Chapter 17-18: Management Control & Performance Measurement

1. Chapter 17-18: Management Control & Performance Measurement Joseph Bao Sarah Lehman Stanley Chan Stanley Htun

2. What is a Balanced Score Card? Why did this method evolve? • A BSC is a comprehensive performance report that monitors both financial and nonfinancial critical success factors for a firm to ensure that the company’s overall strategy is achieved. • Emphasized link between measurements and company strategy • Reflects changing nature of business / competitive advantage • Tangible assets – Inventory, PP&E • 1982 : Tangible book values represented 62% of industrial organizations’ market values • End of 1990s : Accounted for less than 20%!

3. How can the balanced scorecard be used to supplement conventional financial reporting? Through the combined use of both the financial critical success factors as well as other group so critical success factors such as: • Customer perspective : Customer satisfaction, Quality (customer complaints) • Internal process perspective : Productivity, Flexibility (set up and cycle times) • Learning and innovation. : Product innovation, employee morale, competence

4. Give an example of a nonprofit or governmental organization that uses the BSC and explain how it links the scorecard to its overall strategy? • City of Charlotte, NC • United Way of Southeastern New England In the examples mentioned, these NPGO’s chose a customer-based strategy in order to create a real competitive advantage. • Two types of customers – payers vs. consituents • Mission Statement vs. Financial/Shareholder maximization drives the strategy.

5. What is a Key Performance Indicator (KPI) scorecard and how does it differ from a balanced scorecard? • KPI scorecards tend to focus on a diverse group of metrics which may, or may not, be critical to the overall success of the strategy of the company. They are most useful for teams or departments when a strategic program already exists at a higher level.

6. Explain the strategy map and how it is used.

8. Case 17-5 Contribution Income Statement(page 17-9) Presented by Stanley Htun

9. Cathy’s Classic Clothes • Company is divided into regions, districts, and stores • Management By Objectives (MBO) • Responsibility Accounting System • Bonus System to Store Manager Based on Top-line or Bottom-line

10. Organizational Structure Regions: Districts: Stores: Store 1 District A Store 2 Northeast Store 3 District B Store 4 South Store 5 Store 6

11. Bonus System • District A Underperforming • Store 1: Bonus based on Actual Revenue in excess of Budgeted ($570,000) • Store 2: Bonus based on Actual Net Income in excess of Budgeted ($63,600) • Store 3: Not Participating

12. Data: May-2004

14. Consequence of Bonus System • Bonus based on sales → Lots of spending on Advertising to increase Sales • Bonus based on net income → Very little Advertising and inadequate Maintenance

15. Why Contribution Income Statement? • Separate Controllable and Uncontrollable • Separate Traceable and Untraceable

17. How to measure Performance? • Must measure manager’s performance by Controllable Margin • Must measure store’s performance by SBU Contribution

18. Chapter 18: Transfer Pricing with ABS(page 18-13) Presented by Stanley Chan

19. Background • Teva Pharmacutical Industries Ltd. entered the generic drug market in the mid-1980s, and wanted to vie globally in the competitive market. • Teva reorganized its pharmaceutical operations into decentralized cost and profit centers consisting of one operations division (made up of our manufacturing plants) and three marketing divisions. • The manufacturing plants produce to the orders place by the marketing divisions.

20. Teva’s managers decided to introduce a transfer pricing system to enhance profit consciousness and improve coordination between operations and marketing.

21. Why did Teva introduce transfer pricing? • Transfer Pricing: the determination of an exchange price for a product or service when different business units within a firm exchange it. • Enhance profit consciousness • Improve coordination between operations and marketing • Concerned with excessive proliferation of the product line, acceptance of man low-volume orders, and associated large consumption of production capacity for changeovers.

22. What were the goals of the transfer pricing system? • What Top Management Wanted • The transfer price should not encourage actions that improved the profit or cost performance of a division at the expense of Teva’s overall profitability

23. What Division Managers Wanted • Managers could influence the reported performance of their divisions by making business decisions within their scope of authority • Changes in product mix • Improved efficiency • Investments in new equipment • Organizational changes

24. What The Financial Staff Wanted: • The transfer pricing system would be used for internal charging of costs from the operations division to the marketing divisions

25. Why did traditional approaches for transfer pricing not work at Teva, and why did the ABC approach work instead? • Market Price for the transferred product was not feasible because no market existed for Teva’s manufactured and packaged pharmaceutical products that had not been distributed or marketed to customers

26. Teva utilized ABC because it provides better costing information and helps management manage efficiently and gain a better understanding of the firm’s competitive advantages, strengths, and weaknesses. ABC has the most impact on firms that produce numerous products. • Teva produces both high-volume and low-volume products

27. How did the ABC transfer pricing system incorporate batch level costs? Product level costs? Plant level costs? • Unit-Level costs represent all the direct expenses associated with producing individual product units such as tablets, capsules, and ampoules. • Marketing divisions are charged for Unit-Level Expenses (raw materials, packaging materials, and direct wages paid to production workers) based on the actual quantities of each individual product they acquire

28. Batch-Level costs include the expenses of resources used for each production or packaging batch, mainly the costs of preparation, setup, cleaning, quality control, laboratory testing, and computer and production management • Marketing divisions are charged Batch-Level costs based on the actual number of production and packaging batches of each product they order • Product-Specific costs include the expenses incurred in registering the products, making changes to a product’s production processes, and designing the package • These are charged to marketing divisions annually based on the budget

29. Plant-Level costs represent the cost of maintaining the capacity of production lines including depreciation, cost of safety inspections, and insurance, as well as the general expenses of the plant such as security and landscaping • These are charged to marketing divisions annually based on the budget

30. What are some of the benefits of the ABC transfer pricing system at Teva? • Highlights unused capacity to reveal where production can be expanded without spending additional money • Motivates cost reduction and production efficiencies in the manufacturing plants • Managers in different divisions work together to identify ways to reduce Unit and Batch-Level expenses • ABC information helps managers determine which manufacturing facility is appropriate for different types of products • Measure profit performance under changing organizational structures • Financial managers can forecast the potential performance of newly created profit centers and reconstruct what the past profit performance history would have been