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Week 6

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Arthur Shum

This document discusses evaluating strategy using strategic analysis of operating income. It provides an example analysis of operating income for a chipset company from 2012 to 2013. The analysis breaks down changes in operating income into growth, price recovery, and productivity components. It examines the revenue and cost effects of each component, calculating the impact on operating income from changes in units sold, prices, input levels, and efficiency. The example shows increases in operating income driven by growth but decreases due to rising costs and less productivity.

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Week 6 Chapter 12 Strategy, Balanced Scorecard, and Strategic Profitability Analysis 1
4 Evaluating Strategy 5 © Neale O'Connor 2010 Strategy Reengineering Balanced Scorecard Engineered & Discretionary Cost Managing Unused Capacity Evaluating Strategy
6 4.Evaluating Strategy  Strategic Analysis of Operating Income – three parts:  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.  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  Productivity Component – measures the change in costs attributable to a change in the quantity of inputs between the current and prior periods Strategy Reengineering Balanced Scorecard Engineered & Discretionary Cost Managing Unused Capacity Evaluating Strategy Learning objective 4 : Analyze changes in operating income to evaluate strategy … growth, price, recovery, and productivity 4How Accounting Can Help Manage Strategy?
7 NON-FINANCIAL MEASURES BIG DECISIONS —ALLOCATE RESOURCES FEEDBACK CEO CFO CIO CUSTOMER INTERNAL PROCESS LEARNING + GROWTH FINANCIAL MEASURES TRAINING GET ATTENTION 4. Evaluating Strategy Decision Relevance of Financial and Non-Financial Measures inside the Firm INVEST MENT
8
9 Strategic Analysis of Operating Income Cost leadership Product differentiation Growth √ √ Price √ Productivity √ Strategy Reengineering Balanced Scorecard Engineered & Discretionary Cost Managing Unused Capacity Evaluating Strategy Other accounting measures to support cost leadership? Manage costs through Value engineering, Activity based costing, Activity based budgeting Other measures to support differentiation? Focus on non-financial measures Lead indicators of long term customer value Measures of innovation for long term sustainable differentiation How Accounting Can Help Manage Strategy?
Example: Strategic Analysis of Operating Income 2012 2013 1. Units of CX1 produced and sold 1,000,000 1,150,000 2. Selling price $23 $22 3. Direct materials (square centimeters of silicon wafers) 3,000,000 2,900,000 4. Direct material cost per square centimeter $1.40 $1.50 5. Manufacturing processing capacity (in square centimeters of silicon wafer) 3,750,000 3,500,000 6. Conversion costs (all manufacturing costs other than direct material costs) $16,050,000 $15,225,000 7. Conversion cost per unit of capacity (Row 6 ÷ Row 5) $4.28 $4.35 Chipset’s data for 2012 and 2013 follow: 11 Strategy Reengineering Balanced Scorecard Engineered & Discretionary Cost Managing Unused Capacity Evaluating Strategy
Example: Strategic Analysis of Operating Income 2012 2013 Revenues ($23 per unit x 1,000,000 units; $22per unit x 1,150,000 units) $23,000,000 $25,300,000 Costs Direct material costs ($1.40/sq.cm x 3,000,000 sq.cm; $1.50/sq.cm x 2,900,000 sq.cm) 4,200,000 4,350,000 Conversion costs ($4.28/sq.cm x 3,750,000 sq.cm; $4.35/sq.cm x 3,500,000 sq.cm) 16,050,000 15,225,000 Total costs 20,250,000 19,575,000 Operating income $2,750,000 $5,725,000 Change in operating income $2,975,000 F Chipset’s asset structure is very similar in 2012 and 2013. Operating income for each year is as follows: 12 Strategy Reengineering Balanced Scorecard Engineered & Discretionary Cost Managing Unused Capacity Evaluating Strategy
13 Example: Strategic Analysis of Operating Income Basic Data for Growth
14 Example: Revenue Effect of Growth Actual Units of Output Sold in the Prior Period Actual Units of Output Sold in the Current Period X Current Period Selling Price Revenue Effect Of Growth = = (1,150,000 units - 1,000,000 units) X $23 per unit Strategy Reengineering Balanced Scorecard Engineered & Discretionary Cost Managing Unused Capacity Evaluating Strategy Revenue Effect: Easy! Prior
15 Example: Cost Effect of Growth for Variable Costs Actual Units of Input used to produce Prior Period Output Units of Input required to produce Current Output in the Prior Period X Current Period Input Price Cost Effect Of Growth For Variable Costs = Cost effect of growth for direct materials = (3,000,000 sq.cm. x 1,150,000 units - 3,000,000 sq.cm.) X $1.40 per sq.cm. 1,000,000 units = (3,450,000sq.cm. - 3,000,000 sq.cm.) X $1.40 per sq.cm. = $630,000 U Strategy Reengineering Balanced Scorecard Engineered & Discretionary Cost Managing Unused Capacity Evaluating Strategy Cost Effect: Keeping productivity constant – what should DM cost you in the second period? Prior
