Introduction to strategic management accounting

Transcription

1 chapter 1 Introduction to strategic management accounting Chapter learning objectives Upon completion of this chapter you will be able to: explain the role, for organisations in general, of strategic management accounting in strategic planning and control describe the role of corporate planning in: clarifying corporate objectives making strategic decisions checking progress towards the objectives describe, for organisations in general, the purpose, content, structure and potential problems of a mission statement describe the ways in which high level corporate objectives are developed for organisations in general identify, for a given scenario or in general, strategic objectives and describe how they may be incorporated into the business plan and cascaded down the organisation compare planning and control at the strategic and operational levels within a business entity explain how organisational survival in the long term necessitates consideration of life cycle issues explain the main aspects of strategic management accounting in the context of multinational companies explain, for organisations in general, the scope for potential conflict between strategic business plans and short term localised decisions explain, in general and for a given scenario, how SWOT analysis may assist in the performance management process 1

2 Introduction to strategic management accounting describe, in outline, the benefits and difficulties of benchmarking performance with best practice organisations evaluate how risk and uncertainty play an especially important role in long term strategic planning and decision making that rely upon forecasts of exogenous variables assess the impact government policy can have on an organisation in general and its strategy formulation and implementation. 2 KAPLAN PUBLISHING

3 chapter 1 1 The role of strategic management accounting The strategic planning process was examined in detail in the P3 paper. In P5 the focus is more on the performance management aspects of strategic planning and the role of strategic management accounting. Strategic analysis, choice and implementation Johnson and Scholes 3 stage model of strategic planning is a useful framework for seeing the bigger picture of performance management and strategic management accounting issues. KAPLAN PUBLISHING 3

4 Introduction to strategic management accounting Within this, the role of critical success factors (CSFs) is central to performance management: Defining strategic management accounting Historically the role of the management accountant was often limited to the implementation stage summarised above with a focus on operational budgeting, target setting and control. In many respects this is the emphasis of the F5 paper. The term strategic management accounting has come into common use more recently. It refers to the full range of management accounting practices used to provide a guide to the strategic direction of an organisation. Strategic management accounting gives a financial dimension to strategic management and control, providing information on the financial aspects of strategic plans and planning financial aspects of their implementation. It supports managers throughout the organisation in the task of managing the organisation in the interests of all its stakeholders. Strategic management accounting places an emphasis on using information from a wide variety of internal and external sources in order to evaluate performance, appraise proposed projects and make decisions. 4 KAPLAN PUBLISHING

5 chapter 1 It focuses on the external environment, such as suppliers, customers, competitors and the economy in general as much as on the organisation itself. Strategic management accounting monitors performance in line with the organisation s strategic objectives in both financial and non financial terms. Note that many of the tools and techniques studied in F5 (and some in F9) are still examinable in P5, including the following: costing methods, e.g. target costing, life cycle costing limiting factor analysis relevant costing risk techniques, e.g. expected values, minimax regret, maximin, maximax budgeting, e.g. flexed budgets forecasting techniques, e.g. hi low, time series, learning curves standard costing. Expandable text Strategic management accountant role Job descriptions Aspects of strategic management accounting are being incorporated in many management accounting roles. For example, job descriptions for management accountants often include strategic activities such as: providing information for strategic decisions formulating business strategies providing advice on how to improve business performance providing analysis of competitor performance liaising with functional managers to support the business planning process. KAPLAN PUBLISHING 5

6 Introduction to strategic management accounting Test your understanding 1 A company selling wooden garden furniture in northern Europe is facing a number of problems: demand is seasonal it is sometimes difficult to forecast demand as it varies with the weather more is sold in hot summers than when it is cooler or wetter the market is becoming more fashion conscious with shorter product life cycles there is a growth in the use of non traditional materials such as plastics. As a result the company finds itself with high inventory levels of some items of furniture which are not selling, and is unable to meet demand for others. A decision is needed on the future strategic direction and possible options which have been identified are to: use largely temporary staff to manufacture products on a seasonal basis in response to fluctuations in demand however it has been identified that this could result in quality problems automate production to enable seasonal production with minimum labour related problems concentrate on producing premium products which are smaller volume but high priced and less dependent on fashion. How could strategic management accounting help with the decision making? The role of corporate planning The term corporate planning refers to the formal process which facilitates the strategic planning framework described above. 6 KAPLAN PUBLISHING

7 chapter 1 Illustration 1 The role of corporate planning The description of the role of a corporate planning department of a hospital might read: The corporate planning department supports senior management in making decisions to ensure corporate objectives are met. Its main roles are: to manage the business planning process through which the objectives of individual clinical departments and support services are agreed to compile and publish the annual plan for the hospital to monitor performance against the targets set in the business planning process to monitor performance compared with other similar organisations to undertake specific strategic projects. Clarifying corporate objectives The strategic analysis stage will generate a range of objectives, typically relating to: maximisation of shareholder wealth (usually via maximising profit) maximisation of sales (whilst earning an acceptable level of profit) growth (in sales, asset value, number of employees etc.) survival research and development leadership quality of service contented workforce respect for the environment. These need to be clarified in two respects: conflicts need to be resolved, e.g. profit versus environmental concerns to facilitate implementation and control, objectives need to be translated into SMART (specific, measurable, achievable, relevant and time bound) targets. KAPLAN PUBLISHING 7

8 Introduction to strategic management accounting Expandable text Shareholder wealth as an objective Shareholder wealth Resolving conflict is often portrayed as a simple prioritisation shareholder wealth creation should be the main objective. However, in practice, firms often view other objectives (e.g. employee welfare) as constraints within which the firm tries to generate shareholder value. Illustration 2 Clarifying corporate objectives A statement such as maximise profits would be of little use in corporate planning terms. The following would be far more helpful: achieve a growth in EPS of 5% pa over the coming ten year period obtain a turnover of $10 million within six years launch at least two new products per year. Gap analysis Gap analysis is useful for showing how (whether) strategies will enable the firm to meet targets for key objectives (or at least those that can be easily quantified). For example, closing a profit gap: 8 KAPLAN PUBLISHING

9 chapter 1 In the diagram showing the gap: T = target F 0 = initial forecast F 1 = forecast adjusted for improvements in internal efficiency F 2 = forecast adjusted for product market expansion. Analysis of the gap reveals that in this instance the objectives cannot be achieved beyond Year 4 without diversification. This gap is significant if the lead time for diversifying exceeds 4 years. The existence of the gap may or may not lead to the revision of objectives. (There are after all two ways of closing a gap revising objectives or taking action to improve performance expectations.) Expandable text Objectives Objectives would be revised upwards if the forecasts showed that performance could be expected to exceed objectives: in this case, the objectives might also be raised if forecasts showed that the gap was considerably more marked for one objective than for another. For instance, suppose the Return on investment (ROI) target is 10% and increased flexibility is also desired. The forecast shows that the ROI target can be achieved but that little increase in flexibility can be expected. In this case, the flexibility objective might be given greater emphasis. Making strategic decisions Strategic options can be evaluated using the suitability, feasibility, acceptability framework. Suitability whether the options are adequate responses to the firm's assessment of its strategic position. Acceptability considers whether the options meet and are consistent with the firm's objectives and are acceptable to the stakeholders. Feasibility assesses whether the organisation has the resources it needs to carry out the strategy. KAPLAN PUBLISHING 9

