Chapter 1
Corporate Governance
Corporate Governance – meanings
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The system by which organisations are directed and controlled (Cadbury Report)
Corporate governance (cg) is a set of relationship between an entity’s director, shareholders and other stakeholders
Also provides the structure through which the objectives of the entity are set and determines the means of achieving
those objectives and monitoring performance
Cg is an issue for all entities, whether they be
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Large quoted entities
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Commercial entities
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Not-for-profit organisations including:
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Public sector
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Non-governmental organisations
Corporate Governance – elements
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Management, awareness, evaluation and mitigation of risk
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Includes the operation of an adequate and appropriate system of control
Overall performance is improved by good supervision and management within set best practice guidelines
Framework for an organisation to pursue strategy in an ethical and effective way
Offers safeguards against misuse of resources – human, financial, physical and intellectual
Involves more than following externally established codes of good practice also requires a willingness to apply the spirit
as well as the letter of the law
Can attract new investment into entities, particularly in developing nations
Accountability to shareholders and also other stakeholders
Underpins capital market confidence in entities, government, regulators and tax authorities
Corporate Governance – concept
Honesty / Probity – not simply telling the truth but also not being guilty of issuing misleading statements or presenting
information in a confusing or distorted way
Accountability – emphasis of the directors’ accountability to shareholders, but opens the door for discussion about the
extent of their accountability to other stakeholders.
Independence – strong emphasis on the appointment of independence not-executive directors who are free from
conflicts of interest and are thus able to monitor effectively the entity’s and executive directors’ activities, ideally
working closely with the external auditors.
Responsibility – a system of responsibility should exist whereby entity directors acknowledge their responsibilities to
the stakeholders, and will take whatever corrective action is necessary in order to keep the entity focussed.
Decision making / judgement – the skill with which management make decision which will improve the wealth /
prosperity of the organisation.
Reputation – built by directors, often as a result of their ability to comply with other cg concepts
Integrity – straightforward dealing, honesty, and balance for financial statements to have the characteristic of integrity,
this depends upon the integrity of those people who prepare them integrity involves a person who demonstrates high
moral character, is principled, professional, honest and trustworthy.
Fairness – taking into account the interest, rights and views of everyone who has a legitimate interest in the entity.
Transparency / openness – involves full disclosure of material matter which could influence the decision of
stakeholders. This means not simply openness in the reporting of information required by IFRS in the financial
statements. It also involves other information such as cash and management forecasts, environmental reports and
sustainability reports.
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Corporate Governance and agency theory
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directors act as agents of the shareholders
cg tries to ensure that agency responsibilities are fulfilled as agents by requiring disclosure and by suggesting
performance-related rewards
definition: an agency relationship is a contract under which one or more persons (the principals) engage another person
(the agent) to perform some service on their behalf that involves delegating some decision-making authority to the agent
fiduciary duties definition: a duty imposed upon certain persons because of the position of trust and confidence in which
they stand in relation to another. The duty is more onerous than generally arises under a contractual or tort relationship. It
requires full disclosure of information held by the fiduciary, a strict duty to account for any profits received as a result of
the relationship, and a duty to avoid conflicts of interest.
fiduciary duties are owed to the entity, not to individual shareholders
directors must exercise their powers for the proper purpose
Duties of directors as agents
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Performance – if paid, directors have a contractual obligation to perform as agreed (if unpaid, no such obligation)
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Obedience – directors should act strictly in accordance with the principal’s instructions
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Skill and care – directors should act with such a degree of skill and care as may reasonably be expected from a person
with such experience and qualifications
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Personal performance – directors should only delegate their assignments where they have no reason to believe that the
person to whom the work is delegated is not capable of proper performance
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Avoid conflict of interest – eg should not sell his own property to the entity, even though it may be at an independent
arm’s length valuation
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Confidence – agents should not disclose confidential matters about the principal, even after the agency agreement has
ended
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Accounting for benefits – agents must account to the principal for any undisclosed benefit which they receive as a result
of their office as agent
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Because ownership of an entity is necessarily separated from the management, problems may result
Corporate Governance – Potential Problems
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directors may choose to pursue strategies more beneficial for their own interest rather than the entity’s
directors will almost certainly have a different attitude to risk, and risk management, since it is not their own interest
which they are risking
if management have only a small beneficial interest in the entity (or even none at all) then they may well pursue activities
which improve short term results (therefore improving their current bonuses) to the exclusion of more far-sighted
strategies which would be of greater benefit to the entity in the longer term
ultimately, shareholders have the right to decide who shall (and who shall not) be directors of their entity. But this is, in
practical terms, very much a theoretical power. Generally shareholders neither have the dynamism nor organisation to
effect such a change in the composition of the board
Overcoming the problem – Alignment of interests ( goal congruence )
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incentives designed to align interests include:
o profit related pay
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share issue schemes, for instance on the occasion of a management buy—out
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share option schemes
but for all of these there is a natural tendency for management to adopt creative accounting to manipulate the profit figure
upon which these incentives are based
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Agency theory:
Agency is a contract under which one party (the principal) engages another party (the agent) to perform some service on their
behalf. As part of this, the principal will delegate some decision-making authority to the agent.
There are two problems in such a delegation.
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The desires / goals of the principal and agent have a conflict; and
It is difficult or expensive for the principal to verify what the agent is actually doing (whether he is working
appropriately).
Principal: are the shareholders, who cannot run management due to:
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Wide ownership base, especially in companies listed on stock exchanges
Lack of interest in the management due to limited risk and liability
Possible short term motive of capital gains in stock market (have ability to simply sell shares if company is in trouble)
Agent: is employed by Principal to manage the company (management)
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They are delegated the task to run the company
Agent does not share the Principal's motive of profit maximization, and is more interested in his remuneration
Agency Costs: are incurred by Principals to monitor working of their agents (because of lack of trust)
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i.e. Internal and External Audits
Accountability: is the need to explain and justify any failure to fulfill responsibility
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Agent is accountable to the Principal (by whom he is employed) when he accepts to undertake the task given to him
Fiduciary: The person on whom duty is imposed is called 'fiduciary
Fiduciary responsibilities:
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A fiduciary is expected to be extremely loyal to the person to whom they owe the duty (Principal);
They must not put their personal interests before the duty, and
Must not profit from their position as a fiduciary, unless the principal consents.
The fiduciary relationship is highlighted by good faith, loyalty and trust.
Stakeholders: any person or group which get affected by the running of the organization
Corporate governance includes the relationships among the many players involved (the stakeholders) and the goals for which the
corporation is governed. The principal players are the shareholders, management and the board of directors. Other stakeholders
include employees, suppliers, customers, banks and other lenders, regulators, the environment and the community at large.
Corporate governance deals with issues of accountability and fiduciary duty, essentially advocating the implementation of
guidelines and mechanisms to ensure good behaviour and protect shareholders.
Another key focus is the economic efficiency view, through which the corporate governance system should aim to optimize
economic results, with a strong emphasis on shareholders welfare.
Principal Agent Relationship:
• The nature of the relationship is that of Trust. Management has to act in the best interest of the shareholders
• Directors have fiduciary responsibility towards shareholders
• Directors have Fiduciary responsibility as everyone below them in the organization chart is monitored by them.
The relationship works because:
• management is given incentives on good performance, and
• the shareholders monitor their performance closely.
Agency Costs:
Agency loss is zero when the agent takes actions that are entirely consistent with the principal’s interests. As the agent’s actions
diverge from the principal’s interests, agency loss increases
Monitoring costs: are expenditures paid by the principal to measure, observe and control an agent’s behavior. They may include:
• Cost to provide data to shareholders (financial statements)
• Cost of audits of financial statements,
• Cost to hold Annual General Meetings,
• Executive compensation contracts, remuneration schemes, incentives and ultimately the cost of firing managers.
• Too much monitoring will reduce managerial entrepreneurship
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Certain aspects of monitoring may also be imposed by legislative practices. In the UK companies are required to provide
statements of compliance with the Cadbury and Greenbury reports on corporate governance.
Bonding Costs:
Given that agents ultimately bear monitoring costs, they are likely to set up structures that will see them act in shareholder’s best
interests, or compensate them accordingly if they don’t. The cost of establishing and adhering to these systems are known as
bonding costs
Residual Loss:
Despite monitoring and bonding, the interest of managers and shareholders are still unlikely to be fully aligned. Therefore, there
are still agency losses arising from conflicts of interest. These are known as residual loss. i.e. Directors furnishing themselves with
expensive cars.
How to control Agency problems:
• Management’s compensation should be based on market estimation of how well they take care of shareholders interests
(based on prior experience with other companies).
• If Directors do not perform well, they lose their job through resolution by shareholders in the annual meeting
• Board of Directors should largely be composed of independent directors (holding large blocks of shares in the company).
Holding regular meetings between stakeholders
• Hiring independent auditors (agents of shareholders) to monitor shareholders interest
• Threatening management with Divestment as last resort.
Stakeholder theory:
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Companies are large, and should discharge accountability to all stakeholders (not only shareholders)
Typical stakeholders are employees, customers and suppliers, community, government, environment, future generations
Stakeholders provide company with a contribution (infrastructure i.e. road) and expect the company to satisfy their
interest (give employment to locals).
Transactional Cost Theory:
Transactional cost theory relates to the decisions being made with in a company to obtain resources either internally or
from third parties. The theory states that market prices are not the sole factor in making this decision. There are also significant
transaction cost, search cost, contracting costs and co-ordination cost which will affect the decision. In effect, this is the essence of
the ‘make or buy’ decision.
There are two humans and three environmental factors that lead to transaction cost arising.
Human Factors:
• Bounded rationality: Our limited capacity to understand business situations, which limit the factors we consider in the
decision.
• Opportunism: Actions taken in an individual’s best interests, which can create uncertainty in dealing and mistrust
between parties.
Environmental factors:
• Frequency: How often such a transaction is made.
• Uncertainty: Long term relationships are more uncertain, close relationships are uncertain, lack of trust lead to
uncertainty.
• Asset specificity: how unique the component is for you.
Transaction cost theory vs agency cost theory:
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Transaction cost theory and agency cost theory essentially deal with same issues and problems. Where agency theory
focuses on the individual agent, transaction cost theory focuses on the individual transaction.
Agency theory looks at the tendency of directors to act in their own best interests, pursuing salary and status. Transaction
cost theory considers that managers (or directors) may arrange transactions in an opportunistic way.
The corporate governance problem of transaction cost theory is, however, not the protection of ownership rights of
shareholders (as is the agency theory focus), rather the effective and efficient accomplishment of transactions by firms.
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Chapter 2
The board of directors
Development of the UK Corporate Governance Code (CGC)
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1992, the Cadbury Report
followed by Greenbury report on directors’ remuneration
then Hampel report – a list of principles of “good corporate governance”
1998, these three merged into the Combined Code on Corporate Governance
2003, Higgs Report, effectiveness of non-executive directors (NEDs)
2005, Turnbull report, guidance on internal controls
2006, new CGC published
2010, revised and re-named – The UK Corporate Governance Code (CGC)
CGC applies to all UK quoted entities which must state:
o how it has applied CGC principles
o whether or not it has complied with CGC throughout the accounting period, and . . .
o . . . if not , why not
Directors
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anyone who occupies the position of director
shadow directors are ‘anyone in accordance with whose instructions the directors are accustomed to act’
combined code establishes roles and responsibilities:
o provide leadership for the entity
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represent the entity in its dealings, and to the public generally
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set the agendas for board meetings
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decide those matters which are to be determined by the board, and not therefore to be delegated
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decide upon a strategy for the entity
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select a director to be CEO, and…
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another one to be chair
directors’ roles and responsibilities continued
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establish a corporate culture
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ensure that those charged with taking operating decisions are doing their job properly
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establish and implement an effective system of internal controls capable of risk assessment and management
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ensure that aims and objectives of the entity are realistic and achievable
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ensure that all employees are aware of the entity’s responsibilities to its stakeholders
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hold regular and frequent board meetings
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assess own performance, and report annually to shareholders
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submit themselves for re–election every three years ( FTSE 350 entity? re-elect ALL directors every year )
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for listed entities there are “additional requirements”
Non Executive Directors (NED's)
• A non-executive director (NED, also NXD) or outside director is a member of the board of
directors of a company who does not form part of the executive management team.
• He or she is not an employee of the company or affiliated with it in any other way.
• They are differentiated from inside directors, who are members of the board also serving
as executive managers of the company (most often as corporate officers).
Role of NEDs
Strategy Role: contribute to development of strategy of the company; challenging the strategy
produced by Executive Directors and offering advice
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Scrutinizing Role: Review the performance of management. Hold management accountable for its
decisions taken and results obtained.
Risk Role: Ensure Company has adequate system of internal controls and system of risk
management in place.
People Role: Appointment, remuneration, appraisals of senior management, succession planning
_ Lack of unity and trust can put pressure on board operation.
_ The quality of NED willing to serve may be poor
Independent Directors
It is argued that the board of directors should consist partly of independent directors. An independent director is an
individual who:
• has no link to a special interest group or stakeholder group, such as executive management, other employees of the
company, a major shareholder, a supplier or a major supplier of customer of the company
• has no significant personal interests in the company, such as a significant contractual relationship with the company
• the board should consist of half independent NEDs excluding the chair
Reasons for NED independence
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to provide detached and objective view of board decisions
to provide expertise and communicate effectively
to provide shareholders with an independent voice on the board
to provide confidence in corporate governance
to reduce chances of self-interest in the behaviour of executives
Threats to NED independence
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close family ties with directors
significant shareholding
receive other remuneration from the company beside fee
employee in last 5 years
material business relations with company in last 3 years
cross directorship in other companies
serve on board for more than 9 years
Listed entity requirements and the Higgs report contents
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listed entities should
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appoint appropriate and independent NEDs
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establish sub-committees
Audit
Risk
Remuneration
Nomination
Corporate Governance Code sub-divisions
CGC breaks down neatly into four sub-divisions:
• directors
• directors’ remuneration
• accounts and audit
• investor relations (shareholders, institutional investors)
CGC sub-divisions -- directors
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every listed entity should have an effective board
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positions of Chair and CEO should be held by different individuals
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board should comprise both executive and non–executive directors
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there should be at least as many neds as executive directors
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appointment to the board should be formal and transparent
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information should be provided to the board
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there should be a formal assessment of the board’s performance annually
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should submit themselves for re–election on a regular basis
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with intervals not greater than three years
CGC sub-divisions – directors’ remuneration
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should be sufficient to attract, retain and motivate
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a proportion should be performance related
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no director should be involved in determining their own remuneration
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remuneration committee should publish a report of their activities in the annual financial statements
CGC sub-divisions – accounts and audit
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board should present a balanced assessment of the entity’s position
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the board should maintain a sound system of internal control in order to safeguard shareholders’ investments
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formal arrangements should be in place for considering how to apply financial reporting and internal control principles
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the board should make arrangements for maintaining an appropriate relationship with the auditors
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this will involve establishing an audit committee
CGC sub-divisions – investors relations and potential problems with
implementation of CGC
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directors should have regular dialogue with institutional investors
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directors should encourage active participation of all shareholders at the annual general meeting
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to adopt all the recommendations of the CGC sounds like an excellent idea, but there can be problems!
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potential problems
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possible that executive board could lack skill or experience
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when daily management team report to executive, their failings could mean that problems are not fully appreciated or
opportunities could be overlooked
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directors may meet infrequently and are not necessarily close acquaintances This could make it difficult for them effectively to
question the daily management team
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CEOs are often people with forceful personalities who sometimes exercise a dominant influence over the board
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CEO’s performance is judged by the same people who appointed him Could be very difficult for them to be unbiased in their
evaluation of CEO’s performance
Structure of the board – single tier (unified) or two tier?
Single Tier (Unified) Structure
Characteristics
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both control and management are in the hands of a single group of directors
common in the US and the UK
the cgc recommends that at least half the board should be neds
another recommendation concerns the split of the roles of CEO and Chair
the effect is to split the management ( CEO ) from control ( a non–executive Chair )
in practice, the neds not only monitor management but also contribute to strategy development
in larger entities, management is often devolved to sub–committees
all directors, whether management or neds, have equal legal and executive status All are therefore accountable and
responsible for board decisions
neds may also take the initiative in management decisions and are not restricted to post–decision approval
all directors owe the same fiduciary duties to the entity
Two Tier Structure
Characteristics
• consists of a supervisory board and a management board
• entities in France, Germany and other parts of Europe often have a two–tier board
• management is responsible for the general running of the business
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management board is led by CEO
supervisory board is responsible for the appointment, supervision and removal of members from the management
board
also responsible for overseeing the activities of the management board, and its compliance with law, regulation and the
entity’s constitution
also, a general overseeing of the entity and its business strategies
supervisory board is led by the Chair
Advantages of a Two-Tier Board
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Where there is a large Board, splitting into 2 may make discussion and decision making easier.
The existence of 2 Boards allows for more stakeholders to be involved.
By separating NEDs from the Executive Directors, the independence of the NEDs is likely to be improved.
Disadvantages of a Two-Tier Board
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If one board is clearly senior to the other, it may lead to conflict.
It may be better for NEDs to be present during Executive Director discussions, rather than receiving a report of what was
said.
It is likely to lead to slower decisions.
Senior management are now 2 steps away from a final decision, which may demotivate them.
In many countries (e.g. UK) all directors have equal legal status, whether Executive or NED. This may make it necessary
for all to sit on a single Board.
Advantages of a Unitary Board
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Unitary board can be small in size, because there is no requirement to appoint directors who represent stakeholder
interest group. Small board are more likely to act quickly in an emergency or when a fast decision is required.
In a unitary board structure, it is easier for the non-executive directors and the executive directors to work cooperatively. With a two tier structure, there is a risk that the two boards will not co-operate fully, especially when the
chairman of the company and the CEO do not work well together.
Unitary board work towards a common purpose, which is what is what the board considers to be the best interests of
the shareholders and others. With two-tier boards, there is more opportunity for disagreements on the supervisory
board between directors who represent different stakeholder interests.
Directors – structure of the board
The structure should take account of the following factors:
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an effective board is essential for good corporate governance
a balance between executive and neds so that no single group can dominate
the board should not be dominated neither by any individual
nor by any group / section
there needs to be a split of power between CEO and Chair
executive directors should each be an expert in their own field
Directors – sub-division of roles
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Executive directors
o involved in day to day management
o usually remunerated as full–time employees
o dedicate their working lives to fulfilling their duties as director
o take responsibility for the day to day running of the entity
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Non-executive directors
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members of the board, but not involved in the day to day running of the entity
neither a full–time employee, nor connected in any other way with the entity
serve on the various board sub-committees:
• audit
• remuneration
• risk
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nominations
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directors may choose to pursue strategies more beneficial for their own interest rather than the entity’s
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directors will almost certainly have a different attitude to risk, and risk management, since it is not their own interest
which they are risking
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if management have only a small beneficial interest in the entity (or even none at all) then they may well pursue activities
which improve short term results (therefore improving their current bonuses) to the exclusion of more far-sighted
strategies which would be of greater benefit to the entity in the longer term
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ultimately, shareholders have the right to decide who shall (and who shall not) be directors of their entity. But this is, in
practical terms, very much a theoretical power. Generally shareholders neither have the dynamism nor organisation to
effect such a change in the composition of the board
Board Committees
The nature of a board committee
A board committee is a committee set up by the board, and consisting of selected directors, which is given responsibility for
monitoring a particular aspect of the company’s affairs for which the board has reserved the power of decision-making.
A committee is not given decision-making powers. Its role is to monitor as aspect of the company’s affairs, and:
• Report back to the board, and
• Make recommendations to the board
The full board of directors should make a decision based on the committee’s recommendations. When the full board rejects a
recommendation from a committee, it should be a very good reason for doing so.
