chap - 11 evaluation of strategies and performance mesurement

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chapter 11

Evaluation of strategies andpe

Intro

Exam

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Summ

Answ

Answ The Institute of Chartered Accountants in England and Wales, March 2009 483

tents

rformance measurement

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ination context

c list

Evaluation of strategic options

Critical success factors

Strategic control

Assessing a firms performance data analysis

The balanced scorecard

ary and Self-test

ers to Self-test

ers to Interactive questions

Business strategy

484 The Institute of Chartered Accountants in England and Wales, March 2009

Introduction

Learning objectives Tick off Choose, for a given scenario, a strategy or combination of strategies which will achieve the

business's objectives and takes account of known constraints, including stakeholder riskpreferences and ethical stance

Identify the implications for stakeholders, including shareholder value, of choice betweenstrategies

Assess a business's current position from a financial perspective

Specific syllabus references for this chapter are: 1e, 2h, i, j.

Practical significanceChoosing the right strategic option is essential for commercial success and survival of the business. Strategiccontrol indicates the need for a review of strategic performance over a whole host of measures, as opposedto just the numbers, but remember that financial measures of performance are those that you will be mostlikely to have a hand in.

The models in Chapters 5 and 6, such as Porter's Generic Strategies and Ansoff's Product-Market GrowthVector Matrix can be used by management for option generation. Chapters 7, 8, 9 and 10 discussed theimplications of strategies for marketing, organisational structure, risk and method of development. They areall considerations that management must bear in mind when coming to a final decision on which strategiesto adopt and implement.

In approaching this chapter it is helpful to imagine that you are a member of a senior management teamconfronted with a number of business proposals. The firm can't do them all. Some proposals may be ill-advised. It is your job of to decide which ones to discard and which ones to follow through. You will needto consider all the issues raised in the 10 chapters so far.

Stop and thinkHaving the perfect strategy on paper may not lead to the perfect strategy on the ground. Management mustbe able to separate good from bad strategic ideas. They must also be able to implement and control thestrategy.

What strategies can you think of that went wrong?

Working contextThe control systems described in this section, notably the balanced scorecard, may be familiar to you fromyour own firm or clients. The installation and operation of such control systems is increasingly beingundertaken by accountants.

Syllabus linksPerformance management and control are covered in the second part of this chapter. Some of thetechniques were covered in your Business and Finance and Management Information papers atProfessional Stage.

EVALUATION OF STRATEGIES AND PERFORMANCE MEASUREMENT

The Institute of Chartered Accountants in England and Wales, March 2009 485

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Examination context

Exam requirementsThis chapter looks at two key areas, evaluation of strategies and performance measurement.

An important skill when evaluating strategies in the exam is the ability to assess them in the light of theorganisation's current position, mission and stakeholder objectives.

In the exam, at least one of the questions will include data analysis. One context in which this could applywould be in performance measurement. This may include management data, industry data, financialstatement data or other facts and figures that may be relevant to the business or its environment. Issuesbrought out by the data may not be immediately obvious and thus some thought, judgement or analysis maybe needed.

An example might be a company that has developed a new strategy but has since started to generateoperating losses. It may be that the strategy has failed as financial performance is poor, or it may be that thestrategy is the right thing to do in the long term but has adverse financial consequences in turning thecompany around in the short term. The key issue is that the data analysis should be linked to the widerstrategy or issue in the scenario.

Business strategy


1 Evaluation of strategic options

Section overviewStrategic choices are evaluated according to their suitability (to the organisation and its current situation),their feasibility (in terms of usefulness or competences) and their acceptability (to relevant stakeholdergroups).

1.1 Recap of the rational approachThe rational model was described in Chapter 1. Evaluation of options occurs as the second phase ofStrategic choice.

EXTERNALANALYSIS

INTERNALANALYSIS

CORPORATEAPPRAISAL

MISSION ANDOBJECTIVES

GAP

STRATEGICCHOICE

STRATEGYIMPLEMENTATION

REVIEW ANDCONTROL

STRATEGICANALYSIS

STRATEGICCHOICE

STRATEGYIMPLEMENTATION

Devising strategies is a two-step process:

1 Option generation: creative thinking to generate options.

2 Evaluation and selection: assessment of options against goals of the business and commitment to someand not to others.

1.2 Evaluation criteriaJohnson, Scholes and Whittington (Exploring Corporate Strategy) provide a checklist for assessing options:

Suitability: Is this option appropriate considering the strategic position and outlook of the business?

Acceptability: Will this option gain the support of the stakeholders essential for the success of thestrategy and the organisation as a whole? Will the option antagonise significant powerful stakeholdersthat could thwart its success or that of management as a whole?

Feasibility: Does the firm have the resources and competences required to carry the strategy out?Are the assumptions of the strategy realistic?



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1.3 SuitabilitySuitability relates to the strategic logic and strategic fit of the strategy. The strategy must fit thecompany's operational circumstances and strategic position. Does the strategy:

Exploit company strengths and distinctive competences? Rectify company weaknesses? Neutralise or deflect environmental threats? Help the firm to seize opportunities? Satisfy the goals of the organisation? Fill the gap identified by gap analysis? Generate/maintain competitive advantage?

1.4 Acceptability (to stakeholders)The acceptability of a strategy relates to people's expectations of it and its expected performanceoutcomes. This includes consideration of:

Returns the likely benefits that stakeholders will receive, and

Risk the likelihood of failure and its associated consequences.

It is here that stakeholder analysis, described in Chapter 2, can also be brought in.

Financial considerations: Strategies will be evaluated by considering how far they contribute tomeeting the dominant objective of increasing shareholder wealth, using measures such as:

Return on investment Profits Growth EPS Cash flow Price/Earnings Market capitalisation

Customers may object to a strategy if it means reducing service, but on the other hand they mayhave no choice.

Banks are interested in the implications for cash resources, debt levels etc.

Government: A strategy involving a takeover may be prohibited under monopolies and mergerslegislation. Similarly, the environmental impact may cause key stakeholders to withhold consent.

Considerations of ethics and corporate social responsibility are included here.

1.5 Feasibility criteriaFeasibility asks whether the strategy can in fact be implemented.

Is there enough money? Is there the ability to deliver the goods/services specified in the strategy? Can we deal with the likely responses that competitors will make? Do we have access to technology, materials and resources? Do we have enough time to implement the strategy? Will the strategy deliver results within an appropriate timeframe?

Strategies which do not make use of the existing competences, and which therefore call for newcompetences to be acquired, might not be feasible.

Gaining competences via organic growth takes time Acquiring new competences can be costly

Business strategy


2 Critical success factors

Section overview The use of critical success factors (CSFs) can help to determine the information requirements of

an organisation.

CSFs are the areas at which an organisation must excel if it is to achieve sustainable competitiveadvantage. These can be used to identify operational goals which if achieved mean the organisationshould be successful.

DefinitionCritical success factors are a small number of key goals vital to the success of an organisation i.e. 'thingsthat must go right'.

An alternative definition is provided by Johnson, Scholes and Whittington.

'Those product features that are particularly valued by a group of customers and therefore where theorganisation must excel to outperform the competition.'

This is more restricted because it deals merely with product features rather than considering additionalfactors vital commercial success such as product availability, competitive knowledge or cost andperformance control. In this respect it sit outside the mainstream interpretation of CSFs described below.

2.1 Identifying CSFsThe concept of CSFs was originally developed by Daniel in 1962 and refined by the Massachusetts Instituteof Technology (MIT) as a device for aligning the information provided by a firm's information systems to thefirm's business needs to ensure it is relevant and complete (this aspect is discussed further in Chapter 13).

MIT proposed five areas in which CSFs should be identified.

1 The structure of the particular industry: These are the factors shaping the success of theindustry as a whole and the factors that will determine the number and profitability of the playerswithin it e.g. consumer adoption of genetically modified foods is a CSF for any firm involved indeveloping or growing GM crops.

2 Competitive strategy and position: The key elements of the business strategy that must bedelivered. For example growth in market share or percentage coverage of target market.