10 Introduction to strategic management accounting The strategic management accountant will contribute to the acceptability and feasibility aspects in particular: Aspect Key concerns Typical financial analysis Acceptability Returns to stakeholders Cash flow forecasts to ensure dividend growth requirements can be met NPV analysis ROCE Valuation of real options Shareholder value analysis Economic value added Cost benefit analysis Ratio analysis (e.g. dividend yield, growth) Risk Sensitivity Break even Ratio analysis (e.g. gearing, dividend cover) Expected values Feasibility Resources Cash flow forecast to identify funding needs Budgeting resource requirements Ability to raise finance needed Working capital implications Foreign exchange implications Checking progress towards objectives It is not enough merely to make plans and implement them. The results of the plans have to be compared against stated objectives to assess the firm s performance. Action can then be taken to remedy any shortfalls in performance. This is an essential activity as it highlights any weakness in the firm s corporate plan or its execution. Plans must be continually reviewed because as the environment changes so plans and objectives will need revision. 10 KAPLAN PUBLISHING

11 chapter 1 Corporate planning is not a once in every ten years activity, but an on going process which must react quickly to the changing circumstances of the firm. Expandable text Diagram of corporate planning activities Diagram of planning activities Test your understanding 2 Why do you think managers need to understand corporate planning? KAPLAN PUBLISHING 11

12 Introduction to strategic management accounting 2 The performance hierarchy Mission The mission statement is a statement in writing that describes the basic purpose of an organisation, that is, what it is trying to accomplish. There are a number of fundamental questions that an organisation will need to address in its search for purpose (Drucker). These are: Expandable text Mission statement characteristics Mission statements will have some or all of the following characteristics: Usually a brief statement of no more than a page in length. Very general statement of entity culture. States the aims (or purposes) of the organisation. States the business areas in which the organisation intends to operate. Open ended (not stated in quantifiable terms). Does not include commercial terms, such as profit. Not time assigned. Forms a basis of communication to the people inside the organisation and to people outside the organisation. Used to formulate goal statements, objectives and short term targets. 12 KAPLAN PUBLISHING

13 chapter 1 Guides the direction of the entity s strategy and as such is part of management information. Potential Problems Mission statements may: Not represent the actual values of the organisation Be vague be ignored Illustration 3 Mission Example: ICI plc Mission statement The chemical industry is a major force for the improvement of the quality of life across the world. ICI aims to be the world s leading chemical company, serving customers internationally through the innovative and responsible application of chemistry and related sciences. Through achievement of our aim, we will enhance the wealth and well being of our shareholders, our employees, our customers and the communities which we serve and in which we operate. The relevance of a mission for strategic planning A statement of corporate mission is inextricably linked with the organisation s goals and objectives, although it is important to draw a distinction between these three aspects of the strategic planning process. Whilst the organisational objectives comprise the specific targets of the company and the goals comprise its broad aims, the mission encapsulates the reason that the entity exists in terms of the service and utility provided to meet specific needs of society. Before setting about the preparation of a strategic plan the management should consider the mission of an organisation. Many commentators have suggested that consideration and determination of the mission and its articulation into a statement of corporate mission constitutes the first stage in the strategic planning process and that therefore it is central to the whole planning process. KAPLAN PUBLISHING 13

14 Introduction to strategic management accounting Johnson and Scholes have suggested that the mission of an organisation is the most generalised type of objective and can be thought of as an expression of its raison d être. On the other hand, some commentators believe that the mission statement is the endproduct of the process of strategic planning and this illustrates the confusion which often exists between the organisation s mission and its goals and objectives. Because of the vague nature of some mission statements, it can be difficult to assess performance by reference back to the mission. Instead detailed tactical and operational targets are more useful see below. The performance hierarchy To enable an organisation to fulfil its mission, the mission must be translated into Strategic plans and objectives Tactical plans and objectives Detailed operational plans and targets. Each level should be consistent with the one above. This process will involve moving from general broad aims to more specific objectives and ultimately to detailed targets. Expandable text Performance hierarchy of a private sector co. This is a hypothetical example for a private sector company. Mission statement (extract)... and we will enhance the wealth and well being of our shareholders, Goal statements (1) We will provide our shareholders with a return on their investment which is commensurate with their expectations. (2) We will protect the security of our shareholders investments. (3) We will endeavour to increase the capital value of our shareholders investment. 14 KAPLAN PUBLISHING

15 chapter 1 Objectives Goal 1: Shareholders return on investment To realise a return on investment of 25% during the next x years. To achieve a growth in sales turnover of x % in y years. To maintain net profit margins. That the return to shareholders should grow in line with the growth in net profit.... Goal 2: Security of shareholders investments To maintain the quality of existing assets by investing not less than 8% of sales annually for the next x years, and to make new investment at rates of return applicable to the risk involved to meet the company s targeted return on capital employed. To ensure that loans should not exceed 45% of capital employed unless required for exceptional circumstances of a short term nature. To maintain a match between foreign currency assets and liabilities.... Goal 3: Growth in shareholders investments To achieve a price earnings multiple of x by y date.... It is the achievement of the subsidiary objectives that forms the basis for performance evaluation. 3 Planning and control Characteristics of planning and control Planning and control are often portrayed as distinct processes. Planning is concerned with identifying where the organisation wants to be (usually expressed in terms of objectives) and how it will get there (strategies). Control activities are concerned with monitoring achievement of objectives and suggesting corrective action, which may include modification of objectives. Management control also ensures that resources are obtained and used effectively and efficiently. KAPLAN PUBLISHING 15

16 Introduction to strategic management accounting Expandable text Characteristics of planning Planning Strategic planning is characterised by the following: long term considers the whole organisation as well as individual SBUs matches the activities of an organisation to its external environment matches the activities of an organisation to its resource capability and specifies future resource requirements will be affected by the expectations and values of all stakeholders, not just shareholders its complexity distinguishes strategic management from other aspects of management in an organisation. There are several reasons for this including: it involves a high degree of uncertainty it is likely to require an integrated approach to management it may involve major change in the organisation. 16 KAPLAN PUBLISHING

17 chapter 1 Quite apart from strategic planning, the management of an organisation has to undertake a regular series of decisions on matters that are purely operational and short term in character. Such decisions: are usually based on a given set of assets and resources do not usually involve the scope of an organisation s activities rarely involve major change in the organisation are unlikely to involve major elements of uncertainty and the techniques used to help make such decisions often seek to minimise the impact of any uncertainty. use standard management accounting techniques such as costvolume profit analysis, limiting factor analysis and linear programming. Illustration 4 Planning Strategic planning is usually, but not always, concerned with the longterm. For example, a company specialising in production and sale of tobacco products may forecast a declining market for these products and may therefore decide to change its objectives to allow a progressive move into the leisure industry, which it considers to be expanding. Strategic decisions involve the formulation of the new objectives and deciding on the manner in which these new objectives will be achieved, i.e. by acquisition of companies which are already established in the industry (external development), or by starting new businesses itself ( organic growth ). Although strategic planning is concerned with long term goals it often involves short term action. For example, the acquisition of a new company in the leisure industry is made in order to fulfil a long term objective but it requires short term planning and control action, all of which are classified under the heading of strategic planning. KAPLAN PUBLISHING 17

18 Introduction to strategic management accounting Expandable text Strategic or operational control? Control Control can be strategic or operational. Strategic control is concerned with monitoring the implementation of the organisation s strategy to ascertain how well the strategic objectives are being achieved, e.g. managing shareholder expectations. Operational control is concerned with the management of existing assets and resources, given the existing strategic direction. Operational control will not lead to changes in that strategy. Expandable text Criticisms of the planning and control model Criticisms of the planning and control model The view of planning and control put forward above has been criticised by several writers. For example, RN Anthony argues that, although it is possible to identify the different types of mental activity that are required for planning and control decisions, it is wrong to suggest that the activities are clearly separable in practice. All managers make both planning and control decisions, e.g. a foreman who is unhappy with the production figures for his section may revise future forecasts (a planning decision) as well as taking action to motivate his team to perform better in future (a control decision). Where participation is used as a management style, planning and control decisions are bound to be inter related. Anthony identified three types of management activity: strategic planning management control (or tactical planning) operational control. (1) Strategic planning and short term decisions As we saw earlier, strategic planning involves making decisions about: the objectives of the organisation changes in these objectives 18 KAPLAN PUBLISHING

