CHAPTER 12
STRATEGY, BALANCED SCORECARD, AND
STRATEGIC PROFITABILITY ANALYSIS
12-1
Define strategy.
Strategy specifies how an organization matches its own capabilities with the opportunities in the
marketplace to accomplish its objectives.
12-2
Describe the five key forces to consider when analyzing an industry.
The five key forces to consider in industry analysis are: (1) competitors, (2) potential entrants
into the market, (3) equivalent products, (4) bargaining power of customers, and (5) bargaining
power of input suppliers.
12-3
Describe two generic strategies.
Two generic strategies are (1) product differentiation, an organization’s ability to offer products
or services perceived by its customers to be superior and unique relative to the products or
services of its competitors, and (2) cost leadership, an organization’s ability to achieve lower
costs relative to competitors through productivity and efficiency improvements, elimination of
waste, and tight cost control.
12-4
What is a customer preference map, and why is it useful?
A customer preference map describes how different competitors perform across various product
attributes desired by customers, such as price, quality, customer service, and product features.
12-5
What is reengineering?
Reengineering is the fundamental rethinking and redesign of business processes to achieve
improvements in critical measures of performance such as cost, quality, service, speed, and
customer satisfaction.
12-6
What are four key perspectives in the balanced scorecard?
The four key perspectives in the balanced scorecard are (1) Financial perspective—this
perspective evaluates the profitability of the strategy and the creation of shareholder value;
(2) Customer perspective—this perspective identifies the targeted customer and market segments
and measures the company’s success in these segments; (3) Internal business process
perspective—this perspective focuses on internal operations that further both the customer
perspective by creating value for customers and the financial perspective by increasing
shareholder value; and (4) Learning and growth perspective—this perspective identifies the
capabilities at which the organization must excel to achieve superior internal processes that
create value for customers and shareholders.
12-1
12-7
What are the five types of conditions to consider when evaluating a strategy map?
A strategy map is a diagram that describes how an organization creates value by connecting
strategic objectives in explicit cause-and-effect relationships with each other in the financial,
customer, internal business process, and learning and growth perspectives. The structural
analysis of strategy maps identifies (1) how strongly the strategic objectives relate to one another
(2) orphan objectives (3) focal points (4) trigger points and (5) distinctive objectives.
12-8
Describe three features of a good balanced scorecard.
A good balanced scorecard design has several features:
1.
It tells the story of a company’s strategy by articulating a sequence of cause-and-effect
relationships.
2.
It helps to communicate the strategy to all members of the organization by translating the
strategy into a coherent and linked set of understandable and measurable operational
targets.
3.
It places strong emphasis on financial objectives and measures in for-profit companies.
Nonfinancial measures are regarded as part of a program to achieve future financial
performance.
4.
It limits the number of measures to only those that are critical to the implementation of
strategy.
5.
It highlights suboptimal trade-offs that managers may make when they fail to consider
operational and financial measures together.
12-9
What are three important pitfalls to avoid when implementing a balanced scorecard?
Pitfalls to avoid when implementing a balanced scorecard are the following:
1.
Don’t assume the cause-and-effect linkages are precise; they are merely hypotheses. An
organization must gather evidence of these linkages over time.
2.
Don’t seek improvements across all of the measures all of the time.
3.
Don’t use only objective measures in the balanced scorecard.
4.
Don’t fail to consider both costs and benefits of different initiatives before including
these initiatives in the balanced scorecard.
5.
Don’t ignore nonfinancial measures when evaluating managers and employees.
12-10 Describe three key components in doing a strategic analysis of operating income.
Three key components in doing a strategic analysis of operating income are:
1.
The growth component, which measures the change in operating income attributable
solely to the change in quantity of output sold from one year to the next.
2.
The price-recovery component, which measures the change in operating income
attributable solely to changes in the prices of inputs and outputs from one year to the
next.
3.
The productivity component, which measures the change in costs attributable to a change
in the quantity and mix of inputs used in the current year relative to the quantity and mix
of inputs that would have been used in the previous year to produce current year output.
12-2
12-11 Why might an analyst incorporate the industry-market-size factor and the
interrelationships among the growth, price-recovery, and productivity components into a
strategic analysis of operating income?
An analyst can incorporate other factors such as the growth in the overall market and reductions
in selling prices resulting from productivity gains into a strategic analysis of operating income.
By doing so, the analyst can attribute the sources of operating income changes to particular
factors of interests. For example, the analyst will combine the operating income effects of
strategic price reductions and any resulting growth with the productivity component to evaluate a
company’s cost leadership strategy.
12-12 How does an engineered cost differ from a discretionary cost?
Engineered costs result from a cause-and-effect relationship between the cost driver, output, and
the (direct or indirect) resources used to produce that output. Discretionary costs arise from
periodic (usually annual) decisions regarding the maximum amount to be incurred. They have
no measurable cause-and-effect relationship between output and resources used.
12-13 What is downsizing?
Downsizing (also called rightsizing) is an integrated approach configuring processes, products,
and people to match costs to the activities that need to be performed to operate effectively and
efficiently in the present and future. Downsizing is an attempt to eliminate unused capacity.
12-14 What is a partial-productivity measure?
A partial productivity measure is the quantity of output produced divided by the quantity of an
individual input used (e.g., direct materials or direct manufacturing labor).
12-15 “We are already measuring total factor productivity. Measuring partial productivities
would be of no value.” Do you agree? Comment briefly.
No. Total factor productivity (TFP) and partial productivity measures work best together because
the strengths of one offset weaknesses in the other. TFP measures are comprehensive, consider
all inputs together, and explicitly consider economic substitution among inputs. Physical partial
productivity measures are easier to calculate and understand and, as in the case of labor
productivity, relate directly to employees’ tasks. Partial productivity measures are also easier to
compare across different plants and different time periods.
12-3
12-16 Jacobs Inc. is a relatively new company that has established a position in the highly
competitive biotechnology industry. Which of the following statements is correct regarding
Jacobs’ profitability?
a. Profits will increase when buyers have lower switching costs.
b. Significant up-front capital requirements for new entrants will help Jacobs’ profit margins.
c. Profitability is diminished when there are many suppliers.
d. Rival firms willing to spend a lot of money on advertising will increase Jacobs’ profits
SOLUTION
Choice “b” is correct. Since Jacobs is already established in its industry, profits will increase when
barriers to entry are higher because it helps to prevent new firms from entering the industry. Significant
up‐front capital requirements are high barriers to entry which make it more difficult for new firms trying
to enter into the industry and help keep profits higher for those firms already in the industry.
Choice “a” is incorrect. Profits will increase when buyers have higher switching costs because they are
less likely to search for other firms to meet their needs.
Choice “c” is incorrect. Profitability increases when there are many suppliers.
Choice “d” is incorrect. If rival firms are willing to spend a lot on advertising, Jacobs’ profits will likely
suffer as it tries to keep up with its competitors.
12-17 The balanced scorecard describes all of the following except which one?
a. The descriptions of critical initiatives for the organization’s performance.
b. The strategic goals.
c. The related measures associated with strategic and tactical goals.
d. The definition of strategic business
SOLUTION
Choice “d” is correct. The balanced scorecard does not define strategic businesses of a company. It takes
the businesses and strategies as given and describes objectives and measures to implement those
strategies. Similarly, the balanced scorecard does not define strategic business units. Strategic business
units (or responsibility centers) are organizational units managed by an individual who is responsible for
its activities. Examples are cost centers, revenue centers, etc. The responsibility centers may be evaluated
using the balanced scorecard approach.
Choices “a”, “b” and “c” are incorrect. Each of these is described by the balanced scorecard. The
balanced scorecard gathers information on multiple dimensions of an organization’s performance
defined by critical success factors classified as financial, customer, internal business processes, and
learning and growth.
12-18 Canarsie Corporation uses a balanced scorecard to evaluate its digital camera
manufacturing operation. Which of the following statements with respect to balanced scorecards
is/are correct?
I. A balanced scorecard reports management information regarding organizational performance
in achieving goals classified by critical success factors to demonstrate that no single
dimension of organizational performance can be relied upon to evaluate success.
II. Performance measures used in a balanced scorecard tend to be divided into financial,
12-4
customer, internal business process, and learning and growth.
III. In a balanced scorecard, internal business processes are what the company does in its
attempts to satisfy customers.
1. I and II only are correct.
2. II and III only are correct.
3. III only is correct.
4. I, II, and III are correct
SOLUTION
Choice 2 is correct. The balanced scorecard divides performance measures into financial, customer,
internal business process, and learning and growth (item II) and internal business processes are what the
company does in its attempt to satisfy customers (item III). It is not a comprehensive management
information system as described in item I. Some students may interpret item I as only describing
multiple measures of performance to evaluate success. If interpreted this way, item I would be a correct
statement about the balanced scorecard. In this case, Choice 4 would be correct since all three statements
(I, II, and III) would be correct statements with respect to the balanced scorecard.
12-19 Balanced scorecard. Pineway Electric manufactures electric motors. It competes and
plans to grow by selling high-quality motors at a low price and by delivering them to customers
in a reasonable time after receiving customers’ orders. There are many other manufacturers who
produce similar motors. Pineway believes that continuously improving its manufacturing
processes and having satisfied employees are critical to implementing its strategy in 2017.
Required:
1. Is Pineway’s 2017 strategy one of product differentiation or cost leadership? Explain briefly.
2. Ramsey Corporation, a competitor of Pineway, manufactures electric motors with more
sizes and features than Pineway at a higher price. Ramsey’s motors are of high quality but
require more time to produce and so have longer delivery times. Draw a simple customer
preference map as in Exhibit 12-1 for Pineway and Ramsey using the attributes of price,
delivery time, quality, and design features.
3. Draw a strategy map as in Exhibit 12-2 with at least two strategic objectives you would expect
to see under each balanced scorecard perspective. Identify what you believe are any (a) strong
ties, (b) focal points, (c) trigger points, and (d) distinctive objectives. Comment on the
structural analysis of your strategy map.
4. For each strategic objective indicate a measure you would expect to see in Pineway’s
balanced scorecard for 2017.
12-5
SOLUTION
(15 min.)
Balanced scorecard.
1.
Pineway Electric’s 2017 strategy is a cost leadership strategy. Pineway plans to grow by
producing high-quality motors at a low cost delivered to customers at a low price and in a timely
manner. Pineway’s motors are not differentiated, and there are many other manufacturers who
produce similar motors. To succeed, Pineway must produce high-quality motors at lower costs
relative to competitors through productivity and efficiency improvements.
2.
Solution Exhibit 12-19A shows the customer preference map for electric motors for
Pineway and Ramsey on price, timeliness, quality, and design.
SOLUTION EXHIBIT 12-19A
Customer Preference Map for Electric Motors

