Inca Instruments Inc. (III) makes a handheld calculator, the II400. III presents the following data for years 1 and 2:

Year 1 Year 2

Units of II400 produced and sold 50,000 52,500

Selling price $40 $44

Direct materials (kilograms) 150,000 153,375

Direct materials costs per kilogram $4.00 $4.40

Manufacturing capacity for II400 (units) 62,500 62,500

Total manufacturing conversion costs $500,000 $550,000

Manufacturing conversion costs per unit of capacity $8.00 $8.80

Selling and customer-service capacity (customers) 30 29

Total selling and customer-service costs $360,000 $362,500

Cost per customer of selling & customer-service capacity $12,000 $12,500

Manufacturing conversion costs depend on production capacity defined in terms of the number of II400 units that can be produced. Selling and customer-service costs depend on the number of customers that the customer service functions are designed to support. Neither conversion costs nor customer service costs are affected by changes in actual volume. Inca Instruments has 23 customers (retailers) in Year 1 and 25 customers in Year 2. The industry market size for handheld calculators increased 5% from Year 1 to Year 2. Of the $4 increase in unit selling price, $1 is due to a general increase in prices.

1. Calculate the growth (both revenue and cost effect), price-recovery (both revenue and cost effect), and productivity components that explain the change in operating income from Year 1 to Year 2.

2. What type of strategy is the company pursuing: cost leadership or value leadership? Support your answer using the variances calculated in #2 (i.e., explain how the variances may demonstrate that the company is pursuing a particular strategy).