19 chapter 1 the resources used to attain the objectives policies governing: acquisition use disposition of these resources. (2) Management control and tactical planning Management control is the process by which managers ensure that resources are obtained and used effectively and efficiently in the accomplishment of the organisation s objectives. Decisions at the management control, or tactical, level are numerous. They include pricing decisions and other elements of the marketing mix, such as advertising, promotion and distribution decisions relating to purchases and suppliers, inventory levels and other aspects of working capital management and asset replacement decisions. Decisions at this level are usually based on financial analysis, money being the common unit of measurement of resources. The control systems are performance reports relating to profit, cost or revenue centres. These reports are a summary of many different operations. The detailed control over each individual operation is exercised at the operational level, which is described below. (3) Operational control Operational control is the process of ensuring that specific tasks are carried out effectively and efficiently. As more tasks become automated, the human factor in operational control becomes less important. Many tasks are subject to programmed control, where the relationship between inputs and outputs is clearly specified. However, where processes are carried out by people, the human factor in operational control will always be important, as people need to be motivated to consistently perform routine tasks to a high standard. Test your understanding 3 Is the activity of setting a profit maximising selling price for a product a strategic or operational decision? Give reasons for your answer. KAPLAN PUBLISHING 19

20 Introduction to strategic management accounting 4 Life cycles The importance of the product life cycle The various stages of the product life cycle raise a number of important issues with regard to the input of strategic management accounting. There will be different critical success factors at different stages in the life cycle. In order to ensure that performance is managed effectively key performance targets will need to vary over different stages in the life cycle. The stages of the life cycle have different intrinsic levels of risk. Understanding and responding to these risks is vital for the future success of the organisation. Performance objectives and the product life cycle Expandable text Classic life cycle The classic life cycle for a product has four phases, with different CSFs. An introduction phase, when the product or service is first developed and introduced to the market. Sales demand is low whilst potential customers learn about the item. There is a learning process for both customers and the producer, and the producer might have to vary the features of the product or service, in order to meet customer requirements more successfully. A growth phase, when the product or service becomes established, and there is a large growth in sales demand. The number of competitors in the market also increases, but customers are still willing to pay reasonably high prices. The product becomes profitable. Variety in the product or service increases, and customers are much more conscious of quality issues. A maturity phase, which might be the longest stage in the product life cycle. Demand stabilises, and producers compete on price. A decline phase, during which sales demand falls. Prices are reduced to sustain demand and to slow the decline in sales volume. Eventually the product becomes unprofitable, and producers stop making it. 20 KAPLAN PUBLISHING

21 chapter 1 Test your understanding 4 The following table shows order winning and order qualifying factors at different stages in the product life cycle. Suggest key operational performance objectives for each stage. Likely to be an order winning factor Likely to be a qualifying factor Likely to be operational performance objectives Introduction Growth Maturity Decline Features of the product or service Quality Quality Availability Reliability Price Low price Reliable supply Quality Low price Reliable supply Risk and the product life cycle The risk associated with a particular product will vary throughout its life: the launch period is clearly a time of high business risk as it is quite possible that the product will fail the risk is still high during the growth phase because the ultimate size of the industry is still unknown and the level of market share that can be gained and retained is also uncertain during the market maturity phase the risk decreases and the final phase should be regarded as low risk because the organisation knows that the product is dying and its strategy should be tailored accordingly. If there is an analysis of the developing risk profile it should be compared to the financial risk profiles of various strategic options, making it much easier to select appropriate combinations and to highlight unacceptably high or low total risk combinations. Thus for an organisation to decide to finance with debt the development and launch of a completely new product would represent a high total risk combination. KAPLAN PUBLISHING 21

22 Introduction to strategic management accounting Looking at the other end of the life cycle, there are many organisations in a dominant market position with mature products which are holding large positive cash balances. These organisations are obvious acquisition targets. For them to introduce a realistic level of debt can dramatically improve the return to shareholders without increasing the total combined risk to unacceptable levels. 5 Strategic management accounting in multinational companies A multinational company is normally considered to be one that undertakes a substantial proportion of its business in countries other than that in which it is domiciled. The strategic process in a multinational company must take account of certain special features which have financial implications. These include: process specialisation product specialisation economic risk political sensitivities administrative issues. Expandable text Multinational strategic management accounting Process specialisation. There may be a cost advantage in locating certain types of activity in certain countries. For example, a labour intensive operation may be best placed in a low wage area. Many companies (and not just traditional multinationals) have recently relocated customer service desks and telephone call centres to India. Product specialisation. In spite of globalisation and the concept of world products, particular countries have characteristic tastes that the multinational must cater to. Economic risk. The economics of a multinational operation may be highly sensitive to issues such as exchange rate fluctuations. Political sensitivities. The multinational company operates across state boundaries and must be acutely aware of associated risk factors. Administrative issues. A multinational company will find that even its own internal transactions are vulnerable to exchange rate movements, currency exchange controls and the existence (or absence) of international tax treaties. For example, if a multinational domiciled in country A tries to repatriate profits earned by its subsidiary in country B then it may find that those profits are taxed twice once in A and again in B. 22 KAPLAN PUBLISHING

23 chapter 1 Illustration 5 Multinational companies The development of multinational companies Typically, a multinational company takes the form of a central corporation with subsidiaries in each of the countries in which it operates. Wellknown examples include Ford, Shell, Nestlé, General Motors, Toyota and Microsoft. By the early 1990s, 37,000 multinational companies with annual sales of $5.5 billion controlled about one third of the world s private sector assets. The advent of these multinationals is associated with the apparent globalisation of the world economy. Various factors have contributed to this development, but one factor is critical. Increases in the scale of technology (in terms of cost, risk and complexity) have rendered even the largest national markets too small to be meaningful economic units on a stand alone basis. Companies must expand internationally to support the technological development that is needed to remain competitive in many fields. The modern trend in international business seems to be away from the old multinational corporations and towards networks and alliances. Strategic planning for the latter is another issue altogether. Expandable text Impact of exchange rates The impact of exchange rates In the 1980s, many car manufacturers (Nissan, Toyota and Peugeot to name but three) built car assembly facilities in the UK to serve the whole of Europe because the UK was perceived as a low cost area. The UK s non adoption of the Euro and the appreciation of the pound in the late 1990s suddenly made the UK a high cost area. For a time, the viability of several high profile plants was brought into question. Test your understanding 5 A multinational company with subsidiaries in North America and Europe is considering launching its products in South America. As a management accountant supporting senior managers in making strategic decisions, what factors would you need to consider in your assessment of the options facing the company? KAPLAN PUBLISHING 23

