chapter 9 jon

Chapter Nine

Performance Evaluation and

Decision-Making

Copyright © Houghton Mifflin Company. All rights reserved. 9-2

Learning Objectives

• Explain the purpose and benefits of performance evaluation.

• Define and explain the use of responsibility centers.

• Demonstrate how firms evaluate responsibility center performance.

• Illustrate the use of cost-benefit analysis for business decision-making.


Purpose and Benefits of Performance Evaluation

• Monitoring strategic performance: – A system to assess progress, monitor employees, and

guide future decision-making.

• Benefits include– Accountability– Feedback– Decision Guidance

• Balance Scorecard– Learning and growth/Internal Process– Customer Satisfaction and Retention– Financial


Responsibility Centers: Definition

• Decentralization has created independent operating groups within firm.

• Performance in each autonomous segment is evaluated against budget.

• Responsibility center describes a point in the organization where managers control revenues, costs and/or assets.

• There are commonly 4 types of responsibility centers: – Revenue, Cost, Profit, Investment Centers


Responsibility Centers: Characteristics

• Revenue centers– Managers accountable only for revenue from operating unit.

• Cost centers– Managers accountable only for revenue from operating unit.

Danger in focusing on cost and failing in other parts of business.

• Profit centers– Responsible for both revenue and costs, similar to independent

firms.

• Investment centers– Managers accountable for revenues and costs PLUS the amount

and efficiency of assets invested. Performance often assessed via return on investment (ROI) and disaggregated by Du Pont system.

Responsibility Centers Illustration

• Exercise 1



• Evaluating revenue and cost centers– Variance analysis– Ratio analysis

• Evaluating profit centers– Business segment performance report– Contribution margin – Fixed costs

• Controllable - discretionary in segment• Committed – no segmental control

Responsibility Centers: Evaluating Performance


Business Segment Performance Report



• Contribution Margin = Sales – Variable Costs

• Performance Margin = Contribution Margin – Controllable Fixed Costs

• Segment Margin = Performance Margin – Committed Fixed Costs

Cost Categorizing Illustration

• Exercise 2




• Evaluating investment centers– Use ROI– Return on Investment = Segment Margin /

Segment Assets– Is the segment using its allotted assets

efficiently to generate a return?

Evaluating an Investment Center-Illustration

• Exercises 7 and 8


Evaluating a Profit Center

• Exercise 11



Business Decision-Making:Using Cost-Benefit Analysis

• Faced with new business opportunities, managers must compare benefits and costs of each new activity.

• Evaluate the importance of costs:– Incremental– Opportunity– Sunk

• Relevant cost is different under different decision alternatives.– Relevant Costs = Incremental Costs + Opportunity

Costs.



• Incremental cost– Additional expenditure that a decision alternative incurs

or requires – Can be fixed or variable

• Opportunity cost– Forgone benefit that managers give up by choosing a

particular decision alternative

• Sunk cost– Cost that is already incurred and can’t be changed in

the short term.

Cost Classification for Decision Making

• Exercise 6




• Demonstrated through two common management decisions: make or buy and special offers:



• Make or buy– Should we use our time and money to make

the products we are going to sell, or should be buy them.

– Compare Incremental Costs of each decision to Increased Revenue (same whether we make or buy).

– Think about qualitative factors and opportunity costs

Make or Buy Illustration

• Exercise 13




• Special offers– Arrangements with customers for lower price – Usually involves a larger quantity– Compare Costs and Benefits– Benefits are Increased Sales– Costs-Only Relevant Costs!!

• incremental and opportunity, NOT SUNK

Special Offer Illustration

• Exercise 12


chapter 9 jon

Documents

use of responsibility

use of cost

performancecontribution

business decisionmaking

operating unit

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autonomous segment

independent firms