Download CHAPTER 13 Strategic Planning and Control Learning Objectives

CHAPTER 13
Strategic Planning and Control
Learning Objectives
After studying this chapter, you will be able to:
1. Explain the role management accounting plays in guiding strategy.
2. Understand the value chain for a business.
3. Appreciate product life-cycle analysis and target costing.
4. Discuss the need for multiple measures of organizational performance.
5. Describe a balanced scorecard.
Overview
In this chapter, we consider the decision problems facing entrepreneurs such as Avi as well as
managers of established firms. Perhaps the most important task for top management is to develop
the organization’s strategy. This decision charts the firm’s course over the long term. The
chosen strategy must allow management to create and sustain a business model that will yield
sufficient returns to the suppliers of capital. In addition, the planning and control systems of the
firm should support the chosen strategy. In this chapter, we discuss the role of management
accounting in formulating and implementing strategy. We begin this chapter by introducing the
term strategy. We then describe the role management accounting plays in supporting an
organization’s strategy, and in identifying and configuring its value chain. We discuss two
techniques, life-cycle analysis and target costing, that help a firm to incorporate a long-term
view when making such strategic planning decisions. As we learned in Chapter 1, however, we
need to follow such planning decisions with controls. We consider how to monitor the
implementation of strategy. We discuss the need for multiple performance measures in
organizations, and we introduce the notion of critical success factors (CSFs). Finally, we
describe the balanced scorecard, a widely used strategic performance measurement system that
provides a framework for selecting and reporting performance measures tied to an organization’s
CSFs.
Learning Objective 1
Explain the role management accounting plays in guiding strategy.
1. To build and preserve a significant market share in any competitive market, a firm must
offer a unique value proposition, the key source of customer value, to its target market.
2. A firm’s strategy is the approach for creating and sustaining its value proposition.
3. Thus, strategy defines how a firm positions its products within the target market and
distinguishes itself from its competitors to maximize its return on investment.
Determinants of Business Strategy
At least three considerations influence the formulation of a successful business strategy:
 Core competencies and capabilities
 Competitive landscape
 Sustainability
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Core Competencies and Capabilities
1. Core competency is a term used to refer to the skill set and expertise that characterizes a
firm and its employees, and advantages the firm relative to its competitors.
2. Core competencies guide the value propositions of a firm.
3. A strategy not anchored firmly in core competencies is destined to fail.
Competitive Landscape
1. When formulating a business model, it is crucial to have a good understanding of the
competitive landscape.
2. Five important areas include:
1. Industry competitors
2. New entrants
3. Substitute products
4. Supplier power
5. Customer power
Sustainability
1. New and existing competitors will emulate the business strategies of successful firms.
2. A sustainable strategy is difficult to imitate by competitors because of the unique
resource capabilities and market power it brings.
Types of Business Strategy
1. Experts classify business strategy choices along two dimensions: cost leadership and
product or value differentiation.
2. Firms following a cost leadership strategy find innovative ways to improve their
business processes and cut costs.
3. Firms following a value differentiation strategy focus on R&D and product innovation
activities.
4. Successful firms excel at combining value differentiation with cost advantage strategies.
Management Accounting and Business Strategy
1. The cost leadership and differentiation strategies place differing demands on how a firm
goes about selecting its target markets, acquiring resource capabilities, and setting up the
structure of the organization.
2. Firms following the strategy of cost leadership exploit economies of scale, institute tight
cost controls, and in general adopt a firm wide policy of cost minimization.
3. With a differentiation strategy, innovation is more important than cost control.
4. The price that the market is willing to pay for innovative products depends on the
perceived value relative to other competing products.
5. Overemphasis on the use of budgets to evaluate actual performance may prove
counterproductive.
6. In contrast, firms that follow the cost leadership strategy target price-sensitive market
segments by offering products at as low a price as possible.
7. Cost planning and control systems play a crucial role in the success of a cost leadership
strategy.
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8. Flexible budgets play an important role in identifying and eliminating operational
inefficiencies.
Learning Objective 2
Understand the value chain for a business.
