Examples of Managerial Accounting

Seventh Edition

Chapter 11
Performance
Evaluation and
Decentralization

© 2019 Cengage. All rights reserved.

 Learning Objectives

1. Explain how and why firms choose to decentralize

2. Compute and explain return on investment
3. Compute and explain residual income and economic
value added
4. Explain the role of transfer pricing in a decentralized
firm
5. (Appendix 11A) Explain the uses of the Balanced
Scorecard, and compute cycle time, velocity, and
manufacturing cycle efficiency

© 2019 Cengage. All rights reserved.

Decentralization and Responsibility Centers
(1 of 2)
• A company is organized along lines of responsibility
• Most companies use a flattened hierarchy that
emphasizes teams
• Firms with multiple responsibility centers choose one of
two decision-making approaches to manage their
diverse and complex activities: centralized or
decentralized

© 2019 Cengage. All rights reserved.

Decentralization and Responsibility Centers
(2 of 2)
• In centralized decision making, decisions are made at
the very top level, and lower level managers are
charged with implementing these decisions
• Decentralized decision making allows managers at
lower levels to make and implement key decisions
pertaining to their areas of responsibility
• Delegating decision-making authority to the lower
levels of management in a company is called
decentralization

© 2019 Cengage. All rights reserved.

Centralization and Decentralization

© 2019 Cengage. All rights reserved.

 Reasons for Decentralization

• Firms decide to decentralize for several reasons,

including the following:
– ease of gathering and using local information
– focusing of central management
– training and motivating of segment managers
– enhanced competition, exposing segments to market
forces

© 2019 Cengage. All rights reserved.

 Divisions in the Decentralized Firm

• Managers in a decentralized firm make and implement

more decisions than do managers in a centralized firm
• Decentralization usually is achieved by creating units
called divisions
• Divisions can be organized in a number of different
ways, including the following:
– types of goods or services
– geographic lines
– responsibility centers

© 2019 Cengage. All rights reserved.

 Types of Goods or Services

• Here is an example of how PEPSICO creates its

decentralized divisions organized according to its
product lines

• In a decentralized setting, some interdependencies

usually exist, like Pepsi being sold at its restaurants,
which include Pizza Hut, Taco Bell, and KFC
© 2019 Cengage. All rights reserved.
 Geographic Lines

• Divisions may also be created along geographic lines

• The presence of divisions spanning one or more
regions creates the need for performance evaluation
that can take into account differences in divisional
environments

© 2019 Cengage. All rights reserved.

 Responsibility Centers (1 of 2)

• A third way divisions differ is by the type of

responsibility given to the divisional manager
• A responsibility center is a segment of the business
whose manager is accountable for specified sets of
activities

© 2019 Cengage. All rights reserved.

 Responsibility Centers (2 of 2)

• The four major types of responsibility centers are as

follows:
– Cost center: Manager is responsible only for costs
– Revenue center: Manager is responsible only for
sales, or revenue
– Profit center: Manager is responsible for both
revenues and costs
– Investment center: Manager is responsible for
revenues, costs, and investments

© 2019 Cengage. All rights reserved.

Types of Responsibility Centers and Accounting
Information Used to Measure Performance
• Investment centers represent the greatest degree
of decentralization (followed by profit centers and
finally by cost and revenue centers) because their
managers have the freedom to make the greatest
variety of decisions

Cost Sales Capital Other

Investment
Cost center X
Revenue center X
Profit center X X
Investment center X X X X

© 2019 Cengage. All rights reserved.

 Responsibility Center Interdependencies

• The responsibility center manager has responsibility

only for the activities of that center
• Decisions made by that manager can affect other
responsibility centers
• Organizing divisions as responsibility centers creates
the opportunity to control the divisions through the use
of responsibility accounting

© 2019 Cengage. All rights reserved.

 Here’s How It’s Used: IN THE SERVICE
INDUSTRY (1 of 5)
You have been chosen as the CEO of a new hospital. One
important decision you face early is determining the
optimal level of decentralization for your various levels of
supporting management.
What factors should you consider as you decide how
best to structure the hospital management?

© 2019 Cengage. All rights reserved.

 Here’s How It’s Used: IN THE SERVICE
INDUSTRY (2 of 5)
There is no easy, one-size-fits-all answer. However, some
of the top-ranked hospitals in the world, such as the
Cleveland Clinic, recognize that much of the specific
knowledge critically important for making the best patient
care decisions resides with the hospital’s physicians,
surgeons, and nurses rather than with the chief executive
officer or other “C-Suite” executives (e.g., chief financial
officer, chief operations officer, chief integrity officer, etc.).

© 2019 Cengage. All rights reserved.