3 Environmental factors: Although not directly under the influence of management these must bemonitored and control take place if they deviate from where the firm's plan assumed they would be.For example a house building firm would regard the state of the economy and lending rates as CSFsand if they were to become adverse would cut back on its new-starts.

4 Temporary factors: These could be internal changes that are being made to organisationalstructure, or cost reductions. The success of these short-term projects is critical to the overallsuccess of the business.

5 Functional managerial position: Each managerial role will have CSFs associated with it related tothe manager's performance of their role.



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Worked example: CSFs for M-Payment firmsM-Payment refers to the use of mobile phone (cell-phone) credits to pay for goods and services. The ownerwaves their mobile phone handset over the shop's sensor and the transaction fee is charged to the mobilephone operator and billed to their customer in due course. Where goods are purchased using the mobilephone, such as tickets where the handset is used to navigate through an automated switchboard or web-enabled mobile phones accessing websites, the funds can be transferred at the time of purchase.

The benefits are:

Individuals will not have to carry separate credit cards, cash etc.

Security will improve because there will be no opportunity to try to capture Personal IdentificationNumbers (PIN numbers) from terminals.

Individuals denied credit cards will be able to use virtual payments systems.

Provides methods of payment in countries that lack the infrastructure of banks etc providing thecountry has a retail network for 'pay as you go top-up' cards.

According to research carried out in 2005 by Booz Allen and Hamilton M-Payment is proving successful inJapan and Korea, but not USA and Europe.

They outline the following industry CSFs that will determine the uptake of M-Payment.

Banks and credit card companies must evaluate ways to let mobile telecoms participate incollaborative ventures rather than setting up rival payment systems.

Mobile operators must consider new mobile payment systems in the context of new ways to open uprevenue streams, especially from monthly m-payment subscription charges or per transaction fees.Operators must also take full advantage of the positive side effect of embedding the mobile phoneeven deeper into the life of the subscribers a significant motivator in the Japanese model.

Handset suppliers must embrace new approaches and start to consider active integration of mobilepayment capabilities into product road maps and line-ups. Mobile payment capabilities are seen bysome as the next big thing to drive handset replacement, making standardisation and compatibilityacross operators and platforms critical to preserve user attractiveness and scale benefits.

Merchants must use their vast experience with cashless payments to drive further cost decreases thataccrue from giving up cash, and to offset POS technology upgrade costs.

Finally, it needs to be demonstrated to mobile phone users that mobile payment is much moreattractive than other more familiar payment schemes. The bundle of convenience aspects (safe, secure,available, fast, transparent, etc) needs to be packaged and sold to target groups individually.

2.2 Using CSFs for controlCSFs focus management attention on what is important. The advantages are:

The process of identifying CSFs will help alert management to the things that need controlling (andshow up the things that are less important).

The CSFs can be turned into Key Performance Indicators (KPIs) for periodic reporting in the sameway as conventional budgetary control might focus on, and report costs against standard costs.

The CSFs can guide the development of information systems by ensuring that managers receive regularinformation about the factors that are critical to their business.

They can be used for benchmarking organisational performance internally and against rivals(benchmarking was discussed in Chapter 5).

Business strategy


Some KPIs which cover both financial and non-financial criteria are outlined below.

Activity Key performance indicators

Marketing Sales volume

Market share

Gross margins

Production Capacity utilisation

Quality standards

Logistics Capacity utilisation

Level of service

New product development Trial rate

Repurchase rate

Sales programmes Contribution by region, salesperson

Controllable margin as percentage of sales

Number of new accounts

Travel costs

Advertising programmes Awareness levels

Attribute ratings

Cost levels

Pricing programmes Price relative to industry average

Price elasticity of demand

Management information Timeliness of reports

Accuracy of information

3 Strategic control

Section overviewControl at a strategic level means asking the question: 'is the organisation on target to meet its overallobjectives, and is control action needed to turn it around?'

3.1 Strategic control systems

Worked example: EricssonEricsson is the world's third largest supplier of mobile phones. On 26 January 2001, The Financial Timescarried the following report about control action Ericsson was taking.

By Christopher Brown-Humes in Stockholm, Dan Roberts in London and Richard Waters in New York.

'Ericsson, the world's third biggest supplier of mobile phones, is today expected to announce it is pullingout of handset manufacturing in a bid to stem huge losses in its consumer products division

The company will stress it remains committed to mobile phones. It will continue research and developmentand marketing activities, and phones will still carry the Ericsson brand.



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Ericsson is believed to have ruled out any withdrawal from the handset market on the grounds thatknowledge of the market is integral to its telecommunications infrastructure business by far the biggestpart of its operations and is crucial to its ability to be able to offer telecoms operators a full service. But ithas acknowledged that the need to restore profitability to its beleaguered handset division is paramount ata time when the market is deteriorating.

Other big handset makers, including Motorola, the biggest US producer, have contracted out some oftheir production

The group has launched a range of measures to improve performance, including switching production fromSweden and the US to lower cost countries in Latin America and eastern Europe.

But analysts are not convinced the measures will be enough to get the group's handsets operations backinto profit by the second half of this year, in line with the company's target. Some believe the group mayeventually pull out of mobile phones altogether.'

Interactive question 1: Strategic control [Difficulty level: Easy]What do you think the Ericsson case example above says about strategic control?

See Answer at the end of this chapter.

Steps in setting up formal systems of strategic control:

Step 1Strategy review: Review the progress of strategy.

Step 2Identify milestones of performance (strategic objectives), both quantitative and qualitative (e.g. marketshare, quality, innovation, customer satisfaction).

Milestones are identified after critical success factors have been outlined.

Milestones are short-term steps towards long-term goals.

Milestones enable managers to monitor actions (e.g. whether a new product has been launched) andresults (e.g. the success of the launch).

Step 3Set target achievement levels. These need not be exclusively quantitative.

Targets must be reasonably precise. Targets should suggest strategies and tactics. Competitive benchmarks are targets set relative to the competition.

Step 4Formal monitoring of the strategic process. Reporting is less frequent than for financial reporting.

Step 5Reward: For most systems, there is little relationship between the achievement of strategic objectives andthe reward system, although some companies are beginning to use measures of strategic performance aspart of the annual bonus calculations.

Business strategy


3.1.1 Informal control

Many companies do not define explicit strategic objectives or milestones that are regularly and formallymonitored as part of the ongoing management control process.

Choosing one objective (e.g. market share) might encourage managers to ignore or downgrade others(e.g. profitability), or lead managers to ignore wider issues.

Informality promotes flexibility.

Openness of communication is necessary.

Finite objectives overlook nuances especially in human resource management. In other words, anobjective like 'employee commitment' is necessary for success, but hard to measure quantitatively.

Informal control does not always work because it enables managers to skate over important strategic issuesand choices.

3.2 Guidelines for a strategic control systemThe characteristics of strategic control systems can be measured on two axes.

How formal is the process? How many milestones are identified for review?

As there is no optimum number of milestones or degree of formality, Goold and Quinn (Strategic Control)suggest these guidelines.

Guideline Comment

Linkages If there are linkages between businesses in a group, the formality of the process shouldbe low, to avoid co-operation being undermined.

Diversity If there is a great deal of diversity, it is doubtful whether any overall strategic controlsystem is appropriate, especially if the critical success factors for each business aredifferent.

Criticality Firms whose strategic stance depends on decisions which can, if they go wrong, destroythe company as a whole (e.g. launching a new technology) need strategic controlsystems which, whether formal or informal, have a large number of milestones so thatemerging problems in any area will be easily and quickly detected.

Change Fashion-goods manufacturers must respond to relatively high levels of environmentalturbulence, and have to react quickly. If changes are rapid, a system of low formality andfew measures may be appropriate, merely because the control processes must allowdecisions to be taken in changed contexts.

Competitiveadvantage

Businesses with few sources of competitive advantage control can easily focus onperhaps market share or quality with high formality.

Businesses with many sources of competitive advantage success over a widernumber of areas is necessary and the firm should not just concentrate on one ofthem.



