11 Activity 1

Strategic Cost Management

Activity

Metro Corporation makes a special-purpose machine called “OM” used in the textile industry. Metro has

designed the OM machine for 20X3 to be distinct from its competitors with a premium price. It has been

regarded as a superior machine. The company presents the following data for the years 20X2 and 20X3

Requirements (7 items x 10 points):

1. Decide and justify if Metro’s strategy is product differentiation or cost leadership.

Answer: Metro Corporation follows a product differentiation strategy. Metro’s OM machine is different

from its competitors and generally regarded as superior to competitors’ products. To succeed, Metro

must continue to discern its product and charge a premium price.

2. Identify applicable key performance objectives and/or measures for the balanced scorecard of Metro

Corporation. Explain briefly how your cited objectives/ measures can affect the financial performance of

the company.

Answer: Balanced Scorecard measures for 2013 follow:

Financial Perspective

Increase in operating income from charging higher margins, price premium earned on products: These

measures indicate whether Metro has been able to charge premium prices and achieve operating

income increases through product differentiation.

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 Customer Perspective

Market share in high-end special-purpose textile machines, customer satisfaction, new customers:

Metro’s strategy should result in improvements in these customer measures that help evaluate whether

Metro’s product differentiation strategy is succeeding with its customers. These measures are leading

indicators of superior financial performance.

Internal Business Process Perspective

Manufacturing quality and reduced wastage of direct materials, new product features added, order

delivery time: Improvements in these measures are expected to result in more distinctive products

delivered to its customers and in turn superior financial performance.

Learning and Growth Perspective

Development time for designing new machines, improvements in manufacturing processes, employee

education and skill levels, employee satisfaction Improvements in these measures are likely to improve

Metro’s capabilities to produce distinctive products that have a cause-and-effect relationship with

improvements in internal business processes, which in turn lead to customer satisfaction and financial

performance.

3. Calculate the operating income of Metro Corporation in 20X2 and 20X3.

Answer:

Operating income for each year is as follows: 20X2 20X3

Revenue (P40,000 × 200); (P42,000 × 210) 8,000,000 8,820,000
Costs
Direct Material Costs (300,000 × P8); (310,000 × P8.50) 2,400,000 2,635,000
Manufacturing Conversion Costs (P8k×250); (P8.1k×P250) 2,000,000 2,025,000
Selling & Customer Service Costs (10k × 100); (9.9k × 95) 1,000,000 940,500
Total Costs 5,400,000 5,600,500
Operating Income 2,600,000 3,219,500

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 Change in Operating Income 619,500

4. Compute for the revenue effect and cost effects of the growth component. Assuming that the direct

materials costs that would be required in 20X3 to produce 210 units instead of the 200 units in 20X2,

assuming the 20X2 input-output relationship continued into 20X3, equal 315,000 kilograms.

Manufacturing, conversion, design, selling, and customer-service costs remain the same.

Answer:

Revenue Effect of Growth = (Actual Units of Output Sold in 20X3 – Actual Units of Output Sold in 20X2) ×

Selling Price in 20X2 = (210 – 200) × P 40,000 = P 400,000 F

Direct Material Costs (315,000 – 300,000) × 8 = P 120,000

Manufacturing Conversion Costs (250 – 250) × P8,000 = 0

Selling & Customer-Service Costs (100 – 100) × P25,000 = 0

Cost Effect of Growth P 120,000

Net Increase in Operating Income as a Result of the Growth Component:

Revenue Effect of Growth P 400,000

Cost Effects of Growth Component 120,000

Change in Operating Income Due to Growth P 280,000

5. Solve the revenue effect and cost effects of the price-recovery component.

Answer:

The Price-Recovery Component

Revenue Effect of Price-Recovery = (Selling Price 20X3 – Selling Price in 20X2) × Actual Units of Output

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 Sold in 20X3 = (P 42,000 – P 40,000) × 210 = P 420,000

Direct Materials Costs (P 8.50 – P8) × 315,000 = P 157,500

Manufacturing Conversion Costs (P 8,100 – P 8,000) × 250 = 25,000

Selling & Customer-Service Costs (P 9,900 – P 10,000) × 100 = 10,000

Cost Effect of Price-Recovery P 172,500

Net Increase in Operating Income as a Result of the Price-Recovery Component Equals:

Revenue Effect of Price-Recovery P 420,000

Cost Effect of Price-Recovery 172,500

Change in Operating Income Due to Price-Recovery P 247,500

6. Calculate the productivity component that explains the change in operating income from 20X2 and

20X3.

Answer:

The Productivity Component

Direct Materials Costs (310,000 – 315,000) × P8.50 = P 42,500 F

Manufacturing Conversion Costs (250 – 250) × P8,100 = 0

Selling & Customer-Service Costs (95 – 100) × P9,900 = P 49,500

Change in Operating Income due to Productivity P 92,000

7. Provide an analysis of operating income using the provided table. Indicate whether computed

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 amounts are favorable or unfavorable to the company. Then, briefly explain the impact of Metro’s

change in operating income with its strategy

Answer:

The Change in Operating Income Between 20X2 and 20X3:

Income Revenue and R and CE of Cost Effect of Income

Statement Cost Effects of Price Recovery Productivity Statement

Amounts in Growth Component Component in Amounts in

20X2 Component 20X3 20X3

Revenues 8,000,000 400,000 420,000 8,820,000
Costs 5,400,000 120,000 172,500 92,000 5,600,500
Operating 2,600,000 280,000 247,500 92,000 3,219,500

Income
Income statement amounts in 20X3 - Income statement amounts in 20X2 = Change in operating income

= P 619,500

The analysis of operating income indicates that a significant amount of the increase in operating income

resulted from Metro’s product differentiation strategy. The company was able to continue to charge a

premium price while growing sales. Metro was also able to earn additional operating income by

improving its productivity. The productivity gains may be important from the standpoint of funding the

product differentiation strategy and innovation (as has been the case with the pharmaceutical industry in

recent years), but Metro’s strategic focus has to be on differentiating its products.

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