Strategic Profitability Analysis

Strategic Profitability Analysis
PPT-5
Learning Objective 1
Recognize which of two generic
strategies a company is using.
Recognize which of two generic
strategies a company is using.
What is Strategy?
Strategy describes how an organization matches
its own capabilities with the opportunities in the
marketplace to accomplish its overall objectives.
Strategy describes how an organization matches
its own capabilities with the opportunities in the
marketplace to accomplish its overall objectives.
What is Strategy?
What is the focus of industry analysis?
Competitors
Potential entrants into the market Potential entrants into the market
Equivalent products
Bargaining power of customers
Bargaining power of input suppliers
Basic Strategies
1. Product differentiation
2. Cost leadership
Implementation of Strategy
Management accountants design reports
to help managers track progress in
implementing strategy.
The Balanced Scorecard
The scorecard measures an organizations
performance from four perspectives:
1. Financial 1. Financial
2. Customer
3. Internal business processes
4. Learning and growth
Identify what comprises
reengineering.
Identify what comprises
reengineering.
Reengineering
Reengineering is the fundamental rethinking
of business processes delivery to achieve
improvements in critical measures of
performance such as cost, quality, service,
speed, and customer satisfaction.
Reengineering is the fundamental rethinking
of business processes delivery to achieve
improvements in critical measures of
performance such as cost, quality, service,
speed, and customer satisfaction.
Reengineering Example
Customers needs identified Quantities to be shipped
matched against purchase order
Dallas Co. order delivery system:
Purchase order issued
Production scheduled
Manufacturing completed
Finished goods to inventory
Shipping documents sent
to Billing Department
Invoice issued
Customer payment follow up
The following was determined:
Frequently, there is a long waiting time before
production begins in the manufacturing department.
Frequently, there is a long waiting time before
production begins in the manufacturing department.
Sometimes items are held in inventory until
a truck is available for shipment.
If the quantity shipped does not match the
number of items requested by the customer,
a special shipment must be scheduled.
If the quantity shipped does not match the
number of items requested by the customer,
a special shipment must be scheduled.
Dallas discovered that the many transfers
across departments slowed down the
process and created delays.
A multifunctional team reengineered the
order delivery process.
A customer relationship manager is responsible
for each customer.
Dallas will enter into long-term contracts with
customers specifying quantities and prices.
Dallas will enter into long-term contracts with
customers specifying quantities and prices.
The customer relationship manager will work
with the customer and manufacturing to specify
delivery schedules one month in advance.
The schedule of customer orders will be sent
electronically to manufacturing.
Completed items will be shipped directly from
the manufacturing plant to customer sites.
Completed items will be shipped directly from
the manufacturing plant to customer sites.
Each shipment will automatically trigger an
invoice to be sent electronically to the customer.
Present the four perspectives
of the balanced scorecard.
Present the four perspectives
of the balanced scorecard.
Perspectives of Performance
1. Financial
2. Customer 2. Customer
3. Internal business process
4. Learning and growth
Financial Perspective
Objective:
Increase shareholder value Increase shareholder value
Measures:
Increase in operating income
Financial Perspective
I nitiatives:
Target
Performance
Actual
Performance
Manage costs and
unused capacity
$2,000,000 $2,100,000
Manage costs and
unused capacity
Build strong customer
relationships
$2,000,000
$3,000,000
6%
Build strong customer
relationships
$2,100,000
$3,420,000
6.48%
Customer Perspective
Objectives:
Increase market share
Increase customer satisfaction
Measures:
Market share in communication
networks segment
Customer satisfaction survey
Increase customer satisfaction
Customer Perspective
I nitiatives:
Target
Performance
Actual
Performance
Identify future needs
of customer
6% 7%
Identify future needs
of customer
Identify new target
customer segments
6%
7
90% give top
two ratings
Increase customer focus
of sales organization
7%
8
87% give top
two ratings
Internal Business
Process Perspective
Objectives:
Improve manufacturing
quality and productivity
Improve manufacturing
quality and productivity
Measures:
Yield
On-time delivery
Meet specified delivery dates
Internal Business
Process Perspective
I nitiatives:
Target
Performance
Actual
Performance
Identify problems and
improve quality
78% 79.3%
Identify problems and
improve quality
Reengineer order
delivery process
78%
92%
79.3%
90%
Learning and Growth Perspective
Objectives:
Align employee and
organization goals
Align employee and
organization goals
Measures:
Employee satisfaction survey
Improvements in process controls
Improve manufacturing processes
Learning and Growth Perspective
I nitiatives:
Target
Performance
Actual
Performance
Employee
participation and
suggestion program
to build teamwork
80% of
employees
give top
two ratings
88% of
employees
give top
two ratings
Employee
participation and
suggestion program
to build teamwork
Organize R&D/
manufacturing teams
to modify processes
80% of
employees
give top
two ratings
5
88% of
employees
give top
two ratings
5
Aligning the Balanced
Scorecard to Strategy
Different strategies call for different scorecards.
What are some of the financial
perspective measures?
What are some of the financial
Operating income
Revenue growth
Cost reduction is some areas
Return on investment
What are some of the customer
Market share Market share
Customer satisfaction
Customer retention percentage
Time taken to fulfill customers requests
What are some of the internal business
Innovation Process: Innovation Process:
Manufacturing capabilities
Number of new products or services
New product development time
Number of new patents
Operations Process:
Yield
Defect rates Defect rates
Time taken to deliver product to customers
Percentage of on-time delivery
Setup time
Manufacturing downtime
Post-sales service:
Time taken to replace or repair
defective products
Time taken to replace or repair
defective products
Hours of customer training for
using the product
What are some of the learning and growth
Employee education and skill level Employee education and skill level
Employee satisfaction scores
Employee turnover rates
Information system availability
Percentage of processes with advanced controls
Pitfalls When Implementing
a Balanced Scorecard
What pitfalls should be avoided when
implementing a balanced scorecard?
1. Dont assume the cause-and-effect
linkages to be precise.
1. Dont assume the cause-and-effect
linkages to be precise.
2. Dont seek improvements across
all measures all the time.
3. Dont use only objective measures
on the scorecard.
Pitfalls When Implementing
a Balanced Scorecard
4. Dont fail to consider both costs and benefits
of initiatives such as spending on information
technology and research and development.
4. Dont fail to consider both costs and benefits
of initiatives such as spending on information
technology and research and development.
5. Dont ignore nonfinancial measures when
evaluating managers and employees.
6. Dont use too many measures.
Analyze changes in operating
income to evaluate strategy.
Analyze changes in operating
income to evaluate strategy.
Evaluating the Success
of a Strategy
Assume the following operating incomes:
Year 2003 Year 2004
Revenues:
(1,000,000 $26) $26,000,000
(1,100,000 $24) $26,400,000
Expenses:
Materials 4,050,000 3,631,320
Other 16,000,000 16,000,000
Operating income $ 5,950,000 $ 6,768,680
Year 2003 Year 2004
Revenues:
(1,000,000 $26) $26,000,000
(1,100,000 $24) $26,400,000
Expenses:
Materials 4,050,000 3,631,320
Other 16,000,000 16,000,000
Operating income $ 5,950,000 $ 6,768,680
