused
Capacity
Evaluating Strategy
HOW?