The Value Chain
A value chain is a set of logically sequenced, value-adding activities that convert input resources
into products or services in a manner consistent with the chosen business strategy.
Building a Value Chain
1. Building a proper value chain (“configuring the value chain”) is a crucial step in
successfully implementing business strategy.
2. An activity that adds value under one business strategy can diminish value under another
strategy.
3. Firms develop a sustainable competitive edge by carefully identifying strategy relevant
activities and performing them in a manner that differentiates them from their rivals.
Extending the Value Chain Beyond the Firm
1. As shown in Exhibit 13.4, we can classify an organization’s activities into five generic
categories based on the logical sequence in which these activities take place in
organizations.
2. This classification helps us identify the specific areas in which a firm has core
competencies and capabilities to gain and maintain a strategic competitive edge.
3. It may be best for a firm to outsource or form strategic alliances with outside suppliers to
perform those value activities in which it does not have a unique advantage.
4. The value chain often extends beyond the boundaries of a firm.
Management Accounting and the Value Chain
1. Exhibit 13.6 shows how management accounting information can help configure value
chains for value differentiation and cost leadership strategies.
2. The activity-based approach to configuring the value chain is useful for both value
differentiation and cost leadership strategies.
3. The strategies differ in the emphasis they place on what each activity should achieve and
how it ought to contribute to the strategy.
4. Under a value differentiation strategy, we evaluate activities based on how they enhance
the success of a business strategy.
5. In contrast, the cost leadership strategy sustains the competitive edge by constantly
seeking ways to reduce costs throughout the value chain.
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Learning Objective 3
Appreciate product life-cycle analysis and target costing.
Strategic Cost Planning
In this section, we discuss two techniques—life-cycle analysis and target costing—that help a
firm adopt a long-term view when making long-term product planning decisions.
Life-cycle Analysis
1. The life cycle of a product depends on the nature of the product, the nature of the
industry, the level of competition in the industry, and the rate at which technology is
changing in the industry.
2. Thus, life cycles exhibit considerable variability.
3. Product life cycle is an important element of a business strategy because it determines the
rate at which companies have to develop and introduce new products to compete
effectively.
4. The five stages in a product life cycle (See Exhibit 13.7) differ in terms of the
information they need from management accounting.
Development
1. In this stage, we expect no sales revenue from products.
2. If product development is successful, we undertake necessary investments in plant,
equipment, and other resources necessary to make and market the product.
Introduction and Growth
1. In this stage, revenues begin to pick up.
2. Variable costs of production costs are typically higher, especially if making the new
product involves new operations and procedures.
3. Consequently, profitability is typically low at the introduction stage.
4. A cost leadership strategy places more weight on increasing volume relative to generating
higher margins.
5. A differentiation strategy focuses on generating and maintaining high margins for long
periods.
Maturity
1. A product reaches the maturity stage when it has reached its targeted market potential and
compares well against competing products.
2. By this time in the life cycle, the company will have reached its maximal efficiency
levels in making and selling the product.
3. This is the “profit-generating” stage of the product life cycle.
4. Profit variance analysis becomes useful at this stage.
Decline
1. In this final stage, sales and profits decline as the firm cuts prices and clears inventories,
in preparation for the next generation of products.
2. Cost control is tight, with no new investments to maintain capacity or increase efficiency.
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3. As indicated above, product life-cycle analysis emphasizes that the objective is to
maximize the profitability of a product over its entire life cycle and not stage-by-stage.
Target Costing
Target costing, pioneered by some Japanese firms in the late 1970s, is now a common approach
for cost planning at an early stage in the product life cycle.
What Is Target Costing?
1. Target costing is a structured approach to cost planning and management.
2. The premise for target costing is that the firm is a price taker and that there is intense
competition to acquire, retain, and grow customers.
3. A key innovation is to determine the allowable cost at which we must produce a proposed
product with specified functionality in order to achieve a target profit margin at a given
price point.
4. The challenge in target costing is to find a way to meet the allowable cost.
5. Thus, target costing helps establish cost standards for various activities and business
processes, standards that the company must reach in order to achieve the allowable
product cost (brings a cost focus at the planning stage).
Where Is Target Costing Effective?
