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Problem 13-34

For each perspective, select those strategic objectives from the list that best relate to it. For each strategic
objective, select the most appropriate performance measure(s) from the list.
The Balanced Scorecard Approach translates an organization's mission and strategy into a set of performance
measures that provides the framework for implementing its strategy.

Strategy specifies how an organization matches its own capabilities with the opportunities in the marketplace to
accomplish its objectives.

Product differentiation is an organization's ability to offer products or services perceived by its custo
to be superior and unique relative to the products or services of its competitors.

Cost leadership is an organization's ability to achieve lower cost relative to competitors through prod
and efficiency improvements, elimination of waste, and tight cost control.

Performance measures are indicators that drive the organization to achieve its goals. These measures to be gro
into four categories: (1) financial, (2) customer, (3) internal business process, and learning & growth measures.

Financial measures evaluate the profitability of the chosen strategy to create shareholder value. Thes
are lag indicators that report on the results of past actions. Has our financial performance improved?

Customer measures identify targeted customers, market segments, and measure the company's succ
in those markets. The measures are leading indicators of future financial performance.

Internal business process measures focus on internal operations that create value for customers, tha
turn, help achieve financial performance. The internal-business-process perspective comprises three
sub processes:

Innovation processes create products and services that will meet the needs of customers.

Operations processes produce and deliver existing products and services that will meet th
needs of customers.
Postsale-service processes support the customer after the sale of a product or service.

Learning and growth measures identify the capabilities an organization must excel at to achieve supe
internal business processes that in turn create value for customers and shareholders. Is the organiza
maintaining its ability to change and improve?
Balanced Score Card
Perspective

Financial

Strategic
Objectives
Increase Shareholder Wealth

Customer

Internal Business Process

Learning & Growth

Increase Profit Generated / Salesperson


Acquire new customers
Retain Customers
Develop Profitable Customers
Improve Manufacturing Quality
Introduce New Products
Minimize Invoice Error Rate
On-time Delivery by Suppliers
Increase proprietary products
Increase Information System Capabilities
Enhance Employee Skills

at best relate to it. For each strategic

on and strategy into a set of performance

with the opportunities in the marketplace to

products or services perceived by its customers


ces of its competitors.

r cost relative to competitors through productivity


ht cost control.

hieve its goals. These measures to be grouped


process, and learning & growth measures.

strategy to create shareholder value. These


. Has our financial performance improved?

egments, and measure the company's success


future financial performance.

rations that create value for customers, that in


iness-process perspective comprises three

ices that will meet the needs of customers.

ting products and services that will meet the

mer after the sale of a product or service.

organization must excel at to achieve superior


ustomers and shareholders. Is the organization

Performance
Measures
Earnings /Share
Net Income
Return on Assets
Return of Sales
Return on Equity
Product Cost/Unit
Customer Cost/Unit

Profit/Salesperson
Number of New Customers
% of Customers Retained
Customer Profitability
% of Defective Product Units
% of Error-free Invoices
% of On-time Deliveries by Suppliers
Number of Patents
% of Processes With Real-time Feedback
Employee Turnover Rate
Aver. Job-related Training Hrs./Employee

Problem 13-22 Strategy, balanced scorecard


Given: Stanmore Corporation makes a special-purpose machine, D4H, used in the
textile industry. Stanmore has designed the D4H machine for 2011 to be distinct
from its competitors. It has been generally regarded as a superior machine.
Stanmore presents the following data for 2010 and 2011.
2010
2011
Units of D4H produced and sold
200
210
Selling price
$40,000
$42,000
Direct materials (kilograms)
300,000
310,000
Direct material cost per kilogram
$8.00
$8.50
Manufacturing capacity in units of D4H
250
250
Total conversion costs
$2,000,000 $2,025,000
Conversion costs per unit of capacity
$8,000
$8,100
Selling and customer-service capacity (customers)
100
95
Total selling and customer-service costs
$1,000,000
$940,500
Selling & customer-service capacity cost per customer
$10,000
$9,900
Design staff
12
12
Total design costs
$1,200,000 $1,212,000
Design cost per employee
$100,000
$101,000
Stanmore produces no defective machines, but it wants to reduce DM usage per D4H
machine in 2011. Conversion costs in each year depend on production capacity
defined in terms of D4H units that can be produced, not the actual units produced.
Selling & customer-service costs depend on the number of customers that Stanmore
can support, not the actual number of customers it serves. Stanmore has 75 customers
in 2010 and 80 customers in 2011.
At the start of each year, management uses its discretion to determine the number of
design staff for the year. The design staff and its costs have no direct relationship with
the quantity of D4H produced or the number of customers to whom D4H is sold.
1. Is Stanmore's strategy one of product differentiation or cost leadership?
Stanmore Corporation follows a product differentiation strategy for 2011. D4H is distinct from
its competitors and is generally regarded as superior to competitors' products. To succeed,
Stanmore must continue to differentiate its product and charge a premium price.
2. Describe key measures that you would include in Stanmore's balanced scorecard and
reasons for doing so.
Balanced Score Card
Perspective

Strategic Objectives
or Measures
Increase in operating income
from charging higher margins.