The main board committees
Within a system of corporate governance, a company might have at least three or possibly four major committee. These are:
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a remuneration committee, whose responsibility is to consider and negotiate the remuneration of executive directors
and senior managers
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an audit committee, whose responsibility is to monitor financial reporting and auditing within the company
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a nominations committee, whose responsibility is to identify and recommend individuals for appointment to the board
of directors
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a risk management committee, where the responsibility for the review of risk management has not been delegated to
the audit committee.
Audit Committee
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audit committee is a sub–committee of the board and is comprised entirely of neds
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in a listed entity, there should be at least three neds on the audit committee, one of whom has had recent relevant
financial experience
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key roles for the audit committee are:
o oversight
o assessment
o review of the other functions and systems in the entity
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most of the board’s objectives relating to internal control will probably be delegated to the audit committee
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the audit committee should:
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review the entity’s internal financial controls
review all the entity’s ic and risk management systems
approve the wording in the financial statements relating to ic and risk management systems
receive reports from management about the effectiveness of the control systems
receive reports concerning the conclusion of any tests carried out on the controls by either internal or external
auditors
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Remuneration Committee
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importance:
executive directors should not be responsible for determining their own remuneration
remuneration decisions can be seen to be taken by those who will not benefit from those decisions
there is a need for formal, transparent procedures for developing policy and for individual packages
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role:
the committee determines appropriate packages for the executive directors, and the composition of those packages
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composition
in listed entities the committee will typically comprise neds
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accountability
reports to the main board
Strategy of the Remuneration Committee may consider
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greater benefits in kind to compensate for lower basic salaries
offering non–cash motivation for some ( or all ) of the entity’s employees. Non–cash motivators could include things like
crèche facilities, cars and additional holidays
availability of entity resources. For example, the entity may not have sufficient cash resource to pay an annual bonus, but may
offer a share incentive scheme instead
encouragement of long–term loyalty by offering share–purchase schemes
Remuneration Committee responsibilities
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determine, and regularly review, the framework, broad policy and specific terms for the remuneration, terms and conditions
of employment of the Chair and of the executive directors
recommend and monitor the level and structure of the remuneration of senior management
set detailed remuneration for all executive directors and the Chair including pension rights and compensation payments
ensure that executive directors and senior management are fairly rewarded for their individual contributions to the overall
performance of the entity
demonstrate to shareholders that the remuneration of executive directors and senior management is set by individuals with no
personal interest in the outcome of the committee’s decisions
agree compensation for loss of office
ensure that provisions for disclosure of remuneration, including pensions, as set out in law and in the CGC are followed
Nomination Committee
There should be a nomination committee which should lead the process for board appointments and make recommendations to the
board.
The nomination committee should make its terms of reference, explaining its role and the authority available delegated to it by the
board.
1. A majority of members of the nomination committee should be independent NED.
2. The chairman or an independent NED should chair the committee
3. The chairman should not chair the nomination committee when it is dealing with the appointment of a successor to the
chairmanship.
4. The nomination committee should evaluate the balance of skills, knowledge and experience on the board and, prepare a
description of the role and capabilities required for a particular appointment
5. For the appointment of a chairman, the nomination committee should:
a. Prepare a job specification, including an assessment of the time commitment expected, recognizing the need for
availability in the event of crises.
b. A chairman's other significant commitments should be disclosed to the board before appointment and included in the
annual report.
c. Changes to such commitments should be reported to the board as they arise, and included in the next annual report.
d. No individual should be appointed to a second chairmanship of a FTSE 100 company.
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6. For NED's:
a. The terms and conditions of appointment of NED's should be made available for inspection.
b. The letter of appointment should set out the expected time commitment.
c. NED's should undertake that they will have sufficient time to meet what is expected of them.
d. Their other significant commitments should be disclosed to the board before appointment, with a broad indication of
the time involved and the board should be informed of subsequent changes.
e. The board should not agree to a full time executive director taking on more than one non-executive directorship in a
FTSE 100 company nor the chairmanship of such a company.
7. A separate section of the annual report should describe the work of the nomination committee, including the process it has used
in relation to board appointments.
8. An explanation should be given if neither an external search consultancy nor open advertising has been used in the appointment
of a chairman or a NED.
9. The chairman should arrange for the chairmen of the audit, remuneration and nomination committees to be available to answer
questions at the AGM and for all directors to attend.
Duties of the nomination Committee
•Review regularly the structure, size and composition of the board and make recommendations to the board.
• Consider the balance between executives and NEDs on the board of directors.
• Ensure appropriate management of diversity to board composition.
• Provide an appropriate balance of power to reduce domination in executive selection by the CEO/chairman.
• Regularly evaluate the balance of skills, knowledge and experience of the board.
• Give full consideration to succession planning for directors.
• Prepare a description of the role and capabilities required for any particular board appointment including that of the chairman.
• Identify and nominate for the approval by the board candidates to fill board vacancies as and when they arise.
• Make recommendations to the board concerning the standing for reappointment of directors.
• Be seen to operate independently for the benefit of shareholders.
CEO/chairman succession
The search for a potential replacement CEO begins immediately after a new CEO is appointed:
• Identify and nominate for the approval by the board candidates to fill board vacancies as and when they arise.
• Make recommendations to the board concerning the standing for reappointment of directors.
• Be seen to operate independently for the benefit of shareholders.
• for the nomination committee to have access to senior managers to gauge performance
• to have some idea of a successor in case the new CEO dies or leaves
• to monitor senior managers and cultivate possible successors over time
• for a search firm ('head-hunters') to be retained for this and other directorship identification • to think very carefully as to
whether the company wants a visionary at the helm or someone who can execute strategy effectively
• the NED chairman should meet independence criteria at the time of appointment.
The committee should make recommendations to the board:
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As regards plans for succession for both executive and NED's;
As regards the re-appointment of any NED at the conclusion of their specified term of office;
Concerning the re-election by shareholders of any director under the retirement by rotation provisions in the company's
articles of association;
Concerning any matters relating to the continuation in office of any director at any time; and
Concerning the appointment of any director to executive or other office other than to the positions of chairman and chief
executive, the recommendation for which would be considered at a meeting of the board.
Induction Program:
•
•
•
•
•
•
•
Contain selected written text, and presentations about the Company structure, subsidiaries, joint ventures
Gives understanding about markets, people, suppliers, auditors
Annual accounts, interim financials, KPI's, treasury policies
Provide them company's vision and mission and an idea about strategy
Outline of director's duties and responsibilities
Advice on share dealing and disclosure of sensitive information
Should not overload the director with excess information
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Objectives of Induction
•
•
•
•
•
•
•
To communicate vision and culture
To develop an understanding of the company, its business and the markets in which it operates
Get to know the people who work for the company
To develop an understanding of the company’s main relationships, for example with key suppliers or customers.
To communicate practical procedural duties
To reduce the time taken for an individual to become productive in their duties
To ensure retention of individual for future periods
Continuing Professional Development (CPD)
•
•
•
•
To run an effective board, companies need to provide resources for developing and refreshing the knowledge and skills of
their directors, including the NEDs
The chairman should address the development needs of the board as a whole with a view to enhancing its effectiveness as a
team.
The chairman should also lead in identifying the development needs of individual directions, with the company secretary
playing a key role in facilitating provision.
NEDs should be prepared to devote time to keeping their skills up to date.
Objectives of CPD
•
•
•
•
To ensure directors have sufficient skills and ability to be effective in their role
To communicate challenges and changes within the business environment effectively directors
To improve board effectiveness and, through this, corporate profitability
To support directors in their personal development
Board Balance:
The board should include a balance of executive and NED's (and in particular independent nonexecutive directors) such that no
individual or small group of individuals can dominate the board's decision taking.
1. The board should not be so large as to be unwieldy.
2. The board should be of sufficient size that the balance of skills and experience is appropriate for the requirements of the
business and that changes to the board's composition can be managed without undue disruption.
3. To ensure that power and information are not concentrated in one or two individuals, there should be a strong presence on the
board of both executive and non-executive directors.
4. No one other than the committee chairman and members is entitled to be present at a meeting of nomination, audit or
remuneration committee, but others may attend at the invitation of the committee.
a) The board should identify in the annual report each NED it considers to be independent.
b) The board should determine whether the director is independent in character and judgment and whether there are relationships
or circumstances which are likely to affect, or could appear to affect, the director's judgment.
c) The board should state its reasons if it determines that a director is independent notwithstanding the existence of relationships
or circumstances which may appear relevant to its determination, including if the director:
• has been an employee of the company or group within the last five years;
• has, or has had within the last three years, a material business relationship with the company either directly, or as a partner,
shareholder, director or senior employee of a body that has such a relationship with the company;
• has received or receives additional remuneration from the company apart from a director's fee, participates in the company's
share option or a performance-related pay scheme, or is a member of the company's pension scheme;
• has close family ties with any of the company's advisers, directors or senior employees;
• holds cross-directorships or has significant links with other directors through involvement in other companies or bodies;
• represents a significant shareholder;
• or has served on the board for more than nine years from the date of their first election.
d) Except for smaller companies, at least half the board, excluding the chairman, should comprise NED's determined by the board
to be independent. A smaller company should have at least two independent NED.
e) The board should appoint one of the independent NED to be the senior independent director. The senior independent director
should be available to shareholders if they have concerns which contact through the normal channels of chairman, chief executive
or finance director has failed to resolve or for which such contact is inappropriate.
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Retirement by rotation
•
•
At 1st AGM after appointment to Board, and at least every 3 years afterwards, by shareholders (note, for FTSE 350
companies, all directors are up for re-election every year).
If not annual re-election for all directors, sensible to “retire by rotation” and avoid potentially losing all the Board in one go.
Chairman and chief executive
There should be a clear division of responsibilities at the head of the company between the running of the board and the executive
responsibility for the running of the company's business. No one individual should have unfettered powers of decision.
1. The roles of chairman and chief executive should not be exercised by the same individual.
2. The division of responsibilities between the chairman and chief executive should be clearly established, set out in writing
and agreed by the board.
3. The chairman should (on appointment) meet the independence criteria set out below.
4. A chief executive should not go on to be chairman of the same company. If exceptionally a board decides that a chief
executive 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.
Role of Chairman
•
•
•
•
•
•
•
The chairman is responsible for leadership of the board, ensuring its effectiveness on all aspects of its role and setting its
agenda.
The chairman is also responsible for ensuring that the directors receive accurate, timely and clear information.
The chairman should ensure effective communication with shareholders.
The chairman should also facilitate the effective contribution of NED's in particular and ensure constructive relations between
executive and non-executive directors.
Chairman sets agenda of the Board Meeting and chair these meetings
The chairman should hold meetings with the NED's without the executives present.
Led by the senior independent director, the NED's should meet (without the chairman present) at least annually to appraise
the chairman's performance.
CEO's Responsibility:
1. Take responsibility for the performance of the company
2. Report to the Chairman and Board of Directors
3. Manage Financial and physical resources
4. Build and maintain effective team
5. Put adequate operational, financial, planning and risk management systems
6. Represent the company to major suppliers, customers, professional associations
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Chapter 3
Director’s Remuneration
REMUNERATION COMMITTEE:
The role of remuneration committee is to have an appropriate reward policy that attracts , retain an motivates directors to achieve
the long term interest of shareholder.
Objective of the committee:
•
•
•
•
The committee is, and is seen to be, independent with access to its own external advice or consultants.
It has a clear policy on remuneration that is well understood and has the support of shareholders.
Performance packages produced are aligned with long term shareholder interests and have challenging targets.
Reporting is clear, concise and gives the reader of the annual report a bird’s eye view of policy payments and the rationale
behind them.
Responsibilities of the remuneration committee:
The overall responsibilities of the remuneration committee are to:
• Determine and regularly review the framework , board policy and specific terms for remuneration and term and conditions of
employment of the chairman of the board and executive directors (including design of targets and any bonus scheme payments)
• Recommend and monitor the level and structure of the remuneration of senior managers.
• Establish pension provision policy for all board members.
• Set detail remuneration for all executive directors and the chairmen, including pension rights and any compensation payments.
• Ensure that executive directors and key managements are fairly rewarded for their individual contribution to the overall
performance of the company.
• Demonstrate to shareholders that the remuneration of the executive directors and key management is set by individual with no
personal interest in the outcome of the decision of the committee.
• Agree any compensation for loss of office of any executive director.
• Ensure that provision regarding disclosure of remuneration, including pension, as set out in the Directors Remuneration Report
Regulations 2002 and the code, are fulfilled.
Reward Package of Executives:
BASIC SALARY:
Companies set salary level according to:
• the job itself
• the skills individuals doing the job
• the individuals performance in the job
• the individuals overall contribution to company strategy
• Market rate for that type of job.
Performance related elements of remuneration:
Define as those elements of remuneration dependent on the achievement of some form of performance measurement criteria.
• Performance related element should form a significant part of the total remuneration package.
A short term bonus may be paid to directors at the end of accounting year .This could be based on any number of accounting
measures.
Shares / share options:
• It is long term incentive scheme, enabling to retain directors
• Director's make profit if share value increases (sharing the shareholders goal)
• This alignment in goals overcomes the agency problem
• Options can be phased, instead of given in one block, to increase time duration
Pension contribution:
•
•
In general, only basis salary should be pensionable.
The remuneration committee should consider the pension consequences and associated cost to the company of the basis salary
increase and any other change in pensionable remuneration, especially for directors close to retirement.
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Benefit in kind:
•
•
Benefit in kind (also referred to as perks) are various non-wage compensation s provided to directors and employees in addition
to their normal wages or salaries.
The remuneration committee should provide whatever other ancillary benefits would either be expected with the position of
executive directors or would increase their loyalty and motivation (examples of these would be a company car, health insurance
etc)
Non-executive directors remuneration:
To avoid the situation where the remuneration committee (consisting of NED,s) is solely responsible for determining the
remuneration of the NED,s the UK corporate Governance code(2010) state that the board and shareholder should determine the
NED,s remuneration within the limits set out I the company’s constitution.
Ned remuneration consists of a basis salary and non-executive directors may receive share rewards.
Equity based remuneration to non-executive directors should be fully vested on the grant date, but still subject to applicable holding
periods.
Performance measurement remuneration whilst advocated in executive remuneration packages is not generally supported for nonexecutive remuneration. Organization such as the ICGN advocate that performance based remuneration for non-executive directors
has significant potential to conflict with their primary role as an independent representatives of shareowners.
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Chapter 4
Relation with shareholder and Disclosure
Institutional investor:
Institutional investors manage fund invested by individuals.
In the UK there are four types of institutional investors:
• Pension fund
• Life insurance companies
• Unit trust
• Investment trusts.
Shareholder activism:
The activism can be in the form of:
• Making positive use of voting right
• Engagement and dialogue with the directors of investee companies
• Paying attention to board composition /governance of investee companies (evaluate of governance disclosure)
• Presenting resolutions for voting on at AGM (rarely used in UK)
• Requesting an EGM and presenting resolutions.
Institutional shareholder intervention:
Intervention by an institutional investor in a company whose stock it hold is considered to be a radical step. There are number of
condition under which it would be appropriate for institutional investor to intervene
• Strategy: this might be in term of product sold, markets serviced, expansion pursued or any other aspect of strategic positioning.
• Operational performance: this might be in term of divisions within the corporate structure that have persistently underperformed.
• Acquisition and disposal: this might be in term of executive decisions that have been inadequately challenged by NEDs.
• Remuneration policy: this might relate to the failure of the remuneration committee to curtail extreme or self-serving executive
rewards.
• Internal controls: might relate to failure in health and safety, quality control, budgetary control or IT projects.
• Succession planning: this might relate to a failure to adequately balance board composition or recommendation of replacement
executives without adequate consideration of the quality of candidates.
• Social responsibility: this might relate to a failure to a failure to adequately protect or respond to instances of environmental
contamination or other areas of public concern.
• Failure to comply with relevant codes: consistent and unexplained non-compliance in a principal based country will be
penalised by the market. In a rule based country it would have been penalised as a matter of law.
General meetings:
A general meeting of an organization is one which all shareholders or members are entitled to attend.
Annual General MEETING:
EXTRAORDINARY GENERAL
MEETING:
• Must be held once every calendar year. • No set timetables held on an “as
• Legally required.
required” basis.
• Separate resolutions for each issue.
• No legal obligation to have any.
• Not less than 21 day’s notice required.
• separate resolutions for each issue.
• First must be held no more than 18 • Not less than 14 days notice required.
months after date of incorporation, and • All shareholder must be notified to
thereafter no more than 15 months
attend.
between meetings.
• Agenda dictated by need for meeting.
• All shareholder must be notified and
entitled to attend.
• Annual accounts and appointment of
auditors (if applicable) approved at this
meeting.
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Proxy voting:
Proxy voting system is implemented to ensure that shareholder who is unable to attend general meetings where resolutions will be
proposed and voted on can still make their opinions heard.
Mandatory versus voluntary disclosure:
Mandatory: information which must be publicly disclosed to Voluntary: information which a company
comply with a set of laws or rules. Examples are as follows:
Statement of comprehensive income, statement of financial
position, statement of cash flow, statement of change in equity,
operating segment information, auditor’s report, corporate
governance disclosure such as remuneration report and some item
in director report,
may disclose should it choose to do so.
Examples are as follows:
• Risk information
• Operating review
• Social and environmental information
• Chief executive review
Mandatory Disclosures:
Annual report becomes the tool for “Mandatory disclosure”. The report includes:
•
•
•
•
•
•
Chairmen and CEO statement regarding company position:
This is voluntary in the sense that it is requirement of the code but obviously to not include this would be unimaginable.
Business review: this detail report is written in non-financial language in order to ensure information is accessible by a broad
range of users, not just sophisticated analysis and accountants.
The accounts: including the statement of comprehensive income, statement of financial position and cash flow plus notes and
compliance statements.
Governance :a section devoted to compliance with the codes including all provisions show above.
AOB(any other business): shareholder information including notification of AGM ,dividend history and shareholder taxation
position.
Stock exchange listing rules: are also a source of regulation over disclosure.
Advantages of voluntary disclosures:
•
•
•
•
•
Strong disclosure regime can help to attract capital and maintain confidence in the company.
May be made to promote the company in the positive light, and act as a marketing tool.
Help improve public understanding of the structure, activities, corporate policies and performance.
Shareholder and potential investors require access to regular, reliable, comparable information for decision making.
Weak disclosures and non transparent practices contribute to unethical behavior and loss of market integrity.
Expansion of disclosures beyond the annual report:
Since disclosures refer to the whole array of different forms of information produce by the company it also includes:
• Press release
• Management forecast
• Analyst’s presentation
• Information on the corporation website such as stand –alone social and environment reporting.
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Chapter 5
Corporate Governance Approaches
Rule based approach: instils the codes into law with appropriate penalties for transgression.
Principal based approach: require the company to adhere to the spirit rather than the letter of the code. The company must
either comply with the codes or explain why it has not through report to the appropriate body and its shareholder.
Characteristics of the rules based approach
•
•
•
•
•
•
•
•
•
prescribed set of cg requirements
quick way of ensuring compliance
adopts a checklist approach
clear distinction between compliance and non-compliance
easy to see that entity is complying
reduction of flexibility on the part of management and auditors
difficult to set rules to cover all situations
possible to misinterpret rules
same rules apply to all, whatever their size
Characteristics of the principles based approach
•
•
•
•
•
•
•
•
activities of entities must address major principles set out in codes of best practice
not simply a box ticketing exercise
more difficult to avoid than a rules based approach
easy to see that entity is complying
directors required to work in the entity’s best interests
more flexible, and therefore better able to deal with “new” situations
easier justification for apparent breach of principles
but principles may be interpreted differently
Arguments in favour of a rule based approach (and against a principles based approach)
Organisation’s perspective:
•
Clarity in term of what the company must do- the rules are legal requirement, clarity should exist and hence no interpretation
is required.