Evaluating the Success
of a Strategy
How can the increase in operating
income of $818,680 be evaluated?
Growth Growth
Price recovery
Productivity
Growth Component
Assume that for 2003, Dallas produced
and sold 1,000,000 units at $26 per unit.
During the year 2004, Dallas produced
During the year 2004, Dallas produced
What is the revenue effect of growth?
Growth Component
Revenue effect of growth component
(Actual units of output sold in 2004
Actual units of output sold in 2003)
=
Actual units of output sold in 2003)
Output price in 2003
(1,100,000 1,000,000) $26 = $2,600,000 F
This component is favorable because
it increases operating income.
Growth Component
Cost effect of growth component
Actual units of input or capacity that would
have been used in 2003 to produce year 2004
output assuming the same input-output
relationship that existed in 2003
=
Actual units of input or capacity that would
have been used in 2003 to produce year 2004
output assuming the same input-output
relationship that existed in 2003
Actual units or capacity to produce 2003 output
Input prices in 2003
=
Growth Component
To produce 1,100,000 units in 2004 compared
with the 1,000,000 units produced in 2003
(a 10% increase), Dallas would require a
proportional increase in direct materials.
To produce 1,100,000 units in 2004 compared
with the 1,000,000 units produced in 2003
(a 10% increase), Dallas would require a
proportional increase in direct materials.
Assume that 3,000,000 square centimeters of
materials were used to produce the 1,000,000
units in 2003 at a cost of $1.35
per square centimeter.
Growth Component
Assume that manufacturing conversion costs,
selling and customer service costs and research
and development costs were $16,000,000
and remained stable during 2004.
Assume that manufacturing conversion costs,
selling and customer service costs and research
and development costs were $16,000,000
and remained stable during 2004.
What is the cost effect of the growth component?
3,000,000 110% = 3,300,000 centimeters
(3,300,000 3,000,000) $1.35 = $405,000 U
Operating Income and Growth
What is the net increase in operating income
as a result of growth?
Revenue effect of growth component $2,600,000 F
Cost effect of growth component 405,000 U
due to growth component $2,195,000 F
Revenue effect of growth component $2,600,000 F
Cost effect of growth component 405,000 U
due to growth component $2,195,000 F
Price-Recovery Component
Revenue effect of price-recovery component
= (Output price in 2004 Output price in 2003)
Actual units of output sold in 2004
Revenue effect of price-recovery component
= (Output price in 2004 Output price in 2003)
Actual units of output sold in 2004
What is the revenue effect of the
price-recovery component?
($24 $26) 1,100,000 = $2,200,000 U
Cost effect of price-recovery component
(Input prices in 2004 Input prices in 2003)
Actual units of inputs or capacity that would
have been used to produce year 2004 output
assuming the same input-output relationship
that existed in 2003
=
Actual units of inputs or capacity that would
have been used to produce year 2004 output
assuming the same input-output relationship
that existed in 2003
Assume that in the year 2004, direct materials
costs were $1.31 per square centimeter.
What is the cost effect of the
price-recovery component?
($1.31 $1.35) 3,300,000 = $132,000 F ($1.31 $1.35) 3,300,000 = $132,000 F
What is the total effect on operating
income of the price-recovery component?
Operating Income and
Revenue effect
of price-recovery component $2,200,000 U
Cost effect
of price-recovery component 132,000 F
Decrease in operating income
due to price-recovery component $2,068,000 U
Revenue effect
of price-recovery component $2,200,000 U
Cost effect
of price-recovery component 132,000 F
Decrease in operating income
due to price-recovery component $2,068,000 U
Productivity Component
Productivity component
Actual units of inputs or capacity to
produce year 2004 output
=
Actual units of inputs or capacity to
produce year 2004 output
Input prices in 2004
Actual units of inputs or capacity