 Here’s How It’s Used: IN THE SERVICE
INDUSTRY (3 of 5)
Such hospitals choose a highly decentralized
organizational structure so that many important decisions
that affect patient treatment are made by individuals far
removed from top management.
The biggest challenge to effectively managing a highly
decentralized decision-making structure like this one is to
create quantitative performance measures for the decision
makers—in this case, the physicians, surgeons, and
nurses—to assess the quality of their decisions.

© 2019 Cengage. All rights reserved.

 Here’s How It’s Used: IN THE SERVICE
INDUSTRY (4 of 5)
Furthermore, these performance measures need to be
used as part of the decision makers’ compensation
packages to reward (or punish) their wise (or unwise)
decisions that hopefully are taken in the best interest of
the patients and, ultimately, the hospital. A growing
number of publicly traded companies, such as Starbucks,
offer lower-level employees—even part-time employees—
incentives such as health care benefits and stock options
to motivate them to take actions that are in the companies’
best long-term interests.

© 2019 Cengage. All rights reserved.

 Here’s How It’s Used: IN THE SERVICE
INDUSTRY (5 of 5)
In decentralized organizations, managerial accounting is
important in designing effective performance measures
and incentive systems to help ensure that lower-level
managers use their decision-making authority to improve
the organization’s performance.

© 2019 Cengage. All rights reserved.

 Return on Investment (1 of 2)

• One way to relate operating profits to assets employed

is to compute the return on investment (ROI), which
is the profit earned per dollar of investment
• ROI is the most common measure of performance for
an investment center and is computed as follows:

Operating income
ROI 
Average OperatingAssets

© 2019 Cengage. All rights reserved.

 Return on Investment (2 of 2)

• Operating income refers to earnings before interest

and taxes
• Operating assets are all assets acquired to generate
operating income, including cash, receivables,
inventories, land, buildings, and equipment
• Average operating assets is computed as follows:

Average OperatingAssets 
BeginningAssets  Ending Assets 
2

© 2019 Cengage. All rights reserved.

 Margin and Turnover (1 of 3)

• A second way to calculate ROI is to separate the

formula into margin and turnover
• Margin is the ratio of operating income to sales

Operating income
ROI 
Sales

• Margin tells how many cents of operating income

result from each dollar of sales; it expresses the
portion of sales that is available for interest, taxes,
and profit
© 2019 Cengage. All rights reserved.
 Margin and Turnover (2 of 3)

• Turnover is found by dividing sales by average

operating assets

Sales
ROI 
Average OperatingAssets

• Turnover tells how many dollars of sales result from

every dollar invested in operating assets

© 2019 Cengage. All rights reserved.

 Margin and Turnover (3 of 3)
• The equation that yields ROI from the Margin and
Turnover is as follows:

• Notice that ‘‘Sales’’ in the above formula can be

cancelled out to yield the original ROI formula of
Operating Income/Average Operating Assets
© 2019 Cengage. All rights reserved.
 Example 11.1: How to Calculate Average
Operating Assets, Margin, Turnover, and
Return on Investment (1 of 2)
• Celimar Company’s Western Division earned operating
income last year as shown in the following income
statement:

• At the beginning of the year, the value of operating

assets was $277,000. At the end of the
• year, the value of operating assets was $323,000.
© 2019 Cengage. All rights reserved.
 Example 11.1: How to Calculate Average
Operating Assets, Margin, Turnover, and
Return on Investment (2 of 2)
Required:
For the Western Division, calculate the following: (1)
average operating assets, (2) margin, (3) turnover, and
(4) return on investment.

© 2019 Cengage. All rights reserved.

 Here’s How It’s Used: IN YOUR LIFE
(1 of 3)
Kumar and Francie have been study partners in
accounting since the beginning of the semester. They
meet twice a week to work through homework, test each
other on key terms, and, in general, make sure they are
up to speed on what’s required. Now, it’s 1 week before
the final exam, and the two have gotten together to map
out a strategy to study for the final exam. Francie
suggested going over all the old exams and homework
problems. She felt that would familiarize them with the
material and make sure they didn’t forget any important
areas. Kumar argued in favor of targeting problem areas
where they had had particular trouble.

© 2019 Cengage. All rights reserved.

 Here’s How It’s Used: IN YOUR LIFE
(2 of 3)
Both were aware that their time was not unlimited; they
needed to make sure that their studying resulted in the
most “bang for the buck.” They talked with their friend
Jana, the teaching assistant for their accounting class, to
get her input. Jana said both approaches had merit and
then asked what each one thought would work best for
them. Francie felt comfortable with the material overall but
wanted a little practice on the most frequently used
exercises and the accounting vocabulary. She felt that
would be the best use of her time. Kumar, on the other
hand, felt confident of his understanding of the most
recent material, but knew he

© 2019 Cengage. All rights reserved.