Example: Cost Effect of Growth for Fixed Costs  Assuming Adequate Current Capacity: Actual Units of Capacity in the Prior Period Actual Units of capacity in Prior Period to Produce Current Period Output X Prior Period Price per unit of capacity Cost Effect Of Growth For Fixed Costs = Cost effect of growth for conversion cost = (3,750,000 sq.cm. - 3,750,000 sq.cm.) X $4.28 per sq.cm. = $0 Strategy Reengineering Balanced Scorecard Engineered & Discretionary Cost Managing Unused Capacity Evaluating Strategy 16 16 Cost Effect: Doesn’t change because no additional capacity (eg employees) were needed to produce the current period output
17 Example: Cost Effect of Growth for Fixed Costs  Assuming Inadequate Current Capacity: Actual Units of Capacity in the Prior Period Units of Capacity required to produce Current Period Output in the Prior Period X Prior Period Price per unit of capacity Cost Effect Of Growth For Fixed Costs = Strategy Reengineering Balanced Scorecard Engineered & Discretionary Cost Managing Unused Capacity Evaluating Strategy Inadequate Capacity Effect: Fixed Costs don’t change because no additional capacity (eg employees) were needed to produce the current period output
18 Example: Strategic Analysis of Operating Income Basic Data for Price
19 Example: Revenue Effect of Price Recovery Prior Period Selling Price Current Period Selling Price X Current Period Units Sold Revenue Effect Of Price- Recovery = = ($22 per units - $23 per unit) X 1,150,000 units = $1,150,000 U Strategy Reengineering Balanced Scorecard Engineered & Discretionary Cost Managing Unused Capacity Evaluating Strategy Price recovery: How good is your negotiation/pricing power?
20 Example: Cost Effect of Price Recovery  Variable Costs: Prior Period Input Price Current Period Input Price X Units of Input required to produce Current Period’s Output in the Prior Period Cost Effect Of Price- Recovery for Variable Costs = Cost effect of price recovery for direct materials = ($1.50 per sq.cm. - $1.40 per sq.cm.) X 3,450,000 sq. = $345,000U Strategy Reengineering Balanced Scorecard Engineered & Discretionary Cost Managing Unused Capacity Evaluating Strategy Price recovery: How good is your negotiation/pricing power? This is the unit price effect due to increase in unit costs?
21  Fixed Costs with Adequate Capacity Prior Period Price per Unit of Capacity Current Period Price per Unit of Capacity X Actual Units of Capacity on Prior Period to Produce Current Period’s Output Cost Effect Of Price- Recovery for Fixed Costs = Example: Cost Effect of Price Recovery Conversion costs: ($4.35 per sq.cm. - $4.28 per sq.cm.) X 3,750,000 sq. cm. = $262,500 U Strategy Reengineering Balanced Scorecard Engineered & Discretionary Cost Managing Unused Capacity Evaluating Strategy Price recovery: How good is your negotiation/pricing power? This is the unit price effect due to increase in unit costs?
22  Fixed Costs without Adequate Capacity Prior Period Price per Unit of Capacity Current Period Price per Unit of Capacity X Units of Capacity Required to Produce Current Period’s Output in the Prior Period Cost Effect Of Price- Recovery for Fixed Costs = Example: Cost Effect of Price Recovery Strategy Reengineering Balanced Scorecard Engineered & Discretionary Cost Managing Unused Capacity Evaluating Strategy
23 Example: Strategic Analysis of Operating Income Basic Data for Producti- vity
24 Example: Cost Effect of Productivity for Variable Costs Units of Input Required to Produce Current Period’s Output in Prior Period Actual Units of Input used to Produce Current Period Output X Input Price in Current Period Cost Effect Of Productivity for Variable Costs = Cost effect of productivity of direct materials = (2,900,000 sq.cm. - 3,450,000 sq.cm.) X $1.50 per sq.cm. = 550,000 sq.cm. x $1.50 per sq.cm. = $825,000 F Strategy Reengineering Balanced Scorecard Engineered & Discretionary Cost Managing Unused Capacity Evaluating Strategy Efficiency: How good is your production process?
25 Example: Cost Effect of Productivity for Fixed Costs  With Adequate Capacity Actual Units of Capacity in Prior Period to Produce Current Period’s Output Actual Units of Capacity in Current Period X Price Per Unit of Capacity in Current Period Cost Effect Of Productivity for Fixed Costs = Conversion costs: (3,500,000 sq.cm. - 3,750,000sq.cm.) X $4.35 per sq. cm. = $1,087,500 F Strategy Reengineering Balanced Scorecard Engineered & Discretionary Cost Managing Unused Capacity Evaluating Strategy Efficiency: How efficient is your capacity?
