Strategy, Balanced Scorecard

and
Strategic Profitability Analysis

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Strategy
Strategy 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

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Five Aspects of Industry Analysis
1. Number and strength of competitors
2. Potential entrants to the market
3. Availability of equivalent products
4. Bargaining power of customers
5. Bargaining power of input suppliers

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Basic Business Strategies
1. 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

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Implementation of Strategy
Many companies have introduced a Balanced
Scorecard to manage the implementation of their
strategies

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The Balanced Scorecard
The 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

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Balanced Scorecard Perspectives
1. Financial
2. Customer
3. Internal Business Perspective
4. Learning and Growth

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The Financial Perspective
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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The Customer Perspective
Identifies targeted customer and market segments
and measures the company’s success in these
segments

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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 sub processes:
1. Innovation
2. Operations
3. Post-sales service

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The Learning & Growth Perspective
Identifies the capabilities the organization must excel
at to achieve superior internal processes that create
value for customers and shareholders

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The Balanced Scorecard Flowchart

Internal Learning
Financial Customer Business &
Process Growth

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Balanced
Scorecard
Illustrated

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Strategy
and the
Balanced
Scorecard,
Illustrated

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Common Balanced Scorecard
Measures

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Balanced Scorecard Implementation
Must have commitment and leadership from top
management
Must be communicated to all employees

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Features of a Good
Balanced Scorecard
Tells 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

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Features of a Good
Balanced Scorecard
Must motivate managers to take actions that
eventually result in improvements in financial
performance
 Predominately applies to for-profit entities, but has some
application to not-for-profit entities as well
Limits the number of measures, identifying only
the most critical ones
Highlights less-than-optimal tradeoffs that
managers may make when they fail to consider
operational and financial measures together

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Balanced Scorecard Implementation Pitfalls
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

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Balanced Scorecard Implementation Pitfalls
Managers 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

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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

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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

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Revenue Effect of Growth

Revenue Actual Units of Actual Units of Current

Effect Output Sold in Output Sold in Period
= X
Of the Current the Prior Selling
Growth Period Period Price

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Cost Effect of Growth for
Variable Costs

Cost
Effect Units of Input Actual Units of
Of required to Input used Current
Growth = produce Current to produce X Period
For Output in the Prior Period Input
Variable Prior Period Output Price
Costs

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Cost Effect of Growth for
Fixed Costs
Assuming Adequate Current Capacity:

Cost
Effect Actual Units of Actual Units Prior
Of capacity in of Capacity Period
Growth = Prior Period to in the X Price
For Produce Current Prior per unit
Fixed Period Output Period of
Costs capacity

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Cost Effect of Growth for
Fixed Costs
Assuming Inadequate Current Capacity:

Cost
Units of Actual Prior
Effect
Capacity Units Period
Of
required to of Capacity Price
Growth = X
produce Current in the per unit
For
Period Output in Prior of
Fixed
the Prior Period Period capacity
Costs

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Revenue Effect of Price Recovery

Revenue
Effect Current
Current Period Prior Period Period
Of = X
Selling Price Selling Price Units
Price-
Recovery Sold

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Cost Effect of Price Recovery
Variable Costs:

Cost Units of
Effect Input
Of required to
Price- Current Period Prior Period produce
= X Current
Recovery Input Price Input Price
for Period’s
Variable Output in
Costs the Prior
Period

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Cost Effect of Price Recovery
Fixed Costs with Adequate Capacity

Cost
Effect Actual Units of
Of Current Period Prior Period Capacity on
Price- = Price per Unit Price per Unit X Prior Period to
Recovery of Capacity of Capacity Produce
for Fixed Current
Costs Period’s Output

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Cost Effect of Price Recovery
Fixed Costs without Adequate Capacity

Cost Units of
Effect Capacity
Of Current Period Prior Period Required to
Price- = Price per Unit Price per Unit X Produce Current
Recovery of Capacity of Capacity Period’s Output
for Fixed in the Prior
Costs Period

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Cost Effect of Productivity for Variable Costs

Cost
Actual Units of Units of Input
Effect
Input used to Required to
Of Input Price in
= Produce Produce Current X
Productivity Current Period
Current Period Period’s Output
for Variable
Output in Prior Period
Costs

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Cost Effect of Productivity for
Fixed Costs
With Adequate Capacity

Cost
Actual Actual Units of
Effect
Units of Capacity in Prior Price Per Unit of
Of
= Capacity in Period to X Capacity in
Productivity
Current Produce Current Current Period
for Fixed
Period Period’s Output
Costs

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Cost Effect of Productivity for
Fixed Costs
Without Adequate Capacity

Cost
Actual Units of Capacity
Effect
Units of Required to Price Per Unit of
Of
= Capacity in Produce Current X Capacity in
Productivity
Current Period’s Output in Current Period
for Fixed
Period the Prior Period
Costs

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Strategic Analysis of Profitability
Illustrated

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The Management of 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

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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

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Differences Between Engineered
and Discretionary Costs Illustrated

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Differences Between Engineered
and Discretionary Costs Illustrated

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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

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© 2009 Pearson Prentice Hall. All rights reserved.