ACCG 330 Melbourne Institute of Technology Company Strategic Advantage Paper

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ACCG330 WEEKLY ASSIGNMENTS Due Date (1pm each Tuesday – submit via turnitin) TOPIC Week 2 Introduction to Strategic Management Accounting………………….. page 2 Case: Wal-Mart. (Due 1pm 2nd March – submit via turnitin) Week 3 Strategic process and strategic analysis .......................................... page 5 Case: Vershire Company Case (Due 1pm 9th March – submit via turnitin) Week 4 Strategy and management control. ............................................ page 6 Case: Lincoln Electric (Due 1pm 16th March – submit via turnitin) Week 5 No assignment is due this week. Students will engage with a case in groups in class. Week 6 Activity based costing ......................................................................... page 7 Case: Seneca Foods (Due 1pm 30th March – submit via turnitin) Week 7 Assessing and managing performance over the value chain ........... page 9 Case: Mercedes-Benz (Due 1pm 20th April – submit via turnitin) Week 8 Financial measures of performance.................................................... page 13 Case: The Kinkead Equipment Company Ltd (Due 1pm 27th April – submit via turnitin) Week 9 Non-financial measures of performance ........................................... page 17 Case: Chadwick Inc: The Balanced Scorecard (Due 1pm 4th May – submit via turnitin) Week 10 No classes – work on group report due 5pm on Friday 14 th May Week 11 Strategic and behavioural aspects of capital expenditure evaluations…page 22 Case: Mavis Machine Shop (Due 1pm 18th May – submit via turnitin) Week 12 Group research proposal presentations Week 13 No classes 1 Week 2 Assignment INTRODUCTION TO STRATEGIC MANAGEMENT ACCOUNTING 1. Read the Case ‘Wal-Mart’ and answer the questions given at the end of the case. WAL-MART STORES, INC. Founded by Sam Walton, the first Wal-Mart store opened in Rogers, Arkansas, in 1962. Seventeen years later, annual sales topped $1billion. By the end of January 2005, Wal-Mart Stores, Inc. (Wal-Mart) was the world’s largest retailer, with $288 billion in sales (see Exhibit 1 for comparative financial data). In 1995, Wal-Mart sold no grocery; by 2005, the company was the market leader among supermarkets in the U.S. Wal-Mart was the largest private-sector employer in the world. The information technology that powered Wal-Mart’s supply chain and logistics was the most powerful, next only to the computer capability of the Pentagon. The company owned over 20 aircrafts – which were used by managers to travel to its stores in far-flung locations. The number of miles flown by Wal-Mart managers in the company-owned aircrafts would place WalMart on par with a medium sized commercial airline. Wal-Mart had the largest privately owned satellite communication network in the U.S. and broadcasted more television than any network TV. Wal-Mart’s winning strategy in the U.S. was based on selling branded products at low cost. Each week, about 138 million customers visited a Wal-Mart store somewhere in the world. The company employed more than 1.6 million associates (Wal-Mart’s term for employees) worldwide through more than 3,700 stores in the United States and more than 1,600 units in Mexico, Puerto Rico, Canada, Argentina, Brazil, China, Korea, Germany, and the United Kingdom. (The first international store opened in Mexico City in 1991.) Wal-Mart also obtained a 38% controlling share in the Japanese retail chain Seiyu in order to capture a slice of the world’s second largest market estimated at $1.3 trillion. In 2002, Wal-Mart was presented with the Ron Brown award for corporate leadership, a presidential award that recognizes companies for outstanding achievement in employee and community relations. In 2004, Fortune magazine placed Wal-Mart in the top spot on its “Most Admired Companies” list for the second year in a row. By 2005, Wal-Mart held an 8.9% retail store market share in the United States. Put simply, of every $100 that Americans spent in retail stores, $8.90 was spent in Wal-Mart. Procter & Gamble, Clorox, and Johnson & Johnson were among its nearly 3,000 suppliers. Though Wal-Mart may have been the top customer for consumer product manufacturers, it deliberately ensured it did not become too dependent on any one supplier; no single vendor constituted more than 4% of its overall purchase volume. In order to drive up supply chain efficiencies, Wal-Mart had also persuaded its suppliers to have electronic ‘hook-ups’ with its stores and adapt to the latest supply chain technologies like RFID which could increase monitoring and management of the inventory. Wal-Mart used a ‘saturation’ strategy for store expansion. The standard was to be able to drive from a distribution centre to a store within a day. A distribution centre was strategically placed so that it could eventually serve 150-200 stores within a day. Stores were built as far as way as possible but still within a day’s drive of the distribution centre; the area was then filled back (or saturated back) to the distribution centre. Each distribution centre operated 24 hours a day using laser-guided conveyor belts and cross-docking techniques that received goods on one side while simultaneously filling orders on the other. Wal-Mart’s distribution system was so efficient that they incurred only 1.3% of sales as distribution costs compared to 3.5% for their nearest competitor. The company owned a fleet of more than 6,100 trailer trucks and employed over 7,600 truck drivers making it one of the largest trucking companies in the United States. (Most competitors outsourced trucking.) Wal-Mart had implemented a satellite network system that allowed information to be shared between the company’s wide network of stores, distribution centres, and suppliers. The system consolidated orders for goods, enabling the company to buy full truckload quantities without incurring the inventory costs. 