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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1.

Product differentiationan organizations ability to

offer products or services perceived by its
customers to be superior and unique relative to
the products or services of its competitors.

2.

Competitive advantage: brand loyalty and the

willingness of customers to pay high prices.

Cost leadershipan organizations 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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12-6

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

organizations 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 organizations
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 companys
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
managers performance and promotion
prospects.

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12-16

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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 companys 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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12-19

 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 relationshipsthe
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 companys 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:
1.

2.

Growth componentmeasures 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 componentmeasures 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

3.

Productivity componentmeasures 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, well 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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($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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($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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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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(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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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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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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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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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

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