Chapter 11 - Decision Making with a Strategic Emphasis
Chapter 11
Decision Making with a Strategic Emphasis
Learning Objectives
New in this Edition
• One updated Real-World Focus (RWF) item, dealing with distortions and deceptions in decision-making
• Three (3) new Real-World Focus (RWF) items: Sustainability—The Decision to Install Solar;
Amzaon.com—Insourcing of Retail Delivery Service; and, Sustainability—Choice of a New Auto
• Increased use of Excel’s “Goal Seek” function for end-of-chapter exercises and problems
• Shorter, crisper discussion of Predatory Pricing Practices
Teaching Suggestions
A key teaching point for this chapter is that the strategic issues can be more important than the calculation of
contribution margin or relevant cost to determine a preferred decision alternative. The approach I take is to first
introduce the concepts of relevant costs and decision making, and then to bring in the importance of the firm’s
strategy in determining the correct decision.
I typically cover Chapter 11 in two days. In the first day I present the fundamental concepts of
5. evaluating programs, including not-for-profit programs
Chapter 11 - Decision Making with a Strategic Emphasis
this chapter has to be practice, so that they see how to work a variety of different problems and develop
confidence in working these problems.
Assignment Matrix
End-of-Chapter Exercises and Problems
Chapter Learning Objectives
Text Features
11-27
11-27
-
X
45 min.
X
X
Chapter 11 - Decision Making with a Strategic Emphasis
Lecture Notes
A. The Decision-Making Process—see Text Exhibit 11.1. In deciding among alternative choices for a given
situation, managers employ the following five-step process. The first, and probably most important, step is to
consider the strategic issues regarding the decision context. This helps focus the decision maker on answering the
Chapter 11 - Decision Making with a Strategic Emphasis
1. Relevant Cost Information. Relevant costs are costs that will be incurred at some future time and
2. Batch-Level Cost Drivers. Although most relevant costs for many decisions are variable, the
4. Other Relevant Information: Opportunity Costs. Managers should include in their decision
process information such as the capacity usage of the plant. Capacity usage information is a critical
signal of the potential relevance of opportunity costs, the benefit lost when one chosen option
Chapter 11 - Decision Making with a Strategic Emphasis
strategy. A good indication of a manager’s failing to take a strategic approach is that the analysis will have a
product cost focus, while a strategic relevant cost analysis also addresses broad and difficult-to-measure strategic
issues.
D. Special-Order Decisions: Cost Analysis. The special-order decision occurs when a firm has a one-time
opportunity to sell a specific quantity of its product or service. It is called “special order” because it is typically
unexpected and non-recurring in nature. To make this special order decision, managers need critical information
about relevant costs, revenues, and any opportunity costs.
E. Special-Order Decisions: Strategic Analysis. The relevant cost analysis described in the previous section
provides a useful decision regarding the order’s profitability. However, for a full decision analysis, the firm
should also consider the strategic factors of capacity use, short-term vs. long-term pricing, the trend in variable
costs, and the use of activity-based costing. The relevant cost decision rule for special orders is intended only for
those infrequent situations when a special order can increase income. Done on a regular basis, relevant cost
pricing can erode normal pricing policies and lead to a loss on profitability for firms. Special order decisions
should not become the centerpiece of a firm’s strategy.
F. Make, Lease, or Buy Decisions: Cost Issues. The relevant cost information for the make-or-buy decision is
developed in a manner similar to that of the special order decision. The relevant cost information for making the
component consist of the short-term costs to manufacture it, ordinarily the variable manufacturing costs, which
would be saved if the part was purchased. These costs are compared to the purchase price for the part to determine
the appropriate decision. A similar question arises when a firm must choose between leasing or purchasing a piece
of equipment. Such decisions become ever more frequent as the cost and terms of the lease agreement become
more favorable.
G. Make, Lease, or Buy Decisions: Strategic Analysis. The make, lease, or buy decision often raises strategic
issues. Make, lease, or buy analysis has a key role in the decision to outsource by providing an analysis of the
relevant costs. Certain firms have taken the idea of outsourcing one step further, to what is called contract
manufacturing, in which another firm manufactures a portion of the first firm’s products. When one firm has
more capacity or expertise than another firm, contract manufacturing can be a cost-effective strategy for both
firms.
H. Sell Before or After Additional Processing: Cost Analysis. Another common decision concerns the option
to sell a product or service before an intermediate processing step or to add further processing and then selling the
product or service for a higher price. The analysis of features also is important for manufactures in determining
what to do with defective parts. The decision is whether the product should be sold with or without additional
processing. I use class time to distinguish between financial reporting uses of cost information (here, the need to
allocate joint production costs to outputs, so that the accountant can prepare financial statements—inventory on
the Balance Sheet, and Cost of Goods Sold on the Income Statement) versus the decision-use of cost information
(here, whether certain products should be sold at the spilt-off point or processed further and then sold). Again, the
decision process should begin (but not end) with a relevant cost analysis: which costs in the decision are
avoidable, and which are not? Added in the 6th edition was a discussion of the following terms:
Chapter 11 - Decision Making with a Strategic Emphasis
J. Profitability Analysis: Keep or Drop a Line—Cost Issues. An important aspect of management is the
regular review of product profitability. This review should address the following issues:
• Which products are most profitable?
• Are these products properly prices?
• Which products should be promoted and advertised more aggressively?
• Which product managers should rewarded?
1. One Resource Constraint. When there is only one production constraint and excess demand, it is
2. Two Resource Constraints. When the production process requires two or more production constraints,
Chapter 11 - Decision Making with a Strategic Emphasis
1. Consideration of Strategic Objectives. A well-known problem in business today is the tendency of
Advanced Lecture Notes
The illustrations developed in this chapter have assumed that each of the cost and revenue factors in the relevant
cost analysis is known with certainty. In some situations this can be a very unrealistic assumption, as for example,
for new companies, new products, seasonal products, and so on. Rather than to simply calculate the cost and/or
income under each decision alternative based on approximated values, managers often prefer to incorporate the
uncertainty directly into the analysis. Techniques have been developed to deal with this matter; they include
simulation and analytical modeling, which are explained in the teaching notes at the end of Chapter 9 (CVP
analysis) in this guide.
Chapter 11 - Decision Making with a Strategic Emphasis
Since we know from the analysis in the chapter that QUICK COPY should purchase rather than lease the copy
machine if the demand for the number of copies exceeds the indifference point of 5,000,000 copies, and since there
is a 70% probability that the demand for copies will exceed six million copies, we can say that the probability is at
least 70% that QUICK COPY will have less cost if it purchases the new machine.
We can also give the manager a pretty good idea of expected income assuming the purchase of the machine, as
follows. First, we assume that the average price per copy is $.06, the average cost of paper per copy is $.01, and
the expected labor and other operating costs are expected to be $48,000. (Note that this information was irrelevant