ACCA
STRATEGIC BUSINESS LEADER (SBL)
2021
Dr. Parmindar Singh, DBA (Australia), MBA
(Malaysia), B.Sc (Hons) Computer Science
(Malaysia)
parmindar2005@gmail.com
Prepared by Dr. Parmindar Singh
Page 1
Table of contents
Pages
Stakeholders
7-12
Ethics
13-25
CSR
26-31
Environment
32-35
Corporate governance (CG)
CG basics
36-51
Agency
52-57
CG principles
58-59
Rules-based vs. principle-based
60-61
Article on CG convergence and divergence
62-72
UK Governance code 2018 and related issues
73-93
OECD CG framework
94-94
CG differences among public-listed, private firms, charities and family
95-95
Public-sector CG
96-98
Sarbanes Oxley Act
99-102
Board structure (unitary and two-tier)
103-104
Risks
105-118
Internal controls
119-124
Internal audit
125-131
Integrated Reporting (IR)
132-141
Strategy
142-146
Strategic position
Mission statement
147-148
Article on mission statement
149-158
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Vision, goals, objectives
159-160
Core competency
161-161
CSFs/KPIs
161-164
Macro environment – PESTEL analysis
165-165
Scenario planning
165-165
Industry environment – Porter’s five forces
166-172
Strategy clock/hybrid strategy
172-173
Business strategy
174-174
Porter’s Diamond
175-177
Internal appraisal
Resources analysis
178-178
Value chain and value system
178-181
Processes
Benchmarking
182-183
Harmon matrix
184-185
Swimlane diagram
186-188
Baldrige criteria
189-189
Knowledge
189-190
SWOT and TOWs matrix
191-192
Strategic choice
Ansoff matrix
193-195
Acquisition
195-196
Internal development
197-197
Internationalization
197-198
Alliances
199-208
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Decline/divest/recover
209-210
Strategy evaluation
FAS criteria
211-211
BCG matrix
211-212
Public-sector matrix
213-213
Parental value creation
213-214
POPIT
215-215
Capital budgeting
Discount rate
216-216
Payback/discounted payback
216-217
NPV/IRR
217-217
Regression analysis/exponential smoothing/time series/decision trees
218-227
Strategic action
Change
228-233
Organizational structure and design
234-252
Culture
253-255
Article on organizational culture
256-263
Project management
264-281
Leadership
282-289
Entrepreneurship and intrapreneurship
290-290
Financial analysis
291-305
Contribution
306-315
Full costing
316-324
ABC
325-328
Budget
329-342
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IT
E-commerce/M-commerce
343-350
Mobile technologies
351-351
Cloud computing
351-351
Fintech
352-352
E-marketing
352-356
CRM
357-358
Big data analytics
359-364
IT controls
364-364
Software development
365-366
Blockchain technology
367-370
Initial coin offering
371-372
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Page 5
Professional skills (CCASE)
Communication
Inform
–
concisely,
objectively,
and
unambiguously,
while
being
sensitive
to
cultural
differences, using
appropriate media
and technology.
Commercial
acumen
Demonstrate
awareness – of
organizational and
wider
external
factors affecting
the work of an
individual or a
team
in
contributing to the
wider
organizational
objectives.
Persuade – using
compelling
and
logical arguments
demonstrating the
ability to counter
argue
when
appropriate.
Use judgment – to
identify key issues
in
determining
how to address or
resolve problems
and in proposing
and
recommending
the solutions to be
implemented.
Clarify
–
and
simplify complex
issues to convey
relevant
information in a
way that adopts
an
appropriate
tone and is easily
understood by the
intended
audience.
Show insight –
and perception in
understanding
work-related and
organizational
issues, including
the management
of
conflict,
demonstrating
acumen in arriving
at
appropriate
solutions
or
outcomes.
Prepared by Dr. Parmindar Singh
Analysis
Scepticism
Evaluation
Investigate
–
relevant
information from
a wide range of
sources, using a
variety
of
analytical
techniques
to
establish
the
reasons
and
causes
of
problems, or to
identify
opportunities and
solutions.
Enquire
–
of
individuals
or
analyse
appropriate data
sources to obtain
suitable evidence
to corroborate or
dispute
existing
beliefs or opinion
and
come
to
appropriate
conclusions.
Consider
–
information,
evidence
and
findings carefully,
reflecting on their
implications and
how they can be
used
in
the
interests of the
department and
wider
organizational
goals.
Probe – deeply
into
the
underlying reasons
for issues and
problems, beyond
what
is
immediately
apparent from the
usual sources and
opinions available.
Assess – and use
professional
judgment
when
considering
organizational
issues, problems
or when making
decisions on the
organization and
those affected.
Question – facts,
opinions
and
assertions,
by
seeking
justifications and
obtaining
sufficient evidence
for their support
and acceptance.
Estimate – trends
or make reasoned
forecasts of the
implications
of
external
and
internal factors on
the organization,
or the outcomes
of
decisions
available to the
organization.
Challenge
–
information
presented
or
decisions made,
where
this is
clearly justified, in
a
professional
manner; in the
wider
professional,
ethical,
organizational, or
public interest.
Appraise – facts,
opinions
and
findings
objectively, with a
view to balancing
the costs, risks,
benefits
and
opportunities,
before making or
recommending
solutions
or
decisions.
Page 6
Stakeholders
1. Definitions
•
Stakeholders are those whom the firm’s operations has benefited or burdened (Steiner &
Steiner).
•
Stakeholders can also be defined as the individuals or groups who can affect, and are
affected by, the strategic outcomes achieved and who have enforceable claims on a firm’s
performance (Freeman)
2. Types of stakeholders
•
According to Clarkson, there are two types of stakeholders, namely:
 Primary stakeholders – who have an immediate, continuous and powerful impact on a firm,
such as shareholders, customers, employees, communities, governments, suppliers and
creditors,
 Secondary stakeholders – who have less power to influence the firm’s activities but that
effect or are affected by its operations, such as environmentalists (NGOs/SIGs), media,
trade association, universities and religious orders.
•
According to Hitt, Ireland and Hoskisson, stakeholders can also be classified as:
 Capital market stakeholders - shareholders, suppliers of capital such as banks,
 Product market stakeholders – primary customers, suppliers, host communities, unions,
 Organizational stakeholders – employees, managers, non-managers
•
Narrow and wide stakeholders (Evans and Freeman) – narrow stakeholders are those that
are most affected by the organization’s policies. Examples include shareholders,
employees, customers, suppliers. Wide stakeholders are those that are less affected and
may include government, indirect customers, the wider community and other peripheral
groups.
•
Active and passive stakeholders (Mahoney) – active stakeholders are those who seek to
participate in the organization’s activities. Examples are management and employees.
Passive stakeholders include shareholders, government and local communities.
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•
Internal (internal actors – employees and their representatives, board of directors, sub-board
management, company secretary) and external stakeholders (shareholders, stock
exchanges, auditors and governments and regulators).
•
Voluntary and involuntary stakeholders – voluntary stakeholders will include employees,
customers, suppliers and shareholders. Involuntary stakeholders will include local
communities, natural environment, future generations and most competitors.
•
Legitimate and illegitimate stakeholders – legitimate stakeholders are those that an
organization recognizes as having a valid claim on an organization’s operations and
acknowledges its existence and vice-versa for illegitimate stakeholders.
•
Recognized and unrecognized stakeholders - recognized stakeholders are those that an
organization views as a legitimate stakeholder and acknowledges its existence and viceversa for unrecognized stakeholders.
•
Known-about and unknown stakeholders
•
According to Mendelow, in his power-interest matrix, there are four types of stakeholders:
Level of interest (in organizational strategies)
Low
A.
Low
B.
High
Minimal effort
Keep informed
C.
D.
Keep satisfied
Key players
Power
High
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•
Even within “key players”, some stakeholders may dominate due to:

Power (French and Raven) – legitimate, reward, coercive, expert and referent

Prestige, reputability

More demand than supply etc.
Stakeholder relationships have to be managed so as to be a source of competitive advantage –
Hillman & Keim
•
Identify all stakeholders – omit none
•
Classify stakeholders correctly
•
Undertake proper stakeholder relationship management
Stakeholder relationship management
Stakeholder engagement
Shareholders
Employees
Community
AGMs,
Meetings
Meetings,
PA, rewards
Annual dinner,
Family day,
Town-hall meetings, CRM
“open day”,
CSR programs
Prepared by Dr. Parmindar Singh
Customers
Page 9
3. Stakeholders’ needs and wants/demands/claims
•

•

Shareholders:
Dividends, capital growth, safe investment
Customers:
Product quality – reliability, aesthetics, durability, serviceability, performance, conformance,
features, perception; value
Value = Product quality * Service quality
Price * fulfillment time
•

•

•

•

•

•

•

•
- Deise, Nowikow, King and Wright
Managers:
Compensation – rewards (extrinsic and intrinsic); prestige, power
Employees:
Security, compensation, job satisfaction – job rotation, enlargement, enrichment
Governments:
Taxes, employment
Suppliers:
Regular payments, continuity of business
Creditors:
Interest, security of capital
Community:
Employment, preservation of environment
Minority groups:
Fair employment, no discrimination
Special Interest group/lobbying groups/pressure groups/NGOs (examples):
 Amnesty International, Greenpeace, Transparency International
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4. Salient stakeholders – company’s very important stakeholders. A careful analysis must be
done to ensure that these stakeholders are correctly identified. Example, Shell and
Greenpeace.
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Corporate governance – Ethics
1. Definition
•
The study of ethics concerns the questions of right or wrong, duty and obligations and moral
responsibility. Business ethics is the study of what constitutes right and wrong, or good and
bad, human conduct in a business context.
•
Kidder defines ethics as obedience to the unenforceable.
2. Responsibilities of organizations
•
According to Carroll, there are four responsibilities of an organization:
 Economic – economic responsibilities of a business organization’s management are to
produce goods and services of value to society so that the firm may repay its creditors and
shareholders
 Legal – legal responsibilities as defined by the governments in laws that management is
expected to obey
 Ethical – ethical responsibilities of an organization’s management are to follow the generally
held beliefs in a society
 Discretionary – discretionary responsibilities are the purely voluntary obligations a
corporation assumes. E.g. are philanthropic contributions, providing day care centers,
training the unemployed, corporate social responsibility
3. Friedman
•
According to Friedman, the business of business is business – an organization’s
responsibility is only economic and legal
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4. Moral development
•
Whether one views the issue at hand as right or not will depend on one’s moral
development.
•
Kohlberg’s levels of moral development/cognitive moral development:
 Level 1 - The pre-conventional level – an individual at this level initially justifies his/her
action by stating that his/her action is taken to avoid being punished and/or to receive
certain rewards (for example, economic gains). Ultimately, the individual justifies his/her
action(s) by stating that he/she has to take care of his/her self-interest.
 Level 2 - The conventional level – is characterized by considerations of what is approved by
in-group or immediate circle as well as eventually receiving approval from the wider
community and society’s laws and norms. What is right is determined by the laws, rules,
listing requirements and obligations of society and what is needed to maintain social order.
 Level 3 - The post-conventional/principled level – is characterized by a person’s adherence
to a social contract or a utilitarian calculus and eventually this may elevate to an internal
moral code. Individuals are guided by self-chosen ethical principles, justice, and the rights of
human beings. Correct behaviour is framed by the visions of ideal societies.
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Level
1
Stage
1.
2.
2
3.
4.
3
5.
6.
Description
Person acts in such a way
in
order
to
avoid
punishment or to receive
rewards.
Person acts because it is
his/her self-interests to act
in such a way.
Person acts in such a way
so as to nurture long-term
relationships of mutual
support with members on
one’s in-group/immediate
circle or those close to
them.
Consists of upholding the
law, order, LR, regulations,
and policies. Here the ingroup expands to include
one’s larger community.
Conceives
morality
as
compliance with the social
contract.
Rules
are
understood to be relative to
a particular group but are
upheld in the interests of
impartiality.
Morality
based
on
commitment
to
selfselected
universal
principles for governing
social cooperation.
5. Terminologies
•
Ethical relativism is a theory that what is right (i.e. ethical/moral) is determined by what a
culture or society say is right. What is right in one place may be wrong in another.
•
Ethical absolutism - where there are a set of principles that can be applied, irrespective of
culture and society. Ideally at Kohlberg’s Level 3, Stage 6.
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6. Donaldson and Preston’s normative and instrumental view
•
Instrumental view – an action is only taken if it brings about certain desired benefits.
•
Normative view – an action is taken because it is the right way of doing things. There is no
inherent motive or hidden agenda in pursuing such an action. It is pursued because that it
how things should be done.
7. Solving ethical problems based on certain criteria or questions
•
Cavanagh proposes that we solve ethical/moral problems by looking at the following:
 Justice – is it consistent with the canons of justice?
 Rights – does it respect the rights of the stakeholders involved?
 Utility – does it optimize the satisfaction of stakeholders involved?
JRU
•
Tucker proposes to solve ethical problems through a five-set question model:
 Profitable?
 Legal?
 Fair?
 Right?
 Sustainable or environmentally sound?
ProLFaRSu
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•
American Accounting Association
 What are the facts of the case?
 What are the ethical issues of the case?
 What are the norms, principles, and values related to the case?
 What are the alternative courses of action?
 What is the best course of action that is consistent with the norms, principles, and values
identified in step 3?
 What are the consequences of each possible course of action?
 What is the decision?
8. Solving ethical problems based on certain principles/values
Normative theories
Consequentialist/teleological Nonconsequentialist/deontological
(ends justifies means)
Egoism
Personal
Utilitarianism
Categorical imperative
(Kant)
Prima facie
Impersonal
Act
(individual)
Rule
(organization)
9. Egoism
•
Personal egoism – an act is morally right if it promotes one’s (an individual, group,
organization etc.) long-term interests.
•
Impersonal – all should pursue their own (individual, group, organization etc.) long-term
interests
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10. Utilitarianism
•
Bentham – an act is morally right if it promotes the greatest net human welfare/net
happiness in the long run.
•
“Human welfare” or net happiness may refer to a particular group of stakeholders, for
example, the shareholders. Since the ends justify the means, any act (for example insider
trading, off-balance sheet acts, manipulation of share prices etc.) is acceptable as long as
there is greatest “net happiness” of shareholders.
11. Kant’s Categorical Imperative
•
Kant believe that there is just one command (imperative) that is categorical, i.e.
unconditionally binding on all rational agents, regardless of any other considerations.
•
This is called as Kant’s Categorical Imperative, which states that:
One should act in such a way that one can will the maxim of one’s action to
become universal law
•
A categorical imperative takes the form of “do this” or “don’t do that”, no “ifs” and/or “buts”.
•
Kant’s categorical imperative can be broken down into two postulates:
 What makes an action right is that the agent would be willing to be so treated were the
positions of the parties reversed (Universal Acceptability)
 Humanity as an End, never as merely a Means – i.e. human beings has an inherent worth
and should not be treated as a means (to exploit etc.) (Golden Rule).
12. Prima facie principles
•
Ross - an obligation that can be overridden by a more important obligation.
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13. Organizational ethical stances
•
Johnson, Scholes and Whittington came out with 4 ethical stances:
 Short-term shareholder interest – taking responsibility of short-term shareholder interest on
the grounds that it is for government alone to impose wider constraints on business.
Is of the view that an organization has acted ethically if it can perform her economic and
legal responsibilities, i.e. the adage, “the business of business is business”
Tends to adopt an agency model, i.e. to maximize shareholders’ interests/wealth
 Long-term shareholder interest – the organization’s corporate image may be enhanced by
an assumption of wider responsibilities. The cost of such responsibilities may be justified as
promotional expenditure. Also by being a good corporate citizen, will prevent a build-up of
legal regulation.
Is of the view that an organization has acted ethically by promoting and advancing the
long-term value of shareholders by taking care of its other stakeholders (constituents)
All expenses incurred in taking care of other stakeholders are classified as marketing
expenses/PR
Has an instrumental view on CSR
Adopts
an enlightened
shareholder–view
approach on CG
 Multiple
stakeholder
obligations
stakeholder
interest and expectations (not only
shareholders – but also include customers, employees, suppliers etc.) should be more
explicitly incorporated into an organization’s purposes and strategies. Companies in this
category might argue that they retain uneconomic units to retain jobs, would avoid
manufacturing or selling anti-social products and would be prepared to bear reductions in
profitability for the social good.
Is of the view that an organization has acted ethically by taking care of all its stakeholders,
i.e. the firm has a fiduciary duty towards all stakeholders (dualistic or pluralistic) and
therefore must be seen to be acting fairly to all its stakeholders
Has a normative view on CSR
Adopts a stakeholder approach to CG
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•
Examples of firms with multiple stakeholder obligations
Body Shop – providing shelter for the
homeless
Johnson & Johnson’s philosophy – The
Credo – most important stakeholders –
customers, employees, society and
shareholders
 Shaper of society – these are organizations whose purpose is concerned with shaping
society, and financial considerations are regarded as of secondary importance or a
constraint. Examples can be public services and charitable organizations
Is of the view that an organization has acted ethically if it is able to shape and influence
society with its ideals, values, beliefs, principles and doctrines
Mainly for non-profit oriented firms: religious bodies, SIG/NGOs, charitable organizations
Corruption – inducement to do wrong by improper or unlawful means (such as bribery).
14. Discouraging unethical behaviour
•
Self-regulation – SOP, policies, code of ethics
•
Whistle-blowing policy
•
Ethics Ombudsman
•
Appoint senior executives to oversee matters (IKEA’s CEO)
•
Leadership by example
•
Internal controls
•
HRM practices
•
Culture
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15. Cultural Web – to embed ethics in firm’s culture
•
Stories – about CEO, ethics
•
Power structures – create a new senior position to emphasize and oversee all matters
pertaining to ethics, e.g. Chief Ethical Officer
•
Rituals and routines – regular ethics briefings/speeches, “ethics day” etc.
•
Organizational structure – ethics committee/ombudsman, ethics compliance department
•
Control systems – HRM practices (HRP, HRD, performance appraisal, rewards), internal
controls, procedures, policies, code of ethics
•
Symbols – mission statement
•
Paradigm – changing the above will result in a change in the basic underlying assumptions
SPROCS-P
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16. Code of ethics
•
Code of ethics can also be defined as a statement of principles a business agrees to abide
by voluntarily over the course of its operations.
•
A statement setting down corporate principles, ethics, rules of conduct, codes of practice or
company philosophy concerning responsibility to employees, shareholders, consumers, the
environment or any other aspects of society external to the company.
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17. Benefits and problems of code of ethics
Benefits of code of ethics
Clarifies
company
expectations
employee conduct in various situations
of Ineffective –
researchers
Makes clear that the company expects its
people to recognize the ethical dimensions
in decisions and actions
Enhance reputation and brand equity
Communication – sending the right
message about good business practices to
stakeholders as well as to indicate firm is
committed to ethical behavior
Helps to create cohesive corporate culture
Can help firm avoid adversity such as
fines, sanctions and litigations – selfregulation
Globalization imperative – codes may
transcend local laws and culture
Improve employee commitment
Problems
from the work
of
some
Not influential in determining a person’s
ethical decision-making behavior
Inflexibility
Lack of clarity
Irrelevant
18. IFAC code of ethics
•
Professional behaviour – “Members should comply with relevant laws and regulations and
should avoid any action that discredits the profession.” The ACCA Rulebook goes further,
and states that members should behave with courtesy and consideration towards all with
whom they come into contact in a professional capacity
-
•
Complying with laws and regulations, listing
requirements
Complies with policies and procedures
Kind, understanding, considerate, courteous, helpful,
empathetic, P&Qs
Objectivity – “Members should not allow bias, conflicts of interest or undue influence of
others to override professional or business judgments.”
-
Rational, impartial/unbias
Independent
Emotionally detached
Under no undue pressure/duress/influence
Practices professional skepticism - facts
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•
Professional competence and due care – “Members have a continuing duty to maintain
professional knowledge and skill at a level required to ensure that a client or employer
receives competent professional service based on current developments in practice,
legislation and techniques. Members should act diligently and in accordance with applicable
technical and professional standards when providing professional services.”
•
Integrity – “Members should be straightforward and honest in all professional and business
relationships.” The ACCA Rulebook (and the IFAC Code of Ethics) goes on to state that
integrity implies not merely honesty, but fair dealing and truthfulness.
-
•
Strong internal moral code/principles/ high PET
Level 3 stage 6 (Kohlberg)
Honest, truthful
Never compromising on principles
Confidentiality – “Members should respect the confidentiality of information acquired as a
result of professional and business relationships and should not disclose any such
information to third parties without proper and specific authority or unless there is a legal or
professional right or duty to disclose. Confidential information acquired as a result of
professional and business relationships should not be used for the personal advantage of
members or third parties.”
-
Values confidentiality and keep things confidential
unless needed by law
Confidential information obtained not to be used for
one’s personal advantage nor for the advantage of
any 3rd parties
POPIC
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19. Threats to professionalism – conflict of interests/threats
•
Threat of familiarity
•
Threat of intimidation
•
Threat of advocacy
•
Threat of self-interests
•
Threat of self-review
FIASS
20. Benefits of being an ethical company
•
Greater respect for organization, both from within and without
•
Improve organizational credibility
•
Can recruit and retain the best workforce
•
Can foster long-term relationship with stakeholders
•
Eliminate activist and media pressures – improve corporate reputation
•
Can help reduce problems before they occur
•
Can help reduce corruption
•
Globalization imperative
•
Economically profitable
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Corporate governance – corporate social responsibility (CSR)
1. Definitions
•
Corporate social responsibility has been defined as the duty of organizations to conduct
their business in a manner that respects the rights of individuals and promotes human
welfare (Manakkalathil & Rudolf).
•
Steiner & Steiner has defined it as the duty a corporation has to create wealth by using
means that avoid harm to societal assets, protect societal assets, or enhance societal
assets.
2. CSR continuum according to Gray, Owen and Adams
•
According to Gray, Owen and Adams, there are seven positions of social responsibility:
Position
Pristine capitalist
Expedients
Proponents
contract
of
Social ecologist
Socialists
Radical feminists
the
Description
Is of the view that organizations have acted in a socially
responsible manner if they are able to safeguard the
interests of shareholders and creditors; in short,
performing their economic and legal responsibilities.
(related to “the business of business is business” and
short-term shareholder interests
Is of the view that organizations have a limited
responsibility in performing its corporate social
responsibility especially if such a behavior can help to
promote the organization’s self-interests.
social Is of the view that there is a social contract between
organizations and society; hence, among others, this
social contract necessitates that organizations perform
their social responsibilities.
Is of the view that organizations, especially large
organizations have caused much social and
environmental degradation; as such, organizations must
now fully pledge and undertake its CSR to redeem
itself.
Is of the view that organizations can only perform its
CSR if society as a whole is a socialist or an egalitarian
community where organizations are expected to treat its
workers and other stakeholders equally and therefore
one class of workers (the capitalists, shareholders,
bourgeois) do not oppress lower-class workers or the
proletariats.
Is of the view that organizations can only be successful
in undertaking its CSR if the society/country has a
feminine culture.
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Deep ecologists
Is of the view that organizations can only start to
practice its CSR if it starts to respect the rights of the
down-trodden and also to appreciate that human beings
have no greater rights to resources or life than other
species.
3. CSR continuum
•
Corporate social responsibility programs of some organizations can fall into a continuum
from promotional CSR to institutional CSR as indicated below:
Promotional CSR
Institutional CSR
•
Institutional CSR provides a comprehensive approach to CSR. It attempts to fulfill a
company’s social obligations across all stakeholder groups and touches all aspects of the
company.
•
Promotional CSR are initiatives primarily used as a tool to drive product sales, one example
being cause-related marketing.
4. CSR motives
•
According to Cropanzano et al., there are three motives for CSR
•
Instrumental motives – driven by self-interests
•
Relational motives – driven by status and peer standing
•
Moral motives – ethics and welfare of larger groups within society
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5. CSR perspectives (Johnson, Scholes & Whittington)
•
External aspects
 Green issues - reducing pollution below legal standards even when competitors are not
doing so
 Marketing standards - deciding not to sell in some markets, advertising standards
 Suppliers - should the company offer fair terms of trade, blacklisting suppliers?
 Employment - no discrimination of potential employees
 Community activity - sponsoring local events and local good works
•
Internal aspects
 Employee welfare - medical care, assistances with mortgage, extended sickness leave,
assistance for dependants etc.
 Working conditions - social and sporting clubs, safety standards etc., job design
Societal assets
•
trees, plants, grains
•
Animals (for consumption and agriculture)
•
Water – lakes, rivers, streams, hotsprings, ponds etc.
•
Air – clean air
•
Stones – gems
•
Energy – petroleum, natural gas, coal, wind, hydro, geothermal, biofuel
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6. CSR strategy and strategic CSR
•
CSR strategy - decisions taken by a firm regarding its CSR programs and endeavors
•
Strategic CSR:






Affects a company’s long-term direction
May give a firm an advantage over its competitors
Affects an organization’s activities
Will affect a firm’s resource allocation
Will affect operational-level decisions
Can be affected by stakeholders
Examples of CSR strategies
Company
Altria
IBM
Campbell Soup
Wal-Mart
Programs/initiatives
Spend more than $1billion on social projects
such as preventing domestic abuse, feeding
the ill and the elderly, responding to disasters
like Hurricane Katrina
Providing students with associate degree,
modernizing Kenya’s postal service, helping
design online education program in India
Helps design local school menus
Has given global suppliers 5 years to comply
with environmental rules launched in 2009 or
risk being pushed off
7. Other examples of CSR strategy
•
Merck – donates medicine (Ivermectin) to prevent river blindness
•
MS – against malaria. Bill and Melinda Gates Foundation has contributed more than US$ 24
billion to combat against the developing world’s most serious illness
•
Avon – donates money for breast cancer programs – breast cancer detection, treatment and
research
•
Body Shop – no animal testing and donates money for people without homes
Prepared by Dr. Parmindar Singh
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Examples of social responsibilities
•
Education – scholarships, libraries, computer for schools…
•
Donations – welfare homes, Red Cross, social causes, natural disasters
•
Philanthropy
•
Employees – day-care centre, kindergartens, in-house clinics, discounted meals
in cafeteria, educational assistance, financial assistance for mortgage and health
•
Communities – training the unemployed, assimilating ex-drug addicts into society,
recreational parks, preservation of environmental assets
8. Why is social responsibility important?
•
Profits - Research has shown that is a positive correlation between social responsibility and
profits
•
Improve customer loyalty, improving attitude towards company and minimizing skepticism
about company
•
Globalization imperative
•
Successful implementation of strategies - allows an organization to avoid any adverse
actions from different stakeholders and therefore allow strategies to be implemented
successful
•
Competitive advantage – by being a first-mover in CSR, a company may pre-empt its
competitors from taking this position and therefore, have an advantage over its competitors
•
Gen. Y (1977 – 1995) – easier to recruit
.
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9. Social and environmental audit pressures
•
Environmental issues as a source of risk – reputational damage, liabilities
•
Profits – customers may only want to buy from organization that is socially, environmentally
and ethically (SEE) responsible
•
Potential employees – potential employees may only want to work for SEE responsible firms
•
Investors – greater investor attraction
10. Steps to becoming more CSR oriented
•
Comply to codes – UN, OECD, industry, external groups, and own-company principles
•
HRM – HRP, HRD, proper performance appraisal and reward structure.
•
Social auditing – hiring independent auditors to asses the impacts of a corporation on
society. May undertake triple bottom-line reporting.
•
Examples:
Nike, GAP, GE, Chevron, ENI, BP, Shell
Reasons for triple bottom-line reporting:
-
political-economy argument
legitimate theory
shareholders
financial performance
environmental disasters
laws/regulations
stakeholder theory
•
PLS-FELS
Higher senior executives (Coca-Cola has a VP for CSR; IKEA has a Chief Ethical Officer)
•
Mission statement
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Corporate governance – environmental accountability
1. Environmental and social footprint
Environmental footprint
Environmental resources consumed
Social footprint
Compares contribution of company against its
harm
If more net good, then positive social footprint,
otherwise, negative social footprint
Harm caused to environment
If consumed a lot of environmental resources
and caused lots of harm, then large/negative
environmental footprint, otherwise, positive
2. Environmental/carbon footprint reduction
•
Legislations – Germany has more than 800 laws; UK government wants all homes to be
carbon neutral by 2016 (examples)
•
Voluntary initiatives
3. Environmental accountability – voluntary initiatives
•
•
•
•
•
•
Adopting Global Reporting Initiative (GRI) measures
Integrated reporting (IR)
CRASENA (carbon trading, 3Rs, alternative energy sources, sustainable development,
Equator principle, NGOs, awards given by government)
TBL – triple bottom-line reporting
EMS – environmental management system
ISO 14000, EMAS (Eco-management and audit scheme)
Environmental
footprint
Water
footprint
Prepared by Dr. Parmindar Singh
Carbon
footprint
Page 32
4. Sustainable development
•
The Brundtland Commission Report defined sustainable development as:
a process of change in which the exploitation of resources, the direction of investments, the
orientation of technological development, and institutional change are made consistent with
future as well as present needs.
•
Brundtland Commission Reports also mentions the need to internalize all externalities
-
Repletion rate ≥ depletion rate
-
Internalize all externalities
5. EMS
•
Defining environmental goals and missions
•
Developing adequate and effective environmental policies and procedures
•
Properly documenting and communicating the established environmental policies and
procedures to affected personnel
•
Monitoring these policies and procedures and ensuring compliance with them
6. Environmental audits
The regular, systematic audit and voluntary disclosure of a firm’s environmental performance
with regards to its EMS, environmental footprint and compliance of all environmental, health and
safety legislations.
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7. Environmental audit
• Agree upon metrics (and objectives/targets)
 What to measure – emissions (pollution, waste, greenhouse gases) and consumption
(energy, water, feedstock etc.) (see GE)
•
Performance of company measured against these metrics
•
Report on levels of compliance or variance
8. ISO 14000
•
These instrument has 21 standards which are divided into six categories:






Environmental management systems
Environmental auditing
Environmental performance evaluation
Environmental labeling
Life-cycle assessment
Environmental aspects in product development
9. Contents of environmental reports
•
•
•
•
•
•
Message from CEO or Chairman
Environmental objectives
Environmental achievements
Impact of environmental achievements on stakeholders
Environmental objectives not achieved and reasons as well as what a firm intends to do
Future challenges
10. Benefits of environmental audits and subsequent environmental reporting
•
Greater disclosure – greater transparency, accountability, probity, lesser information
asymmetry
•
‘Green’ reputation
•
Satisfaction of multiple stakeholders (improving customer satisfaction)
•
Reduce legislations being imposed and avoid penalties
•
Long term cost reductions – changing their productions processes, lower insurance
premiums etc.
•
First-mover advantage
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GE does environmental reporting through its “Citizenship Report” and also had
launched its Ecomagination program to invest billions in environmentally friendly
technologies
GE’s environmental targets since 2009 (an illustration):
-
Reduce freshwater consumption by 20% by 2015
Reduce energy intensity by 30% by 2012
Reduce absolute greenhouse gas emission by 1% by 2012
Prepared by Dr. Parmindar Singh
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Corporate Social Responsibility: A conceptual analysis
Dr. Parmindar Singh, Cam-Ed Business School, Cambodia
Abstract
Purpose: The purpose of this article is to explain and create enlightenment on corporate social
responsibility and creating shared value concepts. This article explains the definitions of corporate social
responsibility, discusses the importance of corporate social responsibility, explains what can be done for
firms to be seen as practicing their corporate social responsibility, gives examples of issues pertaining to
corporate social responsibility, articulates the concept of creating shared value and culminates with
conclusions on this area.
Methodology: Research on corporate social responsibility and creating shared value was undertaken from
the extant literature; subsequently, the finer points and conclusions drawn for the literature were filtered
and condensed to undertake this conceptual analysis. Information from these sources were summarized,
analysed and tabulated before arriving on this conceptual analysis.
Findings: Corporate social responsibility and/or creating shared value is the way forward. It has become
imperative for organizations to survive and if executed well to achieve competitive advantage.
Keywords: Corporate social responsibility, Creating shared value
Paper type: Conceptual
Prepared by Dr. Parmindar Singh
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Corporate Social Responsibility: A Conceptual Analysis
1.0 Introduction
This article will initially explore the definitions of corporate social responsibility (CSR) from the extant
literature. This will then be followed by a discussion of the importance of CSR. Subsequently, this article
will elaborate what can be done by organizations to be seen as practicing their CSR. The next section will
then analyse some organizational issues that have resulted in CSR taking centre stage followed by a new
view of corporate social responsibility with the introduction of a concept, called, “creating shared value”
(SCV).
2.0 Definitions of Corporate social responsibility
From the extant literature, there have been many definitions of CSR. According to Manakkalathil and
Rudolf (1995), CSR is defined as
“the duty of organizations to conduct their business in a manner that respects the rights of individuals and
promotes human welfare”.
In addition, Steiner and Steiner (2004, p.126) has defined CSR as the duty of a corporation to create
wealth by using means that avoid harm to, protect, or enhance societal assets.
Carroll (1991, cited in Carroll, 1999), states that total CSR consists of organizations performing their
economic, legal, ethical and philanthropic responsibilities.
According to Gray, Owen and Adams (1996) (cited in Professional Accountant, 2007, pp. 271-272), there
are seven positions on social responsibility. These are shown below in Table 1.
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Table 1 – Seven organizational positions on corporate social responsibility
Position
Pristine capitalist
Expedients
Proponents of the social contract
Social ecologists
Socialists
Radical feminists
Deep ecologists
Description
An organization has acted in a socially responsible manner if
it can perform her economic and legal responsibilities. Such
an organization believes in maximizing shareholders’
interests and taking care of creditors and other relevant
stakeholders. They believe in the Friedman’s (1962) adage –
“the business of business is business”.
An organization that has adopted the expedient position of
CSR believes that firms have a limited social responsibility
and will definitely perform her social responsibility if it is
tied to her self-interest. Such organizations have an
instrumental view on CSR.
An organization that adopts this position believes there exist a
social contract between firms and stakeholders and part of
this social contract entails that organizations perform their
social responsibilities.
An organization that adopts this position believes that
corporations, especially large corporations have contributed a
lot towards environmental degradation and should now
redeem themselves by being more socially responsible.
Firms that adopt this position believe that social
responsibility can only be successful if the firm or the
community adopts a socialist position where there is
egalitarianism in societies and organizations, where upperclass workers (executives – bourgeois) do not exploit the
lower-class workers (proletarians).
A corporation that adopts this position believes that social
responsibility can only work if organizations change their
culture to be more feminine. In a feminine culture, there is
gender equality, altruism and greater quality-of-work-life.
Deep ecologists or deep green firms believe that to be
socially responsible, they should not only take care of
shareholders but also all people in the human strata as well as
respecting non-human species.
Having looked at the different definitions and positions on social responsibility, the next section explains
why CSR has become very important.
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3.0 Why CSR is important
Research has shown that there is a positive correlation between corporate social responsibility and profits
(Margolis & Walsh, 2001; Griffin & Mahon, 1997; Dawkins & Stewart, 2003), that is, a certain
percentage of an organization’s profits are due to CSR. As a result, many firms have realized the value of
practicing CSR.
Secondly, endeavoring in CSR initiatives can also result in increasing customer loyalty (Pirsch, Gupta &
Grau, 2007, p. 126). Customers would rather give their businesses to firms that practice CSR than those
that do not. Moreover, customers will have a good impression on firms practicing CSR and this positive
impression will, in the long-term, increase customer loyalty.
Another reason for CSR becoming more prominent is that it helps to facilitate the entry of firms in new
overseas markets (Zyglidopoulos, 2002). This is because host governments will obviously prefer a firm
that is responsible to enter its market than an irresponsible firm. Globalization for a firm can therefore be
promulgated through undertaking her social responsibility.
Fourthly, undertaking CSR initiatives will also allow a firm to implement its strategies successfully
(Zadek, 2004). For instance, if a firm was to pursue a strategy of market penetration and product
development but its promotion mix was deceptive and its factories were sweat shops and used fossil fuel
causing massive contamination and pollution, then stakeholders like customers, government, nongovernmental organizations, shareholders, and employees will not be happy. These stakeholders may take
legal action and others like customers may boycott such a firm. This will affect shareholders’ value. All
of these will not augur well for the firm and it will not be able to implement its strategies successfully. On
the other hand, if the situation was reversed, no stakeholders will oppose and such a firm can then
implement its strategies seamlessly.
The next reason for promoting CSR is it can allow a firm to achieve a first-mover advantage (Sriram &
Manu, 2002). If this advantage can be sustained through the different evolutions of a firm’s CSR
initiatives, then it may also give a firm a sustainable competitive advantage.
Another contributing factor for firms engaging in CSR is that firms believe that CSR can help to recruit,
motivate and retain employees (Sprinkle & Maines, 2010, p. 447). Thus CSR can help a firm to be more
competitive by having the right motivated workforce.
The next section looks at what firms can do to be seen as practicing their CSR.
Prepared by Dr. Parmindar Singh
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4.0 How to be seen as practicing CSR
There are many ways for a firm to be seen as practicing her CSR. One way is to comply with codes.
These codes can be formulated by transnational entities such as the United Nations (such as Global
Compact Principles) (cited in Steiner and Steiner, 2004, p. 139), or by industry groups (the chemical
industry in the United States of America has a code call, Industry Care) (cited in Steiner & Steiner, 2004,
p. 140), by NGOs such as CERES (Coalition for Environmentally Responsible Economies) Principles
(Steiner & Steiner, 2004, p. 142) or a firm can also formulate its own code. For example, Nestle has its
own code of principles which focuses on consumers, human rights and labor practices, employees,
suppliers and customer relations, and environment (Nestle, 2010).
Secondly, a firm may want to change its human resource management practices. She may want to recruit
and select candidates who also believe in the ideals of CSR. A firm may also conduct training on the
importance of CSR and to ensure that staff takes into account matters of social responsibility when
making decisions. In addition, employees should also be appraised based on their contribution towards
society and environment, among others. Employees who do contribute towards society and environment
can then be better rewards, both extrinsic and intrinsic (Steiner & Steiner, 2004, p. 171).
Thirdly, firms may want to undertake triple bottom-line reporting (TBL) as a manifestation of its
commitment towards CSR. In TBL, a firm discloses not only its financial performance but also its
societal and environmental performance. To ensure veracity, these reports, just like financial reports must
be audited (Zadek, 2004; Pirsch, Gupta & Grau, 2007, p. 128; Steiner & Steiner, 2004, pp. 180-181).
Another way to be seen as practicing her CSR is to create high ranking positions or committees to oversee
matters pertaining to CSR. For example, Unilever had created a position called, Chief Sustainability
Officer to oversee matters pertaining to social responsibility and sustainability (Gunther, 2013). Nike on
the other hand has created a corporate responsibility committee back in 2001 to contribute in five ways,
namely, as a source of knowledge and expertise in CSR, as a sounding board and constructive critic on
CSR issues, as a driver of accountability for CSR, as a stimulus for innovation on matters pertaining to
CSR and finally as a resource for the board of directors (Paine, 2014).
Moreover, firms undertake environmental reporting to demonstrate their SCR commitment. One example
of how firms undertake environmental reporting is shown below in Figure 1 (Raiborn, Butler & Massoud,
2011). This environmental report adopts the concept of quality as advocated by Crosby that analyses costs
from three perspectives, namely, prevention costs, appraisal costs and failure costs (both external failure
and internal failure) (ASQ.org, 2016).
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Figure 1 – Environmental Cost Report for Year ended Dec. 31, 20xx
Costs of Compliance
$
1. Prevention
Training on environmental issues……………………………………………………………P
2. Appraisal
Monitoring, inspecting and testing environmental
protection equipment…………………………………………………………………………..A
Costs of non-compliance
3. Internal failure
Rework costs for products not meeting environmental
standards……………………………………………………………………………………………..IF
4. External failure
Recall for environmental damaging products…………………………………….EF
Total environmental costs…………………………………………………………………………….P + A + IF + EF
5. Environmental benefits
Insurance reduction
Process improvements
etc.
…………………………………………………….B
Net environmental cost or benefit…………………………………………………………… B- (P + A + IF + EF)
The next section will look at some CSR issues and how it impacted firms.
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5.0 CSR issues
This section looks at two firms and their corresponding CSR issues. The first firm discussed is BP Oil and
the second is The Coca Cola Company.
The BP oil spill on 22nd April, 2010 at the Deepwater Horizon rig in the Gulf of Mexico had resulted in
the leakage of more than 5000 barrels of oil per day (AFP, 2010; Sky Valley Chronicle, 2010; Wang,
2010). The oil well that leaked was the Macando oil field and the leakage occurred due to an improper
seal on the oil field (Coy & Reed, 2010). As a result of this leak, BP’s shares plunged by around 53%
(Bloomberg, 2010a) and BP recorded a loss of $17.2b in the second quarter of 2010. Their CEO, Tony
Hayward had to step down on October 1, 2010 and the cleanup costs and other liabilities have exceeded
$30b and BP experienced a market capitalization loss of £45b (Bloomberg, 2010b). The spill also resulted
in 11 men being killed and a total of 4.9 billion barrels of crude oil being spewed out into the Gulf of
Mexico (Barrett, 2012).
This incident for BP had caused BP to experience reputational risk with the abovementioned
consequences (Collier & Agyei-Ampomah, 2007). BP still remains at risk for as much as $17.6b for
alleged violations of the Clean Water Act (Barrett, 2012).
As a result of this incident, BP had taken measures to improve its reputation and to undertake greater CSR
initiatives. Among the measures taken were conducting regular oil spill exercises, using technologies such
as satellite imagery to detect potential oil spills, using a tool to develop an integrated picture using
geospatial data, and incorporating learning from past experiences (BP, 2015a). BP’s CSR initiatives now
focus on climate change, safety, environment and society (BP, 2015b).
Coca Cola Company also had experienced some social and environmental issues in India. In 2002, in
Plachimada, a village in Kerala, India, residents accused Coca-Cola’s bottling plant to deplete and pollute
ground water. It takes 2.5 liters of clean water to produce 1 liter of Coca Cola drink. Two years later, the
local government forced Coca-Cola Company to shut down the bottling plant. Coca-Coal Company
denies polluting water and sucking wells dry but admitted it mishandled the controversy on the publicrelations front (Ling, 2008).
From this episode, Coca Cola Company became more aggressive in its CSR front. Among the initiatives
were to help WWF (World Wildlife Fund) to preserve seven of the world’s major rivers, install rainwater
harvesting in Indian states, and promoting environmental education (Ling, 2008).
Coca Cola Company also intends to become water neutral by 2020. In addition, to demonstrate its CSR,
30% of its bottles now use a resin made from sugarcane instead of fossil fuels. It also provides
scholarships and has contributed to build schools in China (Ignatius, 2011).
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6.0 Creating shared value (CSV)
Many firms are shifting their stand from social responsibility, philanthropy or even sustainability to a
shared value concept. According to Porter and Kramer (2011, p.46), creating shared value (CSV) is
defined as
“policies and operating practices that enhance the competitiveness of a company while simultaneously
advancing the economic and social conditions in the communities in which it operates”.
CSV implies that organizations can become more competitive by improving economic and social
conditions of communities. For example, if organizations can help to improve the educational systems of
communities, then this can help the firm to cut costs in remedial training and therefore, a firm’s cost in
the long-term will become lesser.
Thus communities gain and at the same time, organizations also gain. Creating shared value thus results
in a win-win situation between firms and societies.
According to Porter and Kramer (2011), CSV can be achieved by reconceiving products and markets,
redefining productivity in the value chain, and building a supportive industry cluster at a firm’s location.
This is briefly explained below.
6.1 Reconceiving products and markets
Reconceiving products, for example, producing healthier foods or environmentally friendly products can
result in a win-win situation. Society gets better nutritious food and society in turn, will appreciate the
brand more and as a result, brand loyalty will increase, resulting in improve bottom-line for the firm.
Reconceiving products and services can also include serving people at the bottom of the pyramid. For
instance, financial institutions can provide micro-financing. This can allow people at the fringes of
poverty to borrow money. With the money borrowed, these people may use the money to cultivate crops
or to start a business. This will benefit societies. In addition, this can also benefit organizations by earning
more money from the interests paid.
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6.2 Redefining productivity in the value chain
Many activities in a firm’s value chain can harm society. For example, if an organization’s factory uses
fossil fuels, then there will be greenhouse gas effects. In addition, if there is excess packaging, there will
also be disposal issues. Not only will this be bad for society and the environment, it will also be costly to
businesses. Wal-Mart, for example, estimated it could save around 3,800 tress and 1,000 barrels of oil
with an economic saving of $2.4 million by reducing unnecessary packaging of its private-label toy
products (Lai, Cheng & Tang, 2010, p. 6).
Procurement should also be done locally otherwise local suppliers become marginalized. With
marginalized suppliers, suppliers cannot improve their quality. Firms should share technologies with
suppliers, provide financing, and increasing access to inputs and this can allow suppliers’ quality to
improve. Firms can then buy more from local suppliers; local suppliers can then hire more workers and
provide better wages. Thus there will be a virtuous circle.
6.3 Enabling local cluster development
No company can be self-contained, just as no man is an island. The success of a company is affected by
the success of supporting companies and infrastructure around it. Productivity and innovation are strongly
influenced by “clusters” – geographic concentrations of firms, related businesses, suppliers, service
providers, logistical infrastructure, academic institutions, trade associations, standard organizations,
among others.
As a firm and its cluster develops, there will be multiplier effect such as new job creation, new companies
being seeded and higher demand for ancillary services. Thus CSV creates a win-win situation for all
parties.
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7.0 Conclusions
This article has defined the meaning of CSR, explain why CSR has become more prevalent, discussed
what can be done to be seen as practicing CSR, gave examples of CSR issues and culminated with a new
paradigm of CSV.
From this article, it can be dawned that CSR and/or CSV are important for organizations. Organizations,
wherever they are in the world must strive to undertake CSR or CSV. There are no “if’s” or “but’s”; there
are simply no excuses. It has become imperative to pursue it wholeheartedly. For this to occur, there must
be a visionary leader who can steer and influence the firm to move in this direction. Such a leader must be
ethical and believes in the concept of sustainable leadership.
The vision of an ethical and sustainable leader is to achieve moral good, and the core values of integrity,
trust and morality are central (McCann & Sweet, 2014, p. 374). Sustainable leaders are concerned with
creating current and future profits for an organization while improves the lives of all concerned (McCann
& Holt, 2011 cited in McCann & Sweet, 2014, p.374).
Ethical and sustainable leaders must ensure that an ethical culture exist for firms to embark on CSR
and/or CSV. With the right organizational culture, the values on social responsibility, environmental
responsibility and shared value creation can be ingrained in every single employee and hopefully all
stakeholders. With greater commitment from all stakeholders, CSR and/or CSV can become successful
and organizations can coexist comfortably with communities and its environment.
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<http://www.skyvalleychronicle.com/BREAKING
NEWS/BP-OIL-LEAK-CRUDE-OIL-HITSLOUISIANA-S-MARSHLANDS, access May 20th 2010.
Sprinkle, G.B. & Maines, L.A. (2010), ‘The benefits and costs of corporate social responsibility’,
Business Horizons, Vol. 53, pp. 445-453.
Steiner, G.A. & Steiner, J.F. (2004), Business, Government and Society: A Managerial Perspective, (10th
ed.), McGraw Hill, International Edition.
Sriram, V. & Manu, F. (2002), “Corporate Social Responsibility”, Chapter 12 in Cross Cultural
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<http://www.propublica.org/ion/blog/item/bps-oil-gulf-mexico, access May 20th 2010.
Zadek, S. (2004), “The Path to Corporate Responsibility”, Harvard Business Review, Vol. 82, Iss. 12, pp.
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Prepared by Dr. Parmindar Singh
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Corporate Governance
1. Definitions
The Cadbury Committee defined corporate governance as the system by which companies are
directed and controlled
Corporate governance is the relationship among various participants in determining the
direction and performance of corporations (Monks & Minow, 2002, p. 1). The primary
participants are (1) the shareholders, (2) the management (led by the CEO) and (3) the BODs.
2. Owners/principals/shareholders
Shareholders
Government
SOE
Non-government
GLC
Individuals
families
Institutions
: public-listed firms
: private companies
: NGO – charitable firms, religious
bodies, foundations, SIG
:pension funds, mutual funds, hedge
funds, private equity funds
3. Institutional shareholders
•
Pension funds (e.g. CalPERS)
•
Mutual funds
•
Hedge funds
•
Private equity firms
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4. Institutional shareholders
•
Dedicated
•
Transient
5. Sovereign funds/sovereign wealth funds
•
Belonging to government – Abu Dhabi Investment Authority, Temasek Holdings
6. Corporate governance models
•
Shareholder model/agency model – is of the view that there is good corporate governance
when agents (management/CEO, board) take action to maximize shareholders’ wealth.
Hence agent’s fiduciary duty lies only to shareholders; however, this model also recognizes
that agents may tend to pursue their own interests (i.e. act opportunistically) at the expense
of shareholders and therefore, there must be proper mechanisms in place (monitoring,
bonding) to ensure that agents do not act opportunistically and consequently pursuing
shareholders’ interests.
•
Stakeholder model – is of the view that there is good corporate governance when agents
take care of the interests of the organization’s stakeholders. These stakeholders may be
shareholders and employees or the diverse range of stakeholders of an organization such
as customers, suppliers, community and others. All stakeholders have an inherent worth
and none should be exploited for the benefit of some. Therefore, agents must attempt to
treat each stakeholder fairly. Hence agent’s fiduciary lies to all stakeholders –
communitarian position.
•
Stewardship model – is of the view that good corporate governance occurs when agents
view themselves as stewards/guardians of the corporations and diligently work to attain high
levels of corporate profits and shareholders’ returns. Stewards or agents will not shirk their
responsibilities. Being stewards of the organization, agents will never pursue their own selfinterests, and therefore there is no monitoring of agents/management.
•
Enlightened shareholder value – a corporate governance approach where an agent takes
the interests of its diverse stakeholders only in so far as to promote and advance the longterm value of shareholders.
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Members (actual principals)
funds
Pension fund (agents)
(direct principals)
invest
multi-agency framework
C1, C2, C3, C4 ….
Portfolio of firms
SEE responsible
profit
•
Political model – a corporate governance approach where government (being the sole- or
major shareholder) decides how rewards, resources, power, privileges, among others are
allocated. Government will also decide on appointments to be made as well as strategies to
be pursued. Government will also use the firm to pursue its own agenda.
•
Cultural model – is of the view that good corporate governance occurs when a healthy,
dynamic and adaptive culture of the organization moulds, shapes and gels the running of an
organization so that it is well directed and controlled.
7. Other corporate governance developments
•
Principal theory – principal, rather than the agent acting opportunistically to the detriment of
other stakeholders.
•
Principle theory – a governance approach that pursued a set of guiding principles resulting
in sub-optimization of results because ideal principles and their rigid applications may be
either inappropriate for every situation or misapplied by unskilled practitioners.
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8. Yoshimori corporate governance approach
•
Monistic – shareholders (agency model or stewardship model)
•
Dualistic – shareholders and employees (stakeholder model)
•
Pluralistic – shareholders, employees, customers and others (stakeholder model)
9. Yoshimori’s external and internal governance
•
External governance – NEDs, shareholder activism, small board size, external auditors,
rating agencies, laws and regulations.
•
Internal governance – mission, ethics, culture, strategy
10. Corporate governance controlling mechanisms
•
External – external auditor, SEC, market for corporate control, laws and regulations, labour
market
•
Internal – BODs
11. Benefits of good corporate governance
•
Attracts greater investments into firms, both foreign and domestic (McKinsey & Co.) – with
good corporate governance, many investors, both foreign and domestic will be attracted to
the firm. As such, the firm will be highly sought after and consequently, its share price will
be in great demand. Hence its share price may move northwards.
•
Reduces cost of capital
•
Attracts “patient” capital
•
Reduce risk
•
Stimulates performance and improves share price
•
Enhance marketability of products and services by creating confidence among
stakeholders
•
Improve leadership standing
•
Demonstrates transparency and accountability
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Agency
1.
1932 – Berle and Means (US)
Owner
Controller
Jensen and Meckling (1976)
Fiduciary duty
Principal
Agent (CEO)
(ROAD)
Appoint, place some degree of trust and confidence, provide resources
Principal
conflict
Opportunistically
to address
Agency costs
•
Agency conflict
In general, anything that causes a conflict between principals and agents will give rise to
agency conflict and hence to reduce agency conflict, cost, i.e. agency cost is incurred.
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2. Jensen and Meckling define agency costs as the sum of:
 Monitoring management (the agent),
 Bonding the agent to the principal (economic bonding) and,
 Sum of all the previous residual losses.
Agency costs
increase
Adverse selection
Management style poor
Low PET
Compounded by
Information asymmetry
BOD ineffective
poor internal controls &
Risk management
external and
internal auditor
not I&O
Increases agent opportunism
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•
Agency costs can therefore increase due to:
 Information asymmetry
 Ineffective Board of directors
 Management style poor – high turnover of staff
 Poor internal controls and risk management
 External and internal auditors not I&O
 Risky strategies and high risk of failing
 Performance of organization deteriorating
 Independent directors not effective
 Poor succession planning
 Failure to comply with good CG
 Rewards which are in excess etc.
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•
Agency costs can be reduced through:
 Remuneration - performance-based incentive plans – performance shares, performance
bonuses and other remuneration (incentives must be aligned to shareholders’ long-term
interests).
 Direct intervention by shareholders (especially institutional investors)
 The threat of firing (reduced by golden handshake/severance pay and “empire building”)
 The threat of takeover (sometimes agents resist this takeover through greenmail and
“poison pill”) (or use of white knight or white squire)
 An effective board of directors – chairman, nomination committee, audit committee, risk
management committee and other committees, INEDs
 Triple-bottom line reporting or Integrated reporting
 Internal audit – risk management, internal controls and governance
 External audit
If takeover good for shareholders, then CEOs that resist may need
to be given golden parachutes
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-
Greenmail – approaching shareholders of acquiring firm to buy
back shares at a premium
-
Poison pill – (i) share rights option, (ii) borrowing on terms that
require immediate repayment of all loans if the firm/target is
acquired, (iii) selling-off at bargain prices the assets that
originally made the firm a desirable target
-
White knight – friendly acquirer
-
White squire – friendly investor
Empire building (managerial self-interest)
Pursuing unprofitable acquisition
Managerial entrenchment
remuneration
Harder to be laid-off
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3. Fiduciary duty (legal)
•
Fiduciary duty is the duty of agents towards the principals/shareholders as a result of the
agent’s position and due to the trust and confidence the principals have placed upon them.
•
There may also be a need to widen the fiduciary need to other stakeholders – moral
fiduciary or instrumental view on fiduciary duty. Among the reasons (some moral and others,
instrumental):
-
Political-economic argument
Profits
Legitimate theory
Competitive advantage
4. Political-economic argument
•
This argument states that organizations must take care of other stakeholders, otherwise, the
government will enact a law for firms to do so
•
As such the cost of organizations will increase
•
Hence to avoid the government in passing out new legislations pertaining to taking care of
the well-being of other stakeholders, organizations will on their own accord take the
necessary measures to take care of these other stakeholders.
5. Legitimate theory
•
Is the theory that taking care of the diverse stakeholders will improve a firm’s legitimacy and
acceptance among the wide range of stakeholders
•
Hence when other stakeholders legitimize a company’s operations, it will encounter minimal
hassle from these other stakeholders and consequently a firm’s operations can proceed
smoothly.
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Corporate governance – concepts/principles
1. Principles/concepts of good corporate governance
•
Fairness – the directors must practice proper deliberations; they should be unbias, non
discriminatory, rational as well as objective.
•
Independence – Board of directors must have non-executive directors that are
independent
•
Openness/transparency – corporate disclosure to all stakeholders at the same time.
Disclosure should include information in the financial statements, directors’ reports, and
financial review. Also including voluntary disclosure, i.e. disclosure above the minimum
required by law such as management forecasts, analysts’ presentations, press releases,
information placed on website etc. Good transparency also means:
 Adoption of accurate accounting methods
 Full and prompt/timely disclosure of information relating to the company
 Disclosure of conflicts of interest of the directors or majority shareholders; and
 Adequate advance notice of meetings and voting so shareholders may prepare
•
Probity/honesty – telling the truth, not misleading stakeholders, honest, practice candour,
directors should not mislead, or deceive.
•
Responsibility – directors (NEDs) have to monitor agents, attend regular meetings, give
suggestive contributions, protecting shareholders/stakeholders interests
•
Accountability – effective committees, giving suggestive contributions, attend regular
board meetings
•
Judgment – adequate balance of knowledge, skills, abilities, and experience to contribute
towards organizational prosperity.
•
Integrity – integrity is generally understood to describe a person of high moral virtue. A
person of integrity is one who observes a steadfast adherence to a strict moral or ethical
code notwithstanding any other pressures on him or her to act otherwise.
•
Skepticism – directors must practice professional skepticism. Every decision made by
directors must be based on facts and evidence. They should not reply on anecdotal
evidence and must ensure that all facts and evidence are from reputable sources. Directors
must also adopt a questioning approach in analyzing matters
•
Innovation – directors must use their right balance of knowledge, skills and abilities to
provide creative ideas. The board room must allow free-flow of ideas, information and
sharing of these ideas and information. With the right culture in the board room, the
directors will be innovative in providing solutions to issues faced by the firm and the board
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•
Reputation – reputation as an asset to the organization. By fulfilling other principles of
corporate governance, the reputation of a firm can be enhanced
FIT-PRA-JISIR
2. Nolan’s Principles (non-governmental organizations)
•
Selflessness: Holders of public office should take decisions solely in terms of the public
interest. They should not do so in order to gain financial or other benefits for themselves,
their family or their friends.
•
Objectivity: In carrying out public business, including making public appointments,
awarding contracts, or recommending individuals for rewards and benefits, holders of public
office should make choices on merit.
•
Honesty: Holders of public office have a duty to declare any private interests relating to
their public duties and to take steps to resolve any conflicts arising in a way that protects the
public interest.
•
Openness: Holders of public office should be as open as possible about all the decisions
and actions that they take. They should give reasons for their decisions and restrict
information only when the wider public interest clearly demands.
•
Leadership: Holders of public office should promote and support these principles by
leadership and example.
•
Integrity: Holders of public office should not place themselves under any financial or other
obligation to outside individuals or organisations that might influence them in the
performance of their official duties.
•
Accountability: Holders of public office are accountable for their decisions and actions to
the public and must submit themselves to whatever scrutiny is appropriate to their office.
SOHOLIA
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Corporate governance – rules-based and principles-based approaches
1. Rules-based and principles-based approaches to corporate governance (CG)
•
In a rules-based approach to CG, CG has become a law.
•
As such it has become mandatory to comply with all enforced sections, provisions,
paragraphs, and other requirements; failing which the firm can be penalized, officers can be
jailed or firm can be delisted.
•
Examples of CG laws are SOA (2002) – Sarbanes-Oxley Act, Dodd-Frank Act (2010). The
rationale of rules-based is that government knows what is best for firms.
•
In a principles-based approach to CG, public-listed companies are strongly encouraged to
comply with best practices of CG and CG codes, failing which, they have to explain the
reasons for not complying, i.e. comply or explain.
•
Uses the collective wisdom of shareholders to punish errant firms
2. Principles-based approach in other countries
Country
Italy
Spain
South Africa
France
Netherlands
Germany
Belgium
UK
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Name of code/report
Preda code
Olivencia code
King report
Vienot report
Peters report culminated in Tabaksblat
code
Cromme code
Lippens code
Combined code
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3. Benefits of rules-based and principles-based
Rules-based
No opportunism
Easy to compare across firms
Less meticulous scrutiny
Provide fair-level playing field
More disclosure
Less information asymmetry
Principles-based
Costs
Flexibility
Relative ease of adoption
Suitable for developing country
4. Corporate governance may vary from country to country due to
•
National culture
•
Laws (common/civil)
•
Ownership (concentrated/diffused ownership)
•
Financing options (capital market/equity or banks)
•
Hence, ‘one size does not fit all’
5. Corporate governance may also converge due to
•
Existence of transnational entities (UN, IMF, World Bank, OECD, CACG, ICGN)
•
Globalization/FDI
•
Cross-listing
•
Diffusion of corporate governance code – triggered by Cadbury code
•
Harmonization of accounting principles
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Corporate Governance convergence and divergence among countries and companies: A
conceptual analysis
Parmindar Singh, Adjunct Associate Professor, CamEd Business School
1.0 Introduction
The Cadbury Committee (1992, cited in Mintz, 2005, p. 584) defines corporate governance as
the system by which companies are directed and controlled. Countries and companies alike
have realized that corporate governance has become center stage. The prominent driver of
change to corporate governance codes has been due to corporate collapse (United Nations,
cited, 1999, cited in Davies, 2008, p. 533). In addition, the growing number of institutional
ownership and the internationalization of capital markets (Elsayed, 2007) have made corporate
governance to become very critical. Many countries have adopted corporate governance
practices and while there are similarities in their approaches, there are also differences. This
article provides a conceptual analysis of their similarities and differences. This article serves to
enlighten undergraduate students studying corporate governance, students of ACCA studying
the Strategic Business Leader subject, post-graduate students and practitioners on the
foundations of convergence and divergence of corporate governance.
The next section of this article will provide the reasons why there are similarities in countries’
corporate governance. This is followed by reasons, that despite some similarities, there are also
factors that results in differences in corporate governance. The last section wraps up with a
conclusion of the article.
2.0 Convergence of corporate governance
There are many reasons why corporate governance among countries and companies may
converge. Among them are the rise of capitalism, globalization (Economist, 2003), the global
diffusion of corporate governance codes (Peng, 2006), market liberalization, emergence of
powerful foreign investors, and recommendations on global practices by transnational
institutions such as World Bank (Cuervo, 2002; Reid, 2003; cited in Aguilera & Cuervo-Cazurra,
2009).
Other reasons cited for convergence are integration of financial markets, product market
integration and harmonization of accounting rules (Yoshikawa & Rasheed, 2009). This
convergence had also been due to isomorphism of structure, thought and action within
institutional environments (Judge, Li & Pinsker, 2010).
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Some researchers have also made a distinction between form convergence and function
convergence as well as between de jure convergence and de facto convergence. Form
convergence occurs due to similarity in terms of legal framework and institutions while function
convergence implies that although countries may differ in rules and institutions, they are still
able to perform the same functions such as fair disclosures and the practice of accountability.
De jure convergence implies that two or more countries adopting similar corporate governance
laws and when actual practices converged, it is referred to as de facto convergence (Yoshikawa
& Rasheed, 2009).
Some of these are discussed below for greater clarity.
2.1 The rise of capitalism, globalization, market liberalization and product market integration
Due to changes in political, economic and social movements, emerging economies, African
countries and existing liberal market economies are embracing capitalism. Alongside this
acceptance of capitalism, corporate governance practices have to be changed to attract
investors. These changes may result in some similarities in corporate governance. The
convergence may be in form or function or maybe even in de jure or de facto convergence.
Globalization can occur due to foreign direct investment (FDI) and foreign portfolio investment
(FPI). FDI’s can take many forms such as acquisitions and equity alliances (examples being
joint ventures, strategic investments, and cross-shareholdings). The joint venture between
Fujifilm and Xerox that started in 1962 to form FujiXerox and finally the investment of Fujifilm in
Xerox and the subsequent ownership of FujiXerox by Xerox in 2018 (Fujifilm Holdings, 2018)
will definitely result in corporate governance amalgamation.
When Kraft (now KraftHeinz) acquired Cadbury in 2011 (Moeller, 2012), the corporate
governance of Cadbury will inevitably incorporate the corporate governance of Kraft. Hence
through the passage of time, such FDI’s will result in the convergence of corporate governance
among companies and ultimately countries.
The presence of foreign institutional investors will result in better corporate governance
(Mengoli, Pazzaglia & Sapienza, 2009). One reason to explain this is that foreign institutional
investors will expect the companies to be well managed, and one way this can occur is through
adopting best practices in corporate governance, thus encouraging some kind of convergence.
Codes of good governance are also more likely to emerge with the presence of foreign
institutional investors (Aguilera & Cuervo-Cazurra, 2009). All these imply that some similarity will
arise in corporate governance with the pervasive occurrences of FPI’s.
At the institutional level, it is argued that governments compete to attract firms to locate their
operations in their country. This leads each government to introduce attractive regulations
including those on corporate governance. At the firm level, as global product market competition
intensifies, corporate governance systems also become more similar as firms adopt more
efficient elements of corporate governance systems.
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2.2 Diffusion of corporate governance codes prompted by Cadbury Code and transnational
entities
The first code of good governance was issued in 1978 in the US, followed by Hong Kong in
1989, and third was Ireland in 1991. The fourth was the influential Cadbury Report by England
in 1992 (Aguilera & Cuervo-Cazurra, 2009). Cadbury code had had a profound impact on
countries and many countries had used the Cadbury code as a benchmark to improve their
countries’ respective corporate governance.
The spread of good governance around the world was also aided by international
entities/transnational entities such as OECD, World Bank (Aguilera & Cuervo-Cazurra, 2009),
ICGN and CACG (Davies, 2008). The OECD was the first international body to produce globally
acceptable standards of corporate governance (Solomon & Solomon, 2004 cited in Davies,
2008, p.533). The International Corporate Governance Network (ICGN), a global organization
that comprises key international investors such as individual investors, financial companies and
intermediaries adopted the OECD principles as a foundation stone and provided further
guidance on how to put the principles into practice (Davies, 2008). The Commonwealth
Association of Corporate Governance (CACG) had produced a set of corporate governance
principles in 1999 which were similar to the OECD principles. The evolution of corporate
governance in a number of developing African countries had been based on CACG (Davies,
2008).
These corporate governance principles disseminated by transnational entities and the Cadbury
Code have some key universal principles for effective corporate governance such as balance of
executive and non-executive directors, no duality of posts between the chief executive and
chairman, need for timely and quality information being provided to the board, formal and
transparent procedures for the appointment of new directors, balanced and understandable
financial information, maintenance of a sound system of internal controls, among others
(O’Shea, 2005, cited in Aguilera & Cuervo-Cazurra, 2009). The dissemination of such best
practices in corporate governance had influenced many countries and as such, their corporate
governance principles will have some degree of convergence.
2.3 Integration of financial markets
Integration of financial markets may take many forms such as listing by firms from one country
in the stock exchanges of other countries, thus increasing FPIs, cross-border mergers and
acquisitions, and free capital flows across countries. Each of these has implications for
convergence because they bring about a fundamental transformation in the ownership structure
of corporations (Yoshikawa & Rasheed, 2009). One of the reasons for foreign listing either
through cross-listing or initial public offerings (IPO’s) is to engage in bonding. One example of a
foreign IPO is Alibaba, being listed in the US (Reuters, 2018). Cross-listing is the process by
which a firm incorporated in one country elects to list its equity on the public stock exchange of
another country (Ferris, Kim & Noronha, 2009). This signals to investors that firms are willing to
comply with higher standards than required in their home country (Vaaler & Schrage, 2006 cited
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in Yoshikawa & Rasheed, 2009, p. 391). Bonding is found to increase firm’s share value
(Coffee, 2002 cited in Yoshikawa & Rasheed, 2009, p.391) and improve a firm’s corporate
governance (Ferris et al., 2009, p. 338). Other reasons for cross-listing include a desire to
obtain investment capital at a lower rate, achieve higher share valuation (through legal and
reputational bonding), enjoy increased liquidity and market depth for its shares, and obtain a
greater market share for its products and services (Karolyi, 2006 cited in Ferris et al., 2009,
p.338). Hence if many firms undertake cross-listing and subsequent bonding as well as
undertaking foreign IPO’s, in the long-run, in aggregate, the corporate governance of such firms,
and ultimately countries will converge.
2.4 Harmonization of accounting rules
The development of a core set of international accounting standards by the International
Accounting Standards Committee can greatly facilitate the convergence of corporate
governance (Yoshikawa & Rasheed, 2009). The concept of isomorphism as cited by Judge et
al. (2010, pp. 163-164) stems from the work of Di Maggio and Powell (1991) where three types
of isomorphism were identified. These are coercive, mimetic and normative isomorphism.
Coercive isomorphism arises from resource dependence and legitimacy concerns. Mimetic
isomorphism refers to the tendency of social actors to imitate those other social actors
(individuals, organizations and nations) which are viewed as successful and legitimate.
Normative isomorphism on the other hand, refers to collective values that bring about conformity
of thought and deed within institutional environment. Of these forms of isomorphism, coercive
isomorphism is often used by the International Monetary Fund (IMF) when providing financial
aid to developing countries or countries in financial aid with the demand that reform be enacted
in the public and private sectors. Quite often IMF aid is often tied to demands that IFRS
accounting standards be adopted (Judge et al., 2010, p. 163). Egypt’s and Pakistan’s adoption
of IFRS were prompted by IMF’s aid to these countries (Judge et al., 2010, p. 163). As a result
of similar financial reporting standards, through the passage of time, the corporate governance
of countries may also converge.
3.0 Divergence of corporate governance
Although there can be similarities between corporate governance, there can also be some
impediments that make the corporate governance among countries be divergent. Among them
are differences in national culture, corporate ownership, financing options, and legal origin
(Zattoni & Cuomo, 2008). Countries can also be classified as liberal market economies (LME’s)
and coordinated market economies (CME’s) and these countries have differences in corporate
governance practices (Waring & Edwards, 2008).
Differences can also arise due to path dependence, complementarities, rent seeking by interest
groups, differences in property rights and regime, and economic nationalism (Yoshikawa &
Rasheed, 2009). These are articulated below.
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3.1 National culture
According to Hofstede (1993, p.91 cited in Senior & Fleming, 2006, p. 166), there are five
dimensions of national culture, namely, power distance, individualism-collectivism, masculinefeminine, uncertainty avoidance and long-term-short-term orientation. National culture has a
significant influence on corporate governance structure (Li & Harrison, 2008).
The US has low uncertainty avoidance and therefore, in such a nation, organizations are less
sensitive to risks (Li & Harrison, 2008). High uncertainty avoidance has also resulted in a
smaller variable/performance related component of CEO compensation/remuneration package
(Li & Harrison, 2008, p. 377).
For example, the research by Watson Wyatt Worldwide (2009 cited by Filatotchev & Allcock,
2019) shows the following:
Country
USA
Germany
Japan
Base salary
23%
39%
71%
Incentive plan
60%
14%
17%
Thus differences in national culture can affect executive directors’ performance related
component remuneration. On the other hand, Germany is characterized by a high collectivism
and high uncertainty avoidance culture. The corporate governance of Germany emphasizes
cooperative relationships among banks, shareholders, boards, managers, and employees in the
interests of labour peace and corporate efficiency (Li & Harrison, 2008, p. 377). The national
culture can also affect board structure where Germany, and even Finland and Denmark have a
two-tier board.
Scandinavian countries tend to have a culture high in femininity and as such there are more
women on board. For example, the Norwegian government requires that board of directors of
publicly held firms be comprised of at least 40% women (Hoel, 2008 cited in Terjesen, Sealy &
Singh, 2009, p. 321) and the Spanish government has also committed to 40% (De Anca, 2008
cited in Terjesen et al., 2009, p.321).
Hence these differences will inevitably affect a company’s and a country’s corporate
governance arrangements.
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3.2 Corporate ownership and financing options
One commonly used model for corporate governance classification is the insider/outsider model
(Mallin, 2004, cited in Davies, 2008, p. 534). In an outsider model, there is dispersed ownership
of corporate equity among a large number of outside investors (Li & Harrison, 2008) and a clear
separation of ownership from control. This outsider model is also known as diffused ownership
structure (Stulz, 2005, cited in Peng, 2009, p.381). The vast majority of firms in the US and UK
are characterized by diffused ownership (Li & Harrison, 2008; Peng, 2009).
In an insider model, also known as concentrated ownership model, ownership is often
concentrated within a small number of directly related firms, banks and families (Li & Harrison,
2008). The vast majority of large firms throughout continental Europe, Asia, Latin America and
Africa features concentrated family ownership and control (Peng, 2009, p. 382).
The corporate governance issues in a diffused and concentrated ownership will be different.
Since ownership in a concentrated structure is small, there may exist a controlling shareholder.
Controlling shareholders are created either through dual-class or triple-class shares or through
a pyramidal structure
News Corp, for example, practices dual-class shares. In a dual-class share, as the name
implies, there are two classes of shares, type or class-A and class-B. Both shares have cashflow rights but class-B shares have more voting rights than class-A. Facebook too has a dualclass share structure while Zynga has a triple-class share, comprising class-A, B, and class-C
(Colvin, 2011). Old line media such as the New York Times and the Washington Post also have
a dual-class share (Rivlin, 2011).
The corporate governance issues in a diffused and concentrated ownership are different. With
the existence of controlling shareholder(s) in a concentrated ownership, the conflict that occurs
may be a principal-principal conflict, i.e. a conflict between the controlling shareholder and the
minority shareholders in which controlling shareholders may advance their interests at the
expense of minority shareholders (Peng, 2009).
On the other hand, in a diffused ownership, the conflict is more likely to be an agency conflict
(Berle & Means, 1932 cited in Chen, Elder & Hung, 2010, p. 93) i.e. a conflict between the
agent(s) and shareholders due to adverse selection of agents. There are external systems in
place for controlling agency problems, namely, the stock market, the market for corporate
control and the labor market (Cennamo, Berrone, Gomez-Mejia, 2009).
Related to corporate ownership is the financing options companies choose. Firms with insider
model tend to adopt long-term borrowings so as not to dilute its voting rights while those that
adopt an outsider model tends to issue shares.
Due to the differences in corporate governance issues in both an insider and an outsider model,
these companies’ corporate governance cannot be exactly identical and the countries’ corporate
governance where these companies are found also cannot be exactly identical.
Prepared by Dr. Parmindar Singh
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3.3 Legal origins
The legal framework (civil or common law) will affect a country’s corporate governance
arrangements (Davies, 2008). According to Zattoni and Cuomo (2008), common law countries
issue codes of good governance faster than civil law countries.
The first common law country to recommend good corporate governance was the US in 1978
while the first civil law country to come out with codes of good governance was Sweden in 1994
(Aguilera & Cuervo-Cazurra, 2009).
Civil law countries have weaker investor protection as compared to common law countries (La
Porta et al., 1997 cited in Davies, 2008, p. 535). In countries where the protection of
shareholders is weak, the controlling shareholders usually use the excess control rights to
weaken the ability of internal control mechanisms. In such circumstances, external control
mechanisms may be the only recourse available for remedying the problem. Unfortunately, one
of the external control mechanisms, the market for corporate control is weak in countries where
shareholder protection is weak (i.e. in civil law countries) and excess control rights are
prevalent. This situation leaves creditors as the only viable monitoring mechanism to protect
shareholders (Shyu & Lee, 2009). This problem does not arise in common law countries as
frequent as in common law countries.
However the upside for civil law countries is that recommendations of code of good governance
extend to non-listed companies more often than common law countries (Zattoni & Cuomo,
2008).
Hence, the different laws being adopted in countries definitely impact the corporate governance
of countries and therefore there are divergences in corporate governance practices.
3.4 Liberal market economies (LME’s) and coordinated market economies (CME)
In relation to the legal framework as discussed above, another way to classify countries is
whether their market economies are liberal or coordinated. Common law countries tend to have
a liberal market economy while civil law counties have coordinated market economies. The UK,
USA and Australia are often cited examples of LMEs.
In an LME, there are better developed equity markets, competitive market relationships, and
formal contracting. In a CME, there is more reliance on collaborative relationships, and nonmarket modes of coordination (Hall & Soskice, 2008, p.8 cited in Waring & Edwards, 2008, p.
136). Germany and Japan are typical examples of CMEs.
The presence of socially responsible investors are more in LMEs than in CMEs and in a CME
like Germany, bank representatives sit on the supervisory board and acts as proxy to minority
shareholders. Germany has its own code of corporate governance, the Cromme Code
(Hackethal et al., 2005 cited in Davies, 2008, p. 538). German system of corporate governance
has long emphasized cooperative relationships among banks, shareholders, boards, managers,
Prepared by Dr. Parmindar Singh
Page 68
and employees in the interests of labour peace and corporate efficiency (Li & Harrison, 2008, p.
377).
Thus these differences will sure render the corporate governance codes of LMEs and CMEs to
be different.
3.5 Path dependence and complementarities
Path dependence refers to a situation where the current state of a system is determined not
only by its initial condition but also by the path it took. The evolutionary trajectory of the
governance system of a country is the result of thousands of individual historical events and
policy responses to them. The net result is a divergence across corporate governance systems.
The existence of complementary systems can also result in divergence. For example, in US,
independent directors, information disclosure and takeover markets are a key set of
complementary elements in Anglo-American form of corporate governance. In Japan, high
reliance on debt, absence of a market for corporate control, cross-shareholdings by firms, and
long-term employment practices shape corporate governance in Japan (Yoshikawa & Rasheed,
2009). While these may change in the future, these differences are sufficient to cause the
corporate governance arrangements be dissimilar.
3.6 Rent seeking by interest groups and differences in property rights and regime
Rent-seeking actions by interested groups may prevent the convergence of corporate
governance. Rent seeking actions could come from a wide range of actors such as labour
unions, banks, controlling shareholders and lawyers. For example, many European countries
have laws in place that allow unequal voting rights, specifically designed to protect family
control. For such family controlling shareholders, they would definitely oppose the one share,
one vote system (Yoshikawa & Rasheed, 2009).
Where property rights regimes are weak, that is in countries where governments retain
considerable control rights, firms invest in “political capital” which can only be recovered in the
long-term. Firms will not have any incentives to change the status quo as it wants to recover all
its “political capital” (Yoshikawa & Rasheed, 2009).
All these will result in differences in countries’ corporate governance systems.
Prepared by Dr. Parmindar Singh
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3.7 Economic nationalism
Economic nationalism and differences in social norms in Japan and US, say, will vary and this
will affect convergence of corporate governance systems. These differences in social norms can
also result in a lack of consensus on what an ideal corporate governance system should look
like (Yoshikawa & Rasheed, 2009).
4.0 Conclusion
This article highlights that a country’s corporate governance can have similarities as well as
differences with another country’s corporate governance.
Since corporate governance has gained more prominence as more countries try to improve their
economic growth, countries and organizations alike will have to ascertain what model of
corporate governance suits them after taking into account the institutional environment of a
country that will include formal rules (laws, regulations, professional standards, procedures) and
informal constraints (customs, norms, cultures) (North, 1990 cited in Young, Tsai, Wang, Liu &
Ahlstrom, 2014, p. 333).
Organizations operating in countries near and far have also realized the importance of corporate
governance as a means of increasing its share price as well as attracting potential investors.
Therefore governments of countries and agents of companies need to consider the right
corporate governance structure it needs to remain relevant and competitive.
This article also hopes that aspiring practitioners and future leaders will be sensitize to
corporate governance and will give due consideration as it implements formal rules and
influence informal constraints as countries’ economic growth, among others, may be contingent
on its corporate governance.
As mentioned in the introduction section of this article, this article also aims to enlighten
undergraduate students studying corporate governance, students of ACCA studying the
Strategic Business Leader subject, post-graduate students and practitioners on the foundations
of convergence and divergence of corporate governance.
Prepared by Dr. Parmindar Singh
Page 70
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Corporate governance - UK Governance Code (2018)
- Should have a chairman that demonstrates good leadership
- Should
have non-executive directors who are independent (including a senior
Board
of directors
independent non-executive director (INED)) with the right balance of skills,
and (from
experience
• An knowledge
effective board
Governance code 2018):
- Excluding the chairman, at least half of the board must be INED (for small firms,
below FTSE 350, at least two)
- Sufficient diversity on the board – gender, social and ethnic backgrounds,
cognitive and personal strengths
Board members to meet regularly and attendance should be regular
- No duality of posts between chairman and CEO
- Formation of committees – audit, nomination, remuneration, risk etc. which has
the right balance of skills, experience, knowledge and independence
- Should maintain a sound system of risk management and internal control
systems, and at least annually, carry out a review of their effectiveness, and
report on that review in the annual report
- The Board should establish a framework of prudent and effective controls which
enables risk to be assessed and managed
- Directors should describe key risks and how they are being mitigated
- The Board should describe in annual report how opportunities and risks to the
future success have been considered and addressed
- The Board must be effective and entrepreneurial
- To ensure that company is successful, the board must promote long-term
sustainable success, generating value for shareholders and contributing to
wider society
- The Board must establish company’s purpose, objectives, values and strategy
and ensure that these are aligned to culture
- The board should assess and monitor culture and where policies, practices or
behavior are not aligned to purpose, values and strategy (and therefore not
aligned to culture), Board must ensure that corrective action has been taken
and reported in annual report
- The Board should describe how its business model and its governance
contributes to the delivery of strategy.
- The Board should ensure that necessary resources are in place for company to
meet objectives
- Company should arrange appropriate insurance cover in respect of legal action
against its directors
- Board should meet its responsibilities to shareholders and stakeholders by
ensuring effective stakeholder engagement and encouraging participation from
these stakeholders
- Board should ensure that workforce policies and practices are consistent with
company values and support long-term sustainable success and workforce
should be able to raise any matters of concern
- Board should explain in annual report the approach taken to invest and reward
its workforce
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▪
Senior INED together with other INEDs will meet at least annually to appraise chairman’s
performance.
▪
Chairman should hold meetings with the NEDs without the EDs present.
▪
Key risks are risks that can affect a firm’s business model, future performance, solvency or
liquidity.
•
Against CEO duality – reduce unfettered powers, improves monitoring role of
NEDs, improves organizational performance, reduce conflict of interests, reduces
agent opportunism
•
For CEO duality – single unified leader, no guarantee of significant improvement in
organizational performance (Dalton et al.)
If exceptionally a board decides that a CEO should become chairman, the board should consult
major shareholders in advance and should set out its reasons to shareholders at the time of the
appointment and in the next annual report.
•
Chairman
-
•
Provide leadership
Ensures directors receive accurate, clear and timely information and
management and company secretary should provide such information
- Setting board’s agenda and ensuring adequate time is available for discussion
of all agenda items, particularly strategic issues
- Communication with shareholders (through annual report)
- Ensure sufficient communication with shareholders (to discuss governance and
strategy issues)
- Promoting a culture of openness and debate
- Facilitate effective contribution of NEDs
- Ensure constructive relations between EDs and NEDs
- Ensure that directors continually update their skills and knowledge
An
board members
can
be called as ‘rubber-stamp’ or ‘phantom’
- ineffective
Ensure sufficient
resources
allocated
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US Blue Ribbon Report – good corporate governance occurs when there is:
-
•
An effective board
Strong internal audit – independent and objective
Strong external audit – independent and objective
Criteria for independence (Combined code/Governance code):
-
-
-
Should NOT have been an employee of the company or group within the last
five years
Should NOT have or had had within the last three years any material
business relationship with the company either directly or as a partner, director,
or senior employee of a body that has such a relationship with the company
Should NOT have received or receives additional remuneration from the
company apart from a director’s fee, should not participate in the company’s
share option or a performance-related pay scheme, should not be a member
of the company’s pension scheme
Should NOT have close family ties with any of the company’s advisers,
directors, or senior employees
Should NOT hold cross-directorships or has significant links with other
directors through involvement in other companies or bodies
Should NOT represent a significant shareholder
Should NOT have served on the board more than nine years from the date of
the first election
 NEDs who are not independent are called ‘grey’ directors (Baysinger and Butler). Examples
are:
 However, the above can be waived if the board is able to convince the shareholders that the
board member is independent in character and judgment.
If exceptionally, options of shares are granted, shareholder approval should be
sought in advance, and any shares acquired should be held until at least one year
after the NED leaves the board
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-
-
-
•
Mittal Steel – father is founder and chairman (Lakshmi Mittal), son (Aditya
Mittal) is CEO and president, while daughter (Vanisha Mittal) is a NED
Jet Airways – founder and chairman (Naresh Goyal), NEDs consists of Shah
Rukh Khan, Yash Chopra (Bollywood director), Javed Akhtar
(poet/screenwriter)
Walt Disney (pre-2004), CEO (Michael Eisner), NEDs (actor; principal of
elementary school where Eisner’s kids attended; architect who designed
Eisner’s house; president of university where Eisner donated)
Apple – NEDs were friends of Steve Jobs (e.g. Larry Ellison, Bill Campbell)
Role of non-executive directors (Higgs Report)
-
-
-
Strategy – NEDs should constructively challenge and help develop strategies
Performance – NEDs should scrutinize the performance of management in
meeting agreed goals and objectives and monitor the reporting of
performance
Risk – NEDs should satisfy themselves on the integrity of financial
information and that financial controls and systems of risk management are
robust and defensible
People – NEDs are responsible for determining appropriate levels of
remuneration of executive-directors and have a prime role in appointing, and
where necessary removing, executive directors and in succession planning
•
For NEDs – Higgs, improves organizational performance (Choi et al.), reduce group
think
•
Against NEDs - costs (director fees, insurance, induction,
competencies, control (financial vs strategic), “independence”
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CPD),
time,
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Accountability
-
-
-
•
Directors should explain in the annual report their responsibility for preparing the annual
report, and state that they consider the annual report and accounts, taken as a whole, is
fair, balanced, and understandable and provides the information necessary for
shareholders to assess the company’s performance, business model and strategy.
There should be a statement by the auditor about their reporting responsibilities.
The directors should explain in the annual report an explanation on how the company
generates and preserves value over the longer term (the business model) and the
strategy for delivering the objectives of the company.
The directors should report in annual and half-yearly financial statements that the
business is a going concern, with supporting assumptions or qualifications as necessary.
Committee chairs (audit, risk, nomination and remuneration should seek engagement with
shareholders on significant matters related to their areas of responsibility
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Audit committee (Governance/Combined code and Smith Report)
-
-
-
-
Audit committees should have at least three members, who should all be
INEDs (or in the case of smaller companies, i.e. below FTSE 350, two)
The chairman of the company should not be an audit committee member
(except for smaller firms, below FTSE 350)
Appointments to the audit committee should be made by the board on the
recommendation of the nomination committee, in consultation with the audit
committee chairman
Appointments should be for a period of up to one year, extendable through reelection, so long as members continue to be independent
At least one member of the audit committee should have significant, recent and
relevant financial experience, for e.g. as an auditor, or a finance director of a
listed company
It is recommended that there should be not fewer than three meetings during
the year. No one other than audit committee’s chairman and members is
entitled to be present at audit committee meetings. External auditor will be
invited regularly to attend meetings as well as the finance director
The audit committee should review and approve the internal audit function’s
remit; should approve the appointment or termination of the head of internal
audit; should ensure that the internal auditor has direct access to the board
chairman and to the audit committee and is accountable to the audit
committee; meet with the head of internal audit at least once a year without the
presence of management; review and assess the annual internal audit plan
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Audit committee overseeing the internal audit function
1. Review and approve internal audit function’s remit
2. Approve the appointment or the termination of the Head of Internal Audit
3. Ensure that the internal auditor has direct access to board chairman and audit
committee and is accountable to audit committee
4. Meet with head of internal audit at least once a year
5. Review and assess internal audit plan
6. Monitor and review the effectiveness of internal audit function
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Appointments to the Audit Committee
Nomination committee in consultation with the Audit Committee chairman
Recommends candidate
Board (or Board chairman)
Accepts recommendation
Candidate to stand for election during AGM
Selected
Becomes Audit Committee member
To ensure no possible conflict of interest, use open advertising or external
advice (3rd party)
•
Open advertising and/or external search consultancy should generally be used for the
appointment of the chairman and NED. If external search consultancy used, it should be
explained in annual report about any other connection it has with the company or individual
directors – so as to ensure no conflict of interests.
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Role of the audit committee
-
-
-
-
-
Should provide advice to the board on whether the annual reports and
accounts taken as a whole is fair, balanced, and understandable and provides
the information necessary for shareholders to assess company’s performance,
business model and strategy
To monitor the integrity of the financial statements
To review the company’s internal financial control systems
To review the company’s internal control and risk management systems (if there
is no risk committee)
To monitor and review the effectiveness of the company’s internal audit function
(if no internal audit function, then the need to consider annually whether there is
a need for internal audit function and make recommendations to the board, and
the reasons for the absence of such a function)
To recommend to the board for it to put forward to the shareholders in relation
to the appointment, re-appointment and removal of external auditors (if board
does not accept, then board must explain why in annual report or in any
relevant papers) as well as their remuneration and terms of engagement
For FTSE 350 companies, the audit committee should put the external audit
contract out to tender at least every ten years (if the board does not accept
audit committee’s recommendation, it should include in annual report or in any
papers the reasons for not accepting)
To review and monitor the external auditor’s independence and objectivity and
the effectiveness of the audit process
To develop and implement a policy on the engagement of the external auditor to
supply non-audit services taking into account the relevant ethical guidance
Be an avenue for whistle-blowers
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Audit committee overseeing external audit function
1. Recommend appointment, reappointment and removal of external auditor to
board
2. Recommend remuneration of external audit to board
3. Developing engagement policy for external auditor
4. Put out to tender external audit contract at least once every ten years
5. Monitor and review the external auditor’s I&O
6. Monitor and review effectiveness of external audit process
•
Advantages of external auditor providing non-audit services to audit client –
reduce client costs (economies of scope for client), external auditor has better
holistic understanding, reduce fraud and internal controls
•
Problems – increase threat of economic bonding, affect external auditor’s
I&O, self-review threat, reduce share price
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Risk committee/risk management committee
-
Should ideally be made up of INEDs (however, EDs may also be members)
Ideally should be chaired by an INED
Some recommends majority should be insiders from operations
Roles of risk management committee
- Reviewing and approving the organization’s risk management strategy and risk
management policies
- Reviewing reports on key risks prepared by business operating units, management
and auditor
- Assessing overall exposure to risk and ensuring it remains within limits set by the
board
- Providing early warning to the board on emerging risk issues and significant changes
in the company’s exposure to risks
- Reviewing the firm’s internal control systems
- Assessing the effectiveness of the organization’s risks management systems
•
Problems of combining audit committee with risk management committee –
competency, time, focus (finance matters)
12. Shareholders (Combined code)
•
Advantages of combining audit committee with risk management committee –
holistic, effective
•
Some organizations therefore have separate audit and risk management committee
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Nomination committee
-
Appointments to the board must be made on merit and against a set of
objective criteria and with due regard for the benefit of diversity, including –
gender, social and ethnic backgrounds, cognitive and personal strengths
-
Care must be taken to ensure that appointees have enough time, that there is
an appropriate balance of skills and experience within the company and the
board
-
To encourage the use of external advice or open advertising (and to explain if it
was not used)
-
A majority of members must be INEDs and is chaired by either the chairman of
the board or an INED (but chairman of board must not chair the meeting if it is
concerning the succession of board chairman)
Roles of the nomination committee
-
Prepare role and capabilities required for a particular appointment (job description)
(after evaluating the balance of skills, knowledge, and experience needed)
Prepare a job specification for the post
Plans for orderly succession for both executive and NEDs; reviewing regularly the
leadership needs of the organization, both EDs and NEDs
Regularly review the size, structure and composition (to ensure progressive
refreshing) of the board and make recommendations, when necessary
Any NED beyond six years should be subject to a particularly rigorous review
To make recommendations to the re-appointment of any NED
To monitor and convey to the board to ensure that a full time ED does not take
more than one NED or chairmanship of a company (normally a large company, e.g.
FTSE 100 company)
-
Nokia – 12 members (2007)
Toyota – 29 members (2010)
GM – 11 members (2005)
Canon – 25 members (2009)
Xerox – 13 members (2005)
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Appointments to the Nomination Committee
Nomination committee in consultation with other members of the same committee
Recommends candidate
Board (or Board chairman)
Accepts recommendation
Candidate to stand for election during AGM
Selected
Becomes Nomination Committee member
•
Large board size:
 Problems – unwieldy (3Cs, free-rider), costs, time, decreased organizational
performance
 Benefits – improves organizational performance (Dalton et al.), greater stakeholder
8. Remuneration
committee
representation,
do not need to use same persons for committees
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Remuneration committee
-
Remuneration committee should consists of at least three (or in the case of
smaller companies, two) INEDs
-
The company chairman may also be a member of the remuneration committee
but may not chair the committee
-
Before appointment as remuneration committee chairman, the appointee should
have served on the remuneration committee for at least 12 months
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Roles of remuneration committee
-
Setting remuneration for EDs, chairman, TMT and company secretary (the
remuneration of NEDs shall be a matter for the chairman and EDs or
shareholders)
To ensure level of remuneration is sufficient to attract, retain, and motivate
directors to run the company; however, should avoid paying more than what is
necessary
Performance-related elements should be transparent, stretching and rigorous EDs can only vest their shares after holding it for a minimum of 5 years (to ensure
that there is no opportunism)
-
-
10. Risk
management
- committee/risk
ED remuneration
should be: committee
❑ Clear – transparent and promote effective engagement with shareholders and
workforce
❑ Simple – rationale and operation should be easy to understand
❑ Risk – should avoid ED taking excessive risk that may affect reputation
❑ Predictable – the range of possible rewards and any other discretion should be
explained
❑ Proportional – link between rewards and the delivery of strategy and performance
should be clear
❑ Culture – rewards should be aligned to culture
-
Performance-related remuneration should include provisions that would enable
the company to recover sums paid or withhold the payment of any sum, and
specify the circumstances in which it would be appropriate to do so
Should ensure that the remuneration of executive directors be aligned to
corporate and individual performance
Determining targets for any performance-related pay schemes
Determining the policy for and scope of pension arrangements for each ED
Determining the total individual remuneration package of each ED bonuses,
incentive payments, share options
Remuneration committee should also review workforce remuneration policies
-
-
Fixed/basic component – salary, contractual bonuses, allowances, perks
(company car, insurance coverage etc.)
-
Variable/performance-related component – options of shares, restricted share
grants (also used in golden parachute), performance bonuses, any long –term
incentive plans
-
Combined code (the former Governance Code recommends that variable
component should be of a significant proportion than fixed component
Prepared by Dr. Parmindar Singh
Page 87
Why remuneration can differ across companies and countries:
-
National culture
Organizational life cycle – small, large, public-listed, delisted etc.
Costs – direct, indirect, reputation
Shareholders
Motivation
Appointments to the Remuneration Committee
gender
Hence, “one size does not fit all”
Nomination committee in consultation with the Remuneration Committee chairman
Recommends candidate
Board (or Board chairman)
Accepts recommendation
Candidate to stand for election during AGM
Selected
Becomes Remuneration Committee member
Prepared by Dr. Parmindar Singh
Page 88
Shareholders (Governance Code)
-
The board must ensure that shareholders’ (especially institutional shareholders)
views are heard and therefore the board must ensure that a satisfactory
dialogue takes place between them
13. -Shareholder
intervention
(Institutional
Shareholders’
Committee)
The chairman
should discuss
governance
and strategy
issues with major
shareholders
-
The senior INED should also attend sufficient meetings with a range of major
shareholders to listen to their views and to understand their concerns
-
The board should ensure constructive use of the AGM (notice of AGM and
related papers to be sent to shareholders at least 20 working days before
meeting); for other general meetings, 14 working days in advance.
-
When 20% or more of votes have been against board recommendations for a
resolution, the company (chairman) should explain when announcing results
what actions it intends to take to consult shareholders to understand the
reasons for its opposition to the resolution and to update the views received
from shareholders and actions taken to be published not later than six months.
-
The board should then provide a final summary in the annual report on what
impact the feedback has had on the decisions the board has taken and any
actions or resolutions now proposed.
Shareholders intervention (Institutional Shareholders’ Committee)
Prepared by Dr. Parmindar Singh
Page 89
•
Institutional shareholder intervention
- Company’s strategy – acquisition or disposal strategy – too risky
- Company’s operational performance
- Independent directors failing to hold executive management properly to account
- Internal control failings
- Inadequate succession planning
- Unjustifiable failure to comply with combined code
- Inappropriate remuneration levels, incentive or severance packages
➢ Company’s approach to CSR
•
SPICS-FI
Workforce engagement
 The board should understand the views of the company’s other key stakeholders and
describe in the annual report how their interests and matters have been considered in board
discussions and decision making
 The board can engage workforce through one or more of the following methods:
❑
❑
❑
❑
A directors appointed from the workforce
A formal workforce advisory panel
A designated NED
There should be a means for the workforce to raise concerns in confidence and
anonymously (whistleblowing)
Prepared by Dr. Parmindar Singh
Page 90
Board development
-
Chairman should ensure that new directors receive a full, formal and tailored
induction on joining the board
- Chairman should regularly review and agree with each director their training and
16.
Company Secretary
development
needs
Company secretary
-
-
Ensure good information flows within the board and its committees
Facilitating induction and assisting with professional development as required for
directors
Ensuring board procedures are complied with
To be accessed by directors for advice and services, for example the audit
committee chairman on planning the audit committee’s work, drawing up meeting
agendas, maintenance of minutes, and collection of distribution of information.
Responsible for advising the board through the chairman on all governance
matters
IIPAA
Re-election
-
All directors of FTSE 350 should be subject to annual election by shareholders
Directors should be subject to election by shareholders at the first AGM after their
appointment and to re-election thereafter
Directors below FTSE 350 should be subject to election or re-election at intervals of
no more than three years
Names of directors submitted for election or re-election should be accompanied by
sufficient biographical details.
NEDs who served longer than nine years should be subject to annual re-election
Prepared by Dr. Parmindar Singh
Page 91
NED orientation – Higgs Report
•
Business – nature of the firm’s business and operations
•
People – the people in the organization; who’s who
•
Stakeholders – major shareholders, key customers, suppliers etc.
BPS
Board evaluation – Higgs Report
•
It is the responsibility of the chairman to select an effective process and to act on its
outcome.
•
The use of an external third party to conduct the evaluation will bring objectivity to the
process (for FTSE 350 companies and above, external facilitation at least every three years
– starting from Governance code 2012)
•
Performance evaluation is for the boards, its committees, and individual directors
•
Performance evaluation of the board
-
How well has the board performed against objectives that have been set?
What has been the board’s contribution to the testing and development of strategy?
What has been the board’s contribution to ensuring robust and effective risk
management?
Is the composition of the board and its committee appropriate, with the right mix of
knowledge, skills and abilities to maximize performance?
How has the board responded to any problems or crises that have emerged and
could or should these have been foreseen?
Does the board have the right diversity to perform its job?
Prepared by Dr. Parmindar Singh
Page 92
•
Performance evaluation of individual NED
-
How well prepared and informed is the NED for board meetings and is their meeting
attendance satisfactory?
Does the NED demonstrate a willingness to devote time and effort to understand
the company and its business, including site visits?
What has been the quality and contribution of NEDs?
Does the performance and behaviour of NED engender mutual trust and respect?
Does the NED actively and successfully refresh their knowledge?
19. OECD
Prepared by Dr. Parmindar Singh
Page 93
OECD framework for good governance
•
Ensuring the basis for an effective corporate governance framework
 The corporate governance framework should promote transparent and efficient markets, be
consistent with the rule of law and clearly articulate the division of responsibilities among
different supervisory, regulatory and enforcement authorities
•
The rights of shareholders and key ownership functions
 The corporate governance framework should protect and facilitate the exercise of
shareholders’ rights
•
The equitable treatment of shareholders
 The corporate governance framework should ensure the equitable treatment of all
shareholders, including minority and foreign shareholders. All shareholders should have the
opportunity to obtain effective redress for violations of their rights
•
The role of stakeholders in corporate governance
 The corporate governance framework should recognize the rights of stakeholders
established by law or through mutual agreements and encourage active cooperation
between corporations and stakeholders in creating wealth, jobs, and the sustainability of
financially sound enterprise
•
Disclosure and transparency
 The corporate governance framework should ensure that timely and accurate disclosure is
made on all material matters regarding the corporation, including the financial situation,
performance, ownership, and governance of company
•
The responsibilities of the board
 The corporate governance framework should ensure the strategic guidance of the company,
the effective monitoring of management by the board, and the board’s accountability to the
company and the shareholders.
Prepared by Dr. Parmindar Singh
Page 94
Corporate governance differences among different types of organizations – an
illustration
Some differences – public-listed, private, charities and family CG
Traits
Owner
Board
Committees
Succession
planning
Public-listed
firm
Shareholders
Private firm
NGOs
(charities,
foundations etc.)
Shareholders
Founder
and
perhaps
descendent; donor
Ideally, BODs BODs
consist
of Consists of Board of
have the right shareholders/owners
governors/trustees
balance
of
KSA,
competencies,
and there is
independence;
professionally
managed
Family
business
Patriarch/
matriarch
Ideally proper
committees
Ideally proper
succession
planning
with
NC;
properly
managed;
sometimes
difficulties
in
finding the right
candidate
May or may
not
Successor
will
be
another
family
member and
therefore
succession
planning
generally not
a big issue
May or may not have
committees
Succession planning
not formal
Succession
planning
not
important as the
board will ensure
that the ideology of
the founder lives on
even
after
the
demise of founder
on Based on founder’s
of ideologies
and
culture of the NGO;
Terms of reference
(TOR)/stated
purpose
Governance
Based on LR Based
and
CG requirements
perspective – shareholders
principlesbased or rulesbased
Feud/conflict
AGMs, EGMs – Reconciled
among
professionally
owners – may be
managed
violent
and
not
professionally
managed
Prepared by Dr. Parmindar Singh
May or may not
Made
up
mainly
of
family
members
Based
family
member
needs
on
Addressed
by Feud
could
reverting
to be
family
founder’s values or rivalry
to
TOR
wrest control
of
board
decisions.
Also
paternalistic
altruism
Page 95
Corporate governance – public sector organizations (government agencies)
Public sector CG
•
These are organisations that are, in some way, connected to, or deliver, public goods and
services. This means that they help to, in some way, deliver goods and services that cannot
be, or should not be, provided by ‘for profit’ businesses.
•
Agency relationship in public-sector organizations
Principal (tax payer/funder)
Taxes
Also responsible
for delivering
government
policy – ‘political
control’
Can cause
disagreements
between tax
payers on how
much should be
spent on each
public goods and
services
Public sector (employees and government) - Agent
Delivery of public goods and services (e.g. health care, education etc.)
Service users
(patients, students et al. – can sometimes be the tax payer)
Prepared by Dr. Parmindar Singh
Page 96
• Objectives of public sector organizations:
 Public sector organizations are mainly concerned with social purposes and delivering their
services efficiently, effectively and with good value for money.
 Their general objectives are the 3E’s: economy, efficiency and effectiveness
Economy
Value for money
Efficiency
Delivers more for a given level
of resource input
Delivering
the
required The output ÷ input ratio should
serviced on time, on budget be high
and
within
resource
constraints
Doing things right - Drucker
Effectiveness
Delivers what it is intended to
deliver
Achieves targets/objectives
Doing the
Drucker
right
things
–
• Governance arrangements of public sector organizations:
 Accountability is gained in part by having a system of reporting and an oversight body over
others.
 This oversight body maybe a board of governors, a council of reference, a board of trustees,
or similar
•
Roles of oversight body:
 Comply with government rules on whichever public sector government applies
 Ensure that public sector organization is well-run and meets the performance targets
established for it by higher levels of government. It may receive internal or external audit
reports to help achieve this or make site visits and other interventions to ensure that
organization is performing according to expectations.
 May be involved in budget negotiations and then in monitoring performance against budget
 Involved in making senior appointments to the public sector body, monitoring the
performance of the appointee and may even remove the personnel
 To report upwards to local or central authorities
•