Product Attributes
Price
Kearney
Ramsey
Pineway
Ridgecrest

Delivery Time

Quality

Design
1
2
3
4
Poor
5
Very good
Attribute Rating
12-6
3. Solution Exhibit 12-19B presents the strategy map for Pineway for 2017.
SOLUTION EXHIBIT 12-19B
Strategy Map for Pineway for 2017
The strategy map indicates that developing process skill is an important objective because it has
a strong tie to improving manufacturing processes that is a trigger point that has strong ties to
improving productivity to reduce costs, improving quality, and delivering on-time, all of which
are necessary to increase customer satisfaction (a focal point). Improving productivity and
quality are distinctive objectives that give Pineway competitive advantage. The overlap between
strong ties and distinctive objectives means that Pineway has a very good ability to successfully
implement its strategy.
12-7
4.
Measures that we would expect to see on a Pineway’s balanced scorecard for 2017 are
Financial Perspective
(1) Operating income from productivity gain, (2) operating income from growth, (3) cost
reductions in key areas.
These measures evaluate whether Pineway has successfully reduced costs and generated
growth through cost leadership.
Customer Perspective
(1) Market share in electric motors market, (2) number of new customers, (3) customer
satisfaction index. The logic is that improvements in these customer measures are
leading indicators of whether Pineway’s cost leadership strategy is succeeding with its
customers and helping it to achieve superior financial performance.
Internal Business Process Perspective
(1) Productivity, (2) defect rates (2) order delivery time, (3) on-time delivery, (4) number of
major process improvements.
Improvements in these measures are key drivers of achieving cost leadership, quality, and
on-time delivery and are expected to lead to more satisfied customers and in turn to superior
financial performance
Learning and Growth Perspective
(1) Percentage of employees trained in process and quality management, (2) employee
satisfaction ratings.
Improvements in these measures aim to improve Pineway’s ability to achieve cost
leadership and have a cause-and-effect relationship with improvements in internal business
processes, which in turn lead to customer satisfaction and financial performance.
12-20 Analysis of growth, price-recovery, and productivity components (continuation of
12-19). An analysis of Pineway’s operating-income changes between 2016 and 2017 shows the
following:
The industry market size for electric motors did not grow in 2017, input prices did not change,
and Pineway reduced the prices of its motors.
Required:
1. Was Pineway’s gain in operating income in 2017 consistent with the strategy you identified
in requirement 1 of Exercise 12-19?
2. Explain the productivity component. In general, does it represent savings in only variable
costs, only fixed costs, or both variable and fixed costs?
12-8
SOLUTION
(20 min.) Analysis of growth, price-recovery, and productivity components (continuation of
12-19).
1.
Pineway’s operating income gain is consistent with the cost leadership strategy identified
in requirement 1 of Exercise 12-19. The increase in operating income in 2017 was driven by the
$145,000 gain in productivity in 2017. Pineway took advantage of its productivity gain to reduce
the prices of its motors and to fuel growth. It increased market share by growing even though
the total market size was unchanged.
2.
The productivity component measures the change in costs attributable to a change in the
quantity and mix of inputs used in a year relative to the quantity and mix of inputs that would
have been used in a previous year to produce the current year output. It measures the amount by
which operating income increases and costs decrease through the productive use of input
quantities. When comparing productivities across years, the productivity calculations use current
year input prices in all calculations. Hence, the productivity component is unaffected by input
price changes.
The productivity component represents savings in both variable costs and fixed costs.
With respect to variable costs, such as direct materials, productivity improvements immediately
translate into cost savings. In the case of fixed costs, such as fixed manufacturing conversion
costs, productivity gains result only if management takes actions to reduce unused capacity. For
example, reengineering manufacturing processes will decrease the capacity needed to produce a
given level of output, but it will lead to a productivity gain only if management reduces the
unused capacity by, say, selling off the excess capacity.
12-21 Strategy, balanced scorecard, merchandising operation. Gianni & Sons buys T-shirts
in bulk, applies its own trendsetting silk-screen designs, and then sells the T-shirts to a number of
retailers. Gianni wants to be known for its trendsetting designs, and it wants every teenager to be
seen in a distinctive Gianni T-shirt. Gianni presents the following data for its first two years of
operations, 2016 and 2017.
Administrative costs depend on the number of customers Gianni has created capacity to support,
not on the actual number of customers served. Gianni had 3,600 customers in 2016 and 3,500
customers in 2017.
12-9
Required:
1. Is Gianni’s strategy one of product differentiation or cost leadership? Explain briefly.
2. Describe briefly the key measures Gianni should include in its balanced scorecard and the
reasons for doing so.
SOLUTION
(20 min.) Strategy, balanced scorecard, merchandising operation.
1.
Gianni & Sons follows a product differentiation strategy. Gianni’s designs are
“trendsetting,” its T-shirts are distinctive, and it aims to make its T-shirts a “must have” for each
and every teenager. These are all clear signs of a product differentiation strategy, and to succeed,
Gianni must continue to innovate and be able to charge a premium price for its product.
2.
Possible key elements of Gianni’s balance scorecard, given its product differentiation
strategy:
Financial Perspective
(1) Increase in operating income from charging higher margins, (2) price premium earned on
products
These measures will indicate whether Gianni has been able to charge premium prices and
achieve operating income increases through product differentiation.
Customer Perspective
(1) Market share in distinctive, name-brand T-shirts, (2) customer satisfaction ratings,
(3) number of new customers, (4) number of mentions of Gianni’s T-shirts in the leading fashion
magazines
Gianni’s strategy should result in improvements in these customer measures that help
evaluate whether Gianni’s product differentiation strategy is succeeding with its customers.
These measures are, in turn, leading indicators of superior financial performance.
Internal Business Process Perspective
(1) Quality of silk-screening (number of colors, use of glitter, durability of the design),
(2) frequency of new designs, (3) time between concept and delivery of design
Improvements in these measures are expected to result in more distinctive and trendsetting
designs delivered to its customers and in turn, superior financial performance.
Learning and Growth Perspective
(1) Ability to attract and retain talented designers (2) improvements in silk-screening processes,
(3) days of continuous education and marketing and sales staff at different skill levels, (4)
employee satisfaction ratings
Improvements in these measures are expected to improve Gianni’s capabilities to produce
distinctive designs that have a cause-and-effect relationship with improvements in internal
business processes, which in turn lead to customer satisfaction and financial performance.
12-10
12-22 Strategic analysis of operating income (continuation of 12-21). Refer to Exercise 1221.
Required:
1. Calculate Gianni‘s operating income in both 2016 and 2017.
2. Calculate the growth, price-recovery, and productivity components that explain the change in
operating income from 2016 to 2017.
3. Comment on your answers in requirement 2. What does each of these components indicate?
SOLUTION
(25–30 min.) Strategic analysis of operating income (continuation of 12-21).
1.
Operating Income Statement
Revenues ($30  200,000; $31  225,000)
Costs
T-shirts purchased ($15  215,000; $13  245,000)
Administrative costs
Total costs
Operating income
2016
$6,000,000
2017
$6,975,000
3,225,000
1,633,500
4,858,500
$1,141,500
3,185,000
1,593,750
4,778,750
$2,196,250
Change in operating income
2.
$1,054,750 F
The Growth Component
Revenue effect
of growth
Cost effect of
growth for
variable costs
=
Actual units of 
 Actual units of
 output sold  output sold  ×
in 2016
 in 2017

=
(225,000  200,000)  $30 = $750,000 F
=
Actual units of 
 Units of input
 required to  input used  ×
produce 2017
to produce
 output
in 2016
2016 ouput 

Cost effect of
growth for =
fixed costs
Selling
price
in 2016
Input
price
in 2016
Actual 
 Actual units of capacity in
Price per unit
 2016 because adequate  units of  × of capacity
exists to produce
capacity 
 capacity
in 2016
in 2016 
 2017 output in 2016
Direct materials (purchased T-shirts) that would be required in 2017 to sell 225,000 T-shirts
instead of the 200,000 sold in 2016, assuming the 2016 input-output relationship continued into
 225,000

2017, equal 241,875 purchased T-shirts 
 215,000  . Administrative capacity will not
 200,000

change because adequate capacity exists in 2016 to support year 2017 output and customers.
12-11
The cost effects of growth component are
Direct materials costs
(241,875  215,000) 
Administrative costs
(4,500 – 4,500)

Cost effect of growth
$15
$363
=
=
$403,125 U
0
$403,125 U
In summary, the net increase in operating income as a result of the growth component equals:
Revenue effect of growth
$750,000 F
Cost effect of growth
403,125 U
Change in operating income due to growth
$346,875 F
The Price-Recovery Component


Actual units
Revenue effect of
Selling price  Selling price  of output
=
price-recovery
in 2017
in 2016
sold in 2017
= ($31 $30)  225,000 = $225,000 F
Input  Units of input required
Cost effect of
 Input
to produce 2017
price-recovery for =  price in  price in  ×
 2017
variable costs
output in 2016
2016 

Actual units of capacity in
Price per 
 Price per
Cost effect of
2016 because adequate
unit of
unit of 

×

price-recovery for =
capacity exists to produce

capacity
capacity 
fixed costs
 in 2017
2017 output in 2016
in 2016 

Direct materials costs
($13  $15)  241,875 =
Administrative costs
($375  $363)  4,500 =
Total cost effect of price-recovery component
$483,750 F
54,000 U
$429,750 F
In summary, the net increase in operating income as a result of the price-recovery component
equals:
Revenue effect of price-recovery
$225,000 F
Cost effect of price-recovery
429,750 F
Change in operating income due to price-recovery
$654,750 F
The Productivity Component
Units of input 
 Actual units of
Cost effect of
input
used
required to   Input

price

productivity for =
to produce
produce 2017 
 2017
in
2017
variable costs
output
ouput in 2016 

Actual units of capacity in 
Price per
 Actual
Cost effect of
units of  2016 because adequate   unit of
productivity for =  capacity
capacity exists to produce 
capacity
 in 2017
fixed costs
2017 output in 2016 
in 2017

The productivity component of cost changes are
Direct materials costs
(245,000  241,875) 
12-12
$13 =
$40,625U
Administrative costs
(4,500  4,250) 
Change in operating income due to productivity
$375 =
93,750 F
$53,125 F
The change in operating income between 2016 and 2017 can be analyzed as follows:
Revenues
Costs
Operating income
Income
Income
Revenue and
Revenue and
Cost Effect
Statement
Statement
Cost Effects Cost Effects of
of
Amounts
Amounts
of Growth
Price-Recovery Productivity
in 2017
in 2016
in 2017
in 2017
in 2017
(5) =
(1)
(2)
(3)
(4)
(1) + (2) + (3) + (4)

$6,000,000
$750,000 F
$225,000 F
$6,975,000
4,858,500
403,125 U
429,750 F
$53,125 F
4,778,750
$1,141,500
$346,875 F
$654,750 F
$53,125 F
$2,196,250
$1,054,750 F
Change in operating income
3.
The analysis of operating income indicates that growth, price-recovery, and productivity
all resulted in favorable changes in operating income in 2017. Further, a significant amount of
the increase in operating income resulted from Gianni’s product differentiation strategy. The
company was able to continue to charge a premium price while growing sales even as the cost of
shirts decreased. It was also able to earn additional operating income by improving its
productivity.
12-23 Analysis of growth, price-recovery, and productivity components (continuation of
12-21 and 12-22). Refer to Exercise 12-21. Suppose that the market for silk-screened T-shirts
grew by 10% during 2017. All increases in sales greater than 10% are the result of Gianni’s
strategic actions.
Required:
Calculate the change in operating income from 2016 to 2017 due to growth in market size,
product differentiation, and cost leadership. How successful has Gianni been in implementing its
strategy? Explain.
SOLUTION
(20 min.)
Analysis of growth, price-recovery, and productivity components
(continuation of 12-22).
Effect of the industry-market-size factor on operating income
Of the 25,000-unit (225,000 – 200,000) increase in sales between 2016 and 2017, 20,000
(10%  200,000) units are due to growth in market size, and 5,000 (25,000 – 20,000) units are
due to an increase in market share.
The change in Gianni’s operating income from the industry-market size factor rather than
from specific strategic actions is:
12-13
$346,875 (the growth component in Exercise 12-22) 
20, 000
25, 000
Effect of product differentiation on operating income
The change in operating income due to:
Increase in the selling price (revenue effect of price recovery)
Decrease in price of inputs (cost effect of price recovery)
$277,500 F
$225,000 F
429,750 F
Growth in market share due to product differentiation
$346,875 (the growth component in Exercise 12-22) 
5, 000
25, 000
69,375 F
Change in operating income due to product differentiation
$724,125 F
Effect of cost leadership on operating income
The change in operating income from cost leadership is:
Productivity component
$ 53,125 F
The change in operating income between 2016 and 2017 can be summarized as follows:
Change due to industry-market-size
Change due to product differentiation
Change due to cost leadership
Change in operating income
$ 277,500 F
724,125 F
53,125 F
$1,054,750 F
Gianni has been very successful in implementing its product differentiation strategy.
Nearly 69% ($724,125  $1,054,750) of the increase in operating income during 2017 was due to
product differentiation, i.e., the distinctiveness of its T-shirts. It was able to raise prices of its
products despite a decline in the cost of the T-shirts purchased. Gianni’s operating income
increase in 2017 was also helped by a growth in the overall market and a small productivity
improvement, which it did not pass on to its customers in the form of lower prices.
12-24 Identifying and managing unused capacity (continuation of 12-21). Refer to Exercise
12-21.
Required:
1. Calculate the amount and cost of unused administrative capacity at the beginning of 2017,
based on the actual number of customers Gianni served in 2017.
2. Suppose Gianni can only add or reduce administrative capacity in increments of 250
customers. What is the maximum amount of costs that Gianni can save in 2017 by
downsizing administrative capacity?
3. What factors, other than cost, should Gianni consider before it downsizes administrative
capacity?
12-14
SOLUTION
(15 min.)
Identifying and managing unused capacity (continuation of 12-21).
1.
The amount and cost of unused capacity at the beginning of year 2017 based on year
2017 needs follows:
Amount of
Cost of
Unused
Unused
Capacity
Capacity
Administrative, 4,500  3,500; (4,500 – 3,500)  $375
1,000
$375,000
2.
Gianni can reduce administrative capacity by another 750 customers (4,250 – 750 =
3,500 actual customers). Gianni will save another 750  $375 = $281,250. This is the maximum
amount of costs Gianni can save in 2017, in addition to the $93,750 ($375  250 customers) that
Gianni already saved when downsizing from 4,500 customers to 4,250 customers.
3.
Before Gianni downsizes administrative capacity, it should consider whether sales
increases in the future would lead to a greater demand for and utilization of capacity as new
customers are drawn to Gianni’s distinctive products—at that point, customer service may be the
key to new customer retention and further growth. Also, the market feedback often provided by
customer service staff is probably key to Gianni’s cutting-edge fashion strategy; some of this
may be lost if administrative capacity is cut back. In addition, significant reductions in capacity
usually mean laying off people, which can hurt employee morale.
12-25 Strategy, balanced scorecard. Stanmore Corporation makes a special-purpose machine,
D4H, used in the textile industry. Stanmore has designed the D4H machine for 2017 to be
distinct from its competitors. It has been generally regarded as a superior machine. Stanmore
presents the following data for 2016 and 2017.
Stanmore produces no defective machines, but it wants to reduce direct materials usage per D4H
machine in 2017. 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 and 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 2016 and 80 customers in 2017.
12-15
Required:
1. Is Stanmore’s strategy one of product differentiation or cost leadership? Explain briefly.
2. Describe briefly key measures that you would include in Stanmore’s balanced scorecard and
the reasons for doing so.
SOLUTION
(15 min.)
Strategy, balanced scorecard.
1.
Stanmore Corporation follows a product differentiation strategy in 2017. Stanmore’s
D4H machine is distinct from its competitors and generally regarded as superior to competitors’
products. To succeed, Stanmore must continue to differentiate its product and charge a premium
price.
2.
Balanced Scorecard measures for 2017 follow:
Financial Perspective
(1) Increase in operating income from charging higher margins, (2) price premium earned on
products
These measures indicate whether Stanmore has been able to charge premium prices and
achieve operating income increases through product differentiation.
Customer Perspective
(1) Market share in high-end special-purpose textile machines, (2) customer satisfaction, (3) new
customers
Stanmore’s strategy should result in improvements in these customer measures that help
evaluate whether Stanmore’s product differentiation strategy is succeeding with its customers.
These measures are leading indicators of superior financial performance.
Internal Business Process Perspective
(1) Manufacturing quality and reduced wastage of direct materials, (2) new product features
added, (3) order delivery time
Improvements in these measures are expected to result in more distinctive products
delivered to its customers and in turn superior financial performance.
Learning and Growth Perspective
(1) Development time for designing new machines, (2) improvements in manufacturing
processes, (3) employee education and skill levels, (4) employee satisfaction
Improvements in these measures are likely to improve Stanmore’s capabilities to produce
distinctive products that have a cause-and-effect relationship with improvements in internal
business processes, which in turn lead to customer satisfaction and financial performance.
12-16
12-26 Strategic analysis of operating income (continuation of 12-25). Refer to Exercise 1225.
Required:
1. Calculate the operating income of Stanmore Corporation in 2016 and 2017.
2. Calculate the growth, price-recovery, and productivity components that explain the change in
operating income from 2016 to 2017.
3. Comment on your answer in requirement 2. What do these components indicate?
SOLUTION
(30 min.) Strategic analysis of operating income (continuation of 12-25).
1.
Operating income for each year is as follows:
2016
2017
$8,000,000
$8,820,000
Revenue ($40,000  200; $42,000  210)
Costs
Direct materials costs ($8  300,000; $8.50  310,000)
Manufacturing conversion costs ($8,000  250; 8,100  250)
Selling & customer service costs ($10,000  100; $9,900  95)
Total costs
5,600,500
Operating income
Change in operating income
2.
2,400,0002,635,000
2,000,0002,025,000
1,000,000 940,500
5,400,000
$2,600,000
$3,219,500
$619,500 F
The Growth Component
Actual units of 
Selling
 Actual units
Revenue effect
=  of output sold  output sold   price
of growth
 in 2017

