Chapter 15 Productivity Marketing Effectiveness and Strategic Profitability

Chapter 15 Productivity, Marketing Effectiveness, and Strategic Profitability Analysis

3 Learning Objectives n Describe productivity and identify effects of productivity changes on operating results n Compute and interpret partial operational and financial productivity n Separate change in financial productivity into productivity change, input price change, and output change Mc. Graw-Hill/Irwin © 2005 The Mc. Graw-Hill Companies, Inc. , All Rights Reserved.

4 Learning Objectives n Calculate and interpret total productivity n Identify issues of productivity in the new manufacturing environment and the advantages and limitations applying productivity measures to service firms and not -for-profit organizations n Disaggregate sales variance into selling price and sales volume variances Mc. Graw-Hill/Irwin © 2005 The Mc. Graw-Hill Companies, Inc. , All Rights Reserved.

5 Learning Objectives n Separate sales volume variance into sales mix and sales quantity variances n Explain how market size and market share variances lead to sales quantity variances n Analyze factors leading to changes in profitability Mc. Graw-Hill/Irwin © 2005 The Mc. Graw-Hill Companies, Inc. , All Rights Reserved.

6 Learning Objective One Describe productivity and identify effects of productivity changes on operating

7 What is Productivity is the ratio of what is produced and what is required to produce it. Productivity = Output Input Operational productivity uses a physical measure for units of output and input. Mc. Graw-Hill/Irwin Financial productivity uses a dollar measure for units of output and input. © 2005 The Mc. Graw-Hill Companies, Inc. , All Rights Reserved.

8 Learning Objective Two Compute and interpret partial operational and financial productivity Mc. Graw-Hill/Irwin

9 What is Productivity Partial productivity focuses on the relationship between one of the inputs, such as material, to the output attained. Common partial productivity measures include-l l l Direct materials yield productivity, such as output/units of materials Work force productivity, such as output per labor hours or output persons employed Process (or activity) productivity, such as output/machine hours output per kilowatt hours Mc. Graw-Hill/Irwin © 2005 The Mc. Graw-Hill Companies, Inc. , All Rights Reserved.

10 Benchmarks for Evaluating Productivity þPerformance of a previous year. þPerformance of another division of the firm. þPerformance of a competitor. þA target measure set by management. Mc. Graw-Hill/Irwin © 2005 The Mc. Graw-Hill Companies, Inc. , All Rights Reserved.

11 Measuring Productivity Erie Precision Tool Company manufactures Drill bit DB 2. Operational information for two years follows. Mc. Graw-Hill/Irwin © 2005 The Mc. Graw-Hill Companies, Inc. , All Rights Reserved.

12 Measuring Productivity Erie Precision Tool Company 2006 and 2007 Operating Data for DB-2 (Dollar amounts are in 000) 2006 Units of DB-2 manufactured and sold 4, 000 Total sales ($500 price) $2, 000 Direct materials (25, 000 lbs. @ $24/lb. ) 600 Direct labor (4, 000 hrs. @ $40 per hour) 160 Other operating costs 300 Operating income $ 940 2007 4, 800 $2, 400 800 200 300 $1, 100 Sales increased by 20 percent, but income increased by only 17 percent. Did productivity decline? Mc. Graw-Hill/Irwin © 2005 The Mc. Graw-Hill Companies, Inc. , All Rights Reserved.

13 Learning Objective Three Separate change in financial productivity into productivity change, input price change, and output change Mc. Graw-Hill/Irwin © 2005 The Mc. Graw-Hill Companies, Inc. , All Rights Reserved.

14 Measuring Partial Productivity Mc. Graw-Hill/Irwin © 2005 The Mc. Graw-Hill Companies, Inc. ,

15 Measuring Partial Productivity 4, 000 units ÷ 25, 000 pounds 4, 000 units ÷ 4, 000 hours Mc. Graw-Hill/Irwin 4, 800 units ÷ 32, 000 pounds 4, 800 units ÷ 4, 000 hours © 2005 The Mc. Graw-Hill Companies, Inc. , All Rights Reserved.

16 Measuring Partial. Productivity Mc. Graw-Hill/Irwin © 2005 The Mc. Graw-Hill Companies, Inc. ,

17 Measuring Partial Productivity 4, 000 units ÷ $600, 000 4, 000 units ÷ $160, 000 Mc. Graw-Hill/Irwin 4, 800 units ÷ $800, 000 4, 800 units ÷ $200, 000 © 2005 The Mc. Graw-Hill Companies, Inc. , All Rights Reserved.