Stakeholders in public sector
Lobby groups/pressure groups (NGOs and quasi NGOs)
Tax payers
Citizens and service users
Political parties
Prepared by Dr. Parmindar Singh
Page 97
• Social contract
 Political theorists believe there is a social contract between government and tax payers in
which those who pay for and those who use public services must all feel that they are being
fairly treated and not being over-exploited nor badly served.
 Otherwise, there can be changes in the ruling party in the next elections.
•



Different levels of public sector organizations
National
Subnational
Supranational
Supranational – UN, WTO, IMF, ASEAN etc.
National – capital city, administrative center
Subnational – states, districts, municipalities etc.
•
Measures of success for different organizations type
 Profit-oriented firm – financial outcomes
 Charities – social outcomes/TOR/stated purpose
 Government agencies – delivering public goods/services in a 3E manner
Prepared by Dr. Parmindar Singh
Page 98
Corporate governance – rule-based approach
1. Sarbanes-Oxley Act (SOA), 2002
•
Congress passed the Sarbanes-Oxley Act 2002 (SOA) in August 2002.
•
SOA created Public Company Accounting Oversight Board (PCAOB) which will be under the
SEC.
2. Titles
•
Consists of 11 titles
Title number
I
II
III
IV
V
VI
VII
VIII
IX
X
XI
Description
Public Company Accounting Oversight Board (Sec. 101-109)
Auditor independence (Sec. 201-209)
Corporate Responsibility (Sec. 301-308)
Enhanced financial disclosure (Sec. 401-409)
Analyst conflict of interest (Sec. 501)
Commission resources and authority (Sec. 601-604)
Studies and reports (Sec. 701-705)
Corporate and criminal fraud accountability (Sec. 801-807)
White-collar crime penalty enhancement (Sec. 901-906)
Corporate tax returns (Sec. 1001)
Corporate fraud and accountability (Sec. 1101-1107)
3. Key goals of SOA
•
Enhance financial disclosure
•
Enhance auditor independence
•
Improve corporate governance
•
Protect public company employees, whistleblowers, and shareholders
•
Increased accountability of corporate executive
•
Deter and punish fraudulent behaviour
Prepared by Dr. Parmindar Singh
Page 99
4. External auditor independence
- Section 201 – SOA prohibits external auditor from providing internal audit outsourcing
services, financial IS design and implementation, bookkeeping and financial statement services,
management and HR functions, actuarial services, investment advisor, appraisal or valuation
services, audit-related legal services.
- Section 203 – lead audit partner and reviewing partner to rotate the audit engagement every 5
years
- Section 207 – audit firm rotation
5. Section 302
- The CEO and CFO must certify in a statement that accompanies the audit report: the
appropriateness of the financial statements and disclosures; that the statements fairly present,
in all material respects, the operations and financial conditions of the company; and that all
significant deficiencies in internal controls have been disclosed to the auditors and audit
committee.
- Also states that the officers are responsible for internal controls, have evaluated its
effectiveness in the last 90 days, have presented in their report their conclusions about the
effectiveness of their internal controls and have discussed any changes in internal controls,
including corrective actions during the period under review.
6. Section 404
- Management must describe the framework used to evaluate its internal financial controls
- Management must assess the effectiveness of its internal financial controls
- External auditors must assess the effectiveness of the framework used by management to
evaluate its ICOFR
- External auditors must also attest management’s assessment of its internal financial controls
(ICOFR)
- External auditors must also report on the fair presentation of financial statements
4 reports produced
Prepared by Dr. Parmindar Singh
Page 100
Internal control over financial reporting (ICOFR)
Management’s report
a. Describe framework
used to evaluate internal
controls – COSO, CObIT
Auditor’s report (3 reports)
1. Assessment of the
effectiveness of the
framework used
2. Attest on
management’s
assessment of ICOFR
effectiveness
b. An assessment of its
ICOFR effectiveness
3. Presentation of
financial statements: “true
and fair”
7. Problems of Section 404
-
Costs – audit fees, consultancy services, internal audit time
External auditor still providing services (together with active management
involvement)
Four reports – makes interpretation and understanding difficult
No guarantee of fraud reduction
8. Benefits of Section 404
-
Depth and breadth of ICOFR greatly increased
Control environment improved
Increased uniformity and comparability of financial statements
Modest deterrent to fraud and financial statement misrepresentation
Boost to securities market as it shows that government is serious in improving
organization’s corporate governance
Prepared by Dr. Parmindar Singh
Page 101
9. Whistleblowing
- Section 301 – Audit committee should be the avenue for whistleblowers
- Section 806 – no public company or any officer, employee, contractor, or agent of such
company may discharge, demote, suspend, threaten, harass or in any other manner
discriminate against any whistleblowers
- Section 1107 – makes it a crime for anyone knowingly with the intent to retaliate, to interfere
with the employment or livelihood of any person – a whistleblower – who provides a law
enforcement officer any truthful information relating to the possible commission of a SOA
violation offense – fines and imprisonment of up to 10 years
10. Benefits of Sarbanes-Oxley Act
• Improves auditor’s independence
• Improve internal controls
• CEO and CFO must certify financial statements – increased accountability
• Improvements in ICOFR
• All companies that are public listed must have code of ethics (Section 406)
• Improvements in risk management (Section 409)
• Whistleblower protection
11. Problems of SOA
• Accounting and financial scandals still persists post-SOA
• Costs of compliance increased
• Reduce IPOs
• Reduce economic growth of country
• Alteration of business practices, e.g. IS
Prepared by Dr. Parmindar Singh
Page 102
Corporate governance – board structure
1. Board structure – one-tier (unitary) or two-tier (compound) board
•
One-tier board
NEDs
Chairman
EDs






All directors sit on the same board
Have equal legal and executive status
Greater sharing of information, more deliberation, better decision-making
Greater intellectual capacity
Strategies can be more robustly scrutinized
Improve cooperation between directors
Prepared by Dr. Parmindar Singh
Page 103
•
Two-tier board
Supervisory/corporate board
Works council
Give
suggestions
and may
oppose
decisions made
Chairman, NEDs, bank
representatives,
controlling shareholder
representatives,
employee
representatives.
German case
Suggestions
Decisions
EDs
Management/operating board
 Decisions are made by supervisory board and executed by management board – and
therefore, decisions can be executed much faster, which may be useful in times of crises
and fast changing environments (one-tier board counters this by having a small board size).
 Management board may give suggestions but cannot opposed decisions made by
supervisory board.
 Clear separation of duties – no duality of post between CEO and chairman.
 In a German case, there is a Works Council, made up of employees, who may both give
suggestions and even oppose decisions made by the supervisory board
 Example of countries with two-tier boards – Germany, Netherlands, Denmark, Austria,
Finland and Indonesia.
Prepared by Dr. Parmindar Singh
Page 104
Risk
1. Definitions
-
A condition in which there exists a quantifiable dispersion in the possible
outcome from any activity
-
Refers to a chance that some unfavourable event will occur
2. Sources of risks (Ritchie and Marshall)
•
Exogenous risks – PESTEL, market forces
•
Endogenous risks – weakness in 7S, value chain, internal controls
3. Types of risks
-
Financial risks
Operational risks
Compliance risks
Business (including strategic) risks
Any other risk
FOCBA
Prepared by Dr. Parmindar Singh
Page 105
4. Financial risks
-
-
Credit risks – is the risk to a company from the failure of its debtors to meet their
obligations on time
Liquidity risks – is the risk of loss to a mismatch between cash inflows and cash
outflows
Currency risks – is the possibility of loss or gain due to future changes in exchange
rates
Market risks – also known as systematic risk (or non-diversifiable risk) occurs due
to external events such as political (wars), economic (inflation, recession, high
interest rates) etc. Company-specific risks are also known as diversifiable or
unsystematic risks
Derivative risks – CDOs, CDS
5. Currency risks
-
Transaction risks – exchange rate movements between time of entering into
an international trading and the time of cash settlement
Translation risks – changes in balance sheet values due to retranslation at
different prevailing exchange rates at the end of each year
Economic risks – effect of exchange rate movements on foreign labour etc.
6. Operational risks
•
Relates to activities carried out in an organization’s value chain or 7S
•
Examples:
-
Business interruptions
Errors or omissions by employees
Product failure
Health and safety
Failure of IT systems
Fraud
Loss of key people
Loss of suppliers etc.
Prepared by Dr. Parmindar Singh
Page 106
7. Compliance risks
Failing to follow all requirements of the laws, regulations, policies and procedures
8. Business (strategic) risks
Strategic risks are risks that relate to the fundamental and key decisions that the directors
take about the future of the organization. Strategic risks occurs if the decisions made by
board and top management fails to improve organizational performance, losing out in
terms of competitive advantage, failing to create new markets etc. Can lead to strategic
drift.
9. Any other risks
-
Legal risks
Political risks
Technological risks – hardware, software (business flows, FRU issues, security),
data
Natural disasters
Health, safety and environmental
Reputation risks – caused by failing to address some other risks.
Business probity risks
LePTeNHeRP
Prepared by Dr. Parmindar Singh
Page 107
10. Reputation risks
•
Can cause:
-
Loss of confidence – affecting organization’s financial situation
Likely to affect customers, suppliers, competitors
Loss of attractiveness – unable to recruit the best people, unable to source new
funds from banks/creditors
Declining share prices
Greater scrutiny from external auditors and regulators
-
11. Risk correlation
•
If correlation is positive, then risks covary, i.e. risk A increases then risk B also increases
and vice-versa.
•
Some risks can covary, for example, environmental risks and reputational risks
•
If correlation is negative, then risks are inversely proportional, for example, reputational risks
and share price
12. Risk audit – a systematic assessment of understanding the risks that an organization faces
•
Risk identification – nature/source of risks
•
Risk assessment – likelihood and impact of each risk
•
Risk review – analyse the controls the organization has in the event the risk materializes
•
Risk reporting – prepare reports on risks and submit to the board
Risk audit
In-house (internal auditor)
Outsource (external auditor)
Internal auditor highly familiar with Avoids independence and familiarity threat
organization
Problem: familiarity and independence Greater emotional detachment
threat
Higher investor confidence
Fresh perspective
Best practice and current developments
can be introduced
Prepared by Dr. Parmindar Singh
Page 108
13. Risk thermostat
•
Concept to explain the inherent balance and equilibrium for an individual to take risks as
compared to the potential for returns
14. Risk culture
•
Risk culture is the set of shared attitudes, values and practices that characterize how an
entity/organization considers risk in its day-today activities
•
Can be determined in part by organization mission/vision, rewards, and organizational
practices
15. Risk appetite
•
The amount of risk an organization is willing to accept in pursuit of value.
•
Can be analyzed from:
An organization’s strategy, policies and procedures, decisions and actions
16. Risk management
•
Risk management is a continuous process
•
Consists of:
Drennan:
-
Identifying strategic objectives and threats to successful implementation
Evaluating potential threats in terms of probability of occurrence and the likely
impact on the business
Making decisions on the treatments of each risks and prioritizing them – risk
control
Developing plans to ensure business can function effectively and placing
monitoring systems in place
Prepared by Dr. Parmindar Singh
Page 109
Selim and McNamee:
Risk assessment – risk identification, risk measurement, and risk prioritization.
Risk response – acceptance, transference, avoidance or reduction.
Risk communication – internal and external stakeholders.
-
ARC
Risk assessment
Turnbull Risk assessment:
-
Identifying the nature and the extent of risks facing the company
Categorising the risks which it regards as acceptable for the company to bear
Assessing the likelihood (probability) of the risks concerned materializing
Assessing the company’s ability to reduce the incidence/risks and impact on the
business of risks that do materialize
Assess the costs of operating particular controls relative to the benefits thereby
obtained in managing the related risks
Identify risks
Categorize the risks
Acceptable risks
Unacceptable risks
Likelihood? (H, M, L)
Ability? (Y/N)
Impact? (H, M, L)
Costs
Prepared by Dr. Parmindar Singh
Benefits
Page 110
Risk assessment
COSO:
-
Estimating the significance of the risk
Assessing the likelihood of the risk occurring
Considering how the risk should be managed, and assessing what actions to be
taken
Risk assessment:
-
Selim and McNamee – IMP
COSO
Turnbull
Risk
management
Risk
assessment
Prepared by Dr. Parmindar Singh
Page 111
17. COSO risk assessment matrix/TARA matrix
Consequences/impact/significance
Low
High
Acceptance
Low
Transference
High
Low
Risks are not significant.
Insure risks, outsource and
implement contingency
plans to pass to 3 rd parties
Keep under view.
Likelihood
Reduction
High
Avoidance
Take some action, e.g.
Take immediate action e.g.
insurance, contingency
terminate operations etc.
TARA = risk
management strategy
planning, internal controls,
culture of ethics,
code of ethics, risk
management, HRP, HRD,
internal audit
•




Risk heat map
Convert risk assessment matrix into a 5X5 matrix
Then assign a rank from 1to 5 for low to high
Multiply them to get a grade (maximum of 25)
Then band the cells to show the differences
1
Likelihood
2
Impact
3
4
5
1
2
3
4
5
Prepared by Dr. Parmindar Singh
Page 112
• Risk register
 Also referred to as a risk log is a master document that helps to track risks and address
them as they arise.
 The Risk Register will generally be shared between stakeholders, allowing those involved to
be kept aware of issues and providing a means of tracking the response to issues. It can be
used to flag new risks and to make suggestions on what course of action to take to resolve
any issues.
 All corporate and organizational projects face risk at one time or another. Having a Risk
Register in place simply provides a better means of responding to problems as they arise.
The Risk Register is there to help with the decisions making process and enables managers
and project stakeholders to handle risk in the most appropriate way. A risk needn't be a
threat to your project, it is simply an issue that can arise during the project; if effectively
managed, it shouldn't prevent your project from attaining its goals and objectives.
 The Risk Register is a document that contains information about identified project risks,
analysis of risk severity and evaluations of the possible solutions to be applied.
Ris
k
Descriptio
n
Category
Cause
A
Product
failure
Operationa
l
B
Wrong
strategy
Strategic
Lack
of 0.5
competenc
y
Ineffective
0.6
BOD
Prepared by Dr. Parmindar Singh
Probabilit
y
Impac
t
Response
s
Owner
Status
High
Training
Activ
e
High
EGM
Productio
n
manager
Chairman
Close
Page 113
18. Enterprise Risk Management (ERM) definitions
COSO:
A process, effected by an entity’s board of directors, management and other personnel,
applied in strategy setting and across the enterprise, designed to identify potential events
that may affect the entity, and manage risk to be within its risk appetite, and to provide
reasonable assurance regarding the achievement of entity objectives
IIA:
A structured, consistent and continuous process across the whole organization for
identifying, assessing, deciding on responses to and reporting on opportunities and
threats that affect the achievement of its objectives
19. Benefits of ERM
•
Better risk management
-
Aligning risk appetite and strategy
Enhancing risk response decisions
Minimizing operational losses and surprises
Identifying and managing cross-enterprise risk
Providing integrated response to multiple risks
•
Seizing opportunities
•
Rationalizing capital
•
Developing sound internal controls
•
Linking growth, risk and returns
Prepared by Dr. Parmindar Singh
Page 114
20. COSO ERM objectives
•
Strategic – high level goals which are aligned with the organization’s mission
•
Operations – efficient and effective use of resources
•
Reliability of reporting
•
Compliance with laws and regulations
SORC
21. COSO ERM Components
Components
Internal environment
Objective setting
Event identification
-
Risk assessment
-
Risk response
Control activities
-
Information and communication
-
Monitoring
Prepared by Dr. Parmindar Singh
-
Explanation
Tone of organization/top
Ensuring staff with high integrity
Culture of ethics
Objectives/goals align with mission
Consistent with risk appetite
External appraisal – threats and
opportunities
Internal appraisal – strengths and
weaknesses
Threats and weaknesses – pose
risks
Constantly assess likelihood and
impact of risks
ATAR
Proper policies and procedures to
ensure appropriate risk response
Proper controls
Proper information communicated
to the right person at the right time
(external/internal)
Proper monitoring of the above
Make modifications if necessary
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22. Risk terms and expressions:
•
Dynamic nature of risk assessment
- Risks are not static
- Risk assessment therefore should not be one-off but continual
•
Importance and nature of management responses to changing risk assessments
- Since risk assessment is continual, some risks can change in likelihood and importance
- Therefore, proper responses will be needed
•
Risk appetite and risk policy
- If the board or firm has a higher appetite for risks, then the risk policies would reflect this
higher risk appetite
•
External reporting on internal controls and risks
- Less information asymmetry
- Improve investor confidence (more transparent)
•
ALARP principle in risk assessment
- All organizations must take steps to mitigate risks
- In mitigating risks, considerations must be given to cost-benefit analysis
- As long as benefits exceed costs, steps must be taken to mitigate risks such as TAR
- However it does not mean that the organization is no more facing any risks, it has
merely kept it ALARP
•
Difficulties of risk perception
- Some risks are harder to quantify and therefore more difficult to perceive its likelihood
and impact
- If risks are objective/quantifiable, risk perception becomes easier and vice-versa
•
Covariant risk
- Risks are positive correlated
•
Techniques and policies to mitigate business and financial risk
- TAR approaches such as insurance, outsourcing, strategies (JV, franchising, licensing);
hedging
•
Define risk appetite
- The tendency of a board or a firm to take risks after considering the risks thereof. If the
tendency is high, then the firm has a high risk appetite and vice-versa.
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23. Embedding risk into culture
24. The role of risk manager
•
Planning, designing and implementing an overall risk management process for the
organisation;
•
Risk assessment, which involves analysing risks as well as identifying, describing and
estimating the risks affecting the business;
•
Risk evaluation, which involves comparing estimated risks with criteria established by the
organisation such as costs, legal requirements and environmental factors, and evaluating
the organisation's previous handling of risks;
•
Establishing and quantifying the organisation's 'risk appetite', i.e. the level of risk they are
prepared to accept;
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•
Risk reporting in an appropriate way for different audiences, for example, to the board of
directors so they understand the most significant risks, to business heads to ensure they are
aware of risks relevant to their parts of the business and to individuals to understand their
accountability for individual risks;
•
Corporate governance involving external risk reporting to stakeholders;
•
Carrying out processes such as purchasing insurance, implementing health and safety
measures and making business continuity plans to limit risks and prepare for if things go
wrong;
•
Conducting audits of policy and compliance to standards, including liaison with internal and
external auditors;
•
Providing support, education and training to staff to build risk awareness within the
organisation.
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Organizational control and audit – internal controls and internal audit
Internal controls
1. Definitions of a sound internal control system
Turnbull guidance:
A system that encompasses the policies, processes, tasks, behaviours and other aspects of
a company that, taken together:
•
Facilitate its effective and efficient operation by enabling it to respond appropriately to
significant business, operational, financial, compliance and other risks to achieving the
company’s objectives. This includes the safeguarding of assets from inappropriate use or
from loss and fraud and ensuring that liabilities are identified and managed;
•
Help ensure the quality of internal and external reporting. This requires the maintenance
of proper records and processes that generates a flow of timely, relevant and reliable
information from within and outside the organization;
•
Help ensure compliance with applicable laws and regulations, and also with internal
policies with respect to the conduct of business
COSO:
A process, effected by an entity’s board of directors, management, and other personnel,
designed to provide reasonable assurance regarding the achievement of objectives in the
following categories:
•
Effectiveness and efficiency of operations
•
Reliability of financial reporting
•
Compliance with applicable laws and regulations’
ORC
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2. Symptoms of internal control failings
•
Fraud, embezzlement, siphoning, theft, accidents, safety and health hazards, mishaps,
malfeasance
3. Internal controls
•
Should be embedded in organization culture
•
It is the responsibility of the board (risk or audit committees) to ensure that an entity has a
sound system of internal controls and to develop polices on internal controls as well as to
regularly seek assurance that the internal controls in placed are meeting its objectives
•
While it the responsibility of management to decide on how the policies on internal control
will be implemented. Management should therefore design, operate and monitor the internal
control systems in placed
•
All employees have some responsibility for internal control. They, collectively, should have
the necessary knowledge, skills, information and authority to establish, operate and monitor
the system of internal control. This will require an understanding of the company, its
objectives, the industries and markets in which it operates, and the risks it faces.
Internal controls and risk management
DIOM, review;
sound communication processes
for internal and external
information
BOD/committee
Implement and take
day-to-day responsibility for
board policies on RM & IC
CEO
Some responsibility
all employees
Embed in culture
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ERM
Internal controls
Risk assessment
4. Elements of internal control
Turnbull guidance:
•
Control environment and control activities
•
Information and communications processes
•
Process for monitoring the continuing effectiveness of the system of internal control
CIM
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COSO:
•
Control environment
•
Risk assessment
•
Control activities
•
Information and communication
•
Monitoring
CRAIM
5. Control environment
-
-
Strategies – for dealing with risks
Structure – assigning the right people to the right tasks; having a proper organizational
structure (matrix, flat/tall, centralized/decentralized etc.); authority, responsibility and
accountability clearly defined; proper communication so that employees are aware
what is expected of them
Systems – proper risk policies in place; process/activities adjusted to reflect changes in
risks; proper internal audit in place
Staff – competent personnel through HRP; orientation/induction; HRD; rewards;
performance appraisal; promotion and discipline; proper BOD and committees
Style – right management style (setting tone at the top); commitment to competence,
integrity, and fostering a climate of trust
Skills – competent personnel (knowledge, skills)
Super-ordinate goals – integrity and ethical values; code of conduct
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6. Control activities
-
Segregation of duties, physical controls, authorization and approval, management
controls, supervision controls, organization controls, arithmetic and accounting controls,
personnel controls.
SPAMSOAP
7. Information and communication
-
Proper information systems in place – to provide real-time information about internal and
external events
Information is relevant, accurate, reliable, sufficient, complete, concise etc. and IS
constantly reassessed to ensure functionality
Information must be about the firm as well as about the environment
Information must flow vertically, laterally, inside-out and outside-in
Proper channels of communication in place for whistleblowers
8. Monitoring
•
•
Monitoring can be done periodically as well as ongoing (control self-assessment etc.)
Aim:
Emerging risks
Deficiencies in internal controls and risk management systems
-
So as to make the necessary adjustments/modifications to ensure sound/robust internal
controls and risk management systems
9. Typical contents of report on internal controls and audit
• Framework used to evaluate internal controls
• Assessment of internal control effectiveness
• Auditor assessment of framework used to evaluate internal controls
• Auditor verification of internal control effectiveness
• Opinion of “fair and true” of financial statements
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10. Reminder
A sound system of internal control reduces, but cannot eliminate, the possibility of poor
judgment in decision-making; human error; control processes being deliberately
circumvented by employees and others; management overriding controls; and the
occurrence of unforeseeable circumstances.
A sound system of internal control therefore provides reasonable, but not absolute,
assurance that a company will not be hindered in achieving its business objectives, or in
the orderly and legitimate conduct of its business, by circumstances which may reasonably be
foreseen. A system of internal control cannot, provide protection with certainty against a
company failing to meet its business objectives or all material errors, losses, fraud, or breaches
of laws or regulations.
11. Benefits of having a sound internal control system
•
Fulfillment of business objectives
•
Safeguards shareholders’ investments
•
Safeguard company’s assets
•
Enables operations to be done efficiently and effectively
•
Helps ensures the reliability of internal and external reporting
•
Assists compliance with laws and regulations
•
Effective financial controls ensures that company is not unnecessarily exposed to financial
risks, prevents and detects fraud
12. Limitations of internal control
•
Costs of implementing controls must not outweigh the benefits (CBA)
•
Only provides reasonable assurance but not absolute assurance
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Internal audit
1. Definition
IIA:
A systematic and disciplined approach to provide an independent and objective:
-
assurance and
consulting activity on
risk management, internal controls and governance
that is designed to add value to an organization’s operations.
2. Independence
-
Independent of the activities being audited
Independent of management whose activities it may audit
Independence resulting in:
•
Objectivity – judgments are made in a state of detachment from the situation or
decision
Impartiality – not taking sides, in particular not being influenced by office politics in
determining the work carried out and the reports given
Unbiased views – avoiding the perception that internal audit is out to ‘hit’ certain
individuals or departments
Valid opinion – the audit opinion should be based on all relevant factors, rather than
being one that pleases everyone
No spying for management – again internal audit should serve the whole organization
No no-go areas – should not be kept away from certain areas
Sensitive areas audited – internal audit must have the abilities and skills to audit
complex areas effectively
Senior management audited – internal audit must cover the management process and
not just the detailed operational areas
No backing-off – internal auditors must not be distracted from doing the necessary
work and issuing valid opinions
•
•
•
•
•
•
•
•
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3. Threats to independence
•
Involvement in systems design
•
Close professional or personal relationships
•
Reporting relationships – the Head of internal audit or internal audit director should be
independent of the finance director or CFO. The internal audit department or the Head
should report to the board or to the audit committee and this should be enshrined in internal
audit charters
4. Auditor capture
If the independence and objectivity of internal auditors have been compromised, then there has
been ‘auditor capture’
5. Dealing with threats to independence
•
Do not conduct audits on departments in which internal auditors have previously worked
•
Do not conduct post-implementation audits on information systems where internal auditors
have been involved
•
Rotation of internal audit staff
•
Unrestricted access to records, assets and personnel
•
Avoid any conflict of interests (accepting gifts etc.)
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6. Need for internal audit
•
The scale, diversity and complexity of the company’s activities
•
The number of employees
•
Cost-benefit considerations
•
Changes in organizational structures, reporting processes or underlying information systems
•
Changes in key risks
•
Problems with internal control systems
•
An increased number of unexplained or unacceptable events
The role of internal audit is decided by management
7. Objectives/functions/scope of internal audit
•
Evaluate and improve risk management process
- Risk assessment – risk identification, risk measurement, risk prioritization
- Risk response/treatment – how to manage the perceived consequences of risk
- Risk communication – to interested shareholders
•
Evaluate and improve internal controls
Review and appraise the adequacy, effectiveness, and efficiency of the internal
control system in order to provide an independent opinion of it, control framework
monitoring and development
•
Examination of financial and operating information – check for suitability, reliability and
integrity, financial audits
•
Review of the economy, efficiency and effectiveness of operations – operations audit
•
Review of the safeguarding of assets
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•
Review of the implementation of corporate objectives
•
Special investigations, e.g. suspected fraud
•
Review of compliance with legislation, regulations and codes of practices
•
Follow-up action taken to remedy weaknesses identified by internal audit reviews and
ensuring that good practice is identified and communicated widely
•
Testing to ensure robustness – stress-, compliance-, load testing; security issues
•
Social and sustainability audits
•
External audit assistance
•
Corporate takeovers and mergers
•
Project management
•
The operation of the organization’s corporate governance arrangements
8. Internal audit
•
Recruit internal auditors
•
Promote from within
•
For external recruitment of internal auditors
Advantages
Fresh perspectives
Detachment and independence – objective
Transfer and best practice in from outside
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Disadvantages
May not understand the culture, need and
wants of organization – lack of familiarity
and therefore may take time to contribute
Possible lack of cooperation from others
Costly
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9. Outsourcing internal audit
Advantages
Improve focus and cost
Disadvantages
Conflict of interest – if outsourced service
is provided by external auditor – illegal in
US
Outsourcer may have more expertise – Lack of knowledge or awareness of the
improve efficiency
organization objectives, culture or business
Less subject to high turnover of staff from High costs
internal audit
Skills of internal audit may be only be perhaps poor quality
required for a short time in each year
10. Risk personnel
Head of internal audit
•
Developing an annual audit plan based on an assessment of the significant risks to which
the organization is exposed
•
Submitting the plan to the audit committee for approval
•
Implementing the agreed audit plan
•
Maintaining a professional audit team with sufficient knowledge, skills and experience to
carry out the plan
Chief Risk Officer
•
Providing overall leadership, vision, and direction for ERM
•
Establishing an integrated ERM framework for all aspects of risks across the organization
•
Developing risk management policies, including the quantification of management’s risk
appetite through specific risk limits
•
Implementing a set of risk metrics and reports, including losses and incidents, key risk
exposures and early warning indicators
•
Allocating economic capital to business activities based on risk, and optimizing the
company’s risk portfolio through business activities and risk transfer strategies
•
Improving the company’s risk management readiness through communication and training
programs, risk-based performance measurement and incentives, and other change
management programs
•
Developing analytical, systems and data management capabilities to support risk
management program
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Risk manager
•
Assess risk
•
Planning on how to address risks
•
Organizing right personnel to ensure risk is addressed
•
Leading and directing staff to ensure all become responsible to address risks
•
Controlling the occurrence of risks beyond a firm’s appetite
11. Audit plan
•
Description of the system or process to be audited, identifying its boundaries and
connections to other systems and processes
•
Risks that need special attention
•
Scope of work to be carried out, identifying any areas not to be audited
•
Milestone dates for completion and resources allocated to the audit
•
Reporting and review procedure
•
Audit program and techniques to be applied
•
Audit staff allocated to the assignment
12. Factors to evaluate internal audit
•
Has the purpose, authority and responsibility of the internal audit function been formally
defined and approved by the audit committee?
•
Can internal audit carry out consulting services without compromising its primary role?
•
Does the head of internal audit report directly to the audit committee?
•
Is the head of internal audit free of any operational responsibility that might impair
objectivity?
•
Does the head of internal audit have direct access to the chair of the board?
•
Have any members of the internal audit team given assurance on business areas for which
they were previously responsible? Etc.
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The relationship between Audit committee, Chairman, CEO, internal auditor and external auditor
Chairman
Internal
Auditor
has access to
Reports to and accountable to
Approves or terminate
Duty
approve
consulting &
& review
IA remit
assurance
Audit
committee
Reviews and
CEO
Approve IC and
I,O,M
IC & RM
RM
Develops/design IC & Risk management
Recommends the appointment, re-appointment and removal
Decides on engagement policies and remuneration
Reviews the effectiveness of the audit process
External
auditor
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Integrated reporting (IR)
1. Definitions
•
Integrated Reporting (IR) combines information about a company’s strategy, performance,
governance and sustainability activities and aims to show how these various factors connect
in order to provide stakeholders with a complete picture of how the company creates value
over time.
•
An integrated report is a concise communication about how an organization’s strategy,
governance, performance and prospects, in the context of its external environment, lead to
the creation of value over the short, medium and long term.
2.
Aims of IR
Purposes and use of an IR
To provide insight about the external The primary purpose of an integrated report is
environment that affects an organization.
to explain to providers of financial capital how
an organization creates value over time. It
therefore contains relevant information, both
financial and non-financial.
To provide insight about the resources and the
relationships used and affected by the
organization. This resources and relationships
are collectively known as capitals. Capitals are
categorized as financial, manufactured,
intellectual, human, social and relationship,
and natural.
Companies also want to provide information to
other stakeholders with a more complete
picture of how an organization creates value
over the long-term. As such an IR benefits all
stakeholders interested in an organization’s
ability to create value over time, including
employees, customers, suppliers, business
partners, local communities, legislators,
regulators and policy-makers.
To provide insights on how an organization
interacts with the external environment and the
capitals to create value over the short, medium
and long term.
Companies want to avoid the inefficiencies
associated with distinct financial and
sustainability
reports
and
operational
processes.
An integrated report is intended to be more
than a summary of information in other
communications (e.g., financial statements, a
sustainability report, analyst calls, or on a
website); rather, it makes explicit the
connectivity of information to communicate
how value is created over the short, medium
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and long-term.
An integrated report may be either a
standalone report or be included as a
distinguishable, prominent and accessible part
of another report or communication.
Integrated reports are supposed to be
principles-based approach, i.e. comply or
explain.
3. Mandatory publication of IR
•
•
South Africa (Johannesburg Stock Exchange)
Denmark
4. Capitals
•






In Integrated Reporting, the capitals are:
Financial
Manufactured
Human
Intellectual
Social and relationship
Natural
•
There are interactions among these stock and flow of capital
•
An organization should report the inflows, outflows, risks and opportunities for each type of
capital and explain how they affect other capitals.
1. An organization increases its financial capital when it makes a profit and increases its human
capital when employees are trained;
2. However, the training cost reduces its financial capital. The effect is that financial capital has
been transformed into human capital. Thus there is interaction between various capitals albeit
with varying rates and outcomes.
3. An organization using natural resources such as land, water and energy. There is therefore
reduction in natural capital but an increase in financial capital.
4. Cost of employee → outflow to an employer; payment to employees → inflow to employees
and community; investment in training →increases human capital and may also increase social
and relationship capital.
5. Risks: if customers displeased with quality of products and services provided by employees
then there will be a decrease in social, financial and intellectual (reputation) capital.
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6. Opportunities: Employees also provide opportunities for increasing capital
5. Descriptions of capitals
Financial
Debts
Equity
Grants
Investments
Operations
Manufactured
Human
Intellectual
Social
& Natural
relationship
Buildings
Competencies KnowledgeRelationship
Air
based
between and
intangibles – within
tacit
communities
knowledge
Equipment
Capabilities
Intellectual
Stakeholders Water
properties
and
other
networks
Infrastructure Experience
Patents,
Shared
Land
and
(roads, ports,
copyrights,
norms
and forests
bridges,
licenses,
values
plants etc.)
source codes
Products
Loyalties
Protocols,
Trust
and Energy and
procedures
relationships
minerals
Motivations
Systems
Social license Biodiversity
to
operate; and
brand
and ecosystem
reputation
health
6. Benefits and costs of IR
Benefits
Integrated
thinking
–
integrating
environmental, social and governance data
with financial data forces companies to
consider the long-term impact of decisions
rather than focusing on short-term results.
Integrated reports provide a big picture view.
Correlations can be better understood when
financial results are directly connected to ESG
(environmental, social and governance)
performance and ESG performance is directly
tied to overall strategy and business models.
Costs
Companies need to identify information that is
relevant and significant for each strategic
objective.
IR, if done properly should improve both Employees need education and training about
financial and sustainability performance as IR.
well as to ensure that the two are more
aligned.
IR removes the negative impression that Information systems –
organizations are developing sustainability and summarize information.
citizenship reports as a PR gimmick as IR
integrates ESG with strategy and financial,
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to
collect
and
Page 134
making stakeholders believe that it is more
reliable.
Signals to managers and employees that ESG
issues are given the same weight as financial
considerations in making decisions.
Improves reputation.
Lowers risk – reputational risk for example;
improve ability to identify and manage risks.
Lowers cost – integrating all activities into a
single report rather than separate reports.
Results in the connection and cooperation of
various business units within an organization.
Improvements in internal processes.
Reduction in information asymmetry.
IR requires more involvement by senior
management and top management team in
sustainability activities.
IR helps stakeholders better
business prospects and value.
Prepared by Dr. Parmindar Singh
understand
Page 135
7. The value creation process
Mission and vision
Governance
Risks and opportunities
capital
Strategy & resource allocation
capital
Business model
Input
Business
activities
Output
Performance
Outcomes
Outlook
Environment
8. Contents of an Integrated report
•
Organizational overview and external environment
•
Governance
•
Business model
•
Risks and opportunities
•
Strategy and resource allocation
•
Performance
•
Outlook
•
Basis of preparation and presentation
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9. Organizational overview and external environment
•
Mission, vision, culture, ethics and values, ownership and operating structure
•
Macro environment (PESTEL) and market forces (Porter’s five forces)
•
Value chain/system
•
Key quantitative information (e.g., the number of employees, revenue and number of
countries in which the organization operates), highlighting, in particular, significant changes
from prior periods.
10. Governance
•
Leadership structure - skills and diversity (e.g., range of backgrounds, gender, competence
and experience) of those charged with governance
•
Regulatory requirements and impact on governance structure
•
Processes used to make strategic decisions
•
Attitude to risk and mechanisms for addressing integrity and ethical issues
•
Actions taken by those charged with governance to influence and monitor the strategic
direction of the organization
•
Approach to risk management
•
How culture, ethics and values are reflected in its use of and effects on the capitals,
including its relationships with key stakeholders
•
The responsibility those charged with governance take for promoting and enabling
innovation
•
Remuneration and its linkage to value creation and capitals
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11. Business Model
•
•
•
•
Inputs
Business activities
Outputs
Outcomes
Inputs
Business activities
Must be of material Marketing mix
interest
Consists of capitals
Outputs
Products
Outcomes
Internal outcomes –
e.g.
morale,
reputation,
cash
flows, revenue
How firm generates Services
External outcomes –
revenue
brand
loyalty,
customer satisfaction,
tax payments, social
and
environmental
effects
HRM
Waste
materials Positive outcomes –
generated as a by- increase
in
net
product
capital, say
How firm innovates
Negative outcomes –
decrease in capitals,
say
Effects
on
value
system
12. Risks and opportunities
•
Integrated reports should explain the risks and opportunities facing the firm in the short-,
medium- and long-term and how an organization is going to address these issues.
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13. Strategy and resource allocation
•
The organization’s short, medium and long term strategic objectives
•
The strategies it has in place, or intends to implement, to achieve those strategic objectives
•
The resource allocation plans it has to implement its strategy
•
How it will measure achievements and target outcomes for the short, medium and long term
- the linkage between the organization’s strategy and resource allocation plans
•
What differentiates the organization to give it competitive advantage and enable it to create
value – innovation, intellectual capital, and the extent to which environmental and social
considerations have been embedded into the organization’s strategy to give it a competitive
advantage
•
Key features and findings of stakeholder engagement that were used in formulating its
strategy and resource allocation plans
14. Performance
•
Performance as a result of pursuing strategy
•
An integrated report contains qualitative and quantitative information about performance that
may include matters such as:
Quantitative indicators with respect to targets and risks and opportunities - explaining their
significance, their implications, and the methods and assumptions used in compiling them
The organization’s effects (both positive and negative) on the capitals, including material effects
on capitals up and down the value chain
The state of key stakeholder relationships and how the organization has responded to key
stakeholders’ legitimate needs and interests
The linkages between past and current performance, and between current performance and the
organization’s outlook
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•
KPIs should show connectivity:
 Financial measures with other components (e.g., the ratio of greenhouse gas emissions
to sales) or
 Narrative that explains the financial implications of significant effects on other capitals
and other causal relationships (e.g., expected revenue growth resulting from efforts to
enhance human capital)
 In some cases, this may also include monetizing certain effects on the capitals (e.g.
carbon emissions and water use)
 It may be relevant for the discussion of performance to include instances where
regulations have a significant effect on performance (e.g., a constraint on revenues as a
result of regulatory rate setting) or the organization’s non-compliance with laws or
regulations may significantly affect its operations
15. Outlook
•
An integrated report should answer the question - what challenges and uncertainties is the
organization likely to encounter in pursuing its strategy, and what are the potential
implications for its business model and future performance?
•
The organization’s expectations about the external environment and how it will affect the
organization in the short, medium and long term - risks and opportunities, with an analysis of
how these could affect the achievement of strategic objectives
•
How the organization is currently equipped to respond to the critical challenges and
uncertainties that are likely to arise
•
The availability, quality and affordability of capitals the organization uses or affects (e.g., the
continued availability of skilled labour or natural resources), including how key relationships
are managed and why they are important to the organization’s ability to create value over
time
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16. Guiding principles in the preparation of an integrated report
•
Strategic focus and future orientation
•
Connectivity of information
•
Stakeholder relationships
•
Materiality
•
Conciseness
•
Reliability and completeness
•
Consistency and comparability
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Strategy
Concepts of strategy
1. Strategy definitions
•
Strategy is the direction and scope of an organization over the long-term, which achieves
advantage in a changing environment through its configuration of resources and
competences with the aim of fulfilling stakeholder expectations – Johnson et al.
•
Strategy is a set of goal-directed actions a firm takes to gain and sustain superior
performance relative to competitors – Rothaermel
•
Strategy is the set of actions that its managers take to outperform the company’s
competitors and achieve superior profitability – Thomson, Peteraf, Gamble and Strickland
•
Strategy is the creation of a unique and valuable position, involving a different set of
activities, making trade-offs when competing and involves creating fit among a company’s
activities - Porter
2. Strategy
Johnson et al. – levels of strategy
Corporate-level
Business-level
Operational/functional level
Prepared by Dr. Parmindar Singh
Mintzberg – meanings of strategy
Plan – some sort of consciously intended
action, guidelines to deal with a situation.
Ploy – a specific maneuver intended to outwit
an opponent or competitor.
Position - a means of locating an organization
in an environment in achieving competitive
advantage.
Pattern – a stream of actions, whether
intended or not, where there is consistency in
behavior.
Perspective – consisting of an ingrained way
of perceiving the world.
Page 142
3. Characteristics of strategic decisions
•
•
•
•
•
•
Concerns the long-term direction of an organization
Concerns achieving competitive advantage
Concerns with the scope of an organization’s activities
Concerns exploiting the strategic capability of an organization
Concerns with the strategic fit with the business environment
Concerns the values and expectations of stakeholders
DAACER
4. How strategies are developed
•
Mintzberg
Strategy as outcome of
cultural and political
processes
Planned
intended
strategy
Deliberate strategy
Unrealized
strategy
Imposed
strategy
Realized strategy
Emergent strategy
Unrealized strategy – due to implementation failure and can occur because of:




Lack of coordination
Resistance
Unclear strategy or not communicated well
Poor management or lack of leadership
Or because of strategic drift
Prepared by Dr. Parmindar Singh
Page 143
•
Johnson et al. strategy lenses
Design lens
Strategies
being
developed
by
undertaking
a
thorough,
logical
analysis, focusing on
a
firm’s
mission,
goals,
objectives,
external-,
internaland
stakeholder
appraisal
Experience lens
Strategies
being
developed by taking
into
account
the
collective experience
of senior managers as
well as the prevailing
culture
of
the
organization
Ideas lens
Strategies
being
developed as a result
of ideas conceived on
how
to
exploit
opportunities,
overcome threats, or
utilizing strengths and
overcoming
weaknesses;
from
these
ideas,
strategies emerge on
how best to undertake
the aforementioned
Discourse lens
Strategies
being
developed as a result
of the mastery of the
language of strategy
5. Strategic drift
•
The tendency for strategies to develop incrementally on the basis of historical and cultural
influences, but fail to keep pace with a changing environment.
6. Strategic management model – Johnson et al.
•
•
•
Strategic position (understanding the strategic position of the organization)
Strategic choices (making strategic choices for the future)
Strategic action (managing strategy in action)
Prepared by Dr. Parmindar Singh
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Strategic management model
Strategic position
Strategic choices
Strategic actions
7. Strategic position
•
•
•
•
Deciding on mission, vision goals, objectives, CSFs
Analysing environment – macro, industry – external appraisal/external position –
opportunities and threats
Strategic capability analysis/internal appraisal – resources analysis, competencies,
processes, activities, culture – strengths and weaknesses
Stakeholder analysis – including corporate governance issues and CSR issues
Prepared by Dr. Parmindar Singh
Page 145
SWOT
8. Strategic choices
•
Strategic options:
What basis
Generic strategies:
Cost leadership
Which direction
Directions:
Market penetration
Differentiation
Market development
Focus/niche
Product development
Bowman – hybrid strategies
Diversification
International
Divest
•
How/which method
Methods:
Internal growth/internal
development/organic growth
External growthAcquisitions and mergers
Alliances – equity and nonequity alliances
Evaluating strategies – using the FAS criteria (feasibility, acceptability and suitability)
9. Strategic action
•
•
•
•
Ensuring the right organizational structure
Having a proper HRM, IS, and finance
Managing strategic change
Undertaking projects based on changes needed.
Prepared by Dr. Parmindar Singh
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Strategic position
1. Mission Statement
•




According to Campbell and Yeung, a good mission statement will have the following
characteristics:
Purpose – why is the company in existence? Mission statement addresses the question:
“What is the reason for our existence?” (raison d’etre)
Strategy – what is the company’s competitive position and distinctive competence?
Values – what are the company’s beliefs, moral and principles?
Behavior standards – what are the company’s policies, SOPs and behavior patterns (such
as management style)
PSVB
•





According to Russell Ackoff, mission statement will have 5 characteristics:
It specifies the businesses the organization is in and wants to be
It specifies the objectives that the organization wishes to pursue
It helps to differentiate the company from its competitors
It is exciting and inspiring
It specifies the stakeholders of the organization
BODES
Companies that have proper mission (purpose and core values) tends to have enduring long
term success – Collins and Porras
•
Examples of past mission statements:

Absolutely, Positively Overnight - FedEx. (emphasis on total customer satisfaction)

Beat Coke – PepsiCo

We will crush, squash, slaughter Yamaha – Honda
Prepared by Dr. Parmindar Singh
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Mission Statement – Levi Strauss & Co.
The mission statement of Levi Strauss & Co. is to sustain responsible commercial success
as a global marketing company of branded apparel.
We must balance goals of superior profitability and return on investment, leadership
market positions, and superior products and service.
We will conduct our business ethically and demonstrate leadership in satisfying our
responsibilities to our communities and to society.
Our work environment will be safe and productive and characterized by fair treatment,
teamwork, open communications, personal accountability and opportunities for growth
and development.
•
In isolation, however, missions can be self-destructive. Concentrating single- mindedly on
their mission, many entities lose their way when the strived for goal is achieved. Having
landed a man on the moon, NASA drifted.
• The search for a mission:
 According to Peter Drucker, there are a number of fundamental questions that an
organization will need to address in its search for a purpose:




What is our business?
What is value to customer?
What will our business be? (vision/strategic intent)
What should our business be? (quite similar to the one above)
Benefits of mission statement
Establishing a sense of purpose and
commonality – glue that binds all employees
together – conflict resolution
Helps to formulate goals, objectives, strategies
and resource allocation
Super-ordinate goals
Challenges of mission statement
Possibility of more form than substance
Communication tool
Time and cost consuming
Difficulty in crafting – words, contents, impact
No competitive advantage
Enduring long term success
Prepared by Dr. Parmindar Singh
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Research article by Dr. Parmindar Singh
Mission – characteristics, benefits, challenges and financial performance – a look at
Cambodian listed firms.
Abstract
This article explains the characteristics, benefits of having a mission statement and the
challenges faced in developing such a mission statement. An analysis of public-listed
companies’ mission statement on the Cambodian stock exchange was undertaken and
compared with the recommendation of Campbell and Yeung. This was followed by a simple
financial analysis of return on capital employed between a firm that has a better mission
statement as compared to another public listed firm whose mission statement was not as
effective. Controlling for other variables, there may be a positive correlation between a firm’s
mission statement and its financial performance.
1.0 Introduction
This article first explains the characteristics and contents and of good mission statements.
Examples of mission statements are then followed. The subsequent section then articulates the
benefits of effective mission statement, leading to another section that explains the challenges
in developing mission statements. This is then followed by an analysis of mission statements of
public-listed Cambodian firms. Following this, a simple analysis of return on capital employed
was used to infer any positive correlation between mission statement and financial performance.
Finally a conclusions section wraps up the key issues pertaining to mission statements.
2.0 Mission statement
Mission statements are vital communications used by corporations to define themselves to their
various constituencies including customers, employees, creditors, shareholders and other
stakeholders. According to King, Case and Premo (2010), mission statements tend to
communicate an organization’s values, purpose, identity and primary business goals. Mission
statements are often longer than a vision statement which provides a broader statement
reflecting the future aspirations of a company (King et al., 2010). A vision statement should be
clear, concise and compelling (Truskie, 1999, p.66) and it looks at the future state of an
organization.
For example, the vision statement of CamEd Business School, a leading provider of educational
in Cambodia is:
“The vision of CamEd Business School is advancement of the nation and its economy by
creating a vibrant community of accounting and finance professionals performing on par with
those in global financial centers, taking initiative as leaders, and upholding high ethical
standards” (cam-ed.com/about, 2014).
According to Peter Drucker (cited in King et al., 2010, p.72), firms can develop their mission
statements by answering the following questions – “what do we want to become?”, and “what is
our business?”.
Prepared by Dr. Parmindar Singh
Page 149
A mission should specify the business or businesses in which a firm intends to compete and the
customers it needs to serve. A mission statement should also establish a firm’s individuality and
should be inspiring and relevant to all stakeholders. Together with vision, mission statement
provides the foundation that the firm needs to choose and implement one or more strategies
(Ireland, Hoskisson and Hitt, 2013, p. 18).
According to Campbell and Yeung (1991), a good mission statement must encompass a firm’s
purpose, strategy, values and behavior standards. The “purpose” of a firm expostulates its
reason for existence; “strategy”, on the other hand explain in broad terms its strategies and its
core competencies; the “values” focus upon a firm’s values, beliefs, principles; and “behavior
standards” looks at a firm’s rituals and routines, policies, procedures, and management style.
3.0 Mission statement examples
There are many examples of mission statements. The website, makingafortune.biz lists out
many companies’ mission, vision and slogans. For example, Microsoft’s mission statement
consists of the following:
"To enable people and businesses throughout the world to realize their full potential”
(http://www.makingafortune.biz/list-of-companies-m/microsoft.htm, 2015)
while Levi Strauss & Co has the following mission:
“The mission statement of Levi Strauss & Co. is to sustain responsible commercial success as a
global marketing company of branded apparel.
We must balance goals of superior profitability and return on investment, leadership market
positions, and superior products and service.
We will conduct our business ethically and demonstrate leadership in satisfying our
responsibilities to our communities and to society.
Our work environment will be safe and productive and characterized by fair treatment,
teamwork, open communications, personal accountability and opportunities for growth and
development” (Steiner & Steiner, 2004, p. 187).
Comparing these two mission statements, the mission statement of Levis tends to be more
comprehensive covering the purpose, strategy, values and behavior standards as
recommended by Campbell and Yeung (1991) while the mission statement of Microsoft focuses
more on its raison d’etre.
CamEd, the premier provider of tertiary education, including being a platinum status center for
the Association of Chartered Certified Accountants (ACCA) has the following mission statement:
“The mission of CamEd is to provide higher education with a focus on accounting and finance,
leading to qualifications of international quality and recognition.
CamEd strives to maintain a high performing, diverse, and international faculty of lecturers,
collecting and disseminating best practice and the latest developments in their respective fields.
CamEd aims to continually improve effectiveness and efficiency through strategic use of
management techniques, financial management and information technology.
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CamEd works to cultivate a respectful, liberal, encouraging environment conducive to selfdiscovery, freedom of thought, innovation, and constructive debate” (cam-ed.com/about, 2014).
CamEd’s mission statement truly captures the essence of good mission statement as stipulated
by Campbell and Yeung (1991) where the purpose (providing higher education with a focus on
accounting and finance, leading to qualifications of international quality and recognition),
strategy (…a high performing, diverse, and international faculty of lecturers, collecting and
disseminating best practice and the latest developments in their respective fields), values
(…cultivate a respectful, liberal, encouraging environment conducive to self-discovery, freedom
of thought, innovation, and constructive debate) and behavior standards (…use of management
techniques, financial management and information technology) are fully articulated.
Some firms may not have a mission statement; instead they may have a credo. For example,
Johnson and Johnson’s famous credo of putting customers first, employees second,
communities third and shareholders last (Steiner & Steiner, 2004, p. 140).
4.0 Benefits of mission statements
According to King and Cleland (1979, cited in King et al., 2010), a carefully constructed mission
statement lends to some advantages. Firstly, a mission statement tends to ensure unanimity of
purpose. If employees were to embrace the mission statement of a company in “letter and in
spirit”, then all employees, irrespective of caste, creed and background will be able to identify
themselves to the firm. They will therefore have a unanimous spirit when addressing problems
and issues that may arise in the workplace.
Secondly, by having a mission statement, it can serve as a launching pad for an organization to
decide its goals and objectives as well as to formulate long-term strategies. It would be more
difficult for a firm to decide its goals and objectives (both strategic and financial) if the firm does
not have a proper mission statement.
Thirdly, by knowing its mission statement, a firm can not only decide its goals and objectives,
but also to provide a basis or standard for allocating its resources.
Finally, according to the authors’ work above, an effective mission statement will also allow a
firm to establish a general tone or organizational climate; hence it may be a factor in influencing
organizational culture.
Collins and Porras (1996, p.65) uses the term purpose and core values instead of mission
statement and found that firms that have a proper purpose and core values tends to have
enduring long-term success.
One company that did not have a mission and a vision statement was Lehman Brothers
Holdings (King et al. 2010) and this may have resulted, among other factors in the deterioration
and collapse of Lehman Bros.
Prepared by Dr. Parmindar Singh
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5.0 Challenges and issues of mission statements
According to David (2009, cited in King et al., 2010), proactive organizations systematically
review and revise both their mission and vision statements and treat them as living documents.
A mission statement must be revised as the goals and objectives of the firm are updated;
otherwise, a firm may lose its sense of direction. When Unilever changed its product portfolios
and set its priorities for its business, it changed her mission statement to reflect it (Ang, 2004,
p.2; StarBiz, 2004, p.12). Proctor and Gamble (P&G) also had to change its mission when they
changed their goals and objectives (Reingold, 2011).
Another challenge facing organizations is the time taken to develop mission statements. When
Dick Costolo became CEO of Twitter in October 2010, the first thing he did was to change
Twitter’s mission statement to:
“Instantly connect people everywhere to what’s most meaningful to them”, and it took six weeks
for Costolo to do so (Hempel, 2011)!
Unfortunately, Twitter’s mission statement did not last long with a change in its business model
– to generate more revenue from advertisements (Stone, 2014) and ultimately Costolo had to
resign from his post. In addition, framing the mission statement with the right words, contents
and impact can be very challenging. Twitter’s new mission statement is now:
“To give everyone the power to create and share ideas and information instantly, without
barriers” (about.twitter.com/company, 2016).
Mission statements can sometimes be too vague, broad or riddled with superlatives (Ireland et
al., 2013, p. 19).
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6.0 An analysis of Cambodian public-listed firms’ mission statement
The Cambodian stock exchange board opened in 2011 (Reuters, 2014) and currently has five
companies listed on the Cambodian stock exchange board. These are shown in Table 1 below:
Table 1 – List of companies on the Cambodian stock exchange board
Name of company
Date listed
Phnom Penh Water Supply Authority (PWSA)
18-April 2012
Grand Twins International (Cambodia) Plc 16-June 2014
(GTI)
Phnom Penh Autonomous Port (PPAP)
09-December 2015
Phnom Penh SEZ Plc (PPSP)
30-May 2016
Sihanoukville Autonomous Port (PAS)
08-June 2017
Source: http://csx.com.kh/data/lstcom/listPosts.do?MNCD=5010, access 16 June 2017
The mission statements of the above companies will be compared to the recommendations of
good mission statement according to Campbell and Yeung (1991). This is shown in Table 2.
Prepared by Dr. Parmindar Singh
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Table 2 – mission statements of companies listed on the Cambodian stock exchange
Name of company as listed on Website
Mission statement
the Cambodian bourse
PWSA1
http://www.ppwsa.com.kh/
The mission of PPWSA is to
ensure the supply of clean
potable water 24 hours per
day, 7 days per week, with
adequate water pressure and
at a reasonable price to the
people of Phnom Penh and
the urban areas of the Kandal
province adjacent to Phnom
Penh whilst also considering
the needs of those people
living in poverty. In addition,
PPWSA has been sharing its
experience
with
some
provincial-city
water
authorities in the Kingdom of
Cambodia, as well as in the
region and the rest of the
world.
GTI2
http://www.grandtwins.com.kh/ Not Available (except for
business philosophy).
PPAP3
http://www.ppap.com.kh/
Create
sound
economic
growth
through
maritime
commerce
and
related
development.
PPSP4
http://www.ppsez.com/en/
Our mission is to be the
leading SEZ in Cambodia.
With customized, ISO certified
infrastructure solutions, onsite administrative services,
and a central location to
support regional logistics, we
aim to provide manufacturing
companies
with
financial
advantages for a secure longterm investment, while playing
a key role in the development
of the local economy.
PAS5
http://www.pas.gov.kh/
Meet the needs of customers
by increasing service quality,
speed
and
affordability
(translated from Khmer to
English).
Prepared by Dr. Parmindar Singh
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Source: 1. http://www.ppwsa.com.kh/en/index.php?page=vision-and-mission
2.
http://grandtwins.com.kh/index.php?option=com_content&view=article&id=61&Itemid=71&lang=
en
3. http://www.ppap.com.kh/csr.php
4. http://www.ppsez.com/en/about-us/business-overview.html
5. http://www.pas.gov.kh/
From Table 2, the mission statement of PWSA highlights its purpose (providing clean water
supply), and its values (considering people who live in poverty and sharing its expertise).
However, it does not explicitly specify its strategy and behavior standards. Thus it does not
completely adhere to the recommendations given by Campbell and Yeung (1991).
On the other hand, the mission statement of PPAP only emphasizes its “purpose” and nothing
else. The mission statement of PPSP explains its “purpose” (leading SEZ in Cambodia),
“strategy” (customized, ISO certified infrastructure solutions, on-site administrative services, and
a central location to support regional logistics, to provide manufacturing companies with
financial advantages for a secure long-term investment), “values” (playing a key role in the
development of the local economy) but nothing being mentioned about its “behavior standards”.
Finally, PAS’ mission statement looks at its “strategy” and not others. Based on the above,
PPSP’s mission statement comes closest to the recommendation given by Campbell and Yeung
(1991).
Next the firm’s return on capital employed (ROCE) is calculated to see any possible association
between ROCE and mission statement. ROCE is used as it is more appropriate in capital
intensive industries (Investopedia, 2017). Using the Phnom Penh Water Supply Authority and
the Phnom Penh SEZ as a basis of comparison, as shown in the appendix, the ROCE of Phnom
Penz SEZ had increased by around 68 percent while that of the Phnom Penh Water Supply
Authority, its ROCE had only increased by 1.8 percent.
Hence there can be some correlation between a firm’s mission statement and its financial
performance.
Controlling for other variables such as size, industry and others, it would be interesting to find
out whether effective mission statements as stated by Collins and Porras will affect the financial
performance of Cambodian firms.
Prepared by Dr. Parmindar Singh
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7.0 Conclusions
This article has explained the meaning and characteristics of mission statement, followed by
some of the benefits and challenges of having a mission statement. Some examples were given
to illustrate organizations’ mission statement.
This article had also analysed the mission statement of companies listed in the Cambodian
bourse and showed that none has a comprehensive mission statement as expounded by
Campbell and Yeung (1991). The closest to the recommendation was the Phnom Penh SEZ.
This article then made a simple analysis of two firms’ mission statement and its return on capital
employed and found that, controlling for other variables, there may be a positive correlation
between a firm’s mission and its financial performance as advocated by Collins and Porras
(1996).
Therefore, it is recommended that Cambodian firms in general should re-examine their mission
statement and to ensure that all staff can embrace this mission statement in “letter and in spirit”.
If this can help in improving a firm’s financial performance, then, this may also facilitate the firm
concerned to be more quickly publicly listed, if it wants to.
Reference list
about.twitter.com/company (2016), ‘It’s what’s happening’, < https://about.twitter.com/company,
access June 14, 2017
Ang, E. (2004), ‘Unilever focuses on brand, people’, StarBiz, Nov. 16.
CamEd Business School (2014), < http://www.cam-ed.com/about, access June 14, 2017.
Campbell, A. & Yeung, S. (1991), ‘Creating a sense of mission’, Long Range Planning’, Vol. 24,
Iss. 4, pp. 10-20.
Collins, J.C. & Porras, J.I. (1996), ‘Building your company’s vision’, Harvard Business Review,
Vol. 74, Iss. 5, Sept-Oct.
http://csx.com.kh/main.do
(2011),
http://www.csx.com.kh/data/lstcom/listPosts.do?MNCD=5010, access 16 June 2017.
<
GrandTwins International (2013), < http://www.grandtwins.com.kh/, access 16 June 2017.
Hempel, J. (2011), ‘Trouble @ Twittter’, Fortune, May 2, pp. 40-48.
Investopedia (2017), ‘What is ROCE’, < http://www.investopedia.com/terms/r/roce.asp, access
16 June 2017.
Ireland, R.D., Hoskisson, R.E. & Hitt, M.A. (2013), The Management of Strategy: Concepts and
Cases (10th ed.), South-Western CENGAGE Learning, Canada.
King, D.L., Case, C.J. & Premo, K.M. (2010), ‘Current mission statement emphasis: Be ethical
and go global’, Academy of Strategic Management Journal, Vol. 9, No. 2, pp. 71-87.
Prepared by Dr. Parmindar Singh
Page 156
Makingafortune.biz (2015), ‘http://www.makingafortune.biz/list-of-companies-m/microsoft.htm <
http://www.makingafortune.biz, access June 14, 2017.
Phnom
Penh
Water
Supply
Authority
(2017),
http://www.ppwsa.com.kh/en/index.php?page=vision-and-mission, access June 16, 2017.
<
Reingold, J. (2011), ‘Can P&G make money in places where people earn $2 a day?’, Fortune,
Jan. 17, pp. 58-63.
Reuters (2014), ‘Grand Twins makes it 2 on Cambodia bourse’, SunBiz, June 17, p.16.
Sihanoukville Autonomous Port (2017), < http://www.pas.gov.kh/, access June 16, 2017.
StarBiz (2004), ‘Unilever adds “vitality to life” with new corporate logo’, StarBiz, June 16.
Steiner, G.A. & Steiner, J.F. (2004), Business, Government and Society: A Managerial
Perspective (10th ed.), McGraw Hill International Edition.
Stone, B. (2014), ‘Twitter wants to be your TV’, Bloomberg Businessweek, April 28-May 4, pp.
39-40.
Truskie, S.D. (1999), Leadership in High Performance Organizational Culture, Quorum Books,
Westport, CT.
Appendix
Company
Phnom Penh
Authority
Water
Supply
2016
2015
Operating Profit
Total assets
Current liabilities
$
$
14367368
13660660
324432400 311358032
19563487
16202437
ROCE (%)
4.7126379
4.6282911
Source: extracted from Phnom Penh Water Supply Authority (2016), ‘Financial statements and
independent auditor’s report’, < http://www.ppwsa.com.kh/en/index.php?page=financialstatement, access June 16, 2017
Prepared by Dr. Parmindar Singh
Page 157
Phnom Penh SEZ
Operating Profit
Total assets
Current liabilities
483976
56170048
5426865
231804
48670049
7734110
ROCE (%)
0.9537754 0.5662604
Source: extracted from Phnom Penh SEZ Plc (2016), < http://www.ppsez.com/en/financialinformation/financial-statements.html, access June 16, 2017. (the year ended 2016 not audited)
Prepared by Dr. Parmindar Singh
Page 158
2. Vision Statement/Strategic intent
• Is the desired future state of the organization. It is an aspiration around which the strategist,
perhaps a CEO, might seek to focus the energies of the members of the organization
• It addresses the question “What do we want to become?”
• Examples are:
 Empower people through great software anytime, anyplace and on any device – Microsoft
(earlier vision)
 Getting to a billion connected computers worldwide, millions of servers, and trillions of dollars
of e-commerce - Intel
An effective vision statement must pass three tests – clear, concise and compelling – Truskie
3. Goals
• Henry Mintzberg defines a goal as “the intention behind a decision or action”, identified 4
system goals:
 Growth – business and financial
 Survival
 Efficiency
 Control of the environment
Prepared by Dr. Parmindar Singh
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4. Objectives
•
SMART – both financial and strategic objectives (Thompson and Strickland)
Examples of past objectives (an illustration):
Mahindra & Mahindra (India’s biggest tractor maker) – world’s biggest tractor maker by 2010
Nissan – 8% global market share by 2017, 8% operating profit margin by 2017
EPS >=10%, ROE = 25%, ROCE>= 27%, Sales: 30% of sales from products introduced in
the past 4 years - 3M
Operating profit of 8% by 2010 – Audi
Increase worldwide sales by 50% by 2015 – Ford Motor
$5b operating profit by 2014 – Chrysler
13% market share by 2014 – Chrysler
Revenue more than $1.4b by 2015 – Puma
Revenue of $100b by 2017 – Target
$50b total sales by 2018 – Deere and Co
$20 in EPS by 2015 - IBM
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5. Core competence
• Definition:



Resources and capabilities that gives an organization a sustainable advantage over its
competitors (Hitt, Ireland and Hoskisson)
Are the bases upon which an organization achieves strategic advantage in terms of
activities, skills or know-how which distinguish it from competitors and provide value to
customers or clients
Examples: Sharp (LCD), Intel (processor chip), Toyota and Honda (low cost and high quality
manufacturing, short design time to market), Starbuck (store ambience and innovative
coffee drinks), Rubbermaid (innovative rubber and plastic product for household)
To be considered a core competence, must pass three tests (Hamel and Prahalad):
•
•
•
Customer value (perceived)
Differentiation
Extendibility
6. Critical success factors (CSFs)
•
Was formulated/made popular by John Rockart of Sloan School of Management at MIT
(1979).
• Definition of CSF:
 The limited number of areas in which results, if they are satisfactory, will ensure successful
competitive performance of the organization. They are the few areas where ‘things must
go right’ for the business to flourish.
GOALS and Objectives
CSFs
MEASURES (Kpi)
•
By achieving an organization’s CSFs, their goals and objectives will be achieved.
Prepared by Dr. Parmindar Singh
Page 161
•



For a courier service, CSF could be:
Fast delivery
Customer satisfaction
Minimum cost incurred during delivery
•




For an educational institution, CSFs could be:
Retaining, attracting and developing high quality people
Maintaining and improving customer service
Ensuring effective management
Developing long term partnerships with a range of organizations
•



For a police station/department, CSFs could be:
Improving public confidence in the police
Increasing crime detection rate
Increasing professionalism among police staff
• For a hospital, CSFs could be:
 Improving patient service
 Improving medical facilities
 Strategic location
• For an individual, CSF could be:
 Achieving personal goals and objectives (like passing exams)
• For a general business structure, CSFs could be:
 Reducing overall cost
 Improving product quality and innovation
 Customer satisfaction
 Effective management development
 Change management and flexibility
Prepared by Dr. Parmindar Singh
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•
To ensure that CSFs are achieved, there must be measures that can be used to check
whether CSFs have been achieved or not. Such measures are called Key performance
Indicators/Performance Indicators (KPI/PI). KPI’s are information based.
•
For example, if the CSF is customer satisfaction, then the Kpi could be found by conducting
a questionnaire/survey, and if 95% are satisfied (for example), then the firm has achieved its
CSF.
•
If CSF was fast delivery, then Kpi could be to ensure that, maybe, 95% of delivery gets
delivered on time.
•
If our CSF was reducing overall cost, then Kpi could be to measure the amount of waste
produced.
CSF
Customer satisfaction
Sound image in financial market
Improve efficiency
High employee morale
•
PI
Number of customer complaints, number
of closed customer accounts or number
of dormant accounts, number of goods
returned, change in market share
High P/E ratio
Stock-holding cost, time taken to market,
amount of waste produced
Number of staff turnover, number of
absenteeism, change in productivity
The CSF approach has a number of advantages:
 CSFs are flexible - they can be changed quickly and should be continually reviewed.
 Its KPI’s focuses on current information needs.
 Its KPI’s can incorporate hard and soft information. CSFs measures need not be restricted
to typical computerized information such as financial data: the CSF method often indicates a
need for data not currently held to be collected. This data may be soft, for example informal
comments on employment conditions by employees.
 It produces a limited amount of focused information which even senior managers feel
comfortable monitoring.
 It gives senior managers a feeling of ownership since they are able to apply the method
themselves. Therefore they are more likely to use the information.
 It can be used at different levels of aggregation. The method is equally valid when applied
to an organization, a function or and individual.
Prepared by Dr. Parmindar Singh
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•
The prime sources of CSFs (according to Rockart):
 Industry structure - for example, in food retailing, a highly competitive industry, securing the
best sites for supermarkets is a CSF.
 Competitive strategy - this is likely to be a source. For example, if an organization decides to
compete on quality of service, then issues to do with customer reactions will be relevant.
 Environmental factors - for example, at times of trade turbulence, CSFs may be economic
such as interest rates or exchange rates. Or they may relate to some other topic of
international concern, such as energy supply.
 Temporal factors - for example, the resignation of a main BOD may prompt a temporary
focus on senior management recruitment. Or a takeover bid may concentrate an
organization’s attention on defending its independence.
•


•
Rockart identified two types of CSFs:
Monitoring – keeping abreast of ongoing operations
Building – tracking progress of the ‘programs for change’ initiated
If an organization’s Information System (IS) can provide information regarding its KPI or
CSF, then the IS is really a major asset to the organization. An IS should ideally provide
information so that the organization can achieve its goals or objectives.
Prepared by Dr. Parmindar Singh
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7. Environmental analysis – macro environment – PESTEL analysis
Political
Economical
Government
(stability/instabilit
y)
Wars
Business
cycles
Terrorism
Xenophobia/
nationalism/
populism
Unemployme
nt
GDP
Inflation
Money supply
Interest rates
Currency
fluctuations
Stagflation
Socialcultural
Demography
Lifestyle
changes
Linguistic
differences
Consumeris
m
Technologic
al
ICT
Environment
al
GHG
Legal
Global
climate
Disasters
Employment
Taxation
Environment
al protection
Foreign trade
regulations:
tariffs,
excise,
quotas
Customs
Social
mobility
Diseases
and
pestilences
Religious
issues
Energy
BUGIMICES
TEEF
8. Scenario planning
•
Involves macro environmental and possibly competitive environmental analysis
•
Using what-if analysis to formulate scenarios from PESTEL and market forces to act in a
proactive manner
Prepared by Dr. Parmindar Singh
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9. Industry environment
• According to Porter, the state of competition in an industry depends on 5 basic forces:
 Bargaining power of suppliers
 Bargaining power of buyers/customers
 Threat of new entrants
 Threat of substitute products and services
 Competitive rivalry
Potential new entrants
threat of new entrants
Supplier
bargaining power of
suppliers
Competitive
rivalry
Customers
bargaining power of buyers/customers
threat of substitutes products and services
Substitutes
Prepared by Dr. Parmindar Singh
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Threats of new entrants
Economies of scale - unit costs are reduced by making a large number of products
Proprietary product differences/differentiation - means the provision of a product
or service by the user as meaningfully different from competition
Brand loyalty - is there a strong brand image to overcome?
Switching costs - the cost incurred form moving from one firm to another
Capital requirements of entry - the cost incurred by an organization to enter and
operate successfully in a market - e.g. retail clothing cost of setting lesser than
chemical, or power firm
Access to distribution channels - relates to the availability of profitable channels
of distribution - e.g. brewing companies in the UK, France and Germany have
invested in the financing of bars and pubs, which have guaranteed the distribution of
their products and made it difficult for competitors to break into their markets
Government policy/legislation - is there governmental/legislative protection
afforded to existing organizations? In 1995, the US government threatened the
Japanese government with trade sanctions because, it argued, the Japanese
government promoted restrictions to the access of foreign competition
Expected retaliation - if a competitor considering entering a market believes that
the retaliation of an existing firm will be so great as to prevent entry
Cost advantages independent of size - established companies may have cost
advantages independent of size due to favorable locations, learning or experience
curve, incumbent knows market well, has good relationships with key buyers and
suppliers, knows how to overcome market and operating problems, government
subsidies, favorable access to sources of raw materials etc.
Bargaining power of suppliers is likely to be high: determinants of supplier power
heterogeneity of inputs, i.e. supplier’s product is differentiated
switching costs from one supplier to another is high
presence of substitute inputs is few
few suppliers
importance of volume to purchaser
threat of forward integration
supplier’s customers are of little importance to the supplier
if the brand of supplier is powerful
supplier’s customers are highly fragmented - less bargaining power of customers
Threat of substitutes is likely to be high: determinants of substitution threat:
relative price performance of substitutes
switching costs of customers
buyer propensity/tendency to substitute




Different industries
Different categories
Different strategic groups
“Doing without”
Prepared by Dr. Parmindar Singh
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Bargaining power of buyers is high when: determinants of buyer power:
high buyer concentration
buyer volume
buyer switching costs low
buyer information (high
bargaining high)
threat of backward integration
availability of substitute products
price sensitivity
suppliers’ product is undifferentiated or homogenous
Competitive rivalry is high when: rivalry determinants
market growth rates - development, growth, maturity, decline
product differences are low – undifferentiated
brand identity
switching costs is low for buyers
high exit barriers
diversity of competitors
high fixed costs - likely to result in competitors cutting prices to obtain the turnover
required, which can result in price wars
addition of extra capacity is in large increments - creating short term over-capacity
and increased competition
existence of global customers - may increase competition among suppliers
the extent to which the competitors are balanced - where competitors are of roughly
equal size, there is a danger of intense competition; most stable markets have
dominant organizations within them
•





Possible exit barriers could be:
High investment in non-transferable fixed assets
Cost of redundancy
Emotional barriers - managers unwilling to exit because of personal attachment
government discouragement
Strategic inter-relationship - exiting one business may hurt company image, selling ability,
customer perception
REGIS
•



To face this 5 forces, Porter suggests a firm can employ any one of the 3 generic strategies:
Cost leadership
Differentiation
Focus
Prepared by Dr. Parmindar Singh
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Porter hopes by using any 1 of these 3 generic strategies, will enable a company to achieve
competitive advantage, otherwise, it will be ‘stuck in the middle’ (competitive advantage is
anything which gives one organization an edge over its rivals in the products it sells or the
services it offers).
Competitive advantage
Lower cost
broad
target
Differentiation
Cost leadership
Differentiation
Competitive
scope
Cost focus
narrow
target
Differentiation focus
Cost focus
Differentiation
10. Cost leadership
focus
• The lowest cost producer in the industry
• How: automation, bulk-purchasing, SCM, efficiency, benchmarking, no-frills
Air Asia – automation/technology, fuel efficiency, no-frills
IKEA – bulk purchasing, SCM
Woolworths – benchmarking, SCM, bulk-purchasing
Tesco – cut down intermediaries
11. Differentiation
• The exploitation of a product or service that is believed to be unique in the industry as a
whole
PIPS-C
Product, image, personnel, service, channel
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Cost leadership example: Airlines
- Same fleet
- Form alliances
- No-frills
- Automation
- Fast turnaround time
- Hedging – jet fuel for example
- Longer distance on runway
- outsourcing
12. Focus
•
A restriction of activities to only a segment of the market by either providing goods or
services at a lower cost to that segment or by providing a differentiated product or
service for that segment
•
The cost leadership and differentiation strategies seek competitive advantages in a broad
range of industry segments, while focus strategies aim at cost advantage or differentiation
in a narrow segment.
•
Benefits:
 Fewer competitors
 Possibility of improving sales
 Possibility of first-mover advantages
 Possibility of improving brand equity
 Fewer customers – better understanding and satisfaction
 Faster innovation
13. Benefits of cost leadership
•
Increases market share
•
Improve bargaining power of supplier - if supplier has adopted a cost leadership position,
then buyers’ bargaining power would be reduced as they cannot push the price further
•
Build entry barriers:
 By being a cost leader in the industry, it would make competitor entry to become more
difficult
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 Weaken threat of substitutes - once again, cost leadership would result in substitutes
finding difficult to penetrate market
•
Enter new markets - by being a cost leader, a company would find it relatively more easier to
gain inroads in new market
•
Disadvantages:

Perception – low quality

Can affect company’s profitability

Competitor may change the basis of competition
14. Differentiation
•
There are several basis of differentiation such as:
Differentiation (PIPS-C)
Product
Style
Services
Prompt
delivery
Personnel
Beauty and
grace
Image
Brand/logo/
symbols
Design -
Free repair
services
Professional
and
knowledgeable
staff
Packaging
Hot-line
Friendly and
upbeat people
Colours - IBM
(blue),
Campbell (Red
and white),
Microsoft
(green)
Right interior
design, layout,
materials
Labeling
Toll free
number
Friendly and
helpful staff
Durability
Free or paid
consultation
Wal-Mart “people
greeters”
Reliability
Providing
computer or
terminals for
reordering
Channel
Coverage –
national,
regional,
international
Channel
members
Assortments
Consistency
Prepared by Dr. Parmindar Singh
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•



•




Advantages of differentiation:
Increases profit margin
Increases bargaining power of supplier
Erect barriers to entry
Disadvantages:
High cost – harder to achieve economies of scale
Can affect profit margin
Customers may view differentiation as non-value added
Competitor may change the basis of competition
15. Bowman’s strategic clock
Bowman’s Strategic Clock
4
High
Perceived
Value
Added
3
Std
value
5
2
Low
6
1
7
8
Std. Price
Low
High
Price
Failure strategies
1. Low price/low added value – no-frills
2. Low price/standard value – low price
3. Low price/high value – hybrid
4. Standard price/high value
differentiation
5. High price/high value
Prepared by Dr. Parmindar Singh
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6. High price/standard value
7. High price/low value
likely failure
8. Standard price/low value
16. Hybrid strategies (Blue Ocean)
Nintendo Wii:
-
Low cost – processor in MHz, used off-the-shelf components, cheap
parts, use of 3rd party software games
Differentiation – Wii remote, more games
L’Avion:
-
Low cost – lands at suburbs, Boeing 757 (lighter), code sharing with
OpenSkies
Differentiation – business class facilities
Target – “Expect more, pay less”
IKEA
17. Offensive strategies
 Frontal assault - attacking firm goes head to head with its competitor from price to promotion
to distribution. The attacker must have sufficient resources and be willing to persevere. Very
expensive tactic.
 Flanking maneuver - a firm may attack a part of the market where the competitor is weak.
Does not attack head on.
 Encirclement - attacker encircles the competitor’s position in terms of products/services or
markets or both. To succeed, encircler has more product variety and serves more markets.
 Bypass Attack - changing the rules of the game
 Guerilla warfare- “hit and run”, use of small and occasional assaults on different market
segments held by competitors. Normally used by small firms to gain market share of big
rivals
Prepared by Dr. Parmindar Singh
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Business strategy and industry environment
Business Strategy
Blue Ocean
Competitive
Defensive
Offensive
Porter’s
Market forces
Frontal assault,
Flanking maneuver,
Bypass attack
Encirclement
Guerilla warfare
Cooperative
Collusion
Alliance
contested markets
Collusion
Tacit
Explicit
Mutual forbearance
Cartel
Output fixing, price fixing
Alliance (Strategic)
Non-equity
Equity
Strategic networks (multi-party)
Franchising
Joint ventures
Licensing
Strategic investment
Outsourcing
Cross-shareholding
Turnkey operations/BOT
Co-marketing
 Co-branding
Strategic supplier
Strategic distributor
Joint manufacturing
Joint R&D
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National competitiveness – Porter’s Diamond
1. Another example of a set of key environmental influences particularly relevant in the context
of global competition (i.e. at the international level) is by using Michael Porter’s Diamond
Firm strategy, structure
and rivalry
Factor conditions
Demand conditions
Related and supporting
industries
A. Why certain companies/industries in certain nations are more competitive than others?
 Factor conditions – locational economies (land cheaper, wages lesser, tax incentives),
transportation infrastructure, communications infrastructure, possible bestowment of natural
resources, less trade union activities.
 Related and supported industries – quality suppliers of labor (educational institutions,
training centres), materials, and availability of financial support (banks, VC’s, and others).
 Demand conditions – is there any demand for the products? Can it be backed by purchasing
power? Are the expectations high? Home demand conditions provide the basis upon which
the characteristics of the advantage of an organization are shaped. In Japan, for example,
Japanese customers’ high expectations of electrical and electronic equipment have provided
an impetus for those industries.
 Firm strategy, structure and rivalry - the context of characteristics of firm strategy, structure
and rivalry in different countries also helps explain bases of advantage. In Germany, the
propensity for systematic, often hierarchical processes of management has been particularly
successful in providing reliability and technical excellence in engineering industries. Further
domestic rivalry and the search for competitive advantages within a nation can help provide
organizations with bases for achieving such advantage on a more global basis. Porter
argues that one of the main reasons for success in Japan is the extent of domestic rivalry
within many of its industries. Japan is successful in the electrical and automobile industry
because of the competition between its domestic electrical and automobile companies.
Prepared by Dr. Parmindar Singh
Page 175
B. Factors to consider for organizations when moving to new overseas markets?
 Firm strategy, structure and rivalry – analyse potential competitors in terms of strategy,
structure and intensity of rivalry; perform market research
 Demand conditions – demand? Fulfill customer expectations? Levels of consumerism?
Perform market research.