1. The benefits of target costing depend on market characteristics.
2. Target costing is most beneficial in industries where the intensity of competition limits
firms’ abilities to obtain substantial and sustainable price premiums for innovations.
3. Target costing is particularly effective for products with well-defined and discrete
features because it helps make proper trade-offs among price, quality, and functionality
with respect to each product feature.
4. Target costing is less effective in firms that deal with commodity-type products because
there is little scope for differentiating products by their features.
Learning Objective 4
Discuss the need for multiple measures of organizational performance.
Implementing Strategy
1. Experts in organizational theory have discovered that a focus on financial results is not
enough to help an organization implement its strategy successfully.
2. The organization must also identify and focus some of its attention on key critical success
factors (CSFs).
3. The need for lagging and leading indicators motivates firms to employ both financial and
nonfinancial measures to track organizational performance.
4. Financial measures suffer from various deficiencies.
5. As a result, some firms supplement key measures such as ROI.
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Critical Success Factors
1. Critical success factors (CSF), also known as key performance indicators (KPIs), are
performance measures that must “go right” for an organization to implement its strategy
successfully and achieve its mission.
2. Outcomes on the CSFs are the pulse of the organization’s survival.
3. Strategic CSFs are long-term, firm-specific measures.
4. Strategic CSFs help companies monitor the success of their unique corporate and
business strategies.
Properties of a CSF
1. A good CSF is:
a. Simple and easy to understand.
b. Readily quantifiable.
c. Easy to monitor.
d. Linked to strategy.
2. The number of CSFs depends on the size of the organization, the nature of the industry,
and a host of other factors.
Learning Objective 5
Describe a balanced scorecard.
Monitoring Strategy Implementation
1. The balanced scorecard is a performance measurement system that includes a
systematic approach for linking strategy to planning and control.
2. The balanced scorecard includes performance measurement along a number of different
dimensions:
a. Financial and nonfinancial measures of performance
b. Short-term and long-term objectives
c. Past outcome and forward looking measures of performance
d. “Hard” objective and “short” subjective measures of performance
e. External and internal measures of performance
3. Balancing such dimensions as “hard” and “soft” qualitative measures to design an
effective corporate scorecard system can be challenging.
Components of a Balanced Scorecard
A typical balanced scorecard suggests that managers look at their firms from four different
perspectives such as:
 Financial perspective
 Customer perspective
 Internal business perspective
 Innovation and learning perspective
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CHAPTER 13 REVIEW QUESTIONS
TRUE/FALSE
1. The three considerations that influence the formulation of a successful business strategy are
core competencies and capabilities, sustainability, and competitive bidding.
2. Firms following a value differentiation strategy find innovative ways to improve their
business processes and cut costs.
3. Engineering activity is the third step in the value chain configuration.
4. The five stages in a product's life cycle are development, introduction, growth, maturity, and
decline.
5. In the development stage, we expect sales revenue from products.
6. Organizations also require lagging measures as customer satisfaction and product return rates,
which are the drivers of future performance.
7. Employee retention and cost per transaction are examples of potential internal measures.
MULTIPLE CHOICE
1. Which would not be considered one of the five competitive forces?
A. Industry power.
B. Supplier power.
C. New entrants.
D. Industry competitors.
2. When innovation is more important than cost control, firms follow a:
A. Cost leadership strategy.
B. Value differentiation strategy.
C. Customer strategy.
D. Both (A) and (B).
3. Which management accounting functions are critical in a product differentiation strategy?
A. Activity based-cost for product and capacity planning.
B. Role of cost in pricing.
C. Benchmarking costs against competition.
D. None of the above.
4. Which is not one of the four steps in Value chain configuration?
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A.
B.
C.
D.
Focus on engineering efforts.
Define scope and depth of activity-based costing.
Determine activity management.
Identify performance linkages across activities.
5. Which strategy focuses on enhancing benefits from activity and outsources any activity that
does not help differentiate?