2 In its early years, Wal-Mart’s strategy was to build large discount stores in small rural towns. By contrast, competitors such as K-Mart focused on large towns with populations greater than 50,000. Wal-Mart’s marketing strategy was to guarantee ‘everyday low prices’ as a way to pull in customers. Traditional discount retailers relied on advertised ‘sales’. Management Systems Each store constituted an investment centre and was evaluated on its profits relative to its inventory investments. Data from over 5,300 individual stores on items such as sales, expenses, and profit and loss were collected, analyzed, and transmitted electronically on a real-time basis, rapidly revealing how a particular region, district, store, department within a store, or item within a department was performing. The information enabled the company to reduce the likelihood of stock-outs and the need for markdowns on slow moving stock, and to maximize inventory turnover. The data from outstanding performers among 5,300 stores were used to improve operations in ‘problem’ stores. One of the significant costs for retailers was shoplifting, or pilferage. Wal-Mart addressed this issue by instituting a policy that shared 50% of the savings from decreases in a store’s pilferage in a particular store, as compared to the industry standard, among that store’s employees through store incentive plans. Early in Wal-Mart’s history, Sam Walton implemented a process requiring store managers to fillout “Best Yesterday” ledgers. These relatively straightforward forms tracked daily sales performance against the numbers from one year prior. Recalled Walton, “We were really trying to become the very best operators – the most professional managers – that we could ……. I have always had the soul of an operator, someone who wants to make things work well, then better, then the best they possibly can.” His organization was really a “store within a store”, encouraging department managers to be accountable and giving them an incentive to be creative. Succesful experiments were recognized and applied to other stores. One example was the “people greeter”, an associate who welcomed shoppers as they entered the store. Theses greeters not only provided a personal service, their presence served to reduce pilferage. The “10-foot attitude” was another customer service approach Walton encouraged. When the founder visited his stores, he asked associated to make a pledge, telling them “I want you to promise that whenever you come within 10 feet of a customer, you will look him in the eye, greet him, and ask him if you can help him”. In return for employees’ loyalty and dedication, Walton began offering profit sharing in 1971. “Every associate that had been with us for at least one year, and who worked at least 1,000 hours a year, was eligible for it”, he explained. “Using a formula based on profit growth, we contribute a percentage of every eligible associate’s wages to his or her plan, which the associate can take when they leave the company, either in cash or in Wal-Mart stock”. In fiscal 2005, Wal-Mart’s annual company contribution totaled $756 million. Wal-Mart also constituted several other policies and programs for its associates: incentive bonuses, a discount stock purchase plan, promotion from within, pay raises based on performance not seniority, and an open-door policy. Sam Walton, the founder of Wal-Mart, believed in being frugal. He drove an old beat-up truck and flew economy class, despite being a billionaire. He instilled frugality as part of Wal-Mart’s DNA. 3 Exhibit 1 Comparative financial data on selected companies Wal-Mart Return on equity (%) 21.2 Sales growth (%) 11.6 Operating income 11.1 growth (%) Sales ($B) As percentage of sales: Cost of goods sold Gross margin Selling and admin Operating income Net income Inventory turnover Return on equity (%) Five year average:1999-2004 Home Depot Kroger Costco 19.7 20.1 13.4 13.7 4.5 11.9 15.9 (13.8) 10.0 288.2 73.1 76.3 22.7 17.8 5.9 3.6 7.5 23.2 66.6 33.4 22.6 10.8 6.8 4.8 22.1 2004 data 56.4 74.7 25.3 20.0 1.5 (0.2) 9.8 (2.5) Target 17.3 6.8 13.3 48.1 46.8 87.5 12.5 9.6 2.9 1.8 11.3 12.8 68.7 31.3 20.9 7.7 6.8 5.9 15.6 Questions 1. What is Wal-Mart’s corporate level strategy? Discuss. [10%] 2. Use the BCG model to determine the overall mission of Wal-Mart. Also discuss the mission of a particular type of business unit of Wal-Mart (eg a division, segment, or particular store). NB You might like to refer to the following website http://walmartstores.com/ [20%] 3. What is the basis upon which Wal-Mart builds its competitive advantage? How does this differ from retailers such as K-Mart, Big W, Myer, David Jones? Describe specific feature of Wal-Mart’s operations that allow it to achieve competitive advantage. [40%] 4. How do Wal-Mart’s control systems help execute the firm’s strategy? [30%] 4 Week 3 Assignment STRATEGIC PROCESS AND STRATEGIC ANALYSIS 1. Read the Case ‘Vershire Company’ (presented separately under tutorial assignments line on Website) and answer the following questions 1. Prepare an industry analysis using Porter’s 5 Forces model. What are the key determinants of Vershire’s aluminium can profitability? Explain. [30%] 2. Which of Porter’s generic strategies is Vershire following? [20%] 3. Prepare a timeline (May to December) diagram tracing the activities in the budget process at Vershire. The diagram should also show organizational levels (Corporate HQ, Divisional HQ, Plant/Sales Districts) [15%] 4. Should the Vershire plant managers be held responsible for profits? Why? Why not? [15%] 5. Outline the strengths and weaknesses of Vershire Company’s planning and control system. On balance, would you redesign the management control structure at Vershire Company? If so, how and why? [20%] 5 Week 4 Assignment: STRATEGY AND MANAGEMENT CONTROL 2. “Different controls for different strategies”. Explain this statement using three examples. [20%] 3. Read the case “Lincoln Electric” (presented separately under tutorial assignments line on Website) and answer the following questions. [80%] (a) How would you characterize Lincoln Electric’s strategy? In this context, what is the nature of Lincoln’s business and upon what bases does this company compete? [10%] (b) What are the most important elements of Lincoln’s overall approach to organization and control that help explain why this company is so successful? How well do Lincoln’s organization and control mechanisms fit the company’s strategic requirements? [30%] (c) What is the corporate culture like at Lincoln Electric? What type of employees would be happy working at Lincoln Electric? [10%] (d) What is the applicability of Lincoln’s approach to organization and control to other companies? Why don’t more companies operate like Lincoln? [10%] (e) What could cause Lincoln’s strategy implementation approach to break down? What are the threats to Lincoln’s continued success? [10%] (f) Would you like to work in an environment like that at Lincoln Electric? [10%] Week 5: No assignment is due this week. 6 Week 6 Assignment: ACTIVITY BASED COSTING Read the case Seneca Foods, and attempt the questions given at the end of the case. SENECA FOODS Seneca Foods is a regional producer of low-priced private-label snack foods (an Australian equivalent might be the 'Farmland' brand in Coles). Seneca contracts with local supermarkets to supply good-tasting packaged snack foods that the retailers sell at significantly lower prices to price-sensitive consumers. Because Seneca's production costs are low, and it spends no money on advertising and promotion, it can sell its products to retailers at much lower prices than can national-brand snack food companies, such as Frito-Lay. The low purchase prices often allow the retailer to mark this product up and earn a