Related and supporting industries – suppliers of inputs: people, money and materials:
People: colleges, universities, vocational schools, other educational institutions
Money: banks and other financial institutions
Materials: high quality material suppliers
 Factor conditions – locational economies (land, labour- wages, government
policies/legislations);
communication
infrastructure;
transportation
infrastructure;
administrative infrastructure; natural resources; trade union
C. Factors to consider by government to encourage inflow of FDI?
 Firm strategy, structure and rivalry – provide fair-level playing field; no/minimal protectionist
policies
 Demand conditions – encourage people/consumer/citizens to choose only the best – be it
domestic or foreign; encourage high levels of consumerism
 Related and supporting industries – suppliers of inputs: people, money and materials
 Factor conditions – locational economies (land, labour- wages, government
policies/legislations);
communication
infrastructure;
transportation
infrastructure;
administrative infrastructure; natural resources; trade union
D. Factors to consider by government to improve domestic firms’ competitiveness?
 Firm strategy, structure and rivalry – encourage competition among domestic firms; no
protectionist policies – competition toughens domestic firms so that they are able to
compete internationally
 Demand conditions – encourage people/consumer/citizens to have high level of
consumerism; encourage people to seek and demand only the best; formation of consumer
associations and tribunals
 Related and supporting industries – suppliers of inputs: people, money and materials
 Factor conditions – locational economies (land, labour- wages, government
policies/legislations);
communication
infrastructure;
transportation
infrastructure;
administrative infrastructure; natural resources; trade union; seed funding or cradle
investments for enterprising domestic firms
Prepared by Dr. Parmindar Singh
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• Porter’s Diamond has been used in a variety of ways:
 At a national level it has been employed by governments to consider the policies that they
should follow to encourage the competitive advantage of their industry
 Porter’s arguments are in essence, that domestic characteristics of competition should yield
advantages on a wider basis, the implication is that competition should be encouraged at
home, rather than industries being protected from overseas competition
 However, governments can also act to foster such advantage, by for example, ensuring high
expectations of product performance, safety or environmental standards; or encouraging
vertical cooperation between suppliers and buyers on a domestic level, which could lead to
innovation
 Organizations have also used Porter’s Diamond as a way of trying to identify the extent to
which they can build on home based advantages to build competitive advantage in relations
to others on a global front
Prepared by Dr. Parmindar Singh
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Strategic capability analysis/internal appraisal/internal position
1. Resources – tangible and intangible
•
•
•
•
•
•
•
•
•
•
•
Non-current assets – land, plants, factories, warehouses, machines, outlets
Current assets – money, inventories
HRM
Products – market shares and market growth
Organizational structure
IT/IS
Knowledge
Intangibles – goodwill, loyalty, relationships, intangible properties (processes, inventions,
designs, formula – can be patented)
Management/leadership
Methodologies
Processes
2. Value chain
•
Value chain – is a set of discrete interrelated activities that constitutes an organization
Firm infrastructure
Margin
Human Resource Development
Technology development
Procurement
Inbound
logistics
Operations
Outbound
logistics
Marketing
and sales
Service
Margin = Total value added – total cost = total selling price – total cost
Prepared by Dr. Parmindar Singh
Page 178
Activity
Inbound logistics
Operations
Outbound logistics
Marketing and sales
Service
Corporate/firm infrastructure
Human resource management
Technology development
Procurement
Prepared by Dr. Parmindar Singh
Definition
materials receiving, storing, and
distribution to manufacturing premises.
This includes materials handling, stock
control, transport
transforming inputs into finished products
or service. This includes machining,
packaging, assembly, testing etc.
collecting, storing and distributing
products to customers. For tangible
products, this would be warehousing,
materials handling, transport, etc. In the
case of services, it may be more
concerned with arrangements for
bringing customers to the service
promotion and sales force, whereby
consumers are made aware of the
product/service and are able to purchase
it. This would include sales
administration, selling, promotion mix
service to maintain or enhance product
such as installation, repair, training,
spare parts
support of entire value chain, such as
general management, planning, finance,
accounting, legal services, government
affairs, and quality management. Also
consists of structures and routines of the
organization which sustain its culture
recruiting, hiring, training, and
development, rewarding etc.
improving product, service and
manufacturing process through
technology development
process for acquiring the various
resource inputs to the primary activities
Page 179
Value chain and IT







Inbound logistics – bar coding, RFID, QR codes
Operations – CAD, CAM, CIM, FMS
Outbound logistics – GPS, tracking system
Marketing and sales – e-mail, web-based advertising, intranet, text alerts, social networking
sites, forums, blogs
Service – website, e-mail, call-centre
Procurement – web-based ordering, intranet, EDI
HRM – online job application, CBT, intranet for staff to manage their annual leave, rewards
etc
•
One of the key features of most industries is that very rarely does a single organization
undertake all of the value activities from the product design through the delivery of the final
product or service to the final consumer
•
There is usually specialization of role and any one organization is part of the wider value
system which creates a product or service as shown:
Supplier value
chains
Channel value chains
Customer
value
chains
Organization
value chain
Upstream activities
Downstream activities
•
In understanding the basis of an organization’s strategic capability, it is not sufficient to look
at the organization’s internal position alone
•
Much of the value creation will occur in the supply and distribution chains, and this whole
process needs to be analyzed and understood.
•
The ability of an organization to influence the performance of other organizations in the
value chain may be a crucially important competence and a source of competitive
advantage
Prepared by Dr. Parmindar Singh
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•
Core competences in separate activities may provide competitive advantage for an
organization, but nevertheless over time may be imitated by competitors. Core competences
are likely to be more robust and difficult to imitate if they relate to the management of
linkages within the organization’s value chain and linkages into the supply and distribution
chains
•
It is the management of these linkages which provides leverage and levels of performance
which are difficult to match. Basically, there are two types of linkages, i.e. Internal linkage as
well as External linkage
•
Internal linkage:
 Primary - primary
 Primary - support
 Support – support
• External linkage:
 Vertical integration - attempts to improve performance through ownership of more parts of
the value system (takes over supply - backward integration; takes over distributors - forward
integration)
 Specification and checking supplier and distributor performance – quality assurance
 Total quality management - working with suppliers and distributors to improve performance
 Reconfigure value chain - by deleting activities/distributors, for e.g. direct selling
 Strategic alliance between different organizations in the value system to reduce cost, share
expertise etc.
 E-commerce
Prepared by Dr. Parmindar Singh
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3. Processes
•
To improve processes, an organization can undertake benchmarking as well as to map
processes using Harmon’s process complexity-strategic importance matrix and then
subsequently deciding the next course of action.
4. Benchmarking – comparing processes and adopting best practices
•
•
•
•
•
•
•
•
•
•
•
Porsche – benchmarking Toyota
Alfa Romeo – benchmarking Lexus (indirectly)
GE – benchmarking P&G on innovation and FedEx on
customer service
Wipro (India) – benchmarking Toyota (Bangalore)
New Balance – benchmarking Toyota – on lean
manufacturing and re-engineering
Paccar Inc. – benchmarking Dell Inc. in custom
manufacturing (custom built trucks – Kenworth & Peterbilt)
Ford Motors – benchmarking Mazda
British Airways – benchmarking F1 Grand Prix
(maintenance, refueling, and turnaround time)
GM – benchmarking Disney World to improve customer
satisfaction at dealerships
PwC – benchmarking Disney World to improve retention
rates among interns
Types of benchmarking:

Intra benchmarking (goes within the organization)

Industry/competitive benchmarking

World class benchmarking
•
Another way of categorizing benchmarking:
 Historical benchmarking – comparing performance to previous years
 Industry/sector benchmarking
 Best-in-class benchmarking
Prepared by Dr. Parmindar Singh
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•
Benchmarking typically involves the following steps:
 Identify those processes needing improvements (process flow, process performance
standards, process performance management)
 Identify an entity (intra-firm, inter-firm, inter-industry) performing the process
 Contact the managers of that entity and if agreed, make a personal visit interviewing
managers and workers - many companies select a team of workers from that process to be
on a benchmarking team
 Analysis – collect data, perform comparison, computations, interpretations and submit
findings
 Implement and review – if there are deficiencies in own company processes, then
implement the benchmarked process and review regularly.
•
Benefits of benchmarking
 Can provide advance warning of deteriorating competitive position
 Can help to drive organizational change
 Improve organizational performance
•
Problems with benchmarking:
 Resistance
 Reactive
 Time consuming
 Changes in external and internal factors
 Can reduce managerial motivation
 Not easily done – causal ambiguity and social complexity
Prepared by Dr. Parmindar Singh
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5. Harmon’s process complexity-strategic importance matrix
Strategic importance
Low
High
High
,
Process complexity and
dynamics
Low
•
Possible redesign options:
Strategic importance
Low
High
Discontinue, outsource
Software package
Process complexity and
dynamics
Outsource, discontinue
Software package
High
simplify, HRP,
HRD, outsource
automate/IT,
outsource
Low
•
Harmon’s terminology
 Process improvement – tactical level, incremental technique that is appropriate for
developing smaller, stable existing process
 Process redesign – intermediate scale process that need significant change
 Process re-engineering – strategic level rethinking of core processes
Prepared by Dr. Parmindar Singh
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•
Process redesign methodology
 Planning – goals are set, project scope is defined, project team members and other roles
are identified and the overall schedule is developed
 Analysis – current workflow is documented, problems identified and a redesign plan created
and presented to higher management for approval
 Redesign – redesign of the new process is done in more detail and presented to higher
management for approval
 Development – all functional implications are followed through, including management and
information systems
 Transition – moved over into the new processes and modifications may be undertaken as
required
PARDT
•
Business process reengineering [BPR/BPI (innovation]
•
BPR is the fundamental rethinking and radical redesign of business processes to
achieve dramatic improvements in critical, contemporary measures of performance,
such as cost, quality and speed. BPR, then, means more than a small change. The overall
effect of a BPR project on a company can be quite radical - Hammer and Champy
•
According to Davenport, process innovation consists of 5 steps:





Identifying process for innovation (e.g. HRM activities)
Identifying change levers (e.g. IT, HR and organizational factors)
Developing Process visions
Understanding Existing processes
Designing and prototyping the new process
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6. Swimlane diagrams
1. The process is initiated by a customer phoning the TCG call centre.
2. TCG offers call centre services to a number of companies. The supervisor asks the customer which
company they are phoning about. Calls for SE are routed to Stella support. Calls for other companies are
routed to other support teams (not shown here).
3. The TCG support operator asks the customer what their call is about. Three transaction types are
possible.
4. Callers who wish to discuss a service contract are passed immediately to the contracts section. Service
contract options are discussed and if the caller decides to buy a service contract, then this is raised in
the next activity in the process (5: Raise service contract).
5. Raise service contract and details are emailed to the customer. If the caller decides not to have a
service contract, then the call is terminated.
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6. For all other transaction types, Stella support asks the customer for their payment reference number
or service contract reference number. If the customer cannot supply either of these, then the call is
terminated. If the reference number is provided, then the support team member enters it into the
computer system.
7. The computer system retrieves customer details and these are confirmed by the support team
member with the customer. These details include a password which the customer has to give. Failure to
give the correct password leads to the call being terminated.
8. If the password is correct and the customer requires a purchase refund, then the refund is processed
and details emailed to the customer and the call is terminated.
9. If the password is correct and the customer has a technical query, then the call is passed to technical
support who log and then resolve (process 10) the query before terminating the call.
Further information:
– TCG provides a 24 hour/7 days per week service. There are 600 calls per 24 hours from SE customers.
– 60% are technical queries, 25% are requests for refunds and 15% are for service contracts.
– 30% of customers do not know their payment/service reference number.
– 5% of customers who do know their payment/service reference number are unable to remember their
password.
– TCG charges SE $1 for every call they take (so, typically $600 per day).
– TCG has ten staff dedicated to SE: six in technical support, one in the contracts section and three in SE
support.
– SE has calculated that it would cost $50 to employ one equivalent employee in Arborium for an eight
hour shift.
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Baldrige Criteria
7. Further to process improvements via benchmarking, Harmon’s process-strategy matrix and
other performance measures like Balance Scorecard, and CSFs, another approach to
assessing performance is using the Baldrige criteria.
•
•
The underlying purpose of Baldrige criteria is to help organizations improve and achieve
excellence.
Elements of the Baldrige assessment:
Element
Organizational profile
Leadership
Strategy
Customers
Measurements,
management
analysis
and
Workforce
Operations
Results
Criteria
Organization describes what is important to it
– environment, stakeholders, operations etc.
Role of senior leadership; governance and
social responsibilities
Strategy
development;
strategy
implementation
Listening to the voice of the customer;
customer engagement
knowledge Measurement, analysis and improvement of
organizational
performance;
knowledge,
management, information and IT
Working environment; workforce engagement
Work processes; operational effectiveness
Products/processes; customers; workforce;
leadership and governance; financial and
market
8. Knowledge
•
There are differences in data, information and knowledge;
•
Data are raw facts; information is data that has been processed while according to Drucker,
knowledge is information in action;
•
Knowledge management, according to Hansen, Nohria and Tierney consist of codification
and personalization; codification involves documenting all appropriate knowledge so that it
can be stored and reused while personalization strategy involves dialogue between
individuals;
•
Nonaka on the other hand states that knowledge is of two types – explicit and tacit
knowledge and knowledge management consists of the SECI model – socialization,
externalization, combination and internalization as shown below:
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Tacit
Socialization
Externalization
Tacit
Explicit
Internalization
Combination
Explicit
•
Benefits of KM
 Competitive advantage (Earl & Scott, 1999) - better decisions, enhanced customer relations
improve product and services
 Economies - fewer mistakes, less staff needed, quicker problem solving
 Staff - increased work inter- dependence, higher motivation among staff
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SWOT analysis and TOWS matrix
•
SWOT stands for Strengths, Weaknesses, Opportunities and Threats
•
The purpose of SWOT analysis to critically assess the strengths and weaknesses,
opportunities and threats in relation to the internal and external environmental factors
affecting an entity such as an organization in order to establish its condition prior to the
preparation of long term plans
•
By using a SWOT analysis, an organization is trying to finding out how it can reduce the
threat in its environment, capitalize on the environmental opportunities and internal
strengths as well as to reduce the weaknesses of the company
•
A typical SWOT analysis will have the following form:
•
Strengths
Weaknesses
Opportunities
Threats
To determine
whether a potential strength
Opportunities
Threats is real or not, must pass four tests
(Barney):
(VRIS)
Value
Rare
Imitable – imperfectly (inimitable)
Non-substitutable
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•
TOWS analysis
Opportunities
Strength
Threats
SO
ST
WO
WT
WO
WT
Weaknesses
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Strategic choices
•
Strategic options:
What basis
Generic strategies:
Cost leadership
Which direction
Directions:
Market penetration
Differentiation
Market development
Focus/niche
Product development
Bowman – hybrid strategies
Diversification
International
Divest
•
How/which method
Methods:
Internal growth/internal
development/organic growth
External growthAcquisitions and mergers
Alliances – equity and nonequity alliances
Discussion has already been made about Porter’s generic strategies and Bowman’s
Strategy clock
1. Ansoff product-market strategies matrix
Existing market
New market
Existing product/service
New product/service
Market
penetration/concentration
Market development
Product/service
development
Diversification
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Market penetration
 Economic
growth
 Competitors’
market
share/sales
greater
How:
 Marketing mix
 HRM
Market development
 Push or pull
factor
 Ohmae’s 5Cs –
company,
customers,
competitors,
currency,
country
Product development
 Changes in
social-cultural
factors and
other macro
environmental
factors
 Changes in
market forces
 Changes in
leadership and
internal factors

Issues – costs
(R&D),
cannibalization,
risks
Diversification
 Related
diversification
 Unrelated
diversification
(conglomerate
diversification)
Why:
 Survivability
 Risks
 Opportunity
 Control over
value system
 Synergy
• Marketing mix
 Product
 Price – determine pricing objectives, determine demand, estimate costs, analyse
competitors’ price, costs and other offering ---------→ base price; then there are reasons for
adapting the base prices – differentiated pricing, geographic pricing, product-captive pricing;
also base price can change due to changes in environment or other internal factors.
 Place
 Promotion – advertisements, personal selling, sales promotion, PR, direct marketing
 People
 Process
 Physical evidence
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•
Diversification
Product
Related
Concentric
/
Geographic
Unrelated/
Conglomerate
 Related diversification/market broadening/concentric
 Unrelated diversification/conglomerate diversification
2. Mergers and acquisitions
•
Acquisitions and mergers
 Vertical acquisitions
 Conglomerate acquisitions
 Horizontal acquisitions
•
Reasons for acquisition:
Ansoff & McDonnell
Risk
Synergy
Performance
Johnson et al.
Speed
Lack
of
resources/competencies
to
develop internally
Cut down on competitive
retaliation
Financial motives
Cost efficiencies
Dunning (OLI)
Ownership
Locational advantage
Internalization
• In addition for acquisition:
 Legal and management problems may be avoided by assimilating a going concern
 Can avoid nationalistic feelings by hiding in the guise of local company (especially in
xenophobic markets)
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•
Diversification is often achieved by acquisition
•
Some problems/issues of acquisition:
 Asset restructuring and resource deployment:
 Downsizing – lay-offs, outsourcing
 Downscoping – divestments - spin-off, sell-off, carve-off
 Management of post-acquisition issues, maybe with regards to manufacture (continuous
flow versus batch production), communications (advertising versus personal selling),
distribution (use of intermediaries or direct selling), marketing
 Cultural problems – Malekzadeh and Navahandi’s model
 Expensive and risky – due diligence (Drucker’s RUCVQ – retention plan, understand
business, commonality, value adding, quality management team in place)
 Hubris Hypothesis (Roll) – top managers overestimating their ability to make the acquisition
work due to an exaggerated sense of their own ability
 Managerial self-interests – empire building
•
After an acquisition, many acquired companies experienced high
management turnover – Walsh
•
Most acquisitions fail (Dyer, Kale and Singh)
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3. Reasons for internal development (organic growth):













Core competency
Experience/learning curve
Control/ownership
OLI
Costs – spread costs
Cultural or conflict
Minimize disruption
No suitable target
Government discouragement
Protection of proprietary technologies
No possibility of inheriting problems with existing plants
Can be designed to incorporate the most modern production techniques
Hosts Governments are likely to welcome greenfield ventures and there may be grant
assistance or tax incentives
 Problems can be:





Slower penetration of markets
Competitors may raise barriers to entry
Financial benefits slow to materialize
Adds new capacity – price wars
Liability of foreignness
4. International strategies
• There are a host of reasons why an organization may pursue the international option. Kotter
has identified 2 sets of factors which determine whether a company considers the
international option or not:
 Push factors - these include a lack of opportunities in the home market due to depressed
prices or controls by Government
 Pull factors - this means increased opportunities for the company’s products abroad
•
Some of the problems experienced in the international environment:
 PESTEL
 Tariffs and trade barriers (part of legislation)
 Corruption
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•
How do we enter into the international market:
Bartlett and Ghosal basic entry strategies
High
Global
strategy
Pressures
for cost
reductions
Low
Transnational
strategy
Multidomestic
strategy
International
strategy
Low
High
Pressures for responsiveness
Mode
Non-equity mode
equity mode (FDI)
Export
Non-equity alliance
Equity alliance
Wholly-owned
subsidiary
Direct
Franchising
JV
Greenfield
Indirect
Licensing
strategic
investment
Acquisition
Turnkey/BOT
Outsourcing
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5. Alliances
Choosing an alliance
-
Complementarity
Compatibility
Capability
Commitment
•
•
Joint venture:
In the context of international strategies, a joint venture is an agreement in which 2 or more
partners own and control an overseas business. This business is typically in the home
country of one of the partners
•
A company might want to establish an international joint venture for the following reasons:
F- financial outlay
I – independence
N – nationalistic feeling
E - local expertise
R – reduce risk
S – Synergy
FINERS, OLI
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
Problems:



Control
Conflict
Risk to transferring technology to partner – creating a competitor (e.g. JV between Nestle
and Lotte, Japan)

A joint venture contract will address the following:












Transfer pricing of products to JV partnership by one of its partners
Income repatriation policies
Inputs needed – money, management, technology
Strategies to be pursued
Marketing mix
Markets
Profitability – retained earnings and dividends declared
Other parties involved – any subcontracting issue
Who is in charge
Exit clause
Duration
Stake of the partners
(PRISM-MPP-WEDS)
Past Joint Venture examples
1. Carslberg (Denmark) and Orkla (Norway) (60%: 40%) – Carlsberg Breweries. Carlsberg
wants Orkla out and paid compensation to Orkla. Cost of buyout was 14.8 billion Danish crowns
2. Toyota Motor Corp & Guangzhou Automobile (50%:50%) – to produce Toyota Camry for
China market. Both companies to invest 3.82 billion yuan
3. Starbucks Coffee International & Berjaya Coffee (M) Plc (49.9%:50.1%)
4. Xerox & Fuji Photo (25%:75%) – Fuji-Xerox (due to Japanese government’s refusal to set up
wholly-owned)
5. Pepsi Co & General Mills (59.5%: 40.5%) – to form Snack Ventures Europe (to market
products such as Doritos, Fritos, & Ruffles). Pepsi Co later bought over General Mill’s stake for
US$ 750 million – to have greater control over marketing over continental Europe.
6. Cummins Engine and Dongfeng Motors (50%:50%) – to form Dongfeng Cummins Engine Co.
Ltd.
7. Nissan and Dongfeng Motors (50%:50%)
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•
Licensing
Royalty (% of net sales)
Licensor
intangible property
Licensee
Costs:
Production,
marketing mix etc.
Licensing
•
Manufacturing
Intellectual property
P, I, D, F
(patent)
software, music, videos,
books, articles, journals,
notes
(trademark/copyright)
Sales are usually restricted to a particular geographical area and there is usually a time limit
on the agreement
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•
A licensing option is used in the international context when:
 It is commonly used where the product is at the mature stage of the product life cycle,
where competition is strong and profit margins are declining. The company is unlikely to
want to spend money to enter foreign markets
 The licensor is usually a small firm that lacks financial and management resources
 Companies that spend a lot of money in R&D, may not have sufficient financial
resources, and therefore may act as a licensor and others can act as licensee
 It may be a way of marketing a service in the presence of barriers (Fuji-Xerox)
 Deciding that it does not want to develop it further (Bell Labs/AT&T to TI)
•
Some of the problems associated with international licensing are:
 The licensing of technology may involve heavy policing costs. There is a need to ensure
that the technology is used in the way specified
 The licensor always has the risk of creating a competitor – overcome by a cross-licensing
agreement (RCA Corp and Sony, Matsushita; International Harvester and Komatsu)
 There may be no local firm which can profitably absorb the knowledge. This will be most
pronounced in developing countries
 Reputation affected if licensing produced poor quality goods
 There may be problems associated with the transfer of funds, for example exchange control
restrictions, the refusal to pay etc. (Infineon Technologies and Rambus )
 Post-cross licensing disputes (RIM & Motorola)
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Past Licensing examples
1. Mc Donalds licensing to Shanghai Longtrust Trade for Mc Kids clothing line and
accessories – for markets in China, HK, Macau, Taiwan, South Korea
2. Mitsibishi licensing its Lancer model to Chinese car maker
3. Licensed brand – Hart Schaffner and Marx sells under licensed names such as Christian
Dior, Pierre Cardin, Johnny Carson
4. Coca-cola licensing its trademark to clothing manufacturers
5. Xerox licensing its xerographic know-how to Fuji-Xerox and FX can only sell to AsiaPacific market. Duration of contract is 10 years. Royalty fees of 5%of net sales to Xerox.
•
Franchising
•
Used in retail, service (fast-food, hospitality), distribution, education, healthcare
•
Some examples of franchising:
 Fast food chain – KFC, McDonalds, Pizza Hut, A&W etc.
 Hotels – Marriott group, Accor Group
 Ice cream makers
 Avon
 Singer
 Harvey Norman
 Kindergartens/education centres
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Up-front fee; royalty (% of monthly sales); promotion (% of monthly sales)
Franchisor
intangible property
, know-how
Franchisee
•
This can take many forms, but basically it is a business arrangement under which one party
allows another to operate a company, its trademark, logo, product line, and other methods
of operation in return for a fee. Whereas licensing relates to the manufacturing component
of a business, franchising relates to the retail component
•
It is widely used in the fast food (McDonalds, KFC etc.) and hotel industry
•
Franchising, typically requires the payment of a fee up-front and then a percentage of some
revenues. In return the franchiser will provide necessary assistance and in some cases may
require the purchase of goods or supplies so that the quality levels are maintained
Some past examples
Mc Donalds: up-front fee = $1m, royalty = 5% of monthly sales,
promotion = 3.75% of monthly sales
Pinkberry: up-front fee = $40,000, royalty = 5% of monthly sales’
promotion = 2% of monthly sales
Wendy’s: up-front fee = $0.5m
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Franchise applicants
Vet/select
Master franchisee
Chosen franchisee
field audits,
mystery customer
Training, provide documentation/manuals, logo etc.
Fanchise operates
Franchising process
•
The benefits of franchising in an international market are:
 It provides the franchiser with a constant flow of income and the franchisee has a
product/service and a marketing package that can be quickly purchased by the market
 It allows the business to grow rapidly in a number of locations without the considerable
investment of capital that would be required if the company (the franchiser) grew in a more
organic fashion
 It eliminates some of the need for the development of managerial skills required to mange
a large dispersed organization
 It is a suitable strategy for a small firm to get involved in. The risk is considerably lower than
with an independent start-up
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•
Problems may include:
 Quality control/assurance (appoint master franchisee)
 Poor performance of the retail outlet
 Franchised outlets in competition with one another
 Marketing issues
 Competitor (e.g. Minor group, franchisee for Pizza Hut in Thailand for 20 years discontinued
its pizza operations with Pizza Hut and opened its own pizza chain called, The Pizza
Company)
 Free-rider problems
Franchisor
Dommal Food LLC
Yum! Brands
Master franchisee
Product
Dommal Food Services
Domino Pizza
Yum!
Restaurants KFC, Pizza Hut, A&W
International
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•
Outsourcing
Definition
• Passing a task to a 3rd party
Reasons/benefits of outsourcing
• Cost savings
• Focus on core competency
• Believe 3rd party have the right skills
• Intense competition – faster time to produce
• Gaining access to new technologies, specialized resources, learning opportunities – faster
innovation
• Competitive advantage
Problems of outsourcing
• Job lay-offs – resistance
• Creating competitors
• Quality issues (proper SLA/QA needed)
• Control, coordination
• Diminishing firm’s integrative capabilities
• Hollowing of corporation
Factors to consider
• Time constraint
• Cost constraints
• Availability of skilled personnel to do the task in-house, if need be
• Criticality of application/task
• Reputability of existing outsourcing supplier
• Company policies and direction
Criticality of activities
• In order to decide the criticality of applications/tasks, a grid formulated by McFarlan, called
Strategic Grid may be useful in deciding. McFarlan’s Strategic Grid is shown below:
high
Factory
Strategic
Dependency on
existing application/task
low
•
high
Impact of planned application development
Support
Use of Harmon’s process-strategy matrixTurnaround
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In-sourcing
• Bringing in contract staff, part-timers, and co-sourcing
Co-sourcing
• 3rd party staff and own organizational staff working closely to develop/produce task
• E.g. Boeing Co. and HCL Technologies (India) to co-develop software for Boeing 787
Dreamliner jet
•
Eschewing outsourcing (some issues to consider)








Increasing labour costs
Increasing currency appreciation
Time zones
Language barriers
Travel times
Quality
Logistics
Engineering changes etc.
6. Export/import
• Benefits of this option are:
•
•
•

It is a strategy open to any size of company
Banks may be more prepared to give financial assistance for this option
It may be a relatively cheap and low risk method of foreign selling
Problems could be:
 There may be poor representation of the company on the foreign market
 Small firms often manage the effort poorly
 There may be a need to make direct investments in marketing facilities without making a
direct investment in manufacturing facilities
 The fixed costs of a low volume of export sales can be considerable, despite tax advantages
(freight, insurance)
 Trade barriers
 Financial funding
 Lack of expertise
 Lack of marketing knowledge
 Lack of resources
 Competitors
 Currency volatility
 Piracy
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7. Decline/Divest
• According to Slatter (after analyzing 40 UK companies), symptoms of company decline:
 Declining profitability reflected in a decline in profits before tax, or as a percentage of sales
or as a reduction in ROI
 A decline in sales volume in comparison with industry trends. This may be measured in
terms of sales per employee, sales per square meter of factory space etc.
 An increase in the level of gearing due to increase indebtedness
 Decreasing dividends
 Decreasing current or acid test ratio – decreasing liquidity
 Accounting practices including delays in publishing the accounts, the use of unusual
accounting policies etc.
 A significant staff turnover at management level who may be lacking in strategic thinking
 Declining market share
 Lack of planning or strategic thinking
 Top management fear that essential tasks and problems are being ignored
•
Reasons for company decline, can be due to Internal factors or External factors
Predicting a failure:
Altman’s Z value (1968 – U.S.)
Z = 1.2x1 + 1.4x2 + 3.3x3 + 0.6x4 + 1.0x5
x1 = working capital/total assets
x2 = retained earnings/total assets
x3 = EBIT/total assets
x4 = market value of equity/book value of total debt
x5 = sales/total assets
If Z < 1.80
If Z >3.00
certain to go bust (less than 2 years)
won’t go bust
Argenti suggests for U.K. companies:
If Z < 1.50
certain to go bust (less than 2 years)
If Z > 2.00
won’t go bust
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•
Recovery Strategy – financial, organizational and product portfolio restructuring (Bowman
and Singh)
Recovery strategies – some past examples
•
•
•
•
•
•
•
•
•
•
•
•
•
•
Change CEO
Strong leadership
Lay-off workers
Close factories, plants
MBO, LBO
Cut salaries
Product development
Invest in factories overseas
Outsourcing
Improve employee productivity
Changes in organizational structure
Change culture
Reward structure
Exit – Carrefour exiting Japan and selling its 8 stores to Aeon Co.
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Evaluating/recommending/justifying strategies
1. Strategy recommendation/justification – FAS criteria (Johnson et al.)
•
•
•
Feasibility – financial, resources and competencies
Acceptability – returns, risks, stakeholder reactions
Suitability – environment (PESTEL, market forces), exploit strategic capabilities, stakeholder
expectations and influences, cultural influences
2. Managing organizational portfolios
•
Boston Consulting Group (BCG) matrix
High
STAR
PROBLEM
CHILD/WILD
CAT
Rate of growth of market (%)
Low
CASH COW
High
•







DOG
Low
Relative market share
Cash Cow
Products with relative high market share in a low growth market
Since market is low growth, it may soon become mature
If exit barriers are low, then competitors may exit; therefore a firm may incur less costs in
competition, promotion and product development
Hence cash rich
Earnings from cash cow can be used to finance stars and some ‘problem child’
If cash cows are about to reach decline, then the need to consider reviving (licensing,
marketing mix) after careful analysis
Should have adequate cash cows
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• Stars
 Products with relatively high market share in high growth markets
 Since market is high growth, may encourage competition (especially if competitors are wellbalanced)
 While revenues may be high, significant costs may be incurred to maintain “visibility” amidst
increasing “clutter”
 The profits earned may be marginal or breakeven due to intense competition
 Stars need to be retained as it can become future cash cows
 Need to have adequate stars
• Problem child/Wild cat/Question mark
 Careful examination. If possibility of becoming a future ‘star’, then retain, otherwise, divest.
• Dog
 If dog can provide some economies or can act as a “traffic builder”, then retain, otherwise,
divest.
BCG example
All figures in $m
2011
2010
2009
2008
Sector turnover
357·00 357·00 356·00 355·00
POTS sales revenue 107·10 100·00 96·10 88·80
Gross profit
22·50 21·00 22·10 22·20
Net profit
7·50
7·00
8·70
9·80
2009
2008
Figure 1: Selected data for POTS Co
All figures in $m
2011
2010
Sector turnover
88·20 89·00 89·50 90·00
Neach turnover
7·94
7·12
7·16
6·30
Gross profit
1·45
1·28
1·22
1·07
Net profit
0·72
0·57
0·57
0·45
Figure 2: Selected data for Neach Glass
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3. Managing public-sector portfolios
Ability to serve effectively
High
High
Low
Public sector star
Political hot box
Golden fleece
Back drawer issue
Public need and
Support + funding
Attractiveness
Low
4. Corporate parental value creation
• Portfolio manager:
 Buy undervalued assets (either from stock market or private firms), improve them and sell
them (perhaps through an IPO)
 Any units underperforming – divest; those that are performing – retain up to a point
 Parent company’s HQ normally small and parent pursuing an unrelated diversification or
conglomerate strategy
• Synergy manager:
 A corporate parent seeking to enhance value across business units by managing synergies
across business units – building a common purpose, facilitating cooperation, and providing
central resources and services
 Parent company’s HQ normally large and parent pursuing a related diversification strategy
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•
Parenting matrix/Ashridge portfolio matrix (Campbell, Goold and Alexander)
Low
Ballast
Misfit between CSFs
and parenting
characteristics
Heartland
Edge of
Heartland
High
•
•
Low
High
Fit between parenting opportunities and parenting characteristics
Alien territory
Value trap
Parenting characteristics – structure, systems, skills possessed, resources
Parenting opportunity – potential for parent to improve business unit
 What is the CSFs of business?
 Is there any parenting opportunity?
 What is parent’s characteristics?
•
•
•
•
•
Ballast – examine
Value trap – examine
Alien territory – divest
Edge of heartland – retain and move to heartland
Heartland - retain
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5. Business change
•






Organization
Business model – how a firm generates and preserves value over the long-term
Organizational capabilities – core competencies
Organizational memory – knowledge management – SECI model
Culture
Products and services
Management support for business change
• People
 Roles and job descriptions – must be clearly defined to undertake business change projects,
i.e. proper organizational structure
 Skills and competencies – via proper HRD
 Management activities – planning, organizing, leading, controlling
 Individual Culture – beliefs, taken-for-granted assumptions of individuals, attitudes
 Communication – reports, memos, and other forms of formal and informal channels
 HRP
 Motivation – and its mechanisms – job enlargement and job enrichment
 Reward
•



Process
Value propositions – through efficiency, effectiveness, efficacy
Value chain – activities
Core business process
Prepared by Dr. Parmindar Singh
Page 215
•



Information technology
Providing current information
Information to be provided at all levels of management
SICMARDSS, 5E’s
6. Discount factor/rate
•
•
•
Is given by the formula, 1/ (1 + k)n, where k = cost of capital; n = time period
Present value, PV = Future value (FV)/ (1 + k)n
Is the factor by which a future cash flow must be multiplied in order to obtain the present
value.
7. Payback period
•
•
•
Is the expected number of years (or time periods) required to recover the original investment
In general, a shorter payback period is favourable
Example:
Net cash flows
Year
Project S ($)
Project L ($)
0
(1000)
(1000)
1
500
100
2
400
300
3
300
400
4
100
600
Payback = year before complete recovery + (unrecovered investment÷cash flow during the year
in which complete recovery occurs)
For project S:
Year
0
1
2
3
4
Net cash flow ($)
(1,000)
500
400
300
100
Cumulative net cash flow ($)
(1,000)
(500)
(100)
200
300
Using formula:
2 + 100/300 = 2 1⁄3 years
Prepared by Dr. Parmindar Singh
Page 216
8. Discounted payback
• Defined as the number of years required to recover the investment from discounted net cash
flows
• Assuming a discount rate of 10%,
Year
Project S ($)
Discount rate (10%) Discounted net
Cash flow (PV)
0
(1000)
1.0000
(1000)
1
500
0.9001
455
2
400
0.8264
331
3
300
0.7513
225
4
100
0.6830
68
Year
0
1
2
3
4
Discounted net cash flow (PV)
(1000)
455
331
225
68
CNCF (cumulative net cash flow)
(1000)
(545)
(214)
11
79
Discounted payback for Project S = 2 + 214÷225 = 2.95 years
• Problem – ignores all cash flows after the payback period
9. Net present value (NPV)
• Given by the equation, NPV = (CFt /(1 +k)t ); CFt = expected net cash flow at period t and k
= cost of capital.
• The NPV for project S at 10% discount rate = (1000) + 455 + 331 + 225 + 68 ≈ $79
• An NPV of zero signifies that the project’s cash flows are exactly sufficient to repay the
invested capital and provide the required rate of return on that capital
• If a project has positive NPV, then its cash flows are generating an excess return
10. Internal rate of return (IRR)
• The IRR is defined as that discount rate which equates the present value of a project’s
expected cash inflows to the present value of the project’s expected costs
• That is, PV (inflows) = PV (investment costs) or
• (CFt/(1 + IRR)t) = 0
Prepared by Dr. Parmindar Singh
Page 217
11. Regression analysis
•
•
•
•
•
Is of the form y = a + bx;
Make sure it’s based on adequate sample size
Based on historical data
Will not be appropriate if the relationship is curvilinear – scatter diagram needed to
complement
Need to know r (product moment coefficient of correlation)
An r value of +1 denotes a perfect positive relationship between two sets of numbers. An r value
of -1 denotes a perfect negative relationship between two variables: as one variable gets larger,
the other gets smaller. An r value of 0 means there is no linear relationship between two
variables.
Coefficient range
±0.91 to ±1.00
±0.71 to ±0.90
±0.41 to ±0.70
±0.21 to ±0.40
±0.01 to ±0.20
•
Strength of association
very strong
high
moderate
small but definite relationship
slight, almost negligible
Also find r2, i.e. coefficient of determination to find the percentage of variation of y due to x –
therefore regression analysis indicates correlation and not causality
Prepared by Dr. Parmindar Singh
Page 218
12. Forecasting – exponential smoothing
13. Time series
•
•
•
•
A time series is a series of data collected over a period of time. These data can be units of
products sold, sales of a product etc.
Can be additive or multiplicative model
Additive model: T + C + S + I
Multiplicative model: T × C × S× I
Prepared by Dr. Parmindar Singh
Page 219
A
Part 1
Year
B
C
Quarter
Units
2006
1
2
3
4
1
2
3
4
1
2
3
4
1
2
3
4
56
70
74
60
60
80
80
70
62
82
80
70
60
84
82
68
2007
2008
2009
D
524
538
554
570
582
586
588
588
586
586
590
590
Part 2
1
2
2006
2007
2008
2009
Total
Average
Adjusted
New average
-9.25
-11.50
-13.75
-34.50
-11.50
0.15
-11.65
8.75
8.50
10.25
27.50
9.17
0.15
9.02
E
F
G
H
Trend
(T)
Seasonal
(S + I)
Seasonal
(S)
Residual
(I)
65.50
67.25
69.25
71.25
72.75
73.25
73.50
73.50
73.25
73.25
73.75
73.75
8.50
-7.25
-9.25
8.75
7.25
-3.25
-11.50
8.50
6.75
-3.25
-13.75
10.25
7.35
-4.73
-11.65
9.02
7.35
-4.73
-11.65
9.02
7.35
-4.73
-11.65
9.02
1.15
-2.52
2.40
-0.27
-0.10
1.48
0.15
-0.52
-0.60
1.48
-2.10
1.23
3
4
8.50
7.25
6.75
-7.25
-3.25
-3.25
22.50
7.50
0.15
7.35
-13.75
-4.58
0.15
-4.73
0.58
0.00
Required:
Write a briefing paper for the managing director that:
(a) Explains and evaluates the spreadsheet used by the sales forecasting team.
(12 marks)
Prepared by Dr. Parmindar Singh
Page 220
(a)
Explanation
I had the opportunity to analyse the spreadsheet prepared by the sales forecasting team. This approach
to forecasting is known as time series analysis. The word “time series” is coined as it pertains to data
collected over a period of time. This is a popular technique to help in forecasting.
There are several types of time series analysis such as the additive model as well as the multiplicative
model. Every time series consist of four components, namely, the trend, cyclicality, seasonality and any
irregularities. The sales forecasting team had used the additive model. In figure four, cell C presented
the actual sales achieved. The values in cell D represent the eight-quarter moving total while the values
in cell E represents the eight-quartered centred moving average.
These values represent the trend and cyclicality effects after removing the effects of seasonality and any
irregularities/residual values. The values in cell F, called the “variation’, statistically represent the sum of
seasonal effects plus any irregularities. The values in cell G shows the seasonality values and cell H
shows the values of residual.
Subsequently, the information in part two of figure four aims to find a better value for seasonal effects.
They are arranged according to their respective quarters and when they are averaged and added, there
is value of approximately 0.6. These will then be divided by four to get an average value 0.15. The
average is then subtracted by this adjustment to give the new adjusted average whose total will be
equal zero.
It is with these seasonal effects that values are added to provide the forecasts for quarters 3 and 4 for
year 2009 and quarters 1 and 2 for the year 2010. Hence, this technique for forecasting is quite well
established.
Evaluation
There is no indication where the values for the trend for quarters 3 and 4 for 2009 as well as quarters 1
and 2 for 2010 came from nor what assumptions were made in deriving these figures.
Furthermore, the values used for forecasting were given equal weights. Some form of exponential
smoothing could have been used to put more emphasis either on actual or forecasted data.
Also, this technique suffers from placing a lot of reliance on past data. The sales manager had expressed
some doubt but still went on to agree. His initial reservations on customers not replacing old equipment
and entry of cheap foreign products should have been reflected in the values but this was not done so.
Many other factors and assumptions could also have played a part in making the forecast more reliable
such as PESTEL and market forces but this were not taken into consideration. However, time-series
analysis is not suitable when the environment is dynamic and complex. It is only more appropriate for a
stable environment and therefore, while time-series is popular, it may not have been the best technique
to use to forecast if these assumptions were, one way or another, not placed into the forecasted figures.
• Time series is very popular
Prepared by Dr. Parmindar Singh
Page 221
•
•
However, it’s based on past data and may not be able to predict the future
Should be complemented by other techniques such as regression, and exponential
smoothing
Year
2006
Quarter Units (T.C.S.I)
1
56
2
70
3
74
4-quarter moving total 8-quarter moving total 4-quarter centered moving averageratio of actual values to moving averages
(T.C)
(S.I)
260
524
65.50
1.129770992
538
67.25
0.892193309
554
69.25
0.866425993
570
71.25
1.122807018
582
72.75
1.099656357
586
73.25
0.955631399
588
73.50
0.843537415
588
73.50
1.115646259
586
73.25
1.092150171
586
73.25
0.955631399
590
73.75
0.813559322
590
73.75
1.138983051
2008
2009
Average
0.843537415
1.115646259
1.092150171
0.955631399
0.813559322
1.138898305
0.841174243
1.12578386
1.107192507
0.934485369
4.008635979
264
4
60
274
2007
1
60
280
2
80
290
3
80
292
4
70
294
2008
1
62
294
2
82
294
3
80
292
4
70
294
2009
1
60
296
2
84
294
3
82
4
68
Seasonal values (S.I)
2006
Quarter
1
2
3
4
sum
2007
0.866426
1.122807
1.12977099 1.0996564
0.89219331 0.9556314
Prepared by Dr. Parmindar Singh
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14. Decision tress
(a)
Mary is a manager of a gadget factory. Her factory has been quite successful the past three
years. She is wondering whether or not it is a good idea to expand her factory this year. The
cost to expand her factory is $1.5M. If she does nothing and the economy stays good and
people continue to buy lots of gadgets she expects $3M in revenue; while only $1M if the
economy is bad.
If she expands the factory, she expects to receive $6M if economy is good and $2M if economy
is bad. She also assumes that there is a 40% chance of a good economy and a 60% chance of
a bad economy.
Draw a Decision Tree showing these choices.
Decision Tree Example
40 % Chance of a Good Economy
Profit = $6M
Expand Factory
Cost = $1.5 M
60% Chance Bad Economy
Profit = $2M
Good Economy (40%)
Don’t Expand Factory
Cost = $0
Profit = $3M
Bad Economy (60%)
Profit = $1M
NPVExpand = (.4(6) + .6(2)) – 1.5 = $2.1M
NPVNo Expand = .4(3) + .6(1) = $1.8M
$2.1 > 1.8, therefore you should expand the factory
Prepared by Dr. Parmindar Singh
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(b)
Joe’s garage is considering hiring another mechanic. The mechanic would cost them an
additional $50,000 / year in salary and benefits. If there are a lot of accidents in Providence
(US) this year, they anticipate making an additional $70,000 in net revenue. If there are not a
lot of accidents, they could lose $20,000 off of last year’s total net revenues. Because of all the
ice on the roads, Joe thinks that there will be a 70% chance of “a lot of accidents” and a 30%
chance of “fewer accidents”. Assume if he doesn’t expand he will have the same revenue as
last year.
Draw a decision tree for Joe and tell him what he should do.
(c)
An investor has constructed the table below to help him decide the best course of action to take
for his investment. Construct a decision tree to help him make the best decision.
Investment
decision
alternative
Stocks
Bonds
Cash
Mixture
State of the economy
Stagnant (0.25) Slow
(0.45)
-$500
$700
-$100
$600
$300
$500
-$200
$650
growth Rapid
(0.30)
$2200
$900
$750
$1300
growth
(d)
The owner of Hackers Computer Store is considering what to do with his business over the next
five years. Sales growth over the last couple of years has been good, but sales could grow
substantially if a major electronics firm is built in his area as proposed. Hackers’ owner see
three options: the first is to enlarge his store, the second is to locate at a new site, and the third
is simply wait and do nothing. The decision to expand or move would take little time and,
therefore the store would not lose revenue. If nothing were done the first year and strong growth
occurred, then the decision to expand would be reconsidered. Waiting longer than one year
would allow competition to move in and make expansion no longer feasible.
The assumptions and conditions are:
1. Strong growth as a result of the increased population of computer fanatics from the
electronics firm has a 55 percent probability
2. Strong growth with a new site would give annual returns of $195,000 per year. Weak growth
with a new site would mean annual returns of $115,000
3. Strong growth with an expansion would give annual returns of $190,000 per year. Weak
growth with an expansion would mean annual returns of $100,000
Prepared by Dr. Parmindar Singh
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4. At the existing store with no changes, there would be returns of $170,000 per year if there is
strong growth and $105,000 per year if growth is weak
5. Expansion at the current site would cost $87,000
6. The move to the new site would cost $210,000
7. If growth is strong and the existing site is enlarged for the second year, the cost would still be
$87,000
8. Operating costs for all options are equal
Construct a decision tree and find the best option.
0.55
$195,000/yr, 5 yrs
0.45
$115,000/yr, 5 yrs
0.55
$190,000/yr, 5 yrs
0.45
$100,000/yr, 5 yrs
A
Move
Expand
1
B
$190,000/yr, 4 yrs
Do nothing
0.55
expand
2
$170,000, 1 yr
Do nothing
C
0.45
Prepared by Dr. Parmindar Singh
$170,000/yr, 4 yrs
$105,000/yr, 5 yrs
Page 225
Node A: move to new location
Return with strong growth: $195,000 * 5 yrs = $975,000
Return with weak growth: $115,000 * 5 yrs = $575,000
Expected return at A = ($975,000 * 0.55) + ($575,000 * 0.45) = $795,000
Less new site costs = $210,000
Move to new site net return = $585,000
Node B: enlarge the existing store
Return with strong growth: $190,000 * 5 yrs = $950,000
Return with weak growth: $100,000 * 5 yrs = $500,000
Expected return at B = ($950,000 * 0.55) + ($500,000 * 0.45) = $747,000
Less costs of expansion = $87,000
Enlarge the existing store net return = $660,500
Decision point 2: After one year, reconsider:
Enlarging existing store:
Return with strong growth: $190,000 * 4 yrs = $760,000
Less expansion costs = $87,000
Net return = $673,000
Keeping existing store the same:
Return with strong growth: $170,000 * 4 yrs = $680,000
Therefore for decision point 2, choose “do nothing” with return $680,000
Prepared by Dr. Parmindar Singh
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Node C: Do nothing
Strong growth in the first year = $170,000 * 1 yr = $170,000
Value of best decision not to expand = $680,000
Total returns= $850,000
Return with weak growth: $105,000 * 5 yrs = $525,000
Expected return at C = (0.55 * $850,000) + (0.45 * $525,000) = $703,750
Therefore the best choice is to do nothing with a value of $703,750
Prepared by Dr. Parmindar Singh
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Strategic action - change
1. Change
•