 Here’s How It’s Used: IN YOUR LIFE
(3 of 3)
didn’t really have a handle on certain topics from early in
the course, like process costing and budgeting. Jana
pointed out that each one had identified a process with the
highest rate of return for them. That is, by picking the
optimal strategy, each one could maximize the expected
return in terms on points on the final. She encouraged
them to start right away and go for it. Good luck, Francie
and Kumar!

© 2019 Cengage. All rights reserved.

 Advantages of Return on Investment

• At least three positive results stem from the use of

ROI:
– It encourages managers to focus on the relationship
among sales, expenses, and investment, as should be
the case for a manager of an investment center
– It encourages managers to focus on cost efficiency
– It encourages managers to focus on operating asset
efficiency

© 2019 Cengage. All rights reserved.

Disadvantages of the Return on Investment
Measure
• Overemphasis on ROI can produce myopic behavior
• Two negative aspects associated with ROI frequently
are:
– It can produce a narrow focus on divisional profitability at
the expense of profitability for the overall firm
– It encourages managers to focus on the short run at the
expense of the long run

© 2019 Cengage. All rights reserved.

 Residual Income

• Companies have adopted alternative performance

measures such as residual income
– ROI can discourage investments that are profitable for a
company but that lower a division’s ROI
• Residual income is the difference between operating
income and the minimum dollar return required on a
company’s operating assets:
Residual income = Operating income – (Minimum rate of
return × Average operating assets)

© 2019 Cengage. All rights reserved.

Example 11.2: How to Calculate Residual
Income (1 of 2)
Celimar Company’s Western Division earned
operating income last year as shown in the following
income statement:

At the beginning of the year, the value of operating

assets was $277,000. At the end of the year, the value
of operating assets was $323,000.

© 2019 Cengage. All rights reserved.

Example 11.2: How to Calculate Residual
Income (2 of 2)
Required:
For the Western Division, calculate the following: (1)
average operating assets, (2) margin, (3) turnover, and
(4) return on investment.

© 2019 Cengage. All rights reserved.

 Advantage of Residual Income

• The advantage of using residual income is that its use

encourages managers to accept any project that earns
a return that is above the minimum rate
• This prevents the fallacy of using ROI that may reject a
profitable project that reduces divisional ROI

© 2019 Cengage. All rights reserved.

 Disadvantages of Residual Income

• Residual income, like ROI, can encourage a short-run

orientation
• Unlike ROI, it is an absolute measure of profitability
• Direct comparison of the performance of two different
investment centers becomes difficult, as the level of
investment may differ
– To correct this, compute both ROI and residual income
and use both measures for performance evaluation. ROI
could then be used for interdivisional comparisons

© 2019 Cengage. All rights reserved.

 Economic Value Added (EVA)

• Another financial performance measure that is similar

to residual income is economic value added
• Economic value added (EVA) is after-tax operating
income minus the dollar cost of capital employed
– The dollar cost of capital employed is the actual
percentage cost of capital multiplied by the total capital
employed, expressed as follows:
EVA = After-Tax Operating Income – (Actual Percentage
Cost of Capital × Total Capital Employed)

© 2019 Cengage. All rights reserved.

 Example 11.3: How to Calculate
Economic Value Added (1 of 2)
Celimar Company’s Western Division earned net
income last year as shown in the following income
statement:

Total capital employed equaled $300,000. Celimar

Company’s actual cost of capital is 10%.
Required:
Calculate EVA for the Western Division.
© 2019 Cengage. All rights reserved.
Example 11.3: How to Calculate
Economic Value Added (2 of 2)

© 2019 Cengage. All rights reserved.

 Behavioral Aspects of Economic Value
Added (1 of 2)
• The key feature of EVA is its emphasis on after-tax
operating profit and the actual cost of capital
• Investors like EVA because it relates profit to the
amount of resources needed to achieve it
• EVA helps to encourage the right kind of behavior from
their divisions in a way that emphasis on operating
income alone cannot
• The underlying reason is EVA’s reliance on the true
cost of capital

© 2019 Cengage. All rights reserved.

 Behavioral Aspects of Economic Value
Added (2 of 2)
• In some companies, the responsibility for investment
decisions rests with corporate management
• As a result, the cost of capital is considered a
corporate expense rather than an expense attributable
to particular divisions
• Without an EVA analysis, the result of investments do
not show up as reducing divisional operating income
and may seem free to divisions

© 2019 Cengage. All rights reserved.

 Transfer Pricing

• In decentralized organizations, the output of one

division is used as the input of another
– The value of the transferred good is revenue to the
selling division and cost to the buying division
• This value, or internal price, is called the transfer price
– Transfer price is the price charged for a component by
the selling division to the buying division of the same
company

© 2019 Cengage. All rights reserved.