gross margin well above what it earns from brand products, while still keeping the selling price to the consumer well below the price of the brand products. Seneca has recently been approached by several large discount food chains who wish to offer their consumers a high-quality but much lower-priced alternative to the heavily advertised and high-priced national brands. But each discount retailer wants the recipe for the snack foods to be customised to its own tastes. Also, each retailer wants its own name and label on the snack foods it sells. Thus, the retailer, not the manufacturer, would be providing the branding for the private-label product. In addition, the retail chains want their own retailer-branded product to offer a full snack product line, just as the national brands do. Seneca's managers are intrigued with the potential for quantum growth by becoming the prime producer of retailer-brand snack foods to large, national discount chains. As they contemplated this new opportunity, Dale Williams, the senior marketing manager, proposed that if Seneca enters this business, it can think of even higher growth opportunities. Seneca does not have to sell just to the national discount chains that have approached it. Local supermarket chains may also be attracted to the idea of having their own brand of high quality but lower-priced snack products that could compete with the national brands, not just be a low-priced alternative for highly price-sensitive consumers. Perhaps Seneca could launch a marketing effort to regional supermarket chains around the country for a retail-brand snack food product line. Williams noted, however, that the local supermarket chains were not as sophisticated as the national discounters in promoting products under their own brand name. Each supermarket chain likely would need extensive assistance and support to learn how to advertise, merchandise, and promote the store-brand products to be competitive with the national-brand products. John Thompson, director of logistics for Seneca Foods, noted another issue. The national-brand producers used their own salespeople to deliver their products directly to the retailer's store and even stocked their products on the retailer's shelves. Seneca, in contrast, delivered to the retailer's warehouse or distribution centre, leaving the retailer to move the product to the shelves of its various retail outlets. The national producers were trying to dissuade the large discount chains from following their proposed private-label (retailer-brand) strategy by showing them studies that the apparently higher margins they would earn on the private label would be eaten away by much higher warehousing, distribution, and stocking costs for these products. Heather Gerald, the Financial Controller of Seneca, was concerned with the new initiatives. She felt that Seneca's current success was due to its focus. It currently offered a relatively narrow range of products aimed at the high-volume snack food segments to supermarket chains in its local region. Seneca got good terms from its relatively few suppliers because of the high volume of business it did with each of them. Also, the existing production processes were efficient for the products and product range currently produced. She feared that customising products for each discount or supermarket retailer, plus adding additional products so that they could offer a full product line, would cause problems with both suppliers and the production process. She also wondered about the cost of providing new services, such as consulting and promotions, to the 7 supermarket chains and of developing some of the new items required for the proposed full product line strategy. Heather was attracted to the growth prospects offered by becoming the preferred supplier to major discount and supermarket chains. But she was not as optimistic as Dale Williams that these retailers truly believed that selling their own private-label foods would be more profitable than selling the national brands. Perhaps they were only using Seneca as a negotiating ploy, threatening to turn to private labels to increase their power in setting terms with the national manufacturers. Once production geared up, how much volume would these retailers provide to Seneca? How could Seneca convince the large retailers about the profitability associated with the new private-label strategy? Gerald knew that Seneca's existing cost systems were adequate for their current strategy. Most expenses were related to materials and machine processing, and these costs were well assigned to products with their conventional standard costing system. But the new strategy would seem to involve a lot more spending in areas other than purchasing materials and running machines. She wished she knew how to provide input into the strategic deliberations now under way at Seneca, but she didn't know how to quantify all the effects of the proposed strategy. REQUIRED: (a) How can activity-based costing help Heather Gerald assess the attractiveness of the proposed policy? [30%] (b) Assuming that Seneca starts to supply new customers-large discounters and supermarkets outside its local region-what ABC systems would be helpful to guide the profitability of the strategy and assist Seneca managers in making decisions? Be sure to think about the totality of Seneca's operations, including its relationships along the value chain that include both suppliers and customers. (Hint: you should be able to identify four separate cost systems and also consider the concepts in the cost hierarchy) [70%] Adapted from Kaplan, R.S. and A.A. Atkinson (1998) Advanced Management Accounting, pp.166-168 (Prentice-Hall) 8 Week 7 Assignment: ASSESSING AND MANAGING PERFORMANCE OVER THE VALUE CHAIN 1. Read the case Mercedes-Benz – All activity Vehicle and answer the questions given at the end of the case. MERCEDES-BENZ- ALL ACTIVITY VEHICLE 1 INTRODUCTION During the recession beginning in the early 1990s, Mercedes-Benz (MB) struggled with product development, cost efficiency, material purchasing, and problems in adapting to changing markets. In 1993, these problems caused the worst sales slump in decades, and the luxury carmaker lost money for the first time in history. Since then, MB has streamlined the core business, reduced parts and system complexity, and established simultaneous engineering programs with suppliers. In their search for additional market share, new segments, and new niches, MB started developing a range of new products. New product introductions included the C-Class in 1993, the E-Class in 1995, the new sportster SLK in 1996, and the A-Class and M-Class All Activity Vehicle (AAV) in 1997. Perhaps the largest and most radical of MB’S new projects was the AAV. IN April 1993 MB announced it would build its first passenger vehicle-manufacturing facility in the United States. The