26 Example: Cost Effect of Productivity for Fixed Costs  Without Adequate Capacity Units of Capacity Required to Produce Current Period’s Output in the Prior Period Actual Units of Capacity in Current Period X Price Per Unit of Capacity in Current Period Cost Effect Of Productivity for Fixed Costs = Strategy Reengineering Balanced Scorecard Engineered & Discretionary Cost Managing Unused Capacity Evaluating Strategy
27 Strategic Analysis of Operating Income Cost leadership Product differentiation Growth √ √ Price √ Productivity √ Strategy Reengineering Balanced Scorecard Engineered & Discretionary Cost Managing Unused Capacity Evaluating Strategy
28 Example: Strategic Analysis of Profitability - Chipset Strategy Reengineering Balanced Scorecard Engineered & Discretionary Cost Managing Unused Capacity Evaluating Strategy
Strategy Reengineering Balanced Scorecard Engineered & Discretionary Cost Managing Unused Capacity Evaluating Strategy Example: Strategic Analysis of Profitability - Chipset Revenues 2012 G 2013 P E 2013 = growth of 15% Units produced Units produced 1,000,000 1,150,000 1,150,000 27 27 25 27,000,000 31,050,000 28,750,000 4,050,000 (2,300,000) 1. What are the two types of variances for revenues? What are the variances telling management?
Strategy Reengineering Balanced Scorecard Engineered & Discretionary Cost Managing Unused Capacity Evaluating Strategy Example: Strategic Analysis of Profitability - Chipset Costs 2012 G 2013 P E 2013 For growth of 15% should have req 3450000 sq cm Actual Materials costs 3,000,000 3,450,000 3,450,000 2,900,000 1.40 1.40 1.50 1.50 4,200,000 4,830,000 5,175,000 4,350,000 630,000 345,000 (825,000) 1. What are the two types of variances for ordinary standard costing analysis? 2. Where does the third variance come from? Growth Price Productivity
Strategy Reengineering Balanced Scorecard Engineered & Discretionary Cost Managing Unused Capacity Evaluating Strategy Example: Strategic Analysis of Profitability - Chipset Costs 2012 G 2013 P E 2013 Actual units of capacity in prior period to produce current periods output Fixed Conversion costs 3,750,000 3,750,000 3,750,000 3,500,000 Processing capacity - 4.28 4.28 4.35 4.35 sq cm of silicon wafer 16,050,000 16,050,000 16,312,500 15,225,000 - 262,500 (1,087,500) Actual units of capacity in prior period to produce current periods output R & D Costs 40 40 40 39 Employees 100,000 100,000 100,000 100,000 4,000,000 4,000,000 4,000,000 3,900,000 - - (100,000) 24,250,000 24,880,000 25,487,500 23,475,000 630,000 607,500 (2,012,500) Growth Price Productivity 1. What are the two types of variances for ordinary standard costing analysis? 2. Where does the third variance come from?
Strategy Reengineering Balanced Scorecard Engineered & Discretionary Cost Managing Unused Capacity Evaluating Strategy Example: Strategic Analysis of Profitability - Chipset Revenues 2012 G 2013 P E 2013 = growth of 15% Units produced Units produced 1,000,000 1,150,000 1,150,000 27 27 25 27,000,000 31,050,000 28,750,000 4,050,000 (2,300,000) Costs 2012 G 2013 P E 2013 For growth of 15% should have req 3450000 sq cm Actual Materials costs 3,000,000 3,450,000 3,450,000 2,900,000 1.40 1.40 1.50 1.50 4,200,000 4,830,000 5,175,000 4,350,000 630,000 345,000 (825,000) Actual units of capacity in prior period to produce current periods output Fixed Conversion costs 3,750,000 3,750,000 3,750,000 3,500,000 Processing capacity - 4.28 4.28 4.35 4.35 sq cm of silicon wafer 16,050,000 16,050,000 16,312,500 15,225,000 - 262,500 (1,087,500) Actual units of capacity in prior period to produce current periods output R & D Costs 40 40 40 39 Employees 100,000 100,000 100,000 100,000 4,000,000 4,000,000 4,000,000 3,900,000 - - (100,000) 24,250,000 24,880,000 25,487,500 23,475,000 630,000 607,500 (2,012,500)
Revenues 2012 G 2013 P E 2013 = growth of 15% Units produced Units produced 1,000,000 1,150,000 1,150,000 27 27 25 27,000,000 31,050,000 28,750,000 4,050,000 (2,300,000) Costs 2012 G 2013 P E 2013 For growth of 15% should have req 3450000 sq cm Actual Materials costs 3,000,000 3,450,000 3,450,000 2,900,000 1.40 1.40 1.50 1.50 4,200,000 4,830,000 5,175,000 4,350,000 630,000 345,000 (825,000) Actual units of capacity in prior period to produce current periods output Fixed Conversion costs 3,750,000 3,750,000 3,750,000 3,500,000 Processing capacity - 4.28 4.28 4.35 4.35 sq cm of silicon wafer 16,050,000 16,050,000 16,312,500 15,225,000 - 262,500 (1,087,500) Actual units of capacity in prior period to produce current periods output R & D Costs 40 40 40 39 Employees 100,000 100,000 100,000 100,000 4,000,000 4,000,000 4,000,000 3,900,000 - - (100,000) 24,250,000 24,880,000 25,487,500 23,475,000 630,000 607,500 (2,012,500) Strategy Reengineering Balanced Scorecard Engineered & Discretionary Cost Managing Unused Capacity Evaluating Strategy Example: Strategic Analysis of Profitability - Chipset