• standardisation for all companies- there is no choice as to complying or explaining and this creates a standardised and possibly
fairer approach for all businesses.
• Binding requirements-the criminal nature make it very clear that the rules must be explained.
Wider stakeholder perspective:
• Standardisation across all companies- a level playing field is created.
• Sanction-the sanction is criminal and therefore a greater dete0rrent to transgression.
• Greater confidence in regulatory compliance.
Arguments against a rule base approach (and in favour of principles based approach:
Organization perspective:
• Exploitation of loopholes- the exacting nature of law lends itself to seeking of loopholes.
• Underlying belief- the belief is that you must only play by the rules set there is no suggestion that you should want to play the
rules (i.e. no buy-in is required).
• Flexibility is lost- there is no choice in compliance to reflect the nature of the organization, its size or stage of development.
• Checklist approach-this can arise as companies seek to comply with all aspects of rule and start "box ticking".
Wider stakeholder perspective:
• Regulations over load - the volume of rules and amount of legislation may give rise to increasing cost for business and for
regulators.
• Legal cost- to enact new legislations to close loopholes.
• Limits- there is no room to improve, or to go beyond the minimal level set.
• "Box ticking" rather than compliance - this does not lead to well governed organization.
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Sarbanes Oxley( SOX)
•
•
•
•
In 2002, following a number of corporate governance scandals such as Enron and WorldCom, though new corporate governance
regulations were introduced in the US by SOX.
SOX is extremely detailed and carries the full force of law.
SOX includes requirements for securities and exchange commission (SEC) to issue certain rules on corporate governance.
It is relevant to US companies, directors of subsidiaries of US- listed business and auditor who are working on US-listed
businesses.
KEY POINTS OF SOX:
Auditor independence: Auditor are restricted in the additional services they can provide to an audit client.
Audit partner: Senior partner must be change every five years.
Restrictions on dealing: Directors prohibited from dealing in shares at "sensitive times".
Increased financial disclosures: Financial reports to detail off balance sheet financing.
Accuracy of financial statements: Must be vouched for by CEO and CFO. Where financial statements have to be restated
following material not-compliance, CEO and CFO must repay any bonuses received in the previous twelve months
Internal control export: Annual report must include statements concerning the inter control system in the company.
Audit committee: Company must have an audit committee- will be disallowed from trading if it does not have one.
Key effects of SOX:
•
•
•
•
•
•
Personal liability of directors for mismanagement and criminal punishment.
Improve communication of material issues to shareholders.
Improve investor and public confidence in corporate US.
Improve inter controls and external audit of companies.
Greater arm's length relationship between companies and auditor firms.
Improve governance through audit committee.
Negative Reaction to SOX:
•
•
•
•
•
•
Doubling of audit fee cost to organizations
Onerous documentation and internal control cost.
Reduce flexibility and responsiveness of companies.
Reduce risk taking and competitiveness of organization.
Limited impact on the ability to stop corporate abuse.
Legislation defines a legal minimum standard and little more.
Content of the OECD principles:
•
•
•
•
•
The rights of shareholder and key ownership functions.
The equitable treatment of shareholders.
The role of shareholders in corporate governance.
Disclosure and transparency.
The responsibilities of the board.
International corporate governance Network (ICGN):
Content of the ICGN principles:
•
•
•
•
•
•
•
•
Corporate objective - shareholder return.
Disclosure and transparency.
audit
Shareholders' ownership, responsibilities, voting right and remedies.
corporate boards
corporate remuneration policies
Corporate citizenship, stakeholder relations and the ethical conduct of business.
corporate governance implementation.
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Chapter 6
Corporate social responsibility and corporate governance:
A corporation:
•
•
•
Is an artificial person in law. It has the same right and responsibilities as human beings.
Is notionally owned by the shareholders but exist independently of them. The shareholder has a right to vote and be paid a
dividend but the company owns it assets.
Managers have a fiduciary right to protect shareholder investment.
Milton Friedman: argued that, in relation to this definition, a corporation has no responsibility outside of making profit for
shareholders:
• Only human beings have moral responsibility for their actions.
• It is the managers’ duty to act solely in the best interest of the shareholder: this is point of law. Any other action is
shareholder betrayal.
• Social issues are the province of the state and not corporations.
The nature of CSR:
Carroll devised a four part model of CSR: 1) economic responsibility, 2) legal responsibility, 3) ethical responsibility and (4)
philanthropic responsibility.
‘CSR encompasses the economical, legal, ethical and philanthropic expectation placed on organizations by
society at a given point in time.’
Economic responsibility:
•
•
•
Shareholder demand a reasonable return
Employees want a reasonable and fairly paid job
Customers demand quality at affair price.
Legal responsibility:
•
•
The law is a base line for operating within society.
It is an accepted rule book for company operations.
Ethical responsibility:
•
•
•
This relates to doing what is right, just and fair.
Actions taken in this areas provide a reaffirmation of social legitimacy.
This is naturally beyond a previous levels.
Philanthropic responsibility:
•
•
•
Relates to discretionary behavior to improve the lives of others.
Charitable donations and recreational facilities.
Sponsoring the art and sport events.
Developing a CSR strategy:
IDENTIFY
STAKEHOLDERS
DECIDE UPON RESPONSE TO
SOCIAL PRESSURE
CLASSIFY
STAKEHOLDERS
ESTABLISH STAKEHOLDER
CLAIMS
ASSESS IMPORTANCE OF
STAKEHOLSERS (MENDLOW)
Stakeholder claims: these are the demands that the stakeholder makes of an organization. They essentially ‘want something’
from organization.
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Classifications of stakeholder:
Internal and external stakeholders:
Internal: includes employees and managements, and possibly trade unions.
External: include customer, competitor and suppliers.
Narrow and Wide Stakeholders:
Narrow: those most affected and dependent on corporation output, shareholders and employees, management, customer, supplier.
Wide: those are less dependent on company output such as government, wider community and non-dependent customers.
Primary and secondary stakeholders:
Primary: those have a direct effect on the organization and without whom it would be difficult to operate, government,
shareholder and customer.
Secondary: those that have limited direct influence on the organization and without whom company would survive, the
community and management.
Active and Passive Stakeholders:
ACTIVE: Those that wish to participate of course include managements and employees, but may also include regulators
environmental pressure groups and supplier.
Passive: those that do not wish to participate may include shareholder, local communities, government and customers.
Voluntary and involuntary stakeholders:
Voluntary: those that choose to be involve in organizational decision making such as managements, employees, environmental
groups and active shareholders.
Involuntary stakeholders: those stakeholder that do not choose to be involve in organization decisions, but become involved for a
variety of reasons. This could include regulators, key customers, suppliers, government, natural environment and local
communities.
Legitimate and illegitimate stakeholder:
Legitimate: those with an active economic relationship with an organization, such as customers and suppliers.
Illegitimate: those without such a link, such as terrorists, where there is no case for taking their views into account when making
decisions.
Stakeholder mapping: The Mendelow model
INTEREST
P
Low
High
O
Low
Minimal effort
Keep informed
W
E
High
Keep satisfied
Key players
R
Power: relate to the amount of influence (or power) that the stakeholder group can have over the organization. However, the fact
that a group have a power does not necessarily means that their power will be used.
The level of interest indicate that weather the stakeholder is actively interested in the performance of the organization. The amount
of influence the group has depend on the level of power.
Low interest – Low power:
These stakeholder typically include small shareholders and general public. They have low interest in the organization primarily
due to lack of power to change strategy.
High interest- low power:
These stakeholder would like to effect the strategy of the organization but do not have the power to do this. Stakeholder include
staff, customers and suppliers, particularly where the organization provides a significant percentage of sale and purchases for
those organizations. Environmental pressure groups would also be placed in this category as they will seek to influence company
strategy. Normally by attempting to persuade high power group to take action.
Low interest- high pressure:
These stakeholders normally have low interest in the organization, but do have the ability to effect the strategy should they choose
to do so. Stakeholders in this group includes the national government and in some situations institutional shareholders. The latter
may well be happy to let the organization operate as it wants to, but will exercise their if they see their stake being threatened.
High interest- high power:
These stakeholders have high interest and have the ability to effect strategy. Stakeholder include directors, major shareholder and
trade union.
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Organizational motivation regarding stakeholder:
The instrumental view of stakeholders:
• This relates to motivation stemming from the possible impacts of stakeholder action on the objective of the organization.
• The organization reacts to shareholder input because it believes that not to do so would have an impact on its primary
objectives (which may be profit, but could be other objectives for organizations such as charities).
• Such a view od stakeholder is therefore devoid of any moral obligation.
The Normative view of stakeholder:
• This relates to motivation stemming from a moral consciousness that accept a moral duty toward others in order to
sustain social cohesion(the good of society)
• Such an altruistic viewpoint appreciates the need to act in a general sense of what is right rather than in a narrow
interpretation of what is right for the company to achieve its profit targets.
Corporate Citizenship:
The aspects about corporate citizenship is that it goes beyond compliance, obligations and that which is required by law.
It is the conferral of right on stakeholders and the acceptance by the company of its responsibilities. The company therefore
embraces responsibility for its actions and encourage a positive impact on the stakeholder with whom it interfaces. This is
achieved via its activities for example by its interaction with the environment, customer etc
It linked to the concept of corporate accountability.
• Corporate accountability refers to whether the organization is in some way answerable for the consequences for it
actions beyond its relationship with shareholder
The demand for corporation to be more accountable and step up to their new role as a valid member of society comes from two
main sources: government failure and corporate power.
Shareholder ownership, property and responsibilities:
It is worth considering the nature of shareholder ownership in order to determine the extent to which this responsibility exist.
Ownership and property generally have three elements:
•
Owner has the right to use the property as he wishes. If it is food he can eat it, if it is land he can build on it.
• Owner has the right to regulate anyone else’s use of property. if it is food he can share it with or not, if it is land he decided
who crosses the boundary.
• Owner has the right to transfer rights of property on whatever term he wishes. He can sell the food or the land.
A generally agreed fourth point is:
• Owner is responsible for making sure that his use of property does not damage others. If property is a dog then owner must
make sure it does not bite others.
Distinguish between CSR strategy and strategic CSR
To have a strategy for CSR is to have a set of policies which guide and underpin CSR activities.
This means that some causes or areas of activity are favoured over others, in line with the strategy adopted. So, for example, a
company might have a policy to invest in some communities or charitable causes and not others.
The policy or strategy may be agreed based on a number of issues: perhaps the preferences of the employees, the preferences of
senior people in a business, or the preferred outcomes may be chosen based on strategic concerns.
When CSR is undertaken to maximise its effects on the long-term economic benefit of the business, it can be described as
strategic CSR. When CSR activities are strategic, they generally support the main business areas of the business. So a financial
company such as a bank might favour financial education causes whilst a medical supplies company might prefer medical or
nursing research causes or overseas medical efforts. It would be seen as strategically wasteful to use CSR to support activities
which are not aligned to the core activities. An assumption underpinning strategic CSR is that all assets in a company belong to
the shareholders and so all activities, including CSR, should be configured in such a way as to support shareholder value.
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Chapter 7
Ethical Theories
Absolutism / Dogmatic approach
Relativism / Pragmatic approach
• Unchanging and immutable set of moral rights or percepts.
• Wide variety of ethical beliefs and practices.
• Hold true in all situation
• What is ‘correct’ in any given situation will
depend on the conditions at the time.
• Common to all societies.
Dogmatic versus pragmatic approach:
• Dogmatic: approach takes the view that there is one truth and this truth is to be impose in all situations.
- The word is taken from Greek dogma- or given truth.
- The view point corresponds to absolutism.
• Pragmatic: approach attempts to find the best route through a specific moral situation without reference to any absolutist.
-
The approach is similar to relativism in attempting to find a solution based on the given belief system of the
individuals involved.
Kohlberg’s cognitive moral development (CMD) theory:
Kohlberg developed a cognitive moral development (CMD) theory to explain the reasoning process behind moral judgments.
This theory is viewing ethical decision from an individual’s perspective.
Level
1: Pre Conventional
2: Conventional
Explanation
Individual shoe concern for self-interest and
external rewards and punishment.
Individual does what is expected of them by
others.
3: Post Conventional Individual develops more autonomous decision
making based on principles of right and justice.
•
•
•
•
Stage
1.1: Obedience, Reward / Punishment
1.2: Self-Interest
2.1: Interpersonal Accord and Conformity
2.2: Maintaining Social Order
3.1: Social Contract
3.2: Universal Ethical Principles
The three main levels are shown above. Each level is subdivided into two stages- giving six stages in total.
Individuals tend to move from level 1 to level 3 as they get older.
Movement is decided by how a decision is made, not what the decision is about.
Research indicates that most people, including business managers, tend to reason on level 2.
Gray, Owen & Adams’s Seven positions on social responsibility:
Pristine capitalist:
•
•
•
Underpinning value is shareholder wealth maximization.
Anything that reduces shareholder wealth (such as acting in a socially responsible way) is theft from shareholders.
Agent (directors) that take action that may reduce the value of the return to shareholders, are acting without mandate and
destroying value for shareholders.
Expedients:
•
•
•
Recognize social responsibility expenditure may be necessary to strategically position an organization so as to maximize
profits.
This is back to the concept of ‘enlightened self-interest’(discussed in chapter 7)
A company might an environmental policy or give money to charity if it believes that by so doing, it will create a favourable
image that will help in its overall strategic positioning.
Proponent of social responsibility:
• Business enjoys a license to operate granted by society so long as to the business acts in an appropriate way.
•
•
•
The licence is granted by the society as long as the business act in such a way as to be deserving of that licence.
Business need to be aware of the norms (including ethical norms) in society so that they can continually adapt to them.
if an organization act in a way that society find unacceptable, the licence to operate can be withdrawn by the society, so was
the case with Arthur Anderson following the Enron Scandal
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Social ecologist:
•
•
Recognize that a business has a social and environmental footprint and therefore bear responsibility for minimizing that
footprint.
An organization might adopt socially and/or environmentally responsible policies not because it has to in order to be aligned
with the norms of society (as the social contractarians would say) but it feels it has a responsibility to do so.
Socialist:
•
•
•
Actions of business are those of the capitalist class oppressing other classes of people.
Business should be conducted so as to redress imbalances in society.
Providing benefits to stakeholders well beyond the owners of capital.
Radical feminist:
•
•
•
Society and business should be based on feminine characteristics such as equity, dialogue, compassion and fairness.
Argue that society and business are based on values that are usually considered masculine in nature such as aggression,
power, assertiveness and competitiveness.
Representing a major challenge to the way business is done all over the world and hence would require a complete change in
business and social culture.
Deep ecologist (deep green):
•
•
•
Human have no more intrinsic right to exist than any other species.
They argue that just because humans are able to control and subjugate social and environmental system does not mean that
they should.
A full recognition of each stakeholder’ claim would not allow business to continue as it currently does.
Approaches to Ethics
Deontological approach:
• This is a non-consequential theory.
•
•
The motivation or principle is important.
An action can only be deemed right or wrong when the morals for taking that action are known.
There are three maxims, or tests, for any action: An action is morally right if it satisfies all three.
▪ Consistency: Act only according to that maxim by which you can, at the same time, desire that it should become a
universal law.
The action can only be right it everyone can follow the same underlying principle.
▪
Human dignity: Act so that you treat humanity, whether in your own person or in that of another, always as an end
and never as a means only.
▪
Universality: Act only so that through it maxims could regard itself at the same time as universally lawgiving.
-
Would an action be viewed by others as moral or suitable?
Teleological approach:
• This is a consequential theory.
•
•
Weather a decision is right or wrong depends on the consequences or outcome of the action.
As long as the outcome is right, then the action itself is irrelevant.
There are two perspectives from which the outcome can be viewed:
•
Egoism:
-
•
Sometimes thought of as the view ‘what is best for me?’. An action is morally right if decision maker freely decides
in order to pursue either short term desires or long-term interests.
The egoist will also do what appears to be ‘right’ in the society because it makes them feel better.
Egoism does not always work because action on all members of society cannot be determined.
Utilitarianism:
-
Sometimes taught as the idea of ‘what is best for the greater number?’ An action is morally right if it results in the
greater amount of good for greatest number of people affected by that action.
It applies to the society as a whole and not the individual. It is highly subjective.
It is valuable in business decisions because it introduces the concept of ‘utility’– or the economic value of actions.
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Chapter 8
Ethical decision making
Ethical Education
•
•
Ethical decisions models are used in ethics education to provide a framework for ethical decision making.
The main reference in this section is to the International Accounting Education Standards Board (IAESB) where a frame
work for ethical decision making is developed (known as the Ethics Education Framework (EEF)) and then applied using two
models in the study guide.
International Accounting standard board ethics framework
1. Ethics
knowledge
2. Ethical
sensitivity
3. Ethical
judgment
4. Ethical
behavior
Stage
Explanation
1
Ethical knowledge
Education focuses on communicating fundamental ethical knowledge about professional values,
ethics and attitude. The aim is to develop ethical intelligence by obtaining knowledge of different
ethical concepts and theories relating to the accountant’s work. The stage explains the fundamental
theories and principles of ethics. Having obtained knowledge of these theories, the accountant will
understand the ethical framework within which they operate.
2
Ethical Sensitivity
3
Ethical judgment
4
Ethical behavior
This stage applies the basis ethical principles from stage 1 to the actual work of the accountant in the
functional areas being worked on, e.g. auditing, taxation, consultancy, etc. The main aim of this
stage is to ensure that accountants can recognize ethical threats
The stage is developed by providing case studies and other learning aids to show how and where
ethical threats can arise. In other words the accountant is sensitized to ethical issues, i.e. the areas
where ethical threats appear can be identified.
This stage teaches the accountants how to integrate and apply the ethical knowledge and sensitivity
from stages 1 and 2 to form reasoned and hopefully well-informed decisions.
The stage therefore aims at assisting accountants in seceding ethical priorities and being able to
apply a well-founded process for making ethical decisions. It is taught by applying ethical decisions
making models to ethical dilemmas, showing how ethical judgment is being applied.
This stage is primarily concerned with explaining how an accountant should act ethically in all
situations (i.e. not just the work place but other situations where the profession of accountancy must
be uphold).
The stage therefore explain that ethical behavior is more than believing in ethical principles it also
involves acting on those principles. In term of life long education, the accountant must therefore
continue to be aware ethical theory, ethical threats and continually seek to judge actions in the light
of expected ethical behavior. Teaching is primarily through case studies.
American accounting system (AAA) model:
The seven questions in the model are:
1. What are the facts of the case?
2. What are the ethical issues in the case?
3. What are the norms, principles and values related to the case?
4. What are the alternative courses of action?
5. What is the best course of action that is consistent with the norms, principles and values identified in step3?
6. What are the consequences of each possible course of action?
7. What is the decision?
Tucker’s 5 question model:
•
•
•
•
•
Profitable?
Legal?
Fair?
Right?
Sustainable or environmentally sound?
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Ethical behavior:
ETHICAL BEHAVIOUR
Context related
Reward
Authority
Bureaucracy
Work roles
Norms/culture
National Context
ISSUE-RELATED
FACTORS
Moral intensity
Moral framing
factors
Accountants are expected to behave ethically. However, that behavior also depends on:
• The nature of the ethical issue- issue-related factors, and
• The context in which the issue takes place-context-related factors.
Issue-related factors:
•
•
How important the decision to the decision maker.
The higher the intensity, the more likely it is that decision maker will make an ethical rather than an unethical decision.
Moral intensity / moral stance:
The factors effecting moral intensity are shown below:
Concentration of effect
Weather effects of actions are
concentrated on a few people or effect
many people a little.
E.g. concentration on few increases
intensity.
