notes for session term 3

8/10/2019 Notes for session term 3

1/24

Management Control Systems 03/06/2014 03:55:00

Session 1:

Formal systems/Information based systems to implement organizations

strategies.

Hold/Alter organizations activities

Levers of Control(How does an organization control its resources such as

Capital and People given a chosen strategy----It is not a strategy

formulation exercise). Quintessential Example: Narendra Modi

Belief System :(Core values of the organization conveyed through

mission statement, vision statement) that provides the employees

the freedom to be creative. For example: IE provides students with

the ability to choose different ways of implementing learning such

as ICP, Internship for a greater good. (Top down)

Boundary System : Giving limits to the freedom. Be creative but

within the limits, dont jump guns. Decide how you deploy your

resources but also how you do not deploy your resources. (Top

Down)

Diagnostic Control System : Tells you anytime you digress from

the strategy. Gives you a warning signal

Interactive Control System : Futuristic system that helps

organizations deal with unforeseen circumstances. Generally you

are dealing with ambiguous and uncertain circumstances, so it

helps to analyse the current strategy and readjust it or rethink

about a new strategy

Delegation of Decision Rights

Differentiate between delegation of tasks and delegation of decision rights.

DoT is simple but DoDR is a bit tricky.


2/24

Delegation of Task: It is a Behaviour Control. Whip and Carrot approach. Go

and knock at the doors (This is a task).

Delegation of DR: When you ask for an outcome and there is no clear

defined way to reach the outcome. I want an increase in sales of 10% (Thisis an outcome and there is no defined way to accomplish it).

Problems: A manager can delegate the DR to the assistant manager but the

AM can fail because of two reasons: Incompetency or Self-Interest.

Incompetency can be obviated by terminating the employees. Self-Interest

can be obviated by aligning the goals of the employee with that of

companys.

NUCOR Case:

Steel Company in the US

Worst performing

High labour cost/Steel unions

Overcapacity/low exports for the US Steel

High Competition for imported Steel

Not an Integrated Steel manufacturer but a Mini-mills (Steels from

Scrap)

--So basically a Low-Cost strategy

Explanations:

1.)Industry Level: Not an attractive industry

2.) Country Level: Not a good country to start a steel business (already a

developed country)

3.) Intra-Industry Structure

MM > ISM

NUCOR >>>>> Others

4.) Internal Mechanisms

Differentiated Strategy: No

Value Chain partner: Not Really

Internal Organization: There you go ;) MCS rules the roost.

Everything was aligned with the low-cost strategy.


3/24

Session 2:

Budget as a control mechanism

Profit Centres have two categories

Cost Centres:Input Costs (Minimize Cost): Performance measure

= Budgeted Cost Actual Cost

Revenue Centres: Outputs Revenues (Maximize Revenues):

Performance measure: Actual Revenue Budgeted Revenue

Natural Cost Centre:

Factory => Budgeted Costs (Budgeted # units * Budgeted Cost) => Sales

Budget => Difference must only be in the number of units. Any budget vs

Actual variance should only be in the #units. Uncontrollable part is #units

whereas Manager related variance is controllable.

Here we are dealing with efficiency and financial performance measures.

Artificial Cost Centre:

Legal Accounting

Marketing

Information System

Here we are not dealing with efficiency but effectiveness i.e. Qualitative and

non-financial performance measures. But sometimes red-tapism is prevalent

in these cost centres and their existence is dubious and questionable.

Incremental Budget: Based on last years budget and multiply it by some

number. They are not a good management control mechanism since it does

not reflect efficiency but people tend to

Zero-based: Everything is clearly defined and is aimed at reducing costs. It

is applicable to project based companies or in the times of crisis because it is


4/24

very effective in controlling costs. The downside is that it is very time

consuming.

