James Lajo

Gilbert L. Amoguis

Case 9-4

Haglund Department Store is located in the downtown area of a small city. While the store had been
profitable for many years, it is facing increasing competition from large national chains that have set up
stores on the outskirts of the city. Recently the downtown area has been undergoing revitalization, and
the owners of the Haglund Department Store are somewhat optimistic that profitability can be restored.
In an attempt to accelerate the return to profitability, management of Haglund Department Store
is in the process of designing a balanced scorecard for the company. Management believes the company
should focus on two key problems. First, customers are taking longer and longer to pay bills they incur
using the department store’s charge card, and company has far more bad debts than are normal for the
industry. If this problem were solved, the compnany would have more cash to make much needed
renovations. Investigation has revealed that much of the problem with late payments and unpaid bills
results from customers disputing incorrect charges on their bills. These incorrect charges usually occur
because salesclerks incorrectly enter data on the charge account slip. Second, the company has been
incurring large losses on unsold seasonal apparel. Such items are ordinarily resold at a loss to discount
stores that specialize in such distress items.
The meeting in which the balance scorecard approach was discussed was disorganized and
ineffectively led-possibly because no one other than one of the vice presidents had read anything about
how to build a balanced scorecard. Nevertheless, a number of potential performance measures were
suggested by various managers. These potential performance measures are

a. Percentage of charge account bills containing errors.

b. Percentage of salesclerks trained to correctly enter data on charge account slip.
c. Average age of accounts receivables.
d. Profit per employee.
e. Customer satisfaction with accuracy of charge account bills from monthly customer survey.
f. Total sales revenue.
g. Sales per employee.
h. Travel expenses for buyers for trips to fashion shows.
i. Unsold inventory at the end of the season as a percentage of total cost sales.
j. Courtesy shown by junior staff members to senior staff members based on surveys of senior
staff.
k. Percentage of suppliers making just-in-time deliveries.
l. Sales per square foot of floor space.
m. Written-off accounts receivable (bad debts) as a percentage of sales.
n. Quality of food in the staff cafeteria based on staff survey’s.
o. Percentage of employees who have attended the city’s cultural diversity workshop.
p. Total profit.
Required:
1. As someone with more knowledge of the balanced scorecard than almost anyone else in the
company, you have been asked to build an integrated balanced scorecard. In your scorecard,
use only performance measures listed previously. You do not have to use all of the performance
measures suggested by the managers, but you should build a balanced scorecard that reveals a
strategy for dealing with the problems with accounts receivable and with unsold merchandise.
Construct the balanced scorecard following the format used in Exhibit 9-5. Do not be concerned
with whether a specific performance measure falls within the learning and growth, internal
business process, customer, or financial perspective. However, use arrows to show the causal
links between performance measures within your balanced scorecard and explain whether the
performance measures should show increases or decreases.

Financial
Total profit

Average age of accounts Written-off accounts

receivable receivable as a
percentage of sales

Customer
Customer satisfaction
with accuracy of charge
account bills

Internal Percentage of Unsold inventory at end

Business charge account of season as a percentage
bills containing Processes of total cost of sales
errors

Percentage of suppliers
making just-in-time
deliveries

Learning Percentage of sales clerks

and trained to correctly enter Growth
data on charge account slip
 A number of performance measures suggested by managers have not been included in the above
balances scorecard. The excluded performance measures may have an impact on total profit, but they
are not linked in any obvious way with the two key problems that have been identified by
management-accounts receivables and unsold inventory. If every performance measure that
potentially impacts profit is included in a company’s balance scorecard, it would become unwieldy
and focus would be lost.

2. Assume that the company adopts your balanced scorecard. After operating for a year, some
performance measures show improvements, but not others. What should management do
next?

ANSWER:

The results of operation can be exploited for information about the company’s strategy. Each link in
the balanced scorecard should be regarded as a hypotheses of the form “If…., then ...”. For example,
the balanced scorecard on the previous page contains the hypotheses “If customers express greater
satisfaction with the accuracy of their charge account bills, then the average age of accounts
receivable will improve.” If customers express greater satisfaction with the accuracy of their charge
account bills, then the average age of accounts receivable does not improve, this would have to be
considered evidence that is inconsistent with the hypotheses. Management should try to figure out
why the average age of receivables has not improved.

In general, the most important results are those that provide evidence inconsistent with the
hypothesis embedded in the balanced scorecard. Such evidence suggests that the company’s strategy
needs to be reexamined.