24 Introduction to strategic management accounting 6 Long term and short term conflicts The whole concept of strategic planning explored earlier in this chapter implies a certain top down approach. Even in the era of divisional autonomy and employee empowerment it is difficult to imagine that a rigorous strategic planning regime could be associated with a bottom up management culture. There is a potential for conflict here. The idea of divisional autonomy is that individual managers operate their business units as if they were independent businesses seeking and exploiting local opportunities as they arise. Managers are rewarded in a manner which reflects the results they achieve. The pressures on management are for short term results and ostensibly strategy is concerned with the long term. Often it is difficult to motivate managers by setting long term expectations. Long term plans have to be set out in detail long before the period to which they apply. The rigidity of the long term plan, particularly in regard to the rationing and scheduling of resources, may place the company in a position where it is unable to react to short term unforeseen opportunities, or serious short term crisis. Strict adherence to a strategy can limit flair and creativity. Operational managers may need to respond to local situations avert trouble or improve a situation by quick action outside the strategy. If they then have to defend their actions against criticisms of acting outside the plan, irrespective of the resultant benefits, they are likely to become apathetic and indifferent. The adoption of corporate strategy requires a tacit acceptance by everyone that the interests of departments, activities and individuals are subordinate to the corporate interests. Department managers are required to consider the contribution to corporate profits or the reduction in corporate costs of any decision. They should not allow their decisions to be limited by short term departmental parameters. It is only natural that local managers should seek personal advancement. A problem of strategic planning is identifying those areas where there may be a clash of interests and loyalties, and in assessing where an individual has allowed vested interests to dominate decisions. 24 KAPLAN PUBLISHING

25 chapter 1 Expandable text ICI long term and short term conflict Because of the potential for conflict between long term strategy and local decisions most parent companies adopt the strategic control parenting style with which you will be familiar from your earlier studies in the P3 paper. In strategic control companies such as ICI: corporate management take a middle course, accepting that subsidiaries must develop and be responsible for their own strategies, while being able to draw on headquarters' expertise evaluation of performance extends beyond short term financial targets to embrace strategic objectives such as growth in market share and technology development, which are seen to support longterm financial and operational effectiveness diversity is coped with more readily than the strategic planning style there is also a danger of greater ambiguity. Test your understanding 6 How might an organisation take steps to avoid conflict between strategic business plans and short term localised decisions? 7 SWOT analysis and performance management The purpose of a SWOT analysis To assist in closing the gap between its predicted and desired performance, the organisation's strengths, weaknesses, opportunities and threats need to be ascertained. This is often done using a SWOT analysis. The purpose of SWOT analysis is to provide a summarised analysis of the company s present position in the market place. Based on the SWOT analysis the organisation can develop strategies to address the gap between the current position and where it wants to be. It can also be used to help identify CSFs and performance indicators. KAPLAN PUBLISHING 25

26 Introduction to strategic management accounting The work involved draws on the data obtained about objectives, current position, extrapolated position, gaps and environmental forecasts, and is sometimes called corporate appraisal. Strengths Positive factors or distinctive attributes or competencies that provide a significant competitive advantage that the organisation can build on. Opportunities Favourable conditions that usually arise from the nature of changes in the external environment such as new markets, improved economic factors or a failure of competitors. Weaknesses Negative aspects in the organisation, such as deficiencies in the present competencies or resources, or its image or reputation, which limit its effectiveness and which need to be corrected. Threats Opposite of opportunities and also arise from external developments. Test your understanding 7 What types of strengths, weaknesses, opportunities and threats would a 'no frills' airline have? Addressing the performance gap The SWOT analysis can be used to identify the extent to which the organisation has managed to obtain a fit with its environment and can suggest possible strategies to close the resulting performance gap. S O strategies pursue opportunities that are a good fit to the organisation s strengths. W O strategies overcome weaknesses to pursue opportunities. S T strategies identify ways in which the organisation can use its strengths to reduce its vulnerability to external threats. W T strategies establish a defensive plan to prevent the organisation s weaknesses from making it highly susceptible to external threats. 26 KAPLAN PUBLISHING

27 chapter 1 Test your understanding 8 SWOT QUESTION Envie Co owns a chain of retail clothing stores specialising in ladies designer fashion and accessories. Jane Smith, the original founder, has been pleasantly surprised by the continuing growth in the fashion industry during the last decade. The company was established 12 years ago, originally with one store in the capital city. Jane s design skills and entrepreneurial skills have been the driving force behind the expansion. Due to unique designs and good quality control, the business now has ten stores in various cities. Each store has a shop manger that is completely responsible for managing the staff and stock levels within each store. They produce monthly reports on sales. Some stores are continually late in supplying their monthly figures. Envie runs several analysis programmes to enable management information to be collated. The information typically provides statistical data on sales trends between categories of items and stores. The analysis and preparation of these reports are conducted in the marketing department. In some cases the information is out of date in terms of trends and variations. As the business has developed Jane has used the service of a local IT company to implement and develop their systems. She now wants to invest in website development with the view of reaching global markets. Required: (a) Construct a SWOT analysis with reference to the proposal of website development. (b) Explain how the use of SWOT analysis may be of assistance to Envie Co. KAPLAN PUBLISHING 27

28 Introduction to strategic management accounting 8 Benchmarking What is benchmarking? Benchmarks could include the following: Strategic benchmarks market share return on assets gross profit margin on sales. Functional benchmarks % deliveries on time order costs per order order turnaround time average stockholding per order. Operational benchmarks These are at a level below functional benchmarks. They yield the reasons for a functional performance gap. An organisation has to understand the benchmarks at the operational level in order to identify the corrective actions needed to close the performance gap. 28 KAPLAN PUBLISHING

29 chapter 1 Expandable text Benchmarking with external information The practice of using external information for comparative purposes is known as benchmarking. This practice developed to address the limitations of comparisons against internal standards which provide only a limited impression of performance. Benchmarking can be used to identify the performance gap to be closed between results being achieved and the benchmark that has been adopted. The practice of benchmarking will usually involve calculating detailed performance benchmarks for each of the main elements in the activity being reviewed. The performance benchmarks may be arranged in a hierarchy. Several measures of performance will be used. Each measure should be a key performance measure, critical to the success of the organisation. Performance measures can be financial or nonfinancial. Ideally performance should be quantifiable and measurable, although qualitative assessments and comparisons might be necessary. The information available for comparison will depend on whether it has been provided voluntarily by the benchmark. Co operative benchmarking should provide more extensive information. Benchmarking can also be used within an organisation to compare subsidiaries, business units or departments with one another. KAPLAN PUBLISHING 29

30 Introduction to strategic management accounting Illustration 6 What is benchmarking? Benchmarking at Xerox Corporation Among the pioneers in the benchmarking movement were Xerox, Motorola, IBM and AT&T. The best known is the Xerox Corporation. Some years ago, Xerox confronted its own unsatisfactory performance in product warehousing and distribution. It did so by identifying the organisation it considered to be the very best at warehousing and distribution, in the hope that best practices could be adapted from this model. The business judged to provide a model of best practice in this area was L L Bean, a catalogue merchant. Xerox approached Bean with a request that the two engage in a co operative benchmarking project. The request was granted and the project yielded major insights in inventory arrangement and order processing, resulting in major gains for Xerox when these insights were adapted to its own operations. The critical observation here is that Xerox did not select another office machine manufacturer as its benchmarking partner. Rather, it selected as its model a business in an entirely unrelated sector. The commonality was in the activities being benchmarked rather than in the output of the operation. A typical benchmarking process is likely to include: Planning identifying the subject area to be reviewed, defining the objectives for the study and the criteria that will be used to assess success, selecting the approach and type of benchmarking, identifying potential partners etc. Collecting data and information developing with partners a mutual understanding and benchmarking protocol, agreeing terminology and performance measures to be used, undertaking information and data collection, collation of findings. Analysing the findings review of findings, gap analysis, seeking explanation for the gaps in performance, ensuring comparisons are meaningful and credible, communicate the findings, identify realistic opportunities for improvement. Implement recommendations examine the feasibility of making improvements with respect to organisational constraints and preconditions, obtain the support of key stakeholders for making the changes needed, implement action plans, monitor performance, keep stakeholders informed of progress. 30 KAPLAN PUBLISHING