Impact of Transfer Pricing on Divisions and
the Firm as a Whole (1 of 3)
• When one division of a company sells to another
division, both divisions as well as the company as a
whole are affected
• The price charged for the transferred good affects both
– the costs of the buying division
– the revenues of the selling division
• Thus, the profits of both divisions, as well as the
evaluation and compensation of their managers, are
affected by the transfer price

© 2019 Cengage. All rights reserved.

Impact of Transfer Pricing on Divisions and
the Firm as a Whole (2 of 3)
• Since profit-based performance measures of the two
divisions are affected, transfer pricing often can be an
emotionally charged issue
• The next exhibit illustrates the effect of the transfer
price on two divisions of a company
• The selling division typically wants the transfer price to
be as high as possible while the buying division prefers
the transfer price to be as low as possible

© 2019 Cengage. All rights reserved.

 Impact of Transfer Pricing on Divisions
and the Firm as a Whole (3 of 3)
Division A Division C
Purchases component from A at
Produces component and transfers it transfer price of
to $30 per unit and uses it in production
C for transfer price of $30 per unit. of final
product.
Transfer price = $30 per unit Transfer price = $30 per unit
Revenue to A Cost to C
Increases income Decreases income
Increases ROI Decreases ROI

Note: Transfer Price Revenue = Transfer Price Cost; zero dollar impact
on ABC Inc.

© 2019 Cengage. All rights reserved.

 Transfer Pricing Policies: Market Price
(1 of 2)
• Several transfer pricing policies are used in practice,
including:
– market price
– cost-based transfer prices
– negotiated transfer prices

© 2019 Cengage. All rights reserved.

 Transfer Pricing Policies: Market Price
(2 of 2)
• If there is a competitive outside market for the
transferred product, then the best transfer price is the
market price
• Divisional managers’ actions will simultaneously
optimize divisional profits and firmwide profits
• No division can benefit at the expense of another. In
this setting, top management will not be tempted to
intervene
• The market price, if available, is the best approach to
transfer pricing

© 2019 Cengage. All rights reserved.

 Transfer Pricing Policies: Cost-Based
Transfer Prices (1 of 2)
• Frequently, there is no good outside market price
• The lack of a market price occurs because the
transferred product uses patented designs owned by
the parent company
• A company might use a cost-based transfer pricing
approach
• A transfer price at cost does not allow for any profit for
the selling division
• Top management may define cost as “cost plus,” which
allows a certain percentage to be tacked onto the cost

© 2019 Cengage. All rights reserved.

 Transfer Pricing Policies: Cost-Based
Transfer Prices (2 of 2)
• Top management may allow the selling and buying
division managers to negotiate a transfer price
• This approach is useful in cases with market
imperfections, such as an in-house division’s ability to
avoid selling and distribution costs that external market
participants would have to incur
• Using a negotiated transfer price then allows the two
divisions to share any cost savings resulting from
avoided costs

© 2019 Cengage. All rights reserved.

 Negotiated Transfer Prices: Bargaining
Range
• When using negotiated transfer prices, a bargaining
range exists
– Minimum Transfer Price (Floor): The transfer price that
would leave the selling division no worse off if the good
were sold to an internal division than if the good were
sold to an external party
 This is the “floor” of the bargaining range
– Maximum Transfer Price (Ceiling): The transfer price
that would leave the buying division no worse off if an
input were purchased from an internal division than if the
same good were purchased externally
 This is the ‘‘ceiling’’ of the bargaining range

© 2019 Cengage. All rights reserved.

 Example 11.4: How to Calculate Transfer
Price (1 of 4)
Omni Inc. has a number of divisions, including Alpha
Division, a producer of circuit boards, and Delta Division, a
heating and air-conditioning manufacturer. Alpha Division
produces the cb-117 model that can be used by Delta
Division in the production of thermostats that regulate
heating and air-conditioning systems. The market price of
the cb-117 is $14, and the full cost of the circuit board is $9.
Required:
1. If Omni has a transfer pricing policy that requires
transfer at full cost, what will the transfer price be?
Would the Alpha and Delta divisions choose to transfer
at that price?
© 2019 Cengage. All rights reserved.
Example 11.4: How to Calculate Transfer
Price (2 of 4)
2. If Omni has a transfer pricing policy that requires
transfer at market price, what would the transfer price
be? Would the Alpha and Delta divisions choose to
transfer at that price?
3. Assume Omni allows negotiated transfer pricing and
Alpha Division can avoid $3 of selling expense by
selling to Delta Division. Which division sets the
minimum transfer price, and what is it? Which division
sets the maximum transfer price, and what is it? Would
the Alpha and Delta divisions choose to transfer
somewhere in the bargaining range?