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3.3 Strategic performance measuresDesirable features of strategic performance measures are shown below.

Role of measures Comment

Focus attention on what matters in the long term For many organisations this might be shareholderwealth.

Identify and communicate drivers of success Focus on how the organisation generatesshareholder value over the long term.

Support organisational learning Enable the organisation to improve itsperformance.

Provide a basis for reward Rewards should be based on strategic issues notjust performance in any one year.

Characteristics of strategic performance measures:

Measurable Consistently measured Meaningful Re-evaluated regularly Defined by the strategy and relevant to it Acceptable

4 Assessing a firm's performance data analysis

Section overview The examiners have indicated that at least one of the questions will include data analysis and one

example of this would be in performance measurement.

These questions may include financial statement data or alternatively it may include somemanagement data which may require analysis and some supporting argument or judgement tocomment on performance.

The key issue is that the data analysis should be linked to the strategy.

This section reminds you of some of the key financial performance measures you have studied inprevious papers.

4.1 ProfitabilityA company should be profitable, and there are obvious checks on profitability.

Whether the company has made a profit or a loss on its ordinary activities. By how much this year's profit or loss is bigger or smaller than last year's profit or loss.

It is probably better to consider separately the profits or losses on exceptional items if there are any. Suchgains or losses should not be expected to occur again, unlike profits or losses on normal trading.

Business strategy


Interactive question 2: Profit margin [Difficulty level: Easy]A company has the following summarised profit and loss accounts for two consecutive years.

Year 1 Year 2CU CU

Turnover/Revenue 70,000 100,000Less cost of sales 42,000 55,000Gross profit 28,000 45,000Less expenses 21,000 35,000Net profit 7,000 10,000

Although the net profit margin is the same for both years at 10%, the gross profit margin is not.

Year 170,00028,000

= 40% Year 2100,00045,000

= 45%

Requirements

(a) Assess whether this is good or bad for the business.

(b) What would happen to the gross profit margin of (i) a retail company and (ii) a manufacturingcompany if they adopted a price penetration policy.

See Answer at the end of this chapter.

Profit on ordinary activities before taxation is generally thought to be a better figure to use than profit aftertaxation, because there might be unusual variations in the tax charge from year to year which would notaffect the underlying profitability of the company's operations.

Another profit figure that should be calculated is PBIT: profit before interest and tax.

This is the amount of profit which the company earned before having to pay interest to the providersof loan capital. By providers of loan capital, we usually mean longer-term loan capital, such asdebentures and medium-term bank loans, which will be shown in the balance sheet as 'Creditors:amounts falling due after more than one year.' This figure is of particular importance to bankers andlenders.

How is profit before interest and tax calculated?

The profit on ordinary activities before taxation plus

Interest charges on long-term loan capital.

To calculate PBIT, in theory, all we have to do is to look at the interest payments in the relevant noteto the accounts. Do not take the net interest figure in the profit and loss account itself, because thisrepresents interest payments less interest received, and PBIT is profit including interest received butbefore interest payments.

4.2 Sales margin

DefinitionSales margin: Sales turnover less cost of sales. Sometimes expresses as a percentage of sales turnover toindicate the proportion of sales proceeds retained as gross profit.



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Worked example: MarginsLook at the following examples.

(a) Wyside Press Ltd, a printer 20XXCU'000

Turnover/Revenue 89,844Cost of sales (60,769)Gross profit 29,075Distribution expenses (1,523)Administrative expenses (13,300)Goodwill/Intangibles amortisation (212)Operating profit (15.6%) 14,040(Interest etc)

Cost of sales comprises direct material cost, such as paper, and direct labour. Distribution andadministrative expenses include depreciation. Sales margin = 32%.

Sales margin at least shows the contribution that is being made, especially when direct variable costsare very significant.

(b) Bertie Ltd, a bus company 20XXCUm

Turnover/Revenue 1,534.3Cost of sales 1,282.6Gross profit 251.7Net operating expenses 133.8Operating profit (7.6%) 117.9(Interest etc)

Sales margin = 16%. Clearly a higher percentage of costs are operating costs.

(c) Lessons to be learnt

(i) Sales margin as a measure is not really any use in comparing different industries.

(ii) Sales margin is influenced by the level of fixed costs.

(iii) Trends in sales margin are of interest. A falling sales margin suggests an organisation has not beenable to pass on input price rises to customers.

(iv) Comparisons with similar companies are of interest. If an organisation has a lower sales margin thana similar business, this suggests problems in controlling input costs.

In short, the value of sales margin as a measure of performance depends on the cost structure of theindustry and the uses to which it is put.

5 Balanced scorecard

Section overviewAn approach that tries to integrate the different measures of performance is the balanced scorecard,where key linkages between operating and financial performance are brought to light. This offers fourperspectives:

Financial Customer Innovation and learning Internal business processes

Business strategy


5.1 Financial measures of performanceChapter 8 discussed the role of divisionalisation and divisional performance measures. The research ofGoold and Campbell revealed the practice by the boards of divisionalised firms to utilise a strategiccontrol style that combined financial and non-financial performance measures.

There are a number of limitations where management rely solely on financial performance measures.

Encourages short-termist behaviour: Focusing on hitting monthly, quarterly and annual targetsmay be inconsistent with longer term strategic business development.

Ignores strategic goals: Financial control cannot enable senior management to affect otherimportant determinants of commercial success such as customer service and innovation.

Cannot control persons without budget responsibility: Operative and other staff cannot becontrolled by financial targets if they have no responsibility for financial results.

Historic measures: Financial measures of performance are essentially lagging indicators ofcompetitive success i.e. they turn down after competitive battles have been lost. Management needslead indicators of where problems are occurring to avoid losing such battles.

Distorted: Financial measures can be distorted by creative accounting. Also some of the conventionsof financial reporting mean that internal financial control measures are of limited value for decision-making e.g. lack of valuation of intangibles such as brands, failure to value inventory and transactions atopportunity cost and so on.

5.2 The origins of the balanced scorecardKaplan and Norton's balanced scorecard was developed in the early 1990s following research intoperformance measures in high-performing US firms, notably in the IT industries of Silicon Valley, NorthernCalifornia.

According to their research these firms conducted regular assessments of four different perspectives, asfollows.

Perspective Question Explanation

Customer What do existing andnew customers valuefrom us?

Gives rise to targets that matter to customers:cost, quality, delivery, inspection, handling and soon.

Internal business What processes mustwe excel at to achieveour financial andcustomer objectives?

Aims to improve internal processes and decisionmaking.

Innovation andlearning

Can we continue toimprove and createfuture value?

Considers the business's capacity to maintain itscompetitive position through the acquisition ofnew skills and the development of new products.

Financial How do we createvalue for ourshareholders?

Covers traditional measures such as growth,profitability and shareholder value but set throughtalking to the shareholder or shareholders direct.

Performance targets are set once the key areas for improvement have been identified, and the balancedscorecard is the main monthly report.

Kaplan and Norton claimed that the scorecard is balanced in the sense that managers are required tothink in terms of all four perspectives, to prevent improvements being made in one area at theexpense of another.

A decade later and the BSC was being proposed as more than a performance measurement system. In TheStrategy Focused Organization Kaplan and Norton state that the setting of performance measures in the fourareas can drive strategic change (a topic returned to in Chapter 14).



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5.3 Developing a balanced scorecardKaplan (Advanced Management Accounting) offers the following 'core outcome measures'.

Perspective Core outcome measure

Financial Return on Investment

Profitability

Revenue growth/revenue mix

Cost reduction

Cash flow

Customer Market share

Customer acquisition

Customer retention

Customer profitability

Customer satisfaction

On-time delivery

Innovation and learning Employee satisfaction

Employee retention

Employee productivity

Revenue per employee

% of revenue from new services

Time taken to develop new products

Internal business Quality and rework rates

Cycle time/production rate

Capacity utilisation

Kaplan and Norton suggest the following process for setting the BSC.

1 Senior executives decide strategy.

2 Budgets and information systems are linked to the measures in the BSC. This allows divisional andoperational management to monitor the performance of their areas of responsibility.

