1 Module 22 Segment Reporting and Balanced Scorecard (omit pp to 22-11)

2 Decentralization Decentralization - a form of organization in which sub-unit managers are given authority to make substantive decisions. Strongly decentralized - lowest level of managers/workers making various quality decisions. Strongly centralized - all major decisions made at the top level. The key issue is whether the sub-unit has some degree of autonomy over its affairs.

3 Advantages of Decentralization Top management is freed to concentrate on strategic and other high-level issues. Lower level managers have greater and better information, which leads to greater responsiveness to local needs and quicker and better decision making. Increases motivation and job satisfaction. Aids management development and learning. Sharpens the focus of managers and aids in performance evaluation.

4 Disadvantages of Decentralization Lower-level managers may pursue goals that are incongruent with the goals of the organization as a whole. Activities may be uncoordinated among lower-level managers. Communication among divisions may be hindered. Lower-level managers may not see the “big picture” and may have less loyalty toward the organization as a whole.

5 Responsibility Accounting Characteristics of responsibility centers are: The knowledge held the centers’ managers is difficult to acquire, maintain, or analyze at higher levels. The duties that a particular individual in an organization is expected to perform are specified for each center. Types of responsibility centers (more later) Cost center. Profit center. Investment center.

6 Segmented Reporting Effective decentralization requires segmented reporting. The concept of segmented reporting can be extended to the customer level as well (e.g., customer profitability analysis). Segment reports separate fixed costs into direct segment costs (costs traceable to the segment) and allocated common segment costs. When analyzing segments, the relevant common costs are those that are avoidable (e.g., can be changed in the short run.)

7 Cost Center Cost center manager has control over costs but not revenue or investment. Examples include most service departments in an organization, but manufacturing departments may also be cost centers. Goal is to minimize costs while providing services or products to other parts of the organization. Minimizing costs does not necessarily maximize profits. Cost centers have an incentive to produce more units to spread fixed costs over a large number of units. Quality of products produced by cost center must be monitored.

8 Profit Center Profit center manager has control over both costs and revenues. Examples may include branches or segments of a company where a manager sets pricing and production policies, but cannot control investment decisions. Example: "Six Flags" amusement parks. Problems with profit centers: –How to allocate traceable fixed costs or common fixed costs to profit centers. –Profit centers that focus only on their own profits often ignore how their actions affect other responsibility centers.

9 Investment Centers Investment center manager has control of investment opportunities as well as operating decisions. Authority and responsibilities of investment center manager: –Approve and monitor decisions of cost and profit centers. –Decide amount of capital invested or disposed. Performance measurements for investment center: –Return on investment (ROI) –Residual income (RI). Problems with evaluation of investment centers: –Disputes over how to measure income and capital. –Difficult to compare investment centers of different sizes.

10 Return on Investment Return on investment (ROI) for an investment center = Net operating income/Average operating assets DuPont formula separates ROI into two components: ROI= Sales (Asset) turnover x Return on sales (Profit margin) ROI= (Sales /Avg. assets) x (Net op. income / Sales) ROI increases with smaller investments and larger profit margins. Three ways to increase ROI: –Increase sales more than costs (and increase operating income). –Decrease costs (and increase operating income). –Reduce operating assets. Performance evaluation using ROI can lead to under- investment, actions not consistent with the organization’s strategy, and may lead to unfair evaluations when committed costs are significant components in ROI measures.

11 Residual Income Residual income (RI) = Acct. Income – (Minimum return % x Avg. Assets) RI is determined with financial accounting measurements of net income and capital. Each investment center could be assigned a different required rate of return depending on its risk. RI can be increased by increasing income or decreasing investment. Residual income does not lend itself well to evaluating responsibility centers of different size.

12 The Balanced Scorecard No single summary measure can provide a clear performance target or can focus attention on the critical areas of the business. More firms are using a portfolio of measures to assess performance. These measures are both financial and operational (nonfinancial). Kaplan and Norton (1992) have devised a “balanced scorecard” that they argue provides managers with a fast but comprehensive view of the business. The scorecard consists of (1) financial measures to summarize the results of actions already taken, and (2) operational measures that are the drivers of future performance.

13 Strategic Dimensions of The Scorecard The balanced scorecard is a way to clarify, simplify, and then operationalize the vision at the top of the organization. Perspectives of concern: –Financial perspective. –Customer perspective. –Internal business perspective. –Innovation and learning perspective.

14 Measuring Components of Balanced Scorecard Employee skills - proficiency exams. Employee training - courses taken. Process quality - measure number of defects. Process cycle time - measure time to process (manufacturing cycle efficiency). On-time delivery - measure number of on-time deliveries or length of delayed deliveries. Customer loyalty - number of repeat customers. Return on capital - ROI, earnings per share, P/E ratio.

15 A Restaurant Example A new restaurant is being developed at a small ski area. Previously, only snacks were available, and skiers would bring their own meals. The restaurant is being developed to meet more customers’ needs, and to add to the profit of the ski area. Given IL (innovation and learning), IB (internal business processes), C (customer perspective), and F (financial perspective). Classify the following activities measured for the first month of the new restaurant.

16 A Restaurant Example 1.Customer satisfaction with service, as measured by customer surveys. 2.Total restaurant profit for the month. 3.Dining area cleanliness, rated by a “secret” customer. 4.Average time to prepare an order. 5.Number of menu items. 6.Customer satisfaction with menu choices, measured by a customer survey. 7.Average time to take an order. 8.Percent of kitchen staff completing cooking course. 9.Sales 10.Percentage of staff completing a hospitality course. C F IB C IL F