Vershire Company Case:

Session 3:

1.)Sourcing: Freedom to buy from inside/outside

2.)Transfer Pricing: What prices are inside

Retail Price

Market Price

Cost Price (Variable Costs or Total Costs)

3.)Intervention

North Country Auto:

Session 4:

Profit Centre

Increase Compensation

Profit margin

Decision Rule is maximizing divisional profits

Sourcing, Sales and Prices, Intervention

If it is a regular order then you dont deal with variable costs rather

deal with Total Costs. You deal with the variable costs only when it

is a special cost.

How much and How to?

- Many times company wide profits KPIs cannot work because of lack of

information about the profitability of other divisions.

- Hence, the management can force divisions to share information but that

also has downsides since you are destroying their bargaining power. Hence

this option is also out.


5/24

As you decentralize more and more, the control also looses muscle.

Right now it represents only 5% of the overall revenue but if it was 90% of

the revenue then it does not remain the division wide problem, and you have

to integrate the two divisions because then cost matters and not the profits.

Dont jump in the melee, take a step back and let divisional

managers handle the issues especially when it is not a significant

part of the companys revenues.

Session 5:

Profit Equation

Sales

- VC

=C.M.

- FC

= Direct Divisional Profit

- Overheads

= Divisional Profit after Overheads

- Tax

= PAT (Profit after Tax)

Assets: Working Capital (Managers manage this everyday in that they are

always concerned about the Inventory, Accounts Receivables)

If you tie bonuses of the managers to ROA then you have to take the

payments in your hands so that the smart managers do not monkey

around with it. Because they might control the working capital by

negotiating payment terms with the suppliers (basically lengthen the

payment schedule so that accounts payable remains the same and Current

Liabilities increase thereby decreasing the Working capital and increasing the

Profits and hence ROA increase.

Or He might not pay at all or try to decrease the assets in some way or the

other to increase ROA


6/24

Gross Value Vs Book Value of the assets: If Gross Value then managers

will replace old assets to enhance efficiency and hence discard the assets

before its life. If Book Value, they will not replace the machine because the

asset will depreciate and will increase ROA (not because they have improved

on profits but because the assets have been decreasing consistently)

Bonuses contingent upon Residual Income will facilitate more goal

congruence and not the ROA.

EVA or R.I. (Residual Income) = Actual Profit Minimum Profit

Tie the bonuses on Residual Income

ROA: Milwankee (25%), Columbus (38%), Atlanta (8%), Tucson (15%),

Reno (42%)

Smartest manager: Reno

Dumbest Manager: Atlanta

Now if new opportunities arrive the dumbest one will send every opportunity

that generates ROA more than 8% and if he gets 45% one and the Smartest

one gets 35%, 36% and 39%, he will not send it to the Corporate head. So

you are basically leaving the capital budgeting decision in the hands of thedumbest one.

Also when you compare ROA, you need to check whether it is a

measurement issue or an industry issue because consulting projects are

supposed to have higher ROA because they dont use any asset because

human capital is not counted as assets but a different project might be

profitable but a capital intensive one, then ROA Is bound to be low. So

comparison across industries is tricky, so be careful.

Session 6:

Strategic Planning & Budgeting

-Strategic Planning is less used for control and is Long term to medium term

Non Financial measures


7/24

-Budgeting is annual or shorter and is used as a control mechanism.

Financial measures

Expectations

Allied OfficeAllied office is an office products company. We are only concerned about

Total Forms Control (TFC)

Sell forms to the consumers so basically it is a printing press.

Price = Cost + Margin (it is a commodity so it makes sense)

Cost Structure = Materials + Labour (Major contribution in the cost structure

is the Master. So the general tendency is to keep making as many copies as

you want because master cannot be reused. So you have high fixed costs

and the only way to reduce it to manufacture large volumes)

Now they want to change. They came up with another strategy

Any form, Any # of forms, Anytime, Anywhere

Results: Sales increase but the profits went down

Product Hierarchy can be:

From Commodity Commodity + Service Service Trans Services

1:1 Experience

ABC: In ABC we deal with variable overheads and not fixed overheads. But

the upside is that we can find out the non-value added activity and can

remove it.

