Simulation Balanced Scorecard This handout gives you tips for successfully managing the strategy of your firm once we move into the individual simulation toward the end of the semester. Use the lab portion of the simulation (the team competition) to practice each of the tips in the handout to help you prepare. Individual simulation scoring is based on a “balanced scorecard.” A balanced scorecard is used by many organizations to balance competing competitive strategic interests. For example, customer satisfaction often competes with profitability—customers want the best product at the lowest price while firms want low costs with high profits. The balanced scorecard we’ll use for a portion of the individual simulation scoring is composed of metrics related to how well your firm performs financially, how well it manages internal business processes, the extent to which it focuses on customers, and how well it learns and grows over time. The following table shows the metrics we’ll use for each of these categories. Each of the 10 metrics counts 25 points per round for a total of 250 possible points per round. We’ll have four rounds so the total possible on the balanced scorecard is 100 points.
Financial ROA Stock Price Avoiding Emergency Loans Profits Internal Business Process Plant Utilization Stock-Out Costs Inventory Carrying Costs Customer Customer Buying Criteria Market Share Learning & Growth Employee Productivity
Remember that you can find help with many of these metrics in the online Analyst Report. You’ll also find useful tips in the Manager’s Guide. The individual simulation doesn’t have an Analyst Report but you can access the team simulation competition rounds to get help. One caveat: if there are discrepancies between this handout and either of these other sources, rely on the other sources. A goal of this handout is to explain things as simply as possible and this always runs the risk of making things so simple they’re not completely accurate. Now let’s break down each balanced scorecard category. The charts on the following pages give an overview of what each metric means, how to calculate them, and most importantly, how to manage them to receive the maximum number of points.
Financial
Metric ROA What it Means Return on assets, a measure of how efficiently you utilize your firm’s assets in generating profits. The value investors are willing to pay for one share of ownership in your firm. Avoiding an emergency loan means you have enough cash flow to pay for ongoing operations. How to Calculate It Net income/Total assets How to Manage It Avoid idle assets. Utilize balance sheet assets to increase net income. For example, a plant running at 50% capacity utilization means you’re not fully using your plant to make products.
Stock Price
The simulation gives you your stock price; you don’t need to calculate it.
Avoiding Emergency Loans
The simulation will calculate whether or not you have an emergency loan.
Profits
How much money your firm makes after subtracting all costs
The simulation calculates net income for you
A large number of factors affect stock price in the real world, but the simulation boils these down to three things: book value, dividends, and EPS. Increase any or all of these to increase your stock price. Book value is the “accounting value” of your firm. In other words, it’s the original cost of balance sheet assets minus accumulated depreciation. Remember that you have three sources of cash. These are all shown in your cash flow statement: cash flow from investing, operations, and financing. As mentioned in the debt/equity section, using cash flow from operations is ideal. Put simply, it’s best to finance all your firm’s activities by having high sales and low expenses but we know this is the holy grail and isn’t usually realistic. Thus, you’ll most likely need to finance some of your firm’s activities by getting cash through debt financing and/or by selling underutilized plants and equipment. In fact, it makes a lot of sense to sell underperforming and underutilized product lines— this will often improve your net income. However, the other side of the argument12 is that if you’re too aggressive in selling off assets, you may find that you don’t have any way to produce products in the future. Profits are shown as net income on your income statement. The income statement begins with total sales revenue then subtracts costs to determine net income (profits). Total sales revenue is straightforward—it’s the number of units sold times the price you sold them for. The more difficult part is managing all the costs that eat away at net income. Three variable costs that are particularly important in driving gross profit direct labor, direct material, and inventory carrying costs. Manage direct labor costs by increasing plant automation (you’ll need fewer employees); manage direct material costs by reducing MTBF (mean time before failure—a measure of sensor reliability); manage inventory carrying costs by having no more than two months supply of inventory at the end of each round. However, each of these requires trade-offs; for example, reducing MTBF will affect customer satisfaction. The key is to balance these trade-offs in a way that maximized overall value creation. Other expenses also need attention. For example, if you’re overly aggressive in buying plant capacity, creating new products or revising existing products, increasing distribution and promotion, or increasing interest expense through poor debt management, your costs will increase and reduce your net income. To manage these costs, watch your proforma income statement as you make various decisions to see how each decision increases or decreases costs.
Internal Business Process
Metric Plant Utilization What it Means The extent to which you keep your assembly lines producing products How to Calculate It The simulation calculates this for you. How to Manage It Plant utilization is the same as capacity utilization in the Capstone Courier. Plant utilization ranges from 0-198% in the simulation. Running a single shift for a given product line gives you 100% capacity utilization; the simulation adds up all product lines when reporting the plant utilization. Running a double shift raises your capacity to 198% (we’d expect 200% but the simulation has a rounding error). Keep in mind that running above 100% capacity incurs employee overtime expenses but running at less than 100% means you have an idle assembly line and idle workers. Students sometimes have a tendency to try to avoid overtime but if the marginal profit exceeds the additional overtime pay, you should usually run the overtime shift. You can also add plant capacity to avoid overtime (remember to buy capacity in the round before you need it). Because plants and equipment are assets on the balance sheet, your return on assets (ROA) can be affected by running at less than 100% plant utilization. On the other hand, it’s not wise to produce products solely to manage plant utilization if there’s no demand for the additional products you’re producing thus making buy/sell capacity decisions critical. Missing an opportunity to sell additional sensors is sometimes worse than having too many sensors. Consider an example: if you make $5 in net income per sensor and you could have sold 1 million more sensors if you had them available, you missed the opportunity to gain $5 million in additional net income by running out of inventory. In the simulation, the key if to maintain inventory levels between 1-60 days supply. An accurate sales forecast is essential for managing this. Don’t trust the computer’s forecast— use your own. The simulation charges you 12% of the cost of each sensor that is carried forward to the next round. As with stock-out costs, an accurate sales forecast is essential to maintaining an ending inventory level of between 1-60 days supply.
Stock-Out Costs
The opportunity cost of running out of inventory
The simulation calculates this for you.
Inventory Carrying Costs
The cost of storing inventory in your warehouse until the next round.
The simulation calculates this for you.
Customer
Metric Customer Buying Criteria Market Share What it Means The extent to which you’re giving customers what they want Your slice of the total market How to Calculate It The simulation calculates this for you. The simulation calculates this for you. How to Manage It Match your products’ characteristics as closely as possible to the customer buying criteria. Remember that your products don’t have to be good, they just have to be better than your next best competitor. If your competitors have bad products, a mediocre product starts looking good to customers. But if your competitors have great products, your products need to be even better.
Learning & Growth
Metric Employee Productivity What it Means A measure of the number of products produced by each employee How to Calculate It The number of units produced / the number of employees. How to Manage It Employees assembling products by hand will be less productive than employees assembling products using robots. To manage this, increase automation levels. However, there are trade-offs. Increasing automation too rapidly may result in an emergency loan if you run out of cash. Manage this by staging the rate at which you automate your plants and focus automation on the most price sensitive segments. In the simulation, R&D cycle times increase as automation increases. In other words, the longer the R&D cycle time, the longer it will take to get a new product to market or change the position (size and performance) of an existing product. Manage this by increasing spending in TQM to improve efficiency and thus reduce R&D cycle times. You will subsequently notice shorter revision dates in your R&D screen. Also spend money on recruiting and training. Recruiting will attract good employees and training will help them become more productive.