Proximity
The nearness the decision
maker feels to the people
affected by the decision.
E.g. being ‘nearer’ increase
intensity.
Temporal Immediacy
How soon the consequences of
any effect are likely to occur.
E.g. long time delay lowers
intensity.
Moral Framing
This refers to language in which moral issues are discussed in the workplace- a problem or dilemma can be made to appear in
offensive if described (or ‘framed’) in a certain way.
This may lead to people in different organizations perceiving the moral intensity differently.
• Where morals are discussed openly then decision making is likely to be more ethical.
• Use of moral words (e.g. integrity, honesty. Lying and stealing) will normally provide a framework where decision making is
ethical.
• However, many business use ‘moral muteness’ which means that morals are rarely discussed so ethical decision making may
suffer.
Context related factors:
These issues related to how a particular issue would be viewed within a certain context.
For example:
• If certain behaviours are seen t be rewarded, encouraged, or demanded by superiors despite being ethically dubious, decision
making may be affected.
• If everyone in the workplace done something in a certain way, an individual is more likely to conform: this can result in both
higher and lower standard of ethical behavior.
Key contextual factors are:
•
•
•
•
•
•
System of reward
Authority
Bureaucracy
Work roles
Organization group norms and culture
National and cultural context
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CHAPTER 9
Professional and Corporate Ethics
➢
Profession: a body of theory and knowledge which is used to support the public interest.
➢ Professionalism: taking action to support the public interest.
➢ Public interest:
•
•
➢
The distinguishing mark of a profession is the acceptance of a responsibility to the public.
The accountancy profession’s includes:
▪ Client
▪ Credit providers
▪ Governments
What is the public interest?
The public interest can be define as that which support the good of society as a whole (as opposed to what serves the interest of
individual member of society or specific sectional interest groups).
There is much debate over a definition of the term ‘public interest’. However, the public interest is normally seen to refer to the
‘common well- being’ or ‘general welfare’.
An action is usually thought to be in the public interest where it benefits the society in some way. It is unclear though how many
members of society must benefit before the action can be declared to be in the public interest. Some people would argue an action
has to benefit every single member of society in order to be truly in the public interest. At the other extreme, any action can be in
the public interest as long as it benefits some of the population and harm none.
There is a potential clash between the public interest and the interest of the society as a whole. in other words, what is good for
society may not necessarily be good for individuals, and vise versa
ACCA Codes of Ethics / Fundamental Principles:
FUNDAMENTAL ETHICAL PRINCIPLES
Integrity
Objectivity
Members should
be honest and
straight forward
and honest in all
professional and
business dealings.
Members do not
allow bias or
conflict of interest
in business
judgements.
Competence
Confidentiality
Duty to maintain
professional
knowledge and
skill at
appropriate level.
Information on
client not disclose
without
appropriate
specific authority.
Professional
Behaviour
Members must comply
with relevant laws and
avoid actions
discrediting the
profession.
Test your under standing
Explain why each of the following actions appears to be in conflict with the fundamental ethical
principles
1.
2.
3.
4.
5.
An advertisement for firm of accountant states that their audits services are cheaper and more comprehensive than a rival
firm.
An accountant prepares a set of accounts prior to under taking the audit of those accounts.
A director discusses an impending share issue with colleagues at a golf club dinner.
The finance director attempts to complete the company’s taxation computation following the acquisition of some foreign
subsidiaries.
A financial accountant confirms that a report on his company is correct, even the report omits to mention some important
liabilities.
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Corporate code of ethics:
Corporate ethics relates to the application of ethical values to business behavior.
•
•
•
•
It encompasses many areas ranging from board strategies to how companies negotiate with their suppliers
It goes beyond legal requirements and is to some extent therefore discretionary.
Many companies provide details of their ethical approach in a corporate, social responsibility (CSR) report
Key areas included in a code of corporate ethics.
Benefits of code
Draw backs of codes
•
•
•
•
Provide framework for conflict of interest.
Provide guidelines for similar ethical disputes
and methods of resolution.
Provides the ‘boundaries’ across which is
ethically incorrect to pass.
•
•
Is a code only- therefore may not fit the precise ethical issues.
As a code, then it can be incorporated in different ways-two
different conflicting actions may appears to be ethically correct to
two different people.
May be no clear or even ineffective punishment for breaching the
code.
Contents of a professional codes of ethics:
Introduction: Provide the background to the code, stating who it affects, how code is enforced and outlines disciplinary
proceedings.
Fundamental principles: The principles that must be followed by all members/student of the institute. The principles may
be stated in the summary format.
Conceptual framework: Explains how the principles are actually applied, recognizing that principles cannot coverall
situations and so the ‘spirit ‘of the principles must be complied with.
Detailed application: Examples of hoe the principles are applied in the specific situation.
Conflict of interest / Threats on Independance:
The potential threats which may lead to conflict of interest and lack of independence were discussed in details in audit and
compliance chapter.
These are:
•
Self-interest threat- financial or other interests causing auditors to be reluctant to take actions that would be adverse to the
interests of the audit firm or any individual in a position to influence the conduct or outcome of the audit.
•
Self-review threat- where the results of a non-audit services provided by anyone in the firm are reflected in the amounts
included or disclosed in the financial statements
•
Advocacy threat- where the audit firm undertakes work that involves acting as an advocate for an audit client and
supporting a position taken by management in an adversarial context ie having to adopt a position closely aligned to that
of management.
•
Familiarity threat- where the auditors are predisposed to accept or are insufficiently questioning of the client’s point of
view
•
Intimidation threat- where the auditor’s conduct is influenced by fear or pressure by any party
Conceptual framework and safeguards:
A conceptual framework can be explained as follows:
• It provides an initial set of assumptions values and definitions which are agreed upon and shares by all those subject to
the framework.
• It is stated in relatively general terms so it is easy to understand and communicate.
• It recognizes that ethical issues may have no ‘correct’ answers and therefore provides the generalized and principles to
apply to any situation.
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Ethical conflict resolution:
Ethical conflicts can be resolved as follows:
1. Gather all relevant facts.
2. Establish ethical issues involved.
3. Refer to relevant fundamental principles.
4. Follow established internal procedures.
5. Investigate alternative course of action.
6. Consult with appropriate person with in the firm.
7. Obtain advice from professional institute.
8. If the matter is still unresolved, consider withdrawing from the engagement team/assignment/role.
Corruption and bribery:
What is corruption?
Corruption is bribery and any other behaviour in relation to persons entrusted with responsibilities in the public or private sector
which violates their duties and is aimed at obtaining undue advantage of any king for themselves or for others.
The main forms of corruption are bribery, embezzlement, fraud and extortion. Examples include but are not limited to
• Bribery, including excessive ‘hospitality’
• Facilitation payment
• Buying votes
• Lllicit payments to political parties
• Misappropriation of public funds
Why corruption is wrong- the ethical arguments
Corruption is inherently wrong:
• It is a misuse of power and position and has a disproportionate impact on the poor and disadvantaged.
• It undermine the integrity of all involved and damage he fabric of the organization to which they belong.
Why corruption is wrong- the business arguments
There are many reasons why it is in any company’s business interest to ensure that it does not engage in corrupt practices:
Legal risk:
Regardless of what form a corrupt transaction may take, there are obvious legal risks involved.
Not only are the most forms of corruption is illegal where it occurs, but also it is increasingly becoming illegal in a company’s
home country to engage in corrupt practices in another country.
Reputation risks:
Based on the experience of recent years, companies whose policies and practices fail to meet high ethical standards, or take a
relaxed attitude to compliance with laws, are exposed to serious reputational risk. The argument that although what they may have
done may have been against the law or international standards, it was simply the way business was done in a particular country is
not an acceptable excuse. Nor is it good enough to claim that others companies and competitors have engaged in similar practices.
Financial costs:
There is now clear evidence that in many countries corruption adds upwards 10 percent to the cost of doing business and that
corruption adds as much as 25 per cent to the cost of public procurement this undermines business performance and diverts public
resources from legitimate sustainable development.
Pressure to repeat offend:
There is growing evidence that a company is less likely to be under pressure to pay bribes if it has not done so in the past. Once a
bribe is paid, repeat demand is possible and the amount demand is likely to rise. Zero tolerance is the only practical solution.
Blackmail:
By engaging in corrupt practices, company managers expose themselves to blackmail. Consequently the security of staff, plant
and other asset are put at risk.
Impact on staff:
If a company engages in or tolerance corrupt practice, it will soon be widely known, both internally and externally. Unethical
behavior erodes staff loyalty to the company and it can be difficult for staff to see why high standards should be applied within a
company when it does not apply in the company’s external relations. Internal trust and confidence the eroded
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Impact on development:
It is now clear that corruption has played a major part in undermining the world social, economic and environmental development.
Resources have been diverted to improper use and the quality of services and materials used for development seriously
compromised.
Anti-Bribery and Corruption (AB &C) procedures:
The UK act sets out six principles to help a business decide if they need to introduce changes.
1.
Proportionality: Any action a business takes to introduce procedures only needs to be in proportion to the risk your
business faces.
2.
Top-level commitment: If you are running a business, the ministry of justice (MOT) advises, you will want to
show you have been active in ensuring your staff and key people you do business with understand you do not tolerate bribery.
3.
Risk assessment: this shows you have considered the possible risk you face as a company, especially if you are
entering into new business arrangements.
Communication: communicating your policies and procedures to staff and others who will perform services for you.
5. Due diligence: knowing who you are dealing with can help protect business- so it’s advised that you do a few checks
4.
and ask a few questions before engaging others to represent you in the business.
6.
Monitoring and review: you may want to keep an eye on anti-bribery steps you take so that they keep pace with
any change in the risks your business faces.
Barriers to implementing AB & C policies:
•
Competitive Advantage:
The most obvious is the belief that new policies are a tedious and unnecessary chore, together with the fear that unscrupulous
competitors will break any rule to win.
•
Managerial apathy:
Chief executive and finance directors may argue that they deal with risk every day and do not need new system to spot
bribery and corruption.
•
Off-the-shelf solutions:
Many firms implement policy and off-the-shelf procedures before (or in place of) assessing their own unique circumstances.
For example, some companies operating in France have set up whistleblowing hotlines without realizing that French law
make them potentially illegal.
•
Corporate structures:
Decentralized organizations may have more complex business issues to address, as do firms with far flung offices.
For example, many forms with distant operations tend to focus on the needs of the center, rather than the local operations,
making it more difficult to ensure that your sales team in, say, china, is following policy. A silo mentality can also get in the
way because people tend to compartmentalize risk- financial, operational etc- rather than considering cross-cutting dangers.
•
Shadow hierarchies:
The real dynamic of internal control are sometimes different from what appears on an organizational chart. Individual
employees can wield power well beyond their formal spheres of responsibility. Shadow power network not only facilitate
bribery, they may have arisen in order to conceal it.
•
Excessive pressure to hit targets:
Internal controls become marginalized in a culture of immediate results.
•
Culture of secrecy:
Excessive sensitivity about disclosures can prevent one part of a business from learning about incidents that have occurred
elsewhere. Secrecy always works to the advantage of the corrupt employee or associated party.
•
Heterogeneous cultures:
Problem can occur where any staff do not share the values of the organization. Such situations can arise from mergers and
acquisitions, supervision of overseas offices.
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Chapter 10
Social and Environmental Issues
Economic Activity
•
•
•
economic activity is only capable of being sustained where the impact on society and the environment can also be sustained
the social footprint looks at sustainability in terms of three aspects of capital – social capital (social network and mutually
held knowledge), human capital (individual skills and knowledge) and constructed capital (physical infrastructure), and
entities need to ensure that their economic activities are sustainable in all three areas
the environmental footprint is the aspect of ensuring that an entity’s use of scarce resource is replenished That is, we should
leave more natural resource to the next generation than we ourselves inherited from the previous generation
Sustainability
•
•
•
sustainability can be measured objectively or subjectively
the objective approach measures sustainability in terms of actual resource used compared with the amount of resource
available
subjective approach accepts the inability to measure resource and concentrates instead on the intentions of the entity in their
attempts to achieve sustainability goals
Environmental Footprint
•
•
environmental footprint – the effect on the environment of today’s society and how it will affect the next generations
as an example, consider the sealing of food packages The traditional way of sealing these food containers has been to use glue
to stick the see–through cover to the basic container A UK entity has recently designed and patented a method of sealing
which uses radio–waves to effect that seal
o the overall effect of this is multiple!
o
it uses less glue and therefore fewer whales need to be killed (from which the glue is made)
o
it is more efficient in terms of fewer broken food packages, so less wastage and therefore fewer animals killed because of
less wastage
o
the entire package is now bio–degradable whereas previously it wasn’t
o
the equipment necessary for radio–wave sealing can be bought and used in all the separate food packaging entities, so
there is no increase in the use of fuel to transport the food to the supermarkets
Social footprint
•
•
•
•
social footprint looks at the use of capital in terms of social, human and constructed capital
social – involves the use of services provided centrally ( health, education, hospitals, pensions etc ) If these services are not
maintained ( if money raised by central Government is not sufficient to maintain the services ) then tax rates will need to
increase
human – involves the requirement that people should be able to continue working effectively This in turn involves the entity
taking steps to help these people look after their personal health, and improve their knowledge and skills
constructed – involves maintaining the physical structures ( roads, buildings etc ) that society has built
Environmental Accounting System
•
•
•
•
relates to the need to establish and maintain systems for assessing the impact of the entity on the environment
Eco–Management and Audit Scheme ( EMAS ) and ISO 14000 were both developed in the 1990s, and both relate to
the establishment and maintenance of environmental accounting systems
whereas the ISO focuses on internal systems, EMAS focuses on the standard of good reporting and auditing
many entities refer to their compliance within their csr report
EMAS
o
is a voluntary initiative designed to improve entities’ environmental performance
o
aim is to recognise and reward those entities which consistently go beyond compliance with minimum standards in
their efforts to improve their environmental performance
o
requires entities to produce regular reports about their environmental performance
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o
to become a member of the EMAS participators, entities must adopt an Eco–Management System ( EMS ) which
meets the requirements of ISO 14001
o
participating entities must show that they understand and can implement all relevant legislation
o
the entities must recognise and meet the information needs of the shareholders
o
participators are required to improve their environmental performance over time
o
employees of the entities must be involved at all levels
ISO 14000
o
is a series of standards dealing with environmental management together with a supporting audit programme
o
it designs the specifications for an EMS, gives guidance for its use and establishes the standard against which it can
be audited
o
to be registered as ISO 14000 compliant an entity must
-- implement, maintain and improve an EMS
-- assure itself of its own conformance with its own stated environmental policy
-- demonstrate conformance
-- ensure compliance with environmental laws and regulations
-- have its EMS externally certified
•
an entity should identify elements of its operations which have an impact on the environment
•
produce plans for its improvement and a management system to monitor the improvements
Advantages of compliance
•
•
•
•
compliance with either standard will reduce the cost of waste disposal
there will be savings in terms of consumption of energy
improved corporate image
the entity will have a framework to work to in trying to improve its environmental performance
Social auditing
•
•
•
process by which an entity can assess and demonstrate its social, economic and environmental benefits
it also measures the extent to which an entity achieves its objectives as set out in its mission statement
in addition, it establishes the process for environmental auditing
Environmental auditing
•
•
•
aims to assess the impact of the entity on the environment
it normally involves the implementation of EMAS or ISO 14000
it provides the data for the environmental audit
Environmental accounting
•
•
•
the development of an environmental accounting system to support the integration of environmental performance
measures
it provides evidence of the achievements of social and environmental objectives
without social and environmental auditing, environmental accounting would not be possible
Environmental Reporting
•
•
•
•
resources consumption and pollution should be measured (quantitatively or qualitatively)
transparency, openness and responsibility dictates that environmental footprint should be measured and reported
external stakeholders should be aware of the impact on environment by the company
investors should be aware of the potential loss arising from environmental legislation happening in future
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Full cost accounting:
•
•
•
Full cost accounting means calculating the total cost of company activities, including environmental, economic and social
costs.
It attempts to include all the cost of an action, decision or manufacture of a product into a costing system, and as such will
include many non-financial costs of certain actions.
Full cost accounting is about internalizing all environmental cost onto the P&L i.e. making externality cost visible and
chargeable as an expense.
Triple bottom line accounting:
TBL accounting means expanding the traditional company reporting framework to take into account environment and social
performance in addition to financial (economic) performance.
The concept is also explained using the triple ‘P’ of people, planet and profit.
TBL:
TBL attempt to show the full cost of development, and that business should have a triple goal set incorporating not only
economic, but also social and environmental objective. This is commonly shortened to the triple ’P’ headings.
People
People expand the concept of stakeholder interest from simply shareholders (as in financial reporting) to other groups including
employees and community where company carries out its business. Action of the company is therefore is considered in light of
different groups, not simply from the point of view of shareholders.
Planet
Planet refers to the environmental practices of the company to determine whether they are sustainable or not. The TBL
Company attempts to reduce the ‘ecological footprint’ by managing resource consumption and energy usage. The company
therefore attempts to limit environmental damage.
Profit
Is the ‘normal’ bottom line measured in most businesses. As noted above, a non-TBL company will seek to maximize this
measure to improve shareholder return. A TBL company on the other hand will balance the profit objective with the other two
element of TBL.
Integrated reporting:
Integrated reporting demonstrates the linkages between an organization’s strategy, governance and financial performance and
the social, environmental and economic context within which it operates.
By reinforcing these connections, integrated reporting can help business to take more sustainable decisions and enable investors
and other stakeholders to understand how an organization is really performing. An integrated report should be a single report
which is the organization primary report- in most jurisdictions the annual report or equivalent.
Central to integrated reporting is the challenge facing organization to create and sustain value in the short, medium and longer
term. Each element of an integrated report should provide insight into an organization’s current and future performance.
By addressing the material issues for an organization, an integrated report should demonstrate in a clear and concise manner an
organization’s ability to create and sustain value in the short term, medium and longer term.
Integrated reporting is a process founded on integrated thinking that results in a periodic integrated report by an organization
about value creating over time and related communications regarding aspects of value creation.
An integrated is a concise communication about how an organization’s strategy, governance, performance and prospects, in the
contexts of its external environmental, lead to the creation of value in the short, medium and long term.
Integrated reporting is needed by business and investors. Business is need a reporting environment that is conducive
understanding an articulating their strategy, which helps to drive performance internally and attract financial capital for
investment. Investors need to understand how the strategy being pursued creates value over time.
Traditional definition of capital
“Capital” however can have several different meanings. Its specific definition depends on the context in which it is used. In
general, it refers to financial resources available for use, therefore companies and societies with more capital are better off than
those with less capital.
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1. Financial Capital
Financial capital plays an important role in our economy, enabling the other types of capital to be owned and traded. However,
unlike the other types, it has no real value itself but is representative of natural, human, social or manufactured capital; e.g.
shares, bonds or banknotes.
Alternative definitions of capital
It is now recognised that there are five other types of sustainable capital from where we derive the goods and services we need
to improve the quality.
2. Manufactured Capital
This form of capital can be described as comprising of material goods, or fixed assets which contribute to the production process
rather than being the output itself – e.g. tools, machines and buildings.
3. Intellectual capital
This form of capital can be described as the value of a company or organisation's employee knowledge, business training and
any proprietary information that may provide the company with a competitive advantage. Intellectual capital is considered an
asset, and can broadly be defined as the collection of all informational resources a company has at its disposal that can be used
to drive profits, gain new customers, create new products, or otherwise improve the business.
(NB: Some of the subsets of intellectual capital include human capital, information capital, brand awareness and instructional
capital.)
4. Human capital
This can be described as consisting of people's health, knowledge, skills and motivation. All these things are needed for
productive work. Enhancing human capital through education and training is central to a flourishing economy.