© 2019 Cengage. All rights reserved.

Example 11.4: How to Calculate Transfer
Price (3 of 4)
Solution:
1. The full cost transfer price is $9. Delta Division would
be delighted with that price, but Alpha Division would
refuse to transfer, since $14 could be earned in the
outside market.
2. The market price is $14. Both Delta and Alpha
divisions would transfer at that price (since neither
would be worse off than if it bought/sold in the outside
market).
3. Minimum transfer price = $14 – $3 = $11. This price is
set by Alpha, the selling division.

© 2019 Cengage. All rights reserved.

Example 11.4: How to Calculate Transfer
Price (4 of 4)
Maximum transfer price = $14. This price is the market
price and is set by Delta, the buying division.
Both divisions would accept a transfer price within the
bargaining range. Precisely what the transfer price would
be depends on the negotiating skills of the division
managers.

© 2019 Cengage. All rights reserved.

Here’s How It’s Used: AT KICKER (1 of 5)

Kicker’s top management is closely involved in all aspects

of the company, from design and development through
production, sales, delivery, and aftermarket activities.
Profit performance, as measured by periodic income
statements, is an important measure, but Kicker also
keeps track of a number of other measures of
performance.
For example, financial information is very important.
Financial statements are presented to the president and
vice presidents every month.

© 2019 Cengage. All rights reserved.

Here’s How It’s Used: AT KICKER (2 of 5)

These are reviewed carefully for trends and are compared

with the budgeted amounts. Worrisome increases in
expenses or decreases in revenue are analyzed to see
what the underlying factors might be.
Customer satisfaction is also continually measured. Kicker
has two major types of customers—dealers who sell
Kicker products and end users who have Kicker car
speakers installed. Each customer type has specific
needs.

© 2019 Cengage. All rights reserved.

Here’s How It’s Used: AT KICKER (3 of 5)

For example, dealers have the exclusive right to sell

Kicker products and Kicker offers a 1-year warranty on
speakers sold through a dealer. However, end users want
as low a price as possible and will occasionally find
speakers available on the Internet (called “gray market”
speakers because the seller is not authorized to sell
them). In the past, no warranty was available on
nondealer-sold speakers, but problems arose when
customers purchased obviously new products through the
Internet, and they were not covered under warranty when
something went wrong.

© 2019 Cengage. All rights reserved.

Here’s How It’s Used: AT KICKER (4 of 5)

Kicker therefore decided to offer a shorter warranty for

new products sold by unauthorized sellers in order to keep
the customer base happy and increase satisfaction.
Kicker focuses on strategic objectives for the long term.
For example, engineers in R&D take continuing education
to stay current in their fields. When Kicker approached
producing and selling original equipment manufacture
(OEM) speakers to a major automobile maker, a number
of employees had to learn International Organization for
Standardization quality concepts quickly.

© 2019 Cengage. All rights reserved.

Here’s How It’s Used: AT KICKER (5 of 5)

International Organization for Standardization (ISO)

quality concepts quickly. They took classes, met with
consultants, and traveled to the site of other ISO-qualified
firms to learn how to meet quality standards.

© 2019 Cengage. All rights reserved.

Appendix 11A: The Balanced Scorecard—
Basic Concepts (1 of 2)
• Segment income, ROI, residual income, and EVA are
important measures of managerial performance, but
they lead managers to focus only on dollar figures
• The Balanced Scorecard translates an organization’s
mission and strategy into operational objectives and
performance measures for the following four
perspectives:
– The financial perspective describes the economic
consequences of actions taken in the other three
perspectives

© 2019 Cengage. All rights reserved.

 Appendix 11A: The Balanced Scorecard—
Basic Concepts (2 of 2)
• The financial perspective describes the economic
consequences of actions taken in the other three
perspectives
• The customer perspective defines the customer and
market segments in which the business unit will compete
• The internal business process perspective describes
the internal processes needed to provide value for
customers and owners
• The learning and growth (infrastructure) perspective
defines the capabilities that an organization needs to
create long-term growth and improvement

© 2019 Cengage. All rights reserved.

The Balanced Scorecard—An
Example (1 of 2)
Objective Measure

Financial Perspective

Operating Revenues Total daily operating revenue

Revenue per available room

Operating Costs Operating expenses relative to budget

Cost per occupant

Customer Perspective

Customer Satisfaction Customer satisfaction ratings

Number of monthly complaints

Customer Loyalty Number of new reward club members

Percent of returning guests

Internal Perspective

Employee Turnover Employee turnover rate

© 2019 Cengage. All rights reserved.