that would have been used to produce
year 2004 output assuming the same
input-output relationship that existed in 2003
Assume that 2,772,000 actual square
centimeters of direct materials were
used in the year 2004.
Assume that 2,772,000 actual square
centimeters of direct materials were
used in the year 2004.
Actual price was $1.31/square centimeter.
What is the productivity component of cost changes?
(2,772,000 3,300,000) $1.31 = $691,680 F (2,772,000 3,300,000) $1.31 = $691,680 F
There is a $691,680 increase in operating
income due to the productivity component.
Change in Operating Income
$818,680
Growth
component
$2,195,000 F
Price-recovery
component
$2,068,000 U
Productivity
component
$691,680 F
Distinguish between engineered
and discretionary costs.
Distinguish between engineered
and discretionary costs.
Engineered Costs
Engineered costs result specifically from a clear
cause-and-effect relationship between output
and the resources needed to produce that output.
Engineered costs result specifically from a clear
cause-and-effect relationship between output
and the resources needed to produce that output.
They can be variable or fixed in the short run.
Discretionary Costs
Discretionary costs have two important features.
They arise from periodic (usually yearly)
decisions regarding the maximum
amount to be incurred.
They arise from periodic (usually yearly)
decisions regarding the maximum
amount to be incurred.
They have no measurable cause-and-effect
relationship between output and resources used.
Relationships Between
Inputs and Outputs
Engineered costs differ from discretionary
costs along two key dimensions:
Type of process Type of process
Level of uncertainty
Relationships Between
Inputs and Outputs
Engineered costs pertain to processes that are
detailed, physically observable, and repetitive.
Discretionary costs are associated with processes
that are sometimes called black boxes, because
they are less precise and not well understood.
Discretionary costs are associated with processes
that are sometimes called black boxes, because
they are less precise and not well understood.
Identify unused capacity
and how to manage it.
Identify unused capacity
and how to manage it.
Managing Unused Capacity
What actions can management take
when it identifies unused capacity?
Attempt to eliminate the unused capacity Attempt to eliminate the unused capacity
Attempt to use the unused capacity to grow revenue
Name of the Student:
Class Roll No. University No.:
Date: Marks:10
QUI Z No. 5
ATTEMPT ALL QUESTI ONS
MULTIPLE CHOICE QUESTONS
1. Which one of the following is a market force that industry
analysis will focus on?
A. Employees B. Management style C. Capital markets D. Similar
products
ANS. D
QUI Z No. 5
ATTEMPT ALL QUESTI ONS
MULTIPLE CHOICE QUESTONS
1. Which one of the following is a market force that industry
analysis will focus on?
A. Employees B. Management style C. Capital markets D. Similar
products
ANS. D
QUIZ-5
2.Which one of the following factors would make entry into the
market attractive to potential new businesses?
A. Limited profit margins B. Current market has close customer relations C.
Current advanced product development D. Small capital needs
ANS. D
3. Improving manufacturing capability would be included in
which one of the following perspectives?
A. Customer B. Learning and growth C. Internal business process D. Financial
ANS. C
2.Which one of the following factors would make entry into the
market attractive to potential new businesses?
A. Limited profit margins B. Current market has close customer relations C.
Current advanced product development D. Small capital needs
ANS. D
3. Improving manufacturing capability would be included in
which one of the following perspectives?
A. Customer B. Learning and growth C. Internal business process D. Financial
ANS. C
QUIZ-5
4. A measure of the change in operating income attributable solely to changes in
dollar amounts of inputs and outputs from one period to the next is a
component known as the
A. revenue component. B. growth component. C. price-recovery component.
D. productivity component.
ANS. C
5. A firm that focuses on a cost leadership strategy would be most likely to do
which one of the following?
A. Establish low selling prices B. Provide superior products C. Build brand
loyalty D. Cultivate unique products
ANS.A
4. A measure of the change in operating income attributable solely to changes in
dollar amounts of inputs and outputs from one period to the next is a
component known as the
A. revenue component. B. growth component. C. price-recovery component.
D. productivity component.
ANS. C
5. A firm that focuses on a cost leadership strategy would be most likely to do
which one of the following?
A. Establish low selling prices B. Provide superior products C. Build brand
loyalty D. Cultivate unique products
ANS.A
QUIZ-5
TRUE OR FALSE STATEMENTS
6.The fundamental rethinking and redesign of business processes to achieve
improvements is reengineering.
True
False
ANS. TRUE
7. The customer perspective under the balanced scorecard approach focuses on
how to reduce costs to provide less expensive goods.
True
False
ANS. FALSE
TRUE OR FALSE STATEMENTS