5 Analysis of Unused Capacity 34 © Neale O'Connor 2010 Strategy Reengineering Balanced Scorecard Engineered & Discretionary Cost Managing Unused Capacity Evaluating Strategy
35 5. 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 Strategy Reengineering Balanced Scorecard Engineered & Discretionary Cost Managing Unused Capacity Evaluating Strategy Learning objective 5 : Distinguish engineered costs … a cause-and-effect relationship exists between output produced and costs incurred from discretionary costs … no cause-and-effect relationship exists between output Produced and costs incurred 5
36 Example: Differences Between Engineered and Discretionary Costs - Chipset Strategy Reengineering Balanced Scorecard Engineered & Discretionary Cost Managing Unused Capacity Evaluating Strategy
6 Managing Unused Capacity 37 © Neale O'Connor 2010 Strategy Reengineering Balanced Scorecard Engineered & Discretionary Cost Managing Unused Capacity Evaluating Strategy
38 Managing Unused 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 Strategy Reengineering Balanced Scorecard Engineered & Discretionary Cost Managing Unused Capacity Evaluating Strategy Learning objective 6 : Identify unused capacity … capacity available minus capacity used and how to manage it …downsize to reduce capacity 6
39 Example: Differences Between Engineered and Discretionary Costs - Chipset Strategy Reengineering Balanced Scorecard Engineered & Discretionary Cost Managing Unused Capacity Evaluating Strategy
40 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 Strategy Reengineering Balanced Scorecard Engineered & Discretionary Cost Managing Unused Capacity Evaluating Strategy
41 Summary  Strategy  Learning objective 1: Recognize which of two generic strategies a company is using  Reengineering  Learning objective 2: Understand what comprises reengineering  Balanced Scorecard  Learning objective 3: Understand the four perspectives of the balanced scorecard  Evaluating Strategy  Learning objective 4: Analyze changes in operating income to evaluate strategy  Engineered & Discretionary Cost  Learning objective 5: Distinguish engineered costs from discretionary costs  Managing Unused Capacity  Learning objective 6: Identify unused capacity and how to manage it Strategy Reengineering Balanced Scorecard Engineered & Discretionary Cost Managing Unused Capacity Evaluating Strategy
APPENDIX 42
4343 In Practice: Framework for thinking and deciding on strategy Strategic objectives What is the basis for success? What is the Sustainable Competitive Advantage (SCA)? Why? - Direction of effort How? Learn how to beat competitors and provide value to customer Develop consensus as to the priorities and initiatives to undertake in the short term (next 12 months) Strategy Reengineering Balanced Scorecard Engineered & Discretionary Cost Managing Unused Capacity Evaluating Strategy HOW?
In Practice: Framework for thinking and deciding on strategy Sustainable Competitive Advantage (SCA) Source: Aaker (1995) Strategic Market Management (Fourth Edition) New York: Wiley. 44 Strategy Reengineering Balanced Scorecard Engineered & Discretionary Cost Managing Unused Capacity Evaluating Strategy SCA The Way You Compete - Product strategy - Position strategy - Manufacturing strategy - Distribution strategy, etc. Basics of Competition - Assets and skills Where You Compete - Product-market selection Whom You Compete Against - Competitor selection HOW?
45 In Practice: Framework for thinking and deciding on strategy Recently Identified Sustainable Competitive Advantages (SCA) of 248 Firms AAKER (1995) Strategic Market Management (Fourth Edition) New York: Wiley. • Reputation for quality • Customer service/product support • Retain good management & engineering staff • Low-cost production • Financial resources • Customer orientation/feedback/market research • Product-line breadth • Technical superiority • Installed base of satisfied customers • Segmentation/focus • Product characteristics/differentiation • Continuing product innovation • Market share • Size/location of distribution Strategy Reengineering Balanced Scorecard Engineered & Discretionary Cost Managing Unused Capacity Evaluating Strategy HOW?
In Practice: Framework for thinking and deciding on strategy Your Sustainable Competitive Advantage Ability to beat competitors 10 High5Low 0 5 High 10 ValuetoCustomer Top Five Issues 1 2 3 4 5 © Neale O’Connor 2005 T 46 Strategy Reengineering Balanced Scorecard Engineered & Discretionary Cost Managing Unused Capacity Evaluating Strategy HOW?