decision emphasized the company’s globalization strategy and desire to move closer to its customers and markets. Mercedes-Benz United States International used functions groups with representatives from every area of the company (marketing, development, engineering, purchasing, production, and controlling to design the vehicle and production systems. A modular construction process was used to produce the AAV. First-tier suppliers provide systems rather than individual parts or components for production of approximately 65,000 vehicles annually. THE AAV PROJECT PHASES The AAV moved from concept to production in a relatively short period of time. The first phase, the concept phase was initiated in 1992. The concept phase resulted in a feasibility study that was approved by the board. Following board approval, the project realization phase began in 1993, with production commencing in 1997. Key elements of the various phases are described next. Concept Phase, 1992-1993 Team members compared the existing production line with various markets segments to discover opportunities for new vehicle introductions. The analysis revealed opportunities in the rapidly expanding sports utility vehicle market that was dominated by Jeep, Ford, and GM. Market research was conducted to estimate potential world wide sales opportunities for a high-end AAV with the characteristics of a MercedesBenz. A rough cost estimate was developed that included materials, labour, overhead, and one-time development and project costs. Projected cash flows were analysed over a 10-year period using net present value (NPV) analysis to acquire project approval from the board of directors. The sensitivity of the NPV was analysed by calculating “what-if” scenarios involving risks and opportunities. For example, risk factors included monetary exchange rate fluctuations, different sales levels due to consumer substitution of the AAV for another MB product, and product and manufacturing costs that differed from projections. On the basis of the economic feasibility study of the concept phase, the board approved the project and initiated a search for potential manufacturing locations. Sites located in Germany, other European countries, and the United Sates were evaluated. Consistent with the company’s globalization strategy, the decisive factor that brought the plant to the United States was the desire to be close to the major market for sport utility vehicles. Project Realization Phase, 1993-1996 1 Adapted from Atkinson, A. A., Kaplan, R. S., Matsumura, E. A. & Young, M (2007) Management Accounting , 7.64 (Prentice Hall, Pearson) 9 Regular customer clinics were held to view the prototype and to explain the new vehicle concept. These clinics produced important information about how the proposed vehicle would be received by potential customers and the press. Customers were asked to rank the importance of various characteristics, including safety, comfort, economy, and styling. Engineers organized in function groups designed systems to deliver these essential characteristics. However, MB would not lower its internal standards for components, even if initial customer expectations might be lower than the MB standard. For example, many automotive experts believed that the superior handling of MB products resulted from manufacturing the best automobile chassis in the world. Thus, each class within the MB line met strict standards for handling, even though these standards might exceed customer expectations for some classes. MB did not use target costing to produce the lowest-price vehicle in an automotive class. The company’s strategic objective was to deliver products that were slightly more expensive than competitive models. However, the additional cost would have to translate into greater perceived value on the part of the customer. Throughout the project realization phase, the vehicle (and the vehicle target cost) remained alive because of changing dynamics. For example, the market moved toward the luxury end of the spectrum while the AAV was under development. In addition, crash test results were incorporated into the evolving AAV design. For these reasons, MB found it beneficial to place the design and testing team members in close physical proximity to other functions within the project to promote fast communication and decision making. Sometimes new technical features, such as side air bags, were developed by MB. The decision to include the new feature on all MB lines was made at the corporate level because experience had shown that customers’ reactions to a vehicle class can affect the entire brand. Productions Phase, 1997 The project was monitored by annual updates of the NPV analysis. In addition, a 3-year plan (including income statements) was prepared annually and reported to the headquarters in Germany. Monthly departmental meetings were held to discuss actual cost performance compared with standards developed during the cost estimation process. Thus, the accounting system served as a control mechanism to ensure that actual production cost would conform to target (or standard) costs. TARGET COSTING AND THE AAV The process of achieving target cost for the AAV began with an estimate of the existing cost for each function group. Next, components of each function group were identified with their associated costs. Cost reductions targets were set by comparing the estimated existing cost with the target cost for each function group. These function groups included the following: doors, sidewall and roof, electrical system, bumpers, power train, seats, heating system, cockpit, and front end. Next cost reduction targets were established for each component. As part of the competitive benchmark process, MB bought and tore down competitors’ vehicles to help understand their costs and manufacturing processes. The AAV manufacturing process relied on high-value-added system suppliers. For example the entire cockpit was purchase as a unit from a systems supplier. Thus, systems suppliers were part of the development process from the beginning of the project. MB expected suppliers to meet established cost targets. To enhance function group effectives, suppliers were brought into the discussion at an early stage in the process. Decisions had to be made quickly in the early stags of development. The target costing process was led by cost planners who were engineers, not accountants. Because the cost planners were engineers with manufacturing and design experience, they could make reasonable estimates of costs that suppliers would incur in providing various systems. Also, MB owned much of the tooling, such as dies to form sheet metal, used by suppliers to produce components. Tooling costs are a substantial part of the one-time costs in the project phase. Index Development to Support Target Costing Activities During the concept development phase, MB team