Managerial Decision case: Balanced Scorecard

At the beginning of the last quarter of 2016, Redecom, Inc., a large consumer products firm,
hired Downing Imai to take over one of its divisions. The division manufactured small home
appliances and was struggling to survive in a very competitive market. Downing immediately
requested a projected income statement for 2016. In response, the controller provided the
following statement:

Sales $25,000,000
Variable expenses 20,000,000
Contribution margin $ 5,000,000
Fixed expenses 6,000,000
Projected loss $(1,000,000)

After some investigation, Downing soon realized that the products being produced had a
serious problem with quality. He once again requested a special study by the controller’s
office to supply a report on the level of quality costs. By the middle of November, Downing
received the following report from the controller:

Inspection costs, finished product $ 400,000

Rework costs 2,000,000
Scrapped units 600,000
Warranty costs 3,000,000
Sales returns (quality-related) 1,000,000
Customer complaint department 500,000
----------------
Total estimated quality costs $7,500,000

Downing was surprised at the level of quality costs. They represented 30 percent of sales,
which was certainly excessive. He knew that to survive the division had to produce high-
quality products. The number of defective units produced needed to be reduced
dramatically. Thus, Downing decided to pursue a quality-driven turnaround strategy.
Revenue growth and cost reduction could both be achieved if quality could be improved. By
increasing revenues and decreasing costs, profitability can
be increased.

After meeting with the managers of production, marketing, purchasing, and human
resources, the following decisions were made, effective immediately (at the end of
November 2016):
1. More will be invested in employee training. Workers will be trained to detect quality
problems and empowered to make improvements. Workers will be allowed a bonus of 10
percent of any cost savings produced by their suggested improvements.
2. Two design engineers will be hired immediately, with expectations of hiring one or two
more within a year. These engineers will be in charge of redesigning processes and
products with the objective of improving quality. They will also be given the responsibility
of working with selected suppliers to help improve the quality of their products and
processes. Design engineers were considered a strategic necessity.
3. Implement a new process: evaluation and selection of suppliers. This new process has
the objective of selecting a group of suppliers that are willing and capable of providing
nondefective components.

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4. Effective immediately, the division will begin inspecting purchased components.
According to production, many of the quality problems are caused by defective
components purchased from outside suppliers. Incoming inspection was viewed as a
transitional activity. Once the division has developed a group of suppliers capable of
delivering nondefective components, this activity will be eliminated.
5. Within three years, the goal is to produce products with a defect rate less than 0.10
percent. By reducing the defect rate to this level, marketing is confident that market share
will increase by at least 50 percent (as a consequence of increased customer
satisfaction). Products with better quality will help establish an improved product image
and reputation, allowing the division to capture new customers and increase market
share.
6. Accounting will be given the charge to install a quality information reporting system. Daily
reports on operational quality data (e.g., percentage of defective units), weekly updates of
trend graphs (posted throughout the division), and quarterly cost reports are the types of
information required.
7. To help direct the improvements in quality activities, an aggressive continuous
improvement program will be implemented. For example, for the year 2017, rework costs
have a targeted future state value of 6 percent of the selling price per unit, a 25 percent
reduction from the current state cost.

To ensure that the quality improvements were directed and translated into concrete financial
outcomes, Downing also began to implement a Balanced Scorecard for the division. By the
end of 2017, progress was being made. Sales had increased to $26,000,000, and
improvements were meeting or beating expectations. For example, rework costs had
dropped to $1,500,000. At the end of 2018, two years after the turnaround quality strategy
was implemented, Downing received the following quality cost report:

Quality training $ 500,000

Supplier evaluation 230,000
Incoming inspection costs 400,000
Inspection costs, finished product 300,000
Rework costs 1,000,000
Scrapped units 200,000
Warranty costs 750,000
Sales returns (quality-related) 435,000
Customer complaint department 325,000
---------------
Total estimated quality costs $4,140,000

Downing also received an income statement for 2018:

Sales $30,000,000
Variable expenses 22,000,000
Contribution margin $ 8,000,000
Fixed expenses 5,800,000
Income $ 2,200,000

Downing was pleased with the outcomes. Revenues had grown, and costs had been
reduced by at least as much as he had projected for the two-year period. Growth next year
should be even greater as he was beginning to observe a favorable effect from the higher-
quality products. Also, further quality cost reductions should materialize as incoming
inspections were showing much higher-quality purchased components.

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Required:
1. Identify the strategic objectives classified by Balanced Scorecard perspectives. Next,
suggest measures for each objective. Classify the measures as lead or lag
measures.
2. Using the results from Requirement 1, describe Downing’s strategy using a series of
if-then statements. Next, prepare a visual diagram of the strategy similar to the one
shown in Exhibit 16-13 (although more complex).
3. Explain how you would evaluate the success of the quality-driven turnaround
strategy. What additional information would you like to have for this evaluation?
4. Explain why Downing felt that the Balanced Scorecard would increase the likelihood
that the turnaround strategy would actually produce good financial outcomes.
5. The targeted future state for rework was 6 percent of sales for 2007. Was the target
met? Describe the role for continuous improvement in Downing’s strategy.
6. Of the quality activities listed in the 2008 report, which ones are non-value-added?
By eliminating all non-value-added activities, how much further cost reduction is
possible?