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Week 6

  • 1. Week 6 Chapter 12 Strategy, Balanced Scorecard, and Strategic Profitability Analysis 1
  • 2. 4 Evaluating Strategy 5 © Neale O'Connor 2010 Strategy Reengineering Balanced Scorecard Engineered & Discretionary Cost Managing Unused Capacity Evaluating Strategy
  • 3. 6 4.Evaluating Strategy  Strategic Analysis of Operating Income – three parts:  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.  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  Productivity Component – measures the change in costs attributable to a change in the quantity of inputs between the current and prior periods Strategy Reengineering Balanced Scorecard Engineered & Discretionary Cost Managing Unused Capacity Evaluating Strategy Learning objective 4 : Analyze changes in operating income to evaluate strategy … growth, price, recovery, and productivity 4How Accounting Can Help Manage Strategy?
  • 4. 7 NON-FINANCIAL MEASURES BIG DECISIONS —ALLOCATE RESOURCES FEEDBACK CEO CFO CIO CUSTOMER INTERNAL PROCESS LEARNING + GROWTH FINANCIAL MEASURES TRAINING GET ATTENTION 4. Evaluating Strategy Decision Relevance of Financial and Non-Financial Measures inside the Firm INVEST MENT
  • 5. 8
  • 6. 9 Strategic Analysis of Operating Income Cost leadership Product differentiation Growth √ √ Price √ Productivity √ Strategy Reengineering Balanced Scorecard Engineered & Discretionary Cost Managing Unused Capacity Evaluating Strategy Other accounting measures to support cost leadership? Manage costs through Value engineering, Activity based costing, Activity based budgeting Other measures to support differentiation? Focus on non-financial measures Lead indicators of long term customer value Measures of innovation for long term sustainable differentiation How Accounting Can Help Manage Strategy?
  • 7. Example: Strategic Analysis of Operating Income 2012 2013 1. Units of CX1 produced and sold 1,000,000 1,150,000 2. Selling price $23 $22 3. Direct materials (square centimeters of silicon wafers) 3,000,000 2,900,000 4. Direct material cost per square centimeter $1.40 $1.50 5. Manufacturing processing capacity (in square centimeters of silicon wafer) 3,750,000 3,500,000 6. Conversion costs (all manufacturing costs other than direct material costs) $16,050,000 $15,225,000 7. Conversion cost per unit of capacity (Row 6 ÷ Row 5) $4.28 $4.35 Chipset’s data for 2012 and 2013 follow: 11 Strategy Reengineering Balanced Scorecard Engineered & Discretionary Cost Managing Unused Capacity Evaluating Strategy
  • 8. Example: Strategic Analysis of Operating Income 2012 2013 Revenues ($23 per unit x 1,000,000 units; $22per unit x 1,150,000 units) $23,000,000 $25,300,000 Costs Direct material costs ($1.40/sq.cm x 3,000,000 sq.cm; $1.50/sq.cm x 2,900,000 sq.cm) 4,200,000 4,350,000 Conversion costs ($4.28/sq.cm x 3,750,000 sq.cm; $4.35/sq.cm x 3,500,000 sq.cm) 16,050,000 15,225,000 Total costs 20,250,000 19,575,000 Operating income $2,750,000 $5,725,000 Change in operating income $2,975,000 F Chipset’s asset structure is very similar in 2012 and 2013. Operating income for each year is as follows: 12 Strategy Reengineering Balanced Scorecard Engineered & Discretionary Cost Managing Unused Capacity Evaluating Strategy
  • 10. 14 Example: Revenue Effect of Growth Actual Units of Output Sold in the Prior Period Actual Units of Output Sold in the Current Period X Current Period Selling Price Revenue Effect Of Growth = = (1,150,000 units - 1,000,000 units) X $23 per unit Strategy Reengineering Balanced Scorecard Engineered & Discretionary Cost Managing Unused Capacity Evaluating Strategy Revenue Effect: Easy! Prior
  • 11. 15 Example: Cost Effect of Growth for Variable Costs Actual Units of Input used to produce Prior Period Output Units of Input required to produce Current Output in the Prior Period X Current Period Input Price Cost Effect Of Growth For Variable Costs = Cost effect of growth for direct materials = (3,000,000 sq.cm. x 1,150,000 units - 3,000,000 sq.cm.) X $1.40 per sq.cm. 1,000,000 units = (3,450,000sq.cm. - 3,000,000 sq.cm.) X $1.40 per sq.cm. = $630,000 U Strategy Reengineering Balanced Scorecard Engineered & Discretionary Cost Managing Unused Capacity Evaluating Strategy Cost Effect: Keeping productivity constant – what should DM cost you in the second period? Prior