 The Balanced Scorecard—An
Example (2 of 2)

Objective Measure

Number of employee complaints

Response to Customer Complaint Percentage of complaints receiving response

Average response time

Learning and Growth

Growth in reward club membership for new demographic
New Market Identification
segments
Employee Training and Advancement Percentage of employees participating in training courses

Survey scores pre- and post-training sessions

© 2019 Cengage. All rights reserved.

 Strategy Translation (1 of 2)

• Strategy specifies management’s desired relationships

among the four perspectives
• Strategy translation means specifying objectives,
measures, targets, and initiatives for each perspective
• Here is an example for the financial perspective
– Objective: For the financial perspective, a company’s
objective may be to grow revenues by introducing new
products

© 2019 Cengage. All rights reserved.

 Strategy Translation (2 of 2)
– Measure: The performance measure may be the
percentage of revenues from the sale of new products
– Target: The target or standard for the coming year for
the measure may be 20% (i.e., 20% of the total
revenues for the coming year must be from the sale of
new products)
– Initiative: The initiative describes how this is to be
accomplished. The “how,” of course, involves the other
three perspectives

© 2019 Cengage. All rights reserved.

The Role of Performance Measures (1 of 2)

• The Balanced Scorecard is not simply a collection of

critical performance measures
• The performance measures are derived from a
company’s vision, strategy, and objectives

© 2019 Cengage. All rights reserved.

The Role of Performance Measures (2 of 2)

• These measures must be balanced between the

following measures:
– performance driver measures (i.e., lead indicators of
future financial performance) and outcome measures
(i.e., lagged indicators of financial performance)
– objective and subjective measures
– external and internal measures
– financial and nonfinancial measures

© 2019 Cengage. All rights reserved.

Linking Performance Measures to Strategy
(1 of 2)
• Balancing outcome measures with performance drivers
is essential to linking with the organization’s strategy
• Performance drivers make things happen and are
indicators of how the outcomes are going to be realized

© 2019 Cengage. All rights reserved.

Linking Performance Measures to Strategy
(2 of 2)
• Outcome measures are also important because they
reveal whether the strategy is being implemented
successfully with the desired economic consequences
• A testable strategy can be defined as a set of linked
objectives aimed at an overall goal

© 2019 Cengage. All rights reserved.

Here’s How It’s Used: SUPPLIER SUSTAINABILITY
SCORECARDS AT WALMART (1 of 4)
Over the past decade, Wal-Mart has developed a
systematic approach to improving its sustainability
initiatives. One area that has caused real change is its
emphasis on improving supplier sustainability. Wal-Mart
has suppliers fill out a Supplier Sustainability Assessment,
a series of questions on their use of materials, waste, and
their own supply chain. Suppliers are ranked from best to
worst in each subcategory, and these results are shared
with Wal-Mart buyers to use in their purchasing decisions.
As a result, many suppliers have worked to decrease their
waste.

© 2019 Cengage. All rights reserved.

Here’s How It’s Used: SUPPLIER SUSTAINABILITY
SCORECARDS AT WALMART (2 of 4)
Miller Coors, for example, has worked with its barley
farmers to decrease their use of water and pesticides.
Wal-Mart has worked to reduce its carbon footprint
through reductions in energy usage of the Wal-Mart and
Sam’s Club truck fleets. Three opportunities for efficiency
were optimizing how trailers are loaded and filled,
reducing overall miles by optimizing routes, and
technology improvements to improve efficiency and
reduce emissions. Over a 5-year period, expected savings
of $300 million per year were exceeded, with savings of
almost $1 billion.

© 2019 Cengage. All rights reserved.

Here’s How It’s Used: SUPPLIER SUSTAINABILITY
SCORECARDS AT WALMART (3 of 4)
Carbon dioxide emission avoidance of about 650,000
metric tons was achieved.
As the company announced today, it has achieved Lee
Scott’s fleet-efficiency goal. And Scott’s cost-saving
estimate turned out to be grossly underestimated. The
combined efforts of changing loading, routing and driving
techniques, as well as collaborating with tractor and trailer
manufacturers on new technologies will save the company
nearly $1 billion this fiscal year alone. Compared to a
2005 baseline, this is more than three times Scott’s
projection at the time.

© 2019 Cengage. All rights reserved.

Here’s How It’s Used: SUPPLIER SUSTAINABILITY
SCORECARDS AT WALMART (4 of 4)
And it will avoid emissions of nearly 650,000 metric tons of
carbon dioxide.
Sources: Mark Gunther, “Game On: Why Walmart Is Ranking Suppliers on
Sustainability,” GreenBiz (April 15, 2013). Taken from
https://www.greenbiz.com/blog/2013/04/15/game-why-walmart-ranking-
suppliers-sustainability. Joel Makower, “Walmart Sustainability at 10: An
Assessment,” GreenBiz (November 17, 2015). Taken from
https://www.greenbiz.com/article/ walmart-sustainability-10-assessment.