3 Personal scorecards are developed and, through performance management (described in Chapter 12)become the basis for staff development and incentive payments.

4 Collaborative working occurs as many targets require team work to achieve.

5 Therefore strategy is 'operationalised' through being turned into day-to-day operations.

Kaplan and Norton recognise that the four perspectives they suggest may not be perfect for allorganisations: it may be necessary, for example, to add further perspectives related to the environment orto employment.

Business strategy


A balance scorecard for a computer manufacturing company



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5.4 The vertical vectorKaplan and Norton's original perspectives may be viewed as hierarchical in nature, with a vertical vectorrunning through the measures adopted.

Perspective Measures

Financial ROCE

Customer Relationships and loyalty

Internal business Quality, efficiency and timeliness

Innovation and learning Skills and processes

The balanced scorecard only measures performance. It does not indicate that the strategy isthe right one. 'A failure to convert improved operational performance into improved financialperformance should send executives back to their drawing boards to rethink the company's strategy or itsimplementation plans.'

5.5 ProblemsAs with all techniques, problems can arise when it is applied.

Problem Explanation

Conflicting measures Some measures in the scorecard such as research funding and cost reductionmay naturally conflict. It is often difficult to determine the balance which willachieve the best results.

Selecting measures Not only do appropriate measures have to be devised but the number ofmeasures used must be agreed. Care must be taken that the impact of theresults is not lost in a sea of information. The innovation and learningperspective is, perhaps, the most difficult to measure directly, since muchdevelopment of human capital will not feed directly into such crude measuresas rate of new product launches or even training hours undertaken. It will,rather, improve economy and effectiveness and support the achievement ofcustomer perspective measures.

Expertise Measurement is only useful if it initiates appropriate action. Non-financialmanagers may have difficulty with the usual profit measures. With moremeasures to consider, this problem will be compounded.

Interpretation Even a financially-trained manager may have difficulty in putting the figuresinto an overall perspective.

The scorecard should be used flexibly. The process of deciding what to measure forces a business toclarify its strategy. For example, a manufacturing company may find that 50% 60% of costs are representedby bought-in components, so measurements relating to suppliers could usefully be added to the scorecard.These could include payment terms, lead times, or quality considerations.

Business strategy


Worked example: Oil company's use of balanced scorecardAn oil company (quoted by Kaplan and Norton, Harvard Business Review) ties:

60% of its executives' bonuses to their achievement of ambitious financial targets on ROI, profitability,cash flow and operating costs.

40% on indicators of customer satisfaction, retailer satisfaction, employee satisfaction andenvironmental responsibility.

5.6 Using the balanced scorecard Like all performance measurement schemes, the balanced scorecard can influence behaviour among

managers to conform to that required by the strategy. Because of its comprehensive nature, it can beused as a wide-ranging driver of organisational change.

The scorecard emphasises processes rather than departments. It can support a competence-basedapproach to strategy, but this can be confusing for managers and may make it difficult to gain theirsupport.

Deciding just what to measure can be particularly difficult, especially since the scorecard verticalvector lays emphasis on customer reaction. This is not to discount the importance of meetingcustomer expectations, purely to emphasise the difficulty of establishing what they are.

The scorecard can be used both by profit and not-for-profit organisations because it acknowledges the factthat both financial and non-financial performance indicators are important in achieving strategic objectives.

5.7 Developments in the balanced scorecardThe original balanced scorecard of Kaplan and Norton was as a measurement and control tool formanagers. Essentially, its focus was 'strategic control' rather than 'management control'. It has, however,been developed over time in terms of both its design and application.

The second generation balanced scorecard attempted to develop further the guidance on how themeasures should be selected (filtered) and linked to the overall objectives of the organisation. It also beganto look at more complex linkages and causality between the perspectives (sometimes called a 'strategiclinkage model'). As a consequence, the balanced scorecard evolved from an improved measurement systemto a core management system.

More recently, what has been term a third generation balanced scorecard, has been developed. Thisinvolves enhancing the links between the balanced scorecard and the strategic objectives to be achievedwithin a given timeframe. This has been reflected in a 'destination statement' which sets out in some detailwhat the organisation is trying to achieve. Its purpose is to check the extent to which the objectives, targetsand measures chosen, have been attained after a given period of time. It has also supported thedevelopment of multiple balanced scorecards in complex organisations.



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Summary and Self-test

Summary

Business strategy


Self-testAnswer the following questions.

1 What is an example of a critical success factor for the production function?

2 What are the four perspectives associated with the balanced scorecard?

3 What are the Johnson, Scholes and Whittington's criteria for evaluating individual strategies?

4 In what five areas should CSFs be set, according to MIT?

5 A firm's ROCE is the product of which two ratio?

6 Define four liquidity ratios.

7 List four limitations of relying on financial measures alone to manage divisional performance.

8 Cottingham City University

Cottingham City University, in the city of Cottingham, has only recently been awarded the status ofuniversity; previously it had been a college. This government-led move, although giving the institutionthe potential for greater flexibility and increased control over its operations, has also meant that, dueto the removal of local authority control, the university has lost an annual CU3m 'top-up' fund.

Since becoming a university it has been rationalised from the previous five sites to three sites, allwithin walking distance of each other. At the same time the university is increasing its number ofstudents. Also in Cottingham is the Further Education College, which offers a wide range of coursesranging from pre-'A' level stage to some post-'A' level courses, such as accountancy and businessstudies.

The City University

The university's stated objective is 'to become an enterprising, accessible and highly regardeduniversity, with strong continental and regional links, with the aim of having 5,000 students by 20X5'.

It has been reorganised into five faculties across the sites.

Campus A Business SchoolScience

Campus B ArtCatering/Leisure Management

Campus C Social Sciences

Due to the low number of students attracted to the Arts and Science faculties it has been proposedthat these be closed. However, this would result in an overall staff reduction of 15%. Courses at theuniversity range from sub-degree through to post-graduate and post-experience courses, such as theMaster of Business Administration (MBA) and Diploma of Management Studies (DMS). The lattercourses have been popular.

There are currently some 3,400 students at the City University, 75% of whom live within a ten-mileradius of Cottingham. Due to the great demand for places on the business courses, the CottinghamBusiness School was formed from the previous business faculty. Over 50% of all students are on abusiness or business related course, and 70% of all students take some kind of business subjectirrespective of the course taken.

The business school also boasts a strong financial position, generating a profit of CU4m in 20X0/X1,contributing to an overall profit of CU2m for the university as a whole. The university already hasclose links with a number of European countries (e.g. France, Germany, Holland) through its highlypopular and successful European Business Studies course. For this degree course students spend twoperiods of six months studying in a foreign country.



11

Accommodation

Halls of residence both on and off campus provide accommodation for less than half of the students,the rest having to find rooms in a variable and contracting private rental market. The problem is nothelped by the restricted land available for development on campus.

A further problem highlighted by the Student Union is the difficulty faced by students, particularlythose who are part-time, in gaining access to computer and library facilities. The computer facilitieswere last reviewed four years ago when students numbered only 2,000. The difficulties arise from allfirst-year students being required to study Information Technology, and from many lecturers requiringreports to be word processed.

Opening hours Library Sunday Thursday 8.30 am 9.00 pmSaturday 9.00 pm 12.30 pm

Computer rooms As aboveTimetable hours Full-time Sunday Thursday 9.00 am 5.00 pm

Part-time Sunday Thursday 6.00 pm 9.00 pmTeaching and staffing

Recently, a process of restructuring administration and ancillary staff was undertaken. Theadministration side was centralised into one building on each campus, the departmental structurebeing replaced by a faculty structure. This has, however, resulted in a number of redundancies anddemotions, but few promotions. It is hoped that things will change in the next few years asmanagement settle into their new role.

In 20X2 there were seven senior staff responsible for research; this has now fallen to two. Staff havebeen told that no promotional posts will be available for the foreseeable future. Moreover, the latestpay talks only resulted in a 3% offer, with a CU500 bonus for signing new contracts. The union istotally dissatisfied with the offer and has advised its members neither to accept the pay rise nor to signthe new contract, and a number of one-day strikes have been proposed.