  • 12. Example: Cost Effect of Growth for Fixed Costs  Assuming Adequate Current Capacity: Actual Units of Capacity in the Prior Period Actual Units of capacity in Prior Period to Produce Current Period Output X Prior Period Price per unit of capacity Cost Effect Of Growth For Fixed Costs = Cost effect of growth for conversion cost = (3,750,000 sq.cm. - 3,750,000 sq.cm.) X $4.28 per sq.cm. = $0 Strategy Reengineering Balanced Scorecard Engineered & Discretionary Cost Managing Unused Capacity Evaluating Strategy 16 16 Cost Effect: Doesn’t change because no additional capacity (eg employees) were needed to produce the current period output
  • 13. 17 Example: Cost Effect of Growth for Fixed Costs  Assuming Inadequate Current Capacity: Actual Units of Capacity in the Prior Period Units of Capacity required to produce Current Period Output in the Prior Period X Prior Period Price per unit of capacity Cost Effect Of Growth For Fixed Costs = Strategy Reengineering Balanced Scorecard Engineered & Discretionary Cost Managing Unused Capacity Evaluating Strategy Inadequate Capacity Effect: Fixed Costs don’t change because no additional capacity (eg employees) were needed to produce the current period output
  • 15. 19 Example: Revenue Effect of Price Recovery Prior Period Selling Price Current Period Selling Price X Current Period Units Sold Revenue Effect Of Price- Recovery = = ($22 per units - $23 per unit) X 1,150,000 units = $1,150,000 U Strategy Reengineering Balanced Scorecard Engineered & Discretionary Cost Managing Unused Capacity Evaluating Strategy Price recovery: How good is your negotiation/pricing power?
  • 16. 20 Example: Cost Effect of Price Recovery  Variable Costs: Prior Period Input Price Current Period Input Price X Units of Input required to produce Current Period’s Output in the Prior Period Cost Effect Of Price- Recovery for Variable Costs = Cost effect of price recovery for direct materials = ($1.50 per sq.cm. - $1.40 per sq.cm.) X 3,450,000 sq. = $345,000U Strategy Reengineering Balanced Scorecard Engineered & Discretionary Cost Managing Unused Capacity Evaluating Strategy Price recovery: How good is your negotiation/pricing power? This is the unit price effect due to increase in unit costs?
  • 17. 21  Fixed Costs with Adequate Capacity Prior Period Price per Unit of Capacity Current Period Price per Unit of Capacity X Actual Units of Capacity on Prior Period to Produce Current Period’s Output Cost Effect Of Price- Recovery for Fixed Costs = Example: Cost Effect of Price Recovery Conversion costs: ($4.35 per sq.cm. - $4.28 per sq.cm.) X 3,750,000 sq. cm. = $262,500 U Strategy Reengineering Balanced Scorecard Engineered & Discretionary Cost Managing Unused Capacity Evaluating Strategy Price recovery: How good is your negotiation/pricing power? This is the unit price effect due to increase in unit costs?
  • 18. 22  Fixed Costs without Adequate Capacity Prior Period Price per Unit of Capacity Current Period Price per Unit of Capacity X Units of Capacity Required to Produce Current Period’s Output in the Prior Period Cost Effect Of Price- Recovery for Fixed Costs = Example: Cost Effect of Price Recovery Strategy Reengineering Balanced Scorecard Engineered & Discretionary Cost Managing Unused Capacity Evaluating Strategy
  • 20. 24 Example: Cost Effect of Productivity for Variable Costs Units of Input Required to Produce Current Period’s Output in Prior Period Actual Units of Input used to Produce Current Period Output X Input Price in Current Period Cost Effect Of Productivity for Variable Costs = Cost effect of productivity of direct materials = (2,900,000 sq.cm. - 3,450,000 sq.cm.) X $1.50 per sq.cm. = 550,000 sq.cm. x $1.50 per sq.cm. = $825,000 F Strategy Reengineering Balanced Scorecard Engineered & Discretionary Cost Managing Unused Capacity Evaluating Strategy Efficiency: How good is your production process?
  • 21. 25 Example: Cost Effect of Productivity for Fixed Costs  With Adequate Capacity Actual Units of Capacity in Prior Period to Produce Current Period’s Output Actual Units of Capacity in Current Period X Price Per Unit of Capacity in Current Period Cost Effect Of Productivity for Fixed Costs = Conversion costs: (3,500,000 sq.cm. - 3,750,000sq.cm.) X $4.35 per sq. cm. = $1,087,500 F Strategy Reengineering Balanced Scorecard Engineered & Discretionary Cost Managing Unused Capacity Evaluating Strategy Efficiency: How efficient is your capacity?