5. Social capital
This can be described as being concerned with the institutions that help us maintain and develop human capital in partnership
with others; e.g. families, communities, businesses, trade unions, schools, and voluntary organisations.
6. Natural capital
This can be described as any stock or flow of energy and material within the environment that produces goods and services.
Natural capital is the value that nature provides for us, the natural assets that society has and is therefore not only the basis of
production but of life itself. It includes resources of renewable and non-renewable materials e.g. land, water, energy and those
factors that absorb, neutralise or recycle wastes and processes – e.g. climate regulation, climate change, CO2 emissions.
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Chapter 11
Internal Control system
INTERNAL CONTROLL AND COSO:
Objectives / Benefits of Internal Controls by COSO:
1.
2.
3.
Effectiveness and efficiency of operations- that is the basis business objectives including performance goals safeguarding resources.
Reliability of financial reporting- including the preparation of any published financial information.
Compliance with applicable laws and regulations- to which the company is subject.
Internal control definitions:
•
•
Controls: attempt to ensure that risks, those factors which stop the achievements of company objectives, are minimized.
Internal control system: compromises the whole network of systems establish in an organization to provide reasonable assurance that
•
organization objective will be achieved.
Internal management control: refers to the procedures and policies in place to ensure that company objectives are achieved.
The control procedures and policies provide the detail controls implementation within the company.
Objectives of an internal control system:
An internal control system is to ensure, as far as practicable
•
•
•
•
•
the orderly and efficient conduct of business, including adherence to internal policies
the safeguarding of the assets of business
the prevention and detection of fraud an error
the accuracy and completeness of the accounting record, and
timely preparation of financial information.
Sound internal control system:
Turnbull guidelines describes three features of a sound internal control system.
•
•
•
I.C embedded within the operations and not treated as a separate exercise.
I.C should be to respond to changing risk within and outside the company.
It includes procedures for reporting control failings or weakness.
Elements of an effective internal control system:
Control Environment:
The overall ‘tone’ or approach to internal control set by the management. Include commitment by the board to establish and
maintain a control system.
Information and communication:
Gather the correct information and communicate it to the correct people.
Risk assessment:
Determining the risk associated with each objective of the company and then how each risk should be managed.
Monitoring of Controls:
Checking the internal control system (normally by internal audit) to ensure that it is working.
Control activities:
The policies and procedures in place to ensure that instructions of management are carried out.
Control activities:
Segregation of duties
Physical
Authorization and approval
Management
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Supervision
Organization
Arithmetic and accounting
Personnel
35
TYPES OF INFORMATION SYSTEM:
Executive information system (EIS):
A based system for total business modeling.it monitor reality and facilitates actions that improve business results.
Management Information System (MIS):
A system to convert data from internal and external sources into information, and to communicate that information in an
appropriate form to managers at all levels and in all areas of business to enable them to make timely and relevant decisions.
Decision Support System (DSS):
A computer based system which enable managers to confront ill- structured problems by direct interactions with data and
problems-solving programs.
Transaction Processing System (TPS):
A system that routinely captures, process, store and output low level transaction data.
Information Characteristics and quality:
The information should meet the criteria of goof information:
•
•
•
•
•
•
•
•
Accurate
Complete
Cost beneficial
User targets
Relevant
Authoritative
Timely
Easy to use
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Chapter 12
Audit and compliance
Role of internal auditor
Review accounting and internal control systems.
• Assisting with the identification of significant risks.
• Review the economy, efficiency and effectiveness of operations.
• Examining financial and operational information.
• Special investigations, E.G into suspected fraud.
• Review compliance with laws and other external regulations.
Types of audit work:
Examples of audit types are:
• Financial audit
• Operational audit
• Project audit
• Value for money audit
• social and environmental audit
• management audit
Financial audit:
Financial auditing is traditionally the main area of work for the internal audit bdepartment.it embraces:
• The conventional task of examining records and evidence to support financial and management reporting in order to detect
error and prevent fraud.
• Analyzing information, identifying trends and potentially significant variations from the norm.
Operating audit:
•
•
•
Examination and review of a business operations.
The effectiveness of controls.
Identification of area of improvement in efficiency and performance including improving operational economy, efficiency
and effectiveness- the three Es of value for money auditing.
There are four main areas where such as approach is commonly used
Procurement
Marketing
Treasury
Human resources
Project auditing:
Best value and IT assignments are really about looking at processes within the organization and asking:
• Where things done well?
• Did the organization achieve value for money?
Project auditing is about looking at a specific project:
• Commission a new factory
• Implement new IT systems
Value for money audit:
An area that internal auditors have been getting increasingly involved in is the value for money audits. These have been replaced
in terminology more recently by “best value” audits, but many of principles remain the same.
In value for money audit the auditor assesses main three areas.
• Economy:
The economy of is assessed by looking at the input to the business (or process) and deciding whether these are the most
economical that are available at an acceptable quality level.
• Efficiency:
The efficiency of an operation is assessed by considering how well the operation converts inputs to outputs.
• Effectiveness:
The effectiveness of an Organization is assessed by examining whether the organization is achieving its objectives. To access
effectiveness there must be clear objectives for the organizations that can be examined.
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Social and environmental audit:
The social audit look at the company’s contribution to society and the community. The contribution made could be through :
Donations
Sponsorship
Employment practices
Education.
Health and safety
Ethical investment, etc.
A social audit could either conform statements, made by the directors, and make recommendation for social policies that company
should perform.
More on social and environmental audit will be seen in the chapter on social and environmental issues.
Management audit:
A management is defined as ‘an objective and independent appraisal of the effectiveness of managers and the corporate structure
in the achievement of the entities’ objective and policies. Its aim is to identify existing and potential management weaknesses and
recommend ways to rectify them.
Audit committee:
The audit committee is the committee of board of directors consisting entirely of independent non-executive directors (NEDs) (at
least three in large companies) of whom one has recent and relevant financial experience.
Role of audit committee:
•
•
•
•
Review internal control system.
Oversee the work of internal auditor.
Review the work of external audit.
Monitor integrity of financial statement.
Role of audit committee and internal control:
•
•
•
•
•
•
•
Review financial controls
Supervise major transactions
Review report from internal and external auditors regarding controls
Approval annual report internal control statement.
Review fraud & risk management.
Review compliance (regulations, legislations and ethics).
Monitoring adequacy of internal control system.
Audit committee and internal audit:
•
•
•
•
•
•
•
Monitor and assess effectiveness
Review and access the annual internal audit work plan.
Approve the appointment or termination of head of internal audit.
Preserve independence.
Check efficiency.
Ensure recommendations are actioned.
Ensure accountable to the audit committee.
The audit committee and external auditor:
The audit committee should:
• Have the primary responsibility for making a recommendation on the board of appointment, re-appointment or removal and
fee of the external auditor.
• Oversee’ the selection process when new auditor are being considered
• Approve (though not necessarily negotiate) the term of engagement of the external auditors and the remuneration for their
services.
• Have annual procedures for ensuring the independence and objectivity of the external auditors.
• Review the scope of the audit with the auditor, and satisfy itself that this is sufficient
• Make sure that appropriate plan are in place for the audit at the start of each annual audit.
• Carry out a post completion audit review.
• Provide a platform or communication channel between the management of company and external auditor.
• Help the auditor to resolve any issue with management of company.
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Chapter 13
Risk and Risk Management Process
•
•
•
Financial risk is often defined as the unexpected variability or volatility of returns. It includes both potential worse-thanexpected as well as better-than-expected returns.
Means of assessing risk vary widely between professions. For example, a doctor manages medical risk, while a civil
engineer manages risk of structural failure.
A professional code of ethics is usually focused on risk assessment and mitigation (by the professional on behalf of
client, public, society or life in general).
Risk Management
•
•
•
•
•
•
Risk management is the human activity which integrates recognition (identification) of risk, risk assessment (analysis),
development of strategies to manage it (planning), and monitoring of risk using managerial resources.
The strategies include transferring the risk to another party, avoiding the risk, reducing the negative effect of the risk, and
accepting some or all of the consequences of a particular risk.
Some traditional risk managements are focused on risks stemming from physical or legal causes (e.g. natural disasters or
fires, accidents, death and lawsuits). Financial risk management, on the other hand, focuses on risks that can be managed
using traded financial instruments.
Objective of risk management is to reduce different risks related to a pre-selected domain to the level accepted by
society. It may refer to numerous types of threats caused by environment, technology, humans, organizations and
politics.
Risk management is the process of reducing the possibility of adverse consequences either by reducing the likelihood of
an event or its impact.
Management needs to monitor risks on ongoing basis:
a) To identify new risks that may affect the company
b) To identify changes to existing and known risks (amend strategy)
c) To ensure best use is made of the opportunities
Role of Risk Committee
a) Raise awareness about risk within the organization
b) Ensure adequate and efficient risk management processes are in place to identify, monitor and report risks
c) Report to the board, and make recommendations about the risk appetite of the company
d) Develop and review the risk management policy of the company
e) Appropriate communication to all employees and management levels regarding the Risk Policy and their responsibilities.
f) Where applicable, obtain expert advice on risk management processes.
•
•
In most companies board will establish Risk Management Committee (based on size)
Where no such committee is formed, audit committee will perform similar duties
Strategic Risks
These are risks associated with adopting a particular strategy
• A company aiming to achieve growth by acquisitions have more risk compared to the company growing through
slow and gradual increase in sales
• Developing new products is more risky than to enhance the existing ones.
• Strategic risks should be identified by the senior management
Operational Risks
These are risks arising from business operations
•
•
•
Potential loss in business (through failed or inadequate internal processes, people and systems)
Risk of fraud by employee
Poor quality of production / lack of production (stock out)
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Activity 1
A new mobile phone company has recently launched operations. What are its strategic and operational risks?
Some common business risks:
1. Market Risk:
a. Market saturation
b. A new product not being accepted in market
c. Competitors offering better product
d. Sales / demand of product may fall due to change in technology / or taste
e. Increase in price of raw materials (where price of company’s product is inelastic)
f. Change in economic condition of the country (growth / recession)
g. Change in international market conditions
2. Credit Risk
a. Non-payment by customers
b. Organization’s credit policy (terms / credit limits / credit period)
c. Credit rating / Assessment procedures
3. Liquidity:
a. Poor cash flow management
b. Difficulty in raising new finances (due to problems in operations)
c. High gearing (debt to equity ratio)
d. Company may not meet its commitments
e. Fluctuation in interest rates
4. Technology Risk
a. Products change quickly due to change in technology
b. Low investment in R&D
c. Competitors have better products
5. Legal or litigation risk
a. Breach of legal statutes by the company (Companies Act etc)
b. Breach of contract by company or third parties
6. Health/ Safety/ Environmental Risk
a. Safety of workers
b. Safety of the community (pollution, toxic wastes)
c. R&D (testing on animals)
7. Product Reputation Risk
a. Quality of production
b. Product recalls due to quality
c. Business in sectors perceived to be bad (e.g. tobacco)
8. Business Probity (decency) Risk
a. Directors getting increases while company is in loss
b. Questionable transactions (bribes, kickbacks)
c. Active lobbying (e.g. arms and ammunition / tobacco)
9. Currency Risk
a. Transactions in foreign currencies
b. Change in currency rate
c. Competitors price getting attractive due to change in rate
10. Derivative Risk
a. Dealing in derivatives (financial instruments)
b. Not using hedging and continuing with open positions
Generic Risk: that affects all businesses in the market. i.e. increase in interest rate will affect all business with borrowings.
Sector Specific Risk: that is specific to an industry sector. i.e. environmental legislation effecting oil exploration companies
Impact of risk on stakeholders:
•
•
•
Business risk initially affects the company
Consequently, stakeholders will also be affected
Stakeholders can reduce the risk to them by distancing from the company
Shareholders: loss of value of their investment / income
Directors: loss of income / poor reputation
Managers/ employees: loss of income / poor reputation / demotivation
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Customers: sale returns / warranties / guarantees / loss in sale
Suppliers: loss in volume of purchases / price / quality
Government: Lower taxes / employment / exports / infrastructure
Probability and Severity (Impact) of Risk
This tool is used to quantify the likelihood (or frequency) and impact (or consequence) of identified risks in order to
prioritize risk response activities. Experts advise that the probability should be evaluated first, followed by estimating the potential
severity of the consequences. It helps identify the risks that are most urgent or must be avoided, those that should be transferred or
reduced, and those it is reasonable to retain.
Probability
Certain
Likely
Possible
Unlikely
Remote
Insignificant
Medium
Medium
Low
Low
Low
Minor
High
High
Medium
Low
Low
Severity
Moderate
Extreme
High
High
Medium
Medium
Significant
Extreme
Extreme
Extreme
High
High
Catastrophic
Extreme
Extreme
Extreme
Extreme
High
How to manage / handle the risk
Take example of the risk of totalling car in accident. The risk of accident can be handled as follows:
a) Bear the financial risk and do not seek to reduce it. For example, continue driving car without taking any insurance.
b) Transfer the risk to another party. For example take insurance for the car.
c) Reduce or control the risk. For example wear seat belts / drive at slow speed (reduce injury)
d) Remove the risk and avoid it entirely. For example you sell the car and use public transport.
Risk Manager:
•
•
•
Is a member of Risk Management Committee, and reports directly to the committee and the board
His role is more operational rather than strategic
Policies are set by the Risk Management Committee and implemented by the risk manager
Responsibilities of Risk Manager:
1. Identifies and evaluate risks affecting the organization and its operation and business.
2. Designs appropriate internal controls to manage identified risks
3. Monitors the status of internal controls through internal audit reports
4. Develops and implements a risk awareness program within the organization
5. Maintain good working relationship between the committee and the board
6. Provide assurance to external auditors in appraising risks and internal controls within the organization
7. Produce reports (based on jurisdictions) on risk management, including statutory reports (SOX)
Importance of Risk Awareness:
a) Risk awareness should be at all levels in the organization:
i. Strategic Level: Awareness of risk at the highest level. It includes identifying new threats (competitors, technology),
and monitoring of the existing risk management function of the organization.
ii. Tactical Level: Awareness of risk at department / division level. It includes monitoring the business functions of each
department and identifying threats, which may impede the business at middle management level (credit policy)
iii. Operational Level: Awareness of risk at a day-to-day business running basis. Individual threats on their own may not
be significant at this level, but may add up over time, and disrupt business (customer dissatisfaction, stock out).
b) In absence of risk awareness, organization and its people are not geared up to identify new risks
c) Continued monitoring of existing risks is required to ensure business runs smoothly
⇒ Risk and uncertainty are so pervasive in our lives that we deal with them all the time.
⇒ Risk management already exists, in some form, before risk managers and auditors come along to try to
"implement" it.
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Embedding risk management system within the Internal Control System
•
•
•
•
•
•
A sound system of internal control reduces but cannot eliminate risk.
An organization should not have a separate system of risk management; they should include the risk management
processes into their system of internal controls
The risks to business are ever changing because of evolving and expanding operations. An effective internal control
system would be able to identify existing and new threats to business with similar efficiency.
In USA it is a statutory requirement (SOX)
Risk manager (or a risk expert) needs to work closely with management while they design the internal control system
Risk manager should regularly review reports on monitoring of internal control to identify whether controls are capable
to identify all risks.
Embedding risk management system within the Culture and Values of Organization
Culture is:
• Commonly held and relatively stable set of attitudes, values and norms
• Basic assumptions and beliefs that are shared by members of an organization.
o Risk management needs to be incorporated in the policies and procedures of the organization
o Employees should be aware of the importance of risk management system, otherwise they will not be able to identify
potential threats or monitor risks
o The “tone at the top” gives a significant message of awareness to the staff
o An open culture (open to new ideas) will significantly increase efficiency of risk management
o Risk management function may be included in individual job descriptions, and aligned with performance indicators
expected at time of appraisals
Diversifying Risk
•
•
•
•
•
Spreading risk effectively reduces it
Operational risk may be diversified by producing in different geographical regions
Poor performance of one division / product may be offset by good performance of the other
Diversification only works where returns are negatively correlated (move opposite)
Financial risk can be diversified by investing in different sectors or by hedging (it can decrease potential for loss, along
with potential for gain).
Risk Avoidance: A risk strategy where organization avoids risk.
⇒ It is the most effective way to manage risk, especially when the risk appetite of the organization is low
⇒ It means not entering into a new project because of the risks that will arise
⇒ For continuing business, risk avoidance will not be a good decision, because competitors may increase their product range, or
market share.
⇒ Risk avoidance may be feasible when risk cannot be transferred to another party, or activities have a very high chance of
failure.
Risk Retention: The organization decides to retain risk
⇒ The organization may have a higher risk appetite
⇒ Risk may be retained when the consequences of risk taking are less than the cost to manage it
⇒ Organization may estimate a very low probability of the event happening, and may take a chance by assuming risk
⇒ When the cost of transferring risk to another party is higher than the benefit, organizations may choose to take the risk.
Attitudes towards risk taking
⇒ The overall approach towards risk management determines formulation of risk strategy
⇒ The risk appetite, and risk capacity indicates how much risk can organization take.
⇒ Organizations may take risky projects if they have large risk appetite
⇒ Once risk capacity has been reached, organizations may refuse to take more risk and try to transfer risk, or avoid it altogether.
⇒ Organization may make a portfolio of projects (to diversify risk)
⇒ Size, structure of organization does not correlate with its risk appetite
⇒ A small, newly formed company may take more risk to get its product in the market, and an old business may become risk
averse to protect its market share
⇒ A new business, a new product carries more risk
⇒ Small product range carried more risk (product failure)
⇒ A developed company (with functioning board and senior management) will carry less risk than a newly formed company
⇒ Divisionilized structure carries less risk as loss of one division may be offset by others
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⇒ A business operating in different geographical areas would face higher risk
⇒ A large organizations would face many problems (due to large number of stakeholders, and interaction with environment), and
will face emerging risks all the time.
Necessity of risk taking
•
•
•
•
A risk avoidance approach may lead to stagnation, or decline of business
Transferring risk has associated costs, which needs to be accounted for.
Incurring an acceptable amount of risk makes the business more competitive.
Taking higher risk projects may provide higher returns, which may enable the business to have extra surplus to invest
elsewhere
The as low as reasonably practicable principle(ALARP):
As we cannot eliminate risk all together the ALARP principle, simply states that residual risk should be low as reasonably
practicable. Taking into consideration, the costly nature of risk reduction.
• The ALARP principle express a point at which the cost of additional risk reduction would be grossly disproportionate to the
benefit achieved.
• The ALARP principle is usually applied to safety critical, high integrity systems where health and safety risk cannot be
eliminated e.g. oil rigs.
It is a key part of the general duties of the health and safety at work act 1974 and many sets of health and safety regulations that
we and local authorities enforce.
Enterprise risk management(ERM) :
The process effected by an entity board of directors, managements and other personal, applied in strategy setting and across the
enterprise, design to identify potential events that may affect the entity, and manage risk to be within its risk appetite, to provide
reasonable assurance regarding the achievements of organization objective.
The key principle of ERM includes:
• Consideration of risk management in the context of business strategy
• The risk management is everyone’s responsibility, with the tone set from the top.
• The creation of a risk aware culture
• A comprehensive and holistic approach to risk management
• Consideration of a broad range of risk (strategic, financial, operational and compliance)
• A focus risk management strategy, led by the board (embedding risk within the organization’s culture)
The COSO ERM framework reflects the relation between:
• The four objectives of a business (strategic, operational, reporting and compliance) which reflect the responsibility of
different executive across the entity and address different needs.
• The four organizational levels (subsidiary, business unit, division and entity) which emphasizes the importance of
managing risks across the enterprise as a whole.
• The eight components that must function effectively for risk management to be successful.