A. Cost leadership strategy.
B. Value differentiation strategy.
C. Customer strategy.
D. Both (A) and (B).
6. Kaizen and Benchmarking are examples of cost reduction technique that would play a
significant role in the:
A. Cost leadership strategy.
B. Value differentiation strategy.
C. Customer strategy.
D. Both (A) and (B).
7. A key activity in the introduction and growth life-cycle stage is:
A. Promotion.
B. Improve production efficiencies.
C. Product research and development.
D. Test marketing.
E. Both (A) and (B).
8. Financial measures:
A. Are always timely.
B. Do provide specific information about potential areas of concerns.
C. Aggregate.
D. All of the above.
9. Well-defined critical success factors (CSF's):
A. Are also known as key performance indicators.
B. Are simple and easy to understand.
C. Are linked to strategy.
D. All of the above.
10. A typical financial measure is:
A. Number of customer complaints.
B. Return on net assets.
C. Growth in new markets.
D. Employee retention.
MATCHING
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1.
Match the items below by entering the appropriate code letter in the space provided.
A.
B.
C.
D.
E.
Financial Perspective
Value Differentiation
Critical Success Factors
Allowable Cost
Lagging Measures
F.
G.
H.
I.
J.
Cost Gap
Life-cycle Analysis
Cost Leadership
Customer Perspective
Leading Measures
____ 1. Number of customer complaints.
____ 2. Includes five discrete stages: development, introduction, growth, maturity, and
decline.
____ 3. Current cost less allowable cost.
____ 4. A firm's strategy is to institute tight cost controls.
____ 5. Also known as key performance indicators (KPI's).
____ 6. Revenue per aircraft.
____ 7. Reflects past performance.
____ 8. Examples are customers satisfaction and product return rates.
____ 9. A firm's strategy to focus on product innovation activities rather than cutting costs.
____ 10. Price point less target profit margin.
SHORT PROBLEMS
1. The following are the income statements of two firms in the same industry.
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Revenues
Variable Costs
Contribution Margin
Fixed Costs
Profit before taxes
Firm A
$600,000
200,000
400,000
150,000
$250,000
Firm B
$850,000
500,000
350,000
250,000
$100,000
Required:
Compute the contribution margin ratio, profit margin ratio, and sales per dollar in fixed cost for
the two firms.
2. Valley Technologies produces testing equipment used by forges to test their products. Valley
is considering a new X-ray machine that substantially enhances the functionality of the product it
would replace. Valley believes that it might be able to sell 5,000 units of new product at an
average price of $10,000 per unit. Management specifies a target profit margin of 8% return on
sales.
Required:
a. Compute the product's allowable cost.
b. Suppose the product's current cost is $9,900 per unit. What is the cost gap (i.e., or the cost
reduction that must be accomplished during the target costing process)?
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CHAPTER 13 REVIEW QUESTIONS ANSWER KEY
TRUE/FALSE
1. L01 – False
2. L01 – False
3. L02 – True
4. L03 – True
5. L03 – False
6. L04 – False
7. L05 – True
MULTIPLE CHOICE
1. L01 – A
2. L01 – B
3. L01 – D
4. L02 – C
5. L02 – B
6. L02 – A
7. L03 – E
8. L04 – C
9. L04 – D
10. L05 – B
MATCHING
1.
2.
3.
4.
5.
I
G
F
H
C
6.
7.
8.
9.
10.
A
E
J
B
D
SHORT PROBLEMS
1. (L02)
Firm A
Contribution margin ratio
Sales / $ of fixed costs
Profit margin ratio
Firm B
66.67%
4.00
41.67%
41.18%
$3.40
11.76%
The above results are obtained assuming that we compute the contribution margin ratio as
(Contribution margin /sales), the profit margin ratio as profit / sales and the sales per $ of
fixed costs as sales / fixed costs.
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SHORT PROBLEMS (CONT.)
2. (L03)
a.
Total sales revenue
Desired margin
Allowable cost
5,000 units × $10,000 per unit $50,000,000
8%
4,000,000
$46,000,000
Current cost
Allowable cost
Cost gap
5,000 × $9,900
b.
$49,500,000
46,000,000
$3,500,000
Thus, we need to reduce costs by $46,000,000 - $49,500,000 = $3,500,000 to
achieve the cost target.
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