Reasons/Driving forces for organizational change:
Conflicts
Adverse organizational culture
Poor performance
Changes in organizational goals
Changes in capital (financial, manufactured, human, intellectual, social and relationship and
natural)
 Environmental changes – macro and industry
 Changes in business boundaries – globalization
•
Dunphy and Stace - Scale of change – fine-tuning, incremental adjustment, modular
transformation and corporate transformation – FIM-C
•
Balogun and Hope Hailey – types of strategic change
Scope of change (End result)
Realignment
Incremental
Nature
of
change
Transformation
Adaptation
Evolution
Reconstruction
Revolution
Big Bang
•
Revolution
Beer and Nohria – theory EReconstruction
(economic value) change
or theory O (organizational capability)
change.
Prepared by Dr. Parmindar Singh
Page 228
2. Successful implementation of organization change
•
Contextual features of strategic change programs (Balogun and Hope Hailey)
Power – what
power does the
change leader have
to impose power?
Time – how quickly
change is needed?
Scope – how much
change is required?
Capacity – what
is the degree of
change resource
available?
Strategic change
programmes
Readiness – how
ready for change
is the workforce?
Capability – what is the
managerial & personal
capability to implement
change?
•
Preservation – what
organizational resources
and characteristics need
to be maintained?
Diversity – how
homogenous are
the staff groups &
divisions within the
organization?
POPIT framework
Organization
IT
People
Prepared by Dr. Parmindar Singh
Processes
Page 229
•
•
•
•
People – job descriptions, motivation, paradigm, competencies.
Organization – culture, structure, reporting approaches, business model, knowledge
management, HRM (HRP, HRD, performance appraisal, rewards), products and services,
strategy.
Processes – activities, tasks
IT – hardware, software, IT architecture (e.g. client server, server virtualization, cloud
computing, etc.)
3. Dunphy and Stace change matrix – leadership styles to types of change
Scale of change
Fine-tuning
Incremental
Modular
Corporate
M
Participative Evolution
Charismatic transformation
Forced evolution
Dictatorial transformation
Collaborative
A
N
Consultative
A
G
Directive
E
M
Coercive
E
N
T
Style
Prepared by Dr. Parmindar Singh
Page 230
4. Resistance
Kanter, Stein and Jick
Loss of control
Fear of the unknown
Distrust
Loss of status or security
Lack of confidence
Increasing workload
Kotter and Schlesinger
Does not want to lose something of value
Misunderstanding
A feeling that change does not make sense
Low tolerance to change
CUDS-CW
VMST
5. Force-field analysis
Forces for change
Current level of
performance
•
•
•
Forces restraining change
Desired higher level of
performance
Don’t push too hard for change
Understand potential resistances
Weaken these potential resistance, then implement the change necessary
Prepared by Dr. Parmindar Singh
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6. Kotter and Schlesinger styles of managing change or resistance
APPROACH
INVOLVES
Education +
communication
the belief that
communication
about the
benefits of
change to
employees,
groups and
even entire
organization will
result in their
acceptance of
the need to
exercise the
changes
necessary
asking members
of organization
to help design
the change.
Participation +
involvement
Facilitation +
Support
Negotiation +
agreement
offering
retraining
programs, time
off, emotional
support, and
understanding
to people
affected by the
change
. Simply the
process of
negotiation is
exercised ,
enabling several
Prepared by Dr. Parmindar Singh
COMMONL
Y USED
WHEN…
there is a
lack of
information
or accurate
information
and analysis
ADVANTAGE
DISADVANTA
GE
once
persuaded,
people will
often help
implement the
change
can be very
time
consuming if
many people
are involved
The
initiators do
not have all
the
information
they need to
design the
change, and
others have
considerabl
e power to
resist
employees
more likely to
support
change and
give positive
commitments
as they ‘own’
the change.
Another
advantage is
the improved
utilization of
employee
expertise
people are
resisting
because of
adjustment
problems
no other
approach
works as well
with
adjustment
problems
time
consuming,
there need to
be a strong
trusting
relationship
between
employees and
management
as well as
changes
inputted by
employees
may stifle
management
movement
can be time
consuming,
expensive and
still fail
unionized
companies
offers the
company the
opportunity to
note possible
conflict and
time
consuming and
may alert other
employees to
negotiate also
Page 232
parties with
opposing
interests to
bargain. This
bargaining leads
to a situation of
compromise and
agreement
Manipulation +
co-optation
Explicit +
implicit
coercion
giving key
persons a
desirable role in
designing or
implementing
change process
threatening job
loss or transfer,
lack of
promotion. This
method finds its
roots from
formal authority
that
management
possess
other tactics
will not work
or are too
expensive
speed is
essential,
and the
change
initiators
possess
considerabl
e power
allows it to be
dealt with in an
orderly
fashion. Also
when an
agreement has
been made,
the outcome
can be to
encourage
commitment,
preserve
morale, and
maintain
output
can be a
relatively easy,
quick and
inexpensive
way to avoid
conflict
it is speedy
can lead to
future
problems if
people feel
manipulated
lack of
commitment
and support
from workforce
can lead to
weak
motivation, low
morale and
performance
7. Lewin 3-step/stage model
•
•
Lewin’s 3 stage model of planned organization change suggests that change is a systematic
process of moving from 1 stage to another
Lewin’s model is shown below:
old state
Unfreeze Awareness of
need for change
Change movement
from old state
to new state
Refreeze Assurance of
permanent
change
new state
Prepared by Dr. Parmindar Singh
Page 233
Strategic action - Organizational Structure and design
1. Introduction
Perhaps the most important resource of an organization is its people, so how people are
organized is crucial to the effectiveness of strategy. Alfred Chandler observed “as organization’s
changed their growth strategy to suit environmental changes (technology, economy,
demography etc.), these strategies created administrative problems and economic inefficiencies
unless it was also followed suit by structural changes”. When an organization’s strategy
matches its structure, chances of success are high.
2. Definition
Organization structure can simply be defined as the way in which an organization’s activities are
divided, organized and coordinated.
3. Factors to consider in deciding an organization structure
•
•
•
•
•
•
•
•
•
•
•
•
•
Size - e.g. a business controlled by one entrepreneur has quite a different structure from a
multi-million pound/dollar, multi-national giant
Chosen strategy - a company pursuing, say a growth strategy will probably need a different
organization structure from one pursuing a non-growth, low risk strategy
Management style - e.g. a program of decentralization will doom to be a failure if the CEO is
an autocrat
Potential synergy - the greater the potential synergy, the greater the desirability of
integrating a new operation or a new acquisition with the existing operations; while weak
synergy may suggest a holding company/subsidiary company relationship
Extent of diversification - the greater the diversification, there could be greater
decentralization (as top management may not know all areas)
Extent of geographical separation - the greater the geographical distance from the center,
the greater the necessity for decentralized control
Technology - the techniques, equipment and specialized knowledge used to transform
organizational inputs into outputs. Also to what extent is the organization reliant on simple or
complex technologies?
People - the types of people employed, their skills, competencies and level of motivation
Is the organization in a highly complex or changing environment or in a fairly stable
environment? – SLEPT/PESTEL
How diverse is the organization? - the needs of a multinational corporation (MNC) are
different from a small local firm
Changes in market forces
How answerable are the top executives to external stakeholders?
Superordinate goals
Prepared by Dr. Parmindar Singh
Page 234
4. Types of organizational structures
•






There are many types of organizational structures such as:
Entrepreneurial structure
Functional structure
Divisional structure
Holding company structure
Matrix structure
Others
5. Entrepreneurial structure
•
•
•
•
This structure is built around an owner-manager who takes all the key decisions.
All power and authority resides in one person (in reality, it may reside in 2 persons, a
husband and wife, say)
Such business are often started by individuals who have a great deal of expertise in one
area or function, such as selling or manufacturing, say
A typical entrepreneurial structure is shown below:
Entrepreneur
employee
employee
Advantages
quick decision making
short lines of communication
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employee
Disadvantages
highly dependent on the capabilities of
owner-manager
owner-manager may wrestle with the
need to give away control over aspects
of the business and involve other people
in decision making, as the firm becomes
more and more successful and the
owner-manager becomes more and
more busy
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6. Functional structure
•
•
•
This structure is common in firms which have outgrown the entrepreneurial stage
It is used mainly by smaller firms that offer a limited line of products in a stable environment
A typical functional structure is as shown below:
President/Board of
Directors/CEO
Marketing
department
•
Production
department
Finance
department
Human Resources
department
Functional structure brings together in one department everyone engaged in one activity or
several related activities. For example, an organization divided by function might separate
manufacturing, marketing, and sales department. A sales manager in such an organization
would be responsible for the sale of all products; the marketing department would be
responsible for the marketing of all products; the manufacturing/production department
would be responsible for the manufacture of all products etc.
Advantages
makes efficient use of specialized
resources - clear definition of roles
and responsibilities
makes supervision easier, since each
manager must be expert in only a narrow
range of skills
easier to mobilize specialized skills
and bring them to bear where they are
needed
chief executive in touch with all
operations
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Disadvantages
more difficult to get quick decisions or
actions on a problem because functional
managers have to report to central
headquarters and may have to wait a
long time before a request for help is
acted upon - slow to adapt to change
harder to determine accountability
and judge performance - if a new
product fails, who is to be blame? -R&D?, production?, marketing? Etc.
coordinating the functions of members of
the entire organization may become a
problem for top managers - e.g.
manufacturing may concentrate on cost
standards and delivery dates and neglect
quality control, consequently service
department may be flooded with
complaints etc. - problems of
coordinating and sub-optimization
senior managers burdened with everyday
operational issues - may neglect
strategic issues, especially as firm
becomes larger and more diverse
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7. Divisional structure
•
•
•
•
At some point in an organization’s existence, sheer size and diversity of products make
servicing by functional departments very cumbersome
When a company’s departmentalization becomes too complex, top management will create
semi-autonomous divisions, each of which designs, produces, and markets its own products
A division resembles a separate business. The division head focuses primarily on the
operations of his/her division, is accountable for profit and loss, and may even compete for
resources with other divisions. But a division is unlike a separate business in one crucial
aspect: the division manager cannot make a decision as freely as the owner of a truly
separate enterprise, because he/she must still report to central headquarters. As a rule, a
division’s head’s authority ends at the point where his/her decisions have a significant effect
on the workings of other divisions
Divisions may be formed on the basis of products as shown:
CEO/President/BOD
GM
Pharmaceuticals
Division
GM Proprietary
Division
Centralized support
services such as Finance,
Personnel, Sales etc.
GM Personal-care
Division
Functions
•
•
Division by products is logical when each product requires different manufacturing
technology and marketing methods etc.
Divisions may also be formed on the basis of geography as shown:
CEO/President/BOD
GM North
America
GM Latin America
and Far East
Centralized support
services such as Finance,
Personnel, Marketing,
Sales etc.
GM Europe, Africa,
Middle East
Functions
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•
•
This organization is logical when a plant must be located as close as possible to sources of
raw resources, major markets, or to specialized personnel, such as diamond cutting
operations in New York, Tel Aviv, and Amsterdam etc.
Divisions may also be formed on the basis of customers as shown:
CEO/President/BOD
Centralized support
services such as Finance,
Personnel, Marketing,
Sales etc.
GM Industrial
products
GM Consumer
products
GM Military
products
Functions
•
•
In division by customer, a division sells most of its products to a particular customer. From
the diagram above, the company sells to customers who can be manufacturing firms,
individuals and to military agencies
As a general rule, manufacturing firms with highly diversified lines of products tend to be
organized either by customer or by product
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Advantages
easier coordination - all skills and
expertise are grouped under 1 head
(GM, say)
quality and speed of decision making
enhanced because nearer to scene of
action
burden on central management (CEO
etc.) eased because divisional managers
have greater authority - therefore
facilitates senior management’s attention
to strategy
easier accountability - performance of
divisional management can be measured
in terms of that division’s profit or loss places responsibility for profits at the
divisional level and therefore enables
evaluation of contribution of various
divisions
concentration of business area - each
division is able to concentrate on the
problems and opportunities of its
particular business environment
ease of addition and divestment of units
encourages general management
development
Disadvantages
sub-optimization - the interest of the
division may be placed ahead of the
needs and goals of the total organization
short termism - for e.g., because they are
vulnerable to P&L performance reviews,
division heads may take short term gains
at the expense of long range profitability
duplication of skills - administrative
expenses increases because each
division has its own staff members and
specialists, leading to costly duplication
of skills
possible confusion over locus of
responsibility centralization/decentralization confusion
complexity of cooperation if too many
divisions
fosters politics in resource allocation
right personnel - requires more persons
with general manager abilities
8. Holding company structure
•
•
•
•
•
In its most extreme form, a holding company is really an investment company. It may simply
consist of shareholdings in a variety of separate business operations, over which the
corporate center exercises little detailed control
Although part of a parent company, these business units operate independently and
probably retain their original company names
The role of the parent company may be limited to decisions about buying and selling of such
companies with little involvement in their product/market strategy
This kind of structure is ideal for a diversified organization where the parts of the business
have very little in common except that they are owned in whole or in part by the same
shareholders
An example of a holding company structure is given below:
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Parent head
company
Company A
(wholly owned)
•
Company B
(wholly owned)
Company C (90%
owned)
Company D
(75% owned)
The business interests of the parent company are likely to be varied: some of them wholly
owned, and some not, and there may be many business units within the group. This is a
very fundamental difference between a divisional structure as compared to a holding
company. In a divisional structure, all the divisions are wholly owned by the company,
whereas, the companies in a holding structure may not be wholly owned by the parent
company as shown above
Advantages
low central overheads - the parent
company staff is normally small
offsetting of individual business losses
from profits of other business units
availability of finance for individual
businesses
the holding company itself may also
claim benefits, such as the spreading of
risk across many business ventures
ease of divestment for holding company
facilitates decentralization/devolution
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Disadvantages
duplication of effort
sub-optimization - if different companies’
objectives conflict
may lack internal strategic cohesion
difficulties of centralized control
parent company staff may lack skills to
assist individual business
the uncertainty felt by managers of
individual business (company) as to how
the parent company might react to
losses, or a possible sale should a
profitable opportunity come along
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9. Matrix structure
•
•
The matrix structure attempts to combine the benefits of functional and divisional structure
and avoiding their drawbacks
In a matrix structure, employees have in effect 2 bosses - that is, they are under dual
authority. One chain of command is functional or divisional, diagrammed vertically. The
second is horizontal, which depicts a project or a business team as shown:
SENIOR MANAGEMENT
FUNCTIONAL STRUCTURE
PRODUCT STRUCTURE
PROD.
DEPT
PROD/PROJ.
MGR. A
X
SALES
DEPT.
A
FINANCE
DEPT.
B
R&D
DEPT.
D
PROD./PROJ.
MGR. B
PROD./PROJ.
MGR. C
•
•
•
Employees X, A, B, and D works together with Project/Product manager A and comes from
production, sales, finance and R&D respectively. The matrix structure is therefore an
efficient means for bringing together the diverse specialized skills required to solve complex
problems
Problems of coordination are also minimized because the most important personnel for a
project work together as a group
This in itself produces a side benefit: by working together, people come to understand the
demands faced by those who have different areas of responsibility
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•
Other examples of matrix structure is shown:
BOD - CEO, Finance director,
Marketing director etc.
product A
US Area
product B
X
Y
product C
Z
Europe Area
S. America
Area
•
Employees X, Y and Z reports to the GM for US Area as well as GM for product A, B and C
respectively
•
Another example could be:
Head Master
head of languages
head of lower
school
A
head of science
B
head of social science
C
head of upper
school
head of 6th
form
•
Teachers A, B, and C reports to the head of lower school as well as to head of languages,
head of science and head of social studies respectively
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Advantages
Develop employee skills – increases skill
variety, improves motivation and
performance
Allows experts to be moved to crucial
areas as needed
People working participatively in teams –
synergy
Formal bureaucracy is replaced by direct
contact of employees – flatter structure
Managerial motivation - development of
management through increased
involvement in decisions
Avoids unnecessary duplication - since
each project is assigned only the number
of people it needs
By working together, people come to
understand the demands faced by those
who have different areas of responsibility
Disadvantages
Not everyone adapts well to matrix
system - team members must have good
interpersonal skills and be flexible and
cooperative
Morale can be adversely affected when
personnel are rearranged when projects
are completed and new one begins
Possibility of divided loyalties on the part
of members of project teams in relation
to their project manager and their
functional managers
Role conflict, role ambiguity and role
overload may result for managers and
staff
Possible many time consuming meetings
Time taken to make decisions may be
longer because consensus must be
obtained vertically and horizontally
Functional manager may feel that his
authority, to a certain extent could be
undermined
Helps to improve coordination
•







Practical implications for successful matrix:
Training in interpersonal relationships and communication
Clear definition of objectives of projects/tasks
Ensure influence is based on knowledge and information, not rank
Balance of power between functional and project managers
An experienced manager should lead the project
Proper organization/team development
Cost, time and quality controls should be installed
10. Other structures
•
•
•
•
•
Shamrock organization
Business ecosystem
Modular structure
Hollow structure
Virtual structure
11. Line and staff authority
•
•
Line function – contributes directly towards organizational goals
Staff function – contributes indirectly
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12. Boundary-less organization
•
Are organizations in which boundaries, including vertical, horizontal, external and
geographic are permeable (Ketchen, Jr. & Eisner, 2009).
• There are several types of boundary-less organizations:
 Hollow structure
 Modular structure
 Virtual structure
13. Hollow structure
•
Implies an organization that has outsourced some of its activities or process (especially noncore). An example of a hollow organization is a modular organization.
14. Modular organizations
•
•
Are organizations in which non-vital functions are outsourced, which uses the knowledge
and expertise of outside suppliers while retaining strategic control (Ketchen, Jr. & Eisner,
2009).
A modular organization involves an organization outsourcing some parts of its production to
specialist providers. The core company will then assemble the outsourced components inhouse to produce a final product (BPP, 2014).
15. Virtual organizations
•
•
A network of independent companies such as suppliers, customers, even competitors and
others linked together to share skills, costs, and access to one another’s markets (Ketchen,
Jr. & Eisner, 2009).
Can also be called as I-form organization (Miles, Miles & Snow, 2009) where there are
collaborative multi-firm networks and communities-based structures.
16. Consequences of structural deficiencies
•
If there was a structural deficiency, then according to Child, the following may arise:






Motivation and morale may be depressed because of:
Apparent inconsistency
Little responsibility
Lack of clarity as to what is expected
Competing pressures
Overloading due to inadequate support systems





Decision making may be delayed because of:
Information may be delayed in the hierarchy
Decision making is too segmented
Decision makers are overloaded
Past decisions are not evaluated
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 Conflict and lack of coordination, arising from: (N.B. structure by itself cannot resolve
conflict, although a good structure might bring such conflict out into the open)
 Conflicting goals that have not been structured into a single set
 No liaison - people working at cross-purposes
 Operators not involved in planning
 No or slow response to change, because:
 There is no established specialist in research and development (R&D) or market research
(MR)
 R&D and MR do not talk to each other
 R&D and MR are not mainstream activities
 Too many layers or reporting levels
 High administration costs, associated with:
 ‘Too many chiefs, too few red indians’
 Excess of procedures and paperwork
 Some or all of the other organizational problems being present
•




Implementing structure is affected by various contingencies such as:
Technology at the operating level
Environment at the strategic level
Size relating to complexity
Personnel employed, be they viewed as X or Y (McGregor) (Theory X - workers have little
ambition, desire security above all, avoid work unless coerced into it; Theory Y - people can
find satisfaction in work, they desire achievement, they seek responsibility)
17. Organizational Design
•
The successful implementation of strategies would be influenced by how the ‘flesh’ is hung
on the structure. This will depend upon several factors such as the extent of
centralization/decentralization (devolution), organizational configuration and resource
allocation and control processes
18. Centralization and Decentralization
•
•
•




•
Centralization is a condition where the upper levels of an organization’s hierarchy retain the
authority (the legitimate power to act in certain ways) to take most decisions - John Child
Decentralization or delegation describes a condition when the authority to make specific
decisions is passed down to units and people at lower levels in the organization’s hierarchy
Delegation is not:
Abdication
Abandonment of the manager’s responsibility
Loss of control by managers
Avoiding decision making by managers
Absolute decentralization of authority is not possible because any delegated authority
comes from the top, and the activities delegated must conform with the policy decided at a
higher level. Also absolute centralization of authority is not practical except in very small
concerns, because day-to-day decisions must be taken at lower levels
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•
•
•
The extent of centralization/decentralization will depend on top management’s preference as
well as size and scale of its activities. Small businesses are likely to be centralized, while
divisional structure is likely to be decentralized
Research shows that centralization of strategic decisions and delegation of tactical and
operating decisions can be very effective
Advantages and disadvantages of centralization:
Advantages
coordinated decisions and better
management control - less suboptimization
conformity with overall objectives
Senior management more qualified to
make decisions
economies of scale - general
management, finance, purchasing,
production etc.
top managers become better decision
makers
speedier central decisions may be made
in a crisis - delegation can be time
consuming
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Disadvantages
reduced job satisfaction by lower level
employees
senior managers may not posses
sufficient knowledge of all organizational
activities and therefore decisions made
may be myopic
added stress on senior management
restricted opportunity for career
development for lower level employees
decisions often take considerable time
slower decision making impairs effective
communication, which may affect
industrial relations
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•
Advantages and disadvantages of decentralization/delegation are:
Advantages
Disadvantages
prevents top management overload by
sub-optimization - it requires greater
freeing them from many operational
coordination by senior managers to
decisions and enabling them to
ensure that delegated decisions are not
concentrate on their strategic
conflicting
responsibilities
speeds up operational decisions by
requires a plentiful supply of capable and
enabling decisions to be taken at
well motivated managers who are able to
source/locally without reference back to
respond to the increased responsibility
top management all the time
decentralization brings about
improved quality of decision making
requires an adequate control and
since decisions is taken locally
communication system if major errors are
to be avoided by local managers
enables local management to be more
it can lead to inconsistency of treatment
flexible since decisions are taken in the
of customers, clients or public, especially
light of local conditions and thus be more
in the service industry
adaptable in situations of rapid change
can contribute to staff motivation and
possible insecurity and confusion about
morale by enabling middle and junior
who is ultimately responsible for a
management to get a taste of
particular task - the manager or the
responsibility, and by generally
subordinate
encouraging the use of initiative by all
employees
better training for local managers
fear that delegating authority to a
subordinate reduces their own authority
or fear that their subordinates may do a
better job
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19. Organizational configuration
• According to Mintzberg, there are 6 building blocks of organizational design:
 The operating core - where basic work is produced - the factory floor, the operating theatre,
the retail outlet
 The strategic apex - where the general management (senior management, BOD etc.) of
the organization occurs. It is the place where mission, and vision statements are produced.
 The middle line - all those managers who stand between the strategic apex and the
operating core (e.g. middle managers). From strategic apex, middle line and operating core
are all line functions.
 The technostructure - staff analysts who design the systems whereby the work processes
of others are delivered and controlled. They are concerned with coordinating work by
standardizing work processes, outputs and skills. Included here are engineers, accountants,
computer specialists, personnel managers etc.
 The support staff - who support the work of the operating core such as secretarial, clerical
and technical staff, legal staff and catering
 The ideology - or culture of the organization, and consisting of the values, beliefs and taken
for granted assumptions
•
The 6 building blocks is shown below:
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•
The relative sizes and importance of these building blocks will vary with circumstances as
well as the methods by which activities are coordinated within the organization. The
following 6 methods of coordination exists:
 Mutual adjustment - coordination through informal contact between people in the operating
core. Very common in small, simple organizations where people work closely and informally
together. Also common in very complex situations such as R&D projects.
 Direct supervision - through the hierarchy. Work is supervised by instruction from the
strategic apex, through the middle line to the operating core
 Standardization of work processes - through systems which specify how work should be
undertaken. It is usually the job of the analysts in the technostructure to design and develop
these systems of work standardization
 Standardization of outputs - through product or service specifications
 Standardization of skills - through knowledge and competencies. This is an important
coordinating mechanism in many professional service organization . So the operating core
of a professional service such as a hospital or an architect’s practice functions smoothly
because the operators share the same core knowledge and competencies through their
professional training
 Standardization of norms - where employees share the same core beliefs. This is
particularly powerful in many voluntary organizations
•
Based on the 6 building blocks as well as the method of coordination, Mintzberg suggests 6
types of organizational configuration:
 Simple structure - is in many senses a ‘non-structure’. Few of the activities are formalized,
and it makes minimal use of planning. It has a small management hierarchy, dominated by
the chief executive (often the owner) and a loose division of work. The organization is driven
forward by the vision and personality of the chief executive. This configuration can prove
highly effective in small entrepreneurial organizations where flexibility to change in
circumstances is critical to success. Highly centralized.
 Machine bureaucracy - often found in mature organizations operating in markets where
rates of change are low. It is characterized by a large staff function – or technostructure,
which develops systems and work routines to standardize work. It is dominated by a
strategic management that centralized information flows and decision authority. It is likely to
be organized into a functional structure.
 Professional bureaucracy - typical of law firms, school/university systems, accounting firms,
hospitals and other knowledge based organizations that depend on the knowledge and
expertise of professionals. It is much more decentralized than machine bureaucracy. Power
is in the hand of professionals and have weak centralized authority. Professional work is
standardized by ensuring that professionals have the same core knowledge and
competencies
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 Divisionalized bureaucracy - is often found as a response to diversity in the products and/or
markets of the organization. It is likely to be organized into a divisional structure. A great
deal of decision making is decentralized to these divisions, and the role of the senior
managers at the strategic apex at head office is to monitor performance and maintain a
strategic overview of the business as a whole.
 Adhocracy - this “task force” organization is typically found in research organizations,
aerospace companies, medical, biomedical, electronics, advertising agencies, management
consultancies and other high tech firms that must operate in complex and rapidly
changing environments and markets or that derive revenue from government contracts.
Their competitive strategy is largely concerned with innovation and change. This
configuration is highly organic, relying on direct interaction between workers (experts) in the
operating core and a management style that assists and promotes this mutual adjustment.
This is an informal and innovative form of organization. There is extensive decentralization.
 Missionary - are dominated by cultural issues which are clear, focused, inspiring and
distinctive. Many voluntary organizations operate in this way: they attract like minded
individuals who share the same missionary vision, and as such rely little on structures and
systems to drive the organization along
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•
The table below shows the organizational configurations in terms of key building , key
coordinating mechanisms, environment and internal factors:
Configuration
Simple
structure
Environment
(external)
simple/
dynamic
Machine
bureaucracy
simple/ static
Professional
bureaucracy
complex/
static
Divisionalized
bureaucracy
simple/ static
diversity
Adhocracy
complex/
dynamic
Missionary
simple/ static
•
Internal
factors
small,
young firms,
simple
tasks, CEO
control
old, large
firms,
regulated
tasks,
technocrat
control
simple
systems,
professional
control
old, very
large firms,
divisible
tasks
often young
firms,
complex
tasks,
expert
control
middle aged
firms, often
‘enclaves’,
simple
systems
Key building
block
strategic apex
Key coordinating
mechanism
direct
supervision
technostructure
standardization
of work
operating core
standardization
of skills
middle line
standardization
of outputs
operating core,
support staff
mutual
adjustment
ideology
standardization
of norms
Although few organization will fit neatly into just one of these stereotypes, they can be used
to think through some important issues concerning the structure/strategy fit in an
organization. Managers can check out which stereotype their organization currently most
resembles. More importantly, they can describe the external and internal factors for their
organization and see how closely these match the situation and for which particular
configuration it is best suited
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20. Changing configuration
•
•
•
•
•
It is quite possible that changing circumstances will have created a mismatch between the
configuration and the situation
For example, a small company may have grown and diversified so that the simple structure
cannot cope
Many public services took on features of professional bureaucracy during a period of little
change, and then experience considerable difficulty in adjusting parts of their organization
towards adhocracy as a necessary response to a dynamic environment which requires more
flexibility and customization of services (e.g. think of corporatization of universities in
Malaysia)
Also different SBUs in an organization may have different organizational configuration, and
sometimes an organization may have to play 2 or more organizational configuration,
depending on the circumstances
The table below shows some examples of changing configurations as well as their reasons:
From
Simple
Machine bureaucracy
Professional bureaucracy
Missionary
To
Machine bureaucracy
Divisionalized
Adhocracy
Professional
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Reason
growth
growth and diversity
changing environment
growth
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Strategic action - Leadership and organizational culture – discuss the importance of
leadership in defining and managing organizational culture
1. Leaders and organizational culture
•
Culture – definitions
 Basic assumptions and beliefs that are shared by members of an organization, that operates
unconsciously and define in a basic taken-for-granted fashion an organization’s view of itself
and its environment – Schein
 Shared values, ingrained attitudes, and company traditions that determine the norms of
behavior, accepted work practices and styles of operating – Chatham and Cha
 Set of values, beliefs and norms, often taken for granted, that tells employees what behavior
is acceptable and what behavior is not, and often, these values, beliefs and norms are
communicated through stories and other symbolic means.
 Organizational culture is the set of values, beliefs, norms often taken for granted, that
help people in an organization understand which actions are considered acceptable and
which are considered unacceptable. Often these values are communicated through
stories and other symbolic means
Johnson and Scholes – Cultural Web – to analyse existing
culture or deculture
SPROCS-P
• Stories
Power structures
• Rituals and routines
• Organizational structures
• Control structures
• Symbols
• Paradigm
•
•
Leaders/founders can influence organizational culture (founder/leader imprinting). E.g.
Enron
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• Schein’s level of culture
 Artifacts
 Espoused values
 Basic underlying assumptions
Artifacts
Espoused values
Basic underlying assumptions
(Attention, Resource allocation, Role modeling,
Crisis, selection and dismissal, Reward allocation)
•
Culture can be an asset (VRIS - Barney) or a liability (e.g. groupthink, e.g. GM’s ignition
switch cover-up).
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Analysis of culture using Cultural Web and to recommend changes
Cultural Web
SPROCS-P
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Firm level cultural analysis
Dr. Parmindar Singh, CamEd Business School, Cambodia
Abstract
Purpose: The paper aims to analyse organizational culture using Johnson, Scholes and Whittington’s
Cultural Web. The paper also aims to analyse the usage of Cultural Web in understanding how firms can
change their culture as well as how culture can affect chosen strategies.
Methodology: Several firms were analysed to determine their culture.
Findings: Organizations’ culture can be analysed using Cultural Web as well as helping firms to change
their culture. In addition, strategies can also be decided by analyzing organizational culture.
Keywords: Cultural Web
Paper type: Conceptual
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1.0 Introduction
This article examines culture at the firm level. The analysis will be based on Cultural Web (Johnson,
Scholes & Whittington, 2008) and will analyze the culture of some organizations. The first section of this
article will describe cultural model to be used, i.e. Cultural Web (Johnson et al., 2008). This is then
followed by analysis of several organizations. Finally, there will be a conclusion section to wrap up the
main points.
2.0 Cultural Web
The cultural web of Johnson et al. (2008) is diagrammatically illustrated in Figure 1.
Source: Johnson, G., Scholes, K. and Whittington, R. (2008), Exploring Corporate Strategy (8th ed.)
According to Johnson et al. (2008, p. 197), the cultural web shows the behavioral, physical and symbolic
manifestations of culture at the organizational level. The elements of cultural web are explained in the
next paragraphs.
The paradigm is at the core of cultural web and refers to the taken-for-granted assumptions and beliefs
of employees. Routines refer to “the way things are done around here” while rituals are activities or
events that emphasize, highlights or reinforce what is especially important in the culture. Examples
include training programmes, interviews, promotion, assessment procedures, among others.
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The stories told may act to embed the present in its organizational history and also highlights important
events and personalities. The stories told can be about successes, disasters, heroes, villains, mavericks,
among others.
Symbols are objects, events, acts or people that convey, maintain or create meaning over and above
their functional purpose. These include offices and their layouts, cars, titles, pictures, and also mission
statement.
Power structure explains the one who wields the power. While it is often taken for granted that power
structures are people at the highest echelons of an organization, there can at times be other persons
lurking around the shadows of top management that may affect and influence their decisions.
Organizational structure and reporting relationships may also reflect a firm’s values, beliefs and norms.
Taller structures and convey a different meaning while flatter structure that decision-making is
decentralized.
Control systems focus on how to control employee behavior. This may include rewards, performance
appraisal, policies, procedures, handbooks and internal controls.
3.0 Analysis of organizations using cultural web
3.1 Stories
Under the leadership of Paul Polman, CEO of Unilever since 2009, the emphasis has been on
sustainability issues. Polman mentioned that if investors did not believe in this sustainability model, he
told them to put their money elsewhere (Gunther, 2013, p.67). However, investors did not put their
money elsewhere and share price and revenues improved.
During the time of Lee Kun Hee, chairman of Samsung (may soon step down to allow his son, Lee Jae
Yong to become chairman due to illness), when he made a world tour in 1993, he was utterly
disappointed with what he saw and a convened a meeting in Falkenstein Grand Kempinski Hotel in
Frankfurt, Germany, he ordered all of Samsung’s executives to meet him there. Here he delivered a
speech that lasted three days and his most famous mantra was “change everything but your wife and
children”. This event became known as the Frankfurt Declaration and Chairman Lee Kun Hee’s clarion
call was to emphasize on quality. The décor of the hotel room has been replicated in Samsung’s
Creativity Complex, known as the Changjo Kwan (Grobart, 2013).
Another story of chairman Lee occurred in 1995 where he was unhappy with the quality of cellphones
produced and directed his underlings to assemble around 150,000 devices outside the cellphone
manufacturing facility (Gumi Complex) and more than 2,000 staff gathered around the pile of
cellphones. He then set fire on the pile of cellphones. This incident became known as the Great Phone
Incineration of 1995 (Grobart, 2013).
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Other stories abound such as the stories of the CEO of Estee Lauder, Fabrizio Freda who is a good
listener, determined and resolute. His focus is on data and he likes to create a sense of excitement on
cutting costs. He also focuses on employees’ strengths and not trying to improve weaknesses. He likes to
encourage his staff to offer ideas that challenges his own and he is good in synchronizing and allocating
resources (Tully, 2013).
There are also stories about the CEO of Yum Brands (the franchisor of KFC), David Novak who is
recognized as a team builder and has developed a discipline of nurturing and developing leaders. His
office is filled with photos of staff and rubber chickens, and sets of teeth on skinny legs with oversize
feet. He does not take pride in elegance and office deco as well as he is very approachable (Colvin,
2013).
Stories form the fabric of organizational culture and interesting stories spread from one mouth to
another and soon becomes part of an organization’s values, beliefs and norms.
3.2 Power structures
At Yum Brands, a high ranking position has been created, called Chief People Officer so that its brands
like KFC and others have staff that are customer-centric (Colvin, 2013). On the other hand, the power
structure of Estee Lauder consist of the Lauder family that sits on the board and have 86% voting rights
(Tully, 2013).
In the case of Yahoo, it is the CEO, Marissa Mayer who wants to transform Yahoo into a media company
in the mobile age (Stone, 2013). For Unilever, to emphasize sustainability, the board created a position
called, Chief Sustainability Officer (Gunther, 2013).
These positions and the incumbents will strive to steer the company in the direction desired. Hence
these physical manifestation of positions will reflect a firm’s values, beliefs and norms.
3.3 Rituals and routines
For Estee Lauder, their routines consist of encouraging feedback from staff and making brand presidents
fully accountable to profit and loss. The most important metric is profit and cost measures (Tully, 2013).
In Goldman Sachs, their routines consist of formation of affinity networks for minority, special interest
groups and even for an active LGBT (lesbian, gay, bisexual and transsexual) network. In addition, it also
has a program that pairs employees with volunteer projects run by non-profits. This program is called,
Community Team works. Goldman Sachs also has another routine which they called as “Returnship”, a
ten week program designed to help talented people return to the workforce after a “voluntary career
break” of two years or more. It also has a Corporate Citizenship committee which has contributed more
than $100 million to aid women entrepreneurs in developing countries (Vandermey, 2014).
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In Yahoo, under Marissa Mayer, there are Friday “FYI” meetings with employees (Stone, 2013; Hempel,
2014) and an internal online service that allows employees to complain about organizational issues,
called PB & J (process, bureaucracy, and jams) (Stone, 2013).
In Yum Brands, CEO has developed a leadership development program called “Taking the people with
you”. This program has been translated into different languages for training material. The aim of this
program is to build effective teams (Colvin, 2013).
In Samsung’s Gumi Complex where smartphones are built, there is Korean pop music chosen by
psychologists to help reduce stress among employees. In addition, workers are not put in an assembly
line. Production is done on a cellular basis and each employee is then responsible for the overall
assembly of the phone (a form of job enlargement) (Grobart, 2013).
3.4 Organizational structure
Organizational structure will show the power and important roles and relationships. These roles and
relationship may illustrate and personify the values, beliefs and norms of an organization.
Samsung adopts a vertical integration where it has control over upstream activities such as display
screens, memory and processors) as well as over downstream activities such as marketing. In addition,
Samsung also adopts a militaristic structure where all pertinent decisions are decided by the CEO – a
top-down structure (Grobart, 2013).
Pay Pal, on the other hand, adopts a decentralized structure to encourage faster innovation. Its
subsidiaries like Paydiant and Braintree operate independently, keeping their offices, names and
leadership while under the Pay Pal umbrella (Rao, 2016, p.87).
Estee Lauder however believes in centralized purchasing and appointing country heads (Tully, 2013).
Thus different organization’s organizational structure will have an impact on a firm’s subsequent values,
beliefs and norms.
3.5 Control systems
Control systems focus on controlling employee behavior and include rewards and other measurement
systems. These systems will definitely impinge on a firm’s values, beliefs and norms.
In KFC, CEO David Novak spends time listening to franchisees and trying to make top managers and
franchisees share the same ideals so that cooperation can occur easily and therefore, control is more
informal (Colvin, 2013).
In Estee Lauder, control is obtained by altering the reward structure to focus on profits (Tully, 2013).
Goldman Sachs goes all the way to focus on rewards to influence employees’ behavior. They have
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flexible working arrangements, longer maternity leave, infant transition program, inhouse cafeteria,
physical fitness centre, among others (Vandermay, 2014).
In Honda, to address the quality issues such as engine failures, a new management line-up was formed
with direct reports to CEO, Takahiro Hachigo. Hence there is more direct supervision in terms of policies
and procedures (Bloomberg, 2016).
3.6 Symbols
Symbols are objects, events, acts or people that convey, maintain, or create meaning over time and
above their functional purpose (Johnson et al., 2008, p. 199).
In KFC, the symbols used to depict appreciation, honor and rewards are rubber chickens, teeth with
skinny legs and oversized feet. In addition, pictures in the CEO’s office depict staff receiving rewards
(Colvin, 2013). These symbols convey KFC’s values, beliefs and norms.
In Unilever, the manifesto, “Sustainable Living Plan” has become part of an object, act and event where
Unilever plans to double sales, cut down on environmental footprint and source all its agricultural
products in ways that don’t degrade the earth by 2020 (Gunther, 2013).
3.7 Paradigm
Paradigm refers to the taken-for-granted assumptions and beliefs (Johnson et al., 2008, p.197).
In Estee Lauder, the paradigm is on cost savings and focusing on profits while at the same time,
feedback and suggestions are always welcomed (Tully, 2013).
In Samsung, employees feel that the firm is in perpetual crisis and they should not rest on their laurels
but to continue to embrace change, otherwise, Samsung may lose out competitively (Grobart, 2013).
In KFC, the taken-for-granted assumptions are that KFC is a company that focuses on people, their worth
and give their staff due recognition. Their assumptions are also that they have a CEO who is both taskand people-oriented (Colvin, 2013).
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4.0 Conclusions
The Cultural Web as proposed by Johnson et al. can be used to analyse organizational culture.
Organizational culture is a very important consideration for companies in their decisions on strategy. For
example, eBay decided to divest (sell-off) Skype to Microsoft partly because of the lack of compatibility
of Skype’s culture to its parent, eBay (Rao, 2016).Hence compatibility or otherwise of an organization’s
culture can determine strategy chosen.
In addition, compatibility of culture or otherwise can also affect communication and collaboration.
Furthermore, knowing organizational culture can also help a firm to de-culture to achieve its goals and
objectives.
Honda, under its previous CEO had tried to change Honda’s culture by de-emphasizing on research and
focusing more on marketing (Taylor III, 2013).
Therefore Cultural Web can be used to understand a firm’s organizational culture, de-culture a firm’s
culture as well as helping firms to formulate strategies.
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Reference
Bloomberg (2016), ‘Honda chief builds new management team’, The Japan Times, February 24,
<http://www.japantimes.co.jp, access August 1, 2016.
Colvin, G. (2013), ‘Great job’, Fortune, August 12, pp. 38-42.
Grobart, S. (2013), ‘Think colossal’, Bloomberg Businessweek, Apr 1-7, pp. 59-64.
Gunther, M. (2013), ‘Unilever’s CEO has a green thumb’, Fortune, June 10, pp. 67-70.
Johnson, G., Scholes, K., Whittington,R. (2008), Exploring Corporate Strategy (8th ed), FT Prentice Hall,
England.
Hempel, J. (2014), ‘Marissa’s moment of truth’, Fortune, May 19, pp.42-48.
Rao, L. (2016), ‘Pay Pal plays catch-up’, Fortune, June 15, pp. 82-87.
Stone, B. (2013), ‘Can Marissa Mayer save Yahoo?’, Bloomberg Businessweek, Aug. 5-11, pp. 44.49.
Tully, S. (2013), ‘An outsider in the family castle’, Fortune, Nov. 18, pp. 66-68; 70-75.
Vandermey, A. (2014), ‘Yes, Goldman Sachs really is a great place to work’, Fortune, Feb. 24, pp. 44-50.
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Strategic action – Project management
Project management
•
To implement changes, a project or projects have to be undertaken.
1. Project
•
A project is a job/work that consists of a start and end time, divided into
stages/phases/activities, consumes resources such as time, money, HR and other
resources; has deliverables and directed toward some major output.
•
Some examples of a WBS are shown below:
Activity
PA
Normal time
(weeks)
Crash time
(weeks)
Normal cost
Crash cost
A
-
5
3
200
400
B
-
4
4
100
100
C
A
2
1
500
800
D
B
1
1
50
50
E
B
5
3
150
300
F
B
5
4
300
350
G
C, D
4
4
200
200
H
F
3
2
300
500
Activity
Preceding activity (PA)
Duration (days)
A
-
4
B
-
3
C
A
6
D
B
8
E
C, D
3
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2. Characteristics of a project
•
Stakeholders – all those who are interested in the progress or the final outcome of the
project such as:
 Project sponsor - person or organization providing the resources for the project, i.e. the
person responsible for ensuring that the project is successful at the business level
 Project owner - is the person for whom the project is being carried out. They are interested
in the end result being achieved and their needs being met
 Project customer - end user
 Project manager - responsible with achieving overall project output
 Project team - responsible with achieving project tasks that make up overall project
 Suppliers/vendors - of resources (hardware, software materials etc.)
•
•
•
•
•
•
•
•
Uniqueness – not exactly the same as what has been previously done
Objectives – SMART; deliverables, quality, costs, profitability etc.
Resources
Schedules
Quality – Crosby, Juran
Uncertainty – risk
Finiteness – time bound
Change – less time for change
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3. Project life cycle
A.
•
•
•
•
Conception
Development
Realization
Termination
B. Project life cycle of large projects
•
Identification of a need
 A Terms of Reference is created prior to a feasibility of whether the need is feasible or
otherwise.
 A typical TOR may contain:
➢
➢
➢
➢
Background – why the system/project may be needed
Areas that need to be studied or paid attention to (i.e. scope)
Project sponsor
constraints
 Based on TOR, a feasibility study is carried out. The areas of possible feasibility study can
be:
➢
➢
➢
➢
➢
➢
Technical feasibility
Operational feasibility
Social feasibility
Economic/financial feasibility
Ecological feasibility
Legal feasibility
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TOSEEL
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 At the end of feasibility study, a feasibility report is produced. If the report indicates that
system needed is feasible, then a Project Initiation Document (PID) is produced.
 A typical PID may contain the following:
➢ Background of project – why is it necessary
➢ Project objectives
➢ Project scope – work to be carried out, deliverables, constraints
➢ Communication plan (reports, meetings etc.)
➢ Controls in place – steering committee, project sponsor
BOSCC
 If contractors (3rd party) are used, then the company concerned must present an ITT
(invitation to tender) or RFP (request for proposal)
 Contents of ITT:
➢
➢
➢
➢
➢
Background
Organizational/functional requirements
Support needed
Costs
Miscellaneous
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•
Development of a proposed solution
 A blueprint of the proposed solution or system is designed. A project plan can be produced:
➢ Objectives
➢ Methodology
➢ Analysis and evaluation:
❖
❖
❖
❖
❖
WBS
Gantt chart/timeline
Network diagrams – critical path, critical activities, total elapsed time, minimum total costs
Resource Histogram
Benefits map
•
Implementation
 Actual work commences. A WBS is used. The project’s objectives of functionality, quality,
cost and time are monitored. An appropriate reporting system has to be provided as part of
the project plan to keep the team, top management and the customer informed on project
progress, expenditure, costs, and foreseen possible adverse events.
 As part of the reporting system, a comprehensive project log is maintained with details of
any problems which have been met and the way in which they have been resolved.
•
Completion
 The project comes to an end with the successful launch of the product. An analysis of the
project reports will provide invaluable information which can be helpful in other projects. This
will include success of methods used, performance of team members and reliability of
suppliers.
This project life cycle may have to be iterated, if need be.
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C.
Business Case – costs and benefits of the project
Project initiation document (PID)
Project Plan
Project commences
Ends
4. Project management
•
Project management can be defined as planning, organizing, leading/directing and
controlling resources (people, equipment, material, time, money) to ensure that there is no
time overrun, no cost overrun, and that the output meets customer (both external and
internal) requirements, i.e. quality – triple constraint.
Time
Cost
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Scope (including quality)
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5. Risk and uncertainty and reasons for project failure
•
Risk can be defined as the probability of an undesirable event.
•