Activities involved:

Storage

Picking & Packaging

Purchase Order Entry

Desktop Delivery

Reporting


8/24

Low Cost High Cost

High Price Dream Customers Premium Customers

Low Price Price Sensitive Nightmare

I cant price storagesince it is not a customer driven problem but is a

production driven problem.

Pick and Pack and Order taking also cannot be priced

The only thing that can be priced is the desktop delivery because this is the

only added value.

If you change from one model to another, you have to think it through. In

this case if you decide to do away with Customer B, sales people will vie forcustomer A but will get low revenues because the services portion of the

cost is removed. This will decrease the commissions of sales people thereby

decreasing in the number of good sales people.

Sometimes we should look to open up the value chain and should

understand the repercussion of our decisions.

Budgets are contracts that can be used for

Outcomes(short term performance, Control Mechanism, Financial

measures) Established Industries

Behaviours(Long term performance, Not a Control mechanism,

Planning tool, non-financial measures) For new products

Budget Actual = Variance (this is your performance measure)

Expectations Actual Performance = Performance Measure

Therefore Variance analysis is a very disciplined and effective approach inperformance measures.

Session 7:

Individual/Separable effect if each action (factor) on cost profit ceteris

paribus


9/24

Variance Analysis

Sales Variance = Budgeted Sales - Actual Sales

Price Variance = (Budgeted Price Actual Price)*Actual Volume

Volume = (Budgeted Volume Actual Volume)*Budgeted Price

For Example:

BP = $2/unit

BV = 1000 units

Budgeted Sales = 2000

AP = $1.5/unit

AV = 1500 units

Actual Sales = 2250

Production Volume may not be equal to Sales Volume since there is an

inventory as well.

Fixed Costs are uncontrollable (Risk Before), whereas Variable costs are

controllable (Control Damage)

Margin = Selling Price Variable Cost

BEP = FC/(C.M. in percentage)

High FC and Low Variable Costs will increase the BEP and the margin but the

multiplier effect will also be high

Low FC and High VC, the BEP and the margin will be less but the multiplier

will also be less

You can make a profit at BEP in production because the implicit

assumption is the production volume equals sales volume but they

may not be the same.

Product Market Strategy

Margin/Turnover = (Profit/Sales) * (Sales/Assets)


10/24

Profit, Cash Cycle, ROE: Three most important ways to create shareholder

value

ROE is a Financing Strategy

Think about the need before implementing any system

Session 8

Performance measure systems are intended to motivate employees to take

specific actions in order to maximize their performance with regards to

certain actions.

Bring attention to specific actions

Measurement increases motivation and if you tie compensation to

measurement that also increases motivation

Pay for performance or Flat Pay: PFP increases productivity

Pay for performance has a problem that means what are you paying for??

Maximize shareholder value means great Financial results => What are the

fundamental reasons for financial outcomes.

Output of the Map your Strategy is the Strategy Map.

Strategy, goals, objectives, and measures

Leading and Lagging measures OR Driver and Outcome measures

Break Strategy into specific goals (broad statements) such as increase high-

valued customers or max revenue from different customers, then break it

down into specific objectives (specific actions) such as What must I do?, and

tie this to specific metric

One of the problems with balance score card is the kind of measures (self-

serving bias), Internal measures are very reliable. Learning & Innovation

measures are the worst and least reliable.


11/24

Read the presentation in the folder

Session 9

Single Undiversified -------------------------------------Unrelated diversified

Vershire GEQM

AOP

Birch

In the middle lies related diversified

So for the first group, we look for centralization, economies of scale,

functional organization. You also think in terms of promotion from within and

in headquarters you look for industry expertise. Profits, and ROA

For the second group: Decentralization, recruits from outside, HQ = Finance

and ROA.