18 Measuring Partial Productivity Mc. Graw-Hill/Irwin © 2005 The Mc. Graw-Hill Companies, Inc. ,

19 Measuring Partial Productivity 30, 000 pounds @ $25 4, 800 hours @ $50 30, 000* pounds @ $24 4, 800 hours @ $40 25, 000 pounds @ $24 4, 000 hours @ $40 *4, 800 units ÷ 0. 016 units per pound = 30, 000 pounds, the number of pounds that would have been used at the same productivity as in 2006. Mc. Graw-Hill/Irwin © 2005 The Mc. Graw-Hill Companies, Inc. , All Rights Reserved.

20 Measuring Partial Productivity 4, 800 units ÷ $750, 000 4, 800 units ÷ $240, 000 Mc. Graw-Hill/Irwin 4, 800 units ÷ $720, 000 4, 000 units ÷ $720, 000 4, 800 units ÷ $192, 000 4, 000 units ÷ $160, 000 © 2005 The Mc. Graw-Hill Companies, Inc. , All Rights Reserved.

21 Measuring Partial Productivity Direct materials Direct labor Mc. Graw-Hill/Irwin Productivity change Input price change 0. 0004 units per $ U 0. 000267 units per $ U 0. 004 units per $ F 0. 005 units per $ F Output change 0 0 © 2005 The Mc. Graw-Hill Companies, Inc. , All Rights Reserved.

22 Measuring Partial Productivity Summary of Results Mc. Graw-Hill/Irwin © 2005 The Mc. Graw-Hill

23 Limitations of Partial Productivity Analysis Œ It measures only the relationship between an input resource and the output. It ignores any effect that changes in the production factor have on productivity. It ignores any effect that changes in operating characteristics of the firm may have on the productivity of the input resource. No efficiency standard is involved in partial productivity measures. Mc. Graw-Hill/Irwin © 2005 The Mc. Graw-Hill Companies, Inc. , All Rights Reserved.

24 Learning Objective Four Calculate and interpret total productivity Mc. Graw-Hill/Irwin © 2005 The

25 Measuring Total Productivity Erie Precision Tool Company Total Productivity for DB 2 Total productivity in units (a) Total units manufactured (b) Total variable manufacturing costs incurred (c) Total productivity: (a) ÷ (b) (d) Decrease in productivity: 0. 005263 – 0. 0048 = 0. 000463 ÷ 0. 005263 = 8. 8% Mc. Graw-Hill/Irwin 2006 4, 000 2007 4, 800 $760, 000 $1, 000 0. 005263 0. 0048 © 2005 The Mc. Graw-Hill Companies, Inc. , All Rights Reserved.

26 Measuring Total Productivity Erie Precision Tool Company Total Productivity for DB 2 Total productivity in sales dollars (a) Total sales (b) Total variable manufacturing cost incurred (c) Total productivity: (a) ÷ (b) (d) Decrease in productivity: $2. 6316 – $2. 4 = $0. 2316 ÷ $2. 6316 = 8. 8% Mc. Graw-Hill/Irwin 2006 2007 $2, 000 $2, 400, 000 $760, 000 $1, 000 $2. 6316 $2. 4 © 2005 The Mc. Graw-Hill Companies, Inc. , All Rights Reserved.

27 Learning Objective Five Identify issues of productivity in the new manufacturing environment and the advantages and limitations applying productivity measures to service firms and not -for-profit organizations Mc. Graw-Hill/Irwin © 2005 The Mc. Graw-Hill Companies, Inc. , All Rights Reserved.

28 Productivity in the New Manufacturing Environment Quality improvements decrease waste, spoiled units, and rework, so the amount of input resources needed is reduced. Improving productivity through process reengineering results in manufacturing a product with fewer input resources. Mc. Graw-Hill/Irwin © 2005 The Mc. Graw-Hill Companies, Inc. , All Rights Reserved.

29 Managing Marketing Effectiveness l A firm is effective in marketing when it: l l l Earns the budgeted operating income, Attains budgeted market share, and Adapts to changes in the market. Mc. Graw-Hill/Irwin © 2005 The Mc. Graw-Hill Companies, Inc. , All Rights Reserved.

30 Learning Objective Six Disaggregate sales variance into selling price and sales volume variances

31 Sales Variances and Their Components Sales Variance Selling Price Variance Sales Volume Variance Sales Quantity Variance Market Size Variance Mc. Graw-Hill/Irwin Sales Mix Variance Market Share Variance © 2005 The Mc. Graw-Hill Companies, Inc. , All Rights Reserved.

32 Selling Price and Sales Volume Variances Selling Price Variance (SPV) Sales Volume Variance (SVV) The variance resulting from changes in the price of goods sold The variance resulting from changes in the volume of sales Variances that are often used to evaluate marketing performance Mc. Graw-Hill/Irwin © 2005 The Mc. Graw-Hill Companies, Inc. , All Rights Reserved.

