Unit 4 - IP GP

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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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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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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.

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.

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

Customer – the success of the company in its target market

Internal business perspective – the internal operations that create value for customers

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.

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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:

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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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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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 (internal-business); and implementation of ISO 14000 environmental standards (learning and growth).

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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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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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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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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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Strategic analysis of operating income—three parts:

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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Strategic analysis of operating income

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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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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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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Assuming adequate current capacity:

(3,750,000 sq cm – 3,750,000 sq cm) X $4.28 per sq cm = $0.00

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Financial

Customer

Internal Business Process

Learning & Growth

Actual Units of Output Sold in the Current Period

Actual Units of Output Sold in the Prior Period

Current Period Selling Price

Revenue Effect Of Growth

Actual Units of Input used to produce Prior Period Output

Units of Input required to produce Current Output in the Prior Period

Current Period Input Price

Cost Effect Of Growth For Variable Costs

Actual Units of Capacity in the Prior Period

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

Prior Period Price per unit of capacity

Cost Effect Of Growth For Fixed Costs

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($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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The height of the text box and its associated bracket increases or decreases as you add text. To change the width of the comment, drag one of the side handles.

Financial

Customer

Internal Business Process

Learning & Growth

Actual Units of Output Sold in the Current Period

Actual Units of Output Sold in the Prior Period

Current Period Selling Price

Revenue Effect Of Growth

Actual Units of Input used to produce Prior Period Output

Units of Input required to produce Current Output in the Prior Period

Current Period Input Price

Cost Effect Of Growth For Variable Costs

Actual Units of Capacity in the Prior Period

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

Prior Period Price per unit of capacity

Cost Effect Of Growth For Fixed Costs

Actual Units of Capacity in the Prior Period

Units of Capacity required to produce Current Period Output in the Prior Period

Prior Period Price per unit of capacity

Cost Effect Of Growth For Fixed Costs

Prior Period Selling Price

Current Period Selling Price

Current Period Units Sold

Revenue Effect Of Price-Recovery

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($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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The height of the text box and its associated bracket increases or decreases as you add text. To change the width of the comment, drag one of the side handles.

Financial

Customer

Internal Business Process

Learning & Growth

Actual Units of Output Sold in the Current Period

Actual Units of Output Sold in the Prior Period

Current Period Selling Price

Revenue Effect Of Growth

Actual Units of Input used to produce Prior Period Output

Units of Input required to produce Current Output in the Prior Period

Current Period Input Price

Cost Effect Of Growth For Variable Costs

Actual Units of Capacity in the Prior Period

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

Prior Period Price per unit of capacity

Cost Effect Of Growth For Fixed Costs

Actual Units of Capacity in the Prior Period

Units of Capacity required to produce Current Period Output in the Prior Period

Prior Period Price per unit of capacity

Cost Effect Of Growth For Fixed Costs

Prior Period Selling Price

Current Period Selling Price

Current Period Units Sold

Revenue Effect Of Price-Recovery

Prior Period Input Price

Current Period Input Price

Units of Input required to produce Current Period’s Output in the Prior Period

Cost Effect Of Price-Recovery for Variable Costs

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Assuming adequate current capacity:

$4.35 per sq cm - $4.28 per sq cm) X 3,750,000 sq cm = $262,500 Unfavorable

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The height of the text box and its associated bracket increases or decreases as you add text. To change the width of the comment, drag one of the side handles.

Financial

Customer

Internal Business Process

Learning & Growth

Actual Units of Output Sold in the Current Period

Actual Units of Output Sold in the Prior Period

Current Period Selling Price

Revenue Effect Of Growth

Actual Units of Input used to produce Prior Period Output

Units of Input required to produce Current Output in the Prior Period

Current Period Input Price

Cost Effect Of Growth For Variable Costs

Actual Units of Capacity in the Prior Period

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

Prior Period Price per unit of capacity

Cost Effect Of Growth For Fixed Costs

Actual Units of Capacity in the Prior Period

Units of Capacity required to produce Current Period Output in the Prior Period

Prior Period Price per unit of capacity

Cost Effect Of Growth For Fixed Costs

Prior Period Selling Price

Current Period Selling Price

Current Period Units Sold

Revenue Effect Of Price-Recovery

Prior Period Input Price

Current Period Input Price

Units of Input required to produce Current Period’s Output in the Prior Period

Cost Effect Of Price-Recovery for Variable Costs

Prior Period Price per Unit of Capacity

Current Period Price per Unit of Capacity

Actual Units of Capacity on Prior Period to Produce Current Period’s Output

Cost Effect Of Price-Recovery for Fixed Costs

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(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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Financial