members used various indexes to help them determine critical performance, design, and cost relationships for the AAV.14 To construct the indexes, various forms of information were gathered from customers, suppliers, and their own design team. Although the actual number of categories used by MB was much greater, Table 1 illustrates the calculations used to quantify customer responses to the AAV concept. For example, values shown in the “importance column” resulted 10 from asking a sample of potential customers whether they consider each category extremely important when considering the purchase of a new MB product. Respondents could respond affirmatively to all categories that applied. To gain a better understanding of the various sources of costs, function groups were identified together with target cost estimates. (MB also organizes teams called function groups whose role is to develop specifications and cost projections.) As shown in Table 2, the relative target cost percentage of each function group was computed. TABLE 1 Relative Importance Ranking by Category CATEGORY Safety Comfort Economy Styling Total IMPORTANCE 32 25 15 7 79 RELATIVE PERCENTAGE 41% 32 18 9 100% i Table 3 summarizes how each function group contributes to the consumer requirements identified in Table 1. For example, safety was identified by potential customers as an important characteristic of the AAV; some function groups contributed more to the safety category than others. MB engineers determined that chassis quality was an important element of safety (50% of the total function group contribution). Table 4 combines the category weighting percentages from Table 1 with the function group contribution from Table 3. The result is an importance index that measures the relative importance of each function group across all categories. For example, potential customers weighted the categories of safety, comfort, economy, and styling as.41, .32, .18, and .09, respectively. The rows in Table 4 represent the contribution of each function group to the various categories. The importance index for the chassis is calculated by multiplying each row value by its corresponding category value and summing the results: (.50 x .41) + (.30 x .32) + (.10 x .09) = .33. As shown in Table 5, the target cost index is calculated by dividing the importance index by the target cost percentage by function group. Managers at MB used indexes such as theses during the concept design phase to understand the relationship of the Table 2 Target Cost and Percentage by Function Group Function Group Target Cost Percentage of Total Chassis $x,xxx Transmission x,xxx Air conditioner xxx Electrical system xxx Other functions groups x,xxx 20% 25 5 7 43 Total 100% $x,xxx Table 3 Function Group Contribution to Customer Requirements CATEGORY FUNCTION GROUP SAFETY COMFORT ECONOMY Chassis Transmission Air conditioner Electrical system Other function groups Total 50% 20 30% 20 20 10% 30 11 5 25 100% 30 100% STYLING 10% 5 20 40 100% 65 100% Table 4 Importance Index of Various Function Groups CATEGORY FUNCTION GROUP Chassis Transmission SAFETY .41 .50 COMFORT .32 .30 ECONOMY .18 .10 .20 .20 .30 Air conditioner .20 STYLING .09 .10 Importance Index .33 .20 .05 Electrical system .05 Other function groups .25 .30 .20 .40 .85 Total 1.00 1.00 1.00 1.00 .07 .06 .35 Table 5 Target Cost Index INDEX FUNCTION GROUP (A) (B) (C) A/B IMPORTANCE INDEX %OF TARGET COST TARGET COST INDEX Chassis Transmission Air conditioner Electrical system Other functions group Total .33 .20 .07 .06 .35 .20 .25 .05 .07 .43 1.00 1.65 .80 1.40 .86 .81 importance of a function to the target cost of a function group. Indexes less than 1 may indicate a cost in excess of the perceived value of the function group. Thus, opportunities for cost reduction consistent with customer demands may be identified and managed during the early stages of product development. Choices made during the project realization phase were largely irreversible during the production phase because approximately 80% of the production cost of the AAV was for materials and systems provided by external suppliers. The AAV project used a streamlined management structure to facilitate efficient and rapid development. The streamlined MB organization produced an entirely new vehicle from concept to production in 4 years. Using the target costing process as a key management element, MB manufactured the first production in 1997. Required a) What is the competitive environment faced by MB as it considers launching the AAV? [10%] b) How has MB reacted to the changing world of luxury automobiles? [10%] c) How does the AAV Project link with MB’s strategy in terms of market coverage? [20%] d) How does MB approach cost reduction to achieve target costs? [20%] e) How do suppliers factor into the target costing process? Why are they so critically important to the success of the MB AAV? [20%] f) What role does the accounting department play in the target costing process? [20%] 12 Week 8 Assignment: FINANCIAL MEASURES OF PERFORMANCE 1. Read the case The Kinkead Equipment Company Ltd (commencing on the next page) and attempt the following questions. (a) Refer to the Kinkead templates provided on the unit website. Template (A) calculates the market size, market share, sales mix, sales price and variable cost variances for each product and, Template (B) calculates the market size, market share, sales price, and variable cost variances for each product. Which analysis is most appropriate for Kinkead? A or B? Give reasons. [20%] (b) What strategy is electric meters and electric instruments pursuing? ‘Dog’, ‘Cash cow’, ‘Star’, or ‘Question mark’. [20%] (c) What aspects of performance are important for a product pursuing each of those strategies and which variances reflect those aspects of performance? [20%] (d) Critically evaluate the performance of the two divisions. [40%] 13 KINKEAD LTD Kinkead has been a leading Australian firm since World War II in specialty instruments for measuring electric current characteristics (voltmeters, ohmmeters and ammeters). Kinkead’s products are grouped into two main product lines of business for internal reporting purposes (electric meters and electronic instruments). Each line includes many separate products, which are averaged together for the purposes of this case. The electric meters (EM) and electronic instrument (EI) products perform the same basic function for the customer (both are industrial measuring instruments) but they represent two different technologies. EM is the older, but still dominant technology. The EI technology is new and still experimental. An analogy is the mechanical wrist-watch versus the digital watch. Results for the year Andrew Macgregor, Managing Director of Kinkead, glanced at the summary profit and loss statement for 19XX (Exhibit A) then tossed it to Doug Lee and looked out the window of his office