33 Selling Price and Sales Volume Variances Selling Price Variance (SPV) Sales Volume Variance (SVV) SPV = (AP – SP) × AQ SVV = (AQ – SQ) × BC AP = Actual Sales Price SP = Budgeted (Standard) Sales Price AQ = Actual Sales Volume SQ = Master Budget Sales (Standard) Volume BC = Budgeted Contribution Margin Variances that are often used to evaluate marketing performance Mc. Graw-Hill/Irwin © 2005 The Mc. Graw-Hill Companies, Inc. , All Rights Reserved.

34 Selling Price and Sales Volume Variances Let’s recall the Cheese Co. example from

35 Selling Price and Sales Volume Variances Mc. Graw-Hill/Irwin © 2005 The Mc. Graw-Hill

36 Selling Price and Sales Volume Variances 8, 000 units × $10 per unit 8, 000 units × $11 per unit 10, 000 units × $10 per unit Mc. Graw-Hill/Irwin © 2005 The Mc. Graw-Hill Companies, Inc. , All Rights Reserved.

37 Selling Price and Sales Volume Variances SPV = (AP- SP) × AQ SPV = ($11 per unit – $10 per unit) × 8, 000 units SPV = $8, 000 F Mc. Graw-Hill/Irwin © 2005 The Mc. Graw-Hill Companies, Inc. , All Rights Reserved.

38 Selling Price and Sales Volume Variances SPV = (AP- SP) × AQ SPV = ($11 per unit – $10 per unit) × 8, 000 units SPV = $8, 000 F SVV = (AQ – SQ) × BC SVV = (8, 000 units – 10, 000 units) × $5 per unit SVV = $10, 000 U $50, 000 ÷ 10, 000 units Mc. Graw-Hill/Irwin © 2005 The Mc. Graw-Hill Companies, Inc. , All Rights Reserved.

39 Learning Objective Seven Separate sales volume variance into sales mix and sales quantity

40 Sales Mix and Sales Quantity Variances Sales Volume Variance Sales Mix Variance A measure of the impact of a decline in the volume of one product and an increase in the volume of another product Mc. Graw-Hill/Irwin Sales Quantity Variance A measure of the impact of a change in total sales quantity, holding the sales mix constant © 2005 The Mc. Graw-Hill Companies, Inc. , All Rights Reserved.

41 Sales Mix and Sales Quantity Variances Consider a different example from the Magness

42 Sales Mix and Sales Quantity Variances Magness Company First Quarter Estimated and Actual

43 Sales Mix and Sales Quantity Variances * Sales Mix Variance $280, 000 U Sales Quantity Variance $480, 000 F * ASQ = Quantity of Sales Volume Variance = $200, 000 F Mc. Graw-Hill/Irwin * units that would have been sold at the expected mix. © 2005 The Mc. Graw-Hill Companies, Inc. , All Rights Reserved.

44 Sales Mix and Sales Quantity Variances * Sales Mix Variance $140, 000 F Sales Quantity Variance $160, 000 F * ASQ = Quantity of Sales Volume Variance = $300, 000 F Mc. Graw-Hill/Irwin * units that would have been sold at the expected mix. © 2005 The Mc. Graw-Hill Companies, Inc. , All Rights Reserved.

45 Sales Mix and Sales Quantity Variances Mc. Graw-Hill/Irwin © 2005 The Mc. Graw-Hill

46 Sales Mix and Sales Quantity Variances Due to mix change from 60% to 50% of 280, 000 actual units sold × $10 unit contribution Mc. Graw-Hill/Irwin © 2005 The Mc. Graw-Hill Companies, Inc. , All Rights Reserved.

47 Sales Mix and Sales Quantity Variances Due to mix change from 40% to 50% of 280, 000 actual units sold × $5 unit contribution Mc. Graw-Hill/Irwin © 2005 The Mc. Graw-Hill Companies, Inc. , All Rights Reserved.

48 Sales Mix and Sales Quantity Variances 80, 000 total units × 60% expected mix Due to sale of 48, 000 units more than expected × $10 unit contribution Mc. Graw-Hill/Irwin © 2005 The Mc. Graw-Hill Companies, Inc. , All Rights Reserved.

49 Sales Mix and Sales Quantity Variances 80, 000 total units × 40% expected mix Due to sale of 32, 000 units more than expected × $5 unit contribution Mc. Graw-Hill/Irwin © 2005 The Mc. Graw-Hill Companies, Inc. , All Rights Reserved.