Requirements

As a local management consultant prepare a memorandum for the senior lecturers at the businessschool covering the following.

(a) Perform a SWOT analysis on Cottingham City University and suggest a possible strategy (orstrategies), fully explaining your reasons, and also any problems which need to be overcome toachieve those strategies. (15 marks)

(b) In the light of the strategies highlighted above, suggest a range of performance measures whichmight help to assess the success of the university. You should give reasons why you think eachmeasure to be appropriate. (15 marks)

(30 marks)

9 Greens Ltd is a growing firm providing organic fruit and vegetables for delivery via phone or Internetorder. It has decided to measure performance for the coming year using the balanced scorecardapproach. Suggest two measures in each of the four areas covered by the scorecard.

10 Maysize Ltd

Maysize Ltd owns a department store located in a prime site in a regional city in Bangladesh. The storehas 16 different departments, selling such diverse items as shoes, fabrics and children's toys, and it hasan accounts office for administration. The store is run by a store manager and there is a manager foreach department within the store. Selling margins are set by the store manager, although there isscope to flex the margin after consultation with departmental managers. All suppliers are paid by theaccounts office. Each departmental manager is responsible for product sales, employee costs and anysale events (e.g. the January sales).

Management reporting

The management reporting system is very simple. The accounts office prepares a monthly cash flowstatement, balance sheet and cumulative income statement. The income statement and balance sheet

Business strategy


are compiled from the 16 departmental income statements and balance sheets. The departmentsprepare their income statements by calculating cost of goods sold by reference to the selling margins.

Maysize Ltd is now in the process of changing to a computerised management reporting system. Thissystem will be able to generate reports in as much detail as is necessary for management.

The managing director has come to you for advice about the new reporting system. She would like toknow what financial and non-financial performance indicators should be generated by the newreporting system so that she can monitor in more detail and improve the profitability and liquidity ofthe department store.

Requirement

Prepare a memorandum for the managing director suggesting the six most useful performanceindicators that the new system should generate for the departments. For each performance indicatorwhich you recommend, specify what information it should contain, its frequency and why it would beuseful for the managing director. (10 marks)

11 Rockingham Hospital

A new private hospital of 100 beds was opened to receive patients on 2 January 20X4 although manysenior staff members, including the supervisor of the laundry department, had been in situ for sometime previously. The first three months were expected to be a settling-in period, the hospital facilitiesbeing used to full capacity only in the second and subsequent quarters.

On 1 May 20X4 the supervisor of the laundry department received her first quarterly performancereport from the hospital administrator, together with an explanatory memorandum. Copies of bothdocuments are set out below.

The supervisor had never seen the original budget nor had she been informed that there would be aquarterly performance report. She knew she was responsible for her department and had made everyendeavour to run it as efficiently as possible. It had been made clear to her that there would be a slowbuild-up in the number of patients accepted by the hospital and so she would need only threemembers of staff, but she had had to take on a fourth during the quarter due to the extra work. Thisextra hiring had been anticipated for May, not late February.

Rockingham Private Patients Hospital Ltd

Memorandum

To All department heads/supervisors

From Hospital administrator

Date 30 April 20X4

Attached is the quarterly performance report for your department. The hospital has adopted aresponsibility accounting system so you will be receiving one of these reports quarterly. Responsibilityaccounting means that you are accountable for ensuring that the expenses of running your departmentare kept in line with the budget. Each report compares the actual expenses of running yourdepartment for the quarter with our budget for the same period. The difference between the actualand forecast will be highlighted so that you can identify the important variations from budget and takecorrective action to get back on budget. Any variation in excess of 5% from budget should beinvestigated and an explanatory memorandum sent to me giving reasons for the variations and theproposed corrective action.



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Performance report Laundry department

Three months to 31 March 20X4

VariationActual Budget (over)/under % variation

Patient days 8,000 6,500 (1,500) (23.0)Weight of laundry processed (lbs) 101,170 81,250 (19,920) (24.5)

CU CU CU %Department expensesWages 4,125 3,450 (675) (19.5)Supervisor salary 1,490 1,495 5 Washing materials 920 770 (150) (19.5)Heating and power 560 510 (50) (10.0)Equipment depreciation 250 250 Allocated administration costs 2,460 2,000 (460) (23.0)Equipment maintenance 10 45 35 78.0

9,815 8,520 (1,295) (15.0)

Comment. We need to have a discussion about the over-expenditure of the department.

Requirements

(a) Discuss in detail the various possible effects on the behaviour of the laundry supervisor of theway that her budget was prepared, and the form and content of the performance report.

(10 marks)

(b) Re-draft, giving explanations, the performance report and supporting memorandum in a waywhich, in your opinion, would make them more effective management tools. (7 marks)

(17 marks)

12 Old and New

In 20X2 the divisional manager of the household products division of Rogers Industries Ltd, GeorgeOld, announced to the board of directors that he intended to retire at the end of 20X4. In view of thisan assistant manager, Ian M New, was recruited in 20X3 with the intention that he should take overwhen Old retired. As part of his responsibilities New was given the task of preparing the budget for20X4 onwards. It was felt that this would allow him to become acquainted with the way in which thedivision operated and introduce him to one of the jobs he would have to do when he becamedivisional manager.

As a divisionalised company Rogers Industries Ltd gives each division a fair degree of autonomy.Divisional budgets are reviewed by the central finance committee but rarely amended. Any capitalinvestment decisions are made jointly by the finance committee and divisional manager; it is theresponsibility of the divisions to implement the investment programmes. Rogers Industries Ltdassesses performance of divisions and their managers by reference to return on capital employed.Cash is controlled centrally. The figures below show the performance of the household productsdivision for the years 20X3 to 20X5 and the budgets for 20X5 and 20X6. These budgets have beenapproved by the finance committee which agreed with New that there was no need to amend the20X6 budget in the light of 20X5 performance.

Business strategy


Household products division

Actual Budget20X3 20X4 20X5 20X5 20X6

CU'000 CU'000 CU'000 CU'000 CU'000Sales 2,000 3,000 3,600 4,000 4,800Variable costs

Materials 200 300 360 400 480Labour 300 450 540 600 720Overheads 40 60 70 80 96Repairs 100 150 90 200 240

Divisional fixed costsStaff training 60 70 40 80 90Advertising 10 15 10 20 24Maintenance 100 110 90 120 140Depreciation 240 320 310 400 410Rent 160 205 220 250 250Other costs 20 25 30 30 35

Total divisional costs 1,230 1,705 1,760 2,180 2,485Net profit 770 1,295 1,840 1,820 2,315Divisional net assets

Non-current assets 3,200 5,180 5,500 6,700 7,550Receivables 200 300 350 400 480Inventory 400 600 550 800 960Payables (300) (450) (750) (600) (720)

Divisional investment 3,500 5,630 5,650 7,300 8,270Return on capital employed 22% 23% 32.5% 25% 28%

Requirements

(a) Comment on the performance of Ian M New during 20X5, calculating those extra ratios you feelare important and including a note on the areas of Mr New's responsibility for the householdproducts division. (8 marks)

(b) Suggest what changes might be made in either the responsibilities of the divisional managers orthe method of assessing their performance. (6 marks)

(c) Set out possible reasons why Rogers Industries Ltd might wish to be organised on divisional linesand the possible disadvantages of such a corporate structure. (6 marks)

(20 marks)

13 Accounting For Business Ltd

Accounting for Business Ltd (AFB) is a national organisation which provides private tuition courses inaccounting. The courses are generally attended by individuals who work as bookkeepers for othercompanies and who want to develop their practical skills. None of the attendees is aiming towards anyprofessional qualification or examination.

Courses are run on basic bookkeeping, value added tax, payroll, credit control, companyadministration and basic business management. Other bespoke courses, run on demand, are chargedout at higher than normal rates.

AFB has six branches nationwide with individual branch managers. Head office is situated at Rajshahiand has responsibility for company accounting, payroll and inventory ordering activities. Individualbranch managers have responsibility for all other areas of the business, such as pricing, product mixand staffing.