The eight components of COSO ERM Framework are:
Internal environment: This is the tone of organization, including the risk management philosophy and risk appetite.
Objective setting: Objective should be aligned with organization’s mission and need to be consistent with the organization’s
defined risk appetite.
Event identification: These are internal and external event (both positive and negative) which impact upon the achievement
of an entity objective and must be identified.
Risk assessment: Risks are analysed to consider their likelihood and impact as a basis for determining how they should be
managed.
Risk response: management select risk response(s) to avoid, accept, reduce or share risk. The intention is to develop a set of
action to align risk with the entity’s risk tolerances and risk appetite.
Control activities: policies and procedures help ensure that risk responses are effectively carried out.
Information and communication: the relevant information is identified, captured and communicated in a form and
timeframe that enables people to carry out their responsibilities.
Monitoring: the entire ERM process is monitored and modifications made as necessary.
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The concept of related risk factors:
Related risk: are the risks that because of presence of another risk or where two risk have a common cause. This means when
one risk increase it has an effect on the other risk and it has said that two are related. Risk correlation is an example of related risk.
Positive correlated: those risk that are positively related in that one will fall with the reduction of the other, and
increase with the rise of other.
Negative correlated: risk are those that are negatively related in that if one rose as the other fell.
Correlation between risks:
Positive Correlation
Negative Correlation
Both risk move in the same direction.
For example:
As the Environmental risk increases so does the
Reputation risk.
Each risk moves in an opposite direction.
For example:
As more money is spent on reducing the environmental
damage, therefore reducing the risk. There is an increase
in the financial risk facing the company.
Risk perception:
A further complication to the risk assessment is the quality of information available upon which to assess the risks .
Different risk perception:
Objective Risk
Subjective Risk
Assessment made with high degree of
certainty.
Examples of objective measurement:
Impact: number of homes effected if a
local power distribution plant ceases to
operate. (the number of homes served by
that plant is known since it covers a precise
geographical area)
Likelihood:
Drawing an ace of spades out of a normal
pack of cards(1 in 52 chance)
Very difficult to assign value to impact & likelihood.
Subjective risk perception have obvious limitations:
• It may affect the suitability of selected risk mitigation
techniques.
• It may impact resource decisions.
Examples of subjective measurement:
Impact: the amount of revenue lost by business if websites are
“down” due to loss of power.(this would depend on the amount of
revenue that flow through website, and is hard to determine exactly
how much would have been earned in the specific period of a power
outage.)
Likelihood: the FTSE100 rises by 50 points in the next week.(this
could be affected by so many variables that it would be impossible
to quantify.)
RISK APPITITE
How much risk the business will
accept.
RISK
ATTITUDES
Overall approach to risk.
RISK AVERSE:
Seeking to avoid risk and with
draw from risky situations.
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RISK STRATEGY(TARA)
How risk will be managed.
Risk capacity (threshold)
Maximum risk business can
accept.
Residual risk
Risk that cannot be
managed
RISK SEEKING:
Actively seek risk, in the
belief that higher the risk
equals higher the returns.
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Risk strategy and Ansoff’s matrix:
Ansoff,s: product/market matrix provides a summary of strategic options for an organization when looking to expand. The
matrix is shown below
Existing market
Existing product
New product
Internal efficiency and market
penetration 1
Product development 2
Market development 3
Diversification 4
New market
In summary matrix illustrate that an organization can expand using existing or new products into existing or new markets. The
level of risk associated with each strategy is:
Option 1: low risk as the product and the market are known- The risk here is attempting to sell a product in the market place
when demand is falling.(e.g video players).
Options2: Higher risk -although the market is known there is a risk that customer will not like the enhanced or new product
(e.g, a mobile telephone that can double as an MP3 player).
Option 3: again high risk – the product is known but the marketplace is not. The risk relates to the poor sales strategy or poor
market research indicating that customer wants the product when they do not.
Option 4: high risk option – both the market and the product are new combining the risk from option 2 and 3. While the risk is
highest here, so are potential returns if the new product can be successfully sold in the new market.
DIFFERENT TYPES OF RISKS:
Fundamental risks are those that affect society in general, or broad groups of people, and are beyond the control of any one
individual. For example there is the risk of atmospheric pollution which can affect the health of a whole community but which
may be quite beyond the power of an individual within it to control.
Particular risks are risks over which an individual may have some measure of control. For example there is a risk attached to
smoking and we can mitigate that risk by refraining from smoking.
Speculative risks are those from which either good or harm may result. A business venture, for example, presents a speculative
risk because either a profit or loss can result.
Pure risks are those whose only possible outcome is harmful. The risk of loss of data in computer systems caused by fire is a pure
risk because no gain can result from it.
Risk appetite describes the nature and strength of risks that an organisation is prepared to bear.
Risk attitude is the directors' views on the level of risk that they consider desirable.
Risk capacity describes the nature and strength of risks that an organisation is able to bear.
Strategic risks are risks that relate to the fundamental decisions that the directors take about the future of the organisation.
Operational risks relate to matters that can go wrong on a day-to-day basis while the organisation is carrying out its business.
Financial risks include reductions in revenues or profits, or incurring losses. The ultimate financial risk is that the organisation
will not be able to continue to function as a going concern.
Liquidity risk is the risk of loss due to a mismatch between cash inflows and outflows.
Gearing risks are the risks of financial difficulty through taking on excessive commitments connected with debt.
Credit risk is the risk to a company from the failure of its debtors to meet their obligations on time.
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Currency risk is the possibility of loss or gain due to future changes in exchange rates.
There are three types of currency risk.
(a) Transaction risk – arising from exchange rate movements between the time of entering into an international trading
transaction and the time of cash settlement.
(b) Translation risk – the changes in balance sheet values of foreign assets and liabilities arising from retranslation at
different prevailing exchange rates at the end of each year.
(c) Economic risk – the effect of exchange rate movements on the international competitiveness of the organisation, eg
in terms of relative prices of imports/exports, the cost of foreign labour etc.
Market risk is a risk of gain or loss due to movement in the market value of an asset – a stock, a bond, a loan, foreign exchange
or a commodity – or a derivative contract linked to these assets. Market risk is often discussed in the context of the stock markets.
Market risk is a risk arising from any of the markets in which a company operates, including resource markets (inputs), product
markets (outputs) or capital markets (finance).
Market risk is the risk that the fair values or cash flow of a financial instrument will fluctuate due to market prices. Market risk
reflects interest rate risk, currency risk and other price risks. (IFRS 7)
Product Risk: Product risks will include the risks of financial loss due to producing a poor quality product.
Political risk is the risk that political action will affect the position and value of an organisation.
Probity risk is the risk of unethical behaviour by one or more participants in a particular process.
Physical risk is the risk of goods being lost or stolen in transit, or the documents accompanying the goods going astray.
Trade risk is the risk of the customer refusing to accept the goods on delivery (due to sub-standard/inappropriate goods), or the
cancellation of the order in transit.
Liquidity risk is the inability to finance the organisation's trading activities. It generally is regarded as a lack of short-term
financing needs and a mismatch between short-term assets and liabilities.
Reputation risk is a loss of reputation caused as a result of the adverse consequences of another risk.
Industry-specific risks are the risks of unexpected changes to a business's cash flows from events or changing circumstances in
the industry or sector in which the business operates.
Residual risk is the risk remaining after actions have been taken to manage risks.
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Chapter 14
Strategy Basics
Strategy is difficult to define. The reasons for this difficulty are many:
1: There are different levels of strategy- corporate, business, functional and networks- each concerned with different
issues. In basic terms:
Corporate level: the role of the corporate HQ in a firm
diversified across industries. Most firms therefore do not
have corporate strategy because they are not diversified
across industries.
Key issues: What industries to be in and how the
corporate HQ manages its business subsidiaries.
Business level: the role of the business HQ (or in the case
of a diversified company, the business HQs since each
subsidiary will have its own business HQ)
Key issues: how the business deals with competition in its
environment especially source of competitive advantage.
Functional Levels: the strategy adopted by functional
departments within the business – marketing, finance,
operations, IS, HRM etc.
Key issue: ensuring the functional strategies are aligned
with the business strategy and with one another.
Network level: the relationship between the firm and the
other firm notably suppliers, distributors and competitors,
research organization and NGOs.
Key issues: managing partnerships and alliances implying
some degree of co-operation.
Example of virgin group:
The virgin group of companies is diversified across a range of industries and it is constantly entering new industries and exiting- or
partly exiting – some of its existing industries. The decision of which industries to be in a corporate strategy decision.
Each of subsidiaries faces a different competitive environment. The airline- virgin Atlantic- faces a different set of opportunities
and threats from virgin finance- its financial services subsidiary. Therefore each of its subsidiaries needs to have their own strategy.
This is business or competitive strategy.
Virgin different businesses have their own financial activities- operating an airline is different from operating a financial services
business and detail HRM, IS, financial, marketing etc. strategies will be mostly specific to each subsidiary. This is functional
strategy.
Virgin operates using joint ventures (setting up a jointly owned and managed subsidiary) or monitory stakes with a business in the
various industries it covers. Virgin puts in its brand name while the joint venture partner provides the industry specific resources
and skills and typically most of the capital. When virgin decides to exit a joint venture it typically retain a minority stake. This is
alliance or network strategy.
2: Strategy can be done in a range of different ways.
This is strategy as “process”: how strategy is formulated and implemented (as distinct from what the strategy is-strategy as
“contents”). Although it is tempting to equate strategy with a planned approach (and your syllabus tend to do just that) there is no
convincing evidence that a planned approach to strategy works better than other approaches.
The key distinction is between “deliberate” and “emergent” strategies. Deliberate are forward looking (or proactive) and top down
(centralized) while emergent are reactive and bottom up- those close to the action provide top management with insight into what
the business needs to do. This distinction is made by Mintzberg who recognizes that there is “no such thing as a purely deliberate
strategy or a purely emergent one”. (Mintzberg is deeply critical of a planned approach to strategy formulation although accepts its
usefulness for strategy implementation). The complication is that:
1. Deliberate strategy can be of two sorts: a planned strategy and entrepreneurial strategy. Planned strategies are rational,
formal and techniques or rules based whereas entrepreneurial are visionary, informal and highly personal- it is all in the
mind of entrepreneur.
2. Emergent strategy can take two forms: experienced based and imposed. Experience based is where firms learn from its
experience and its mistakes whereas imposed strategy is where external forces determined the strategy- there are no options.
Deliberate
MINTZBERG AND WATERS
Emergent
Proactive
Reactive
Top down
Bottom up
Planned: formal, rational, Technique based
experienced based: learning & adaption
Entrepreneurial: informal, visionary, rule breaking
imposed: determined by external forces
Unfortunately the examiner favors the Johnson and Scholes and Whittington treatment of strategy process rather then that by
Mintzberg. They suggest that there are three very different strategy processes or what they term “lenses” (i.e. Different ways of
seeing strategy).
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Two of these falls easily within planned and emergent although they use different terms, entrepreneurial strategy process is
ignored.
Johson, Scholes & Whittington: THREE STRATEGY LENSES
DESIGN
EXPERIENCE
Highly deliberate: formal
strategic decision making
processes. Hierarchically
based: heavily top down
strategy formulation. Rule
and techniques based with
an emphasis on rationality.
Highly emergent based on
learning and adoption, trial
and error. Informal
processes with significant
inputs from lower levels.
Culturally based with an
emphasis in incremental
change.
IDEAS
Complexity and conflicts
create conditions necessary
for strategic ideas to
develop. An evolutionary
struggle for survival
between competing
strategic ideas. Innovation
based with an emphasis on
diversity and change.
Johson, Scholes & Whittington also used the term “strategic drift” to describe a situation where strategic decision are not being
made to deal with changes in the environment and absence of strategy process and therefore an absence of strategy.
SO WHATIS STRATEGY AND WHY HAVE ONE?
Restricting our answers to business strategy some feature stand out:
1. It is about the long term direction in which the business moves. However the direction may necessarily be one of deliberate
choice and different groups may have different views about its purposes.
2. It is about the environment in which the firm operates and how the firm has to cope with changes in the environment. Some
firms cope better than others- the history of auto industry is full of car firms that didn’t make it, including Austin of England
despite having a world beating lead (used by BMW and Nissan) in the design of small cars. A complication is that a business
operates in two rather than different environment- a country or regional environment and an industry environment.
3. It is about the resources the firm uses and how well it exploits them- resourcefulness. BMW illustrates the skill full way that
the company has survived despite being in the armaments industry on the losing side in two world wars.
4. It is about the choices the firm makes (if we favour a deliberate view of strategy), or the choices it is pushed into making (if we
favour emergent view). These choices includes the product/markets the firm seeks to compete in, whether it seeks to compete
by being cheaper or perceived to be better, and whether it uses organic or internally generated growth, acquisition, joint
ventures, minority stakes , licensing, franchising and outsourcing.
5. It is about implementing choices in a consistent way and managing the change processes involved. This implies that a strategy
can fail for two main reasons- it is the wrong strategy (so change it) or it is the right strategy being implemented badly ( so
improve the implementation). The problem is deciding which!
6. It is about monitoring the performance of the firm and its strategies, as a basis for modifying or shifting strategy. What matter
most has to be monitored the most.
7. It is about the stakeholders – shareholders, managers, customers, suppliers, the state- whose interests may not always coincide.
This implies that strategic decision making involves some degree of conflict and bargaining between stakeholder groups.
What all this implies is that firm need to have a strategy- without one, decision making is aimless and un-coordinated ( remember
“strategic drift”). What is more interesting is whether the strategy is a winning one, a losing one, or a survival strategy. At
different times in their history firms may experience all three.
Histories studies of firms have discovered a pattern in how
and when they change strategy. Where the firm is successful
it is under little pressure to change.
As it result there is considerable continuity or
Inertia or gradual incremental changes.
As it result there is considerable continuity
Or inertia or gradual incremental change.
Sooner (in a turbulent environment) the
firm fails to deal with the changes in the
environment- “strategic drift”) the strategy
fails to deliver resulting in a crisis. This
prompt a shift in strategy (and typically a
change of top management) which may be short lived if it
does not deliver the expected recovery (“flux”). If the firm
survives it will be by adopting a new consistently pursued
strategy that deals with its environment (“transformation”)
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Chapter 15
Growth
Most firms seek to grow. This appears to have more to do with managerial interests than shareholder interests since many form of
growth seems not to be benefit shareholders. Crudely growth can be split into two types- growth within industries and growth
across industries although in the long term the distinction can be blurred.
4 stage model of growth (by Chandler)
EMPIRE BUILDING
•
•
•
•
Founder builds up business
Owner managed-personal involvement
Entrepreneurial strategy process
Minimal structure / power structure
Crisis
size/complexity of firm becomes too great for
Personal control illness or death of ownerPower struggles over succession
ORGANIZATION BUILDING
•
•
•
Power passes to professional managers
Formalisation of processes
Adoption of centralized functional structure offering scale economies
Crisis
market saturation and intensifying competition in
home market puts limits on growth in existing product/markets.
DIVERSIFYING
•
•
•
Crisis
Development of new products
Entry into new markets
Diversification across industries
centralized functional structure
Unable to cope with product market diversity
DIVISIONALIZATIONS
•
•
•
Subsidiaries created based on geography or product families/industries
Each subsidiary /division has its own functional resources and operate as an independent business
Corporate HQ created which decides what business to be in, measures divisional performance and act as a banker to its subsidiaries.
Post Chandler: From the perspective of the 21th century chandler’s can be updated by adding a 5th stage of dating from around the
late 1970s and 1980s.
RESTRUCTURING
•
•
•
Conglomerates restructured themselves or broken up by acquirers who sold off their constitutes businesses for more than they paid for
the company.
Emphasis on related diversification and exploiting synergy through sharing of resources and transferring skills between subsidiaries.
Growth of market efficiency prompts outsourcing and call into question vertical integration (owing supplier and distributers)
MOTIVES BEHIND GROWTH:
Economies of scale:
1. Indivisibilities: in the sense of some input into production not being available in the small sizes
2. Proportionalities: fatter containers are cheaper than longer containers in term of unit cost of storage
3. Specialization: division of labour increase productivity
Economies of learning:
As employees gain experience of production, ways of dealing with problems can be turned into routines or more simply the
operation become standardized around best practice and there are opportunities to improve best practice
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Bargaining Power:
Relative size increase the bargaining power that the firm can exercise over its supplier to reduce unit costs, and the bargaining
power it enjoy over its customers to charge higher prices.
Relative Market Share:
One way of measuring potential experience curve effects is through relative market share- the market Tesco share of the firm
divided by the market share of the Asda biggest competitor.
PROBLEMS OF GROWTH:
Firms tend to grow within their
existing product market until
they run out of growth
opportunities, and this prompts
them to seek growth through
entering other countries with
their existing products and/or
developing new products for
their existing customers.
The issue whether the growth
is god for shareholders.
Greater Managerial
complexity
market saturation
slow growth
need for more
formal processes
need for more
complex structure
problems of
growth
Relative And
Imitation by
competitors
Dilution of
Culture
Shift into lower
Any growth creates problems
Risk of overtrading
profit margin activities
– and firms tend to wait for the problems to surface before seeking to deal with them.
Market saturation: eventually the market stops growing as most customers in the market have purchased the product. Attention
then shifts from first time buyer to replacement sales. A further complication is that firms having expanded their capacity to cope
with the growth end up with over capacity when the growth sales. This in turn prompts price cutting and falling profit margins and
stimulates diversification into new products and markets.
Need for complex structure: as business gets bigger they need more sophisticated structure to deal with the problems of
coordination. Face to face contact in smaller forms gives way to formal meeting in large firms. More resources have to devote to
achieving formally what used to occur informally.
Greater managerial complexity: business not only gets bigger they also get more complex as they diversified into new market
and new products. This requires a greater range of managerial specialization further increasing coordination problems.
Diluation of culture: growth requires new employees and new managers none of were the part of the founding stage of the firm’s
history. Inevitably they will not share the values and the beliefs of those who were in at the start.
Need for more formal process: whereas in the small firms employees can usually be relied on to put in extra to ensure that the
work gets done, this is not the case in the large firms. Instead there is the need for standardization and repeatability irrespective of
who it is that performs the activity. This is itself is not a problem- but typically things have to go wrong before the activity. This in
itself is not a problem – but typically things have to go wrong before the firm realizes the need for formalization.
Lower profit margin activities: firms may exhaust higher profits margin activities and grow by entering less profitable activities.
This is often the case when firms enter overseas markets.
Growth versus profitability
Recent researches by Zook and Allen suggest that few firms grow profitability. Those that do share similar strategies.
Define the core. The basis for sustained, profitable growth is clear definition of a company’s core business which is defined as
“that set of product, capabilities, customers, channels and geographies that defines the essence of what the company is or aspire to
be...”
Defining the core business or businesses may be straightforward or difficult- is Coca-Cola in the Cola business, the soft drink
business, the beverage business or what?
Establish competitive advantage for market power. They emphasises the importance of relative market share: “75%
of sustained growth companies had achieved leadership in their core business, as measured by their market share relative to their
next largest competitor”. However they emphasise that market share is not the cause of their success but is the result of other
sources of competitive advantage.
Adjacency expansion: they this as “company’s continual moves into related segments or businesses that utilise, and usually
reinforce, the profitable core.” “The most successful sustained growth companies almost always follow the pattern of expanding
in a regular and organized way into a series of adjacencies around one or two strong cores. The pattern resembles the rings of a
tree, emanating out from the center, expanding and reinforcing the core.”
The problem is the sheer diversity of adjacent opportunities that face a firm. Another is the danger of expanding into adjacencies
and failing to consolidate them, or neglecting the profitable core that spawned the adjacencies.