Products

New build to Old harvest with hold in between

New builds are net cash users

Holds net cash = 0

Old Harvest are net cash givers

Pelican Case:

Electric meters - (Old), analogue meters

Electronic Instruments New, digital meter

Sales Variance +ve (F) More sales than budget

Cost Variance -ve (U) Cost is more

Sales Mix Variance ve (U)More of Lower margin product and less of

higher margin products than budgeted

Industry Volume Variance

Budgeted Mkt 1000 cans

Budgeted Sales = 100

Budgeted market share = 10%


12/24

Actual Industry = 2000 cans

Actual sales = 150 cans

He might have sold 200 instead of 150. So the industry variance is 50 forwhich the manager cannot be held responsible but for the manager specific

variance manager should be held accountable.

EM EI

Sales Price Variance -ve +ve

Sales Volume Variance -ve +ve

Industry VolumeVariance

-ve +ve

Market Share Variance +ve -ve

Cost Variance -ve -ve

(Budgeted Market share Actual Market share)*Actual Industry volume *

Budgeted Contribution Margin = Industry Market

EM: Industry is in shambles and the sales volumes are also declining then it

is a Harvest Product. If you are dealing with the harvest product then

market share is irrelevant and the only thing what matters is the

PROFITS!!!. So basically if you reduce the price of this product but you

also reduce your profit then it is a bad strategy.

EI:Industry is growing, sales volumes are increasing but the market share

is decreasing bad. Here you consider the future market share. The price

should be high enough to offset the loss in the market share. If the net is

positive then it is good or else it is bad. In this case the net is negative sothe manager is not competitive.

Sales (differentiated) = High P * Low Quantity

Sales (Low Cost) = Low P * High Quantity


13/24

So the price should be enough so that Sales (differentiated) should be

greater than Sales (Low cost) for my strategy to be effective. If not then my

differentiation is not good enough.

The profits are always good but the way the profits are made isparamount.

CROWN POINT:

1.)Elasticity of rewards is very high but the elasticity of punishment is

very low. Hence rewards are better than punishments.

2.)Monetary rewards are good at lower levels but they have diminishing

returns.

3.)Salary + Incentive bonus + Benefits Increase in motivation

4.)Overtime after meeting a floor subject to a maximum.

5.)Measurement & Reward close to task. Close together then motivation

increases.

6.)Vesting/ Golden handcuffs are one way of retaining people


14/24

Marketing Strategy 03/06/2014 03:55:00

Unilever Case

Problem:

The company wants to make inroads into low-income households market

that poses few germane questions Should the company fight in the lower-end of the market where even

small players with a lower cost structure struggled to make profits?

Should the company launch a new brand or position its already existing

cheaper brands?

Ideal marketing mix for lower end consumers?

Marketing Strategy?

4Cs

Company Consumers Collaborators Competitors Context(PEST)

Consumer

goods

Well

known

company

with 45

brands of

detergents

81%

market

share of

detergent

powder

with 75%market

share in

NE

detergent

market

Low-

income

Consumers

48 million

(53% of

whom are

below 1-2

times

average

national

income)

Dependent

on

agriculture 28% Own

washing

m/c in NE

(67% in

SE)

Generalist

Wholesalers

but are

sometimes

dependent

on small

wholesalers

Specialized

Distributors

with

exclusive

rights to sell

Unilevers

detergent incertain

regions

Since it is a

big

component

P&G (15%

market

share)

and 17.5

in NE

detergent

market

Ace (11%

market

share)

Cheaper

Local

Brands

Tax Incentives

for companies

investing in NE

Water is soft

which

facilitates

more foam

formation

which

basically

removes one

key advantage

of the

detergentpowder


15/24

73% think

bleach is

necessary

in NE (18%

in SE) Use bars of

laundry

soap and

use the

detergent

only for

good

fragrance

5 times a

week in NE

vs 3.9 time

a week in

SE

Women

consider it

pleasurable

of the

product cost

and the

decision

cannot bereversed,

the choice

of

distributors

is vital

4Ps

Product Price Place Promotion

Detergent

powder OMO

(Favourite

brand)