Financial
Price premium earned on
products

Reasons for
Elements
These measures indicate
whether Stanmore has been
able to charge premium prices
and achieve operating income
increases through product
differentiation.

Increase market share in highend special-purpose textile


machines
Customer
Increase customer satisfaction

Stanmore's differentiation
strategy should result in
improvements in these
measures which are LEADING
indicators of future financial
performance.

Increase new customers

Improve manufacturing quality


Internal
Business
Process

Increase product features


Decrease order delivery time

Improvements in these
measures are expected to
result in more satisfied
customers and in turn
superior financial performance.

Decrease development time


for designing improved/new
products

Learning
and
Growth

Develop improvements in mfg.


processes
Improve/increase educational
opportunities for employees
Improve employee skill levels
through retraining and crosstraining
Improve employee satisfaction

Improvement in these
measures have a cause-andeffect relationship with
improvements in internal
business processes, which in
turn lead to improved customer
satisfaction and improved
financial performance.

Problem 13-23 Strategic analysis of operating income (continuation of 13-22).


Given: Stanmore Corporation makes a special-purpose machine, D4H, used in the
textile industry. Stanmore has designed the D4H machine for 2011 to be distinct
from its competitors. It has been generally regarded as a superior machine.
Stanmore presents the following data for 2010 and 2011.
2010
2011
Units of D4H produced and sold
200
210
Selling price
$40,000
$42,000
Direct materials (kilograms)
300,000
310,000
Direct material cost per kilogram
$8.00
$8.50
Manufacturing capacity in units of D4H
250
250
Total conversion costs
$2,000,000 $2,025,000
Conversion costs per unit of capacity
$8,000
$8,100
Selling and customer-service capacity (customers)
100
95
Total selling and customer-service costs
$1,000,000
$940,500
Selling & customer-service capacity cost per customer
$10,000
$9,900
Design staff
12
12
Total design costs
$1,200,000 $1,212,000
Design cost per employee
$100,000
$101,000
Stanmore produces no defective machines, but it wants to reduce DM usage per D4H
machine in 2011. Conversion costs in each year depend on production capacity
defined in terms of D4H units that can be produced, not the actual units produced.
Selling & customer-service costs depend on the number of customers that Stanmore
can support, not the actual number of customers it serves. Stanmore has 75 customers
in 2010 and 80 customers in 2011.
At the start of each year, management uses its discretion to determine the number of
design staff for the year. The design staff and its costs have no direct relationship with
the quantity of D4H produced or the number of customers to whom D4H is sold.
1. Calculate the operating income of Stanmore Corporation in 2010 and 2011.

Units sold
Unit selling price
Total Revenue
Costs
Direct Materials Costs
Kilograms used
Cost per kilogram
Total Direct Materials Cost
Manufacturing Conversion Costs
Selling & customer service costs
Design Costs
Total Costs
Operating Income
Increase in operating income

2010
200
$40,000
$8,000,000

1,500.00

2011
210
$42,000
$8,820,000

300,000
310,000 1,476.19
$8.00
$8.50
$2,400,000 $2,635,000
2,000,000
2,025,000
1,000,000
940,500
1,200,000
1,212,000
$6,600,000 $6,812,500
$1,400,000 $2,007,500
$607,500
Favorable

2. Calculate the growth, price-recovery, and productivity components that explain


the change in operating income from 2010 to 2011.
The Growth Component measures the change in operating income attributable
solely to the change in the quantity of output sold between 2010 and 2011.
The Growth Component:
Revenue effect of growth component:
Actual units of output sold in 2011
Actual units of output sold in 2010
Increase in units sold
Output price in 2010
Favorable Revenue effect

Cost effect of growth component:


Actual units of input or capacity that would
have been used to produce year 2011 output
assuming the same input/output relationships
that existed in 2010
Less:
Actual units of inputs or capacity used to
produce 2010 output
Difference
Input prices in 2010

Unfavorable Cost effect

210
200
10
$40,000
$400,000

Direct
Materials

Mfg.
Conversion
Costs (1)

Selling &
Customer
Service
Costs (1)

315,000

250

100

300,000
15,000
$8.00
$120,000

250
0
$8,000
$0

100
0
$10,000
$0

(300,000/200) X 210 = 1,500 X 210 = 315,000


Note: (1) Mfg. Conversion Costs and Selling & Customer-Service Costs will not change since
adequate capacity exists in 2010 to support year 2011 output and customers.
(2) Design Costs would not change since there is no direct relationship with the quantity
of D4H produced or the number of customers to whom D4H is sold.
Summary:
Revenue effect of growth component:
Cost effect of growth component:
Change in operating income due to the growth component