Customer

Internal Business Process

Learning & Growth

Actual Units of Output Sold in the Current Period

Actual Units of Output Sold in the Prior Period

Current Period Selling Price

Revenue Effect Of Growth

Actual Units of Input used to produce Prior Period Output

Units of Input required to produce Current Output in the Prior Period

Current Period Input Price

Cost Effect Of Growth For Variable Costs

Actual Units of Capacity in the Prior Period

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

Prior Period Price per unit of capacity

Cost Effect Of Growth For Fixed Costs

Actual Units of Capacity in the Prior Period

Units of Capacity required to produce Current Period Output in the Prior Period

Prior Period Price per unit of capacity

Cost Effect Of Growth For Fixed Costs

Prior Period Selling Price

Current Period Selling Price

Current Period Units Sold

Revenue Effect Of Price-Recovery

Prior Period Input Price

Current Period Input Price

Units of Input required to produce Current Period’s Output in the Prior Period

Cost Effect Of Price-Recovery for Variable Costs

Prior Period Price per Unit of Capacity

Current Period Price per Unit of Capacity

Actual Units of Capacity on Prior Period to Produce Current Period’s Output

Cost Effect Of Price-Recovery for Fixed Costs

Prior Period Price per Unit of Capacity

Current Period Price per Unit of Capacity

Units of Capacity Required to Produce Current Period’s Output in the Prior Period

Cost Effect Of Price-Recovery for Fixed Costs

Units of Input Required to Produce Current Period’s Output in Prior Period

Actual Units of Input used to Produce Current Period Output

Input Price in Current Period

Cost Effect Of Productivity for Variable Costs

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Assuming adequate current capacity:

(3,500,000 sq cm – 3,750,000 sq cm) X $4.35 per sq cm = $1,087,500 Favorable

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Financial

Customer

Internal Business Process

Learning & Growth

Actual Units of Output Sold in the Current Period

Actual Units of Output Sold in the Prior Period

Current Period Selling Price

Revenue Effect Of Growth

Actual Units of Input used to produce Prior Period Output

Units of Input required to produce Current Output in the Prior Period

Current Period Input Price

Cost Effect Of Growth For Variable Costs

Actual Units of Capacity in the Prior Period

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

Prior Period Price per unit of capacity

Cost Effect Of Growth For Fixed Costs

Actual Units of Capacity in the Prior Period

Units of Capacity required to produce Current Period Output in the Prior Period

Prior Period Price per unit of capacity

Cost Effect Of Growth For Fixed Costs

Prior Period Selling Price

Current Period Selling Price

Current Period Units Sold

Revenue Effect Of Price-Recovery

Prior Period Input Price

Current Period Input Price

Units of Input required to produce Current Period’s Output in the Prior Period

Cost Effect Of Price-Recovery for Variable Costs

Prior Period Price per Unit of Capacity

Current Period Price per Unit of Capacity

Actual Units of Capacity on Prior Period to Produce Current Period’s Output

Cost Effect Of Price-Recovery for Fixed Costs

Prior Period Price per Unit of Capacity

Current Period Price per Unit of Capacity

Units of Capacity Required to Produce Current Period’s Output in the Prior Period

Cost Effect Of Price-Recovery for Fixed Costs

Units of Input Required to Produce Current Period’s Output in Prior Period

Actual Units of Input used to Produce Current Period Output

Input Price in Current Period

Cost Effect Of Productivity for Variable Costs

Actual Units of Capacity in Prior Period to Produce Current Period’s Output

Actual Units of Capacity in Current Period

Price Per Unit of Capacity in Current Period

Cost Effect Of Productivity for Fixed Costs

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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.

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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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:

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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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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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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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

Actual Units

of Capacity

in the

Prior

Period

Actual Units of

capacity in

Prior Period to

Produce Current

Period Output

Prior

Period

Price

per unit

capacity

Cost

Effect

Growth

For

Fixed

Costs

Prior Period

Selling Price

Current Period

Selling Price

Current

Period

Units

Sold

Revenue

Effect

Price-

Recovery

Prior Period

Input Price

Current Period

Input Price

Units of

Input

required to

produce

Current

Period’s

Output in

the Prior

Period

Cost

Effect

Price-

Recovery

for

Variable

Costs

Prior Period

Price per Unit

of Capacity

Current Period

Price per Unit

of Capacity

Actual Units of

Capacity on

Prior Period to

Produce

Current

Period’s Output

Cost

Effect

Price-

Recovery

for Fixed

Costs

Units of Input

Required to

Produce Current

Period’s Output

in Prior Period

Actual Units of

Input used to

Produce

Current Period

Output

Input Price in

Current Period

Cost

Effect

Productivity

for Variable

Costs

Actual Units of

Capacity in Prior

Period to

Produce Current

Period’s Output

Actual

Units of

Capacity in

Current

Period

Price Per Unit of

Capacity in

Current Period

Cost

Effect

Productivity

for Fixed

Costs