© 2019 Cengage. All rights reserved.

A Testable Strategy Example

© 2019 Cengage. All rights reserved.

 Invalid Strategy (1 of 2)

• If the targeted levels of performance drivers were

achieved and the expected outcomes did not
materialize, then the problem could very well lie with
the strategy itself
– Double-loop feedback occurs whenever managers
receive information about both the effectiveness of
strategy implementation as well as the validity of the
assumptions underlying the strategy

© 2019 Cengage. All rights reserved.

 Invalid Strategy (2 of 2)

• In a functional-based responsibility accounting

system, typically only single-loop feedback is provided
– Single-loop feedback emphasizes only effectiveness
of implementation
– In single-loop feedback, actual results deviating from
planned results are a signal to take corrective action
so that the plan (strategy) can be executed as
intended

© 2019 Cengage. All rights reserved.

 The Four Perspectives and Performance
Measures
• The four perspectives define the strategy of an
organization and provide the structure or framework for
developing an integrated, cohesive set of performance
measures
• These measures become the means for articulating
and communicating the strategy of the organization to
its employees and managers
• The measures also serve the purpose of aligning
individual objectives and actions with organizational
objectives and initiatives

© 2019 Cengage. All rights reserved.

 The Financial Perspective
Objective Measure

Revenue Growth:

Increase the number of new products Percentage of revenue from new products

Create new applications Percentage of revenue from new applications

Develop new customers and markets Percentage of revenue from new sources

Adopt a new pricing strategy Product and customer profitability

Cost Reduction:

Reduce unit product cost Unit product cost

Reduce unit customer cost Unit customer cost

Reduce distribution channel cost Cost per distribution channel

Asset Utilization:

Improve asset utilization Return on investment

Economic value added

© 2019 Cengage. All rights reserved.

 Customer Perspective (1 of 2)

• The customer perspective is the source of the revenue

component for the financial objectives
• It defines and selects the customer and market
segments in which the company chooses to compete

© 2019 Cengage. All rights reserved.

Customer Perspective (2 of 2)
Objective Measure
Core:
Increase market share Market share (percentage of market)
Percentage growth of business from
Increase customer retention
existing customers
Percentage of repeating customers
Increase customer acquisition Number of new customers
Increase customer satisfaction Ratings from customer surveys
Increase customer profitability Customer profitability
Customer Value:
Decrease price Price
Decrease post-purchase costs Post-purchase costs
Improve product functionality Ratings from customer surveys
Improve product quality Percentage of returns
On-time delivery percentage
Increase delivery reliability
Aging schedule
Improve product image and
Ratings from customer surveys
reputation

© 2019 Cengage. All rights reserved.

 Internal (Process) Perspective (1 of 4)

• The internal perspective focuses on identifying the

organization’s core internal business processes
needed for creating customer and shareholder value to
achieve the customer and financial objectives

© 2019 Cengage. All rights reserved.

 Internal (Process) Perspective (2 of 4)
• The framework needed for this perspective is the
process value chain, which is made up of three
processes:
– The innovation process anticipates the emerging and
potential needs of customers and creates new products
and services to satisfy those needs. It represents what is
called the long-wave of value creation
– The operations process produces and delivers existing
products and services to customers. It begins with a
customer order and ends with the delivery of the product
or service. It is the short-wave of value creation

© 2019 Cengage. All rights reserved.

Internal (Process) Perspective (3 of 4)
– The post-sales service process provides critical and
responsive services to customers after the product or
service has been delivered

© 2019 Cengage. All rights reserved.

Internal (Process) Perspective (4 of 4)
Objective Measure
Innovation:
Increase the number of new products Number of new products vs. planned
Increase proprietary products Percentage revenue from proprietary products
Decrease new product development time Time to market (from start to finish)
Operations:
Increase process quality Quality costs
Output yields
Percentage of defective units
Increase process efficiency Unit cost trends
Output/input(s)
Decrease process time Cycle time and velocity MCE
Post-Sales Service:
Increase service quality First-pass yields
Increase service efficiency Costs trends
Output/input
Decrease service time Cycle time

© 2019 Cengage. All rights reserved.

Responsiveness: Cycle Time and Velocity
(1 of 2)
• The time to respond to a customer order is referred to
as responsiveness. Cycle time and velocity are two
operational measures of responsiveness
– Cycle time is the length of time it takes to produce a unit
of output from the time raw materials are received
(starting point of the cycle) until the good is delivered to
finished goods inventory (finishing point of the cycle)
 Thus, cycle time is the time required to produce a product
(Time ÷ Units produced)

© 2019 Cengage. All rights reserved.