Each branch rents its premises (a national company policy) and staff numbers range from 4 in Jamalpurto 18 in Dhaka. Staff are generally former accountants, bankers and tax inspectors who concentrate onkeeping courses practical and applicable to their customers.

To date managers have always been appraised by return on investment (ROI) with a target return of40%. Branches have regularly exceeded this target and branch managers seem happy to be appraised inthis manner.



11

Jim Buxton, the company's main shareholder and managing director, recently visited all branches inorder to promote corporate identity and inspect performance at a local level. He returned dismayedat the condition of some branch premises and feels overall that, although recent financial performancehas been consistent with previous years, the company does not seem to have changed or developedsince he last visited branches five years ago.

Jim believes that he needs to change the appraisal method for branches so that they fit more closelywith what he expects from the company. He wants the business to develop and grow and become theleading provider of business training in Bangladesh.

Requirements

Answer the following questions, considering each independently from the others, and supporting youranswers with appropriate calculations.

(a) Outline the problems the business is likely to have from its use of ROI as its sole performanceindicator. (4 marks)

(b) Describe the balanced scorecard approach to performance measurement and how it mightrectify these problems. (12 marks)

(c) Outline possible performance measures which might be used in each area of the balancedscorecard for AFB. (9 marks)

(25 marks)Now go back to the Learning Objectives in the Introduction. If you are satisfied you have achieved theseobjectives, please tick them off,

Business strategy


Answers to Self-test

1 Quality standards / capacity utilisation

2 Financial Customer Innovation and learning Internal business processes

3 Suitability, feasibility and acceptability

4. 1 The structure of the particular industry2 Competitive strategy and position3 Environmental factors4 Temporary factors5 Functional managerial position

5 Profit margin asset turnover = ROCE

6 Current ratio: current assets/current liabilitiesQuick ratio: (current assets less inventories)/current liabilitiesDebtor (Receivable) days: trade debtors/ turnover 365Creditor (Payable) days: trade creditors/cost of sales 365

7 Four of:

Encourages short-termist behaviour: Ignores strategic goals Cannot control persons without budget responsibility Historic measures Distorted

8 Cottingham City University

Note: 'Not for profit' organisations are only examinable at a basic level and all relevant informationwould be given in an examination question.

Memorandum

To Mr A Lecturer

From M Consultant

Date Today

SubjectCottingham University The future

(a) Analysis and strategy

Findings

The stated objective of Cottingham University is 'to become an enterprising, accessible, andhighly-regarded university, with strong continental and regional links, with the aim of having 5,000students by 20X5'. The words 'enterprising', 'accessible' and 'highly-regarded', are somewhatintangible, thus making it difficult to quantify their success. However, in order to look at astrategy(ies) for achieving this goal, it is necessary to look first at the resources which theuniversity has to offer.



11

Resources available

There are a number of valuable resources which the university has to offer, including three easilyaccessible sites, an excellent business school, links with continental countries (providing potentialfor growth) and a good location in the town.

In order to understand the situation fully, it is necessary to perform a SWOT analysis whichhighlights strengths, weaknesses, opportunities and threats to the university.

SWOT analysis

The important points are that the opportunities need to be turned into strengths, and theweaknesses need to become opportunities. This is the basis of the following strategy.

Formulation and evaluation of alternatives

In order to turn opportunities into strengths, a number of alternative strategies are suggested

Strengths

Strong reputation of businessschool

Location in town

Links with continent

Opportunities

Change of status from college touniversity allows greatercompetition for university students

Students from College of FurtherEducation

Development of old sites into hallsof residence

Development of courses, such asthe MBA

Growth in continental ties

Increased emphasis on businessfacilities

Part-time students

Weaknesses

Accommodation problems

Low staff morale

Time tabling problems

Threats

Lack of funding

Teaching staff leaving

Competition from other local educationalinstitutions

Effect on potential students of teachers strikes

(i) Develop other related professional courses, such as CIMA, ACCA and bankingexaminations. This will be in direct competition with the College of Further Education butthe business schools reputation will help in attracting students.

(ii) Due to the problems with accommodation, a further strategy would be to develop existingland, which the university owns, into halls of residence. Obviously the costs of such aproject would be high in the short term but in the long term the benefits gained fromattracting new students will outweigh the costs. Before going ahead with such a scheme, athorough financial analysis must be carried out.

(iii) Courses such as MBA and DMS have proved very popular in the past and should bedeveloped and strengthened. This will probably increase the number of part-time students,which is another possible growth area for the university.

(iv) Growth in continental ties is probably more of a long-term strategy, especially if theuniversity wishes to broaden its horizons to countries further afield. In the short tomidterm, continental students provide the potential for developing business strategies

Business strategy


abroad. Before this can be done, however, extensive market research into the needs andexpectations of foreign students must be carried out.

Obviously the above are only some options to be considered and hopefully lecturers will beencouraged to put forward ideas of their own.

It is clear, in any case, that the business school is the key area to be developed if the universitysobjective is to be achieved.

Problems to overcomeThere are a number of problems to be faced before considering the best way to implement thestrategies suggested.

(i) Competition from other institutions: The University of North Midlands is also expandingand may be in direct competition for local students.

(ii) Staff disruptions: Problems caused by staff pay deals, leading to strikes, will deter potentialstudents.

(iii) Poor accommodation: Non-local students will be put off by the lack of accommodation bothin the university and in the town.

(iv) Lack of funding: Now that the university is self-funding, it must turn around the CU2m lossmade by the non-business faculties.

From the above discussion it is suggested that the following strategies be considered.

To concentrate the universitys resources towards the business school by

Improving the range of courses offered

Increasing ties with the continent

Encouraging part-time students and local professional students.

In order to achieve this objective it must

Overcome teacher problems

Create better accommodation facilities.

(b) Performance measuresIn order to assess the success of the above strategies, a number of performance indicators can beused.

Financial indicators(i) Profitability (by department)

In 20X1 the university contained 3,400 students and had a profit of CU2m.

The business school contained 1,700 students and had a profit of CU4m.

Therefore, the other four faculties were making a CU2m loss.

In future it will be possible to assess the profitability more accurately because there will befewer departments.

(ii) Profitability (per student)In 20X1 the university contained 3,400 students and had a profit of CU2m.

Profit per university student = CU588

In 20X1 the business school contained 1,700 students and had a profit of CU4m.

Profit per business school student = CU2,353

A number of variations on this measure might be used, depending on the statistics available(e.g. profitability per foreign student and profitability per non-degree student).

There are also a number of non-financial performance measures which may be equally useful.



11

Non-financial performance measures

(i) Increase in number of students

As one of the main aims of the university is to increase its student numbers to 5,000, animportant way of assessing the performance of the implemented strategy is to monitor theincrease in the number of new students.

This can be split into a number of categories.

Part-time students: These are obviously an important sector for the university and itwill be advantageous to create more places in this area.

Non-degree students (i.e. MBA, DMS, CIMA, ACCA, etc): This is also an importantgrowth area for the university, particularly where there is direct competition from thelocal college. Therefore, if the university can attract students in this area, this willindicate confidence in the institution.

Overseas students: This is a clear aim for the university, which can be monitored bythe increase in overseas students.

(ii) Achieving objective

As previously mentioned the stated objective contains a number of intangible goals(i.e. 'enterprising', 'accessible' and 'highly-regarded').

Obviously it will be difficult to measure the achievement of such goals, but the followingpoints may be useful.

Accessibility could be achieved by making as many courses available to as many students aspossible. Therefore, a measure of accessibility could be the number of non-local students atthe university. Accessibility could also be measured by the variety of students (e.g. ageranges, mixtures of degree, non-degree and other students).

Reputation could be measured by the calibre of students attracted to the university.Traditionally, universities attract students with high grades, but if the university can competeagainst the University of North Midlands for students, then it will gain a high regard amongstboth students and academics.

A further performance measure is the calibre of staff attracted to the university and theirresearch record (number and quality of papers published). A good research reputationshould attract funds and grants from the various educational research councils.