6.The fundamental rethinking and redesign of business processes to achieve
improvements is reengineering.
True
False
ANS. TRUE
7. The customer perspective under the balanced scorecard approach focuses on
how to reduce costs to provide less expensive goods.
True
False
ANS. FALSE
QUIZ-5
8. When implementing a balanced scorecard, the cause-and-effect
linkages are always precise.
True
False
ANS. FALSE
9. When evaluating managers and employees under the balanced
scorecard approach, only financial measures should be
considered.
True
False
ANS. FALSE
8. When implementing a balanced scorecard, the cause-and-effect

linkages are always precise.
True
False
ANS. FALSE
9. When evaluating managers and employees under the balanced
scorecard approach, only financial measures should be
considered.
True
False
ANS. FALSE
QUIZ-5
10. A company can adequately gauge the success
of their strategy by measuring the change in
operating income from one year to the next.
True
False
ANS. FALSE
10. A company can adequately gauge the success
of their strategy by measuring the change in
operating income from one year to the next.
True
False
ANS. FALSE
HOME ASSIGNMENT-5
1. DEFINE STRATEGY. WHAT IS A CUSTOMER
PREFERENCE MAP ANDWHY IS IT USEFUL?
2. WHAT IS A STRATEGY MAP? ALSO EXPLAIN
BALANCED SCORE CARD. DESCRIBE THREE
FEATURES OF A GOOD BALANCED SCORE
CARD.
1. DEFINE STRATEGY. WHAT IS A CUSTOMER
PREFERENCE MAP ANDWHY IS IT USEFUL?
2. WHAT IS A STRATEGY MAP? ALSO EXPLAIN
BALANCED SCORE CARD. DESCRIBE THREE
FEATURES OF A GOOD BALANCED SCORE
CARD.
QUESTIONS RELATING TO STRATEGIC PROFITABILITY ANALYSIS
Q.NO.1
Snyder Corporation is small information systems consulting firm that
specializes in helping companies implement sales management software. The
market for Synders products is very competitive. To compare, Snyder must
delivery quality service at a low cost. Snyder bills clients in terms of units of work
performed, which depends on the size and complexity of the sales management
system. Snyder presents the following dates for 2008 and 2009.
PARTICULARS 2008 2009
UNITS OF WORK PERFORMED 60 70
SELLING PRICE $ 50,000 $ 48,000
SOFTWARE IMPLEMENTATION LABOUR HOURS 30,000 32,000
COST PER SOFTWARE IMPLEMENTATION
LABOUR HOUR
$ 60 $ 63
SOFTWARE IMPLEMENTATION SUPPORT
CAPACITY ( IN UNITS OF WORK)
90 90
TOTAL COST OF SOFTWARE IMPLEMENTATION
SUPPORT
$ 360,000 $ 369,000
CAPACITY COST PER UNIT OF WORK
$ 4,000 $ 4,100
NUMBER OF EMPLOYEES DOING SOFTWARE
DEVELOPMENT
3 3
TOTAL SOFTWARE DEVELOPMENT COSTS $ 375,000 $ 390,000
SOFTWARE DEVELOPMENT COST PER
EMPLOYEE
$ 125,000 $ 130,000
Software implementation labour costs are variable costs. Software implementation
support costs for each year depend on the software implementation support
capacity (defined in terms of units of work) that Snyder chooses to maintain each
year. It does not vary with the actual units of work performed that year. At the start
of each year, management uses its discretion to determine the number of software
development employees. The software development staff and costs have no direct
relationship with the number of units of work performed.
Calculate the operating income of Snyder Corporation in 2008 and 2009.
ANS. 1 Strategic analysis of operating income
Operating income for each year is as follows:
2008 2009
Revenues ($50,000 60; $48,000 70) $3,000,000 $3,360,000
Costs
Software implementation labor costs
($60 30,000; $63 32,000) 1,800,000 2,016,000
Software implementation support costs
($4,000 90; $4,100 90) 360,000 369,000
Software development costs
($125,000 3; $130,000 3) 375,000 390,000
Total costs 2,535,000 2,775,000
Operating income $ 465,000 $ 585,000
Change in operating income $120,000 F
Q. No. 2
Describe three key components in doing a strategic analysis of operating
income.
Q.NO. 3
SELLING PRICE $ 50,000 $ 48,000
LABOUR HOUR
$ 60 $ 63
90 90
SUPPORT
$ 360,000 $ 369,000
$ 4,000 $ 4,100
DEVELOPMENT
3 3
EMPLOYEE
$ 125,000 $ 130,000
Calculate the growth, price recovery and productivity components that
explain the change in operating income from 2008-2009.
ANS.
The Growth Component
Revenue effect
of growth
=
Actual units of Actual units of
output sold output sold
in 2006 in 2005
|
|
|
' .