$400,000
($120,000)
$280,000

The Price-Recovery Component measures the change in operating income attributable solely to
changes in Stanmore's prices of inputs and output between 2010 and 2011.
The Price-Recovery Component:
Revenue effect of price-recovery component:
Output price in 2011
Output price in 2010
Difference in price
Times actual units of output sold in 2011

$42,000
40,000
$2,000
210

Favorable revenue effect of price-recovery component

$420,000

Cost effect of price-recovery component:

Input prices in year 2011


Input prices in year 2010
Difference in price
Actual units of inputs or capacity that would
have been used to produce year 2011 output
assuming the same input-output relationship
that existed in 2010
Unfav. cost effect of price-recovery component
Total for all inputs -- unfavorable

Mfg.
Direct
Conversion
Materials
Costs
$8.50
$8,100
8.00
8,000
$0.50
$100

Selling &
Customer
Service
Costs
$9,900
10,000
($100)

315,000

250

100

$157,500
$184,500

$25,000

($10,000)

Summary:
Revenue effect of price-recovery component:
Cost effect of price-recovery component:
Change in operating income due to the price-recovery component

$420,000
($184,500)
$235,500

The Productivity Component measures the change in costs attributable to a change in the quantity of
inputs used in 2011 relative to the quantity of inputs that would have been used in 2010 to produce the
2011 output.
The Productivity Component:
Direct
Materials
Actual units of inputs or capacity used to produce
year 2011 output
Less:
Actual units of inputs or capacity that would have
been used to produce year 2011 output assuming
the same input-output relationship that existed
in 2010
Difference in units
Input prices in 2011
Change in operating income -- favorable
Total for all inputs -- favorable

Mfg.
Conversion
Costs

Selling &
Customer
Service
Costs

310,000

250

95

315,000
(5,000)
$8.50
($42,500)
($92,000)

250
0
$8,100
$0

100
(5)
$9,900
($49,500)

The change in operating income between 2010 and 2011 can be analyzed as follows:
Income
Statement
Amounts
in 2010

Revenues

Revenue & Revenue &


Cost Effect
Cost Effects Cost Effects
of
of Growth
of PriceProductivity
Component Recovery
Component
in 2011
Component
in 2011
in 2011
$8,000,000
$400,000
$420,000

Costs
Operating Income

(6,600,000)
$1,400,000
$1,400,000

(120,000)
$280,000
F

(184,500)
$92,000
$235,500
$92,000
F
F
$607,500
$607,500
Change in operating income in 2011

3. What do these components indicate?


Companies that have been successful at cost leadership will show large
favorable productivity and growth components.
Companies that have successfully differentiated their products will show
large favorable price-recovery and growth components.
The analysis of operating income indicates that a significant amount of the increase
in operating income resulted from Stanmore's product differentiation strategy. The
company was able to continue to charge a premium price while growing sales.
Stanmore was also able to earn additional operating income by improving its
productivity.

Design
Costs (2)
12

12
0
$100,000
$0

210 = 315,000

ot change since

p with the quantity

Favorable
Unfavorable
Favorable

Design
Costs
$101,000
100,000
$1,000
12

$12,000

Favorable
Unfavorable
Favorable

e quantity of
o produce the

Design
Costs
12

12
0
$101,000
$0

Income
Statement
Amounts
in 2011

$8,820,000

(6,812,500)
$2,007,500
$2,007,500
$2,007,500

Problem 13-24 Analysis of growth, price recovery, and productivity components


(continuation of 13-23)
Suppose that during 2011, the market for Stanmore's special-purpose machines
grew by 3%. All increases in market share (that is, sales increases greater than
3%) are the result of Stanmore's strategic actions.
1. Calculate how much of the change in operating income from 2010 to 2011 is
due to the industry-market-size factor, product differentiation, and cost
leadership. How successful has Stanmore been in implementing its strategy?

Effect of the industry-market-size factor


Sales increased from 200 units to 210 units or a total of 10 units.
Some of this increase is due to the 3% growth in the size of the
overall market. Six (6 = 3% X 200) units of the total increase of 10
units is probably due to an increase in the size of the overall market.
The remainder of the change, 4 units (10-6), is due to increase of
market share.
The change in Stanmore's operating income from the
industry market size factor rather than from specific actions is:
Favorable Growth Component

$280,000

0.6

Effect of product differentiation


The change in operating income (OI) due to:
Increase in the selling price of D4H
(revenue effect of price recovery)
Increase in price of inputs
(cost effect of price recovery)
Change in OI due to the price-recovery component
Growth in market share due to
product differentiation
$280,000
Change in OI due to product differentiation

$168,000 F

$420,000 F
(184,500) U
$235,500 F

0.4

112,000 F
$347,500 F

Effect of cost leadership


The change in operating income from cost leadership is:
Productivity component
The change in operating income between 2010 and 2011:
Change due to industry-market-size
Change due to product differentiation
Change due to cost leadership
Increase in operating income
2. How successful has Stanmore been in implementing its product

$92,000 F

$168,000
$347,500
$92,000
$607,500

F
F
F
F

differentiation strategy?
Stanmore has been successful in implementing its product
differentiation strategy. About 57% ($347,500/$607,500) of
the increase in operating income during 2011 was due to
product differentiation.