overlooking the industrial skyline of western Sydney. “As you can see Doug, we beat our overall turnover goal for the year, improved our trading margin a bit, and earned more profit than we had planned. Although our selling costs did seem to grow faster than our turnover, all things considered, I would say 1978 was a good year for the firm.” Doug Lee, a recent graduate of a well-known business school, was serving a training period as executive assistant to Mr. Macgregor. He looked over the figures and nodded his agreement. “Doug, I’d like you to prepare a short report for the managing committee meeting next week summarizing the key factors which account for the favourable overall profit variance of $51,000. That might not be much for a firm like ours, but it would still pay your salary for a while, wouldn’t it” he laughed. “I think your about ready to make a presentation to the committee if you can pull together a good report”. “Check with the financial director’s staff for any additional data you may need or want. Just remember to keep it on a commonsense level – no high powered financial double talk. How about giving me a draft to look at in a day or so?” Doug smiled somewhat meekly as he rose to return to his office. “I’ll give it a try” he said. His first step was to gather the additional information shown in Exhibit B. 14 Exhibit A Kinkead Ltd Preliminary operating results 15 January 19XX ($000s) Turnover Contribution Less other fixed Expenses: Manufacturing Selling Administrative Research PROFIT Budget 19XX 6,150 3,495 % of turnover 100 56.8 Actual 19XX 6,322 3,564 % of turnover 100 56.4 1,388 250 320 318 1,219 22.6 4.1 5.2 5.2 19.8 1,399 245 325 325 1,270 22.1 3.9 5.1 5.1 20.1 Budget 6,150 4,931 1,219 Actual 6,322 5,052 1,270 Variance 172F 121U 51F Summary for 19XX Turnover Expenses Profit before tax Remarks Good sales performance with some minor variances on selling, administration and R&D but overall performance was essentially on target with profit $51K above budget. 15 Exhibit B: Additional Information Electric Meters (EM) Electronic Instruments (EI) Selling prices per unit Average standard price Average actual prices $30 $29 $150 $153 Product costs per unit Average standard variable m/f cost Average actual variable m/f cost Average standard selling commission Average actual selling commission $15 $16 $ 1 $ 1 $40.00 $42.10 $15.00 $14.90 Volume information Units produced and sold – actual Units produced and sold – planned 65,000 80,000 29,000 25,000 Total industry turnover – actual $26m $36m Kinkead’s share of the market (% of physical units) Planned 10% Actual 10% 10% 8% Fixed expenses at Kinkead ($000s) Fixed manufacturing expenses Fixed selling expenses Fixed administrative expenses Fixed research expenses Planned $1,388 250 320 318 Actual $1,399 245 325 325 Source: Adapted from Shank, J. and Govindarajan (1998) Strategic Cost Analysis, pp.96-98 (Irwin). 16 Week 9 Assignment: NON-FINANCIAL MEASURES OF PERFORMANCE 1. Read the case “Chadwick Inc: The Balanced Scorecard” and answer the questions given at the end of the case. CHADWICK INC: THE BALANCED SCORECARD2 Company Background Chadwick, Inc. was a diversified producer of personal consumer products and pharmaceuticals. The Norwalk Division of Chadwick developed, manufactured and sold ethical drugs for human and animal use. It was one of five or six sizable companies competing in these markets and, while it did not dominate the industry, the company was considered well-managed and was respected for the high quality of its products. Norwalk did not compete by supplying a full range of products. It specialized in several niches and attempted to leverage its product line by continually searching for new applications for existing compounds. Norwalk sold its products through several key distributors who supplied local markets, such as retail stores, hospitals and health service organizations, and veterinary practices. Norwalk depended on its excellent relations with the distributors who served to promote Norwalk’s products to end users and also received feedback from the end users about new products desired by their customers. Chadwick knew that its long-term success depended on how much money distributors could make by promoting and selling Norwalk’s products. If the profit from selling Norwalk products was high, then these products were promoted heavily by the distributors and Norwalk received extensive communication back about future customer needs. Norwalk had historically provided many highly profitable products to the marketplace, but recent inroads by generic manufacturers had been eroding distributors’ sales and profit margins. Norwalk had been successful in the past because of its track record of generating a steady stream of attractive, popular products. During the second half of the 1980’s however, the approval process for new products had lengthened and fewer big winners had emerged from Norwalk’s R & D laboratories. Research and Development The development of ethical drugs was a lengthy, costly, and unpredictable process. Development cycles now averaged about 12 years. The process started by screening a large number of compounds for potential benefits and use. For every drug that finally emerged as approved for use, up to 30,000 compounds had to be tested at the beginning of a new product development cycle. The development and testing processes had many stages. The development cycle started with the discovery of compounds that possessed the desirable properties and ended many years later with extensive and tedious testing and documentation to demonstrate that the new drug could meet government regulations for promised benefits, reliability in production, and absence of deleterious side effects. Approved and patented drugs could generate enormous revenues for Norwalk and its distributors. Norwalk’s profitability during the 1980s was sustained by one key drug that had been discovered in the late 1960s. No blockbuster drug had emerged during the 1980s, however, and the existing pipeline of compounds going through development, evaluation and test was not as healthy as Norwalk management desired. Management was placing pressure on scientists in the R & D lab to increase the yield of promising new products and to reduce the time and costs of the product development cycle. Scientists were currently exploring new bio-engineering techniques to create compounds that had the specific active properties desired rather than depending on an almost random search through thousands of possible compounds. The new techniques started with a detailed specification of the chemical properties that a new drug should have and then attempted to synthesize candidate compounds that could be tested for these 2 Adapted from Simons, R. (2000) Performance Measurement and Control Systems for Implementing Strategy, pp. 539543 (Prentice Hall) 17 