Minerva (only

Low price

(52%) OMO at$3 /kg

(17%) Minerva

at $2.4 /kg

(6%)

Campeiro at

Northeast of

Brazil Rural

Cant use products

for low-incomepeople which will

alienate them from

the brand and will

leave them with a

perception that the


16/24

brand sold as

both detergent

powder and

laundry soap)

and

Campeiro

(companys

cheapest

brands)

Low Margin

Solutions:

Large packet

or sachets

Right

attributes to

control price

1.7 /kg product is of inferior

quality

Cannot make it

aspirational which

will jeopardise theexisting consumers

Explaining to the

small stores where

the most of the

target customers go

and rely on their

advice

70% ATL (lower cost

per contact and

increased visibility)

and 30% BTL

or 70% BTL (overall

reduced cost but

higher cost per

contact and lower

visibility) and 30%

ATL

6 Product attributes looked before effecting purchase:

1. (24%) Perceived power more cleanliness per quantity of product,

whitening and productivity

2. (20%) Smell, and softness

3. (16%) Ability to remove stains w/o need of for laundry soap and

bleach4. (16%) Consistency and granularity of the powder (Ease of

dissolving)

5. (13%) Packaging: simple, easily recognizable

6. (11%) Impact on colours (Fading) ---Least preferred metric

Market (Northeast)


17/24

1.

Detergent Powder:

$ 106 million

42000 tons

Growing at a rate of 17%

Barriers to entry are high because its capital intensive Average revenue $2520 per ton

2.Laundry Soap

102 million

81250 tons

Growing at 6%

Barriers to entry are lower since it is easy to produce

Average revenue $1250 per ton

Used to remove tough stains

No fragrance

Top 4 have 38% market share with Minerva at 19% selling @

$1.7/kg

P&G is absent in this segment leaving only local brands as big

competitors out of which the biggest one being ASA with its brand

Bem-te-vi enjoying 11% market share and sold @ $1.2 /kg and

Flora Fabril with 6%

Concerns of entering low-income segment

o Cannibalisation of high-margin brands with low-margin ones

o Starting of price war

o Brand dilution since its been operating in premium segment

o Will result in repelling top students and brand managers

o Whether they have right skills and organization to compete in this

market

o Cost-benefit trade off??

o Brand repositioning or brand extension?

GO:

Big Market 50 million

If we dont go, P&G will occupy


18/24

Leverage experience in India

Focus on customers who may be growing


19/24


20/24

Managing People at Work 03/06/2014 03:55:00

Session10

Hewlett Packard abandons pay-for-performance plans

Because costs of these programs are higher than the benefits. Instead

effective leadership, clear objectives, coaching or training were betterinvestments. Why? Let us explore now

Higher performance means search for managerial practices that will enhance

competitiveness ===MONEY!!! :P

Problems with traditional compensation systems:

Pay becomes entitlement

Benefits are given for tenure

Base pay is function of levels and not performance

Merit increases do not differentiate performance sufficiently

Even bonuses becomes entitlement

Pay for Performance:

Efficiency improves in 2 out of 3 programs

ROI is 134%

Those using showed twice the return than those not using itProblems:

Destructive effect on

o Intrinsic motivation

o Self-esteem

o Teamwork

o Creativity

Motivate employees to focus on doing to gain rewards. Sometimes

at the expense of doing other things that would help the

organization

Two barriers to implementing this system

Linking performance to effort

o Difficulty in measuring performance

o Uncontrollable factors being paid for that performance


21/24

o Managers and peers are uncomfortable with ratings

employees differently

Linking pay to performance

o

Employees can come to rely on the additional compensationo Employees are biased toward overestimating their own

contribution

o Corporate budgets for bonuses limits payout

o Managers can lose commitment to the pay system if it pays

out more than anticipated due to problems in payout

standards and if there are changes in performance standards

due to changes in technology and organizational

arrangements and unanticipated learning curves.