0.57201646

Stanmore's operating income increase in 2011 was also helped


by a growth in the overall market and some productivity
improvements.

Reconciliation Spreadsheet
Growth Component
Revenue effect of growth component:
Cost effect of growth component:
Change in operating income due to the growth component

The Price-Recovery Component:


Revenue effect of price-recovery component:
Cost effect of price-recovery component:
Change in operating income due to the price-recovery component

The Productivity Component:


Cost effect of productivity component:
Change in operating income in 2011

$400,000 F
($120,000) U
$280,000 F

Not Part of Co. Strategy


Industry
Growth
$240,000
($72,000)
$168,000

$420,000 F
($184,500) U
$235,500 F
$92,000 F
$607,500

$168,000

Not Part of Co. Strategy


Cost
Leadership

Strategy
Product
Differentiation
$160,000
($48,000)
$112,000
$420,000
($184,500)

$92,000
$92,000

$347,500

$607,500

Problem 13-25 Identifying and managing unused capacity (continuation of 13-22).


1. Calculate the amount of and cost of (a) unused manufacturing capacity and (b)
unused selling and customer-service capacity at the beginning of 2011 based
on actual production and actual number of customers served in 2011.
(a) unused manufacturing capacity
Amount of unused capacity
Capacity in units of D4H at the beginning of 2011
250
Units of D4H produced and sold in 2011
210
Unused capacity
40
Conversion cost per unit of capacity made available in 2011
$8,100
Cost of unused capacity
$324,000
(b) unused selling & customer-service capacity
Amount of unused capacity
Selling & customer service capacity at the beginning of 2011
100
Customers serviced in 2011
80
Unused capacity
20
Cost per unit of capacity made available in 2011
$9,900
Cost of unused capacity
$198,000
(c) unused design capacity
Amount of unused capacity (and related costs) cannot be determined because
design costs is a discretionary cost -- there is no direct relationship with the
quantity of D4H produced or the number of customers to whom D4H is sold.
2. Suppose Stanmore can add or reduce its manufacturing capacity in increments of
30 units. What is the maximum amount of costs that Stanmore could save in 2011
by downsizing manufacturing capacity?
Stanmore can reduce mfg. capacity from 250 units to 220 (250 - 30) units. Stanmore
could save $243,000 (30 X $8,100). This is the maximum amount of cost savings from
downsizing. If additional downsizing is attempted then Stanmore would not have enough
capacity to manufacture the 210 units needed.
3. Stanmore, in fact, does not eliminate any of its unused manufacturing capacity. Why might
Stanmore not downsize.
Stanmore may choose not to downsize because it might expect sales increases that
would lead to a greater demand for and utilization of capacity.
The fact that Stanmore can only downsize in relatively large increments may deter
downsizing.
Stanmore may be focused on product differentiation (its strategy) rather than on cost
reduction.
Not downsizing (especially in large chunks) often helps to boost and maintain employee
morale.

Problem 13-27 Strategic analysis of operating income (continuation of 13-26)


Given:
Westlake Corporation is a small information-systems consulting firm that specializes in
helping companies implement standard sales-management software. The market for
Westlake's products is very competitive. To compete successfully, Westlake must deliver
quality service at a low cost. Westlake presents the following data for 2010 and 2011.

Number of jobs billed


Selling price
Software-implementation labor-hours
Cost per software-implementation labor-hour
Software-implementation support capacity (in jobs)

Total cost of software-implementation support


Software-implementation support-capacity costs / jobs

Number of software-development employees


Total software-development costs
Software-development cost per employee

2010

2011

60
$50,000
30,000
$60
90
$360,000
$4,000
3
$375,000
$125,000

70
$48,000
32,000
$63
90
$369,000
$4,100
3
$390,000
$130,000

Software-implementation labor-hour costs are variable costs. Software-implementation


support costs for each year depend on the software-implementation support capacity that
Westlake chooses to maintain each year (that is the number of jobs it can do each year). It
does not vary with the actual number of jobs done that year.
At the start of each year, management uses its discretion to determine the number of
software-development employees. The software-development staff and costs have no
no direct relationship with the number of jobs it can do each year.