When necessary, redefine the core. This is a rare strategy associated with discontinuous change- new technologies (such
as the internet), new business models (such as Dell’s built-to order, or southwest Airline’s low cost carrier model), and changes in
government regulations. Zook, however, is of the view that turbulence is increasing and that firm must be increasingly nimble in
redefining their core business. Somewhat embarrassingly he cites Enron as successful example of such a transformation.
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Chapter 16
Purposes
Purposes are basic to strategy- some would say that strategy is the chain of means and ends that stretches from the top to the bottom
of the firm. Most would agree that no purpose implies no strategy (save opportunism) since there is likely to be little consistency
over time. No purposes also imply a fragmentation of decision making and a lack of co-ordination across sub-units and levels. No
purposes also imply no choices since these assumption is that firms will select options that best achieve their purposes. No purposes
implies no measurement or control since se presuppose the existence of standards and targets that derive from purposes. However
it is considerable debate about the appropriate purposes that firms should have.
1. general visionary purposes - missions
2. specific measurable purposes- objectives
3. politically determined purposes- stakeholder analysis or mapping
MISSIONS AND MISSION STATEMENTS
1. be able to define mission. JSW offer various definitions including "the raison d’etre of organisation"; and "overriding purpose
in line with the values or expectations of stakeholders".
2. Understand the difference between mission (strong sense of shared purpose) and mission statement (formal public communication
of the mission)
3. The strategic functions that mission and mission statements can perform- defining
Scope: What business are-we in and will enter?
Position: how we deal with the competition?
Vision: where we want to be in the future?
4. The mission model of Campbell et al with its emphasis on consistency between
Purposes: why do we exist?
Values: what do we believe in?
Behaviour: actions, standards, policies
Strategy: how we position relative to the competition
It is not what the values, beliefs,
behaviour and strategy is that
matters in this model but how well
they fit together
When push comes to shove all that is being said is that firms need to have a clear agreed idea of where they want to be, of how they
want to get there and of what they believe in, and to put these ideas and beliefs into effect in a determined way. Whether they write
it down and shove it on the wall is another matter.
OBJECTIVES/PERFORMANCE MEASURMENT: BALANCED SCORECARD
The last 20 or so years has seen a sustained attack on the stupidity of financially based decision making. The attack started with
Peter Drucker in the 1950s but accountants didn't really pay attention until one of their own took a swipe at management accountingKaplan and Johnson's "Relevance Lost" (1982).
Johnson subsequently drifted into TQM while Kaplan teamed up with Norton to provide a repackaged version of Drucker’s ideas
on objectives and measurement. their "Balanced Scorecard" (1994) was part of an enthusiasm in the management literature for
"metrics" on basis that "what you measure is what you get” and "if you can't measure it, you can't manage it’.
1. The critique of purely financially based objectives. Such objectives
are:
• too narrow in that they omit strategically important non-financial
objectives
• result in short term decision making and starve business of
necessary investment
• are prone to manipulation such as profit smoothing
• And encourage "management by numbers" or management by
remote control" by decision makers who do not understand the
physical activities of the business.
2. The four sets of objectives identified by Kaplan and Norton and how
performance might be measured, targets set and improvements
encouraged. Remember that:
• The starting point is the strategy of the business. Although we are
looking at the Balanced Scorecard as a model of objectives, it is
equally relevant under implementation where strategic monitoring
is a key element. A balanced scorecard links strategy to objectives
and to performance measurement including key performance
indicators.
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Balanced scorecard is useful in benchmarking where performance of one firm is compared to that of another, typically firms in same
industry (competitor benchmarking) or branches or outlets or subsidiaries of same firm (internal benchmarking)
A major issue in applying the balance scorecard is determining priorities (“balance" element or how the objectives and targets fit
together) and deciding on the time frames over which performance is to be measured and improved.
STAKEHOLDERS
The stakeholder model sees the firm as made up of different groups with different
interests. The role of management, itself a stakeholder, is to maintain a viable
coalition of stakeholders. Read the section in the bluff notes paying attention to:
1. The definition of what a stakeholder is- and add in the definition by JSW: "those
individuals or groups who depend on an organisation to fulfill their own goals and
on whom, in turn, organisation depends."
2. The importance of stakeholders in terms of:
• The availability and costs of resources.
• competitive advantage: through having better stakeholders and stakeholder
relations
• turning around failing businesses by securing concessions and support from
stakeholders
• measuring organisational performance in terms of stakeholder satisfaction
• constraining strategic decisions- need to be acceptable to key stakeholders.
"3 i" model (identity, interests, and influence) and the Mendlow grid. The former is a
more sensible approach but the latter is preferred by the ACCA and is reproduced
opposite. The model is a little confusing in it’s of use of the term "interest". This refers
to how closely stakeholder stakeholders track the firm's decisions NOT the interests or
goals that the stakeholders have. The key point of the model is that different stakeholders
have to be managed in different ways.
Stakeholder model can be made more sophisticated by recognising that:
1. The level of stakeholder interest in decisions is likely to be issue specific- they are
more interested in some decision areas than others. Equally they may be able to exert more influence on some decision areas than
others.
2. The membership of stakeholder groups is not homogeneous- all shareholders or all employees or all suppliers are not identical.
The same applies to senior management.
3. The senior management will seek to influence stakeholders as well as being influenced by them. This will involve shareholder
briefings, public relations exercises, employee communications, lobbying government, seeking to influence regulators. More
fundamentally, senior managers can, within limits, select their stakeholders.
4. Stakeholders do not act in isolation from one another- they may join together to influence particular decisions. The result is a
shifting coalition of interests.
5. Stakeholder expectations, interest and influence are not static- they will change over time and in response to changed
circumstances- such as a crisis.
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Chapter 17
External Analysis
OVERVIEW
The traditional view of strategy is an "outside in" view which suggests that firms need to understand their environment, and how it
may change as a basis for selecting an appropriate strategy. This is this approach of workbook 4 (in workbook 5 we will look at the
alternative approach which is "inside out".) the complication is that firms operate simultaneously in two overlapping environments:
an industry environment (composed of firms who compete directly with one another in making similar products, as well as their
suppliers and customers) and a country environment (the geographic and political region in which the firm operates). What further
complicates this is that the characteristics of the industry environment will be different in different countries. For example in the
USA and Europe the auto industry is mature and is contested by some 12 global competitors. In China and India car ownership is a
fraction of the USA and Europe, growth rates are considerably faster, and there are competitors that are unique to India and to China.
Technically therefore firms should conduct two overlapping external analyses- one at the level of the industry and the other at the
country level. Also industries and markets (including the characteristics and competitors, and customers, and the elements in a
successful strategy) change over time.
PESTEL ANALYSIS: COUNTRY OR
REGION – Macro Analysis
When was a lad we made do with PEST (Political Economic, Social;
Technological) before it expanded into a SLEPT analysis (Legal was added
or rather separated, out- from Political). Now another element has been
added-Ecological or Environmental.
Under the previous examiner students used to wet their knickers as to whether they should use a PEST/SLEPT/PESTEL for external
analysis or some or framework notably a Five Forces analysis. In theory the decision should have been simple PESTEL for countries
and Five Forces for industries but sometimes the examiner did not play by these rules. The current examiner alarmed at the incidence
of knickers wetting has removed the uncertainty by telling students what framework to use- and if he asks for a macro environmental
analysis he wants a PESTEL.
PESTEL contains no theory- it is simply a set of headings under which to analyses a country or regional environment. Although
they are reproduced below from the manual it is pointless to learn them! The trick is to be able to apply them.
POLITICAL
•
•
•
•
degree of state intervention
power holders and elites
stability and continuity
•
•
•
•
•
demographic
social structure and inequalities
culture, values and beliefs
family patterns
work and leisure patterns
•
•
•
•
•
degree of sophistication
technical standards
rate of diffusion and impact
product & process technology
technical infrastructure
policies
SOCIAL
TECHNOLOGICAL
© Zia Ul Haq
Macro:
ECONOMIC
Industry:
•
•
•
•
•
•
•
growth rates
inflation rates
exchange rates
unemployment
income levels
monetary policy
fiscal policy
•
•
power of environmental pressure groups
environmental policies (e.g. specific issues relating
to energy, pollution, greenhouse gases, and
recycling)
industry profitability
Industry growth
competitors
resource factors
substitutes
suppliers
customers
ECOLOGICAL
LEGAL
Employment law, company law, consumer law,
environmental law at both the country and regional (EU)
level.
53
Porter’s FIVE FORCES Analysis / INDUSTRY Analysis
This is the most theoretical of the external analysis frameworks and is associated with Michael porter. The emphasis of 5 forces is
upon the industry environment rather than the country environment. For Porter:
1. "The essence of strategy formulation is dealing with the competition”. This focuses attention upon the competitive environment
in which the firm operates.
2. However competition goes beyond existing industry
competitors to include potential entrants into the industry,
substitute products from other industries the power of suppliers
to competitors in the industry and the power of their customers.
These 5 forces constitute the structure of competition in the
industry.
3. Some industries are more attractive than others. The
attractiveness of an industry is the level or intensity of
competition that exists and may develop. In simple terms it is
easier for a firm to be profitable in an attractive industry (where
there is little competition) than an unattractive industry (where
there is a lot of competition). An attractive industry is one in
which:
-firms in the industry are profitable and the industry is
growing
-there are high entry barriers
-suppliers to the industry are weak
-customers of the industry are weak
-there are no substitutes available to customers, or substitutes
which perform badly
-there are no competitors or competitors with small relative
market share
-none of the competitors seek to compete on price thus
avoiding price wars
-demand for the industry products exceeds supply
KEY CONCEPT: SWITCHING COSTS
A key concept in the mode is that of "switching costs”. This arises in the context of:
• entrants: to be successful entrants have to attract customers always from their existing firms and if customers are satisfied or
locked in some way they are unlikely to shift
• customers: customers are less powerful when they face switching costs and they switch to another firm whether within industry'
or from a substitute industry
• suppliers: firms in industry would like to be able to switch between suppliers and indeed to switch to substitutes as this will
weaken suppliers
KEY ADDITIONAL FRAMEWORKS COMPATIBLE WITH 5 FORCES:
Although Porter emphasises that competition goes beyond existing competitors he acknowledges that for firms in an industry
competitors typically are the most immediate of the competitive forces. Accordingly he develops two additional frameworks that
can be slotted into tine 5 forces that deal specifically with existing industry competitors.
Strategic Group Analysis
SGA is useful in determining:
-which group the firm is in and who are its direct competitors
-which groups are more and less attractive in terms of the level of competition
-which firms are moving across which groups
The variables that most usefully be applied include:
- Strategy employed by firms in the industry
- The types of customer’s firms target
- The product range y offer
-their geographic base
-The extent of vertical integration
-their ownership structure (privately owned, publicly quoted or state owned)
(It may be helpful to think of a strategic group as a miniature industry or an industry within an industry.)
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Competitor analysis
This involves a detailed analysis of competitors particularly those in or likely to enter the firm’s strategic group. Key areas of
interest include:
-the strategies that they employ
-their strategic objectives and priorities
-their resources both tangible and intangible
-their resourcefulness (how effectively they use their resources)
SGA and competitor analysis are particularly concerned with identifying industry winners and losers (and future winners and losers).
Note that once SGA and competitor analysis are added to the 5 Forces a shift is occurring from pure external analysis of the industry
in terms of attractiveness and change to a positioning analysis which includes how specific firms are positioned within the industry
and how their positions may change.
LIFE CYCLE ANALYSIS
One of the most basic frameworks is the life cycle model. It divides up the life of an industry into stages and identifies the
dominant characteristics of each stage. Typically the stages identified are introduction, growth maturity and decline.
1. The characteristics of competition in the industry will be different at different stages. In strategy speak, it suggests that the
critical or key success factors (what it takes to - succeed) will shift with the stage. In particular the model implies that over time
it becomes more likely that the industry product will become a commodity and that cost and price based competition will
become the norm. This is because of the diffusion of learning among firms in the industry (who learns from one another and
copies one another) and among customers (who become more knowledgeable and sophisticated).
2. Industries have a finite life span and there are significant risks of getting locked into a declining industry. If firms are to survive
they eventually need to diversify across industries.
3. Although an industry based model, it does emphasise that an industry will have different characteristics in different countries
which are at different stages of their economic development. Thus there are country as well as industry elements in the model.
4. The model is a forecasting model- it predicts that all industries will pass through the stages- although it’s not too specific as to
when the shifts will occur. (This is the strength and weakness of the model. To suggest, as life cycle model does, that in
fundamental respects all industries are similar does provide useful generalizations that can be applied to any industry; however
every industry has its unique characteristics which tine life cycle model is not going to highlight.)
Introduction
Growth
Maturity
High income
adventurous
Demand
Increasing market
mass market:
Penetration
Replacement sales
TECHNOLOGY
New and
Non-standard
Some technologies
Eliminated
Low quality/reliability
and wide variety
Short production rune &
specialized distribution
Few competitors
Product innovation
© Zia Ul Haq
Standardized and
well understand
Products
Design and quality
Increased product
Improves
standardization
Manufacturing & distribution
Capacity shortages and
Overcapacity as supply
shift to mass
outstrips demand
production/distribution
Competition
Firms enter
Consolidation
Key success factors
Process innovation to make Cost based/efficiency
possible mass production
Decline
Falling sales
Technology becoming
Obsolete
Product becomes a
commodity
Heavy
overcapacity/specialized
distribution re-emerges
Price was and exits
Ruthless rationalization of
capacity, and cost cutting
55
KEY SUCCESS FACTORS
Over the years this has been given different names such as dominant competitive issue, critical success factors. They involve
analysing competitors and customers to identify what is needed to survive or succeed in a particular competitive environment. This
is illustrated below:
Critical success factors (CSFs) are the essential areas of the business that must be performed well if the mission, objectives and
goals of the business are to be achieved.
Critical success factors (CSFs) are performance requirements that are fundamental to an organisation’s success. In this context
CSFs should thus be viewed as those product features that are particularly valued by customers. This is where the organisation
must outperform competition.
1. KSFs are country/market and industry/strategic group specific. KSFs in the auto industry are different from the airline industry;
The KSFs for scheduled airlines are different from LCCs; the KSFs operating in Nigeria or Russia are different from Denmark or
Holland.
2. KSFs are likely to change over time. The life cycle model suggests a shift to cost/price based competition as industries mature.
3. KSFs should be the basis for prioritizing what matters most in terms of performance and measurement key performance
indicators.
4. KSFs are not set in concrete. Firms may be able to redefine the KSFs or introduce new KSFs through innovation (this is taking
us into an "inside out" model of strategy).
Portor’s National Diamond
Porter tried to answer the following questions:
• Why does a nation become the home base for successful international competitors in an industry? Germany is renowned for car
manufacture; Japan is prominent in consumer electronics.
• Why are firms based in a particular nation able to create and sustain competitive advantage against the world’s best competitors
in a particular field?
• Why is one country often the home of so many of an industry’s world leaders?
Porter called the answers to these questions the determinants of national competitive advantage. He suggested that there are four
main factors which determine national competitive advantage and expressed them in the form of a diamond.
(a) Favourable factor conditions:
(i) physical resources such as land, minerals and weather
(ii) capital
(iii) human resources such as skills, motivation, price and industrial relations
(iv) knowledge that can be used effectively
(v) infrastructure.
Porter also found that countries with factor disadvantages were forced to innovate to overcome these problems, e.g. Japanese
firms experienced high energy costs and were forced to develop energy efficient products and processes that were subsequently
demanded worldwide.
Porter found that domestic competition was vital as a spur to innovation and also enhanced global competitive advantage.
Conversely, where governments have encouraged mergers to get the critical mass required to be a global player, these national
monopolies have not, on the whole, been successful in establishing a global position.
(b) Demand conditions:
There must be a strong home market demand for the product or service. This determines how industries perceive and respond to
buyer needs and creates the pressure to innovate. A compliant domestic market is a disadvantage because it does not force the
industry to become innovative and able to excel.
(c) Relating and supporting industries:
The success of an industry can be due to its suppliers and related industries. Sweden’s global superiority in its pulp and paper
industries is supported by a network of related industries including packaging, chemicals, woodprocessing, conveyor systems and
truck manufacture. Many of these supporting industries have also achieved leading global positions.
(d) Firm strategy, structure and rivalry:
Organisational goals can be determined by ownership structure. Unquoted companies may have slightly longer time horizons to
operate in because their financial performance is subject to much less scrutiny than quoted companies. They may also have
different ‘return on capital’ requirements.
Porter called the answers to these questions the determinants of national competitive advantage. He suggested that there are four
main factors which determine national competitive advantage and expressed them in the form of a diamond.
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Chapter 18
Internal Analysis
This revolves around two issues: resources (tangible and intangible) and resourcefulness-how well the firm exploits its resources.
Three main frameworks are applicable: 7S model, value chain analysis and idea derived from the resource based view of the
firm. Remember that any (internal analysis framework can also be used as an implementation framework difference being time
frame (what have we got is analysis bit and what do we need to have if strategy is to work is implementation bit).
7S Model
Associated with consulting firm McKinsey, re are now several different versions. What is common to m all (besides Ss and in some
cases Framework has to struggle to get m all to start with S) is a set of headings under which to analyses strengths and weaknesses,
with added sophistications of emphasizing need for fit between Ss-especially strategy S and Or Ss. This makes it useful as a
strategy implementation model as well as a strategic analysis model if you change strategy you may have to change some of or &s
if it is to be implemented effectively (In this respect Chandler has a two S model- “structure follows strategy”)
Exercise: Do a 7 S analysis of a College identifying:
1.Strategy: what its objective are, and its choices of where to compete, how to compete and means and methods.
2.Structure: formal deliberate aspects of organisation in terms of departmentation; centralization/decentralization; degree of
formalization; number of authority levels.
3.Systems: procedures and processes used by college in terms of registration, student attendance; payment of fees.
4.Staff: lecturing and admin staff in terms of age and experience; performance; turnover; reward packages; teamwork.
5.Style: how Principal manages college and way that decisions are made and implemented
.
6.Shared values: degree of co-operation or conflict; degree of staff loyalty and commitment
7.Skills: any special areas of strengths or outstanding performance?
Porter’s Value Chain
A technique used by Michael Porter (for internal analysis) who pointed out that within a business entity:
• there is a primary value chain, and
• there are support activities (also called secondary value chain activities)
Primary value chain:
Porter identified the chain of activities in the primary value chain as follows.
– Inbound logistics. These are the activities concerned with receiving and handling purchased materials and
components, and storing them until needed. In a manufacturing company, inbou nd logistics therefore include
activities such as materials handling, transport from suppliers, inventory management and inventory control.
– Operations. These are the activities concerned with converting the purchased materials into an item that
customers will buy. In a manufacturing company, operations might include machining, assembly, packing,
testing and equipment maintenance.
– Outbound logistics. These are activities concerned with the storage of finished goods before sale, and the
distribution and delivery of goods (or services) to the customers. For services, outbound logistics relate to the
delivery of a service at the customer’s own premises.
– Marketing and sales. These are the activities associated with the ‘4Ps’ of marketing, namely; product, place,
price, and promotion.
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–
Service. These are all the activities that occur after the point of sale, such as installation, warranties, repairs
and maintenance, and providing training to the employees of customers. An important aspect of service is often
the work of customer call centres or customer service centres.
Secondary value chain activities: Support activities
In addition to the primary value chain activities, there are also secondary activities or support activities. Porter
identified these as:
– Procurement. These are activities concerned with buying the resources for the entity – materials, plant,
equipment and other assets.
– Technology development. These are activities related to any development in the technological systems of the
entity, such as product design (research and development) and IT systems.
– Human resources management. These are the activities concerned with recruiting, training, developing and
rewarding people in the organisation.
– Corporate infrastructure. This relates to the organisation structure and its management systems, including
planning and finance management, quality management and information systems management.