3. a. Suppose that customers express greater satisfaction with the accuracy of their charge account
bills but the performance measures for the average age of accounts receivable and for bad
debts do not improve. Explain why this might happen.

ANSWER:

The evidence is inconsistent with two of the hypotheses underlying the balanced scorecard. The first
of these hypotheses is “If customers express greater satisfaction with the accuracy of their charge
account bills, then the average age of accounts receivable will improve.” The second of these
hypotheses is “If customers express greater satisfaction with the accuracy of their charge account
bills, then there will be improvement in bad debts.” There are number of possible explanations. Two
possibilities are that the company’s collection efforts are ineffective and that the company’s credit
reviews are not working properly. In other words, the problem may not be incorrect charge account
bills at all. The problem may be that the procedures for collecting overdue accounts are not working
properly. Or, the problem may be that the procedures for reviewing credit card applications let
through too many poor credit risks. If so, this would suggest that efforts should be shifted from
reducing charge account billing errors to improving the internal business processes dealing with
collections and credit screening. And in that case, the balanced scorecard should be modified.

b. Suppose that the performance measures for the average age of accounts receivable, bad debts, and
unsold inventory improve, but total profits do not. Explain why this might happen. Assume in your
answer that the explanation lies within the company.

ANSWER:

This evidence is inconsistent with three hypotheses. The first of these is “If the average age of
receivables declines, then profits will increase.” The second hypotheses is “If the written-off accounts
receivable decrease as a percentage of sales, then profits will increase.” The third hypotheses “If
unsold inventory at the end of the season as a percentage of cost of sales declines, then profits will
increase.”

Again, there are number of possible explanations for the lack of results consistent with the
hypotheses. Managers may have decreased the average age of receivables by simply writing off old
accounts earlier than was done previously. This would actually decrease reported profits in the short
term. Bad debts as a percentage of sales could be decreased by drastically cutting back on extensions
of credit to customers-perhaps even canceling some charge accounts. (Bad debts would be zero if
there were no credit sales.) This would have effect of reducing bad debts, but might irritate otherwise
loyal credit customers and reduce sales and profits.

The reduction in unsold inventories at the end of the season as a percentage of cost of sales could
have occurred for a number of reasons that are not necessarily good for profits. For example,
managers may have been too cautious about ordering goods to restock low inventories-creating
stockouts and lost sales. Or, managers may have cut prices drastically on excess inventories in order
to eliminate them before the end of the season. This may have reduced the willingness of costumers
to pay the stores normal prices. Or, managers may have gotten rid of excess inventories be selling
them to discounters before the end of the season.
Problem 9-16A Creating a Balanced Scorecard (L09-4)

Mason Paper Company (MPC) manufactures commodity grade papers for use in computer printers and
photocopiers. MPC has reported net operating losses for the last two years due to intense price
pressure from much larger competitors. The MPC management team—including Kristen Townsend
(CEO), Mike Martinez (vice president of Manufacturing), Tom Andrews (vice president of Marketing),
and Wendy Chen (CFO)—is contemplating a change in strategy to save the company from impending
bankruptcy. Excerpts from a recent management team meeting are shown below:

Townsend: As we all know, the commodity paper manufacturing business is all about economies of
scale. The largest competitors with the lowest cost per unit win. The limited capacity of our older
machines prohibits us from competing in the high-volume commodity paper grades. Furthermore,
expanding our capacity by acquiring a new paper-making machine is out of the question given the
extraordinarily high price tag. Therefore, I propose that we abandon cost reduction as a strategic goal
and instead pursue manufacturing flexibility as the key to our future success.

Chen: Manufacturing flexibility? What does that mean?

Martinez: It means we have to abandon our “crank out as many tons of paper as possible” mentality.
Instead, we need to pursue the low-volume business opportunities that exist in the nonstandard,
specialized paper grades. To succeed in this regard, we'll need to improve our flexibility in three ways.
First, we must improve our ability to switch between paper grades. Right now, we require an average of
four hours to change over to another paper grade. Timely customer deliveries are a function of
changeover performance. Second, we need to expand the range of paper grades that we can
manufacture. Currently, we can only manufacture three paper grades. Our customers must perceive
that we are a “one-stop shop” that can meet all of their paper grade needs. Third, we will need to
improve our yields (e.g., tons of acceptable output relative to total tons processed) in the nonstandard
paper grades. Our percentage of waste within these grades will be unacceptably high unless we do
something to improve our processes. Our variable costs will go through the roof if we cannot increase
our yields!

Chen: Wait just a minute! These changes are going to destroy our equipment utilization numbers!