in 2016
in 2016


=
(210  200)  $40,000 = $400,000 F
Actual units
 Units of
of inputs
Cost effect of
 input required
used to
growth for =  to produce 
2017
output
produce
variable costs
 in 2016
2016 ouput

Cost effect of
growth for =
fixed costs

Input


price

in
2016


Actual 
 Actual units of capacity in
Price per unit
 2016 because adequate  units of  × of capacity
capacity
exists
to
produce
capacity
 2017 output in 2016
in 2016
in 2016 

12-17
Kilograms of direct materials that would be required in 2017 to produce 210 units instead of the
200 units produced in 2016, assuming the 2016 input-output relationship continued into 2017,
 300,000

 210  . Manufacturing conversion costs and selling and
equal 315,000 kilograms 
 200

customer-service capacity will not change because adequate capacity exists in 2016 to support
year 2017 output and customers.
The cost effects of growth component are:
Direct materials costs
Manufacturing conversion costs
Selling & customer-service costs
Cost effect of growth
(315,000  300,000) 
$8 =
(250  250)  $8,000 =
(100  100)  $25,000 =
$120,000 U
0
0
$120,000 U
In summary, the net increase in operating income as a result of the growth component equals:
Revenue effect of growth
$400,000 F
Cost effect of growth
120,000 U
Change in operating income due to growth
$280,000 F
The Price-Recovery Component


Revenue effect of
Selling price
Selling price


price-recovery =
in 2017
in 2016
Actual units
of output
sold in 2017
= ($42,000  $40,000)  210 = $420,000 F
Cost effect of
price-recovery for =
variable costs
Units of input
Input 
 Input
required to
price
in

price
in
×


produce
2017
2016 
 2017
output in 2016
Cost effect of
price-recovery for =
fixed costs
Actual units of capacity in
Price per 
 Price per
 unit of  unit of  × 2016 because adequate
capacity exists to produce
capacity 
 capacity
2017 output in 2016
in 2016 
 in 2017
Direct materials costs
Manufacturing conversion costs
Selling & customer-service costs
Cost effect of price-recovery
($8.50  $8)  315,000 =
($8,100  $8,000) 
250 =
($9,900  $10,000) 
100 =
$157,500 U
25,000 U
10,000 F
$172,500 U
In summary, the net increase in operating income as a result of the price-recovery component equals:
Revenue effect of price-recovery
Cost effect of price-recovery
Change in operating income due to price-recovery
12-18
$420,000 F
172,500 U
$247,500 F
The Productivity Component
Units of input 
 Actual units of
Cost effect of
input
used
required to   Input

price

productivity for =
to produce
produce 2017 
 2017
in
2017
variable costs
output
ouput in 2016 

Actual units of capacity in 
Price per
 Actual
Cost effect of
units
of
2016
because
adequate
unit of


productivity for = capacity  capacity exists to produce  capacity
 in 2017

fixed costs
2017 output in 2016 
in 2017

The productivity component of cost changes are
Direct materials costs
(310,000  315,000) 
Manufacturing conversion costs
(250  250) 
Selling & customer-service costs
(95  100) 
Change in operating income due to productivity
$8.50 =
$8,100 =
$9,900 =
$42,500 F
0
49,500 F
$92,000 F
The change in operating income between 2016 and 2017 can be analyzed as follows:
Revenues
Costs
Operating income
Income
Statement
Amounts
in 2016
(1)
$8,000,000
Revenue and
Revenue and
Cost Effect
Cost Effects Cost Effects of
of
of Growth
Price-Recovery Productivity
Component
Component
Component
in 2017
in 2017
in 2017
(2)
(3)
(4)

$400,000 F
$420,000 F
Income
Statement
Amounts in 2017
(5) =
(1) + (2) + (3) + (4)
$8,820,000
5,400,000
120,000 U
172,500 U
$92,000 F
5,600,500
$2,600,000
$280,000 F
$247,500 F
$92,000 F
$3,219,500
$619,500 F
Change in operating income
3.
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. The productivity gains may be
important from the standpoint of funding the product differentiation strategy and innovation (as
has been the case with the pharmaceutical industry in recent years), but Stanmore’s strategic
focus has to be on differentiating its products.
12-19
12-27 Analysis of growth, price-recovery, and productivity components (continuation of 1225 and 12-26). Suppose that during 2017, 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.
Required:
Calculate how much of the change in operating income from 2016 to 2017 is due to the industrymarket-size factor, product differentiation, and cost leadership. How successful has Stanmore been in
implementing its strategy? Explain.
SOLUTION
(20 min.)
Analysis of growth, price-recovery,
(continuation of 12-25 and 12-26).
and
productivity
components
Effect of the industry-market-size factor on operating income
Of the 10-unit increase in sales from 200 to 210 units, 3% or 6 (3%  200) units is due to
growth in market size, and 4 (10  6) units is due to an increase in market share.
The change in Stanmore’s operating income from the industry-market size factor rather
than from specific strategic actions is:
6
$280,000 (the growth component in Exercise 12-26) 
$168,000 F
10
Effect of product differentiation on operating income
The change in operating income due to:
Increase in the selling price of D4H (revenue effect of price recovery)
$420,000 F
Increase in price of inputs (cost effect of price recovery)
172,500 U
Growth in market share due to product differentiation
$280,000 (the growth component in Exercise 12-26) 
4
10
112,000 F
Change in operating income due to product differentiation
$359,500 F
Effect of cost leadership on operating income
The change in operating income from cost leadership is:
Productivity component
$ 92,000 F
The change in operating income between 2016 and 2017 can be summarized as follows:
Change due to industry-market-size
Change due to product differentiation
Change due to cost leadership
Change in operating income
$168,000 F
359,500 F
92,000 F
$619,500 F
Stanmore has been successful in implementing its product differentiation strategy. More
than 58% ($359,500  $619,500) of the increase in operating income during 2017 was due to
12-20
product differentiation, i.e., the distinctiveness of its machines. It was able to raise the prices of
its machines faster than the costs of its inputs and still grow market share. Stanmore’s operating
income increase in 2017 was also helped by a growth in the overall market and some
productivity improvements.
12-28 Identifying and managing unused capacity (continuation of 12-25). Refer to Exercise
12-25.
Required:
1. Calculate the amount and cost of (a) unused manufacturing capacity and (b) unused selling and
customer-service capacity at the beginning of 2017 based on actual production and actual
number of customers served in 2017.
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 2017 by downsizing
manufacturing capacity?
3. Stanmore, in fact, does not eliminate any of its unused manufacturing capacity. Why might
Stanmore not downsize?
SOLUTION
(15 min.) Identifying and managing unused capacity (continuation of 12-25).
1.
The amount and cost of unused capacity at the beginning of year 2017 based on year
2017 production follows:
Manufacturing, 250  210; (250 – 210)  $8,100
Selling and customer service, 100 – 80; (100 – 80)  $9,900
Amount of
Unused
Capacity
40
20
Cost of
Unused
Capacity
$324,000
198,000
2.
Stanmore can reduce manufacturing capacity from 250 units to 220 (250  30) units.
Stanmore will save 30  $8,100 = $243,000. This is the maximum amount of costs Stanmore
can save in 2017. It cannot reduce capacity further (by another 30 units to 190 units) because it
would then not have enough capacity to manufacture 210 units in 2017 (units that contribute
significantly to operating income).
3.
Stanmore may choose not to downsize because it projects sales increases that would lead
to a greater demand for and utilization of capacity. Stanmore may have also decided not to
downsize because downsizing requires a significant reduction in capacity. For example,
Stanmore may have chosen to downsize some more manufacturing capacity if it could do so in
increments of say, 10, rather than 30 units. Also, Stanmore may be focused on product
differentiation, which is key to its strategy, rather than on cost reduction. Not reducing
significant capacity also helps to boost and maintain employee morale.
12-21
12-29 Strategy, balanced scorecard, service company. Compton Associates is an
architectural firm that has been in practice only a few years. Because it is a relatively new firm,
the market for the firm’s services is very competitive. To compete successfully, Compton must
deliver quality services at a low cost. Compton presents the following data for 2016 and 2017.
Architect labor-hour costs are variable costs. Architect support costs for each year depend on the
Architect support capacity that Compton chooses to maintain each year (that is, the number of
jobs it can do each year). Architect support costs do not vary with the actual number of jobs done
that year.
Required:
1. Is Compton Associate’s strategy one of product differentiation or cost leadership? Explain
briefly.
2. Describe key measures you would include in Compton’s balanced scorecard and your
reasons for doing so.
SOLUTION
(15 min.) Strategy, balanced scorecard, service company.
(Please note that Architect support costs are in the form of Software-implementation
support and are used interchangeably in the problem.)
1.
Compton Associates’ strategy in 2017 is cost leadership. Compton’s architectural
services are not distinct from its competitors. The market for these services is very competitive.
To succeed, Compton must deliver quality service at low cost while improving productivity.
2.
Balanced Scorecard measures for 2017 follow:
Financial Perspective
(1) Increase operating income from productivity gains and growth, (2) revenues per employee,
(3) cost reductions in key areas, for example, architect and software-implementation support
These measures indicate whether Compton has been able to reduce costs and achieve
operating income increases through cost leadership.
Customer Perspective
(1) Market share, (2) number of new customers, (3) customer responsiveness index, (4) customer
satisfaction index
12-22
Compton’s strategy should result in improvements in these customer measures that help
evaluate whether Compton’s cost leadership strategy is succeeding with its customers. These
measures are leading indicators of superior financial performance.
Internal Business Process Perspective
(1) Time to complete customer jobs, (2) time lost due to errors, (3) quality of job (are the
architectural designs what the customer wanted?)
Improvements in these measures are key drivers of achieving cost leadership and are
expected to lead to more satisfied customers, lower costs, and superior financial performance.
Learning and Growth Perspective
(1) Time required to analyze and design steps, (2) time taken to perform key steps in the design
process, (3) skill levels of employees, (4) hours of employee training, (5) employee satisfaction
and motivation
Improvements in these measures are likely to improve Compton’s ability to achieve cost
leadership and have a cause-and-effect relationship with improvements in internal business
processes, customer satisfaction, and financial performance.
12-30 Strategic analysis of operating income (continuation of 12-29). Refer to Exercise
12-29.
Required:
1. Calculate the operating income of Compton Associates in 2016 and 2017.
2. Calculate the growth, price-recovery, and productivity components that explain the change in
operating income from 2016 to 2017.
3. Comment on your answer in requirement 2. What do these components indicate?
SOLUTION
(30 min.) Strategic analysis of operating income (continuation of 12-29).
1.
Operating income for each year is as follows:
2016
2017
$1,280,000
$1,500,000
Revenues ($32,000  40; $30,000  50)
Costs
Architect labor costs
($35  24,000; $36  27,000)
Software implementation support costs
($2,800  60; $3,000  60)
Total costs
Operating income
Change in operating income
2.
840,000
972,000
168,000
180,000
1,008,000
1,152,000
$ 272,000
$ 348,000
$76,000 F
The Growth Component
12-23
Actual units of 
Selling
 Actual units
Revenue effect
=  of output sold  output sold   price
of growth
 in 2017

in 2016
in 2016


= (50 – 40)  $32,000 = $320,000
Actual units
 Units of
of inputs
Cost effect of
 input required
used to
growth for =  to produce 
2017
output
produce
variable costs
 in 2016
2016 ouput