Risk management:
Risk assessment – risk identification, measurement and risk prioritization
Risk response – ATAR/TARA
Risk communication
•
Reasons for project failure/project slippage
 Resource estimates unrealistic
 Objectives not clearly defined or measurable
 Project manager having poor communication skills
 Objectives changed during project – requirements creep
 Poor leadership skills of project manager
 Senior management not showing strong support – no project champion
 Stakeholders not taking ownership of project
 Role and responsibilities of project team not defined
 Resources not identified or made available at the start
 Project team did not work as a team
 Poor project planning
 Lack of controls
 Insufficient budget
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•
A successful project teamwork will include the following:
 Clear understanding of project objectives
 Clear understanding of each team member’s role and duties
 Results focused team
 High level of coordination, cooperation and commitment
•
Problems of team working:
 Unclear team goals and objectives
 Lack of team structure
 Lack of definition of roles
 Poor leadership
 Poor team communication
 Lack of commitment
 Not everyone adapts well to a team
 Social loafing/free rider
 Groupthink
 Abilene paradox
 Group polarization/risky shift – to take more risky decisions than individuals since no one
can be held responsible
 Time consuming meetings
 Possible adverse emotional reactions as members leave the team and others join in
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6. Roles, responsibilities and skills of a project manager
•
Role – to ensure success of project objectives. The project manager must manage,
coordinate, control and communicate project tasks. The project manager must manage
people, carry out processes, and produce the final deliverable (product).
•
Responsibilities
 Planning - deciding the type of methodology, techniques etc. to be used. This can be divided
into tasks or activities. Each activity will be given a preceding activity (or activities), their
budgeted time(s), and other resources such as cost (budgeted)and HR. Tools like bar charts
(Gantt charts) as well as network tools can be used for planning purposes. Also deciding on
the project objective (time, money, customer requirements, and other resources needed).
 Organizing - assigning the respective personnel to their specific roles and responsibilities.
There should be a clear match between the personnel and their specific duties. Sometimes,
if there are insufficient personnel or due to cost reasons, the project may be outsourced.
 Leading - the project manager must have good leadership skills to ensure the project gets
completed within budget. In general, the larger the size of the project, the more unstructured
the project or the technology used is relatively new to the organization, then, the risk of
project failure would be higher. Warren McFarlan has established an Implementation risk
matrix for project as shown:
Structured-ness
low
high
Highest
Medium
risk
risk
Medium risk
Lowest risk
high
Relative
Technology
low
(Manager beware)
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The right project manager must be needed for each quadrant as well as the right tools.
 Controlling - the project manager must ensure that the project gets completed within budget
(time, cost) as well as within the resource constraints (people, material, equipment). To
ensure this, the project manager may use tools like Gantt charts, and network analysis.
 Liaising - the project manager must liaise with people at all levels, in all functions as well as
with development staff and outside vendors. He/she must be both business and IT literate.
•
Skills of a project manager:
 Communication abilities - the project manager will often be called upon to address meetings,
both business and public, on a variety of matters concerning the project. Additionally there
will be a need to teach project and customer’s staff on the use of techniques and methods
and to assess training needs and courses. Communication is done through meetings (formal
or informal with customers and team members), written reports, listening etc.
 Leadership skills
 Negotiation skills - on resources, schedules, priorities, standards, costs, quality, people
issues
Negotiation point
Possible issues
•
Resource
Funding
• Staff
• Equipment
• Timescale
Schedules
• Order of activities
• Duration of activities
• Timing of activities
• Deadlines
Priorities
Procedures
•
Over other projects or
work
• Between cost, quality,
and time
• Of team members
activities
• Methods
• Roles and
responsibilities
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Negotiate with
•
Senior management
• Line managers
• Purchasing
departments
• Customer and senior
management
• Customers/teams
• Line managers/team
members
• Line managers/team
members
• Customer/line
manager
• Senior management
• Customer/team
members
• Team members
•
Team members
• Team
members/customers
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•
• Senior
management/customer
• Team members
• Customer/teams
• Customer/teams
• Customer/teams
Reporting
Relationships
•
Quality
Assurance check
• Performance
measures
• Fitness of purpose
• Estimates
• Budgets
• Expenditure
Costs
People
•
•
Getting team to work
together
• Getting required skills
• Work allocations
• Effort needed
•
Accountants/team
members
• Customer/senior
management
• Customer/accountants
• Team members
• Team members/line
managers
• Team members/line
managers
• Team members/line
managers
 Delegation skills
 Problems solving skills
 Change management skills
7. Project objective constraints
•
Scope/functionality – all the work that must be carried out
•
Schedule/time
•
Cost
•
Customer satisfaction/quality
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8. Project planning and control tools
•
The most common tools used in project control are SWOT analysis, WBS, and position
audit, Gantt charts, Network analysis, Resource histogram, budgets, progress reports and
completion reports.
Duration
Activity
A
B
C
D
E
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4
A
C
6
Start
E
3
B
•
•
•
•
3
End
8
D
Critical path – path that connects all critical activities
Critical activity – activity that has no slack resources
Critical period/total elapsed time – fastest time taken to complete project given there is no
additional resources allocated
If an activity has slack, it ought to be used up
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Benefits map
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9. Advantages of project management software
•
Tools
•
Automatic construction
•
Accurate
•
Affordable
•
Ease of use
•
Speed
•
What-if analysis
•
Able to handle complexity
•
Monitoring progress
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10. PRINCE 2 methodology
•
PRojects IN Controlled Environment version 2
11. Business case, managing benefits, post-project review, post-implementation review benefits
realization review, benefit owner, benefits map
Business case
While certainly there are benefits and costs incurred, these benefits must be quantified and all
other costs and related problems should as much as possible be quantified too. Also the timing
of benefits (cash flow) and costs (cash outflow) needs to be ascertained as accurately as
possible.
Hence with proper quantification of benefits (made as tangible as possible) as well as costs and
problems, proper capital budgeting techniques can be applied such as NPV, payback analysis
and IRR using appropriate discount factors.
Managing benefits
The project, if implemented must be managed to ensure that it remains on track and schedule to
deliver value to the organization. There must be proper work breakdown structure, timelines and
critical path analysis done so as to ensure project and progress remains on track.
Post-project review
A post-project review takes place once the project has been completed. In fact, it can often be
the last stage of the project, with the review culminating in the sign-off of the project and the
formal dissolution of the project team. The focus of the post-project review is on the conduct of
the project itself, not the product it has delivered. The aim is to identify and understand what
went well and what went badly in the project and to feed lessons learned back into the project
management standards with the aim of improving subsequent project management in the
organisation.
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Post-implementation review
A post-implementation review focuses on the product delivered by the project. It usually takes
place a specified time after the product has been delivered. This allows the actual users of the
product an opportunity to use and experience the product or service and to feedback their
observations into a formal review. The post-implementation review will focus on the product’s
fitness for purpose. The review will not only discuss strategies for fixing or addressing identified
faults, but it will also make recommendations on how to avoid these faults in the future. In this
instance these lessons learned are fed back into the product production process.
Benefits realization review
A benefits realisation review also takes place after the product has been delivered. It is primarily
concerned with revisiting the business case to see if the costs predicted at the initiation of the
project were accurate and that the predicted benefits have actually accrued. In effect, it is a
review of the initial cost/benefit analysis and any subsequent updates made to this analysis
during the conduct of the project. It may be part of a post-implementation review, although the
long-term nature of most benefits means that the post-implementation review is often held too
soon to properly conduct benefits realisation. In fact, it can be argued that benefits realisation is
actually a series of reviews where the predicted long-term costs and benefits of the business
case are monitored. Again, one of the objectives is to identify lessons learned and in this case
to feed these back into the benefits management process of the organisation.
Benefit owner
A benefit owner is someone who has responsibility for defining, agreeing and delivering a
benefit defined in the business case. Without benefit owners, benefits are unlikely to happen. It
is very unlikely that the project manager responsible for a change project would be the benefit
owner. Their responsibility is to deliver the project, not to operationally run the outcome of the
project. This must be the responsibility of the business and so the benefit owner should be a
person who has authority to make business decisions which help deliver the benefits. Many
projects which have promised cost savings may not been delivered because no-one had
responsibility for making those savings. It is very important that a benefit owner be appointed for
administrative cost reductions. Sometimes, the extent of those savings cannot be reliably
estimated due to problems in requirements definition and, also, because someone has to
actually make these staff cuts when the new system is in place to deliver the benefits promised
in the initial business case.
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Benefits maps
A benefits map helps the benefit owner determine what has to be put in place to deliver the
promised benefit. The map can also be used to show how the benefits relate to the objectives of
the organisation. For example, increased student numbers may be part of improving the
accessibility of the qualification. Benefits may require business changes and enabling changes
which have to be put in place to deliver the benefit. For example, the eventual elimination of
marker costs (a benefit) will only be achieved once a question bank has been defined (an
identified cost). A process will have to be put in place to define how questions will be
commissioned, how they will be evaluated and how they will be entered and maintained in the
question bank. These business and enabling changes require tasks which will have to be
estimated and scheduled in a project plan. They form the link between the IT enabler (the
software solution) and actually delivering the benefit. The benefits map shows exactly what has
to be done to actually deliver the promised benefit.
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Strategic action - leadership
Leadership
1. Meaning of leadership and management
•
Leadership is defined as the ability to influence people toward the attainment of goals.
•
Management is the process of achieving organizational objectives, within a changing
environment, by balancing efficiency, effectiveness and equity, obtaining the most from
limited resources and working with and through people.
•



Management:
Promotes stability, order and problem-solving
Takes care of where you are
More concerned with the “hard” S of strategy, structure and systems.
•



Leadership:
Promotes vision, creativity, and change
Takes you to a new place
Concerned with the “soft” S of staff, style, skills and super-ordinate goals.
Manager qualities – focus on organization
Rational
Maintains stability
Assigns tasks
Organizes
Analyses
Position power
Prepared by Dr. Parmindar Singh
Leader qualities – focus on people
Visionary
Promotes change
Defines purpose
Nurtures
Innovates
Personal power
Page 282
2. Leadership traits
•
Physical characteristics – energy, physical stamina
•
Personality – self-confidence, honesty and integrity, optimism, desire to lead, independence
•
Work-related characteristics – achievement drive, desire to excel, conscientiousness in
pursuit of goals, persistence against obstacles, tenacity
•
Intelligence and ability – intelligence, cognitive ability, knowledge, judgment, decisiveness
•
Social characteristics – sociability, interpersonal skills, cooperativeness, ability to enlist
cooperation, tact, diplomacy
•
Social background – education, mobility
3. Contemporary leadership
Level 5 leadership
Complete lack of ego
– full of humility
Servant leadership
Serves others to fulfill
followers’ needs and
goals
Authentic leadership
Individuals who know
and understand
themselves
Fierce resolve to do
what is best for
organization
As well as to achieve
organization’s larger
mission
Who espouse and act
consistent with
higher-order ethical
values
Empower and inspire
others with their
openness and
authenticity
Prepared by Dr. Parmindar Singh
Interactive leadership
Individuals that
favours a consensual
and collaborative
process
Influence derives from
relationships rather
than position power
and formal authority
Page 283
4. Behavioral approach
•
Ohio State Studies – two major behaviours – consideration and initiating structure
Consideration
People-oriented behavior - the extent the
leader is mindful of subordinates, respect their
ideas and feelings, and establishes mutual
trust. Considerate leaders are friendly, provide
open communication, develop teamwork, and
are oriented toward their subordinates’ welfare
high
Initiating structure
The extent to which the leader is task oriented
and directs subordinate work activities toward
goal attainment. Initiating structure leaders
give instructions, spend time planning,
emphasize deadlines, and provides explicit
schedules of work activities.
X
Consideration
low
low
high
Initiating structure
Prepared by Dr. Parmindar Singh
Page 284
•
Michigan studies – two major behaviours – employee-centered leaders and job/productioncentered leaders
Employee-centered behavior
leaders who established high performance
goals and displayed supportive behavior
towards subordinates
high
Job/production centered leaders
Less in favor of goal achievement and human
needs and more in favor of meeting
schedules, keeping costs low and achieving
production efficiency
X
Employee-centered
low
low
high
Job/task/production centered
Prepared by Dr. Parmindar Singh
Page 285
•
Leadership Grid (Blake and McCanse, 1991, formerly Blake and Mouton Managerial Grid)
 Built on the work of Ohio State and Michigan studies
Concern for people
9
1,9
9,9
8
7
6
5
5,5
4
3
2
.
1
1,1
1
9,1
2
3
4
5
6
7
8
9
Concern for production
Prepared by Dr. Parmindar Singh
Page 286
Position
1,1
Description
Impoverished Management – exertion of
minimum effort to get required work done is
appropriate to sustain organization
membership. The 1,1 leader’s desire is to
remain as uninvolved as possible with other
people, compatible with fulfilling the
requirements of the job and sustaining
organization membership. Conflict is
deliberately avoided by remaining neutral on
most contentious issues
9,1
Authority Compliance
–
efficiency
in
operations results from arranging conditions of
work in such a way that human elements
interfere to a minimum degree. This leader
emphasizes concern for task and little concern
for people. There is a belief that production
can only be achieved if people are closely
supervised and controlled. This approach is
unlikely to elicit the cooperation, involvement
or commitment of those who are expected to
complete the task.
Middle of the Road Management – adequate
organization performance is possible through
balancing the necessity to get work with
maintaining morale of people at a satisfactory
level
Country Club – thoughtful attention to the
needs of people for satisfying relationships
leads to a comfortable friendly organization
atmosphere and work tempo
Team Management – work accomplishment is
from committed people; interdependence
through a ‘common stake’ in organization’s
purpose leads to relationships of trust and
respect
5,5
1,9
9,9
Prepared by Dr. Parmindar Singh
Page 287
5. Contingency approaches
•
Fiedler’s contingency model of leadership
 Three situational variables are said to determine the style of leadership:
➢ Leader-member relations – the extent to which a leader has the support of her or his group
members
➢ Task structure – the extent to which the task or purpose of a group is well defined and the
outcomes can be seen clearly to be a success of failure
➢ Leader position power – the amount of power (particularly reward power) the leader can use
to accomplish his/her and the group’s purposes
 The table below shows the type of leadership suitable:
Leader-member relationships
Task structure
Position power leadership style
1
2
3
good
good
good
structured
structured
unstructured
high
low
high
task-oriented style
recommended
4
5
6
good
poor
poor
unstructured
structured
structured
low
high
low
people-oriented style
recommended
7
8
poor
poor
unstructured
unstructured
high
high
task-oriented style
recommended
 When situation is very favourable or very unfavourable, the most effective leadership style is
a task-oriented, more directive one
 When situation is of moderate favourability, the style recommended is a person-oriented
one.
Prepared by Dr. Parmindar Singh
Page 288
•
Hershey and Blanchard’s situational theory
high
3. Share ideas and facilitate
2. Explain your decisions
in decision-making –
Participating
and provide opportunity for
clarification Selling
4. Turn over responsibility for
1. Provide specific
decisions and implementation –
instructions and closely
Relationship behaviour
(support)
supervise performance -
low
Delegating
low
Telling
Task behaviour (guidance)
high
able
Job Readiness
unable
willing
Psychological readiness unwilling
6. Transactional and transformational leaders (Bass, 1990, cited in Senior & Fleming, 2006,
p.262)
Transactional leaders
Contingent rewards
Management by exception
Laissez-faire
Prepared by Dr. Parmindar Singh
Transformational leaders
Charisma
Inspire
Intellectual stimulation
Individualized consideration
Page 289
Strategic action - Apply the concepts of entrepreneurship and ‘intrapreuneurship’ to
exploit strategic opportunities and to innovate successfully
1. Entrepreneurship
•
Entrepreneurship is the process of initiating a business venture, organizing the necessary
resources, assuming the associated risks and enjoying the rewards.
•
Characteristics of entrepreneurs
Autonomy
Entrepreneurial
sacrifice
Locus of
control
Entrepreneurial
personality
High energy
Selfconfidence
Need to achieve
2. Intrapreneurship
•
Intrapreneurship involves creating or discovering new ideas or opportunities for the purpose
of creating value, where this activity involves creating a new and self-financing organization
within or under the auspices of an existing company.
Prepared by Dr. Parmindar Singh
Page 290
Strategic action - Financial performance
1. Useful ratios
Liquidity ratios
•
Current ratio = current assets/current liability
•
Quick ratio/acid test ratio = (total current assets – stock)/total current liability
Profitability ratios
•
Gross profit margin = gross profit/sales * 100
•
Net profit margin = net profit/sales * 100
•
ROCE = PBIT/Capital employed (Total assets – current liabilities)
•
Return on equity = net profit/equity * 100
•
Return on net assets (RONA) = net profit /capital employed * 100
•
Return on sales/operating profit margin = operating profit/sales * 100
Efficiency ratios
•
Inventory turnover period (days) = average stock/cost of sales * 365
•
Asset turnover ratio = sales/total assets
•
Fixed asset turnover ratio = sales/fixed assets
•
Receivables collection period = receivables/sales * 365
•
Payables payment period = payables/cost of sales * 365
Gearing ratio
•
Gearing ratio = debt/equity or debt/(debt + equity)
Prepared by Dr. Parmindar Singh
Page 291
Investor ratios
•
Interest cover = profit before interest and taxes/interest payment (or finance costs)
•
EPS = profit after tax/number of ordinary shares
•
P/E ratio = market price per share/EPS
•
Dividend cover = EPS/dividend per share
Extras:
•
Net assets = total assets – total liability
•
Working capital = current assets – current liability
•
Working capital turnover ratio = sales/working capital
•
Own ratios – e.g. sales per employee; number of employees per km of railway
2. Performance review
• Rudyard Kipling “I keep six honest serving men. They taught me all I know. Their names are
What, When, Why, Who, Where and How.”
1. Show formula
2. Use the 3W’s – what, when and why
3. Put in a tabular form
Prepared by Dr. Parmindar Singh
Page 292
June 2002 - Table 1
Comparison of Statistical Data between Bethesda Heights Memorial Hospital and the
Neighbouring Hospital for calendar year 2001 (figures for 2000 in brackets) (unless
otherwise stated figures are in US$ ‘000)
Bethesda
Income from central government
Income from local government
Income from medical insurance
Total income
Labour costs
Medical equipment
Drugs
Other variable costs – catering,
laundry
Fixed costs
Total costs
Surplus/deficit
76,000
20,000
19,000
115,000
55,000
20,000
25,000
Heights
Hospital
(76,000)
(19,000)
(23,000)
(118,000)
(53,000)
(19,000)
(22,000)
10,000
15,000
125,000
-10,000
(9,000)
(15,000)
(118,000)
(0)
Neighbouring
Hospital
85,000
22,000
63,000
170,000
57,000
28,000
30,000
(85,000)
(21,000)
(60,000)
(166,000)
(55,000)
(25,000)
(28,000)
13,000
17,000
145,000
+25,000
(12,000)
(16,000)
(136,000)
(+30,000)
Further referrals required %
(need for re-admittance)
17
(14)
9
(7)
Mortality % (% of patients dying in
hospital)
0.05
(0.03)
0.007
(0.003)
Number of staff (actual)
1,000
(970)
1,100
(1,150)
Number of beds (actual)
350
(350)
450
(450)
Waiting time (days)*
95
(90)
35
(40)
Post-operation time in hospital
(days)**
7
(8)
10
(10)
Day surgery operations*** (actual
numbers)
1,500
(1,150)
7,000
(1,500)
Number of patients treated annually
residentially
10,650
(10,900)
12,700
(12,500)
Ratio outpatients to those
committed to hospital****
3:1
(3:1)
5:1
(4:1)
*
from seeing doctor to hospital admittance
**
number of days kept in hospital after an operation
***
minor operations which require no overnight stay
****
number of patients dealt with as external patients (excluding day surgery) compared with
those committed to hospital for one night or longer
Prepared by Dr. Parmindar Singh
Page 293
June 2003 - Table 1: Details of Performance of Hair Care Ltd: 2000—2003
(unless otherwise stated, figures are in £‘000)
2000
2001
2002
£‘000
£‘000
£‘000
Sales
2,300
Cost of Sales
1,450
Marketing Costs
200
Distribution Costs
300
Administration
50
Interest Payments
0
Operating Profit
300
Loans
0
Number of suppliers (actual)
15
Range of products (actual)
35
Total staff including Sam and Annabelle 12
Stocks
230
Fixed assets
500
Return on Sales (%)
13.0
3,500
2,380
250
400
55
80
335
850
20
85
14
400
1,500
9.6
5,010
3,507
290
430
80
220
483
2,400
30
110
15
700
2,700
9.6
2003
(forecast)
£‘000
7,500
5,250
350
500
120
700
580
5,000
50
130
23
1,400
6,300
7.7
December 2005 - Table 1: Financial information on DPP and Papier Presse (£’000,000) for 2005
Sales
Cost of sales
Gross margin
Sales & administration
Marketing
R&D
Depreciation
Operating profit
Datum Paper Products Papier Presse
195.5
90.0
122.2
67.5
73.3
22.5
27.4
13.5
9.5
1.4
4.5
0.5
10.0
1.0
21.9
10.6
Net assets
Debt
Equity
Earnings per share
Dividend per share
Return on sales
275.0
100.0
175.0
12·5p
5·6p
11·2%
148.0
68.0
80.0
13·3p
10·0p
11·8%
Employees
Absenteeism (days p.a.)
Patents – 2004
Manufacturing facilities
Sales from products less than 5 years old
1250
8
5
4
20%
750
16
0
3
5%
Prepared by Dr. Parmindar Singh
Page 294
Share of major European markets:
UK
France
Italy
Germany
Spain
Sales outside Europe
North America region
Rest of World
45%
10%
8%
15%
10%
50%
40%
10%
14%
60%
20%
15%
25%
5%
3%
2%
June 2007 - Table 1: Fleet details
Boeing 737
Total aircraft in service
2006
21
2005
21
2004
20
Capacity (passengers)
147
Introduced
October 1991
Average age
12·1 years
Utilisation (hrs per day)
8·70
Airbus A320
Embraer RJ145
27
27
26
149
November 1988
12·9 years
7·41
3
3
2
50
January 1999
6·5 years
7·50
Table 2: Key operational statistics for ONA in 2006
Low-cost
Competitor
Average
Regional
International
Contribution to revenue ($m)
Passenger
Cargo
400
35
280
15
Passenger load factor
Standard Class
Business Class
Average annual pilot salary
73%
90%
$106,700
67%
74%
$112,500
87%
75%
$96,500
Source of revenue
On-line sales
Direct sales
Commission sales
Average age of aircraft
Utilisation (hrs per day)
40%
10%
50%
See Table 1
See Table 1
60%
5%
35%
84%
12%
4%
4.5 years
9·10
Prepared by Dr. Parmindar Singh
Not applicable
Not applicable
Page 295
Table 3: Extracted Financial Information
all figures in $m
Extracted from the Balance Sheet
Non-current assets
Property, plant and equipment
Other non-current assets
Total
Current assets
Inventories
Trade receivables
Cash and cash equivalents
Total
Total assets
2006
788
60
848
2005
785
56
841
2004
775
64
839
8
68
289
365
1213
7
71
291
369
1210
7
69
299
375
1214
Total shareholders’ equity
250
259
264
Non-current liabilities
Interest bearing long-term loans
Employee benefit obligations
Other provisions
Total non-current liabilities
310
180
126
616
325
178
145
648
335
170
143
648
Current liabilities
Trade payables
Current tax payable
Other current liabilities
Total current liabilities
282
9
56
347
265
12
26
303
255
12
35
302
Total equity and liabilities
1213
1210
1214
680
50
119
849
675
48
112
835
650
45
115
810
535
535
525
525
510
510
314
215
17
22
310
198
16
21
300
187
15
18
254
235
220
60
18
42
75
23
52
80
24
56
Extracted from the income statement
Revenue
Passenger
Cargo
Other revenue
Total
Cost of Sales
Purchases
Total
Gross Profit
Wages & Salaries
Directors’ Salaries
Interest payable
Total
Net Profit before tax
Tax Expense
Net Profit after tax
Prepared by Dr. Parmindar Singh
Page 296
Tabular layout:
2006
2005
2004
Current ratio
1.05
1.22
1.24
Quick ratio
1.03
1.20
1.22
Fixed asset turnover ratio
1.00
0.99
0.97
Asset turnover ratio
0.70
0.69
0.67
Gross profit margin
37%
37%
37%
Net profit margin
(after tax)
5.0%
6.2%
6.9%
Interest cover
3.7
4.6
5.4
Wages & salaries
increasing
Directors’ fees
increasing
Return on capital employed
9.5%
10.6%
10.7%
Return on net assets
4.9%
5.7%
6.1%
% increase of revenue:
passenger
cargo
4.6
11.0
3.8
6.7
-
Stock turnover ratio
5.5
4.9
5.0
ROE
?
Prepared by Dr. Parmindar Singh
Page 297
June 2009 - Figure 1: RiteSoftware Accounts
Extract from the statement of financial position
Assets
Non-current assets
Property, plant and equipment
Goodwill
Current assets
Inventories
Trade receivables
Total assets
Liabilities
Current liabilities
Trade payables
Current tax payable
Bank overdraft
Non-current liabilities
Long-term borrowings
Total liabilities
Equity
Share capital
Total equity and liabilities
Extract from the statement of comprehensive income
Revenue
Cost of sales
Gross profit
Other costs
Finance costs
Profit before tax
Income tax expense
Profit for the year
Extract from the annual report
Number of staff
Prepared by Dr. Parmindar Singh
$000
2008
30
215
–––––
245
2007
25
133
–––––
158
3
205
–––––
208
–––––
453
–––––
2
185
–––––
187
–––––
345
–––––
257
1
10
–––––
268
178
2
25
–––––
205
80
–––––
348
–––––
35
–––––
240
–––––
105
–––––
453
–––––
105
–––––
345
–––––
2,650
(2,600)
–––––
50
–––––
(30)
(10)
–––––
10
(1)
–––––
9
2,350
(2,300)
–––––
50
–––––
(20)
(4)
–––––
26
(2)
–––––
24
90
70
Page 298
Required:
(a) W&P concluded in their report ‘that there were clear signs that the company (RiteSoftware) was in
difficulty and this should have led to further investigation’.
Assess, using the financial information available, the validity of W&P’s conclusion.
(13 marks)
Answer:
(a)
Gross profit margin
Net profit margin
Current ratio
Quick ratio
Return on sales
ROE
RONA
Interest cover
ROCE
Gearing ratio
Trade receivables days
Trade payables days
Inventory days/stock turnover ratio
Fixed asset turnover ratio
Asset turnover ratio
Sales per employee
2008
2007
1.89%
0.34%
0.78
0.76
0.75%
8.57%
4.86%
2
10.81%
0.76
28
36
0.42
10.8
5.85
$29.4
2.13%
1.02%
0.91
0.90
1.28%
22.86%
17.14%
7.5
21.43%
0.33
29
28
0.32
14.9
6.81
$33.6
From the figures above, RiteSoftware’s gross profit margin has taken a dip due to a 13% increase in the
cost of sales. In addition, the net profit margin has decreased by three times due to a more than a double
increase in interest payments as well as an increase in other expenses. RiteSoftware’s current ratio has
also decreased in 2008 reflecting a decrease in working capital. Furthermore, its quick ratio has also
taken a downfall indicating a decrease in liquidity. Its return on sales has also decreased by nearly half
due to a decline in operating profits. Similarly, RiteSoftware’s return on equity has also decreased around
three times while its return on net assets has declined by four times due to its decreasing net profits.
RiteSoftware’s interest cover has dramatically fallen from 7.5 to 2. This indicates that RiteSoftware is
starting to feel the pinch of paying off its interests. This has occurred due to borrowings that had doubled
since 2007. Its ROCE has also similarly taken a downward spiral as not much returns are being
generated from its capital employed.
RiteSoftware’s gearing had also increased by 43% points due to borrowings.
RiteSoftware’s trade receivables days remain with the normal range of 30 days while it is taking a longer
time to settle its payables. These payables may have been settled by using its overdraft facility since
overdraft facility has fallen by more than 50%. Its inventory days had also increased.
Its fixed asset and asset turnover ratio have both decreased. However, this figure was calculated with
goodwill being incorporated. Excluding goodwill, its fixed asset turnover ratio had changed from 94 to 88.
Finally, its sales per employee had decreased from $33600 to $29400. Based from the financial
information above, there are signs that RiteSoftware can be experiencing some difficulty. Its profitability,
Prepared by Dr. Parmindar Singh
Page 299
efficiency, and liquidity have all decreased while its gearing has increased. This warrants greater
investigation and hence W&P’s conclusion is valid.
Figure One (all in 2008)
December 2009
Revenue
Cost of sales as a percentage of revenue
Average payables settlement period
Average receivables settlement period
Sales revenue to capital employed
Gross profit margin
Net profit margin
Liquidity ratio
Gearing ratio
Interest cover ratio
CATalyst
$35,000,000
65%
65 days
30 days
3·36
35%
6%
0·92
30%
3·25
Batrain
25,000,000
63%
60 days
35 days
3·19
37%
8%
0·93
25%
4·75
Figure Two: Financial Analysis: Ecoba Ltd
(All figures in $000)
Extract from the statement of financial position
2008
2007
Assets
Non-current assets
Intangible assets
Property, plant, equipment
Total
5,800
500
6,300
5,200
520
5,720
Current assets
Inventories
Trade receivables
Cash and cash equivalents
Total
70
4,300
2,100
6,470
90
3,000
1,500
4,590
Total assets
12,770
10,310
Current liabilities
Trade payables
Current tax payable
Total
6,900
20
6,920
4,920
15
4,935
Non-current liabilities
Long-term borrowings
200
225
Total
7,120
5,160
Equity
Share capital
Retained earnings
5,100
550
5,100
50
Prepared by Dr. Parmindar Singh
Page 300
Total equity and liabilities
12,770
10,310
Extract from the statement of comprehensive income
Revenue
22,000
Cost of sales
(17,500)
Gross profit
4,500
Overhead expenses
(3,500)
Profit before tax and finance costs
1,000
Finance costs
(20)
Profit before tax
980
Tax expense
(30)
Profit for the year
950
17,000
(13,750)
3,250
(2,500)
750
(20)
730
(25)
705
Answer:
Financial analysis of Ecoba
Revenue
Cost of sales as a percentage of revenue
Average payables settlement period
Average receivables settlement period
Sales revenue to capital employed
Gross profit margin
Net profit margin
Current ratio
Quick ratio
Gearing ratio
Interest cover ratio
ROCE
ROE
Return on sales
2008
22000
80%
144 days
71 days
3.76
20.5%
4.3%
0.93
0.93
3.5%
50
17.1%
16.8%
4.5%
2007
17000
81%
131 days
64 days
3.16
19.1%
4.1%
0.93
0.91
4.4%
37.5
14.0%
13.7%
4.4%
From the above table as well as the financial information provided for CATalyst and Batrain, Ecoba has
lesser revenue of the three. This perhaps indicates that among the ‘big three’, Ecoba is trailing at the third
position. However, the revenue of Ecoba had increased by 29% from 2007 to 2008. The percentage
increase for CATalyst and Batrain are not provided. Nevertheless, there is promising hope that Ecoba’s
revenue can further increase as a result of a large insurance company as well as another customer
sending their staff for training at Ecoba.
In terms of cost of sales as a percentage of revenue, Ecoba is at around 80% while those of its
competitors are much lesser (65% and 63% respectively). While these do not augur well for Ecoba, more
investigation has to be done to ascertain these values. It was envisaged that Ecoba would have lesser
cost of sales as a result of using contract staff. However, this did not appear the case. As a result, a
thorough investigation will be needed in this area.
Ecoba’s average payables settlement period has also increased from 131 to 144 days while those of its
competitors are in the range of 60-65 days. While this is much higher than its competitors, with the
signing of the two new major customers, it is expected that this settlement period will decrease in line with
industry norms.
Prepared by Dr. Parmindar Singh
Page 301
Ecoba’s average receivables payment period has also increased from 64 to 71 days. This may partly
explain why it has taken a longer time to pay their contract staff and other suppliers. In addition, it is way
behind its competitors (CATalyst and Batrain) in terms of receivables. Proper decisions need to be made
in this area to improve its collection.
Despite some of its weaknesses, there is lots of hope in Ecoba. Firstly, its sales revenue to capital
employed has increased from 2007 and is higher than the other two competitors. This shows that its
capital is better utilized and there is more revenue from every one dollar of capital.
Its gross profit margin and net profit margin have also increased marginally. While it is lesser than the
other two competitors, it is envisaged that these profitability ratios can further improve with the two larger
customers starting to do business with Ecoba.
Ecoba’s liquidity ratio is similar to its two competitors. Hence there is not much basis for comparison.
Ecoba’s liquidity ratios have remained quite consistent in these two periods of comparison.
The gearing ratio of Ecoba is similarly much smaller than CATalyst and Batrain. Ecoba does not depend
on its long term borrowings to finance its operations as it has adequate liquidity. This augurs well for
Ecoba.
Its interest cover ratio had increased from 37.5 in 2007 to 50 in 2008 while its competitors’ interest cover
ratio is 3.25 and 4.75 (CATalyst and Batrain respectively). This once again shows that it has enough
operating profit to cover its finance costs. Once again, this is good news for Ecoba.
Its other profitability ratios (ROCE, ROE and return on sales) have also improved. All these show that
Ecoba has great potential.
Prepared by Dr. Parmindar Singh
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December 2011 - Figure 1: Selected information for GET in 2010
Extract from the statement of financial position: All financial figures in $m
ASSETS
Non-current assets
Property, plant, equipment
Intangible assets
$m
2,175
100
––––––
2,275
Total
Current assets
Inventories
Trade receivables
Cash and cash equivalents
275
10
300
––––––
585
––––––
2,860
––––––
Total
Total assets
EQUITY AND LIABILITIES
Share capital
Retained earnings
550
110
––––––
660
Total equity
Non-current liabilities
Long-term borrowings
2,000
––––––
2,000
Total non-current liabilities
Current liabilities
Trade and other payables
Current tax payable
199
1
––––––
200
Total current liabilities
Total liabilities
2,200
––––––
2,860
––––––
Total equity and liabilities
Extract from the statement of comprehensive income
All financial figures in $m
Revenue
Cost of sales
Gross profit
Administrative expenses
Profit before tax and interest
Finance cost
Profit before tax
Tax expense
Prepared by Dr. Parmindar Singh
320
(210)
110
(40)
70
(60)
10
(1)
Page 303
Profit for the year
9
Extract from the annual report
Number of employees
Number of rail kilometres
3,010
920
Figure 2: Financial information for the Rudos rail industry as a whole
Measure
ROCE
Operating profit margin
Gross profit margin
Current ratio
Acid test ratio
Gearing ratio
Revenue/employee per year
Number of employees per rail kilometre
National rail industry average
4·50%
10·00%
22·00%
2·1
1·2
48%
$85,000
4·1
Answer:
The financial analysis for GET is shown below. For the sake of consistency, the ratios used below are the same as
used for industry financials.
ROCE (PBIT/capital employed * 100)
2.63%
Operating profit margin (operating profit/sales * 100)
21.85%
Gross profit margin (gross profit/sales * 100)
34.38%
Current ratio (current assets/current liability)
2.9
Acid test ratio ((current assets – stock)/current liability)
1.6
Gearing ratio (debt/(equity + debt)) * 100
75%
Revenue/employee per year
$106,312
Number of employees per rail km
3.3
Compared to the industry average, GET’s ROCE is lesser by 1.87 percentage points. This can be due to a higher
amount of capital employed. Ways must be contemplated on how to reduce its capital employed without affecting
its operating profits. On the upside, GET’s operating profit margin is more than double industry average. The gross
profit margin for industry average is only slightly more than half of GET’s. As such, GET’s profitability ratio, in
general, is much better than industry average.
In terms of liquidity, GET is much more solvent than its competitors. Its current ratio is more than industry
average. Likewise, for its acid test ratio.
Prepared by Dr. Parmindar Singh
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Its gearing ratio is 27 percent points more than industry average. However, its interest cover is 1.17 and therefore
GET is still able to service its debt. However, GET must be careful so as not to increase its financial risk.
GET’s revenue per employee is much more than industry average by $21,312. This indicates that employees of GET
can be more efficient and productive as compared to its competitors.
Finally, its number of employees per rail kilometre is lesser indicating more efficiency as fewer employees are
needed to man each kilometre of rail line.
Hence, its profitability ratio, its current ratio and its efficiency ratio are much better than its competitors but due
regard must be given to ensure its gearing ratio does not rise unnecessarily.
3. Break-even analysis and margin of safety
Total sales revenue
Costs ($)
Total costs
Break-even point
F
Volume of activity (units of output)
Let b be the number of units of output at BEP, then
b × sales revenue per unit = fixed costs + (b × variable costs per unit)
b = fixed costs/ (sales revenue per unit – variable costs per unit)
Margin of safety is the extent to which the planned volume of output or sales lies above the BEP, i.e. to
make a profit. Margin of safety = expected volume of output or sales – BEP
Prepared by Dr. Parmindar Singh
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Question
Cottage Industries Ltd. makes baskets. The fixed costs of operating the workshop for a month total $500.
Each basket requires materials that cost $2. Each basket takes one hour to make, and the business pays
the basket makers $10 an hour. The basket makers are all on contracts such that if they do not work for
any reason, they are not paid. The baskets are sold to a wholesaler for $14 each. What is the BEP for
basket making for the business?
Answer:
BEP, b = 500/[14-(2+10)] = 250 baskets per month
Example:
Motormusic Ltd makes a standard model of car radio, which it sells to car manufacturers for $60 each.
Next year, the business plans to make and sell 20,000 radios. The business’ costs are as follows:
Manufacturing
Variable materials
Variable labor
Other variable costs
Fixed costs
Administration and selling
Variable
Fixed
$20 per radio
$14 per radio
$12 per radio
$80,000 per year
$3 per radio
$60,000 per year
Required:
(a) Calculate the break-even point for next year, expressed both in quantity of radios and sales value.
(b) Calculate the margin of safety for next year, expressed both in quantity of radios and sales value.
4. Marginal analysis
•
Contribution = sales revenue (or selling price) – variable costs
•
Contribution per unit = sales revenue per unit – variable costs per unit
•
Contribution – fixed costs = net profit
 Contribution covers the variable costs of the items sold; then, it contributes to the organization’s fixed
costs; then, if any cash remains, it contributes to the profit of the organization.
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 Contribution therefore “contributes towards covering fixed costs and then making a profit”