Selling
price
in 2005
= (70 60) $50,000 = $500,000 F
Cost effect
of growth for
variable costs
=
Units of input Actual units
Input
required to produce of input
price
2006 output used to produce
in 2005
in 2005 2005 output

|
|
|
|
' .
Cost effect of
growth for
fixed costs
=
Actual units of capacity in
2005 if adequate to produce
2006 output in 2005 Ac
OR
If 2005 capacity inadequate
to produce 2006 output in 2005,
units of capacity required
to produce 2006 output in 2005
'
tual units
of capacity
in 2005
|
|
|
|
|
|
|
.

Price per
unit of capacity
in 2005
Software implementation labor costs that would be required in 2006 to produce 70 units
instead of the 60 units produced in 2005, assuming the 2005 input-output relationship continued
into 2006, equal 35,000 (
30 000
60
,
70) labor-hours. Software implementation support costs
would not change since adequate capacity exists in 2005 to support year 2006 output and
customers. Software development costs are discretionary costs not directly related to output and,
hence, would not change in 2005 even if Snyder had to produce and sell the higher year 2006
output in 2005.
The cost effects of growth component are
Software implementation labor costs (35,000 30,000) $60 = $300,000 U
Software implementation support costs (90 90) $4,000 = 0
Software development costs (3 3) $125,000 = 0
Cost effect of growth $300,000 U
In summary, the net increase in operating income as a result of the growth component equals:
Revenue effect of growth $500,000 F
Cost effect of growth 300,000 U
Change in operating income due to growth $200,000 F
The Price-Recovery Component
Revenue effect of
price-recovery
=

Actual units
Selling price Selling price
of output
in 2006 in 2005
sold in 2006

= ($48,000 $50,000) 70 = $140,000 U
Cost effect of
price-recovery for
variable costs
=
Input Input
price in price in
2006 2005

|
|
|
' .
Units of input
required to produce
2006 output in 2005
Cost effect of
price-recovery for
fixed costs
=
Price per Price per
unit of unit of
capacity capacity
in 2006 in 2005
|
|
|
' .

2005, if adequate to produce
2006 output in 2005
OR
If 2005 capacity inadequate to
produce 2006 output in 2005,
units of capacity required to
produce 2006 output in 2005
Software implementation labor costs ($63 $60) 35,000 = $105,000 U
Software implementation support costs ($4,100 $4,000) 90 = 9,000 U
Software development costs ($130,000 $125,000) 3 = 15,000 U
Cost effect of price recovery $129,000 U
In summary, the net decrease in operating income as a result of the price-recovery component
equals:
Revenue effect of price-recovery $140,000 U
Cost effect of price-recovery 129,000 U
Change in operating income due to price recovery $269,000 U
The Productivity Component
Cost effect of
productivity for
variable costs
=
Actual units of Units of input
input used to produce required to produce
2006 output 2006 output in 2005