1. Calculate the operating income of Westlake in 2010 and 2011.


Number of jobs billed
Selling price per job
Total Revenue
Costs
Software implementation labor-hour costs
Software implementation labor-hours
Cost per software implementation labor-hour
Total software implementation labor-costs
Software implementation support costs
Software development costs
Total Costs
Operating Income
Increase in operating income

2010
60
$50,000
$3,000,000

500

30,000
$60.00
$1,800,000
360,000
375,000
$2,535,000
$465,000
$120,000
Favorable

2. Calculate the growth, price-recovery, and productivity components that explain the change
in operating income.
The Growth Component measures the change in operating income attributable

solely to the change in the quantity of output sold between 2010 and 2011.
The Growth Component:
Revenue effect of growth component:
Actual number of jobs billed in 2011
Actual number of jobs billed in 2010
Increase in units sold
Selling price per job in 2010
Favorable revenue effect of growth component

Cost effect of growth component:


Actual units of input or capacity that would
have been used to produce year 2011 output
assuming the same input/output relationships
that existed in 2010
Less:
Actual units of inputs or capacity used to
produce 2010 output
Difference
Input prices in 2010

Unfavorable Cost effect

70
60
10
$50,000
$500,000

Software
Software
Implementation Implementation
Labor
Support
Costs
Costs (1)

35,000

90

30,000
5,000
$60.00
$300,000

90
0
$4,000
$0

(30,000/60)*70 = 35,000
Note: (1) Software implementation support costs would not change since adequate capacity
exists in 2010 to support year 2011 output and customers.
(2) Software development costs are discretionary costs not directly related to output
and, hence, would not change in 2010 even if Westlake had to produce and sell the higher
year 2011 output in 2010.
Summary:
Revenue effect of growth component:
Cost effect of growth component:
Change in operating income due to the growth component
The Price-Recovery Component measures the change in operating income attributable solely to
changes in a Westlake's prices of inputs and output between 2010 and 2011.
The Price-Recovery Component:
Revenue effect of price-recovery component:
Job price in 2011
Job price in 2010
Difference in price
Times actual jobs sold in 2011
Unfavorable revenue effect of price-recovery component
Cost effect of price-recovery component:

$48,000
50,000
($2,000)
70
($140,000)

Software
Software
Implementation Implementation

Labor
Costs

Input prices in year 2011


Input prices in year 2010
Difference in price
Actual units of inputs or capacity that would
have been used to produce year 2011 output
assuming the same input-output relationship
that existed in 2010
Unfav. cost effect of price-recovery component

Total for all inputs (unfavorable)

Support
Costs

$63.00
60.00
$3.00

$4,100
4,000
$100

35,000

90

$105,000
$129,000

$9,000

Summary:
Revenue effect of price-recovery component:
Cost effect of price-recovery component:
Change in operating income due to the price-recovery component
The Productivity Component measures the change in costs attributable to a change in the quantity of
inputs used in 2011 relative to the quantity of inputs that would have been used in 2010 to produce the
2011 output.
The Productivity Component:

Software

Software

Implementation Implementation

Labor
Costs
Actual units of inputs or capacity used to produce
year 2011 output
Less:
Actual units of inputs or capacity that would have
been used to produce year 2011 output assuming
the same input-output relationship that existed
in 2010

Difference in units
Input prices in 2011
Change in operating income (favorable)
Total for all inputs (favorable)

Support
Costs

32,000

90

35,000
(3,000)
$63.00
($189,000)
($189,000)

90
0
$4,100
$0

The change in operating income between 2010 and 2011 can be analyzed as follows:
Income
Statement
Amounts
in 2010

Revenues
Costs
Operating Income

$3,000,000
2,535,000
$465,000

Revenue &
Cost Effects
of Growth
Component
in 2011

Revenue &
Cost Effects
of PriceRecovery
Component
in 2011
$500,000
($140,000)
(300,000)
(129,000)
$200,000
($269,000)
F
U

Change in operating income in 2011

$120,000
F

3. What do these components indicate?


Companies that have been successful at cost leadership will show large
favorable productivity and growth components.
Companies that have successfully differentiated their products will show
large favorable price-recovery and growth components.
The analysis of operating income indicates that a significant amount of the increase
in operating income resulted from Westlake's productivity improvements in 2011. The
company had to reduce selling prices while labor costs were increasing but was able to
increase operating income by improving its productivity. The productivity gains also
allowed Westlake to be competitive and grow the business. The unfavorable price recovery
component indicates that Westlake could not pass on increases in labor-related wages via
price increases to its customers, very likely because its product was not differentiated
from competitors' offerings.

pecializes in

e must deliver

lementation
t capacity that
o each year). It

2011
70
$48,000
$3,360,000

32,000 457.14
$63.00
$2,016,000
369,000
390,000
$2,775,000
$585,000
$120,000
Favorable

ain the change

Software
Development
Costs (2)