Cost effect of
growth for =
fixed costs

Input

price
×

in
2016


Actual 
 Actual units of capacity in
Price per unit
 2016 because adequate  units of  × of capacity
capacity
exists
to
produce
capacity
 2017 output in 2016
in 2016
in 2016 

Architect labor-hours that would be required in 2017 to complete 50 jobs instead of the 40
jobs completed in 2016, assuming the 2016 input-output relationship continued into 2017, equal
æ 25,000
ö
30,000 ç
´ 55÷ labor-hours. Architect (software implementation) support capacity
è 40
ø
would not change since adequate capacity exists in 2016 to support year 2017 output and
customers.
The cost effects of growth component are
Architect labor costs
(30,000 – 24,000)
Architect (Software implementation) support cost (70 – 70)
Cost effect of growth

$35 =
 $3,200 =
$210,000 U
0
$210,000 U
In summary, the net increase in operating income as a result of the growth component equals:
Revenue effect of growth
$320,000 F
Cost effect of growth
216,000 U
Change in operating income due to growth
$104,000 F
The Price-Recovery Component


Revenue effect of
Selling price
Selling price


price-recovery =
in 2017
in 2016
Actual units
of output
sold in 2017
= ($30,000 – $32,000)  50 = $100,000 U
Cost effect of
price-recovery for =
variable costs
Units of input
Input 
 Input
required to
price
in

price
in
×


produce
2017
2016 
 2017
output in 2016
12-24
Cost effect of
price-recovery for =
fixed costs
Actual units of capacity in
Price per 
 Price per
2016 because adequate
unit
of
unit
of



capacity  × capacity exists to produce
 capacity
2017 output in 2016
in 2016 
 in 2017
($36 – $35) 
30,000
$30,000 U
Architect (Software implementation) support costs ($3,000 – $2,800)  60 =
Cost effect of price recovery
Architect labor costs
=
12,000 U
$42,000 U
In summary, the net decrease in operating income as a result of the price-recovery component
equals:
Revenue effect of price-recovery
$100,000 U
Cost effect of price-recovery
42,000 U
Change in operating income due to price recovery
$142,000 U
The Productivity Component
Units of input 
 Actual units of
Cost effect of
input
used
required to   Input

price

productivity for =
to produce
produce 2017 
 2017
in 2017
variable costs
output
ouput
in
2016


Actual units of capacity in 
Price per
 Actual
Cost effect of
units
of
2016
because
adequate
unit of


productivity for = capacity  capacity exists to produce  capacity
 in 2017

fixed costs
2017 output in 2016 
in 2017

The productivity component of cost changes are:
Architect labor costs
(27,000 – 30,000) 
Architect (Software implementation) support costs (60 – 60) 
Change in operating income due to productivity
$36
$3,600
=
=
$108,000 F
0
$108,000 F
The change in operating income between 2016 and 2017 can be analyzed as follows:
Income
Statement
Amounts
in 2016
(1)
Revenues
Costs
Operating income
Revenue and
Cost Effects
of Growth
Component
in 2017
(2)
Revenue and
Income
Cost Effects of Cost Effect of
Statement
Price-Recovery Productivity
Amounts
Component
Component
in 2017
in 2017
in 2017
(5) =
(3)
(4)
(1) + (2) + (3) + (4)

$1,280,000
$320,000 F
$100,000 U
1,008,000
210,000 U
42,000 U
$108,000 F
1,152,000
$ 272,000
$110,000 F
$142,000 U
$108,000 F
$ 348,000
$76,000 F
Change in operating income
12-25
$1,500,000
3.
The analysis of operating income indicates that a significant amount of the increase in
operating income resulted from Compton’s productivity improvements in 2017. The company
had to reduce selling prices while architect labor costs were increasing but it was able to increase
operating income by improving its productivity. The productivity gains also allowed Compton to
be competitive and grow the business. The unfavorable price recovery component indicates that
Compton could not pass on increases in labor-related wages via price increases to its customers,
very likely because the market was very competitive and its product was not differentiated from
competitors’ offerings.
12-31 Analysis of growth, price-recovery, and productivity components (continuation of
12-29 and 12-30). Suppose that during 2017, the market for architectural jobs increases by 10%.
Assume that any ­increase in market share more than 10% and any decrease in selling price are
the result of strategic choices by Compton’s management to implement its strategy.
Required:
Calculate how much of the change in operating income from 2016 to 2017 is due to the industrymarket-size ­factor, product differentiation, and cost leadership. How successful has Compton been
in implementing its strategy? Explain.
SOLUTION
(25 min.) Analysis of growth, price-recovery, and productivity components (continuation
of 12-29 and 12-30).
Effect of industry-market-size factor on operating income
Of the 10-unit increase in sales from 40 to 50 jobs, 10% or 4 jobs (10%  40) are due to growth
in market size, and 6 (10  4) jobs are due to an increase in market share.
The change in Compton’s operating income from the industry market-size factor rather
than from specific strategic actions is:
4
$110,000 (the growth component in Exercise 12-30) 
$ 44,000 F
10
Effect of product differentiation on operating income
Increase in prices of inputs (cost effect of price recovery)
$ 42,000 U
Effect of cost leadership on operating income
Productivity component
Effect of strategic decision to reduce selling price, $2,000  50
Growth in market share due to productivity improvement
and strategic decision to reduce selling price
6
$110,000 (the growth component in Exercise 12-30) 
10
Change in operating income due to cost leadership
12-26
$108,000 F
100,000 U
66,000 F
$ 74,000 F
The change in operating income between 2016 and 2017 can then be summarized as
Change due to industry-market-size
Change due to product differentiation
Change due to cost leadership
Change in operating income
$ 44,000 F
42,000 U
74,000 F
$ 76,000 F
Compton has been very successful in implementing its cost leadership strategy. Despite the
increase in the cost of architect labor and architect (software-implementation) support, Compton
strategically decreased the selling price of a job by $2,000. That is, Compton took advantage of
its productivity gains to reduce price, gain market share, and increase operating income. Some
students might debate if Compton cut its prices too much. It gained $66,000 by increasing its
market share but it lost $100,000 by reducing its prices. Of course, gaining market share might
benefit Compton in the long run.
12-32 Identifying and managing unused capacity (continuation of 12-29). Refer to Exercise
12-29.
Required:
1. Calculate the amount and cost of unused architectural support capacity at the beginning of
2017, based on the number of jobs actually done in 2017.
2. Suppose Compton can add or reduce its architectural support capacity in increments of 10
units. What is the maximum amount of costs that Compton could save in 2017 by downsizing
architectural support capacity?
3. Compton, in fact, does not eliminate any of its unused architectural support capacity. Why
might Compton not downsize?
SOLUTION
(20 min.) Identifying and managing unused capacity (continuation of 12-29).
1.
The amount and cost of unused capacity at the beginning of year 2017 when Compton
makes its capacity decisions for the year based on work done in year 2017 follows:
Amount of Cost of
Unused
Unused
Capacity Capacity
Architect (software implementation) support, (60  50); (60  50)  $3,000
10
$30,000
2.
Compton can reduce architect (software implementation) support capacity from 60 jobs
to 50 (60  10) jobs. Compton will save 10  $3,600 = $36,000. This is the maximum amount of
costs Compton can save by downsizing in 2017. It cannot reduce capacity further because it
would then not have enough capacity to do 50 jobs in 2017 (jobs that contribute significantly to
operating income).
12-27
3.
Compton may have chosen not to downsize because it projects sales increases in the near
term that would lead to greater demand for and utilization of capacity. Compton may have also
decided not to downsize because downsizing requires a significant reduction in capacity. For
example, Compton may have chosen to downsize additional architect (software implementation)
support capacity if it could do so in, say, increments of 5, rather than 10 units. Not reducing
significant capacity by laying off employees boosts employee morale and keeps employees more
motivated and productive.
12-33 Balanced scorecard and strategy. Scott Company manufactures a DVD player called
Orlicon. The company sells the player to discount stores throughout the country. This player is
significantly less expensive than similar products sold by Scott’s competitors, but the Orlicon
offers just DVD playback, compared with DVD and Blu-ray playback offered by competitor
Nomad Manufacturing. Furthermore, the Orlicon has experienced production problems that have
resulted in significant rework costs. Nomad’s model has an excellent reputation for quality.
Required:
1. Draw a simple customer preference map for Scott and Nomad using the attributes of price,
quality, and playback features. Use the format of Exhibit 12-1.
2. Is Scott’s current strategy that of product differentiation or cost leadership?
3. Scott would like to improve quality and decrease costs by improving processes and training
workers to reduce rework. Scott’s managers believe the increased quality will increase sales.
Draw a strategy map as in Exhibit 12-2 describing the cause-and-effect relationships among
the strategic objectives you would expect to see. Present at least two strategic objectives you
would expect to see under each balanced scorecard perspective. Identify what you believe are
any (a) strong ties, (b) focal points, (c) trigger points, and (d) distinctive objectives.
Comment on your structural analysis of the strategy map.
4. For each strategic objective, suggest a measure you would recommend in Scott’s balanced
scorecard.
SOLUTION
(20–25 min.) Balanced scorecard and strategy.
1. Solution Exhibit 12-33A shows the customer preference map for DVD players for Scott
Company and Nomad Manufacturing on price, playback features, and quality.
SOLUTION EXHIBIT 12-33A
Customer Preference Map for DVD Players
12-28
Nomad
Manufacturing

Price
Product Attributes
Scott Company
Playback Features

Quality

1
2
3
4
Poor
5
Very good
Attribute Rating
2. Scott currently follows a cost leadership strategy, which is reflected in its lower price
compared to Nomad Manufacturing. The Maxus DVD player is similar to products offered by
competitors.
3. Solution Exhibit 12-33B presents Scott’s strategy map explaining cause-and-effect relationships in its balanced scorecard.
SOLUTION EXHIBIT 12-33B
Strategy Map for Scott Company
12-29
In the learning and growth perspective, Scott measures the percentage of employees trained in
quality management and the percentage of manufacturing processes with real-time feedback.
These objectives improve manufacturing processes, which has strong ties to improving
productivity and quality in the internal-business process perspective. Moreover, improving
quality and productivity are distinctive objectives. Improvements in these measures increase
customer satisfaction (as a strong tie) and market shares, which in turn increase revenues and
operating income. To see if the increases in operating income are coming from productivity
improvements, Scott measures the changes in operating income specifically attributable to
productivity and quality improvements. The strategy map suggests that Scott has a very good
implementation plan to successfully implement its strategies.
4. To achieve its goals, Scott could include the following measures under each perspective of the
balanced scorecard related to its strategy map:
12-30
Financial Perspective
Operating income from productivity and quality improvement
Operating income from growth
Revenue growth
Customer Perspective
Market share
Number of additional customers
Customer-satisfaction ratings
Internal-BusinessProcess Perspective
Percentage of defective products sold
Number of major improvements in manufacturing process
Learning-and-Growth
Perspective
Employee-satisfaction ratings
Percentage of employees trained in quality management
Percentage of line workers empowered to manage processes
Percentage of manufacturing processes with real-time feedback
12-34 Strategic analysis of operating income (continuation of 12-33). Refer to Problem 1233. As a result of the actions taken, quality has significantly improved in 2017 while rework and
unit costs of the Orlicon have decreased. Scott has reduced manufacturing capacity because
capacity is no longer needed to support rework. Scott has also lowered the Orlicon’s selling price
to gain market share and unit sales have increased. Information about the current period (2017)
and last period (2016) follows.
Conversion costs in each year depend on production capacity defined in terms of kits that can be
processed, not the actual kits started. Selling and customer-service costs depend on the number
of customers that Scott can support, not the actual number of customers it serves. Scott has 140
customers in 2016 and 160 customers in 2017.
Required:
1. Calculate operating income of Scott Company for 2016 and 2017.
2. Calculate the growth, price-recovery, and productivity components that explain the change in
operating income from 2016 to 2017.
3. Comment on your answer in requirement 2. What do these components indicate?
12-31
SOLUTION
(25–30 min.) Strategic analysis of operating income (continuation of 12-33).
1.
Operating income for each year is as follows:
2016
2017
$1,520,000
$1,760,000
Revenue ($95  16,000; $80  22,000)
Costs
Direct materials costs ($32  20,000; $32  22,000)
Conversion costs
Selling & customer service costs
Total costs
1,256,400
Operating income
Change in operating income
2.
640,000
704,000
560,000
520,000
27,000
32,400
1,227,000
$ 293,000 $ 503,600
$210,600 F
The Growth Component
Actual units of 
Selling
 Actual units of
Revenue effect
=  output sold 
output sold   price
of growth
 in 2017

in 2016
in 2016


=
(22,000  16,000)  $95 = $570,000 F
Actual units
 Units of
of inputs
Cost effect of
 input required
used to
growth for =  to produce 
output
produce
variable costs
 2017
2016 ouput
 in 2016
Cost effect of
growth for =
fixed costs