31 chapter 1 Monitoring and reviewing evaluate the benchmarking process and the results of improvement initiatives against business objectives, document the lessons learnt, periodically re consider the benchmarks in the light of changes. Types of benchmarking: Internal Benchmark within a business e.g. industry unit Competitive Benchmark presentation or development with competitors Functional Benchmark comparable progression with in an business Generic Evaluate procedure with unconnected industries Illustration 7 Example of benchmarking success Kellogg s factories all use the same monitoring techniques, so it is possible to compare performance between sites, although there are always some things that are done differently. They can interrogate this information to improve performance across every site. As things have improved, Kellogg s have also had to reassess their baseline figures and develop more sophisticated tools to monitor performance to ensure they continue to make progress. They have seen a 20% increase in productivity in six years using this system. The benefits of benchmarking The potential benefits to be obtained from a benchmarking exercise are: identifying gaps in performance by comparing an organisation s own performance with the performance of the organisation acting as the benchmark putting the company s resources and performance into perspective, reflecting the fact that it is the relative position of a company which matters in assessing its capabilities learning and applying best practices learning from the success of others minimising complacency and self satisfaction with your own performance encouraging continuous improvement. KAPLAN PUBLISHING 31

32 Introduction to strategic management accounting Expandable text Performance comparison Performance comparison with the competition Comparative analysis can be usefully applied to any value activity which underpins the competitive strategy of an organisation, an industry or a nation. To find out the level of investment in fixed assets of competitors, the business can use physical observation, information from trade press or trade association announcements, supplier press releases as well as their externally published financial statements, to build a clear picture of the relative scale, capacity, age and cost for each competitor. The method of operating these assets, in terms of hours and shift patterns, can be established by observation, discussions with suppliers and customers or by asking existing or ex employees of the particular competitor. If the method of operating can be ascertained it should enable a combination of internal personnel management and industrial engineering managers to work out the likely relative differences in labour costs. The rates of pay and conditions can generally be found with reference to nationally negotiated agreements, local and national press advertising for employees, trade and employment associations and recruitment consultants. When this cost is used alongside an intelligent assessment of how many employees would be needed by the competitor in each area, given their equipment and other resources, a good idea of the labour costs can be obtained. Another difference which should be noted is the nature of the competitors costs as well as their relative levels. Where a competitor has a lower level of committed fixed costs, such as lower fixed labour costs due to a larger proportion of temporary workers, it may be able to respond more quickly to a downturn in demand by rapidly laying off the temporary staff. Equally, in a tight labour market and with rising sales, it may have to increase its pay levels to attract new workers. In some industries, one part of the competitor analysis is surprisingly direct. Each new competitive product is purchased on a regular basis and then systematically taken apart, so that each component can be identified as well as the processes used to put the parts together. The respective areas of the business will then assess the costs associated with each element so that a complete product cost can be found for the competitive product. 32 KAPLAN PUBLISHING

33 chapter 1 A comparison of similar value activities between organisations is useful when the strategic context is taken into consideration. For example, a straight comparison of resource deployment between two competitive organisations may reveal quite different situations in the labour cost as a percentage of the total cost. The conclusions drawn from this, however, depend upon circumstances. If the firms are competing largely on the basis of price, then differentials in these costs could be crucial. In contrast, the additional use of labour by one organisation may be an essential support for the special services provided which differentiate that organisation from its competitors. One danger of inter firm analysis is that the company may overlook the fact that the whole industry is performing badly, and is losing out competitively to other countries with better resources or even other industries which can satisfy customers needs in different ways. Therefore, if an industry comparison is performed it should make some assessment of how the resources utilisation compares with other countries and industries. This can be done by obtaining a measurement of stock turnover or yield from raw materials. Benchmarking against competitors involves the gathering of a range of information about them. For quoted companies financial information will generally be reasonably easy to obtain, from published accounts and the financial press. Some product information may be obtained by acquiring their products and examining them in detail to ascertain the components used and their construction ( reverse engineering ). Literature will also be available, for example in the form of brochures and trade journals. However, most non financial information, concerning areas such as competitors processes, customer and supplier relationships and customer satisfaction will not be so readily available. To overcome this problem, benchmarking exercises are generally carried out with organisations taken from within the same group of companies (intragroup benchmarking) or from similar but non competing industries (interindustry benchmarking). Difficulties in benchmarking There are a number of difficulties and issues facing organisations wishing to undertake a benchmarking exercise. Benchmarking exercises can be costly and time consuming it is necessary to consider whether the value of the exercise is sufficient to justify its cost. Other organisations may be unwilling to share information. It may be difficult to obtain information, particularly non financial information about competitors. KAPLAN PUBLISHING 33

34 Introduction to strategic management accounting The business functions being benchmarked must be similar enough to allow meaningful comparison. Companies need to be as specific as possible when identifying areas to benchmark. For example, if a company is interested in studying customer service, it needs to determine what specific area or activity within customer service needs to be examined. Success will hinge on the level of commitment from top managers who must be prepared to make changes in response to the results of benchmarking. Benchmarking information must be interpreted carefully to ensure that organisations are being compared on a similar basis, and account must be taken of differences in the way data is produced, such as differences in accounting treatment, and external factors which influence performance in the area being benchmarked. It may be difficult to choose sectors to measure. Organisations should concentrate on areas that: tie up most cash significantly improve the relationship with customers impact on the final results of the business. 9 Risk and uncertainty The impact of exogenous variables In addition to factors under their control, organisations are affected by a range of variables which do not originate from within the organisation itself and are not controllable by its management. These are known as exogenous variables. Such variables may include long term market trends, government policy in areas such as taxation and technological development. It may be possible to assess the impact over the immediate future for the purposes of short term decision making, but forecasting the longterm effects is much more difficult. The existence of such variables means that long term planning always involves an element of risk and uncertainty. Changes in one of these variables could completely invalidate a strategy. It is very difficult to quantify the impact of these variables. 34 KAPLAN PUBLISHING

35 chapter 1 Forecasting the long term impact of exogenous variables is made more difficult because: the organisation s environment is complex there are interrelationships between the environmental variables involved changes in these variables, such as political change, can be very rapid There is limited data available to aid forecasting. Illustration 8 The impact of exogenous variables A hospital has developed a new surgical technique as a more expensive alternative to existing treatments. It is considering whether to begin to provide the treatment to all its patients, which would mean building a new facility. In order to inform the decision, the hospital is considering the likely effect of a number of variables. The likelihood that another alternative cheaper treatment, either a surgical technique or a drug regime, will be discovered. The likelihood that other hospitals will begin to offer similar services which will limit demand. Government policy changes in the way that treatment is funded and therefore whether the costs of the treatment will be paid for. The implications for strategic planning It is never possible to forecast the future with certainty. However there are a number of means by which organisations take account of the impact of exogenous variables in their strategic plans. Using structured methods such as scenario planning and sensitivity analysis which can be used to quantify the impact of different factors on the long term plan. Being sensitive to changes through constant scanning of the environment. Quantifying the probability and impact over a shorter timescale and taking a more general view of the long term direction. Precise objectives are not specified in the longer term. Developing strategy incrementally in a more dynamic process which allows for flexibility in response to changes in the environment. KAPLAN PUBLISHING 35