properties. The bio-engineering procedures were costly, requiring extensive investment in new equipment and computer-based analysis. A less expensive approach to increase the financial yield from R & D investments was to identify new applications for existing compounds that had already been approved for use. While some validation still had to be submitted for government approval to demonstrate the effectiveness of the drug in the new applications, the cost of extending an existing product to a new application was much, much less expensive than developing and creating an entirely new compound. Several valuable suggestions for possible new applications from existing products had come from Norwalk salesmen in the field. The salesmen were now being trained not only to sell existing products for approved applications, but also to listen to end users who frequently had novel and interesting ideas about how Norwalk’s products could be used for new applications. Manufacturing Norwalk’s manufacturing processes were considered among the best in the industry. Management took pride in the ability of the manufacturing operation to quickly and efficiently ramp up to produce drugs once they had clear governmental regulatory processes. Norwalk’s manufacturing capabilities also had to produce the small batches of new products that were required during testing and evaluation stages. Performance Measurement Chadwick allowed its several divisions to operate in a decentralized fashion. Division managers had almost complete discretion in managing all the critical processes: R&D, Production, Marketing and Sales, and administrative functions such as finance, human resources, and legal. Chadwick set challenging financial targets for divisions to meet. The targets were usually expressed as Return on Capital Employed (ROCE). As a diversified company, Chadwick wanted to be able to deploy the returns from the most profitable divisions to those divisions that held out the highest promise for profitable growth. Monthly financial summaries were submitted by each division to corporate headquarters. The Chadwick executive committee, consisting of the chief executive officer, the chief operating officer, two executive vice presidents and the chief financial officer met monthly with each division manager to review ROCE performance and back up financial information for the preceding month. The Balanced Scorecard Project Bill Baron, Comptroller of Chadwick, had been searching for improved methods for evaluating the performance of the various divisions. Division managers complained about the continual pressure to meet short-term financial objectives in businesses that required extensive investments in risky projects to yield long-term returns. The idea of a Balanced Scorecard appealed to him as a constructive way to balance short-run financial objectives with the long-term performance of the company. Baron brought the article and concept to Dan Daniels the President and Chief Operation Officer of Chadwick. Daniels shared Baron’s enthusiasm for the concept, feeling that a Balanced Scorecard would allow Chadwick divisional managers more flexibility in how they measured and presented their results of operations to corporate management. He also liked the idea of holding managers accountable for improving the long-term performance of their division. After several days of reflection, Daniels issued a memorandum to Chadwick division managers. The memo had a simple and direct message. Read the Balanced Scorecard article, develop a scorecard for your division, and be prepared to come to corporate headquarters in 90 days to present and defend the divisional scorecard to Chadwick’s Executive Committee. John Greenfield, the Division Manager at Norwalk, received Daniel’s memorandum with some concern and apprehension. In principle, Greenfield liked the idea of developing a scorecard that would be more responsive to his operations, but he was distrustful of how much freedom he had to develop and use such a scorecard. Greenfield recalled: This seemed like just another way for corporate to claim that they have decentralized decision making and authority while still retaining ultimate control at headquarters. 18 Greenfield knew that he would have to develop a plan of action to meet corporate’ request but lacking a clear sense of how committed Chadwick was to the concept, he was not prepared to take much time from his or his subordinates’ existing responsibilities for the project. The next day, at the weekly meeting of the Divisional Operating Committee, Greenfield distributed the Daniels memo and appointed a three man committee, headed by Divisional Controller, Wil Wagner, to facilitate the process for creating the Norwalk Balanced Scorecard. Wagner approached Greenfield that day: I read the Balanced Scorecard article. Based on my understanding of the concept, we must start with a clearly defined business vision. I’m not sure I have a clear understanding of the vision and business strategy for Norwalk. How can I start to build the scorecard without this understanding? Greenfield admitted: “That’s a valid point. Let me see what I can do to get you started.” Greenfield picked up a pad of paper and started to write. Several minutes later he had produced a short business strategy statement for Norwalk. Wagner and his group took Greenfield’s strategy statement and started to formulate scorecard measures for the division. Several days later, Greenfield sent Wagner a copy of a memo that he had just received from Dan Daniels. The President had decided that he wanted all the divisions to follow some guiding principles as they developed their scorecards. The memo reiterated Daniels’ initial principle that each division should develop the scorecard “that was right for the division.” But he wanted all scorecards to use quantitative, objective data; Daniels had heard that several divisions wanted to include measures on customer satisfaction that would be collected from surveys and interviews. Daniels wanted only “hard data” on the scorecard. Opinions measured in surveys may be collected for internal divisional purposes but such information was not to be sent up to corporate headquarters or discussed in Executive Committee reviews of divisional operations. Wagner was not surprised by this restriction. He recalled hearing Executive Committee members, on several occasions, declaring that only “hard data” counted. Wagner thought, as he re-read Daniels’ memo, “I guess tough-minded managers at Chadwick don’t use ‘soft data’.” Creating Norwalk’s Balance Scorecard The Scorecard project arrived at a time when Wil Wagner and the two other members of his team already had heavily booked calendars. Several weeks passed before the team could really start to meet and focus on the project. Several more weeks passed before the team could schedule a meeting with the top divisional