CULTURE shapes the policies implemented to pay-to-performance

Discourages opportunism

Top managers lead by example by reinforcing this culture

Long-term careers in which reputation is a valuable commodity


22/24

Corporate Finance 03/06/2014 03:55:00

Session 5:

Asset beta/Unlevered contains only business/operational risk

Equity/Levered beta contains business + financial risk

Ba = Be/[1 + (D/E)*(1-t)]

So unlever first and then use different debt equity ratios to calculate Equity

beta and cost of equity capital

Value = FCF*(1+g)/[WACC g]

Actual Tax Shield = 5559*0.36 = 5977*t*

If we do not change the tax rate then we are overestimating the tax

shield.

Session 6:

Dividend Cash Assets goes down That means Equity also goes down

Leverage goes up

If you have been doling out dividends but stop paying in the next fiscal year,

then it gives a negative sign in the market that the firm must have stoppedto grow.

Every cash flow is discounted depending upon its type such as interest

payments are discounted at rd and the dividend will be discounted as re , the

cash flows will be discounted at WACC.

After paying the dividend, the stock price will go down by the same amount

since that dollar amount has been taken out of the expected cash flow and

will change the calculations of the potential investor. Present Value concept

If declaration provides new information then it will attract market reaction

such as if the company announces dividend unexpectedly then the reaction

will result in increase in the share price, but if it is a regular process then the

stock price will not change but will fall on the ex-dividend date.


23/24

Return on stock = (Share Price1 Share Price0)/P0 + D1/P0 = (P1 P0 +

D1)/P0

(Share Price1 Share Price0) is known as Capital Gains

Re = Risk free rate + Beta*(market risk premium)

For Diageo:

Re = 5.83 + 0.55*5% (CAPM) = 8.58%

Dividend yield for Diageo = 5%

=> Dividend as a percentage of total return for Diageos shareholder =

5/8.58% = 58%

So Diageos shareholders are receiving their 58% of the return in form of

dividends.

Dividend Policy is very important for Diageo, when dividend is such a big

chunk of the returns. Which is why Diageo did not want to cut the dividends

and would rather cut the CapEx and Marketing Expenditures.

Stock Price is the present value of the expected dividends from now to

infinity and if you take out a portion of the dividend the P.V. goes DOWN!!!!

Signalling implications of the dividend policy matters and not the

mathematics of it. Check the slide of Dividend Irrelevance

Free Cash flow is the cash available to pay to shareholders and bondholders

So FCFE is calculated after deducting interest payments (considering debt

cushion) and any change in debt.

Session 12&13

g = Max(GDP growth) = Risk Free Rate (Real growth + Inflation)

Beta = (Rd Rf)/Market risk premium = Yield spread/market risk premium


24/24

To calculate Country Risk, we have two approaches:

1.) Default risk spread * ( Std. deviation of stocks in country X)/(Std.

deviation of stocks in the U.S.)

2.) Default risk spread * ( Std. deviation of equity in country x)/(Std.

deviation of Debt in country X)

The latter one more accurate but it is very difficult to get std. deviation of

debt in any country

Country Risk spread

10 year bond (USD) gives 15% return

10 year bond (USD) gives 3% return

So Default Risk country premium = 15 3 = 12%

Whenever we are discounting free cash flow at WACC, We are

calculating Enterprise value because we are weeding out excess

cash

Whenever we are downloading market multiples, we are assumingthat we are minority shareholders because majority shareholders

will not forgo control, it is the minority shareholders that trade in

the market

Whenever we are downloading market multiples, we are assuming

that the market is liquid

Berkus Method: Million Dollar idea

notes for session term 3

Documents