36 Introduction to strategic management accounting Establishing wide ranging discussions inside and outside the organisation, in particular with operational staff who are closer to customers and may understand more about the environment than senior managers. Reviewing the accuracy of information on a continuous basis to improve forecasting ability. Expandable text Tools to improve forecasts Tools for improving forecasts There are a number of tools which can be used to incorporate the impact of uncertain factors, such as: scenario planning, developing alternative views of the future to consider possible outcomes, often through wide ranging discussions computer simulations which can generate a large number of possible future outcomes, for example the Monte Carlo model sensitivity analysis to assess the extent to which the outcome of a strategy is likely to vary with changes in specific factors using knowledge about the past impact of variables which can give an indication of the likely future impact the use of techniques such as decision trees which can be used to map stages in a new venture and the possible uncertainties at each stage, to estimate an expected value for the whole venture maximin, maximax, minimax regret expected values. The use of probabilities When considering a scenario it may be possible to make several predictions about alternative future outcomes and to assign probabilities to each outcome. An expected value is computed by multiplying the value of each possible outcome by the probability of that outcome, and summing the results. A matrix can be a useful way to represent and analyse a scenario where there is a range of possible outcomes and a variety of possible responses. 36 KAPLAN PUBLISHING

37 chapter 1 Test your understanding 9 A redesign of component A is being considered that is likely to result in changes in the quantity of timber and number of cuts, in the shaping process that will be required. A data table analysis has been prepared to monitor the effect on unit cost for component A of a range of values for such changes. In addition, a set of subjective probabilities have been assigned to the likelihood of (i) the timber required and (ii) the number of cuts required, being at the levels shown in the data table analysis. A matrix has been constructed showing the combined probability for each possible combination of changes of timber and number of cuts. The data table analysis and combined probability matrix are as follows: The total component cost for component A has been estimated as $41.21 per unit Timber (sqm) Number of cuts Combined probability matrix showing combined probability values for a range of values of number of cuts in Shaping and timber required (square metres =sqm). Number of cuts Timber (sqm) Prob Note: The expected value of unit cost, based on above data table and combined probability matrix is $ KAPLAN PUBLISHING 37

38 Introduction to strategic management accounting You may assume that management attitudes vary as follows: (i) (ii) Some of the management team are in favour of change provided that a reduction of at least 12% from the existing total unit cost is achieved; Others in the management team are not in favour of change if it might lead to an increase in total unit cost from the current level of $41.21; and (iii) The remainder of the management team are of the view that they are willing to consider the re design change if the expected value (EV) solution is less than the current value of total unit cost. Discuss the impact of the possible changes in the quantity of timber and number of cuts in the Shaping process caused by the re design of component A on the total cost per unit of component A. You should incorporate an analysis of statistics from the datatable and probability information contained in the model into your discussion with specific reference to the impact of management attitude to risk when deciding whether or not to change from the existing quantity of timber and number of cuts for component A. When probabilities are not available, there are still tools available for incorporating risk into decision making. Maximax, maximin and minimax regret The maximax rule applies to an optimist who seeks to maximise the maximum possible gain of possible outcomes. The maximin rule involves selecting the alternative that maximises the minimum payoff achievable. This approach would be appropriate for a pessimist who: seeks to achieve the best results if the worst happens. The minimax regret strategy is the one that minimises the maximum regret. Essentially this is the technique for a sore loser who does not wish to make the wrong decision. Regret in this context is defined as the opportunity loss through having made the wrong decision. 38 KAPLAN PUBLISHING

39 chapter 1 Test your understanding 10 Stow Health Centre specialises in the provision of exercise and dietary advice to clients. The service is provided on a residential basis and clients stay for whatever number of days suits their needs. Budgeted estimates for the year ending 30 June 2009 are as follows: The maximum capacity of the centre is 50 clients per day for 350 days in the year. Clients will be invoiced at a fee per day. The budgeted occupancy level will vary with the client fee level per day and is estimated at different percentages of maximum capacity as follows: Client fee per day Occupancy level Occupancy as percentage of maximum capacity $180 High 90% $200 Most likely 75% $220 Low 60% Variable costs are also estimated at one of three levels per client day. The high, medium and low levels per client day are $95, $85 and $70 respectively. The range of cost levels reflects only the possible effect of the purchase prices of goods and services. Required: (a) Prepare a summary which shows the budgeted contribution earned by Stow Health Centre for the year ended 30 June 2009 for each of nine possible outcomes. (b) State the client fee strategy for the year to 30 June 2009 which will result from the use of each of the following decision rules: (i) maximax; (ii) maximin; (iii) minimax regret. Your answer should explain the basis of operation of each rule. Use the information from your answer to (a) as relevant and show any additional working calculations as necessary. KAPLAN PUBLISHING 39

40 Introduction to strategic management accounting The learning curve effect As workers become more familiar with the production of a new product, average time (and average cost) per unit will decline. Wrights Law: as cumulative output doubles, the cumulative average time per unit falls to a fixed percentage (referred to as the learning rate) of the previous average time. The learning curve effect can be calculated by: (i) (ii) reducing cumulative average time by the learning rate each time output doubles in a table or using the formula: y = ax b where y = cumulative average time (or average cost) per unit or per batch a = time (or cost) for first unit or batch b = log r/log 2 (r = rate of learning, expressed as a decimal) x = cumulative output in units or in batches Conditions for the learning effect to apply: the activity is labour intensive a repetitive process for each unit low turnover of labour early stages of production no prolonged breaks in production. 40 KAPLAN PUBLISHING

41 chapter 1 Test your understanding 11 BFG Ltd is investigating the financial viability of a new product, the S pro. The S pro is a short life product for which a market has been identified at an agreed design specification. The product will only have a life of 12 months. The following estimated information is available in respect of the S pro.: (1) Sales should be 120,000 in the year in batches of 100 units. An average selling price of $1,050 per batch of 100 units is expected. (2) An 80% learning curve will apply for the first 700 batches after which a steady state production time will apply, with the labour time per batch after the first 700 batches being equal to the time of the 700th batch. The labour cost of the first batch was measured at $2,500. This was for 500 hours at $5 per hour. (3) Variable overhead is estimated at $2 per labour hour. (4) Direct material will be $500 per batch for the S pro for the first 200 batches produced. The second 200 batches will cost 90% of the cost per batch of the first 200 batches. All batches from then on will cost 90% of the batch cost for each of the second 200 batches. (5) S pro will require additional space to be rented. These directly attributable fixed costs will be $15,000 per month. A target net cash flow of $130,000 is required in order for the project to be acceptable. Note: At the learning curve rate of 80% the learning factor (b) is equal to Required: Prepare detailed calculations to show whether S pro will provide the target net cash flow. KAPLAN PUBLISHING 41

42 Introduction to strategic management accounting 10 The impact of government policy The role of government policy As discussed earlier, the ways in which government policies might influence future corporate strategy are difficult to forecast. Government policies in a number of areas will be ingredients in the political environment facing enterprises. Such policy areas could include: The performance of many business operations is influenced very strongly by the statutory and regulatory environment. There is an almost endless list of laws, or categories of legislation, that affect business enterprises in domestic, national or international dimensions. More detail on the impact of the government can be found in chapter KAPLAN PUBLISHING