management of Norwalk. Such a meeting was thought necessary to solicit more information about divisional strategy and key success factors, and to get feedback on the tentative set of measures the project team had formulated. After many postponements, a one day meeting was schedule with senior divisional management to comment on the Wagner team’s proposed scorecard. This meeting took place only ten days before Greenfield would present the scorecard to the Chadwick Executive Committee at corporate headquarters. Wagner felt that a full day meeting would be necessary to achieve the final consensus so he scheduled the meeting off-site at a hotel, one block from Norwalk’s offices. By staying away from office distractions, Wagner hoped that division management could focus on the details of the scorecard design. Wagner arrived early at the hotel meeting site. He received a message from Greenfield’s secretary that the division general manager would be delayed in arriving at the meeting, but that the meeting should start without him. Wagner opened the meeting with 10 top managers (other than Greenfield). He outline the ground rules established by President Daniels, reviewed Greenfield’s strategy statement for Norwalk, and suggested a process to develop and review measures for each of the four perspectives of the Balanced Scorecard.2 As Wagner finished his opening statement, he was distressed to discover that Mike Hassler, the 19 VP of Marketing, was not present in the room. Wagner learned that Hassler was negotiating a contract with Norwalk’s largest distributor and could not join the meeting until 3.00P.M. The group of 10 managers started to discuss financial and customer-based measures and Wagner was pleased with the enthusiasm the group was bringing to the Task. But after about 25 minutes, the phone in the hotel meeting room rang. Hassler needed to speak with the Sales vice president. Wagner attempted to maintain the momentum of the discussion with the other nine managers, but the telephone conversations going on in the background was clearly distracting the group. By the end of the day, the phone had rung seven more times to pull managers out of the discussion to take care of company business. Greenfield never showed up. Wagner, however, persisted under the difficult conditions and was able to mobilize the managers in attendance to produce a Balance Scorecard for the Norwalk Division (see Exhibit 2). Wagner briefed Greenfield on the scorecard at a breakfast meeting several days later, prior to Greenfield’s appearance at Chadwick Corporate Headquarters. EXHIBIT 1: Norwalk Pharmaceutical Division –Business Strategy 1. Manage Norwalk portfolio of investments.    Minimize cost to executing our existing business base Maximize return/yield on all development spending Invest in discovery of new compounds. 2. Satisfy customer needs 3. Drive responsibility to the lowest level  Minimize centralized staff overhead. 4. People development   Industry training Unique mix of technical and commercial skills. 20 EXHIBIT 2 Norwalk Pharmaceutical Division FINANCIAL MEASURES CUSTOMER MEASURES INTERNAL MEASURES Net Contribution Market Share for Key Markets Working Capital Customer Complaint Rate INNOVATION MEASURES Price index for “basket” $Revenue from of formulation New Products introduced in last 3 years Cost index for Technical compounds Operating Profit After Taxes Capital Turnover Inventory turns by product class. Gross Margin $ SG&A $ Source: Simons (2000). Performance measurement and control systems for implementing strategy, Pearson Education Inc., Upper Saddle River NJ. Required: (b) Develop the balanced scorecard for the Norwalk Pharmaceutical Division of Chadwick, Inc. What parts of the business strategy that John Greenfield sketched out should be included? Are there any parts that should be excluded or cannot be made operational? What are the scorecard measures you should use to implement your scorecard in the Norwalk Pharmaceutical Division? What are the new measures that need to be developed, and how would you go about developing them? [50%] (c) How would a Balanced Scorecard for Chadwick Inc differ from ones developed in its divisions, such as the Norwalk Pharmaceutical Division? Do you anticipate that there might be major conflicts between divisional scorecards and those of the corporation? If so, should those conflicts be resolved, and if so, how should they be resolved? [30%] (d) Critically evaluate the process used to formulate the strategy of the Norwalk Pharmaceutical Division and the Balanced Scorecard. [20%] 21 Week 10: No classes – work on group report due 5pm, Friday 14 th May Week 11 Assignment: STRATEGIC AND BEHAVIOURAL ASPECTS OF CAPITAL EXPENDITURE EVALUATIONS 1. Read the case Mavis Machine Shop case (presented separately under tutorial assignments line on website) and answer the following questions. (a) What evidence is there for Mavis’ strategy to be based on product differentiation and what aspects of Mavis’s product and service are likely to be the basis of its differentiation? What is the likely source of Mavis’s differentiation? [35%] (b) Assume that the NPV for the new automated lathe is profitable (in fact its IRR is about 30%), what non-financial arguments are there against buying the new lathe? [35%] (c) What decision should Mavis take? (Hint: examine the balance sheet numbers as to whether they can afford the investment)? [30%] Week 12: No assignment due - group research proposal presentations Week 13: No classes 22
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Explanation & Answer

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b) A solid vision for the organization must be developed in order to produce a good Balanced
Scorecard. A successful strategy must provide two components:


a straightforward statement of the company's strategic advantage in the industry



the nature of this strategy.

The corporate strategy for Norwalk, as seen in Exhibit 2-22, has the following aspects: managing
the Norwalk investment portfolio by minimizing costs to run the existing base, maximizing
returns on all spending on growth, and investing in the discovery of new compounds; meeting
customer needs; reducing accountability by minimizing centralized overheads; and in this
approach, the scorecard should be generated by looking at the four viewpoints.
Each insight must be considered with essential elements. In the view of consumers, the business
has to consider the retention of customers, market share, innovative technologies published, core
partnerships with dealers and end users, several applications proposed by customers, a variety of
new applications recommended by salespeople and the benefit of customers. The management
has to take the value generation period of the sector into consideration for the operation
viewpoint....


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