Input


price

in
2017


Actual 
 Actual units of capacity in
Price per unit
 2016 because adequate  units of  × of capacity
exists to produce
capacity 
 capacity
in 2016
in 2016 
 2017 output in 2016
Direct materials that would be required in 2017 to produce 22,000 units instead of the 16,000
units produced in 2016, assuming the 2016 input-output relationship continued into 2017, equal
 10,000

27,500 kits 
 11,000  . That is, the number of kits to produce 22,000 units is
 8,000

20,000 kits  16,000 units = 1.25 kits per unit  22,000 units = 27,500 kits. Conversion costs and
selling and customer-service capacity will not change because adequate capacity exists in 2016
to support year 2017 output and customers.
The cost effects of growth component are:
Direct materials costs
(27,500  20,000)
$240,000 U
Conversion costs
(28,000  28,000)
Selling & customer-service costs
(180  180) 
Cost effect of growth
12-32
$ 32
$ 20
$ 150
=
=
=
0
0
$240,000 U
In summary, the net increase in operating income as a result of the growth component equals:
Revenue effect of growth
$570,000 F
Cost effect of growth
240,000 U
Change in operating income due to growth
$330,000 F
The Price-Recovery Component


Actual units
of output
sold in 2017
Revenue effect of
Selling price
Selling price


price-recovery =
in 2017
in 2016
= ($80  $95)  22,000 = $330,000 U
Cost effect of
price-recovery for =
variable costs
Units of input
Input 
 Input
required to
×
price
in

price
in


produce
2017
2016 
 2017
output in 2016
Cost effect of
price-recovery for =
fixed costs
Actual units of capacity in
Price per 
 Price per
 unit of  unit of  × 2016 because adequate
capacity exists to produce
capacity 
 capacity
2017 output in 2016
in 2016 
 in 2017
($32 – $32)  27,500 =
($20  $20)  28,000 =
($180  $150) 
180 =
Direct materials costs
Conversion costs
Selling & customer-service costs
Cost effect of price-recovery
$
0
0
5,400 U
$5,400 U
In summary, the net increase in operating income as a result of the price-recovery component
equals:
Revenue effect of price-recovery
$330,000 U
Cost effect of price-recovery
5,400 U
Change in operating income due to price-recovery
$335,400 U
The Productivity Component
Units of input 
 Actual units of
Cost effect of
input used
required to   Input
price

productivity for =  to
produce
produce
2017 
 2017 output
in
2017
variable costs
ouput in 2016 

Actual units of capacity in 
Price per
 Actual
Cost effect of
units
of
2016 because adequate   unit of
productivity for =  capacity  capacity
exists to produce
capacity
 in 2017
fixed costs
2017 output in 2016 
in 2017

The productivity component of cost changes are
Direct materials costs
(22,000  27,500) 
Conversion costs
(26,000 – 28,000) 
Selling & customer-service costs
(180  180) 
Change in operating income due to productivity
12-33
$32 =
$20 =
$180 =
$176,000 F
40,000 F
0
$216,000 F
The change in operating income between 2016 and 2017 can be analyzed as follows:
Revenues
Costs
Operating income
Income
Statement
Amounts
in 2016
(1)
$1,520,000
Revenue and
Revenue and
Cost Effect
Income
Cost Effects Cost Effects of
of
Statement
of Growth
Price-Recovery Productivity
Amounts
Component
Component
Component
in 2017
in 2017
in 2017
in 2017
(5) =
(2)
(3)
(4)
(1) + (2) + (3) + (4)