43 chapter 1 Illustration 9 The role of government policy The capital engaged in some business operations is a direct function of relations with government. The following is an extreme example of this. The UK Independent Television regional franchises were auctioned in the early 1990s. The system is that a public body owns the transmitter network but franchises the right to broadcast programmes (and advertising) from regional centres every 10 years. Organisations interested in obtaining a franchise were required to submit sealed bids prior to certain dates. Those bids stated (among other things) the amount that the applicant was prepared to pay for the franchise. Some of the franchises were keenly contested particularly some of the more attractive ones in London and the south east. Several wellresourced consortia offered substantial nine figure sums for the London franchises. One organisation, Central Television, was preparing a bid for the Birmingham franchise. Through discreet enquiries it found that no other bids were going to be made for the franchise. So, it submitted a bid for 2,000 which the government had to accept. A rich franchise, worth millions, was thereby acquired without any significant capital outlay. The performance of Central Television on the basis of ROCE would have been phenomenal but this had nothing to do with commercial success or efficiency. It was just an accident of the way that the industry is regulated. Expandable text Porter's view on influence of government The influence of government on an industry Porter identifies seven ways in which a government can affect the structure of an industry. Capacity expansion. The government can take actions to encourage firms or an industry as a whole to increase or cut capacity. Examples include capital allowances to encourage investment in equipment; regional incentives to encourage firms to locate new capacity in a particular area, and incentives to attract investment from overseas firms. The government is also (directly or indirectly) a supplier of infrastructure such as roads and railways, and this may influence expansion in a particular area. KAPLAN PUBLISHING 43

44 Introduction to strategic management accounting Demand. The government is a major customer of business in all areas of life and can influence demand by buying more or less. It can also influence demand by legislative measures. The tax system for cars is a good example: a change in the tax relief available for different engine sizes has a direct effect on the car manufacturers product and the relative numbers of each type produced. Regulations and controls in an industry will affect the growth and profits of the industry, for example minimum product quality standards. Divestment and exit. A firm may wish to sell off a business to a foreign competitor or close it down, but the government might prevent this action because it is not in the public interest (there could be examples in health, defence, transport, education, agriculture and so on). Emerging industries may be controlled by the government. For instance governments may control numbers of licences to create networks for next generation mobile phones. Entry barriers. Government policy may restrict investment or competition or make it harder by use of quotas and tariffs for overseas firms. This kind of protectionism is generally frowned upon by the World Trade Organisation, but there may be political and economic circumstances in which it becomes necessary. Competition policy. Governments might devise policies which are deliberately intended to keep an industry fragmented, preventing one or two producers from having too much market share. New product adoption. Governments regulate the adoption of new products (e.g. new drugs) in some industries. They may go so far as to ban the use of a new product if it is not considered safe (a new form of transport, say). Policies may influence the rate of adoption of new products, e.g. the UK government intends to switch off the analogue television networks by the year 2012, effectively forcing users to buy digital cable or satellite services. Expandable text Legislation and regulation Legislation and regulation Strategic planners cannot plan intelligently without a good working knowledge of the laws and regulations that affect their own companies and the businesses they operate in. 44 KAPLAN PUBLISHING

45 chapter 1 There is an almost endless list of laws, or categories of legislation, that affect business enterprises in domestic, national or international dimensions. The main categories are listed below: local by laws (for example planning permission, construction of roads, licences) labour legislation (such as safety at work, employee protection, redundancy payments) trade union legislation consumer protection legislation company legislation taxation legislation anti trust (monopolies) legislation and rulings trade legislation (e.g. countries restricted for export) business legislation (e.g. contract and agency law) social legislation such as welfare benefits. At a more general level, laws are passed that enable government to levy taxes which will have an impact both on demand and the organisation s profits. There are special regulatory regimes for particular industries or sectors, such as nuclear energy, transport, broadcasting or food. Legislation is becoming more complex, particularly for those companies that trade internationally where the interface, indeed probable conflict, between domestic laws, the host country s laws, and probably also the laws of the trading block of nations the host country belongs to, provides an extremely complicated legal scenario. Expandable text Government major stakeholder in public sector Public sector organisations In public sector organisations the government is the major stakeholder. This can have a number of particular impacts: the motivation to meet customer needs may be reduced the consequences of failure to provide an appropriate level of service for the organisation and the individual are reduced being dependent on government policy also means that objectives may change rapidly as policy changes and this political dimension reduces the scope of management options and increases the time for decisions to be taken KAPLAN PUBLISHING 45

46 Introduction to strategic management accounting when the public sector companies are privatised they may still remain subject to elaborate regulatory regimes. The performance of the operations involved is monitored and measured using various indicators, with the possibility of fines for poor performance or price restrictions imposed by regulators. Expandable text Political change Planning for political change The problem facing strategic planners is how to plan for changes in the political environment. It is necessary to consider what type of political change could affect the enterprise rather than trying to estimate all the political changes that might occur, by: examining changes in social behaviour and values, economic activity, and problems arising from the physical infrastructure or environment which can be related to the trend of political actions monitoring indicators of possible or intended future government actions and policy. These indicators are obtained from: annual conferences of political parties public utterances of party leaders and seniors international events directives from international trading groups political commentators and analysts international summit meetings staged legislation efforts of public pressure groups (particularly with regard to local government policy) political manifestos. Test your understanding 12 Give some examples of areas of government policy are likely to affect a multinational electronics company and how will the impact will be felt? 46 KAPLAN PUBLISHING

47 chapter 1 Chapter summary KAPLAN PUBLISHING 47

48 Introduction to strategic management accounting Test your understanding answers Test your understanding 1 Possible activities which would support the decision making process by providing a comparison of different options could include: analysis of the market for different types of product: analysis of competitors likely size and value of different market sectors price comparison of different products forecasts of costs of manufacturing new products, comparing different levels of automation forecasts of profitability of different products investigation of capital costs of different options and investment appraisal of possible options analysis of the cost of holding inventory under different options. Test your understanding 2 All organisations, both large and small, should carry out some form of corporate planning activity. The need for involvement increases with the complexity of the organisation and with the uncertainty and turbulence of its environment. An understanding of corporate planning is essential for all management because lower level objectives are inexorably linked to higher level strategies. An appreciation of these strategies and how they are formulated can be an effective guide to action. Moreover, whatever the level at which a manager operates within an organisation, he or she can have some influence over that organisation's corporate strategy. Test your understanding 3 This is an operational decision. Setting a profit maximising selling price is an exercise based on forecast demand and marginal costs over a coming period such as a year. It does not involve asking whether a product should be sold at all, whether its design should be modified or how its selling price should be influenced by the position of the product in its life cycle or the product matrix of the business. 48 KAPLAN PUBLISHING

49 chapter 1 Test your understanding 4 Introduction Growth Maturity Decline Likely to be an order winning factor Features of the product or service Quality Availability Low price Reliable supply Low price Likely to be a qualifying factor Quality Reliability Price Quality Reliable supply Likely to be key operational performance objectives Flexibility Quality Speed Availability Quality Cost Reliability Cost Reliability KAPLAN PUBLISHING 49

50 Introduction to strategic management accounting Test your understanding 5 Possible factors could include: Process The company needs to determine where best to locate activities related to the new market, e.g. whether to manufacture products in South America as well as selling there. This will require a comparison of the total product costs with manufacture in different locations, including factors such as: labour costs materials costs of purchasing in different areas, costs of sourcing elsewhere and transporting to manufacturing site distribution costs under different scenarios including setting up own salesforce, using existing distributors costs of after sales support. Product In addition to changes in manufacturing costs due to the location of manufacture there may be additional costs if products need to be tailored for the South American market. These need to be estimated. Exchange rates The company needs to assess the impact of exchange rate fluctuations on the value of income earned in South America. There is a need to consider how this risk will be managed, e.g. by hedging. Administrative issues The financial impact of a number of other factors needs to be incorporated into the evaluation of the options such as the impact on internal transactions of exchange rate movements, currency exchange controls and tax regimes. There will, e.g. be implications for any transfer pricing system. Exchange rate fluctuations also need to be taken into account in developing performance measures for business unit managers in overseas locations to ensure that they are not being penalised for changes in income which are out of their control. 50 KAPLAN PUBLISHING