Accepting/rejecting special contracts
Determining the most efficient use of scarce resources
Make-or-buy decisions
Closing or continuation decisions
5. Accepting/rejecting special contracts
•
Consider only the effect on contribution
•
If there is additional contribution, then the contract should be accepted
Question
Cottage Industries Ltd. has spare capacity in that its basket makers have some spare time. An overseas
retail chain has offered the business an order for 300 baskets at a price of $13 each. Should the business
accept the order?
Answer
Additional revenue per unit = $13
Variable cost per unit = $12
Contribution per unit = $1
Since there is additional contribution, the contract should be accepted, provided all other factors are the
same.
(However, other factors may also need to be taken into consideration)
6. Determining the most efficient use of scarce resources
•
The limiting factor is most efficiently used by maximizing its contribution per unit
•
Limited/scarce resources such as labour, raw materials, space, machinery etc. will limit sales.
Prepared by Dr. Parmindar Singh
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•
Example:
Intermediate Products Ltd produces four types of water pump. Two of these (A and B) are sold by the
business. The other two (C and D) are incorporated, as components, into another of the business’s
products. Neither C nor D is incorporated into A or B. Costings (per unit) for the products are as follows:
A
$
15
25
5
20
$65
$70
Variable materials
Variable labor
Other variable costs
Fixed costs
Selling price (per unit)
B
$
20
10
3
8
$41
$45
C
$
16
10
2
8
$36
D
$
17
15
2
12
$46
There is an outside supplier who is prepared to supply unlimited quantities of products C and D to the
business, charging $40 per unit for product C and $55 per unit for product D.
Next year’s estimated demand for the products, from the market (in the case of A and B) and from other
production requirements (in the case of C and D) is as follows:
A
B
C
D
Units
5000
6000
4000
3000
For strategic reasons, the business wishes to supply a minimum of 50 percent of the above demand for
products A and B.
Manufacture of all four products requires the use of a special machine. The products require time on this
machine as follows:
A
B
C
D
Hours per unit
0.5
0.4
0.5
0.3
Next year there are expected to be a maximum of 6,000 special-machine hours available. There will be
no shortage of any other factor of production.
Required:
(a) State, supporting workings and assumptions, which products the business should plan to make next
year.
(b) Explain the maximum amount that it would be worth the business paying per hour to rent a second
special machine.
(c) Suggest ways, other than renting an additional special machine that could solve the problem of the
shortage of special machine time.
Prepared by Dr. Parmindar Singh
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Answer:
(a)
A
B
C
D
$
$
$
$
Selling/buying price per unit
70
45
40
55
Variable cost per unit
45
33
28
34
Contribution per unit
25
12
12
21
Hours on special machine
0.5
0.4
0.5
0.3
Contribution per hour
50
30
24
70
Order of preference
2nd
3rd
4th
1st
Optimum use of hours on special machine
Balance of hours
D
3000 * 0.3 = 900
5,100 hrs (6000 – 900)
A
5,000 * 0.5 = 2,500
2,600 hrs (5100 – 2500)
B
6,000 * 0.4 = 2,400
200 hrs (2600 – 2400)
C
400 * 0.5 = 200
-
Therefore, make all of the demand for Ds, As, and Bs plus 400 (of 4,000) Cs.
(b) The contribution per hour from C is $24, and so this is the maximum amount per hour that it would be
worth paying to rent the machine, for a maximum of 1,800 hours (that is 3,600 * 0.5, the time necessary
to make the remaining demand for Cs).
(c) Other possible actions to overcome the shortage of machine time include the following:
- alter the design of the products to avoid the use of the special machine
- increase the selling price of the product so that the demand will fall, making the available time machinetime sufficient but making production more profitable.
Prepared by Dr. Parmindar Singh
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Question
A business makes three products, the details of which are as follows:
Product (code name)
B14
B17
B22
Selling price per unit ($)
25
20
23
Variable cost per unit ($)
10
8
12
Weekly demand (units)
25
20
30
Machine time per unit (hours)
4
3
4
Fixed costs are not affected by the choice of the product because all three products use the same
machine. Machine time is limited to 148 hours a week. Which combination of products should be
manufactured if the business is to produce the highest profit?
Answer
Product (code name)
B14
B17
B22
Contribution per unit
15
12
11
Contribution per machine hour
$3.75
$4
$2.75
Priority
2nd
1st
3rd
Since there is only 148 hours, produce
20 units of product B17 -----------→
60 hours
22 units of product B14 ----------→
88 hours
----------148 hours
------------
This leaves unsatisfied the market demand for a further 3 units of product B14 and 30 units of product
B22.
Prepared by Dr. Parmindar Singh
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Additional question
What steps could be contemplated that could lead to a higher level of contribution for the business?
Answer
•
Consider obtaining additional machine time either through sub-contracting, buying a new machine or
both. A careful cost-benefit analysis has to be done. If sub-contracting, should not exceed the
contribution for B14 and B22.
•
Redesign the products that require less time per unit on the machine
•
Re-engineer the production process
•
Consider increasing the price of B17 (and maybe B14)
7. Make-or-buy decisions (outsourcing)
•
Take the action that leads to the highest total contributions
Question
Shah Ltd. needs a component for one of its product. It can subcontract production of the components to a
subcontractor who will provide the components for $20 each. The business can produce the components
internally for total variable costs of $15 per component. Shah ltd. has spare capacity. Should the
component be subcontracted or produced internally?
Answer
Internal production
Outsourcing
Variable costs - $15 per component
$20 per component
Therefore, Shah Ltd. must produce internally.
Prepared by Dr. Parmindar Singh
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Question
If Shah Ltd. has no spare capacity, so it can only produce the component internally by reducing its output
of another of its product. While it is making each component, it will lose contributions of $12 from the
other product. Should the component be subcontracted or produced internally?
Answer
Cost of producing internally
Outsourcing
Variable cost - $15 per component
$20 per component
Opportunity cost - $12
Total = $27
Therefore, Shah Ltd should sub-contract, based on no other additional information.
8. Closing or continuation decisions
•
Should be assessed by net effect on total contributions
Question
Goodsports Ltd. is a retail shop that operates through three departments, all in the same premises. The
three departments occupy roughly equal-sized areas of the premises. The trading results for the year just
finished showed the following:
Total
Sports
Sports
General
($)
equipment ($)
clothes ($)
clothes ($)
534
254
183
97
Fixed
138
46
46
46
Variable
344
167
117
60
Profit/(loss)
52
41
20
(9)
Sales revenue
Total costs:
Prepared by Dr. Parmindar Singh
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Should the general clothes department be closed?
Answer
Total
Sports
Sports
General
($)
equipment ($)
clothes ($)
clothes ($)
Sales revenue
534
254
183
97
Variable
344
167
117
60
Contribution
190
87
66
37
Since the general clothes department makes a contribution of $37, it should not be closed (without any
other developments) as closing it would make the business worse off by $37.
Any other developments to the general clothes department should generate at least $37 a year.
June 2015 - Section B – TWO questions ONLY to be attempted
2 Yvern is large region in the country of Gaulle. It is ethnically and culturally distinct from the rest of the country and it has
aspirations for independence. The desire for this independence is reflected by consumers in Yvern preferring to buy products
which have been produced in the region.
Yvern Trinkets Regional (YTR) is a manufacturer of giftware products aimed at the Yvern market. Its products are bought
primarily by residents of Yvern and visitors to the Yvern region. It is the third largest company of its type in the region, and the
50th largest producer of giftware in Gaulle. Its marketing message stresses the regional identity of the company and its
employment of local skills and labour. It currently manufactures four products, designated here as products A, B, C and D. The
company does not sub-contract or outsource any element of production and it has never done so. Data concerning products A,
B, C and D are given in Table one.
Monthly production (in units)
Direct materials cost ($ per unit)
Direct labour cost ($ per unit)
Variable production
overheads ($ per unit)
A
2,000
3
9
2
B
5,500
5
6
3
C
4,000
2
9
1
D
3,000
4
6
2
Table one: Production and marginal cost data for the YTR product range
YTR recently appointed a new managing director, born outside the region. He has been tasked with improving the profitability
of the company.
After a short period of consultation, the new managing director produced a proposal for the board. Here is an extract of his
proposal.
‘First of all, we need to be clear about our generic strategy. Strategists have suggested that we have four alternatives. I have
reproduced them in this slide (shown here as Table two).
Prepared by Dr. Parmindar Singh
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Cost Leadership
Cost Focus
Differentiation
Differentiation Focus
Table two: Generic strategies
My vision for YTR is that we should pursue a cost leadership strategy. I have already established that our products can be
produced by an established company in the distant country of Tinglia at the following prices (see Table three). These costs
include the delivery of products to our warehouse here in Yvern.
Buy-in price ($ per unit)
A
11·5
B
16·5
C
12·5
D
13·5
Table three: Contract prices per unit from the external supplier in Tinglia
Our financial director of YTR has also estimated that we have company-wide fixed overheads of $75,000 per month. He assures
me that $16,000 per month of these is directly attributable to the production of products A, B, C and D, evenly split across the
four products, each having $4,000 of fixed overheads. So, we could save overheads of $16,000 per month by outsourcing all of
our products to the Tinglia supplier.
I realise that this leaves us with $59,000 per month fixed overheads, but I will be looking for savings there also. The information
technology of YTR is outdated and inefficient. Productivity benefits will follow from harnessing the power of modern
technology.
However, returning to my main concern: production costs. My view is that increased profitability can only be achieved if we
take advantage of the cheaper production costs now available to us. All four products can be produced more cheaply by the
supplier in Tinglia. So, this strategy of outsourcing is the one we should pursue to achieve our cost leadership strategy.’
Required:
(a) Evaluate the claim that ‘all four products can be produced more cheaply by the supplier in Tinglia’ and discuss the issues
raised by outsourcing the production of YTR’s products to Tinglia.
(15 marks)
(b) Examine the relevance of each of the four generic strategies shown in Table two to the competitive environment in which
YTR operates and evaluate the choice of a cost leadership strategy by YTR’s managing director.
(10 marks)
(25 marks)
Prepared by Dr. Parmindar Singh
Page 314
(a)
Evaluation of claim
1.
A
$12
Looking at total variable cost per unit:
B
$13
C
$12
D
$12
It is only cheaper to outsource A and not B, C, D.
2.
3.
4.
5.
6.
If only outsource A, supplier in Tinglia may not charge $11.5 per unit but higher as it will not be achieve
any economies;
The stated price of A ($11.5) will only be charged with the assumption that YTR will outsource all four
products;
It’s not stated clearly how $4000 of fixed overheads for each products A, B, C and D were derived or
justified;
In addition, it’s hard to expect all products having the same fixed overheads;
Moreover, with improvements in IT, YTR may reduce its variable costs per unit as well as its overheads.
Issues raised by outsourcing
1. YTR has never subcontracted before and therefore has no experience whatsoever;
2. By outsourcing, YTR will lose its regional identity;
3. YTR’s marketing message stresses its regional identity and this will be lost by outsourcing;
4. Also outsourcing will result in laying-off local skills and labour;
5. This will exacerbate its loss of regional identity;
6. Consequently, consumers in Yvern who prefer to buy products from YTR because it is produced in Yvern
will no longer do so. Hence YTR will experience loss of revenue;
7. There will be a loss of income and this may thwart Yvern’s economic development;
8. Moreover, as discussed earlier, outsourcing may not allow YTR of achieving its cost leadership strategy, let
alone being the right strategy;
9. Finally, outsourcing will also result in YTR failing to differentiate itself and its entire marketing message
and other promotional material has to be revised.
Prepared by Dr. Parmindar Singh
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9. Full-cost and overhead cost apportionment
•
Why managers need full-costs?
 Budgetary planning and control – makes use of direct costs (direct labour, direct materials) and
overheads (indirect costs).
 General decision making – having full-cost information can enable managers to make decisions
on all aspects of the business.
 Pricing – when setting the price for the output, it is very useful to know how much it cost to
produce.
 Income measurement – to measure profit or income generated, we need to compare sales
revenue with the associated expenses. Logically, this is the full-cost of what was sold.
•
Direct and indirect costs (multi-product businesses)
▪
Direct costs – these are costs that can be identified with specific cost units. A cost unit is one unit
of whatever that is having its cost determined. It can be one unit of a product (service or a
manufactured item). Examples are direct labour and direct materials.
 In a motor car repair – direct costs – costs of parts used in repair (direct materials), costs of
mechanic’s time (rate of pay of direct workers)
 In an electrical business – direct costs – wages of electricians who did the job, the cost of the
cable and other materials used on the job
▪
Indirect costs (or overheads/common costs) – all other costs that cannot be measured in respect
of each particular unit of output.
 Rent of workshop to repair the car
 Depreciation (wear and tear) of the tools used by electricians
 Salary of the electrical business’s accountant
 In a legal firm – rent, lighting, heating, cleaning, building maintenance
•
Full-cost of a job/output = direct cost (of the job) + indirect costs (fair share of indirect costs for
the job)
•
Cost units absorb overheads; full-costing can also be called as absorption costing.
•
Overheads must be apportioned (absorbed or recovered) among the cost units.
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Question:
Marine Suppliers Ltd undertakes a range of work, including making sails for small sailing boats on a
made-to-measure basis.
The business expects to incur the following costs during the next month as shown below.
The business has received an enquiry about a sail. It is estimated that the particular sail will take 12 direct
hours and will require 20 square metres of sailcloth, which costs $2 per square metre.
The business normally uses a direct labour hour basis of charging overheads to individual jobs. What is
the full (absorption) cost of making the sail?
Direct labour costs
$60,000
Direct labour time
6,000 hours
Indirect labour cost
$9,000
Depreciation of machinery
$3,000
Rent and rates
$5,000
Heating, lighting and power
$2,000
Machine time
2,000 hours
Indirect materials
$500
Other miscellaneous indirect costs
$200
Direct material cost
$3,000
Prepared by Dr. Parmindar Singh
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Answer:
Overheads are:
$
Indirect labour
9,000
Depreciation of machinery
3,000
Rent and rates
5,000
Heating, lighting and power
2,000
Indirect materials
500
Other miscellaneous indirect costs
200
Total indirect costs
19,700
Overhead recovery rate $19,700÷6,000 hours = $3.28 per direct labour hour
Thus, the full cost of the sail would be expected to be:
$
Direct materials (20 ×2)
40
Direct labour (12 × ($60,000÷6,000 hours))
120
Indirect cost/overheads (12×3.28)
39.36
Full cost
199.36
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Question:
Suppose that Marine Suppliers Ltd used a machine hour basis of charging overheads to jobs. What would
be the cost of the job detailed if it was expected to take 5 machine hours as well as 12 direct labour
hours?
Answer:
Total overhead is $19,700.
Overhead recovery rate, on a machine hour basis is $19,700÷2000 hours = $9.85 per machine hour
Full cost of sail is
$
Direct materials (20×2)
40
Direct labour (12× ($60,000÷6,000 hours))
120
Indirect costs (5×9.85)
49.25
209.25
•
Which is better?
 A matter of judgment; accounting is concerned only with providing useful information to decisionmakers.
 However, usefulness is a concept that is difficult to assess.
 Irrespective of the choice, the total overheads remain the same.
•
Dealing with overheads on a departmental basis
 Each department is known as a cost centre.
 Cost centres can be viewed as product cost centres and service cost centres.
 Product cost centres are departments in which jobs are worked on by direct workers and/or
where direct materials are added.
 Service cost centre costs – is one where no direct costs are involved - must be charged to
product cost centres and become part of the product cost centres’ overheads, so that those
overheads can be recharged to jobs.
 Examples of service cost centres – general administration, accounting, stores, maintenance,
personnel, catering etc.
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Example:
A business consists of four departments:
-
Preparation department
-
Machining department
-
Finishing department
-
General administrative department (GA)
The first three are product cost centres and the last renders a service to the other three. The level of
service rendered is thought to be roughly in proportion to the number of employees in each product cost
centres.
Overhead costs, and other data, for next month are expected to be as follows:
$ (000s)
Rent
10,000
Electricity to power machines
3,000
Electricity for heating and lighting
800
Insurance of premises
200
Cleaning
600
Depreciation of machines
2,000
Salaries of the indirect workers are as follows:
$ (000s)
Preparation department
2,000
Machining department
2,400
Finishing department
1,800
General administrative department
1,800
The general administrative department has a staff consisting of only indirect workers (including
managers). The other departments have both indirect workers (including managers) and direct workers.
There are 100 indirect workers within each of the four departments and none do any direct work.
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Each direct worker is expected to work 160 hours next month. The number of direct workers in each
department is:
Preparation department
600
Machining department
900
Finishing department
500
Machining department direct workers are paid $12 an hour; other direct workers are paid $10 an hour.
All of the machinery is in the machining department. Machines are expected to operate for 120,000 hours
next month.
The floorspace (in square metres) occupied by the departments is as follows:
Sq m
Preparation department
16,000
Machining department
20,000
Finishing department
10,000
GA department
2,000
Assume that the machining department overheads are to be charged to jobs on a machine hour basis,
but that the direct labour hour basis is to be used for other two departments.
A job has the following characteristics:
Preparation
Machining
Finishing
Direct labour hours
10
7
5
Machine hours
-
6
-
Direct materials ($)
85
13
6
What will be the full (absorption) cost?
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•
The steps involved when overheads are handled on a departmental basis
Allocate specific departmental overheads to the relevant department
Apportion general overheads between departments
Total allocated and apportioned overheads to find the total for each department
Apportion service department costs to product cost centres
Total product department overheads
Calculate departmental overhead absorption for each department
Cost units absorb overheads as they pass through product cost centres
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Answer:
Overheads
All in $ (000s)
Preparation
Machining
Finishing
GA
Machine power
-
3,000
-
-
Machine depreciation
-
2,000
-
-
Indirect salaries
2,000
2,400
1,800
Apportioned by floor area
3,867
4,833
2,417
483
Departmental overheads
5,867
12,233
4,217
2,283
(including the indirect workers)
695
993
595
Total overheads by department
6,562
13,226
4,812
Allocated costs:
1,800
Apportioned costs:
Rent
10,000
Heating and lighting
800
Insurance of premises
200
Cleaning
600
11,600
Reapportioned GA costs by
number of staff
(2,283)
-
Overhead recovery rate for preparation department (direct labour hour based):
$6,562,000÷(600×160) = $68.35
Overhead recovery rate for machining department (machine hour based):
$13,226,000÷120,000 = $110.22
Overhead recovery rate for finishing department (direct labour hour based):
$4,812,000÷(500×160) = $60.15
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The cost of the job is as follows:
$
$
Direct labour:
Preparation department (10 × 10)
100
Machining department (7 × 12)
84
Finishing department (5 × 10)
50
234
Direct materials:
Preparation department
85
Machining department
13
Finishing department
6
104
Overheads:
Preparation department (10 × $68.35)
683.50
Machining department (6 × $110.22)
661.32
Finishing department (5 × $60.15)
300.75
Full cost of the job
Prepared by Dr. Parmindar Singh
1,645.57
1,983.57
Page 324
10. Activity-based costing (ABC)
•
ABC sees overheads as being caused by activities.
•
Activities drive cost overheads.
•
Identification of the activities puts management in a position where it may well be able to control
these activities effectively.
Example:
Psilis Ltd. makes a product in two qualities, Basic and Super. The business is able to sell these products
at a price that gives a standard profit mark-up of 25% of full cost. Management is concerned by the lack
of profit. Full cost for one unit of a product is calculated by charging overheads to each type of product on
the basis of direct labour hours. The costs are as follows:
Basic
Super
$
$
Direct labour (all $10/hour)
40
60
Direct materials
15
20
The total overheads are $1,000,000.
Based on experience in recent years, in the forthcoming year, the business expects to make and sell
40,000 Basics and 10,000 Supers.
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Answer:
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11. Budget
•
•
A budget is a business plan for the short term – typically one year – and is expressed in financial
terms
•
Its role is to convert strategic plans/decisions into actionable blueprints for the immediate future.
How budgets help managers
 Tends to promote forward thinking and the possible identification of short-term problems – while
preparing budgets, managers may be made aware of problems such as production facilities etc.
and therefore give managers time for calm and rational consideration of the best way of
overcoming it.
 Can be used to help coordination between the various sections of the business – for e.g. between
purchasing and production; production and sales etc.
 Can motivate managers to better performance – having a stated task can motivate managers and
staff in their performance. Budgets articulate the required effort of managers and therefore
making it more effective as a tool to motivate staff.
 Can provide a basis for a system of control – budgets can be compared with actual performance
and this allows management by exception where managers can spend most time dealing with
deviations (exceptions) that have unfavorable consequences.
 Can provide a system of authorization for managers to spend – budgets can provide a basis for
managers to spend on certain activities (such as HRD, research etc.) so that it can help the firm
achieve its budgets.
•
The budget-setting process
 Establish who will take responsibilities – perhaps, through a budget committee comprising senior
representative of most functional areas (marketing, production, sales, HR and others). A budget
officer can also be appointed to carry out the technical tasks of the committee or to supervise
others carrying out the tasks.
 Communicate budget guidelines to relevant managers – managers must be made aware of the
strategies and environment and how the budget is intended to work towards them.
 Identify the key, or limiting factors – identify the limiting factor at the earliest stage in the budget
setting process.
 Prepare the budget for the area of the limiting factor – the limiting factor will determine the overall
level of activity for the business.
 Prepare draft budgets for all other areas – the other budgets are prepared, complementing the
budget for the area of the limiting factor.
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 Review and co-ordinate budgets – budget committee will review the various budgets and satisfy
itself that the budgets complement one another.
 Prepare the master budgets – the budgeted income statement and budgeted balance sheet.
 Communicate the budgets to all interested parties – the formally agreed budgets are now passed
to the individual managers who will be responsible for their implementation
 Monitor performance relative to the budget – compare actual performance with planned
performance (budget).
•
Non-financial measures in budgeting
 Non-financial measures such as customer or supplier delivery times, set-up times, defect levels
and customer satisfaction levels are some examples.
 Non-financial measures can also be used as the basis of targets and can be incorporated into the
budgeting process and reported alongside the financial targets for the business.
•
Limitations of conventional budgeting
 Cannot deal with fast changing environment
 Focus too much management attention on the achievement of short-term financial targets instead
of innovation, brand loyalty, competition etc.
 ‘Command and control’ structure that concentrates power in the hands of senior managers
 Takes up too much time
 Based around functions (sales, marketing, production etc.) instead on processes
 Encourages incremental thinking by employing a ‘last year plus x percent’ approach to planning
instead of ‘break out’ strategies
 Promote ‘sharp’ business practices among managers by lowering sales targets or higher cost
allocations than really necessary so as to achieve budget.
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•
The budgetary control process
Prepare budgets
Perform and collect
information on actual
performance
Respond to variances
between planned and
actual performance and
exercise control
•
By having a system of budgetary control, decision-making and responsibility can be delegated to
junior management, yet senior management can still retain control.
•
This enables a management-by-exception environment where senior management can focus on
areas where things are not going according to plan and junior management who are performing
to budget can be left to get on with their jobs.
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12. Variances from budget
•
Example:
The following are the budgeted and actual income statement for Baxter Ltd for the month of May
Budget
Actual
1000 units
900 units
$
$
Sales revenue
100,000
92,000
Raw materials
(40,000) (40,000 metres)
(36,900) (37,000 metres)
Labour
(20,000) (2,500 hours)
(17,500) (2,150 hours)
Fixed overheads
(20,000)
(20,700)
Operating profits
20,000
16,900
Output
(production and sales)
•
Flexing the budget
 We need to ‘flex’ the budget to what it would have been had the planned level of output been 900
units rather than 1000 units. Flexing the budget simply means revising it, assuming a different
volume of activity. Flexible budgets enable us to make a more valid comparison between the
budget and the actual results.
 The flexed budget would be as follows:
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Flexed Budget
Output
900 units
(production and sales)
$
Sales revenue
90,000
Raw materials
(36,000) (36,000 metres)
Labour
(18,000) (2,250 hours)
Fixed overheads
(20,000)
Operating profits
16,000
•
Putting the original budget, flexed budget and actual figures for May together, we obtain the following:
Original Budget
Flexed budget
Actual
1000 units
900 units
900 units
$
$
$
Sales revenue
100,000
90,000
92,000
Raw materials
(40,000) (40,000 metres)
(36,000) (36,000 metres)
(36,900) (37,000 metres)
Labour
(20,000) (2,500 hours)
(18,000) (2,250 hours)
(17,500) (2,150 hours)
Fixed overheads
(20,000)
(20,000)
(20,700)
Operating profits
20,000
16,000
16,900
Output
(production and sales)
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13. Variance analysis
Variance
Description
adverse/favourable
Sales volume
Profit of original budget –
profit of flexed budget
-ve -------→
favourable
•
Check from sales
manager
+ve-------→ adverse
•
Poor
performance by
sales personnel
•
Deterioration of
market conditions
between the
setting of the
budget and the
actual event
•
Lack of goods or
services to sell as
a result of some
production
problems
+ve-------→
favourable
•
Lower prices
being charged
-ve-------→ adverse
•
Poor
performance by
sales personnel
•
Deterioration of
market conditions
between the
setting of the
budget and the
actual event
•
More materials
used than
budgeted
•
Responsibility of
the production
manager
•
Poor
performance by
Sales price
Direct materials
usage
Actual sales revenue –
flexed budget’s sales
revenue
(Actual quantity of direct
materials – flexed budget’s
quantity of direct materials)
*budgeted cost for unit of
direct materials
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-ve -------→
favourable
Reasons for adverse
variance
+ve-------→ adverse
Page 334
production
department staff,
leading to high
rates of
scrap/wastage
Direct materials
price
Actual costs of direct
materials – actual costs of
direct materials allowed
-ve ------→ favourable
(Actual labour hours
worked – flexed budget’s
Prepared by Dr. Parmindar Singh
Substandard
materials, leading
to high rates of
scrap, defective
materials
•
Faulty machine,
causing high
rates of scrap
•
Paying more than
budgeted cost –
increased prices
charged by the
supplier, delivery
costs
•
Poor
performance of
buying
department staff,
inefficient buying
procedures
•
Change in market
conditions
between setting
the standard and
the actual event
•
Using a different
supplier who is
more expensive
•
Buying smallersized orders and
losing planed
bulk purchase
discounts
•
Poor supervision
+ve-------→ adverse
Actual costs of direct
materials allowed = actual
quantity of direct materials
used * cost per unit at
budget
Direct labour
•
-ve -------→
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efficiency
labour hours) * budgeted
hourly rate
favourable
•
Worker’s skill was
poorer than
anticipated
•
Low-grade
materials, leading
to high levels of
scrap and wasted
labour time
•
Problem with
customer for
whom a service is
being rendered
•
Problems with
machinery,
leading to longer
labour time
•
Dislocation of
materials supply,
and employees
being unable to
proceed with
production
•
Higher rates paid
•
Poor
performance by
the personnel
function
•
Using a higher
grade worker
than was planned
•
Change in labour
market conditions
between setting
the standard and
the actual event
•
Unexpected
increase in basic
rates of pay
•
Poor supervision
+ve-------→ adverse
Direct labour rate
(Actual cost – allowed
costs at budgeted rate per
hour)
-ve -------→
favourable
+ve-------→ adverse
Fixed overhead
Actual overhead costs –
flexed/original overhead
Prepared by Dr. Parmindar Singh
-ve -------→
favourable
Page 336
costs
+ve-------→ adverse
of overheads
•
•
General increase
in costs of
overheads not
taken into
account in the
budget
•
Sales volume variance for May = 20,000-16,000 = $4,000 (A)
•
Sales price variance = 92,000-90,000 = $2000 (F)
•
Direct materials usage variance = 37,000-36,000 = 1,000 metres * $1 = $1000 (A)
•
Direct materials price variance = 37,000-36,900 = $100 (F)
•
Direct labour efficiency variance = (2250 -2150) * 8 = $800 (F)
•
Direct labour rate variance = 17,500-17,200 = $300 (A)
•
Fixed overhead variance = 20,700-20,000 = $700 (A)
Example:
Antonio plc makes product X, the standard costs of which are:
$
Sales revenue
31
Direct labor (2 hours)
(11)
Direct materials (1 kg)
(10)
Fixed overheads
(3)
Standard profit
7
The budgeted output for March was 1,000 units of product X; the actual output was 1,100 units, which
was sold for $34,950. There were no inventories at the start or end of March.
The actual production costs were:
Direct labor (2150 hours)
Direct materials (1170 kg)
Fixed overheads
$
12,210
11,630
3,200
Required:
Deduce the budgeted profit for March and perform the necessary variance analysis. State which manager
should be held accountable, in the first instance, for each variance calculated.
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Original budget
Output
1000 units
Sales revenue
$31,000
Raw materials
($10,000) (1,000kg)
Labor
($11,000) (2,000 hours)
Fixed overheads
($3,000)
Operating profit $7,000
Original Budget
Flexed budget
Actual
1000 units
1100 units
1,100 units
$
$
$
Sales revenue
31,000
34,100
34,950
Raw materials
(10,000) (1,000 kg)
(11,000) (1,100 kg)
(11,630) (1,170 kg)
Labour
(11,000) (2,000 hours)
(12,100) (2,200 hours)
(12,210) (2,150 hours)
Fixed overheads
(3,000)
(3,000)
(3,200)
Operating profits
7,000
8,000
7,910
Output
(production and sales)
Variance
$
Manager accountable
Sales volume
1000 (F)
Sales
Sales price
850 (F)
Sales
Materials price
70 (F)
Purchasing
Materials usage
700 (A)
Production
Labour rate
385 (A)
Personnel
Labor efficiency
275 (F)
Production
Fixed overhead
200 (A)
Various – depend on O/H
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Question
Pilot Ltd makes a standard product, which is budgeted to sell at $5.00 a unit. It is made by taking a
budgeted 0.5kg of material, budgeted to cost $3.00 a kilogram, and working on it by hand by an
employee, paid a budgeted $5.00 an hour, for a budgeted 15 minutes. Monthly fixed overheads are
budgeted at $6,000. The output for March was budgeted at 5,000 units.
The actual results for March were as follows:
$
Sales revenue (5,400 units)
26,460
Materials (2,830kg)
(8,770)
Labor (1,300 hours)
(6,885)
Fixed overheads
(6350)
Actual operating profit
4,455
No inventories existed at the start or end of March.
Required:
Deduce the budgeted profit for March and perform the necessary variance analysis. State which manager
should be held accountable, in the first instance, for each variance calculated.
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Page 339
(a)
Original budget
Output
5000 units
Sales revenue
$25,000
Raw materials
($7,500) (2,500kg)
Labor
($6,250) (1,250 hours)
Fixed overheads
($6,000)
Operating profit $5,250
Original Budget
Flexed budget
Actual
5000 units
5,400 units
5,400 units
$
$
$
Sales revenue
25,000
27,000
26,460
Raw materials
(7,500) (2,500 kg)
(8,100) (2,700 kg)
(8,770) (2,830 kg)
Labour
(6,250) (1,250 hours)
(6,750) (1,350 hours)
(6,885) (1,300 hours)
Fixed overheads
(6,000)
(6,000)
(6,350)
Operating profits
5,250
6,150
4,455
Output
(production and sales)
Variance
$
Manager accountable
Sales volume (5250 – 6150)
900 (F)
Sales
Sales price (27,000 – 26,460)
540 (A)
Sales
Materials price [8770 – (2830 * 3)]
280 (A)
Purchasing
Materials usage (2830 – 2700) * 3
390 (A)
Production
Labour rate [6885 – (1300 * 5)]
385 (A)
Personnel
Labor efficiency (1300 – 1350) * 5
250 (F)
Production
Fixed overhead (6,000 – 6,350)
350 (A)
Various – depend on O/H
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Introduction (Pilot Paper June 2011)
CoolFreeze construct refrigeration systems for supermarkets, food processing plants, warehouses and other
industrial premises. It has a sales forecasting committee consisting of the company’s sales manager, procurement
manager, production manager and the head of administration. The committee produces annual sales forecasts for
the company which they review quarterly. Historically, these forecasts have been reasonably accurate.
In the second quarter of 2009 they revised/produced their estimates for the next four quarters. The predicted unit
sales volume and prices are given in figure one
Figure one: Sales forecast 2009–2010
Year
2009
2010
Quarter Predicted sales
3
81
4
69
1
62
2
83
Predicted sales price
$1000
$1000
$1000
$1000
Revenue
$81,000
$69,000
$62,000
$83,000
At the meeting that agreed this forecast the sales manager expressed some doubts about the figures. “My team
are telling me that it is very tough out there. Companies are not replacing old equipment or constructing new
plants. Furthermore, cheaper foreign products are becoming available – undercutting our prices by 10%”. Despite
these reservations, the sales manager agreed the sales forecasts produced by the committee.
Actual sales performance
The actual sales for the four projected quarters were as follows (figure two).
Figure two: Actual sales 2009–2010
Year
2009
2010
Quarter
3
4
1
2
Predicted sales
81
69
62
83
Actual sales
82
68
61
50
The sudden drop in quarter 2 sales caused consternation in the boardroom, particularly as it was a quarter when
high demand and profits were anticipated. An analysis of the quarter 2 trading is shown in figure three.
The managing director of CoolFreeze has called you in to review the forecasting model used by the sales
forecasting team. “It must be very flawed to go so badly wrong. I have the feeling that the model is not based on a
well-accepted approach”. He has obtained a copy of the spreadsheet used by the sales forecasting team (see figure
four) to help you in your analysis.
The managing director recognises that the actual quarter 2 performance has to be analysed against the budgeted
one. “I think everyone here has made mistakes – the sales manager, procurement manager, production manager,
administration manager. They all have to take responsibility. We are in this together and now we must pull
together to get out of this mess”.
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Figure three: Analysis of quarter 2 trading; budget and actual
Quarter 2 – 2010
Units
Revenue
Raw materials
Labour
Fixed overheads
Operating profit
Budget
Actual
83
$83,000.00
($29,050.00)
($26,975.00)
($18,000.00)
$8,975.00
50
$45,000.00
($15,000.00)
($15,750.00)
($18,000.00)
($3,750.00)
b. Analyse the quarter 2 – 2010 performance of CoolFreeze.
•
(13 marks)
Making budgetary control effective
 A serious attitude taken to the system by all levels of management.
 Clear demarcation between areas of managerial responsibility.
 Budget targets which are challenging yet achievable.
 Established data collection, analysis and reporting routines, which take the actual results and the
budget figures, and calculate and report the variances.
 Producing reports aimed at individual managers rather than general-purpose documents.
 Fairly short reporting periods, typically a month, so that things cannot go too far wrong before
they are picked up.
 Variance reports being produced and made available to managers shortly after the end of the
relevant reporting period.
 Action being taken to get operations back under control if they are shown to be out of control.
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Strategic action - Technology and data analytics
1. Why IT/IS (information is strategic)
•
According to Michael J. Earl, IS/IT is strategic because:







IT/IS involves high costs
IT is critical to the success of many organizations
IT is used as a strategic weapon for competitive advantage
IT is required by the economic context (competitive necessity)
IT/IS affects all levels of management
IT may mean a revolution in the way information is created, and presented to management
IT involves many stakeholders
2. E-commerce
E-Commerce
Definition
Types
Benefits
Limitations
Agents
Generic
Organization Individual
•
Society
Definition – the process of selling, buying, and exchanging products, services, and
information over computer networks, including the internet
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Types
B2B
…
EDI
•
B2C
EFT
C2B
C2C
VAN
G2B
B2G
e-SCM
P2P
Non-business EC
e-CRM
Intranet
Extranet
IOS
IOS – inter-organizational system; VAN – value added network providers
Generic benefits of e-commerce
Cost savings – communication, paperless, people, publications and distributions, CBT
Convenience – anywhere, anytime, ease of use
Access to more information
Improves decision making
Simplifies business process – shorter time to market
Improves customer service
Global reach
Access to greater expertise
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Page 344
Generic limitations
Cost
Security
(contd.)
Technical
limitations
Legal issues Negative
elements
demand/
mindset
problem
Start-up
cost
Bandwidth
Pornography
Upgrades
Data-transfer
rate
On-line gambling
Maintenance
Breakdown
of human
relationships
Terrorist sites
Compatibility
issues
Anti-God etc.
Security (security concerns – APIN – authentication, privacy, integrity and non-repudiation)
Fraud
Hacking
Sniffing
DoS
Spamming
Modifying,
deleting data
Malicious software
Deface of Web site
(virus, worms, Trojan horse,
time bomb, logic bomb,
trap door)
Spoofing
Disclosing data
(privacy issues)
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E-commerce benefits to organizations
Cost savings:-
Convenience:-
Communication
Anywhere,
anytime
Paper-less
Easy to use
People –less
Organizational
flexibility –
24/7/364
Access to
more
information:Improves
employee
productivity
Customers
can access
company
information
Other
stakeholders
Improve
decision
making:Helps
find new
business
partners
Simplifies
processes:Shorter time
to market
Improve
customer
service:Intranet
Competitive
advantage
Global
reach
Access to
greater
expertise
Live
chats
Video
displays
Publication &
distribution
Training - CBT
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E-Commerce benefits to individual
Cost savings Convenience
Access to Improves Increases
Forms
Telecommuting
more
decision business
user group
Information making
opportunities to exchange
ideas &
experience
Communication Anywhere,
Anytime
Ease of usage
Improves educational
opportunity
Discounts etc.
Conduct quick
comparisons
Access to many
Services
Quick delivery
(digital products)
Customers can also access more of company
information (products and services)
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E-Commerce benefits to society
Due to telecommuting
Paperless
Cleaner air
Ecologically
friendly
Lesser road
Accidents
Improves
literacy levels
of society
Improves
society’s
standard of
living
Healthcare,
social
services thru
Internet
as a result of
greater educational
opportunities
Improve employment opportunity
Decrease crime rates
Drivers/benefits for e-business
Reduce
costs/increase
efficiency/profit/increase turnover
Improve communication with customers,
staff, suppliers/improve relationships
Keep up with progress
Keep up with competitors/competitive
pressures
Increase speed of access to information
Standardize/simplify/integrate processes
Customer,
management,
employee,
supplier demands
Improve/shorten delivery time
Increase range of products/services
Barriers to e-business adoption
Costs
Lack of resources
knowledge
Staff resistance
Integration problems
–
time,
skills,
Lack of board interest
Difficult of changing processes
Security
Insufficient government regulations
Technology
–
current
bandwidth
problems
Increase IT knowledge
Increase customer base
Improve corporate image/enhancement
of brand
Faster product development lifecycle
Identifying
new
partners/supporting
existing partners better
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•
Internet adoption (Chaffey)






Content
Customization
Community
Convenience
Choice
Cost reduction
Contents on a retail Web site (general checklist)
•




About the company
History
Office location, address and maps
Contact us
Financial performance
•










Products and services
Catalogue of products and services
On-line sales ordering
Current stock levels and delivery times
Detailed technical specifications
Customer testimonials and clients list
White papers
Press releases
Special offers, discounts, coupons
Demonstrations
Where to obtain them
•





Customer services
Product returns
Electronic Help Desk
FAQs
Chat rooms and news groups
Customer feedback form
•



Events
Seminars
Exhibitions
Training
•





General information
What’s new
Job vacancies
Search facility
Links to related sites
Security features
Prepared by Dr. Parmindar Singh
APCEI
Page 349
Web retailing from customer perspective (criteria)
•






Performance and service:
Fast downloading
Good navigation
Proper background and text colors
No ‘endlessly scrolling page’
Similar look and feel
Search facilities
•

Incentives:
Coupons, discounts, special offers
•


Personalization:
Enhance shopping experience (VR, video demonstration)
Customized Web pages for customers
•

Security and reliability:
Encryption type, payment options
•

Community:
Chat rooms, e-newsletter
•




Others:
Price comparisons
Currency converter
Tracking services
E-card etc.
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PIPS-CO
Page 350
3. Mobile technologies
•
Is concerned with technology that is portable.
•
Mobile technology devices include laptops, tablets, smartphones, GPS technologies.
•
Such devices enable users to communicate with one another in different ways, some of
which may make use of the Internet.
•
Communicative features of mobile technologies include Wifi connectivity, Bluetooth and
cellular phone genarational languages
Benefits
Anytime, anywhere work place
Risks
Costs and obsolescence
M-commerce
Security
Mobile apps
Privacy issues
Allows organizational stakeholders to interact Features in smartphones may be abused
in different ways
4. Cloud computing
•
Is a model for enabling ubiquitous, convenient, on-demand network access to a shared pool
of configurable computing resources
•
These resources include networks, servers, storage, applications and services – thus SaaS,
DaaS
Benefits
Cost effective
Risks
Loss of control
Faster implementation
Loss of privacy
Easier access
Security issues
Allows smaller firms to be on par with large
firms with regards to IT resources
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5. FinTech
•
Describes the evolving intersection of financial services and technology
•
The FinTech ecosystems consist of:
 Large well-established institutions like banks etc. – the incumbents
 Big tech companies that are active in the financial services – Apple, Google, Alibaba
 Firms that provide infrastructure or technology that facilitates financial services transactions
 Disruptors – fast moving companies
6. E-marketing
•
Definition
 E-marketing is the application of the Internet and related technologies to achieve marketing
objectives (Chaffey et al., 2003)
•
E-marketing plan
 Smith (1999) developed a marketing plan called SOSTAC:
➢ Situation analysis – where are we now?
➢ Objectives – where do we want to be?
➢ Strategy – how do we get there?
➢ Tactics – how exactly do we get there?
➢ Action – what is our plan?
➢ Control – did we get there?
Prepared by Dr. Parmindar Singh
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Situation
analysis
Control
Objectives
Action
Strategy
Tactics
•
Situation analysis
 PESTEL analysis
 Competitor analysis
 Resource analysis
 Demand analysis
 Intermediary analysis
•
Objective setting – objectives of e-marketing (web site)
•
Strategy – e-marketing strategy
 Decide on e-marketing strategy – penetration, brand loyalty, improve service, pull customers
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•
Tactics – more specific details:
 Marketing mix:
➢ Products
➢ Price
➢ Place
➢ Promotion
➢ People – sales and marketing personnel (can be automated by auto-responders, e-mail,
web site)
➢ Process – procedures, processes in place to achieve all marketing functions
➢ Physical evidence – how customer purchases and uses a product, physical site
•
Actions
 Level of investment
 Training
 Implementing and maintaining a dynamic web site
•
Control
 Monitor, review and change
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Branding
•
Online branding to improve brand identity and equity
•
A good brand name must be simple, distinctive, meaningful and compatible with the product
(Chernatony & McDonald, 1992)
•
A good brand name can also be short, appealing memorable, and active (SAMA)
An organization has several choices when it comes to online branding:
 Migrate traditional brand online
 Extend traditional brand
 Partner with existing digital brand
 Create a new digital brand
Web based advertising
•
Advantages of Web advertisements
 Cheap - can be much cheaper as compared to traditional forms of advertising
 Interactive - customers can click and the ads can then interact with them. This is much more
effective as compared to traditional means which is not interactive
 Global reach - web ads has the potential to reach a global audience
 People - more and more people are surfing the Net. These people are generally more well
off as compared to non Internet surfers
 Update - Web ads can be updated anytime with minimal cost; therefore they are always
timely
 Convergence - Web ads can use the convergence of text, audio, graphics, animation etc. to
make it more attractive so as to grab customer attention
 One-to-one marketing - as customers clicks through ads, there is a possibility of learning
more about a particular customer and hence there is an opportunity to further customize the
product or service to cater for his/her needs
 24/7/365 - can be open 24 hours a day, 7 days a week and 365 days a year
Prepared by Dr. Parmindar Singh
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CIGPUCO –
24/7/365
New media marketing communications
•
Interactivity – traditional media normally push mechanism while the Internet is pull media.
There is also a dialogue in Internet media
•
Intelligence – cookies, agents, clickstream tracking, collaborative filtering, questionnaire on
web site
•
Individualization – mass customization/personalization
•
Integration – seamless ordering, integrated communication facilities (phone, e-mail etc.),
integration of databases
•
Industry restructuring – disintermediation, re-intermediation,
•
Independence of location – anywhere, anytime
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7. CRM
•
IT term for methodologies, strategies, software and other Web based capabilities that helps
an enterprise organize and manage customer relationship
•
The aim of CRM is that the same information is available to all in the company so that every
production or service need of the customer is met. CRM implies that everyone in the
enterprise is focused on the customer - customer centric
•
Importance of CRM
 Increased competition - global competition driven by Internet and deregulation of
telecommunications industry. The Internet has lowered the barriers for new players to enter
the market
 Products and services are getting harder to differentiate
 Customer is king (costly to find new customer than to retain existing ones)
 Technology has become ripe for use - IVR (interactive voice response), data warehousing
and tools, call centers (PABX, VoIP), WWW (self service- bill presentment, payment;
revenue enhancement etc.), mobile apps, smartphones, stronger internet connection
•
Enablers of CRM
 Qualified professional people
 Well-designed business process
 Leading edge technology
 Proper business rules
•
Benefits of CRM
 Faster response to customer service
 Increased efficiency through automation
 Deeper understanding of customer needs (in conjunction with data mining)
 Increased marketing and selling opportunities
 Identifying most profitable customers
 Receiving customer feedback that leads to new and improved products and services
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•
Problems/disadvantages of CRM
 Integration with legacy systems
 Time consuming to build
 Can be very expensive
 User resistance (participation, communication, training and education)
 Risky project
 Deciding how to develop (packages, bespoke outsourcing, inhouse, co-source)
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8. Big Data (this information on big data comes from accaglobal.com)
•
Extremely large collections of data (data sets) that may be analysed to reveal patterns,
trends, and associations, especially relating to human behaviour and interactions.
•
In addition, many definitions also state that the data sets are so large that conventional
methods of storing and processing the data will not work
•
Big data has the following characteristics, known as the 3Vs:
 Volume
 Variety
 Velocity
•
The
commonest
fourth
'V'
that
is
sometimes
Veracity: is the data true and can its accuracy be relied upon?
•
The processing of big data is generally known as big data analytics and includes:
added
is:
 Data mining: analysing data to identify patterns and establish relationships such as
associations (where several events are connected), sequences (where one event leads to
another) and correlations
 Predictive analytics: a type of data mining which aims to predict future events. For example,
the chance of someone being persuaded to upgrade a flight.
 Text analytics: scanning text such as emails and word processing documents to extract
useful information. It could simply be looking for key-words that indicate an interest in a
product or place.
 Voice analytics: as above but with audio.
 Statistical analytics: used to identify trends, correlations and changes in behaviour.
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Volume

The volume of big data held by large companies such as Walmart (supermarkets), Apple
and EBay is measured in multiple petabytes. What is a petabyte? It’s 10 15 bytes (characters)
of information. A typical disc on a personal computer (PC) holds 10 9 bytes (a gigabyte), so
the big data depositories of these companies hold at least the data that could typically be
held on 1 million PCs, perhaps even 10 to 20 million PCs.

These numbers probably mean little even when converted into equivalent PCs. It is more
instructive to list some of the types of data that large companies will typically store.

Retailers
Via loyalty cards being swiped at checkouts: details of all purchases you make, when,
where, how you pay, use of coupons.

Via websites: every product you have every looked at, every page you have visited, every
product you have ever bought.

Social media (such as Facebook and Twitter)
Friends and contacts, postings made, your location when postings are made, photographs
(that can be scanned for identification), any other data you might choose to reveal to the
universe.

Mobile phone companies
Numbers you ring, texts you send (which can be automatically scanned for key words),
every location your phone has ever been whilst switched on (to an accuracy of a few
metres), your browsing habits. Voice mails.

Internet providers and browser providers
Every site and every page you visit. Information about all downloads and all emails (again
these are routinely scanned to provide insights into your interests). Search terms which you
enter.

Banking systems
Every receipt, payment, credit card information (amount, date, retailer, location), location of
ATM machines used.
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Variety

Some of the variety of information can be seen from the examples listed above. In particular,
the following types of information are held:
▪
Browsing activities: sites, pages visited, membership of sites, downloads, searches
▪
Financial transactions
▪
Interests
▪
Buying habits
▪
Reaction to advertisements on the internet or to advertising emails
▪
Geographical information
▪
Information about social and business contacts
▪
Text
▪
Numerical information
▪
Graphical information (such as photographs)
▪
Oral information (such as voice mails)
▪
Technical information, such as jet engine vibration and temperature analysis
This data can be both structured and unstructured

Structured data: this data is stored within defined fields (numerical, text, date etc) often with
defined lengths, within a defined record, in a file of similar records. Structured data requires
a model of the types and format of business data that will be recorded and how the data will
be stored, processed and accessed. This is called a data model. Designing the model
defines and limits the data which can be collected and stored, and the processing that can
be performed on it.

An example of structured data is found in banking systems, which record the receipts and
payments from your current account: date, amount, receipt/payment, short explanations
such as payee or source of the money.

Structured data is easily accessible by well-established database structured query
languages.
Prepared by Dr. Parmindar Singh
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
Unstructured data: refers to information that does not have a pre-defined data-model. It
comes in all shapes and sizes and it is this variety and irregularity which makes it difficult to
store in a way that will allow it to be analysed, searched or otherwise used. An often quoted
statistic is that 80% of business data is unstructured, residing it in word processor
documents, spreadsheets, powerpoint files, audio, video, social media interactions and map
data.

Here is an example of unstructured data and an example of its use in a retail environment:

You enter a large store and have your mobile phone with you. That allows your movement
round the store to be tracked. The store might or might not know who you are (depending on
whether it knows your mobile phone number). The store can record what departments you
visit, and how long you spend in each. Security cameras in the ceiling match up your image
with the phone, so now they know what you look like and would be able to recognise you on
future visits. You pass near a particular product and previous records show that you had
looked at that product before, so a text message can be sent perhaps reminding you about
it, or advertising a 10% price reduction. Perhaps the store has a marketing campaign that
states that it will never be undersold, so when you pass near products you might be making
a price comparison and the store has to check prices on other stores websites and message
you with a new price. If you buy the product then the store might have further marketing
opportunities for related products and consumables and this data has to be recorded also.
You pay with an affinity credit card (a card with associations with another organisations such
as a charity or an airline), so now the store has some insight into your interests. Perhaps
you buy several products and the store will want to discover if these items are generally
bought together.

So just walking round a store can generate a vast quantity of data which will be very
different in size and nature for every individual.
Velocity

Information must be provided quickly enough to be of use in decision making. For example,
in the above store scenario, there would be little use in obtaining the price-comparison
information and texting customers once they had left the store. If facial recognition is going
to be used by shops and hotels, it has to be more or less instant so that guests can be
welcomed by name. You will understand that the volume and variety conspire against
velocity and, so, methods have to be found to process huge quantities of non-uniform,
awkward data in real-time
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
The analytical findings can lead to:
▪
Better marketing
▪
Better customer service and relationship management
▪
Increased customer loyalty
▪
Increased competitive strength
▪
Increased operational efficiency
▪
The discovery of new sources of revenue
Dangers of big data
Despite the examples of the use of big data in commerce, particularly for marketing and
customer relationship management, there are some potential dangers and drawbacks.

Cost: It is expensive to establish the hardware and analytical software needed, though
these costs are continually falling.

Regulation: Some countries and cultures worry about the amount of information that is
being collected and have passed laws governing its collection, storage and use. Breaking a
law can have serious reputational and punitive consequences.

Loss and theft of data: Apart from the consequences arising from regulatory breaches as
mentioned above, companies might find themselves open to civil legal action if data were
stolen and individuals suffered as a consequence.

Incorrect data (veracity): If the data held is incorrect or out of date incorrect conclusions
are likely. Even if the data is correct, some correlations might be spurious leading to false
positive results.

Employee monitoring: data collection methods allow employees to be monitored in detail
every second of the day. Some companies place sensors in name badges so that employee
movements and interactions at work can be monitored. The badged monitor to whom each
employee talks and in what tone of voice. Stress levels can be measured from voice
analysis also. Obviously, this information could be used to reduce stress levels and to
facilitate better interactions but you will easily see how it could easily be used to put
employees under severe pressure.
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9. IT controls
Security
•
Security is the establishment and application of safeguards (measures) to protect:
 Data, software and hardware from accidental or malicious:
➢ Modification, destruction, disclosure as well as from natural disasters
Malicious software
•
Is software that causes havoc, chaos or problems to the computer systems
•
Examples are virus, Trojan horses, time bombs, logic bombs, worms, back door, spyware,
adware
IT controls and applications
•
Policy – company policy on security breaches and transmission of malicious software
•
Legislation – cyberlaws and computer misuse laws
•
Access controls – locks, CCTV, password, removable drives, restrict use of computers,
access privileges, firewall systems, intrusion detection systems
•
Backups – cloud-based, removable drives
•
Anti-malicious software
•
Establishing cyber-security team
•
Training and contingency planning
•
Backup equipment – power supply, servers
•
Protection from disasters like fire (Argonite system), floods and other natural disasters
•
System authentication – user-id, passwords, biometrics, PIN and questions only actual user
can answer
•
Encryption and fiber optics
Prepared by Dr. Parmindar Singh
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10. Software development
Software development
In-house
Bespoke
tailor-made
Off-the-shelf packages
Advantages
Comparatively cheap as compared to
tailor-made, or bespoke
Readily available - time saving
Normally come with easy to follow manual
Staff savings - since the company does not
need to hire in-house programmers,
reduction in headcount in other functional
areas
Easy to use - GUI, context sensitive help
function
Continuously updated
Relatively tried and tested, written by
specialist, reputable - confidence
Maintenance contract
Try before you buy
Prepared by Dr. Parmindar Singh
Outsource
off-the-shelf
tailor-made
bespoke
Disadvantages
User will be dependent on supplier for
maintenance and upgrades
All users will get the same standard
features, therefore no competitive
advantage
Sometimes, especially the older software,
WYSINWYG/WYSINWIR
There could be a high turnover of
programmers in an environment that
advocates the use of packages; resistance
among staff
May have problems such as illogical data
entry, unclear field entry, inconsistent
cursor control, commands/terms used not
the same as used in organization
Also may not follow the business flows
needed, functions and features not
sufficient
May still have bugs – impossible to try and
test completely
Supplier may close business
Page 365
•
Evaluating and implementing an off-the-shelf package
 Benchmark testing
 Implementation – training, data conversion, ensure proper documentation and manuals and
Changeover – direct changeover, parallel run, pilot run, staged/phased changeover
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Blockchain technology
1. Definition
•
Blockchain is an open distributed ledger that can record transactions between two parties
efficiently and in a verifiable and permanent way. The ledger itself can also be programmed
to trigger transactions automatically.
•
Blockchain is not a disruptive technology. It is a foundational technology – i.e. it has the
potential to create new foundations for our economic and social system (an analogy, TCP/IP
→ foundational technology; internet → disruptive technology).
•
Blockchain is a peer-to-peer network that sits on top of the internet.
2. Five basic principles underlying blockchain technology:
•
Distributed database
•
Peer-to-peer transmission
•
Transparency with pseudonymity
•
Irreversibility of records
•
Computational logic
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3. Distributed database
•
Each party on a blockchain has access to the entire database and its complete history. No
single party controls the data or information. Every party can verify the records of its
transaction partners directly, without an intermediary.
Database 1 (30-plus alphanumeric
address)
Interested party 1
(e.g. supplier)
hosts and maintains
Ledger A
Updates ledger A
Database 2
Interested party 2
(e.g. customer)
hosts and maintains
Ledger A
Updated ledger A
Database 3
Interested party 3
(e.g. distributor)
hosts and maintains
Ledger A
Updated ledger A
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•
When changes are made in ledger A of database 1, those changes will also be reflected in
databases 2 and 3 (through peer-to-peer transmission).
4. Peer-to-peer transmission
•
Communication occurs directly between peers instead of through a central node. Each node
(user/party/database) stores and forwards information to all other nodes.
5. Transparency with psedonymity
•
Every transaction and its associated value are visible to anyone with access to the system.
Each node or user, on a blockchain has a unique 30-plus alphanumeric address that
identifies it. Users can choose to remain anonymous or provide proof of their identity to
others. Transactions occur between blockchain address.
6. Irreversibility of records
•
Once a transaction is entered in the database and the accounts are updated, the records
cannot be altered, because they are linked to every transaction record that came before
them (hence the term “chain”). Various computational algorithms and approaches are
deployed to ensure that the recording on the database is permanent, chronologically
ordered, and available to all others on the network – permanence.
•
With blockchain, contracts can be embedded in a digital code (stored inside ledger) and
stored in transparent, shared databases (distributed databases), where they are protected
from deletion, tampering and revisions. In this world, every agreement, every process, every
task, and every payment would have a digital record and signature that can be identified,
validated, stored and shared.
•
Intermediaries like brokers, and bankers might no longer be necessary. Individuals,
organizations, machines, and algorithms would freely transact and interact with one another
with little friction.
7. Computational logic
•
The digital nature of the ledger means that blockchain transactions can be tied to
computational logic and in essence, programmed (i.e. transactions can be programmed).
So users can set up algorithms and rules that automatically trigger transactions between
nodes.
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Database 1
Ledger A –
contains all
the
transactions
and
user/node
address
Database 4
Database 2
Peer-to-peer
transmission
Ledger A – when
ledger A is updated
from database 1, the
contents cannot be
altered → but
appears in a
chronological order
to all users →
“CHAIN” in databases
2, 3, 4 etc.
Database 3
Ledger A – transactions can be
tied to computational logic and
therefore programmed and
hence users can set up
algorithms that automatically
triggers transactions
Source: Iansiti, M. & Lakhani, K. R. (2017), ‘The truth about blockchain’, Harvard Business
Review, Jan-Feb, pp. 118-127.
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Initial coin offering (ICO)
1. Definition
•
ICO is an open call, through the internet, for funding by organizations, entrepreneurs and
others to raise money in the form of cryptocurrencies, in exchange of tokens and smart
contracts and relying on blockchain technology to undertake certain projects and allowing
the token holder to enjoy certain rights; the tokens can also be sold in secondary markets.
•
The party buying the tokens (funders) can pay in the form of cryptocurrencies (desired) or in
fiat money.
2. Advantages of ICOs
•
Reduce the cost of capital – by adopting blockchain technology and avoiding intermediaries
such as crowdfunding platforms and payment agents (banks, credit cards).
•
The tokens allow funders to create a secondary market for their investments. ICO tokens
may be sold on the secondary market where sellers can deposit their tokens and specify
certain conditions such as minimum prices, accepted currencies etc.
3. Token holder rights
•
Right to access services provided by the ICO project.
•
Governance powers (voting rights on decisions).
•
Profits from ICO project.
•
Tokens can also be used as currency in their blockchain.
•
Contribution rights – the opportunity to decide the characteristics of products/services to be
offered.
4. ICO success
•
Code availability for the blockchain projects so that funders can see the viability of the
project.
•
Pre-sale initiatives – to generate interests.
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ICO steps
•
Company wants to fund certain projects and needs cryptocurrencies through ICO. Company
issues white paper or “token sale terms”.
•
Funders contribute cryptocurrencies and/or fiat money.
•
Funders receive tokens.
•
Tokens give contributors certain privileges and tokens can also be traded on secondary
market.
Source: Adhami, S., Giudici, G. & Martinazzi, S. (2018), ‘Why do business go crypto? An
empirical analysis of initial coin offerings’, Journal of Economics and Business (article in press).
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