3
0
$125,000
$0

nge since adequate capacity

ot directly related to output


had to produce and sell the higher

$500,000 Favorable
($300,000) Unfavorable
$200,000 Favorable

attributable solely to

Software

Development
Costs

$130,000
125,000
$5,000
3

$15,000

($140,000) Unfavorable
($129,000) Unfavorable
($269,000) Unfavorable

change in the quantity of


sed in 2010 to produce the

Software
Development

Costs
3

3
0
$130,000
$0

Cost Effect
of
Productivity
Component
in 2011

$189,000
$189,000
F

Income
Statement
Amounts
in 2011

$3,360,000
2,775,000
$585,000
$585,000

was able to

e price recovery
ated wages via

Problem 13-28 Analysis of growth, price-recovery, and productivity


components (continuation of 13-27)
Given:
Suppose that during 2011 the market for implementing sales-management
software increases by 5% and that Westlake experiences a 1% market decline
in selling prices. Assume that any further decreases in selling price and
increases in market share are strategic choices by Westlake's management
to implement their strategy.
1. Calculate how much of the change in operating income from 2010 to 2011
is due to the industry market-size factor, cost leadership, and product
differentiation. How successful has Westlake been in implementing its
strategy?
Effect of the industry-market-size factor
Jobs increased from 60 to 70 units. Three jobs of the ten total
increase is due to the 5% growth in market size (5% X 60 =3).
The change in Westlake's operating income from the industry market-size
factor rather than from company specific actions is:
Growth Component

$200,000

0.3

$60,000 F

Effect of product differentiation


Of the $2,000 decrease in selling price, $500
(1% X $50,000) is due to a general decline
in prices, and the remaining decrease of
$1,500 ($2,000 - $500) is due to a strategic
decision by Westlake's management to implement
its cost leadership strategy of lowering prices to
stimulate demand.
The total decrease in NOI due to the lower SP is
the revenue effect of price recovery component
($2,000 X 70)
The portion of the revenue effect of the price
recovery component due to the planned strategic
price decrease ($1,500 X 70) is
The portion of the revenue effect of the price
recovery component due to the 1% general market
price decline ($500 X 70) is
The total decrease in NOI due to the increase in the
price of inputs is the cost effect of the price recovery
component
Total change in operating income not due to cost
leadership strategy is therefore
Effect of cost leadership

($140,000) U

$105,000 U

($35,000) U

(129,000) U
($164,000) U

The change in operating income from cost leadership


is:
The portion of the revenue effect of the price
recovery component due to the planned strategic
price decrease is (See above.)
Growth component resulting from strategic price
decrease ($200,000 X (7/10))
Productivity component
Total cost leadership effect
The change in operating income between 2010
and 2011:
Change due to industry-mkt. growth
Change due to product differentiation
Change due to cost leadership
Change in operating income in 2011

($105,000) U
$140,000 F
$189,000 F
$224,000 F

$60,000
($164,000)
$224,000
$120,000

F
U
F
F

How successful has Westlake been in implementing its


cost leadership and pricing strategy?
Westlake has been very successful in implementing its cost leadership
and pricing strategy. Westlake was unable to pass along increases in
labor costs by increasing the selling price -- in fact, the selling price
was decreased as part of the cost leadership strategy by $1,500.
Westlake was able to take advantage of its productivity gains to reduce
price, gain market share, and increase operating income.
Reconciliation Spreadsheet
Growth Component
Revenue effect of growth component:
Cost effect of growth component:
Net change in operating income due to the growth component
The Price-Recovery Component:
Revenue effect of price-recovery component:
Cost effect of price-recovery component:
Net change in operating income due to the price-recovery component
The Productivity Component:
Cost effect of productivity component:
Change in operating income in 2011

$500,000 F
($300,000) U
$200,000 F
($140,000) U
($129,000) U
($269,000) U
$189,000 F
$120,000 F

Not Part of Co. Strategy


Industry
Product
Growth
Differentiation
$150,000
($90,000)
$60,000
($35,000)
($129,000)
($164,000)

$60,000

($164,000)

Strategy
Cost
Leadership
$350,000
($210,000)
$140,000

70%
70%
70%

($105,000)

$189,000
$224,000

$120,000

Problem 13-29 Identifying and managing unused capacity (continuation of 13-26).