|
|
|
' .
Input
price in
2006
Cost effect of
productivity for
fixed costs
=
2005, if adequate to produce
2006 output in 2005
Actual units of
OR
capacity in
If 2005 capacity inadequate
2006
to produce 2006 output in 2005,
units of capacity required to
pro
'
duce 2006 output in 2005
|
|
|
|
|
|
|
.
Price per
unit of
capacity
in 2006
The productivity component of cost changes are:
Software implementation labor costs (32,000 35,000) $63 = $189,000 F
Software implementation support costs (90 90) $4,100 = 0
Software development costs (3 3) $130,000 = 0
Change in operating income due to productivity $189,000 F
The change in operating income between 2005 and 2006 can be analyzed as follows:
Income
Statement
Amounts
in 2005
(1)
Revenue and
Cost Effects
of Growth
Component
in 2006
(2)
Revenue and
Cost Effects of
Price-Recovery
Component
in 2006
(3)
Cost Effect of
Productivity
Component
in 2006
(4)
Income
Statement
Amounts
in 2006
(5) =
(1) + (2) + (3) + (4)
Revenues $3,000,000 $500,000 F $140,000 U

$3,360,000
Costs 2,535,000 300,000 U 129,000 U $189,000 F 2,775,000
Operating income $ 465,000 $200,000 F $269,000 U $189,000 F $ 585,000
$120,000 F
Change in operating income
Q.NO.4
SELLING PRICE $ 50,000 $ 48,000
LABOUR HOUR
$ 60 $ 63
SOFTWARE IMPLEMENTATION SUPPORT 90 90
SUPPORT
$ 360,000 $ 369,000
$ 4,000 $ 4,100
DEVELOPMENT
3 3
EMPLOYEE
$ 125,000 $ 130,000
Comment on your answer in requirement. What do these components
indicate?
ANS. 4
The analysis of operating income indicates that a significant amount of the
increase in operating income resulted from Snyders productivity improvements in
2006. 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 Snyder to be competitive and grow the business.
The unfavorable price recovery component indicates that Snyder could not pass on
increases in labor-related wages via price increases to its customers, very likely
because its product was not differentiated from competitors offerings.
Q. No. 5. Define strategy.
Q.NO.6
SELLING PRICE $ 50,000 $ 48,000
LABOUR HOUR
$ 60 $ 63
90 90
SUPPORT
$ 360,000 $ 369,000
$ 4,000 $ 4,100
DEVELOPMENT
3 3
EMPLOYEE
$ 125,000 $ 130,000
Suppose that during 2009 the market for implementing sales management
software increases by 5% and that Snyder experience a 1% decline in selling
prices. Assume that any further decreases in selling price and increases in market
share are strategic choices by Snyders management to implement their strategy.
Calculate how much of the change in operating income from 2008 to 2009 is
due to the industry market size factor, cost leadership and product
differentiation. How successful has Snyder been in implementation its
strategy. Explain.
ANS.
Analysis of growth, price-recovery, and productivity components
Effect of industry-market-size factor on operating income
Of the 10-unit increase in sales from 60 to 70 units, 5% or 3 units (5% 60) are
due to growth in market size, and 7 (10 3) units are due to an increase in market
share.
The change in Snyders operating income from the industry market-size factor
rather than from specific strategic actions is:
$200,000 (the growth component in Exercise 13-27)
10
3
$60,000 F
Effect of product differentiation on operating income
Of the $2,000 decrease in selling price, 1% or $500 (1% $50,000) is due to a
general decline in prices, and the remaining decrease of $1,500 ($2,000 $500) is
due to a strategic decision by Snyders management to implement its cost
leadership strategy of lowering prices to stimulate demand.
The change in operating income due to a decline in selling price (other than the
strategic reduction in price included in the cost leadership component) $500 70
units = $ 35,000 U
Increase in prices of inputs (cost effect of price recovery) 129,000 U
Change in operating income due to product differentiation $164,000 U
Effect of cost leadership on operating income
Productivity component $189,000 F
Effect of strategic decision to reduce selling price, $1,500 70 105,000 U