51 chapter 1 Test your understanding 6 Possible steps include: involving local managers in strategy formulation agreeing strategies with business units within certain boundaries ensuring performance management reflects a combination of shortand long term issues permitting flexibility within the strategic planning process to allow for changes due to local circumstances. Test your understanding 7 Strengths: Airports used are better than those used by competitors Management skills Lower costs than established airlines Ease of booking flights Recognised logo IT facilities Good employee relations. Opportunities: Strong business demand for cheap air fares Strong leisure demand for cheap air fares The internet Many secondary airports underused. Weaknesses: Airports used are worse than those used by the big carriers Punctuality Cash flows No established safety record Poorer than average customer service. Threats: Higher airport charges Stringent security checks Entry of subsidiaries of big carriers. KAPLAN PUBLISHING 51

52 Introduction to strategic management accounting Test your understanding 8 SWOT Question Envie Co (a) Strengths: Successful company Steady increase in market share Experience in the market Founder s entrepreneurial skills Good designs Good quality control Keen to exploit to technology Strong IT Weakness: Management of information is often out of date No in house IT expertise No web experience Not sure if the new system will generate new sales Lack of control over store managers Out of date reporting from some stores Over reliance on IT provider Opportunities: E trading can provide a new sales channel and revenue stream Identification and recording of customer details to enhance customer relationships Extension of customer base Global market potential Cut costs in many areas Create a vision of a modern company Develop product range further Look at employing an IT specialist Threats: Customer resistance to on line shopping Loss of unique identity; may become just another website trader Resistance within the company Effects on existing personnel and working conditions Costs of developing the website may outweigh the benefits Security issues Loss of competitive edge The above are suggested answers. 52 KAPLAN PUBLISHING

53 chapter 1 (b) The use of SWOT analysis will focus management attention on current strengths and weaknesses of the organisation which will be of assistance in formulating the business strategy. It will also enable management to monitor trends and developments in the changing business environment. Each trend or development may be classified as an opportunity or a threat that will provide a stimulus for an appropriate management response. Management can make an assessment of the feasibility of required actions in order that the company may capitalise upon opportunities whilst considering how best to negate or minimise the effect of any threats. Test your understanding 9 A number of points may be raised, by examining the data table analysis, and the combined probability matrix provided. The data table shows the range of values of product unit cost for product A for a range of values of number of cut in Shaping AND quantity of timber (square metres) required. We can check the current value of product unit cost of 41.21, which is the value in the data table where the number of cuts per unit in Shaping is 40 and the timber required is 0.60 square metres. An analysis of the management team attitudes may be viewed as follows: (i) (ii) A fall of 12% from the current level would result in a unit cost of x 88% = However, the combined probability of this cost level being achieved is only 18% (this can be abstracted from the probability matrix). This might, therefore, be seen as a risk seeking stance if management decide to proceed with the redesign. Other members of the management team are not willing to proceed with the re design if it might lead to a cost increase from the current level. There is a 32% combined probability that the changes could result in a unit cost greater than the current level of But there is also a 66% likelihood that the unit cost of product A could be less than the current level. This is a risk averse stance since management are not swayed by the 66% likelihood that unit costs may fall. (iii) The expected value solution ( 39.84) is the weighted average view i.e. the sum of each possible value of unit cost x the combined probability of each occurring. This may be viewed as a risk neutral view of the likely unit cost. In this case since it is less than the current value of management would proceed with the redesign of product A. KAPLAN PUBLISHING 53

54 Introduction to strategic management accounting Test your understanding 10 (a) Budgeted Net Profit/Loss outcomes for year ending 30 June Occupancy level The maximax rule looks for the largest contribution from all outcomes. In this case the decision maker will choose a client fee of $180 per day where there is a possibility of a contribution of $1,732,500. Maximin Client days = 50 clients x 350 days x occupancy% Fee per client day Var. cost per client day Contribution per client day Total contribution per year $ $ $ $ 90% 15, ,338,750 90% 15, ,496,250 90% 15, ,732,500 75% 13, ,378,125 75% 13, ,509,375 75% 13, ,706,250 60% 10, ,312,500 60% 10, ,417,500 60% 10, ,575,000 (b) Maximax Fee per client day ($) Best possible contribution ($) 180 1,732, ,706, ,575,000 The maximin rule looks for the strategy which will maximise the minimum possible contribution. Fee per client day ($) Best possible contribution ($) 180 1,338, ,378, ,312,500 In this case the decision maker will choose client fee of $200 per day where the lowest contribution is $1,378, KAPLAN PUBLISHING

55 chapter 1 Minimax regret The minimax regret rule requires the choice of the strategy which will minimise the maximum regret from making the wrong decision. Regret in this context is the opportunity lost through making the wrong decision. Using the calculations from part (a) we may create an opportunity loss table as follows: State of variable cost Client fee per day strategy $180 $200 $220 High (W1) 39, ,625 Medium (W2) 13, ,875 Low (W3) 0 26, ,500 Maximum regret 39,375 26, ,500 W1 at the high level of variable costs, the best strategy would be a client fee of $200. The opportunity loss from using a fee of $180 or $220 per day would be $39,375 (1,378,125 1,338,750) or $65,625 (1,378,125 1,312,500) respectively. W2 at the medium level of variable costs, the best strategy would be a client fee of $200. The opportunity loss from using a fee of $180 or $220 per day would be $13,125 (1,509,375 1,496,250) or $91,875 (1,509,375 1,417,500) respectively. W3 at the low level of variable costs, the best strategy would be a client fee of $180. The opportunity loss from using a fee of $200 or $220 per day would be $26,250 (1,732,500 1,706,250) or $157,500 (1,732,500 1,575,000) respectively. The minimum regret strategy (client fee $200 per day) is that which minimises the maximum regret (i.e. $26,250 in the maximum regret row above). KAPLAN PUBLISHING 55

56 Introduction to strategic management accounting Test your understanding 11 BFG Ltd Sales 120,000 units $ Sales revenue 1,260,000 Costs: Direct material (W1) 514,000 Direct labour (W2) 315,423 Variable overhead (W3) 126,169 Rent 180,000 Net cash flow 124,408 Target cash flow 130,000 The target cash flow will not be achieved. Workings: (W1) Direct material Batches $ First $ ,000 Second $450 90,000 Remaining 324,000 $405 Total 514,000 (W2) Direct labour y = a.xb where; a = 2,500 and b = Total cost for first 700 batches (x = 700); 700 x 2,500 x = $212,423 Total cost for first 699 batches (x = 699); 699 x 2,500 x = $212,217 Cost of 700th batch ($212,423 $212,217 = $206 Total cost of final 500 batches; $206 x 500 = $103,000 Total labour cost ($212,423 + $103,000) = $315,423 (W3) Variable overhead Variable overhead is $2 per labour hour, or 40% of the direct labour cost. 56 KAPLAN PUBLISHING

57 chapter 1 Test your understanding 12 Areas could include: Interest rates Changes in the interest rates for consumer debt may affect demand for luxury goods which may include high value electronic products. The company s cost of debt may change, affecting the cost of developing new facilities. Exchange rates Changes in interest rates may change the value of profits earned in different countries or the price to consumers of imported goods. Taxation levels The level of personal taxation will affect the demand for products. Changes in the company tax regime will affect the returns to shareholders. Incentive schemes The availability of incentive schemes may make expanding into certain countries more attractive. Worker protection Legislation in this area may have an impact on the requirements for facilities and their costs. Restrictive practices These may affect the company s ability to export to certain countries. Environment protection The company may need to develop new products which are more economical to run or which use materials which are less harmful to the environment when thrown away. KAPLAN PUBLISHING 57

58 Introduction to strategic management accounting 58 KAPLAN PUBLISHING