1. Calculate the amount and cost of unused
(a) Software- implementation support capacity at the beginning of 2011,
based on the number of jobs actually done in 2011.
Amount of unused capacity
Capacity in jobs at the beginning of 2011
90
Jobs in 2011
70
Unused capacity
20
Cost per unit of capacity made available in 2009
$4,100
Cost of unused capacity
$82,000
b) Software-development capacity
Amount of unused capacity (and related costs) cannot be determined because
development costs are discretionary. We cannot determine the amount of softwaredevelopment resources used for completed jobs to compare with job capacity
available. There is no causal relationship between jobs completed and
software-development resources used.
2. Suppose Westlake can add or reduce its software-implementation support
capacity in increments of 15 units. What is the maximum amount of costs that
Westlake could save in 2011 by downsizing software-implementation support
capacity?
Westlake can reduce software implementation support capacity from 90 units to 75
(90 - 15) units. Westlake will save 15 X $4,100 = $61,500.
It can not reduce capacity further (by another 15 units to 60 units) because it would
then not have enough capacity to complete 70 jobs in 2011.
3. Westlake, in fact, does not eliminate any of its unused software-implementation
support capacity. Why might Westlake not downsize?
Westlake may choose not to downsize because it projects sales increases that would
lead to a greater demand for and utilization of capacity.
The fact that Westlake can only downsize in relatively large increments may deter
downsizing.
Not downsizing (especially in large chunks) often helps to boost and maintain employee
morale.

Chapter 13 Problem: Strategic Analysis of Operating Income


Halsey Company sells women's clothing. Halsey's strategy is to offer at premium prices a wide selection
of distinctive clothes accompanied by excellent customer service. Halsey presents the following data
for 2007 and 2008.
2007
2008
1. Number of customers serviced
40,000
41,000
2. Pieces of clothing purchased and sold
40,000
41,000
3. Average selling price
$60
$59
4. Average cost per piece of clothing
$40
$41
5. Selling and customer-service capacity (expressed in customers)
51,000
43,000
6. Selling and customer-service costs
$357,000
$296,700
7. Purchasing and administrative capacity (expressed in designs)
980
850
8. Purchasing and administrative costs
$245,000
$204,000
Total selling and customer-service costs depend on the number of customers that Halsey has
created capacity to support, not the actual number of customers that Halsey serves. Total
purchasing and administrative costs depend on purchasing and administrative capacity that Halsey
has created (defined in terms of the number of distinct clothing designs that Halsey can purchase
and administer). Purchasing and administrative costs do not depend on the actual number of
distinct clothing designs purchased. Halsey purchased 930 distinct designs in 2007 and 820
designs in 2008.
At the start of 2008, Halsey planned to increase operating income by 10% over operating income
in 2007.
Required:
1. Is Halsey's strategy one of product differentiation or cost leadership? Explain.
2. Calculate Halsey's operating income in 2007 and 2008.
3. Calculate the growth, price-recovery, and productivity components of changes in
operating income between 2007 and 2008.
4. Does the strategic analysis of operating income indicate Halsey was successful in
implementing its strategy in 2008? Explain.

Problem: 13-33
Halsey Company sells women's clothing. Halsey's strategy is to offer at premium prices a wide selection
of distinctive clothes accompanied by excellent customer service. Halsey presents the following data
for 2007 and 2008.
2007
2008
1. Number of customers serviced
40,000
41,000
2. Pieces of clothing purchased and sold
40,000
41,000
3. Average selling price
$60
$59
4. Average cost per piece of clothing
$40
$41
5. Selling and customer-service capacity (expressed in customers)
51,000
43,000
6. Selling and customer-service costs
$357,000
$296,700
7. Purchasing and administrative capacity (expressed in designs)
980
850
8. Purchasing and administrative costs
$245,000
$204,000

$60,300
$41,000

Total selling and customer-service costs depend on the number of customers that Halsey has
created capacity to support, not the actual number of customers that Halsey serves. Total
purchasing and administrative costs depend on purchasing and administrative capacity that Halsey
has created (defined in terms of the number of distinct clothing designs that Halsey can purchase
and administer). Purchasing and administrative costs do not depend on the actual number of
distinct clothing designs purchased. Halsey purchased 930 distinct designs in 2007 and 820
designs in 2008.
At the start of 2008, Halsey planned to increase operating income by 10% over operating income
in 2007.
Required:
1. Is Halsey's strategy one of product differentiation or cost leadership? Explain.
Halsey is following a product differentiation strategy. Halsey offers a wide selection of clothes and
excellent customer service but at a premium price. A premium price requires product differentiation.
2. Calculate Halsey's operating income in 2007 and 2008.
Units sold
Unit selling price
Total revenue
Less costs:
Cost of goods sold
Pieces of clothing purchased and sold
Average cost per piece of clothing
Cost of goods sold
Other costs:
Selling and customer-service costs
Purchasing & administrative costs
Total Costs
Operating Income
Increase in operating income

2007
40,000
$60
$2,400,000

2008
41,000
$59
$2,419,000

40,000
$40
$1,600,000

41,000
$41
$1,681,000

357,000
296,700
245,000
204,000
$2,202,000
$2,181,700
$198,000
$237,300
$39,300
Favorable