Andrews: You're right Wendy; however, equipment utilization is not the name of the game when it
comes to competing in terms of flexibility. Our customers don't care about our equipment utilization.
Instead, as Mike just alluded to, they want just-in-time delivery of smaller quantities of a full range of
paper grades. If we can shrink the elapsed time from order placement to order delivery and expand our
product offerings, it will increase sales from current customers and bring in new customers.
Furthermore, we will be able to charge a premium price because of the limited competition within this
niche from our cost-focused larger competitors. Our contribution margin per ton should drastically
improve!
Martinez: Of course, executing the change in strategy will not be easy. We'll need to make a substantial
investment in training because ultimately it is our people who create our flexible manufacturing
capabilities.

Chen: If we adopt this new strategy, it is definitely going to impact how we measure performance. We'll
need to create measures that motivate our employees to make decisions that support our flexibility
goals.

Townsend: Wendy, you hit the nail right on the head. For our next meeting, could you pull together
some potential measures that support our new strategy?

Required:

1. Contrast MPC's previous manufacturing strategy with its new manufacturing strategy.

ANSWER:
MPC’s previous manufacturing strategy was focused on high-volume production of a limited range of
paper grades.

o The goal of this strategy was to keep the machines running constantly to maximize the
number of tons produced.
o Changeovers were avoided because they lowered equipment utilization.
o Maximizing tons produced and minimizing changeovers helped spread the high fixed
costs of paper manufacturing across more units of output.
o The new manufacturing strategy is focused on low-volume production of a wide range
of products.
o The goals of this strategy are to increase the number of paper grades manufactured,
decrease changeover times, and increase yields across non-standard grades.
o While MPC realizes that its new strategy will decrease its equipment utilization, it will
still strive to optimize the utilization of its high fixed cost resources within the confines
of flexible production.
o In an economist’s terms, the old strategy focused on economies of scale while the new
strategy focuses on economies of scope.

2. Generally speaking, why would a company that changes its strategic goals need to change its
performance measurement system as well? What are some examples of measures that would have
been appropriate for MPC prior to its change in strategy? Why would those measures fail to
support MPC's new strategy?

ANSWER:
Statement: Employees focus on improving those measures that are used to evaluate their
performance. Same goes for students, they focus on questions that will be used in the examination.
  Therefore, strategically-aligned performance measures will channel employee effort towards
improving those aspects of performance that are most important to obtaining strategic
objectives.
 If a company changes its strategy but continues to evaluate employee performance using
measures that do not support the new strategy, it will be motivating its employees to make
decisions that promote the old strategy, not the new strategy. And if employees make
decisions that promote the new strategy, their performance measures will suffer.
 Some performance measures that would be appropriate for MPC’s old strategy include:
o equipment utilization percentage,
o number of tons of paper produced, and
o cost per ton produced.
 These performance measures would not support MPC’s new strategy because
o they would discourage increasing the range of paper grades produced,
o increasing the number of changeovers performed, and
o decreasing the batch size produced per run.

3. Construct a balanced scorecard that would support MPC's new manufacturing strategy. Use arrows
to show the causal links between the performance measures and show whether the performance
measure should increase or decrease over time. Feel free to create measures that may not be
specifically mentioned in the chapter, but nonetheless make sense given the strategic goals of the
Exercise 9-4 (continued)
company.
3. Students’ answers may differ in some details from this solution.

Financial
Sales Contribution
+ +
margin per ton

Customer
Number of new
+
customers acquired

Time to fill Customer satisfaction with

– +
an order breadth of product offerings

Internal
Business
Processes Number of different +
paper grades produced

Average change- Average

over time – manufacturing +
yield

Learning
and Growth Number of employees
trained to support the +
flexibility strategy
4. What hypotheses are built into MPC's balanced scorecard? Which of these hypotheses do you
believe are most questionable and why?

ANSWER:

The hypotheses are:

° If the number of employees trained to support the flexibility strategy increases, then the average
changeover time will decrease and the number of different paper grades produced and the average
manufacturing yield will increase.

° If the average changeover time decreases, then the time to fill an order will decrease.

° If the number of different paper grades produced increases, then the customer satisfaction with
breadth of product offerings will increase.

° If the average manufacturing yield increases, then the contribution margin per ton will increase.

° If the time to fill an order decreases, then the number of new customers acquired, sales, and the
contribution margin per ton will increase.

° If the customer satisfaction with breadth of product offerings increases, then the number of new
customers acquired, sales, and the contribution margin per ton will increase.

° If the number of new customers acquired increases, then sales will increase.