Recommendations

From the above discussion and analysis, it is clear that there is a need for change andreorganisation if the university is to achieve its objective.

(i) The university should concentrate its efforts on its most successful department, namely thebusiness school.

(ii) To widen its operations and increase its numbers, it should compete for students fromother local institutions in other business-related courses.

(iii) A wide range of student needs should be recognised and catered for (i.e. part-time, postdegree, professional, etc).

(iv) In order to increase overseas ties, the problems of accommodation and teaching staffdissatisfaction need to be overcome.

Business strategy


9 Financial perspectiveIncrease in revenueMarket share

Customer perspectiveTime taken from order to deliveryFreshness of products (measured in terms of days since harvesting)

Internal business process perspectiveTime taken to process an individual orderSpeed with which product availability updates register on the website

Innovation and learning perspectiveNumber of different products in the range offeredGeographical areas covered by delivery teams

10 Maysize Ltd

Memorandum

To Managing director, Maysize Ltd

From AN Consultant

Date 1 January 20X2

Subject Departmental performance indicators

This memorandum considers the new computer management reporting system for Department StoreX. As requested six specific performance indicators for departments are identified as being of criticalimportance.

The relative importance of each of these indicators will vary over time as organisational prioritieschange (e.g. if liquidity were to become more important than profitability).

The specific indicators identified are, as requested, local in nature. Global considerations, such asmarket share and capital expenditure, will also be of relevance but are not discussed in this report. Ineach instance the reporting system should incorporate information on prior period and (flexed)budgetary comparatives, and be analysed between individual departments and the store as a whole.Where possible, appropriate industry averages should also be incorporated (e.g. in margin analysis orarea utilisation).

Suggested indicators are as follows.

(1) Customer feedback summaries

Content

A summary of customer feedback, including details of the number and nature of complaints.These should include feedback received at the customer service desk, and a log of matters notedby store and department managers.

Frequency

Periodically (monthly depending on the extent and gravity of matters arising).

Benefits

Levels of service quality will be critical to the success of the store. Weaknesses in customerrelations management need identification to ensure that the appropriate client culture is adopted.

(2) Sales margins

Content

Gross profit margins should be calculated, expressing gross departmental profitability as apercentage of departmental revenue.



11

Frequency

Margins should be calculated periodically (probably weekly). In the event of specific queries,further detailed analyses could be provided on demand (e.g. a summary of exceptional marginsfor product lines relating to a specific department).

Benefits

Since authority to fix margins is delegated to the store manager (and in some cases departmentmanagers), some control will be vital.

Weak margins may indicate poor purchasing policies, or highlight high or low profitability forspecific departments that may warrant a reallocation of resources.

Margins will also be relevant when considering strategic pricing policies (e.g. price wars). Highlevel review should also facilitate overall goal congruence, e.g. one area targeting economypurchases (low margin), with another targeting the other end of the market.

(3) Area utilisation

Content

A measure of departmental revenue against space occupied should be prepared. [If possible amore elaborate measure of departmental profitability by floor space would provide furtherbenefit.]

Frequency

Periodically (monthly) or even as sales seasons change.

Benefits

Store space is a key scarce resource; maximising returns from available space will be critical tosuccess.

Measures yielding higher utilisation of existing space, once identified, could also be replicatedwithin other departments.

Potential improvements in profitability from devoting more space to areas yielding the highestreturn will need to be balanced with interdependencies between the departments. Shoppers may,for example, be using the store primarily for convenience food shopping, but may make additionalimpulsive purchases while on the premises.

(4) Staffing

Content

A simple calculation of departmental turnover against head count should be performed.

Frequency

This should be produced on a periodic basis (monthly).

Benefits

Staff costs will represent a significant determinant of profitability. Given the extent of delegationof responsibilities, they are also an important resource.

The measure should highlight areas of possible over/under staffing and may assist in staff planning.

An 'equitable' allocation of the workload should also avoid demotivating the staff and reduce staffturnover (training costs, etc).

Business strategy


(5) Inventory holding

Content

Average inventory holding days by department calculated as

salesofcostAnnualgoodsfinishedofinventoryAverage

365

Frequency

Periodically (possibly monthly) with fuller analyses of individual product lines available on demandin the event of exceptional inventory holdings.

Benefit

Inventory will be the key element of working capital. Inventory levels may also have a directimpact on sales levels (e.g. if shelves are bare).

A simple comparison of inventory levels between departments will identify excessive or minimalinventory levels, assisting in the review of purchasing policies, or handling of slow movinginventory lines and the use of sales.

Inventory counts may also be modified to allow investigation of unusual inventory levels, whichmay have been a result of inventory losses or inaccuracies in the recording of inventorymovements.

(6) Purchasing efficiency

Content

Value of trade and settlement discounts, in both absolute and relative (as a percentage ofpurchases) terms.

Frequency

Periodically (monthly), with the option of specific exception reporting (e.g. discounts overCU1,000).

Benefits

The ability to purchase quality goods at a reasonable price will be a key factor in the success ofthe store.

The organisation of purchasing responsibilities between departments and a central purchasingdepartment will be particularly relevant.

A review of discounts obtained may assist in consideration of strategic purchasing policy (centralbuying from key suppliers giving rise to potential economies of scale) and a consideration ofpayables management issues.

Conclusion

The new system offers the opportunity for a review of the full range of operational and tacticalmanagement information. The six indicators suggested have considered measures that may havemore 'strategic' relevance. I would be happy to offer further advice on other informationenhancements at your instruction.

11 Rockingham Hospital

(a) Discussion of the behavioural effects of the performance report

The following features of the way in which the budget was prepared, and the form and content ofthe performance report might give rise to an adverse response from the laundry supervisor.

(i) Lack of participation the supervisor was not consulted over the preparation of the budgetand did not know that one was being prepared.



11

(ii) Unflexed budget no attempt has been made to adjust budgeted costs in the light of theincrease in volume, presumably because the fixed and variable elements of costs have notbeen established.

(iii) Uncontrollable costs included the memorandum's references to 'responsibility accounting'and 'expenses of running your department' have been ignored when producing the reportwhich includes 'allocated administration costs' and 'equipment depreciation'.

(iv) Fixed percentage for investigation this may not be an ideal system for deciding whichvariances should be investigated and which should not. It seems an arbitrary figure and isbeing applied to all costs.

(v) Aggressive style the memorandum has been presented in a somewhat authoritarian stylebased solely on accounting information.

The effects that this might have on the behaviour of the supervisor include the following.

(i) Creating a negative attitude a phrase which encompasses a whole range of behaviouralproblems such as dampening initiative (possibly leading to wrong decisions such as notrecruiting staff when needed), reducing co-operation and communication betweendepartments (particularly with the hospital administrator), reducing morale within thedepartment, and giving rise to a lack of commitment to the hospital.

(ii) Reduced performance with the lack of co-operation mentioned it is less likely that thesupervisor will try to control or reduce costs. More effort will be put into finding excusesfor poor cost control or even attempting to falsify data where possible.

(iii) Budget pressure management could be said to be adopting a style of management whereobsession with the quarterly targets could lead to impaired performance. Steps might betaken to ensure not that costs do not exceed a budget, but rather to ensure that they donot fall below the budget lest the budget is pruned in the next quarter.

(iv) Wrong decisions the possibility of wrong decisions being made through 'dampenedinitiative' has already been mentioned. However, the use of a fixed percentage rule forinvestigating variances could also lead to wasted time looking at variances. Such variancesmight be small in absolute terms, caused by a poor budget, poor recording of costs or dueto random fluctuations: such variances might not be worth investigating.

Research into these various behavioural effects and their possible causes has grown over theyears following earlier papers based more on surmise and opinion. It has been a feature of muchof the empirical work into the relationship between accounting and behaviour that results haveproduced conflicting conclusions on matters such as management style, budgetary pressure,design of accounting measures and participation.

