Topic 3

Topic 3
Performance Evaluation and

Decentralization
Mowen/Hansen/Heitger, Managerial Accounting: The Cornerstone of Business Decision Making, 7th Edition. © 2018 Cengage.
All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part
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
Mowen/Hansen/Heitger, Managerial Accounting: The Cornerstone of Business Decision Making, 7th Edition. © 2018 Cengage. All
Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part
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
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
Centralization and Decentralization
Reasons for Decentralization
• Firms decide to decentralize for several reasons, including the following:
o ease of gathering and using local information
o focusing of central management
o training and motivating of segment managers
o enhanced competition, exposing segments to market forces
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:
o types of goods or services
o geographic lines
o responsibility centers
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
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
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
Responsibility Centers (2 of 2)
• The four major types of responsibility centers are as follows:
o Cost center: Manager is responsible only for costs
o Revenue center: Manager is responsible only for sales, or revenue
o Profit center: Manager is responsible for both revenues and costs
o Investment center: Manager is responsible for revenues, costs, and investments
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
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
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?
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.).
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.
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.
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.
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 Operating Assets
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:
AverageOperating Assets =
( Beginning Assets + Ending Assets )
2
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
• Turnover is found by dividing sales by average operating assets
Sales
ROI =
• Turnover tells how many dollars of sales result from every dollar invested in
operating assets
• 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
Example 11.1: How to Calculate Average Operating
Assets, Margin, Turnover, and Return on Investment (1 of 3)
• Celimar Company’s Western Division earned operating income last year as
shown in the following income statement:
Sales $480,000
Cost of goods sold (222,000)
Gross margin $258,000
Selling and administrative expense (210,000)
Operating income $ 48,000
• 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.
Required:
For the Western Division, calculate the following: (1) average operating assets,
(2) margin, (3) turnover, and (4) return on investment.
Solution:
1. Average Operating Assets =
2
=
( $277,000 + $323,000 )
2
= $300,000
Operating Income $48,000

2. Margin = =
Sales $480,000
= 0.10, or 10 %
3.
Sales $480,000
Turnover = = = 1.6
Average Operating Assets $300,000
4. ROI = Margin × Turnover = 0.10 × 1.6 = 0.16, or 16%
Note: ROI can also be calculated as:

Operating Income
ROI =
$48,000
=
$300,000
= 0.16, or 16%
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.
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
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!
Advantages of Return on Investment
• At least three positive results stem from the use of ROI:
o 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
o It encourages managers to focus on cost efficiency
o It encourages managers to focus on operating asset efficiency
Disadvantages of the Return on Investment Measure
• Overemphasis on ROI can produce myopic behavior
• Two negative aspects associated with ROI frequently are:
o It can produce a narrow focus on divisional profitability at the expense of
profitability for the overall firm
o It encourages managers to focus on the short run at the expense of the long run
Residual Income
• Companies have adopted alternative performance measures such as
residual income
o 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)
Example 11.2: How to Calculate Residual Income (1 of 3)
Celimar Company’s Western Division earned operating income last year as
shown in the following income statement:
Sales $480,000
Cost of goods sold (222,000)
Selling and administrative expense (210,000)
Operating income $48,000
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.
Required:
For the Western Division, calculate the following: (1) average operating assets,
(2) margin, (3) turnover, and (4) return on investment.
Solution:
=
1. Average Operating Assets
2
= ( $277,000 + $323,000 )
2
= $300,000
(Minimum Rate of Return 
2. Residual Income = Operating Income −
Average Opening Assets)
= $48,000 − ( 0.12  $300,000 )
= $48,000 − $36,000
= $12,000
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
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
o To correct this, compute both ROI and residual income and use both measures
for performance evaluation. ROI could then be used for interdivisional
comparisons
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
o 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)
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:
Sales $480,000
Cost or goods sold 222,000
Selling and administrative expense 210,000
Operating income $48,000
Less: Income taxes (@ 30%) 14,400
Net income $33,600
Total capital employed equaled $300,000. Celimar Company’s actual cost of
capital is 10%.
Required:
Calculate EVA for the Western Division.
Example 11.3: How to Calculate Economic Value
Added (2 of 2)
Solution:
EVA = After-Tax Operating Income