$570,000 F
$330,000 U
$1,760,000
1,227,000
240,000 U
5,400 U
$216,000 F
1,256,400
$ 293,000
$330,000 F
$335,400 U
$216,000 F
$ 503,600
$210,600 F
Change in operating income
3.
The analysis of operating income indicates that a significant amount of the increase in
operating income resulted from Scott’s cost leadership strategy. The company was able to
increase productivity, lower costs, improve quality and grow sales. The price recovery
component indicates that Scott reduced prices to be competitive in the market, but Scott also
improved direct material productivity and reduced conversion cost capacity as rework decreased.
Lower prices and higher quality boosted sales.
12-35 Analysis of growth, price-recovery, and productivity components (continuation of
12-34). Suppose that during 2017, the market for DVD players grew 10%. All increases in market
share (that is, sales increases greater than 10%) and decreases in the selling price of the Orlicon
are the result of Scott’s strategic actions.
Required:
Calculate how much of the change in operating income from 2016 to 2017 is due to the industrymarket-size factor, product differentiation, and cost leadership. How does this relate to Scott’s
strategy and its success in implementation? Explain.
SOLUTION
(20 min.) Analysis of growth, price-recovery, and productivity components
of 12-34 and 12-35).
(continuation
Effect of the industry-market-size factor on operating income
Of the 6,000-unit increase in sales from 16,000 to 22,000 units, 10% or 1,600 (10%  16,000)
units are due to growth in market size, and 4,400 (6,000  1,600) units are due to an increase in
market share.
The change in Scott’s operating income from the industry-market size factor rather than from
specific strategic actions is:
12-34
$330,000 (the growth component in Exercise 12-34) 
1, 600
6, 000
Effect of product differentiation on operating income
The change in operating income due to:
Increase in price of inputs (cost effect of price recovery)
$
Effect of cost leadership on operating income
The change in operating income from cost leadership is:
Productivity component
Decrease in selling price (revenue effect of price recovery)
Growth in market share due to cost leadership
$330,000 (the growth component in Exercise 12-34) 
Change in operating income due to cost leadership
$ 88,000 F
5,400 U
$216,000 F
330,000 U
4, 400
6, 000
242,000 F
$128,000 F
The change in operating income between 2016 and 2017 can be summarized as follows:
Change due to industry market-size
Change due to product differentiation
Change due to cost leadership
Change in operating income
$ 88,000 F
5,400 U
128,000 F
$210,600 F
Scott has been successful in implementing its cost leadership strategy. The increase in
operating income during 2017 was due to cost leadership through quality improvements and
sales growth. Some students might argue that Scott cut its prices too much. It gained $242,000
by increasing its market share but it lost $330,000 by reducing its prices. However, the gain in
market share that might also benefit it in future periods.
Scott’s operating income increase in 2017 was also helped by a growth in the overall
market size.
12-36 Identifying and managing unused capacity (continuation of 12-34). Refer to the
information for Scott Company in Problem 12-34.
Required:
1. Calculate the amount and cost of (a) unused manufacturing capacity and (b) unused selling
and customer-service capacity at the beginning of 2017 based on actual production and actual
number of customers served in 2017.
2. Suppose Scott can add or reduce its selling and customer-service capacity in increments of 10
customers. What is the maximum amount of costs that Scott could save in 2017 by
downsizing selling and customer-service capacity?
3. Scott, in fact, does not eliminate any of its unused selling and customer-service capacity.
Why might Scott not downsize?
SOLUTION
12-35
(20 min.) Identifying and managing unused capacity (continuation of 12-34).
1.
The amount and cost of unused capacity at the beginning of year 2017 when Scott makes
its capacity decisions for the year based on year 2017 production follows:
Amount of
Unused
Capacity
Manufacturing, 28,000  22,000; (28,000 – 22,000)  $20
Selling and customer service, 180 – 160; (180 – 160)  $180
6,000
20
Cost of
Unused
Capacity
$120,000
$
3,600
2.
Scott can reduce selling and customer-service capacity by another 20 customers (180 –
160 = 20 customers). Scott will save another 20  $180 = $3,600. This is the maximum amount
of costs Scott can save in 2017.
3.
Scott may have chosen not to downsize because it projects sales increases in the near
term that would lead to greater demand for and utilization of selling and customer-service
capacity. It is difficult to reduce and then immediately increase capacity. Not reducing
significant capacity by laying off employees boosts employee morale and keeps employees more
motivated and productive.
12-37 Balanced scorecard. Following is a random-order listing of perspectives, strategic
objectives, and performance measures for the balanced scorecard.
Required:
For each perspective, select those strategic objectives from the list that best relate to it. For each
12-36
strategic objective, select the most appropriate performance measure(s) from the list.
SOLUTION
(20–30 min.)
Balanced scorecard.
Perspectives
▪ Financial
Strategic
Objectives
Performance
Measures
▪ Increase shareholder value
▪
▪
▪
▪
▪
▪
▪ Increase profit generated
by each salesperson
▪ Profit per salesperson
▪ Customer
▪ Acquire new customers
▪ Retain customers
▪ Develop profitable customers
▪
▪
▪
▪
▪ Internal Business
Process
▪ Improve manufacturing
quality
▪ Introduction of new products
▪ Percentage of defective
product units
▪ Number of new products
▪ Minimize invoice error rate
▪ On-time delivery by suppliers
▪ Percentage of error-free invoices
▪ Percentage of on-time deliveries
by suppliers
▪ Number of patents
▪ Increase proprietary products
▪ Learning and
Growth
▪ Increase information system
capabilities
▪ Enhance employee skills
Earnings per share
Net income
Return on assets
Return on sales
Return on equity
Product cost per unit
Number of new customers
Percentage of customers retained
Customer profitability
Customer cost per unit
▪ Percentage of processes with
real-time feedback
▪ Employee turnover rate
▪ Average job-related training
hours per employee
12-38 Balanced scorecard. (R. Kaplan, adapted) Petrocal, Inc., refines gasoline and sells it
through its own Petrocal gas stations. On the basis of market research, Petrocal determines that
60% of the overall gasoline market consists of “service-oriented customers,” medium- to highincome individuals who are willing to pay a higher price for gas if the gas stations can provide
excellent customer service, such as a clean facility, a convenience store, friendly employees, a
quick turnaround, the ability to pay by credit card, and high-octane premium gasoline. The
remaining 40% of the overall market are “price shoppers” who look to buy the cheapest gasoline
available. Petrocal’s strategy is to focus on the 60% of service-oriented customers. Petrocal’s
balanced scorecard for 2017 follows. For brevity, the initiatives taken under each objective are
12-37
omitted.
Required:
1. Was Petrocal successful in implementing its strategy in 2017? Explain your answer.
2. Would you have included some measure of employee satisfaction and employee training in
the learning-and-growth perspective? Are these objectives critical to Petrocal for
implementing its strategy? Why or why not? Explain briefly.
3. Explain how Petrocal did not achieve its target market share in the total gasoline market but
still exceeded its financial targets. Is “market share of overall gasoline market” the correct
measure of market share? Explain briefly.
4. Is there a cause-and-effect linkage between improvements in the measures in the internalbusiness-process perspective and the measure in the customer perspective? That is, would
you add other measures to the internal-business-process perspective or the customer
perspective? Why or why not? Explain briefly.
5. Do you agree with Petrocal’s decision not to include measures of changes in operating
income from productivity improvements under the financial perspective of the balanced
scorecard? Explain briefly.
SOLUTION
(20 min.) Balanced scorecard.
1.
Petrocal’s strategy is to focus on “service-oriented customers” who are willing to pay a
higher price for services. Even though gasoline is largely a commodity product, Petrocal wants to
differentiate itself through the service it provides at its retailing stations.
Does the scorecard represent Petrocal’s strategy? By and large it does. The focus of the
scorecard is on measures of process improvement, quality, market share, and financial success
from product differentiation and charging higher prices for customer service. There are some
12-38
deficiencies that the subsequent assignment questions raise but, abstracting from these concerns
for the moment, the scorecard does focus on implementing a product differentiation strategy.
Having concluded that the scorecard has been reasonably well designed, how has Petrocal
performed relative to its strategy in 2017? It appears from the scorecard that Petrocal was
successful in implementing its strategy in 2017. It achieved all targets in the financial, internal
business, and learning and growth perspectives. The only target it missed was the market
share target in the customer perspective. At this stage, students may raise some questions about
whether this is a good scorecard measure. Requirement 3 gets at this issue in more detail. The
bottom line is that measuring “market share in the overall gasoline market” rather than in the
“service-oriented customer” market segment is not a good scorecard measure, so not achieving
this target may not be as big an issue as it may seem at first.
2.
Yes, Petrocal should include some measure of employee satisfaction and employee
training in the learning and growth perspective. Petrocal’s differentiation strategy and ability to
charge a premium price is based on customer service. The key to good, fast, and friendly
customer service is well-trained and satisfied employees. Untrained and dissatisfied employees
will have poor interactions with customers and cause the strategy to fail. Hence, training and
employee satisfaction are very important to Petrocal for implementing its strategy. These
measures are leading indicators of whether Petrocal will be able to successfully implement its
strategy and should be measured on the balanced scorecard.
3.
Petrocal’s strategy is to focus on the 60% of gasoline consumers who are serviceoriented, not on the 40% price-shopper segment. To evaluate if it has been successful in
implementing its strategy, Petrocal needs to measure its market share in its targeted market
segment, “service-oriented customer,” not its market share in the overall market. Given
Petrocal’s strategy, it should not be concerned if its market share in the price-shopper segment
declines. In fact, charging premium prices will probably cause its market share in this segment to
decline. Petrocal should replace “market share in overall gasoline market” with “market share in
the service-oriented customer segment” in its balanced scorecard customer measure. Petrocal
may also want to consider putting a customer satisfaction measure on the scorecard. This
measure should capture an overall evaluation of customer reactions to the facility, the
convenience store, employee interactions, and quick turnaround. The customer satisfaction
measure would serve as a leading indicator of market share in the service-oriented customer
segment.
4.
Although there is a cause-and-effect link between internal business process measures and
customer measures on the current scorecard, Petrocal should add more measures to tighten this
linkage. In particular, the current scorecard measures focus exclusively on refinery operations
and not on gas station operations. Petrocal should add measures of gas station performance such
as cleanliness of the facility, turnaround time at the gas pumps, the shopping experience at the
convenience store, and the service provided by employees. Many companies do random audits of
their facilities to evaluate how well their branches and retail outlets are performing. These
measures would serve as leading indicators of customer satisfaction and market share in
Petrocal’s targeted segments.
12-39
5.
Petrocal is correct in not measuring changes in operating income from productivity
improvements on its scorecard under the financial perspective. Petrocal’s strategy is to grow by
charging premium prices for customer service. The scorecard measures focus on Petrocal’s
success in implementing this strategy. Productivity gains per se are not critical to Petrocal’s
strategy and, therefore, should not be measured on the scorecard.
12-39 Balanced scorecard. Vic Corporation manufactures various types of color laser printers
in a highly automated facility with high fixed costs. The market for laser printers is competitive.
The various color laser printers on the market are comparable in terms of features and price. Vic
believes that satisfying customers with products of high quality at low costs is important to
achieving its target profitability. For 2017, Vic plans to achieve higher quality and lower costs by
improving yields and reducing defects in its manufacturing operations. Vic will train workers
and encourage and empower them to take the necessary actions. Currently, a significant amount
of Vic’s capacity is used to produce products that are defective and cannot be sold. Vic expects
that higher yields will reduce the capacity that Vic needs to manufacture products. Vic does not
anticipate that improving manufacturing will automatically lead to lower costs because many
costs are fixed costs. To reduce fixed costs per unit, Vic could lay off employees and sell
equipment, or it could use the capacity to produce and sell more of its current products or
improved models of its current products.
Vic’s balanced scorecard (initiatives omitted) for the just-completed fiscal year 2017 follows.
Required:
1. Was Vic successful in implementing its strategy in 2017? Explain.
2. Is Vic’s balanced scorecard useful in helping the company understand why it did not reach its
target market share in 2017? If it is, explain why. If it is not, explain what other measures
you might want to add under the customer perspective and why.
3. Would you have included some measure of employee satisfaction in the learning-and-growth
perspective and new-product development in the internal-business-process perspective? That
is, do you think employee satisfaction and development of new products are critical for Vic
to implement its strategy? Why or why not? Explain briefly.
12-40
4. What problems, if any, do you see in Vic improving quality and significantly downsizing to
eliminate unused capacity?
SOLUTION
(30 min.) Balanced scorecard.
1.
The market for color laser printers is competitive. Vic’s strategy is to produce and sell
high-quality laser printers at a low cost. The key to achieving higher quality is reducing defects
in its manufacturing operations. The key to managing costs is dealing with the high fixed costs of
Vic’s automated manufacturing facility. To reduce costs per unit, Vic would have to either
produce more units or eliminate excess capacity.
The scorecard correctly measures and evaluates Vic’s broad strategy of growth through
productivity gains and cost leadership. There are some deficiencies, of course, that subsequent
assignment questions will consider.
It appears from the scorecard that Vic was not successful in implementing its strategy in
2017. Although it achieved targeted performance in the learning and growth and internal
business process perspectives, it significantly missed its targets in the customer and financial
perspectives. Vic has not had the success it targeted in the market and has not been able to
reduce fixed costs.
2.
Vic’s scorecard does not provide any explanation of why the target market share was not
met in 2017. Was it due to poor quality? Higher prices? Poor post-sales service? Inadequate
supply of products? Poor distribution? Aggressive competitors? The scorecard is not helpful for
understanding the reasons underlying the poor market share.
Vic may want to include some measures in the customer perspective (and internal business
process perspective) that get at these issues. These measures would then serve as leading
indicators (based on cause-and-effect relationships) for lower market share. For example, Vic
should measure customer satisfaction with its printers on various dimensions of product features,
quality, price, service, and availability. It should measure how well its printers match up against
other color laser printers on the market. This is critical information for Vic to successfully
implement its strategy.
3.
Vic should include a measure of employee satisfaction to the learning and growth
perspective and a measure of new product development to the internal business process
perspective. The focus of its current scorecard measures is on processes and not on people and
products.
Vic considers training and empowering workers as important for implementing its highquality, low-cost strategy. Therefore employee training and employee satisfaction should appear
in the learning and growth perspective of the scorecard. Vic can then evaluate if improving
employee-related measures results in improved internal-business process measures, market share
and financial performance.
Adding new product development measures to internal business processes is also
important. As Vic reduces defects, Vic’s costs will not automatically decrease because many of
Vic’s costs are fixed. Instead, Vic will have more capacity available to it. The key question is
how Vic will obtain value from this capacity. One important way is to use the capacity to
produce and sell new models of its products. Of course if this strategy is to work, Vic must
12-41
develop new products at the same time that it is improving quality. Hence, the scorecard should
contain some measure to monitor progress in new product development. Improving quality
without developing and selling new products (or downsizing) will result in weak financial
performance. The new product development need not focus on designing innovative products
that can command a price premium because Vic’s strategy is one of cost leadership and not
product differentiation but rather on product extensions that could help it grow sales.
4.
Improving quality and significantly downsizing to eliminate unused capacity is difficult.
Recall that the key to improving quality at Vic Corporation is training and empowering workers.
As quality improvements occur, capacity will be freed up, but because costs are fixed, quality
improvements will not automatically lead to lower costs. To reduce costs, Vic’s management
must take actions such as selling equipment and laying off employees. But how can management
lay off the very employees whose hard work and skills led to improved quality? If it did lay off
employees now, will the remaining employees ever work hard to improve quality in the future?
For these reasons, Vic’s management should first focus on using the newly available capacity to
sell more products. If it cannot do so and must downsize, management should try to downsize in
a way that would not hurt employee morale, such as through retirements and voluntary
severance.
If it had to downsize, the preferred approach for Vic to follow is to first downsize by
laying off employees, assure the remaining employees that there will be no more layoffs, and
then seek to improve quality.
12-40 Balanced scorecard, environmental, and social performance. Gardini Chocolates
makes custom-labeled, high-quality, specialty candy bars for special events and advertising
purposes. The company employs several chocolatiers who were trained in Germany. The
company offers many varieties of chocolate, including milk, semi-sweet, white, and dark
chocolate. It also offers a variety of ingredients, such as coffee, berries, and fresh mint. The real
appeal for the company’s product, however, is its custom labeling. Customers can order labels
for special occasions (for example, wedding invitation labels) or business purposes (for example,
business card labels). The company’s balanced scorecard for 2017 follows. For brevity, the
initiatives taken under each objective are omitted.
12-42
Required:
1. Was Gardini successful in implementing its strategy in 2017? Explain your answer.
2. Would you have included some measure of customer satisfaction in the customer
perspective? Are these objectives critical to Gardini for implementing its strate gy? Why
or why not? Explain briefly.
3. Explain why Gardini did not achieve its target market share in the candy bar market but still
exceeded its financial targets. Is “market share of overall candy bar market” a good measure
of market share for Gardini? Explain briefly.
4. Do you agree with Gardini’s decision not to include measures of changes in operating
income from productivity improvements under the financial perspective of the balanced
scorecard? Explain briefly.
5. Why did Gardini include balanced scorecard standards relating to environmental and social
performance? Is the company meeting its performance objectives in these areas?
SOLUTION
(25 min.) Balanced scorecard, environmental and social performance.
1.
Gardini’s strategy is to focus on “service-oriented customers” who are willing to pay a
higher price for services. Even though candy bars are largely a commodity product, Gardini
12-43
wants to differentiate itself through the service it provides with its custom labeling and highquality product.
Does the scorecard represent Gardini’s strategy? By and large it does. The focus of the
scorecard is on measures of process improvement, quality, market share, and financial success
from product differentiation and charging higher prices for customer service. There are some
deficiencies that the subsequent assignment questions raise, but abstracting from these concerns
for the moment, the scorecard does focus on implementing a product differentiation strategy.
Based on the scorecard being reasonably well designed, how has Gardini performed
relative to its strategy in 2017? It appears from the scorecard that Gardini was successful in
implementing its strategy in 2017. It achieved all targets in the financial, internal business, and
learning and growth perspectives (other than women and minorities in the workplace). The only
target it missed was the market share target in the customer perspective. At this stage, students
may raise some questions about whether this is a good scorecard measure. Requirement 3 gets at
this issue in more detail. The bottom line is that measuring “market share in the overall candy
market” rather than in the “specialty candy” market segment is not a good scorecard measure, so
