Strategy, Balanced Scorecard and Strategic Profitability Analysis

Strategy Strategy specifies how an organization matches its own capabilities with the opportunities in the marketplace to accomplish its objectives A thorough understanding of the industry is critical to implementing a successful strategy

Five Aspects of Industry Analysis Number and strength of competitors: Are there numerous competitors with advantages in quality, costs, and timing of products and services for customers? Potential entrants to the market: What are the determining factors for entering this industry? For Example: Initial capital investment, Low or High Fixed Costs, Learning curve for industry, relationships with suppliers and vendors Availability of equivalent products: Is there risk that equivalent products or substitute services on the market can replace your product or service? Bargaining power of customers: Do customers have bargaining power? For example: Volume discounts for large quantity orders? Bargaining power of input suppliers: Do suppliers have bargaining power for higher prices and wages? Due to the high demand for their quality of product and skilled employees

Basic Business Strategies 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 Leads to brand loyalty and the willingness of customers to pay high prices. For example: Mercedes Benz, Gucci, Sony Computers & TVs 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 Leads to lower selling prices. For example: Costco, Wal-Mart, Home Depot, Dell Computers

The Balanced Scorecard & Implementing Strategy Many companies have introduced a Balanced Scorecard to manage the implementation of their overall strategies The Balanced Scorecard translates an organization’s mission and overall strategy into a set of performance measures that provides the framework for implementation. It is called the Balanced Scorecard because it balances the use of financial and nonfinancial performance measures to evaluate performance

Balanced Scorecard Perspectives Financial Perspective Customer Perspective Internal Business Perspective Learning and Growth Perspective

1- The Financial Perspective Evaluates the profitability of the strategy Uses the most objective measures in the scorecard. For example: Changes in Operating Income, due to growth in sales revenues (revenue growth), decreases in costs & prices, increases in productivity, management of capacity designed to measure overall increases in shareholder value. The other three perspectives eventually feed back into this element of the balance scorecard

2- The Customer Perspective Identifies targeted customer and market segments and measures the company’s success in these segments. Retaining existing customers and developing new customers to increase market share For example: Customer satisfaction with quality, costs, and timing (on-time deliveries and efficient shipping) of products and services.

3- The Internal Business Prospective Focuses on improving internal operations (internal processes) to increase their ability to create additional value for customers, which in turn, furthers the company’s financial perspective by increasing shareholder value. Includes Three Processes: Innovation: Innovative products and technology (Such as: number of new patents) Operations: Re-engineered efficient processes for ordering, manufacturing, and distribution that eliminate waste (Such as: defect rates). Post-sales service: Customer service, recalls, warranties, and payments

The Learning and Growth Perspective Identifies the capabilities the organization must excel at to achieve superior internal processes that create value for customers and shareholders Includes Three Capabilities: Employee Capabilities: Training and Education of employees in internal processes and quality management Information System Capabilities: Computer Systems with efficient real-time feedback. Availability of the information system for employees. Organizational Structure Capabilities: Communication structures for effective communication of goals and teamwork within the organization which will empower manufacturing and sales employees (line employees) to manage internal processes

The Learning and Growth Perspective Includes Three Performance Measures: Employee Retention: Decrease in employee turnover will increase years of average experienced employee, decrease inefficiencies and waste by employees, and increase recognition of employees by customers. Employee Satisfaction: Increase in percentage of positive motivated employees will increase in-house promotions versus outside recruiting for management positions and increase ideas from employees to improve internal processes. Employee Production: Increased quality output by employees will increase the company’s capacity for higher revenues and decrease in inefficiencies and waste in manufacturing or service processes.

The Balanced Scorecard Flowchart

Balanced Scorecard Illustrated Exhibit 13-2 (See p.468)

Strategy & the Balanced Scorecard Exhibit 13-3 (See p.470) 14

Balanced Scorecard Measures

Balanced Scorecard Implementation To effectively implement the Balanced Scorecard: It must have commitment and leadership from top management It must be communicated to all employees

Features of a Good Balanced Scorecard Tells the story of a firm’s strategy, articulating a sequence of cause-and-effect relationships: the links among the various perspectives that describe how a strategy will be implemented to reach the optimal desired results Helps 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 for an overall strategy to include all divisions and departments.

Features of a Good Balanced Scorecard Must motivate managers to take actions that eventually result in improvements in financial performance Limits the number of performance measures, identifying only the most critical ones Highlights less-than-optimal tradeoffs that managers may make when they fail to consider operational and financial measures together. For example: The trade-off of meeting current short-run financial objectives over future long-term financial objectives or visa-versa. Such as: Research & development, product or service differentiation, innovation, or advertising.

Balanced Scorecard Implementation Pitfalls Managers should not assume the cause-and- effect linkages are precise: they are merely hypotheses of desired results Managers should not seek improvements across all of the measures all of the time Managers should not use only objective measures. But they should include subjective measures that are important as well – such as: customer & employee satisfaction ratings

Balanced Scorecard Implementation Pitfalls Managers must include both costs and benefits of initiatives placed in the balanced scorecard. Costs, such as: Information Technology and Research & development that are often overlooked to meet long-term strategic goals of the business Managers should not ignore nonfinancial measures when evaluating managers and employees. Such as customer feedback, increased employee morale, or reduction in sick days Managers should not use too many performance measures

Evaluating Strategy Strategic Analysis of Operating Income – three parts: Growth Component – Measures the change in operating income attributable solely to the change in the quantity of output sold (Finished Good Units Sold – change in units sold affects revenues) between the current and prior periods Price-Recovery Component – Measures the change in operating income attributable solely to changes in prices of inputs (DM, DL, MOH- change in prices of inputs affects costs) and outputs (Selling prices of Finished Goods – changes in selling prices affects revenues) between the current and prior periods Productivity Component – Measures the change in costs attributable to a change in the quantity of inputs (DM, DL, MOH – change in the quantity of materials or labor hours affects costs) between the current and prior periods