− ( Actual Percentage Cost of Capital  Total Capital Employed )
= $33,600 − ( 0.10  $300,000 )

= $33,600 − $30,000
= $3,600
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
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
Transfer Pricing
• In decentralized organizations, the output of one division is used as the input
of another
o 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
o Transfer price is the price charged for a component by the selling division to the
buying division of the same company
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
o the costs of the buying division
o 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
• 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
Division A Division C
Purchases component from A at transfer price of
Produces component and transfers it to
$30 per unit and uses it in production of final
C for transfer price of $30 per unit.
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.
Transfer Pricing Policies: Market Price (1 of 2)
• Several transfer pricing policies are used in practice, including:
o market price
o cost-based transfer prices
o negotiated transfer prices
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
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
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
Negotiated Transfer Prices: Bargaining Range
• When using negotiated transfer prices, a bargaining range exists
o 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
o 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
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?
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?
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.
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.
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.
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.
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.
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.
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.
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:
o The financial perspective describes the economic consequences of actions
taken in the other three perspectives
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
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
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
New Market Identification
demographic segments
Percentage of employees participating in
Employee Training and Advancement
training courses
Survey scores pre- and post-training
sessions
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
o Objective: For the financial perspective, a company’s objective may be to grow
revenues by introducing new products
Strategy Translation (2 of 2)
o Measure: The performance measure may be the percentage of revenues from
the sale of new products
o 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)
o Initiative: The initiative describes how this is to be accomplished. The “how,” of
course, involves the other three perspectives
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
The Role of Performance Measures (2 of 2)
• These measures must be balanced between the following measures:
o performance driver measures (i.e., lead indicators of future financial
performance) and outcome measures (i.e., lagged indicators of financial
performance)
o objective and subjective measures
o external and internal measures
o financial and nonfinancial measures
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
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
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.
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.
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.
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/. Joel Makower, “Walmart Sustainability at 10:
An Assessment,” GreenBiz (November 17, 2015). Taken from
https://www.greenbiz.com/article/.
A Testable Strategy Example
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
o 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
Invalid Strategy (2 of 2)
• In a functional-based responsibility accounting system, typically only
single-loop feedback is provided
o Single-loop feedback emphasizes only effectiveness of implementation
o 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
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
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
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
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
Increase delivery reliability On-time delivery percentage Aging schedule
Improve product image and reputation Ratings from customer surveys
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
• The framework needed for this perspective is the process value chain,
which is made up of three processes:
o 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
o 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
o The post-sales service process provides critical and responsive services to
customers after the product or service has been delivered
Objective Measure
Innovation:
Increase the number of new products Number of new products versus 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
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
o 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)
Responsiveness: Cycle Time and Velocity (2 of 2)
o Velocity is the number of units of output that can be produced in a given period
of time (Units produced ÷ Time)
Example 11.5: How to Compute Cycle Time and
Velocity (1 of 3)
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.
Velocity (2 of 3)
Solution:
1. Theoretical Cycle Time =
( 40,000 hours )( 60 minutes per hour )
200,000 units
= 12 minutes per unit
Actual Cycle Time =

( 40,000 hours )( 60 minutes per hour )
= 15 minutes per unit
2.
160,000units
60 minutes per hour
3. Theoretical Velocity = = 5 units per hour (Or,
12 minutes per unit
200,000 units per quarter
= 5 units per hour)
40,000 hours per quarter
Velocity (3 of 3)
60 minutes per hour
4. Actual Velocity = = 4 units per hour (Or
15 minutes per unit
160,000 units per quarter
= 4 units per hour)
40,000 hours per quarter
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
o 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)
Manufacturing Cycle Efficiency (2 of 2)
• The formula for computing MCE is:
Processing Time
MCE =
Processing Time + Move Time + Inspection Time + Waiting Time
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.
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
Processing Time 12
MCE = = = 0.8, or 80%
(Processing Time + NonprocessingTime) (12 + 3 )
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:
o increase employee capabilities
o increase motivation, empowerment, and alignment
o increase information systems capabilities
• 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
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 capabilities feedback capabilities
Percentage of customer-facing employees with
online access to customer and product
Information
End

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