  • 22. 26 Example: Cost Effect of Productivity for Fixed Costs  Without Adequate Capacity Units of Capacity Required to Produce Current Period’s Output in the Prior Period Actual Units of Capacity in Current Period X Price Per Unit of Capacity in Current Period Cost Effect Of Productivity for Fixed Costs = Strategy Reengineering Balanced Scorecard Engineered & Discretionary Cost Managing Unused Capacity Evaluating Strategy
  • 23. 27 Strategic Analysis of Operating Income Cost leadership Product differentiation Growth √ √ Price √ Productivity √ Strategy Reengineering Balanced Scorecard Engineered & Discretionary Cost Managing Unused Capacity Evaluating Strategy
  • 24. 28 Example: Strategic Analysis of Profitability - Chipset Strategy Reengineering Balanced Scorecard Engineered & Discretionary Cost Managing Unused Capacity Evaluating Strategy
  • 25. Strategy Reengineering Balanced Scorecard Engineered & Discretionary Cost Managing Unused Capacity Evaluating Strategy Example: Strategic Analysis of Profitability - Chipset Revenues 2012 G 2013 P E 2013 = growth of 15% Units produced Units produced 1,000,000 1,150,000 1,150,000 27 27 25 27,000,000 31,050,000 28,750,000 4,050,000 (2,300,000) 1. What are the two types of variances for revenues? What are the variances telling management?
  • 26. Strategy Reengineering Balanced Scorecard Engineered & Discretionary Cost Managing Unused Capacity Evaluating Strategy Example: Strategic Analysis of Profitability - Chipset Costs 2012 G 2013 P E 2013 For growth of 15% should have req 3450000 sq cm Actual Materials costs 3,000,000 3,450,000 3,450,000 2,900,000 1.40 1.40 1.50 1.50 4,200,000 4,830,000 5,175,000 4,350,000 630,000 345,000 (825,000) 1. What are the two types of variances for ordinary standard costing analysis? 2. Where does the third variance come from? Growth Price Productivity
  • 27. Strategy Reengineering Balanced Scorecard Engineered & Discretionary Cost Managing Unused Capacity Evaluating Strategy Example: Strategic Analysis of Profitability - Chipset Costs 2012 G 2013 P E 2013 Actual units of capacity in prior period to produce current periods output Fixed Conversion costs 3,750,000 3,750,000 3,750,000 3,500,000 Processing capacity - 4.28 4.28 4.35 4.35 sq cm of silicon wafer 16,050,000 16,050,000 16,312,500 15,225,000 - 262,500 (1,087,500) Actual units of capacity in prior period to produce current periods output R & D Costs 40 40 40 39 Employees 100,000 100,000 100,000 100,000 4,000,000 4,000,000 4,000,000 3,900,000 - - (100,000) 24,250,000 24,880,000 25,487,500 23,475,000 630,000 607,500 (2,012,500) Growth Price Productivity 1. What are the two types of variances for ordinary standard costing analysis? 2. Where does the third variance come from?
  • 28. Strategy Reengineering Balanced Scorecard Engineered & Discretionary Cost Managing Unused Capacity Evaluating Strategy Example: Strategic Analysis of Profitability - Chipset Revenues 2012 G 2013 P E 2013 = growth of 15% Units produced Units produced 1,000,000 1,150,000 1,150,000 27 27 25 27,000,000 31,050,000 28,750,000 4,050,000 (2,300,000) Costs 2012 G 2013 P E 2013 For growth of 15% should have req 3450000 sq cm Actual Materials costs 3,000,000 3,450,000 3,450,000 2,900,000 1.40 1.40 1.50 1.50 4,200,000 4,830,000 5,175,000 4,350,000 630,000 345,000 (825,000) Actual units of capacity in prior period to produce current periods output Fixed Conversion costs 3,750,000 3,750,000 3,750,000 3,500,000 Processing capacity - 4.28 4.28 4.35 4.35 sq cm of silicon wafer 16,050,000 16,050,000 16,312,500 15,225,000 - 262,500 (1,087,500) Actual units of capacity in prior period to produce current periods output R & D Costs 40 40 40 39 Employees 100,000 100,000 100,000 100,000 4,000,000 4,000,000 4,000,000 3,900,000 - - (100,000) 24,250,000 24,880,000 25,487,500 23,475,000 630,000 607,500 (2,012,500)
  • 29. Revenues 2012 G 2013 P E 2013 = growth of 15% Units produced Units produced 1,000,000 1,150,000 1,150,000 27 27 25 27,000,000 31,050,000 28,750,000 4,050,000 (2,300,000) Costs 2012 G 2013 P E 2013 For growth of 15% should have req 3450000 sq cm Actual Materials costs 3,000,000 3,450,000 3,450,000 2,900,000 1.40 1.40 1.50 1.50 4,200,000 4,830,000 5,175,000 4,350,000 630,000 345,000 (825,000) Actual units of capacity in prior period to produce current periods output Fixed Conversion costs 3,750,000 3,750,000 3,750,000 3,500,000 Processing capacity - 4.28 4.28 4.35 4.35 sq cm of silicon wafer 16,050,000 16,050,000 16,312,500 15,225,000 - 262,500 (1,087,500) Actual units of capacity in prior period to produce current periods output R & D Costs 40 40 40 39 Employees 100,000 100,000 100,000 100,000 4,000,000 4,000,000 4,000,000 3,900,000 - - (100,000) 24,250,000 24,880,000 25,487,500 23,475,000 630,000 607,500 (2,012,500) Strategy Reengineering Balanced Scorecard Engineered & Discretionary Cost Managing Unused Capacity Evaluating Strategy Example: Strategic Analysis of Profitability - Chipset