not achieving this target may not be as big a miss as it may seem at first.
2.
Yes, Gardini should include some measure of customer satisfaction in the customer
perspective. Gardini’s differentiation strategy and ability to charge a premium price is based on
meeting and/or exceeding customer expectations, especially in the custom design of the labels.
Unsatisfied customers will not be loyal or will be unlikely to recommend the company’s product.
Hence, customer satisfaction is very important to Gardini for implementing its strategy. These
measures are leading indicators of whether Gardini will be able to increase its market share in the
specialty candy market and should be measured on the balanced scorecard.
3.
To evaluate if it has been successful in implementing its strategy, Gardini needs to
measure its market share in its targeted market segment, not its market share in the overall
market. Given Gardini’s strategy, it should not be concerned if its market share in the candy bar
segment declines. In fact, charging premium prices will probably cause its market share in this
segment to decline. Gardini should replace “market share in overall candy bar market” with
“market share in the specialty food/candy segment” in its balanced scorecard customer measure.
If Gardini is successfully implementing its strategy, its market share in the specialty candy
segment should increase.
Gardini is correct in not measuring changes in operating income from productivity
improvements on its scorecard under the financial perspective. Gardini’s strategy is to grow by
charging premium prices for customer service. The scorecard measures focus on Gardini’s
success in implementing this strategy. Productivity gains per se are not critical to Gardini’s
strategy and, therefore, should not be measured on the scorecard.
4.
5.
Gardini included social and environmental performance measures in its balanced
scorecard because it believes strong environmental and social performance gives it a competitive
advantage by (1) attracting and inspiring outstanding employees, (2) enhancing its reputation
with socially conscious customers, investors and analysts, and (3) boosting its image with
governments and citizens, all of which contribute to long-run financial performance. Gardini also
believes that focusing on environmental and social performance in addition to financial
12-44
performance helps it to innovate in technologies, processes, products, and business models to
reduce the trade-offs between financial and sustainability goals and build transformational
leadership and change capabilities to implement these “triple bottom line” strategies.
Following the concept of shared value, Gardini includes social and environmental
measures (together with business goals and measures) in its balanced scorecard to evaluate how
well it is doing toward achieving its social and environmental goals. The balanced scorecard
indicates that Gardini’s social and environmental initiatives are having an effect. Gardini’s
increased use of recycled materials as a percentage of total materials used has resulted in
attracting customers for whom using recycled materials matters, creating long-term financial
benefit. Similarly increasing the number of women and minorities employed will allow Gardini
to target a larger number of talented individuals. Reducing the size of packaging both increases
income and reduces waste, achieving both financial and sustainability objectives.
Not all companies believe in implementing sustainability goals, but those that do find the
balanced scorecard to be a useful tool to simultaneously implement both financial and
sustainability goals.
12-41 Balanced scorecard, social performance. Comtex Company provides cable and Internet
services in the greater Boston area. There are many competitors that provide similar services.
Comtex believes that the key to financial success is to offer a quality service at the lowest cost.
Comtex currently spends a significant amount of hours on installation and post-installation
support. This is one area that the company has targeted for cost reduction. Comtex’s balanced
scorecard for 2017 follows.
12-45
Required:
1. Was Comtex successful in implementing its strategy in 2017? Explain.
2. Do you agree with Comtex’s decision to include measures of developing innovative services
(research and development costs) in the internal-business-process perspective of the balanced
scorecard? ­Explain briefly.
3. Is there a cause-and-effect linkage between the measures in the internal-business-process
perspective and the customer perspective? That is, would you add other measures to the
internal-business-process perspective or the customer perspective? Why or why not? Explain
briefly.
4. Why do you think Comtex included balanced scorecard measures relating to employee safety
and community engagement? How well is the company doing on these measures?
SOLUTION
(25 min.) Balanced Scorecard, social performance.
1.
The market for cable and Internet providers is competitive. Comtex’s strategy follows a
cost-leadership strategy—providing quality service at low cost by being efficient, and effective.
12-46
The scorecard correctly measures and evaluates Comtex’s strategy of growth through
productivity gains and cost leadership. There are, however, some deficiencies that subsequent
assignment questions will consider.
It appears from the scorecard that Comtex was not successful in implementing its strategy
in 2017. Although it achieved targeted performance in most of the learning and growth and
internal business process perspectives, it significantly missed its targets in the customer and
financial perspectives. Comtex has not had the success it targeted in the market and has not been
able to improve efficiency in order to reduce costs.
Comtex’s scorecard does not provide an explanation of why the target customer
satisfaction measure was not met in 2017. Was it due to poor quality? Higher prices? Poor postsales service? Aggressive competitors? The scorecard is not helpful for understanding the
reasons underlying the poor customer satisfaction.
2.
Comtex should not include R&D costs in its internal business process perspective. It
should not focus on developing innovative services because it is not following a product
differentiation strategy. It needs to cut these costs and focus instead on providing customers a
quality service at the lowest costs, and faster and more efficient installation, consistent with its
low-cost strategy.
3.
There is a cause-and-effect relationship between the installation time per customer and
customer satisfaction but not between money spent in R&D and customer satisfaction. As
discussed in requirement 2 above, I would drop the R&D measure. I would then add measures
for the quality of the installation service to the internal business process perspective. How much
time does it take to schedule an appointment after the customer calls? Does the service work
flawlessly after it has been installed? Do customers call Comtex to fix problems? How much
time is spent on post-installation support? The point is to add more measures to the internal
business process perspective so that Comtex can get a better understanding of the reasons
underlying increases and decreases in customer satisfaction.
In the customer perspective, I would add measures to track Comtex’s market share in the
Boston area. Do increases in customer satisfaction translate into higher market shares? Is Comtex
correctly identifying the factors that customers care deeply about and making improvements in
those areas faster than its competitors?
Although not required by the question, the instructor could ask the class what else
Comtex might want to include in the learning and growth perspective to support the customer
and internal business process perspectives. The learning and growth measures would then serve
as leading indicators (based on cause-and-effect relationships) for the internal-business processes
and customer satisfaction. For example, Comtex could include a measure related to employee
satisfaction or retention. For example, higher employee satisfaction would lead to greater
motivation of employees in providing a quality service. This is critical for Comtex to
successfully implement its strategy.
4.
Comtex included social and environmental performance measures in its balanced
scorecard because it believes strong environmental and social performance gives it a competitive
advantage by (1) attracting and inspiring outstanding employees, (2) enhancing its reputation
with socially conscious customers, investors and analysts, and (3) boosting its image with
governments and citizens, all of which contribute to long-run financial performance. Comtex
12-47
also believes that focusing on environmental and social performance in addition to financial
performance helps it to innovate in technologies, processes, products, and business models to
reduce the trade-offs between financial and sustainability goals and build transformational
leadership and change capabilities to implement these “triple bottom line” strategies.
Following the concept of shared value, Comtex includes social and environmental
measures (together with business goals and measures) in its balanced scorecard to evaluate how
well it is doing toward achieving its social and environmental goals. The balanced scorecard
indicates that Comtex’s social and environmental initiatives are having mixed results. Comtex’s
focus on safety certification training aims to decrease workplace injuries and to reduce overall
costs. So far, the safety certification goals have not been met and workplace injuries have not
been reduced to their target levels. Comtex would need to consider if the safety certification
training has been as effective as it was intended. Similarly increasing the number of new
programs with community organizations aims to increase the number of new customers acquired
as a result of these initiatives and in turn to increase revenue from new customers. Even though
the number of new programs started exceeded the target, it did not result in the targeted number
of new customers nor the target revenues from new customers. Comtex would need to reevaluate
the kinds of new programs it is implementing.
Not all companies believe in implementing sustainability goals, but those that do find the
balanced scorecard to be a useful tool to simultaneously implement both financial and
sustainability goals.
12-42 Balanced scorecard, environmental, and social performance. WrightAir is a nofrills airline that services the Midwest. Its mission is to be the only short-haul, low-fare, highfrequency, point-to-point ­carrier in the Midwest. However, there are several large commercial
carriers offering air transportation, and WrightAir knows that it cannot compete with them based
on the services those carriers provide. WrightAir has chosen to reduce costs by not offering
many inflight services, such as food and entertainment options. Instead, the company is
dedicated to providing the highest quality transportation at the ­lowest fare. WrightAir’s
balanced scorecard measures (and actual results) for 2017 follow:
12-48
Required:
1. What is WrightAir’s strategy? Was WrightAir successful in implementing its strategy in
2017? Explain your answer.
2. Draw a strategy map as in Exhibit 12-2 for WrightAir describing the cause-and-effect
relationships among the strategic objectives described in the balanced scorecard. Identify
what you believe are any (a) strong ties, (b) focal points, (c) trigger points, and (d) distinctive
objectives. Comment on your structural analysis of the strategy map.
3. Based on the strategy identified in requirement 1 above, what role does the price-recovery
component play in explaining the success of WrightAir?
4. Would you have included customer-service measures in the customer perspective? Why or
why not? Explain briefly.
5. Would you have included some measure of employee satisfaction and employee training in
the learning-and-growth perspective? Would you consider this objective critical to WrightAir
for implementing its strategy? Why or why not? Explain briefly.
6. Why do you think Wright Air has introduced environmental measures in its balanced
scorecard? Is the company meeting its performance objectives in this area?
12-49
SOLUTION
(25 min.) Balanced Scorecard.
1.
WrightAir is following a cost-leadership strategy based on low-cost, no frills, and high
quality. WrightAir was successful in meeting its financial targets in 2017, but it did not achieve
target performance in the other three perspectives. It was therefore only partially successful in
implementing its strategy. The nonfinancial measures are leading indicators of future
performance. Not meeting these targets means that WrightAir may not be able to sustain its
performance in future periods. In other words, while WrightAir was able to achieve its shortterm goals, will it be able to achieve its long-term goals? To do so, WrightAir needs to improve
its internal business and learning and growth performance.
2.
Solution Exhibit 12-42A presents the strategy map for WrightAir and identifying strong
ties, focal points, and distinctive objectives.
SOLUTION EXHIBIT 12-42A
Strategy Map for WrightAir
On the business side of the balanced scorecard, WrightAir measures the motivation of
ground crew (learning and growth perspective) that helps to reduce turnaround time of the planes
on the ground (internal business process perspective), increases the number of on-time arrivals
(customer perspective) and increases shareholder value (financial perspective). In the
environmental management part of the scorecard Wright Air measures its energy management
12-50
tools and technologies (learning and growth perspective), reduction in carbon dioxide emissions
(internal-business process perspective), improvement in its environmental brand image
(customer perspective) that also ties into increasing shareholder value (financial perspective).
The only strong tie is the cause-and-effect relationship between investments in energy
management tools and techniques to reduce carbon dioxide emissions. Wright Air believes that
this is also a distinctive objective. To see if the sources of operating income WrightAir measures
operating income changes from productivity, price recovery, and growth as well as cost savings
from reduction in jet fuel consumption. The strategy map suggests that WrightAir has a very
good implementation plan to successfully implement its strategies around business and
environmental goals.
3.
Normally, the price recovery component indicates that a company has been successful in
differentiating its product or service to command a price premium so that the prices of outputs
rise faster than the prices of inputs. For WrightAir, the price recovery component measures the
lower input prices resulting from strong negotiations with suppliers while maintaining output
prices. The productivity component measures the efficiently use of input quantities and the
elimination of certain inflight services. A favorable price recovery component from reducing
input prices is an important part of WrightAir’s strategy that contributes to its profitability.
4.
I would not have included customer-service measures in WrightAir’s customer
perspective because it is not part of WrightAir’s strategy. WrightAir does not compete with other
carriers on the basis of its services. In fact, it does not offer inflight services such as food and
entertainment options. It is a no-frills airline, whose strategy is to eliminate services in order to
reduce costs. We are not debating the merits of the strategy. Only that given the strategy,
measures of customer service should not appear on the scorecard.
5.
Yes, WrightAir should include some measure of employee satisfaction and employee
training in the learning and growth perspective. WrightAir’s low-cost strategy is based on
efficiency. The key to good, fast, and friendly customer service is well trained and satisfied
employees. Untrained and dissatisfied employees have poor interactions with customers and
other employees and cause the strategy to fail. Hence, training and employee satisfaction are
very important for WrightAir to implement its strategy. These measures are, therefore, leading
indicators of whether WrightAir will be able to successfully implement its strategy over the long
term and should be measured on the balanced scorecard.
6.
WrightAir included social and environmental performance measures in its balanced
scorecard because it believes strong environmental and social performance gives it a competitive
advantage by (1) attracting and inspiring outstanding employees, (2) enhancing its reputation
with socially conscious customers, investors and analysts, and (3) boosting its image with
governments and citizens, all of which contribute to long-run financial performance. WrightAir
also believes that focusing on environmental and social performance in addition to financial
performance helps it to innovate in technologies, processes, products, and business models to
reduce the trade-offs between financial and sustainability goals and build transformational
leadership and change capabilities to implement these “triple bottom line” strategies.
12-51
Following the concept of shared value, Smooth Air includes social and environmental
measures (together with business goals and measures) in its balanced scorecard to evaluate how
well it is doing toward achieving its social and environmental goals. The balanced scorecard
indicates that WrightAir’s social and environmental initiatives are by and large succeeding.
WrightAir has successfully obtained ISO 50001 certification in energy management. This focus
has helped it to implement engineering changes that decrease CO2 emissions. (It was to
implement 10 such changes. but it made only 9.) As it made these changes, customer surveys
indicated that 96% of customers approved of Smooth Air’s sustainability efforts, slightly lower
than the 100% of customers that Smooth Air had targeted. In turn, these actions resulted in cost
savings in jet fuel consumption that exceeded targets. Smooth Air may need to make some small
changes in its sustainability and environmental performance measures and targets, but by and
large it is helping Smooth Air meet its long-term financial and sustainability goals.
Not all companies believe in implementing sustainability goals, but those that do find the
balanced scorecard to be a useful tool to simultaneously implement both financial and
sustainability goals.
12-43 Partial-productivity measurement. Gable Company manufactures wallets from fabric.
In 2016, Gable made 2,160,000 wallets using 1,600,000 yards of fabric. In 2016, Gable has
capacity to make 2,448,000 wallets and incurs a cost of $8,568,000 for this capacity. In 2017,
Gable plans to make 2,203,200 wallets, make fabric use more efficient, and reduce capacity.
Suppose that in 2017 Gable makes 2,203,200 wallets, uses 1,440,000 yards of fabric, and
reduces capacity to 2,295,000 wallets at a cost of $7,803,000.
Required:
1. Calculate the partial-productivity ratios for materials and conversion (capacity costs) for
2017, and compare them to a benchmark for 2016 calculated based on 2017 output.
2. How can Gable Company use the information from the partial-productivity calculations?
SOLUTION
(20 min.)
1.
Partial productivity measurement.
Gable Company’s partial productivity ratios in 2017 are as follows:
Direct materials
partial productivity
=
Conversion costs
partial productivity
=
Quantity of output produced in 2017
Yards of direct materials used in 2017
Quantity of output produced in 2017
Units of manuf. capacity in 2017
=
=
2, 203, 200
1, 440, 000
2, 203, 200
2, 295, 000
=
1.53 wallets
per yard
0.96 wallets
= per unit of
capacity
To compare partial productivities in 2017 with partial productivities in 2016, we first calculate
the inputs that would have been used in 2016 to produce year 2017’s 2,203,200 units of output
assuming the year 2016 relationship between inputs and outputs.
Direct materials
=
1,600,000 yards (2016) 
12-52
2,203,200 output units in 2017
2,160,000 output units in 2016
= 1,600,000 yards  1.02 = 1,632,000 yards
Alternatively, we can calculate direct materials that would have been used in year 2016 to produce
year 2017’s 2,203,200 output as
1,600,000 yards  2,160,000 units = 0.74074 yards per unit  2,203,200 units = 1,632,000 yards.
Manufacturing capacity
=
2,448,000 units of capacity, because manufacturing capacity is fixed,
and adequate capacity existed in 2016 to produce year 2017 output.
Partial productivity calculations for 2016 based on year 2017 output (to make the partial
productivities comparable across the two years):
Direct materials
partial productivity
=
Conversion costs
partial productivity
=
Quantity of output produced in 2017
Yards of direct materials that would
have been used in 2016 to produce
year 2017 output
Quantity of output produced in 2017
Units of manufacturing capacity
that would have been used in
2016 to produce year 2017 output
=
=
2, 203, 200
1, 632, 000
= 1.35 wallets
per yard
2, 203, 200
0.9 wallets per
= unit
of capacity
2, 448, 000
The calculations indicate that Gable improved the partial productivity of direct materials and
conversion costs between 2016 and 2017 via efficiency improvements and by reducing unused
manufacturing capacity.
2.
Gable Company management can use the partial productivity measures to set targets for
the next year. Partial productivity measures can easily be compared over multiple periods. For
example, they may specify bonus payments if partial productivity of direct materials increases to
1.6 units of output per yard and if partial productivity of conversion costs improves to 0.98 units
of output per unit of capacity. A major advantage of partial productivity measures is that they
focus on a single input; hence, they are simple to calculate and easy to understand at the
operations level. Managers and operators can also examine these numbers to understand the
reasons underlying productivity changes from one period to the next—better training of workers,
lower labor turnover, better incentives, or improved methods. Management can then implement
and sustain these factors in the future.
12-44 Total factor productivity (continuation of 12-43). Refer to the data for Problem 12-43.
Assume the fabric costs $4.00 per yard in 2017 and $4.10 per yard in 2016.
Required:
1. Compute Gable Company’s total factor productivity (TFP) for 2017.
2. Compare TFP for 2017 with a benchmark TFP for 2016 inputs based on 2017 prices and
output.
3. What additional information does TFP provide that partial-productivity measures do not?
12-53
SOLUTION
(25 min.) Total factor productivity (continuation of 12-43).
1.
Total factor
productivity
for 2017 using
2017 prices
=
=
=
=
Quantity of output produced in 2017
Costs of inputs used in 2017 based on 2017 prices
2,203,200
(1,440,000  $4.00) + (7,803, 000)
2, 203, 200
2,203,200