3. Calculate the growth, price-recovery, and productivity components of changes in


operating income between 2007 and 2008.
The Growth Component measures the change in operating income attributable
solely to the change in the quantity of output sold between 2007 and 2008.
The Growth Component:
Revenue effect of growth component:
Units sold in 2008
Units sold in 2007
Increase in units sold
Average selling price per unit during 2007
Favorable revenue effect

Cost effect of growth component:


Actual units of input or capacity that would

41,000
40,000
1,000
$60
$60,000

Clothes

Selling and
CustomerService

Purchasing
and
Administrative

Costs

Costs (1)

Costs (2)

Capacity = customers

have been used to produce year 2008 output


41,000
51,000
980 output = article of clothing
assuming the same input/output relationships
that existed in 2007
Less:
Actual units of inputs or capacity used to
produce 2007 output
40,000
51,000
980
Difference
1,000
0
0
Input prices in 2007
$40.00
$7
$250
Unfavorable Cost effect
$40,000
$0
$0
(40,000/40,000 X 41,000) Each customer generates sales of one article of clothing
Note: (1) Selling & customer-service costs depend on the number of customers that Halsey
has created capacity to support, not the actual number of customers serviced.
(2) Purchasing and administrative costs depend on purchasing and administrative
capacity that Halsey has created (defined in terms of the number of distinct clothing
designs that Halsey can purchase and administer). Purchasing and administrative
costs do not depend on the actual number of distinct clothing designs purchased.
Summary:
Revenue effect of growth component:
Cost effect of growth component:
Change in operating income due to the growth component

$60,000 Favorable
($40,000) Unfavorable
$20,000 Favorable

The Price-Recovery Component measures the change in operating income attributable solely to
changes in a Meredith's prices of inputs and output between 2007 and 2008.
The Price-Recovery Component:
Revenue effect of price-recovery component:
Output price in 2008
Output price in 2007
Difference in price
Times actual units of output sold in 2008
Unfavorable revenue effect of price-recovery component

$59
60
($1)
41,000
($41,000)

Cost effect of price-recovery component:


Clothes
Costs

Input prices in year 2008


Input prices in year 2007
Difference in price
Actual units of inputs or capacity that would
have been used to produce year 2008 output
assuming the same input-output relationship
that existed in 2007
Unfav. cost effect of price-recovery component
Total for all inputs (unfavorable)

Selling and
CustomerService
Costs

Purchasing
and
Administrative
Costs

$41.00
40.00
$1.00

$6.90
$7.00
($0.10)

$240
250
($10)

41,000

51,000

980

$41,000
$26,100

($5,100)

($9,800)

Summary:
Revenue effect of price-recovery component:
Cost effect of price-recovery component:
Change in operating income due to the price-recovery component

($41,000) Unfavorable
$26,100 Unfavorable
($67,100) Unfavorable

The Productivity Component measures the change in costs attributable to a change in the quantity of
inputs used in 2008 relative to the quantity of inputs that would have been used in 2007 to produce the
2008 output.
The Productivity Component:

Actual units of inputs or capacity used to produce


year 2008 output
Less:
Actual units of inputs or capacity that would have
been used to produce year 2008 output assuming
the same input-output relationship that existed
in 2007
Difference in units

Clothes

Selling and
CustomerService

Purchasing
and
Administrative

Costs

Costs

Costs

41,000

43,000

850

41,000
0

51,000
(8,000)

980
(130)

Input prices in 2008


Change in operating income (favorable)
Total for all inputs (favorable)

$41.00
$0
($86,400)

$7
($55,200)

$240
($31,200)

The change in operating income between 2005 and 2006 can be analyzed as follows:
Income
Statement
Amounts
in 2005

Revenues
Costs
Operating Income

Revenue &
Cost Effects
of Growth
Component
in 2006

Revenue &
Cost Effect
Cost Effects
of
of PriceProductivity
Recovery
Component
Component
in 2006
in 2006
$2,400,000
$60,000
($41,000)
2,202,000
40,000
26,100
($86,400)
$198,000
$20,000
($67,100)
$86,400
$39,300
Change in operating income in 2006
$39,300
$0

4. Does the strategic analysis of operating income indicate Halsey was successful in implementing
its strategy in 2008? Explain.
Companies that have successfully differentiated their products will show
large favorable price-recovery and growth components.
This is not the case for Halsey which is implementing a product differentiation strategy.
Companies that have been successful at cost leadership will show large
favorable productivity and growth components.
The strategic analysis of operation income indicates that a significant amount of the increase in OI resulted
from productivity gains rather than product differentiation.
Although OI increased by more than the planned increase of 10% between 2007 and 2008, Halsey could
not pass on increases in purchase costs to its customers via higher prices. Halsey was not able to charge
a premium price for its product and services. Halsey needs to either change its strategy or improve the
implementation of its current product differentiation strategy.

Income
Statement
Amounts
in 2006

$2,419,000
2,181,700
$237,300

of clothing