(b) Re-drafted report and memorandum

Rockingham Private Patients Hospital Ltd

Memorandum

To Mrs A Brown, Laundry Supervisor

From BC Smith, Hospital Administrator

Date 30 April 20X4

Subject Budget reporting

As you know, the hospital has adopted a responsibility accounting system in order to ensure thateach department runs as efficiently as possible. To help the operation of such a system it will beuseful for you to receive some form of performance report each quarter and I have attached myversion of such a report for the first quarter.

This first report is something of a trial run, since the first quarter was expected to be a settling-inperiod and as such not typical, and this report, having been produced without consultation withdepartment heads or supervisors, may need modification. It will, when fully operational, act as a

Business strategy


useful aid to cost control and I am very keen that we should meet as soon as possible to discussthe form and content of future reports.

This report shows the actual costs of running the department together with a budget based onthe weight of laundry processed. Variations from budget have been calculated and some markedas requiring your attention. Such variations will be those which are large in terms of the totalcost of the department and of the actual cost incurred, bearing in mind expected variations incertain costs.

I will expect a quick response to such reports by way of an explanatory memorandum but anyqueries over this or subsequent reports could be most easily sorted out by coming to my office.

Performance report Laundry department

Three months to 31 March 20X4

Flexed VariationActual budget (over)/ under Action needed

Patient days 8,000Weight of laundry processed (lbs) 101,170

CU CU CUWages (W1) 4,125 3,833 (292) NoneSupervisor salary 1,490 1,495 5 NoneWashing materials (W2) 920 959 39 NoneHeating and power (W3) 560 572 12 NoneEquipment maintenance 10 45 35 None

7,105 6,904 (201)

Comment. Congratulations on coping with the unexpected rise in volume. However, we must sortout these budgets properly, particularly the wages budget.

The memorandum has been toned down a little, made more personal and an attempt made to justifythe purpose of the report and encourage co-operation in establishing a system of cost control.

The report itself has been modified by eliminating uncontrollable elements (budgeted activity levels andcertain costs). The budget has been flexed by assuming that:

(i) Wages are variable subject to staff being employed for whole weeks

(ii) Materials are variable, and

(iii) Heating and power are 50% fixed and 50% variable (these arbitrarily proposed figures wouldneed to be established properly).

The report could have been less formally drawn up with the original budget shown together withcalculations to indicate how it was flexed to take into account the actual weight of laundry processedand variations laid out. In either case the hospital administrator should highlight which variations are tobe investigated and, with the flexed budget, no such investigation is needed for the first quarter.

The performance report could also show various figures to assess efficiency, such as total labour hoursand number of washing loads. With additional information price and usage variances could be foundfor washing materials. Details of the use of laundry capacity could be established by noting how muchlaundry was presented and how much processed as opposed to being sent outside.

WORKINGS

(1) Wages

CU3,450 10/9 = CU3,833

(2) Materials

CU770 81,250

101,170= CU959



11

(3) Heating and power

CU255 + CU255 81,250

101,170= CU(255 + 317)

Fixed variable = CU572

12 Old and New

(a) Performance evaluation

It would appear at first sight that Mr New has achieved much in his first year as divisionalmanager. Return on capital employed has risen by nearly 10% on the previous year and is well upon budget. The growth in net profit seen under Mr Old's management has been sustained underMr New and the division's net profit percentage has cleared 50% (W1). However, when oneexamines how this has been achieved, Mr New's performance looks less spectacular, in particularwith respect to the following points.

(i) Sales are down on budget (down CU400,000 or 10% on budget and the chances of achievingthe 20X6 budget seem remote).

(ii) Repair costs are down (other variable costs have maintained their normal relation to salesbut repair costs have dropped off markedly) (W2).

(iii) Discretionary fixed costs are below budget (previously-made commitments to staff training,advertising and maintenance have been cut by 25% or even 50%).

(iv) Depreciation is below budget (perhaps as a result of reduced investment see below).

(v) Non-current assets are CU1.2 million below budget (capital investment programmes havenot been carried out).

(vi) Receivables and inventory levels are down on budget (the first could be attributable to thelow level of sales, the latter to efficient working capital management, though there could beproblems of meeting future sales).

(vii) Payables have increased dramatically (this could be called good credit management orperhaps an attempt to manipulate figures used for divisional assessment).

Each of these items, of which items (ii) to (vii) are controllable by Mr New, have moved in such away as to improve the division's reported return on capital employed. However, in the case ofmost of the controllable items, they could be said to have changed in a way that has improvedshort-term profitability whilst seriously jeopardising longer-term performance. The fall in repaircosts, training and maintenance must put a question mark over whether the division can continueto be run efficiently. The cuts in non-current assets, inventory and advertising make it unlikelythat sales will be maintained, even at their current level.

(b) Changes in responsibility and evaluation

Although the responsibilities that appear to have been assigned to Mr New, particularly theresponsibility for producing regular budgets, are in line with what one would expect of adivisional manager, some changes need to be implemented.

(i) There is a need for managers' budgets to be more critically reviewed. Questions should beasked as to how certain budgetary targets can be attained.

(ii) Divisional managers must be fully committed to any capital investment programmesfollowing joint discussions with the finance committee.

Major improvements, however, can be made in the method of appraising divisional performance.

(i) The extent to which a division might contribute towards the company's profit would bebetter measured by residual income (an absolute measure of profitability) rather than byreturn on capital employed (a relative measure).

Business strategy


(ii) Subsidiary ratios should be used such as asset/turnover; gross profit percentage; inventory,receivables and payables periods though these may be open to the sort of 'window-dressing' carried out by Mr New.

(iii) Other performance measures could be introduced to establish whether discretionary costshave been cut back too far. Examples would be machine downtime and staff turnover ratios.

(iv) Using a balanced scorecard approach would involve assessing success from a financial,customer, innovation and learning and internal business perspective. Other useful measuresmight then include market share, dissatisfied customer orders, number of new productslaunched.

The important steps are to change the main evaluation measure used and to support it withother measures that aim to examine every facet of 'performance'.

(c) Reasons for and disadvantages of decentralisation

(i) Reasons why Rogers Industries Ltd might wish to be organised along divisional lines mightinclude the following.

(1) Size it is useful to split a large organisation into smaller manageable units.

(2) Specialisation and complexity central management may not have sufficient skills to beresponsible for the day-to-day control of certain specialised tasks.

(3) Uncertainty and unpredictability in uncertain trading conditions local management willbe able to react to changes more quickly than central management.

(4) Motivation by assigning responsibility for a section of the business to one divisionalmanager, that manager might be encouraged to ensure that the division's performance isenhanced. The division also presents the manager with a degree of independence andacts as a training ground for him to develop his management skills.

(5) Economic a geographical separation of divisions might allow advantage to be taken oflocal investment grants and favourable tax rates. Such geographical dispersion alsoallows a firm to be closer to markets or sources of supply.

(6) Freeing central management being released from day-to-day responsibilities for someoperations of the business allows central management to concentrate more on longer-term strategic planning and control.

(ii) Though these may be valid reasons for a firm decentralising, there are certain disadvantagesof such a policy.

(1) Interdependencies complete separation of divisions is probably impossible, sincedivisions may be engaged in supplying each other with goods or services or sellingcomplementary or substitute products. Each makes demands on centralized resources,especially cash.

(2) Cost the advantages gained from economies of scale may well be lost bydecentralisation, with divisions each requiring certain types of assets or otherresources which might otherwise be shared.

(3) Loss of goal congruence divisional managers may make decisions which, whilst in thebest interest of their own division, are not in the best interest of the organisation as awhole.

(4) Loss of control central management will need to learn to delegate responsibility, co-ordinate divisional activities and control their performance.



11

WORKINGS

(1) Net profit percentage

20X3 20X4 20X5

2,000770

1003,0001,295

1003,6001,840

100

= 38.5% = 43.2% = 51.1%

(2) Variable costs as a percentage of sales

% % %Materials 10 10 10Labour 15 15 15Overheads 2 2 2Repairs 5 5 2.5

Note: Other ratios may be calculated though most of the comparisons made with earlier years and withthe budget are sufficiently

chap - 11 evaluation of strategies and performance mesurement

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