  • 30. 5 Analysis of Unused Capacity 34 © Neale O'Connor 2010 Strategy Reengineering Balanced Scorecard Engineered & Discretionary Cost Managing Unused Capacity Evaluating Strategy
  • 31. 35 5. 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 Strategy Reengineering Balanced Scorecard Engineered & Discretionary Cost Managing Unused Capacity Evaluating Strategy Learning objective 5 : Distinguish engineered costs … a cause-and-effect relationship exists between output produced and costs incurred from discretionary costs … no cause-and-effect relationship exists between output Produced and costs incurred 5
  • 32. 36 Example: Differences Between Engineered and Discretionary Costs - Chipset Strategy Reengineering Balanced Scorecard Engineered & Discretionary Cost Managing Unused Capacity Evaluating Strategy
  • 33. 6 Managing Unused Capacity 37 © Neale O'Connor 2010 Strategy Reengineering Balanced Scorecard Engineered & Discretionary Cost Managing Unused Capacity Evaluating Strategy
  • 34. 38 Managing Unused 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 Strategy Reengineering Balanced Scorecard Engineered & Discretionary Cost Managing Unused Capacity Evaluating Strategy Learning objective 6 : Identify unused capacity … capacity available minus capacity used and how to manage it …downsize to reduce capacity 6
  • 35. 39 Example: Differences Between Engineered and Discretionary Costs - Chipset Strategy Reengineering Balanced Scorecard Engineered & Discretionary Cost Managing Unused Capacity Evaluating Strategy
  • 36. 40 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 Strategy Reengineering Balanced Scorecard Engineered & Discretionary Cost Managing Unused Capacity Evaluating Strategy
  • 37. 41 Summary  Strategy  Learning objective 1: Recognize which of two generic strategies a company is using  Reengineering  Learning objective 2: Understand what comprises reengineering  Balanced Scorecard  Learning objective 3: Understand the four perspectives of the balanced scorecard  Evaluating Strategy  Learning objective 4: Analyze changes in operating income to evaluate strategy  Engineered & Discretionary Cost  Learning objective 5: Distinguish engineered costs from discretionary costs  Managing Unused Capacity  Learning objective 6: Identify unused capacity and how to manage it Strategy Reengineering Balanced Scorecard Engineered & Discretionary Cost Managing Unused Capacity Evaluating Strategy
  • 39. 4343 In Practice: Framework for thinking and deciding on strategy Strategic objectives What is the basis for success? What is the Sustainable Competitive Advantage (SCA)? Why? - Direction of effort How? Learn how to beat competitors and provide value to customer Develop consensus as to the priorities and initiatives to undertake in the short term (next 12 months) Strategy Reengineering Balanced Scorecard Engineered & Discretionary Cost Managing Unused Capacity Evaluating Strategy HOW?
  • 40. In Practice: Framework for thinking and deciding on strategy Sustainable Competitive Advantage (SCA) Source: Aaker (1995) Strategic Market Management (Fourth Edition) New York: Wiley. 44 Strategy Reengineering Balanced Scorecard Engineered & Discretionary Cost Managing Unused Capacity Evaluating Strategy SCA The Way You Compete - Product strategy - Position strategy - Manufacturing strategy - Distribution strategy, etc. Basics of Competition - Assets and skills Where You Compete - Product-market selection Whom You Compete Against - Competitor selection HOW?
  • 41. 45 In Practice: Framework for thinking and deciding on strategy Recently Identified Sustainable Competitive Advantages (SCA) of 248 Firms AAKER (1995) Strategic Market Management (Fourth Edition) New York: Wiley. • Reputation for quality • Customer service/product support • Retain good management & engineering staff • Low-cost production • Financial resources • Customer orientation/feedback/market research • Product-line breadth • Technical superiority • Installed base of satisfied customers • Segmentation/focus • Product characteristics/differentiation • Continuing product innovation • Market share • Size/location of distribution Strategy Reengineering Balanced Scorecard Engineered & Discretionary Cost Managing Unused Capacity Evaluating Strategy HOW?
  • 42. In Practice: Framework for thinking and deciding on strategy Your Sustainable Competitive Advantage Ability to beat competitors 10 High5Low 0 5 High 10 ValuetoCustomer Top Five Issues 1 2 3 4 5 © Neale O’Connor 2005 T 46 Strategy Reengineering Balanced Scorecard Engineered & Discretionary Cost Managing Unused Capacity Evaluating Strategy HOW?