Growth in market share due to productivity improvement and strategic decision to
reduce selling price
$200,000 (the growth component in Exercise 13-27)
10
7
140,000 F
Change in operating income due to cost leadership $224,000 F
The change in operating income between 2005 and 2006 can then be summarized
as
Change due to industry-market-size $ 60,000 F
Change due to product differentiation 164,000 U
Change due to cost leadership 224,000 F
Change in operating income $120,000 F
Snyder has been very successful in implementing its cost leadership strategy. Due
to a lack of product differentiation, Snyder was unable to pass along increases in
labor costs by increasing the selling pricein fact, the selling price declined by
$2,000 per work unit. However, Snyder was able to take advantage of its
productivity gains to reduce price, gain market share, and increase operating
income.
Q. No. 7 Describe the five key forces to consider when analyzing an industry.
Q.NO. 8
SELLING PRICE $ 50,000 $ 48,000
LABOUR HOUR
$ 60 $ 63
90 90
SUPPORT
$ 360,000 $ 369,000
$ 4,000 $ 4,100
DEVELOPMENT
3 3
EMPLOYEE
$ 125,000 $ 130,000
Where possible calculate the amount and cost of (a) unused software
implementation support capacity and (b) unused software development capacity at
the beginning of 2009 based on units of work performed in 2009. If you are
unable to calculate the amount and cost of unused capacity. Indicate why not.
ANS.
Identifying and managing unused capacity
The amount and cost of unused capacity at the beginning of year 2006 based on work
performed in year 2006 follows:
Amount of Cost of
Unused Unused
Capacity Capacity
Software implementation support, 90 70; (90 70) $4,100 20 $82,000
Software development Discretionary Discretionary
cost, so cannot cost, so cannot
determine be calculated*
unused capacity*
*The absence of a cause-and-effect relationship makes identifying unused capacity for discretionary costs difficult.
Management cannot determine the software development resources used for the actual output produced to compare
against software development capacity.
Q.NO. 9
SELLING PRICE $ 50,000 $ 48,000
LABOUR HOUR
$ 60 $ 63
90 90
SUPPORT
$ 360,000 $ 369,000
$ 4,000 $ 4,100
DEVELOPMENT
3 3
EMPLOYEE
$ 125,000 $ 130,000
Suppose Snyder can add or reduce its software implementation support capacity
in increments of 10 units. What is the maximum amount of costs that Snyder
could save in 2009 by downsizing software implementation support capacity?
ANS.
Snyder can reduce software implementation support capacity from 90 units
to 75 (90 15) units. Snyder will save 15 $4,100 = $61,500. This is the
maximum amount of costs Snyder can save by downsizing in 2006. It cannot
reduce capacity further (by another 15 units to 60 units) because it would then not
have enough capacity to perform 70 units of work in 2006 (work that contributes
significantly to operating income).
Q.NO.10
SELLING PRICE $ 50,000 $ 48,000
LABOUR HOUR
$ 60 $ 63
90 90
SUPPORT
$ 360,000 $ 369,000
$ 4,000 $ 4,100
DEVELOPMENT
3 3
EMPLOYEE
$ 125,000 $ 130,000
Snyder , in fact, does not eliminate any of its unused software implementation
support capacity. Why might Snyder not downsize?
ANS.
Snyder may choose not to downsize because it projects sales increases that
would lead to greater demand for and utilization of capacity. Snyder may have also
decided not to downsize because downsizing requires significant reduction in
capacity. For example, Snyder may have chosen to downsize additional software
implementation support capacity if it could do so in, say, increments of 5, rather
than 15 units. Not reducing significant capacity by laying off employees boosts
employee morale and keeps employees more motivated and productive.

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Strategic Profitability Analysis

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TRUE OR FALSE STATEMENTS

8. When implementing a balanced scorecard, the cause-and-effect

Actual units of capacity in

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