50 Learning Objective Eight Explain how market size and market share variances lead to

51 Market Size and Market Share Variances Market size variance measures the effect on operating income of changes in the total market size of the firm’s product. Mc. Graw-Hill/Irwin Market share variance assesses the effect on operating income of changes of a firm’s proportions of the total market. © 2005 The Mc. Graw-Hill Companies, Inc. , All Rights Reserved.

52 Market Size and Market Share Variances Consider the followin g additional data from

53 Market Size and Market Share Variances Estimated market volume = 40, 000 units Cheese Co. estimated market share = 25 percent Budgeted Cheese Co. sales =. 25 × 40, 000 = 10, 000 units Actual market volume = 33, 333 units Actual Cheese Co. sales = 8, 000 units Actual Cheese Co. market share = 8, 000 ÷ 33, 333 = 24 percent How much of the 2, 000 unit sales activity decline is due to general market conditions, and how much is due to a change in the company’s market share? Mc. Graw-Hill/Irwin © 2005 The Mc. Graw-Hill Companies, Inc. , All Rights Reserved.

54 Market Size and Market Share Variances Given the industry volume decline from 40, 000 to 33, 333 units, Cheese Co. would expect a volume decline of 1, 667 units at the expected market share of 25 percent: (40, 000 – 33, 333) ×. 25 = 1, 667 units U (rounded) Mc. Graw-Hill/Irwin © 2005 The Mc. Graw-Hill Companies, Inc. , All Rights Reserved.

55 Market Size and Market Share Variances Given the industry volume decline from 40, 000 to 33, 333 units, Cheese Co. would expect a volume decline of 1, 667 units at the expected market share of 25 percent: (40, 000 – 33, 333) ×. 25 = 1, 667 units U (rounded) The market share decline from 25 to 24 percent results in an unfavorable market share effect of 333 units: (. 25 –. 24) × 33, 333 = 333 units U (rounded) Mc. Graw-Hill/Irwin © 2005 The Mc. Graw-Hill Companies, Inc. , All Rights Reserved.

56 Market Size and Market Share Variances Given the industry volume decline from 40, 000 to 33, 333 units, Cheese Co. would expect a volume decline of 1, 667 units at the expected market share of 25 percent: (40, 000 – 33, 333) ×. 25 = 1, 667 units U (rounded) The market share decline from 25 to 24 percent results in an unfavorable market share effect of 333 units: (. 25 –. 24) × 33, 333 = 333 units U (rounded) Sales quantity variance in units = 1, 667 units U + 333 units U = 2, 000 units U Mc. Graw-Hill/Irwin © 2005 The Mc. Graw-Hill Companies, Inc. , All Rights Reserved.

57 Market Size and Market Share Variances Multiplying each unit amount by the standard contribution margin converts each unit amount to a variance in dollars: Industry volume variance = ($10 – $5) × 1, 667 units = $ 8, 335 U Market share variance Sales quantity variance Mc. Graw-Hill/Irwin = ($10 – $5) × 333 units = 1, 665 U = $10, 000 U © 2005 The Mc. Graw-Hill Companies, Inc. , All Rights Reserved.

58 Market Size and Market Share Variances Market share variance SP = Standard Sales Price SV = Standard Variable Cost AQ = Actual Quantity Mc. Graw-Hill/Irwin Market size variance BMS = Budgeted Market Share AIQ = Actual Industry Volume SQ = Standard Quantity © 2005 The Mc. Graw-Hill Companies, Inc. , All Rights Reserved.

59 Market Size and Market Share Variances * Market share variance $1, 665 U Market size variance $8, 335 U Sales quantity variance = $10, 000 U Mc. Graw-Hill/Irwin *Rounded down to agree with previous example © 2005 The Mc. Graw-Hill Companies, Inc. , All Rights Reserved.

60 Learning Objective Nine Analyze factors leading to changes in profitability Mc. Graw-Hill/Irwin ©

61 Strategic Profitability Analysis The purpose of strategic profitability analysis is to analyze the difference in operating income between two periods to assess successful implementation of the firm’s strategy. To facilitate the analysis, changes in operating income are separated into effects of changes in sales volume (growth), selling price and cost of input resources (price-recovery), and productivity. Mc. Graw-Hill/Irwin © 2005 The Mc. Graw-Hill Companies, Inc. , All Rights Reserved.

62 Strategic Profitability Analysis The growth factor measures the change in operating income attributable to change in sales quantity. The price-recovery factor measures changes in operating income attributable to changes in the selling prices of products and the costs of inputs resources. The productivity factor measures impacts of changes in the input-output relationship on 20 x 2 operating income based on the 20 x 2 costs of input resources capacity. See Pages 650 through 657 for details. Mc. Graw-Hill/Irwin © 2005 The Mc. Graw-Hill Companies, Inc. , All Rights Reserved.