Responsiveness: Cycle Time and Velocity
(2 of 2)
– Velocity is the number of units of output that can be
produced in a given period of time (Units produced ÷
Time)

© 2019 Cengage. All rights reserved.

Example 11.5: How to Compute Cycle Time
and Velocity (1 of 2)
A company has the following data for one of its
manufacturing cells:
Maximum units produced in a quarter (3-month period):
200,000 units
Actual units produced in a quarter: 160,000 units
Productive hours in one quarter: 40,000 hours
Required:
1. Compute the theoretical cycle time (in minutes).
2. Compute the actual cycle time (in minutes).
3. Compute the theoretical velocity in units per hour.
4. Compute the actual velocity in units per hour.
© 2019 Cengage. All rights reserved.
Example 11.5: How to Compute Cycle Time
and Velocity (2 of 2)
Solution:
1. Theoretical Cycle Time = (40,000 hours)(60 minutes
per hour)/200,000 units = 12 minutes per unit
2. Actual Cycle Time = (40,000 hours)(60 minutes per
hour)/160,000 units = 15 minutes per unit
3. Theoretical Velocity = 60 minutes per hour/12 minutes
per unit = 5 units per hour (Or, 200,000 units per
quarter/40,000 hours per quarter = 5 units per hour)
4. Actual Velocity = 60 minutes per hour/15 minutes per
unit = 4 units per hour (Or 160,000 units per
quarter/40,000 hours per quarter = 4 units per hour)

© 2019 Cengage. All rights reserved.

 Manufacturing Cycle Efficiency (1 of 2)

• Another time based operational measure calculates

MCE (manufacturing cycle efficiency)
• MCE is measured as:

Value - added Time

Total Time

– Total time includes both value-added time (the time

spent efficiently producing the product) and nonvalue-
added time (such as move time, inspection time, and
waiting time)

© 2019 Cengage. All rights reserved.

 Manufacturing Cycle Efficiency (2 of 2)

• The formula for computing MCE is:

Processing Time
MCE 
Processing Time  Move Time  Inspection Time  Waiting Time

© 2019 Cengage. All rights reserved.

 Example 11.6: How to Calculate
Manufacturing Cycle Efficiency (1 of 2)
A company provided the following information:
Maximum units produced in a quarter (3-month period):
200,000 units
Actual units produced in a quarter: 160,000 units
Productive hours in one quarter: 40,000 hours
Actual cycle time = 15 minutes
Theoretical cycle time = 12 minutes
Required:
1. Calculate the amount of processing time and the
amount of nonprocessing time.
2. Calculate MCE.
© 2019 Cengage. All rights reserved.
 Example 11.6: How to Calculate
Manufacturing Cycle Efficiency (2 of 2)
Solution:
1. Processing time is equal to theoretical cycle time. That
is, if everything goes smoothly and there is no wasted
time, it takes 12 minutes to produce one unit.
Nonprocessing time, therefore, must be the difference
between actual cycle time (which includes some
waste) and theoretical cycle time.
Processing Time = Theoretical Cycle Time = 12 minutes
2. Nonprocessing Time = Actual Cycle Time – Theoretical
Cycle Time = 15 – 12 = 3 minutes
MCE = Processing Time/(Processing Time +
Nonprocessing Time) = 12/(12 + 3) = 0.8, or 80%
© 2019 Cengage. All rights reserved.
 Learning and Growth Perspective (1 of 3)
• The learning and growth perspective, which represents
the source of the capabilities that enable the
accomplishment of the other three perspectives’
objectives
• This perspective has three major objectives:
– increase employee capabilities
– increase motivation, empowerment, and alignment
– increase information systems capabilities

© 2019 Cengage. All rights reserved.

 Learning and Growth Perspective (2 of 3)
• Employees must not only have the necessary skills, but
they must also have the freedom, motivation, and initiative
to use those skills effectively
• Increasing information system capabilities means
providing more accurate and timely information to
employees so that they can improve processes and
effectively execute new processes

© 2019 Cengage. All rights reserved.

Learning and Growth Perspective (3 of 3)

Objective Measure
Employee Capabilities: Employee satisfaction ratings
Increase employee capabilities Employee productivity (Revenue/Employee)
Hours of training
Strategic job coverage ratio (percentage of
critical job requirements filled)
Motivation: Suggestions per employee
Increase motivation and alignment Suggestions implemented per employee
Information Systems Capabilities: Percentage of processes with real-time
Increase information systems feedback capabilities
capabilities Percentage of customer-facing employees
with online access to customer and product
Information

© 2019 Cengage. All rights reserved.