$5, 760, 000  $7,803,000
$13,563,000
0.1624419 units of output per dollar of input
2.
By itself, the 2017 TFP of 0.16244 units per dollar of input is not particularly helpful. We
need something to compare the 2017 TFP against. We use, as a benchmark, TFP calculated using
the inputs that Gable would have used in 2016 to produce 2,203,200 units of output calculated in
requirement 1 at 2017 prices. Using the current year’s (2017) prices in both calculations controls
for input price differences and focuses the analysis on the adjustments the manager made in the
quantities of inputs in response to changes in prices.
Cost of capacity in 2017
$7,803, 000
2017 price of capacity =

 $3.40 per unit of capacity
Capacity in 2017
2, 295, 000 units
Benchmark
TFP
=
Quantity of output produced in 2017
Costs of inputs that would have been used in 2016
to produce 2017 output at year 2017 input prices
=
=
=
=
2,203,200
(1,632,000  $4.00) + (2,448,000  $3.40)
2,203,200
$6,528,000 + $8,323,200
2,203,200
$14,851,200
0.1483516 units of output per dollar of input
Using 2017 prices, total factor productivity increased 9.5% [(0.16244  0.14835) 
0.14835] from 2016 to 2017.
3.
Total factor productivity increased because Gable produced more output per dollar of
input in 2017 relative to 2016, measured in both years using 2017 prices. The change in partial
productivity of direct materials and conversion costs tells us that Gable used less materials and
capacity in 2017 relative to output, than in 2016.
A major advantage of TFP over partial productivity measures is that TFP combines the
productivity of all inputs and so measures gains from using fewer physical inputs and
substitution among inputs.
Partial productivities cannot be combined to indicate the overall effect on cost as a result
of these individual improvements. The TFP measure allows managers to evaluate the change in
12-54
overall productivity by simultaneously combining all inputs to measure gains from using fewer
physical inputs as well as substitution among inputs.
Try It 12-1 Solution
The following is Nile's strategy map. The strong ties are indicated by bolder arrows, for example,
attracting and retaining quality employees and employee training, improving delivery time,
product offerings and customer service. Attracting and retaining quality employees and
employee training are also trigger points for improving delivery time, product offerings and
customer service. Achieving these internal business process objectives leads to higher customer
satisfaction which in turn increases market share, operating income growth and shareholder
value. The three internal business process perspectives are what make Nile distinctive. If Nile
can be better than its competitors in these perspectives, it has an excellent chance of achieving
consistent superior performance.
SOLUTION EXHIBIT TRY IT 12-1
Strategy Map for Nile Company
12-55
2. To achieve its goals, Nile includes the following measures under each perspective of the
balanced scorecard related to its strategy map:
Financial Perspective
Customer Perspective
Internal-BusinessProcess Perspective
Learning-and-Growth
Perspective
Strategic Objective
Increase operating income:
Increase shareholder value:
Balanced Scorecard Measure
Operating income from product differentiation
Operating income from growth
Revenue growth
Increase market share:
Market share
Increase customer satisfaction:
Number of additional customers
Customer-satisfaction ratings
Reduce delivery time:
Average number of days to deliver product
Increase product offerings:
Number of new products available
Improve customer service:
Number of customer complaints
Improve quality of employee training:
Percentage of employees trained
Attract and retain quality employees:
Employee turnover of high-rated employees
Employee satisfaction
Enhance information system capabilities: Average system customer response time
12-56
Try It 12-2 Solution
1.
Operating income for each year is as follows:
2016
2017
$1,280,000
$1,550,000
Revenues ($3,200  400; $3,100  500)
Costs
Engineering labor costs
($35  24,000; $36  27,000)
Engineering support costs
($300  600; $320  600)
Total costs
Operating income
Change in operating income
840,000
972,000
180,000
192,000
1,020,000
1,164,000
$ 260,000
$ 386,000
$126,000 F
The Growth Component
Actual units of 
Selling
 Actual units
Revenue effect
=  of output sold  output sold   price
of growth
 in 2017

in 2016
in 2016


= (500 – 400)  $3,200 = $320,000
Actual units
 Units of
of inputs
Cost effect of
 input required
used to
growth for =  to produce 
2017
output
produce
variable costs
 in 2016
2016 ouput

Cost effect of
growth for =
fixed costs

Input

  inprice
2016


Actual 
 Actual units of capacity in
Price per unit
 2016 because adequate  units of  × of capacity
exists to produce
capacity 
 capacity
in 2016
in 2016 
 2017 output in 2016
Engineering labor-hours that would be required in 2017 to complete 500 jobs instead of the
400 jobs done in 2016, assuming the 2016 input-output relationship continued into 2017, equal
30,000  500 jobs  24,000 labor-hours  labor-hours. Engineering support capacity would not
400 jobs


change since adequate capacity exists in 2016 to support year 2017 jobs.
The cost effects of growth component are
Engineering labor costs
Engineering support costs
Cost effect of growth
(30,000 – 24,000) 
(600 – 600) 
12-57
$35 =
$300 =
$210,000 U
0
$210,000 U
In summary, the net increase in operating income as a result of the growth component equals:
Revenue effect of growth
$320,000 F
Cost effect of growth
210,000 U
Change in operating income due to growth
$110,000 F
The Price-Recovery Component


Actual units
of output
sold in 2017
Revenue effect of
Selling price
Selling price


price-recovery =
in 2017
in 2016
= ($3,100 – $3,200)  500 = $50,000 U
Cost effect of
price-recovery for =
variable costs
Units of input
Input 
 Input
required to
×
price
in

price
in


produce
2017
2016 
 2017
output in 2016
Cost effect of
price-recovery for =
fixed costs
Actual units of capacity in
Price per 
 Price per
2016 because adequate
unit
of
unit
of



capacity  × capacity exists to produce
 capacity
2017 output in 2016
in 2016 
 in 2017
Engineering labor costs
Engineering support costs
Cost effect of price recovery
($36 – $35) 
$30,000 U
($320 – $300) 
30,000
600
=
=
12,000 U
$42,000 U
In summary, the net decrease in operating income as a result of the price-recovery component
equals:
Revenue effect of price-recovery
$50,000 U
Cost effect of price-recovery
42,000 U
Change in operating income due to price recovery
$92,000 U
The Productivity Component
Units of input 
 Actual units of
Cost effect of
input
used
required to   Input

price

productivity for =
to produce
produce 2017 
 2017
in
2017
variable costs
output
ouput in 2016 

Actual units of capacity in 
Price per
 Actual
Cost effect of
units
of
2016
because
adequate
unit of


productivity for = capacity  capacity exists to produce  capacity
 in 2017

fixed costs
2017 output in 2016 
in 2017

The productivity component of cost changes are:
Engineering labor costs
(27,000 – 30,000) 
Engineering support costs
(600 – 600) 
Change in operating income due to productivity
12-58
$36
$320
=
=
$108,000 F
0
$108,000 F
The change in operating income between 2016 and 2017 can be analyzed as follows:
Income
Statement
Amounts
in 2016
(1)
Revenues
Costs
Operating income
Revenue and
Cost Effects
of Growth
Component
in 2017
(2)
Revenue and
Cost Effects of
Price-Recovery
Component
in 2017
(3)
Cost Effect of
Productivity
Component
in 2017
(4)
$50,000 U 
$1,280,000
$320,000 F
1,020,000
210,000 U
42,000 U
$108,000 F
$ 260,000
$110,000 F
$92,000 U
$108,000 F
Income
Statement
Amounts
in 2017
(5) =
(1) + (2) + (3) + (4)
$1,550,000
1,164,000
$ 386,000
$126,000 F
Change in operating income
3.
The analysis of operating income indicates that a significant amount of the increase in
operating income resulted from Ronaldo’s productivity improvements in 2017. The company had
to reduce selling prices while labor costs were increasing but it was able to increase operating
income by improving its productivity. The productivity gains also allowed Ronaldo to be
competitive and grow the business. The unfavorable price recovery component indicates that
Ronaldo could not pass on increases in labor-related wages via price increases to its customers
(it, in fact, had to decrease prices), very likely because its product was not differentiated from
competitors’ offerings.
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Try It 12-3 Solution
Effect of industry-market-size factor on operating income
Of the 100 jobs increase in sales from 400 to 500 jobs, 10% or 40 jobs (10%  400) are due to
growth in market size, and 60 (100  40) jobs are due to an increase in market share.
The change in Ronaldo’s operating income from the industry market-size factor rather than
from specific strategic actions is:
40
$110,000 (the growth component in Try It 12-2) 
$ 44,000 F
100
Effect of product differentiation on operating income
Increase in prices of inputs (cost effect of price recovery)
$ 42,000 U
Effect of cost leadership on operating income
Productivity component
Effect of strategic decision to reduce selling price, $100  500
Growth in market share due to productivity improvement
and strategic decision to reduce selling price
60
$110,000 (the growth component in Try It 12-2) 
100
Change in operating income due to cost leadership
$108,000 F
50,000 U
66,000 F
$124,000 F
The change in operating income between 2016 and 2017 can then be summarized as
Change due to industry-market-size
Change due to product differentiation
Change due to cost leadership
Change in operating income
$ 44,000 F
42,000 U
124,000 F
$126,000 F
Ronaldo has been very successful in implementing its cost leadership strategy. Despite the
increase in the cost of engineering labor and engineering support, Ronaldo strategically
decreased the selling price of a job by $100. That is, Ronaldo took advantage of its productivity
gains to reduce price, gain market share, and increase operating income.
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Try It 12-4 Solution
1. The amount and cost of unused capacity at the beginning of year 2017 when Ronaldo makes
its capacity decisions for the year based on jobs done in year 2017 follows:
Engineering support (600  500; (600  500)  $320
Amount of
Cost of
Unused
Unused
Capacity
Capacity
100
$32,000
2. Ronaldo can reduce engineering support capacity by 100 jobs from 600 jobs to 500 jobs.
Ronaldo will save 100  $320 = $32,000. This is the maximum amount of costs Ronaldo can
save by downsizing in 2017. It cannot reduce capacity further (by another 50 jobs to 450 jobs)
because it would then not have enough capacity to do 500 jobs in 2017 (jobs that contribute
significantly to operating income).
3. Ronaldo may have chosen not to downsize because it projects sales increases in the near term
that would lead to greater demand for and utilization of capacity. Ronaldo may have also decided
not to downsize because downsizing requires a significant reduction in capacity and capability of
the organization. Not reducing significant capacity by laying off employees boosts employee
morale and keeps employees more motivated and productive.
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