Support activities are often seen as necessary ‘overheads’ to support the primary value chain, but value can also be
created by support activities. For example:
• Purchasing can add value by identifying a cheaper source of materials or equipment.
• Technology development can add value to operations with the introduction of a new IT system.
• Human resources management can add valu e by improving the skills of employees through training.
• Corporate infrastructure can help to create value by providing a better management information system that
helps management to make better decisions.
Resource Based Approach:
Whereas tendency, for-Porter type strategy is to start with industry and n work out what strategy would fit competitive
environment (an "outside-in" approach), resource based v ie w (RBV) reverses this. Starting point is an understanding
of resources of firm- although term resource is used widely to include tangible and intangible resources as well as
skills. Different writers use different terms - resources (Barney), capabilities (Stalk/JSW), competences (Hamel and
Prahalad) but idea are same. Don’t adjust to competitive environment but adjust competitive environment to resources
of business. This could involve:
• finding a niche position within industry where firm can exploit its exceptional resources
• Changing competitive, environment through innovation an d rule breaking behaviour based on its exceptional
resources.
• Diversifying into industries where its exceptional resource is a key success factor (providing it is not easily copied by existing industry players). We will return to R B V when we look at corporate strategy;
Firm resource
heterogeneity
Firm resource
Immobility
•
•
•
•
Value
Rareness
Imperfect
imitability
o History
dependent
o Causal
ambiguity
o Social
complexity
Non
substitutability
Sustained
competitive
advantage
© Zia Ul Haq
This approach assumes that every firm is unique and that uniqueness is not easily copied or
transferred between firms, if uniqueness characteristics possess four characteristics n this is
a basis for competitive advantage as in diagram opposite.
Valued: customers have a preference for whatever it is firm is good at it is valued by
customer.
Rare: only a few firms possess’ resource; not necessarily unique to ' firm. This could be
because of unique historical factors, or because no -one understands what it is or because it is
derived from complex social factors such as culture or networks.
Imperfect mutability: whatever it is cannot be easily copied by competitors
Non-substitutable: or factors can’t be used to replace it or get around it.
Sustainability of competitive advantage is a key issue whoever's model is preferred and
whether an inside-out or outside in view is adopted. This implies investing in, legally
protecting, and finding opportunities to exploit core competences.
58
Resources (7 M) –
Money, Market, Material, Manufacture, Make-Up, Man power, Management
POSITIONING ANALYSIS
SWOT analysis is a technique (or ‘model’) for identifying key factors that might affect business strategy. It is a simple but useful
technique for analysing strategic position.
Environmental threats and opportunities recognised in an environmental scan, and internal strengths and weaknesses recognised in
a position analysis (or resource analysis) are brought together to carry out a strategic analysis of strengths, weaknesses,
opportunities and threats, which is called SWOT analysis.
Internal
analysis/
resource analysis
External /
Environmental
analysis
SWOT analysis
SWOT analysis is an analysis of strengths, weaknesses, opportunities and threats.
Strengths are internal strengths that come from the resources of the entity.
Weaknesses are internal weaknesses in the resources of the entity.
Opportunities are factors in the external environment that might be exploited, to the entity’s strategic advantage.
Threats are factors in the external environment that create an adverse risk for the entity’s future prospects.
Thus far extend and internal analysis have been separated out. However lives purpose of such analyses is to analyses the position
of firm and how it may change. Simplest and most inclusive positioning analysis framework is a SWOT (and of course inside-out
approach would priorities strengths and weaknesses and outside-in opportunities and threats.)
Do remember when doing a SWOT that:
1. Some things are more important than others and this applies to all four of SWOT headings.
2. Any of internal, analysis frameworks and any of external analysis; frameworks can be integrated into a SWOT most obviously a
5 Forces and a value chain (and generic strategy is way in which firm deploys its resources to cope with its competitive
environment).
3. Try to reach a conclusion. Is position strong or weak? Is it likely to become stronger or weaker?
Easiest indicator of strength of position and how that position has/will change is financial performance of firm- its profit margins
(gross and net) and its debt (gearing and interest cover). In exam case it is extremely likely that position of firm will either be
weak or weakening- otherwise there is no problem and without a problem examiner cannot (examine choice (which is about repositioning the firm more advantageously). Positioning and repositioning are at the heart, of business strategy and it may be
helpful to present the possibilities in a matrix form:
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Examination Approach
SWEAT THE QUESTIONS: make the questions work for you - they are examiner's way of telling you what he wants you to do
to pass.
Question requirements become answer headings. This breaks the answer up into easily makeable form, gives the impression that
you are attempting to answer the questions, and helps to keep you on track. However do NOT write the question out- abbreviate it.
The mark weightings tell you how much to write. Don't write a lot because you know a lot- writes a lot because there are a lot of
marks on that section.
The questions tell you which possible to frameworks to apply. Typically the questions will be ordered into strategic analysis,
strategic choice and strategy implementation and you should know what frameworks fit which areas.
The questions tell you what to look for in the case. Students who assume that by reading the case questions will become clearer
are termed resist. If you do not know what to look for in the case, you will never find it. ...
The questions as a whole give your insight into the case. The questions fit together to give you a general picture of what is going
on in the case scenario.
INTERREPT THE FINANCIAL AND QUANTIFIABLE DATA: before you look at the case, look at all figures. All cases are
based on comparison either across time (same firm at different dates) or across firms or both; it is "spot the difference". Typically
if it across time it will be about firm whose position is weak or weakening; if it is across firms it will be between a winner and
loser.
If across time can ignore the intermediate years and just use first and last?
If across time are forecasts and estimates realistic or optimistic?
What are financial figures saying in terms of sales volume, sales value and price? What about gross and net profit margins? What
is happening to debt in terms of gearing, interest cover and cost of debt? What about stock turnover and debtor periods?
Calculation is less important that interpretation!
Is there any operational data and if so how does it line up with the financial data?
ANALYSE THE CASE: but don't read every word because every word is not equally important.
Keep the questions in (his front of your mind when reading the case so you know what to look for and which bits of the case
answer which questions. If the case is broken up into section with headings, line these up with the questions.
use underlining and labeling- underline which bits are usable and label why and where they are going (don't just underline because
you are going to forget why you underlined ill)
Don’t get distracted by detail and faff- you are not expected to be able to do a highly detailed case analysis in time allowed.
Do not argue with the case don't start thinking "ah but, and start introducing complexity into your answer. Keep it simple, and
basic.
Decide which frameworks best fit the case information (although in most cases examiner will tell you this in questions).
PRESENT EFFECTIVELY: make it marker friendly- don’t writing essays or using long paragraphs.
use headings (from questions) and sub-headings (from whatever framework you are applying)
use the ease information including quantitative data don't just vomit theory and frameworks.
Don’t cross out-this will automatically attract the attention of marker (who will not be reading every word or sentence anyway).
Don't do their job for them.
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Chapter 19
Strategies for competitive advantage
Porter’s Generic Strategies:
Cost leadership: Set out the lowest cost procedures in an industry. By producing at the lowest possible cost the manufacture
can compete on price with every other procedure in the industry and earn the highest unit profit.
Differentiation: Here the firm creates a product which is perceived highly in the market.
Ways of achieving differentiation:
Quality differentiation
Design differentiation
Image differentiation.
Focus: Position oneself to uniquely serve one particular niche in the market. A focus strategy is based on fragmenting the
market and focusing on particular market segments. The firm will not market its products industry-wide but will concentrate on a
particular type of buyer or geographical area.
Cost focus
Differentiation focus
The strategy clock
An alternative ways of identifying strategies that might lead to competitive advantage is to look at ‘market facing’ generic
strategies.
1- No frills:
Commodity-like products and services. Very price sensitive customers. Simple products and services where innovation is quickly
imitated-price is a key competitive weapon. Costs are kept low because the product/service is very basic.
2- Low price:
Aim for low price without sacrificing perceived quality or benefits. I the long-run, the lowest price strategy must be supported by
a low cost base.
3- Hybrid strategy
Achieves differentiation, but also keeps price down. This implies high volumes or some other way in which cost can be kept low
despite the inherent cost of differentiation.
Route 4 and 5 are differentiation strategies.
4- Differentiation
Offering better products and services at higher selling prices. Product and services need to targeted carefully if customers are
going to be willing to pay a premium.
5- Focused differentiation:
Offering high perceived benefits at high prices. Often this approach relies on powerful branding. New ventures often start with
focused strategies, but then become then less focused as they grow and need to address new markets.
6, 7, 8- Unsustainable strategies
Ordinary products and services being sold at high prices. Can only work if there is a protected monopoly. Some organizations try
option 8 by sneakily reducing benefits while maintaining prices.
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Hyper Competition
Hyper-competition: where the frequency, audacity, innovation and aggressiveness of competitors create an environment of
constant movement and change. Examples are seen in:
▪ The impact of the internet on the music business
▪
Technological development in telephony
▪
Bio-engineering/pharmaceutical
Strategies for hyper-competitive environment:
-- Repositioning on strategy clock
-- Competing successfully
-- Fight and overcome competitors’ strategies
Benchmarking
Benchmarking is the process of systematic comparison of a service, practice or process. Its use is to provide a target for action in
order to improve competitive position.
Types of benchmarking:
There are various types of benchmarking such as:
Internal
Competitive/industry
Activity
Generic
Internal benchmarking:
This method examine past performance over a period of time to determine trends and best performance. Alternatively, a range of
processes might be assessed in order to determine internal best practice, which can then be used as then benchmark for other
processes. There is a danger however that this will result in the continuance of poor had habits and that competitors are ignored.
Competitive benchmarking:
This method compares performance of the process against other firms in the same industry or sector. Major automakers, for
example, will buy cars made by their competitors then reverse engineer those cars to see how to improve their own product.
However, there is a danger that, if this is only carried out on a local level, it may not promote performance that is good enough to
match wider (e.g. international) rivals.
Activity benchmarking:
This method looks at other organization, not necessarily competitors, who are performing similar activities. For example, if a firm
wanted to improve its delivery times to customers it might benchmark this activity against the delivery times of the specialist
delivery companies such as DHL. In this commercial best practice is identified.
Generic benchmarking:
For some activities, the process might be so unique that there may not be competitive or activity benchmarks available. In these
cases, a conceptually similar process is sought as a benchmark.
For example, when building a rail tunnel connecting Aomori prefecture on the Japanese island of Honshu and the island of
Hokkaido which travel under sea, the construction company would have had no similar activities against which to benchmark(the
under-sea tunnel between England and France was yet to be built). However, the tunneling was conceptually similar to
explorations into volcanic crusts and this process was used as the benchmark.
Benefits and danger of benchmarking:
Improve performance and added value – benchmarking identifies methods of improving operational efficiency and product
design and help companies focus on capabilities critical to building strategic advantage
Improve understanding of environmental pressure
Improve competitive position- benchmarking reveals a company’s relative cost position and identifies opportunities for
improvement
A creative process of change
A target to motivate and improve operations
Increased rate of organizational learning- benchmarking brings new ideas into the company and facilities experience sharing.
Danger of benchmarking:
‘you get what you measure’- managers may learn to direct attention at what get benchmarked rather than at what is important
strategically
Benchmarking does not always reveal the reason for good/poor performance.
Managers need to aware that a benchmarking exercise can appear to threaten staff where it appear that benchmarking is design
to identify weaknesses in individual performance rather than how the process itself can be improved. To alleviate this fear,
managers need to involved in the benchmarking exercise and provide reassurance to staff regarding the aims and objectives of
benchmarking.
In today’s environment, the more innovative companies are less concerned with benchmarking numbers (for example, cost or
productivity) than they are with focusing on the processes. If a company focuses on the processes, the numbers will eventually
self correct.
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Other elements of strategic choice
Ansoff’s matrix:
Existing products
New products
Existing
markets
A
B
New
markets
C
•
•
•
•
Market Consolidation
Withdrawal
Efficiency gain
Market Penetration/growth.
•
Market development
D
•
Product development
•
Diversification
Related / Unrelated
Strategy evaluation:
Johnson, Scholes and Whittington argue that for a strategy to be successful it must satisfy three criteria:
Suitability- where the options are adequate responses to the firm’s assessment of its strategic position
Acceptability- considers whether the options meet and are consistent with the firm’s objectives and acceptable to the
stakeholders.
Feasibility- assesses whether the organization has the resources it needs to carry out the strategy.
Methods of strategic development
Acquisition:
Advantages:
• It is quick way to grow.
• There can be synergic (2+2=5) gains
• Acquire the necessary strategic capabilities.
• Overcome barrier to entry.
• Can choose a target that fits best.
• Enhances reputation with finance provider.
Disadvantage:
• Can be very expensive.
• Synergies are not automated.
• Can lead to cultural clashes.
• There may be legal barriers to overcome (e.g. competition law)
• All parts of targets are acquired (including its problems)
• Require good change management skills.
Organic Growth:
Advantages:
• Can spread the cost
• No cultural clashes or control issues
• Can be set up in any way
• May get access to government grant
• Easier to terminate
• Can be developed slowly ( less risk)
Disadvantage:
• Lack of experience in new areas.
• Less attractive to finance providers.
• There may be barrier to organic entry
• It may be too slow
• No access to skills, reputation etc. or other strategic capabilities required for success.
• Managers may be spread too thinly.
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Joint venture:
Advantage:
• Can share the set-up and running costs.
• Can learn from each other.
• Can focus on relative strengths
• May reduce political or cultural risks
• It is better than going it alone and then competing
Disadvantage:
• Can often leads to disputes
• May give access to strategic capabilities and eventually allow the partner to compete in core areas.
• There may be a lack of commitment from each party.
• Requires strong central support which may not be provided.
• Transfer pricing issue may arise and performance appraisal can be complicated.
Franchising:
Advantages:
• Receive an initial capital injection
• Can spread brad quickly.
• East to terminate.
• A good way to test the market before full investment.
• Franchise may provide better local knowledge.
• Franchisor management can focus on strategic rather than operational issues.
Disadvantage:
• Share profits
• May give access to strategic capabilities and eventually allow partner to compete in core areas.
• There may be a lack of goal congruence
• There is a loss of consistency across franchises.
Strategic alliance: A strategic alliance can be define as a co-operative business activity, form by two or more separate
organizations for strategic purposes, that allocate ownership, operational responsibilities, financial risk, and reward to each
member, while preserving their separate identity/autonomy.
• Alliances can allow participants to achieve critical mass, skills and can allow skill transfer between participants.
• The technical difference between a strategic alliance and joint venture is whether or not a new, independent business
entity is formed.
• A strategic alliance often a preliminary step to a joint venture or an acquisition. A strategic alliance can take many
forms, from a loose informal agreement to a formal joint venture.
• Alliances include partnership, joint ventures and contracting out services to outside suppliers.
Seven characteristics of a well-structured alliance have been identified.
Strategic synergy- more strength when combined than they have independently.
Positioning opportunity-at least one of the companies should be able to gain a leadership position (e.g. to sell a new product or
service, to secure access to raw material or technology).
Limited resource availability-A potentially good partner will have strengths that complement weakness of the other partner,
one of the partner could not do this alone.
Less risk-Forming the alliance reduces the risk of the venture.
Co-operative spirits-Both companies want to do this and be willing to co-operate fully.
Clarity purpose-Results, milestones, methods and resources commitments must be clearly understood,
Win-win-The structure, risk, operations and rewards must be fairly apportioned among members.
The SWOT and TOWS Matrix
Effective SWOT analysis does not simply require a categorisation of information, it also requires some evaluation of the relative
importance of the various factors under consideration.
(a) These features are only of relevance if they are perceived to exist by the consumers. Listing corporate features that internal
personnel regard as strengths/weaknesses is of little relevance if they are not perceived as such by the organisation's consumers.
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(b) In the same vein, threats and opportunities are conditions presented by the external environment and they should be
independent of the firm.
The SWOT can now be used guiding strategy formulation.
Internal to
the company
Exist
independently
of the company
Strengths
Weaknesses
Opportunities
Threats
▪
Match strengths with market opportunities
Strengths that do not match any available opportunity are of limited use while opportunities which do not have any
matching strengths are of little immediate value.
▪
Conversion
This requires the development of strategies that will convert weaknesses into strengths in order to take advantage of some
particular opportunity, or converting threats into opportunities which can then be matched by existing strengths.
The SWOT technique can also be used for specific areas of strategy such as IT and marketing.
Weirich's TOWS matrix
Weirich, one of the earliest writers on corporate appraisal, originally spoke in terms of a TOWS matrix in
order to emphasise the importance of threats and opportunities. This is therefore an inherently positioning approach to
strategy. A further important element of Weirich's discussion was his categorisation of strategic options:
Internal Factors
Strengths
Opportunities
External
Factors
Threats
Weaknesses
(S – O)
Examine strategies that use
strengths to make use of
opportunities
(maxi – maxi strategy)
(W – O)
Examine strategies that take
advantages of opportunities by
overcoming / avoiding
weaknesses
(maxi – mini strategy)
(S – T)
Examine strategies that use
strengths to overcome or
avoid threats
(mini – maxi strategy)
(W – T)
Examine strategies that
minimise the effect of
weaknesses and avoid or
overcome threats
(mini – mini strategy)
▪ SO strategies employ strengths to seize opportunities.
▪ ST strategies employ strengths to counter or avoid threats.
▪ WO strategies address weaknesses so as to be able to exploit opportunities.
▪ WT strategies are defensive, aiming to avoid threats and the impact of weaknesses.
One useful impact of this analysis is that the four groups of strategies tend to relate well to different time horizons. SO
strategies may be expected to produce good short-term results, while WO strategies are likely to take much longer to show results.
ST and WT strategies are more probably relevant to the medium term.
This consideration of time horizon may be linked to the overall resource picture: SO strategies can be profitable in the short
term, generating the cash needed for investment in WO strategies, improving current areas of weakness so that further
opportunities may be seized. ST and WT strategies are likely to be more or less resource-neutral, but care must be taken to achieve
an overall balance.
Successful companies, even if they temporarily use SO, WO and WT strategies, will attempt to get into a situation where they can
work from strengths to take advantage of opportunities (SO strategy). They will strive to overcome weakness and make them
strengths; and if they face threats, they will cope with them so that they can focus on opportunities.
It is important to remember the TOWS matrix when considering the strategic options available to an organisation.
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Chapter 20
Corporate Strategy
Corporate parenting:
Goold and Campbell: Parenting Styles
Goold and Campbell (1991) identified three board approaches or ‘parenting’ style reflecting the degree to which staff at corporate
headquarters become involved in the process of business strategy development. The approach will have significant impact on the
role of central departments such as the accounting function. The different styles are:
• Strategic planning
• Financial control
• Strategic control
1. Strategic planning companies:
•
•
•
Corporate management plays a major role in setting the strategies of the each of SBUs (strategic business unit).
The approach is based on the belief that strategic decisions occur relatively infrequently and that when they do. It is important
for corporate headquarters to frame and control the strategic planning and decision making process.
Decisions are made at senior level and hence there is less likelihood of short-term views predominating.
2. Financial control companies:
In the financial control companies:
• The head office takes a ‘hands-off’ approach but sets stringent short-term financial targets that have to be met to ensure
continued funding capital investment plans.
• These types of strategy allow for diversity and companies generally have a wide corporate portfolio with limited links
between divisions and acquisition/divestment is a continuing process as opposed to an exceptional event.
3. Strategic control companies:
•
•
Corporate management take a middle course, accepting that subsidiaries must develop and be responsible for their own
strategies, while being able to draw on headquarters, expertise.
Evaluation of performance extends beyond short-term financial targets to embrace strategic objectives such as growth in
market share and technology development that are seen to support long-term financial and operation effectiveness.
Adding value:
Corporate parents do not generally have direct contact with customers or suppliers but instead their main function is to manage the
business units within the organization. The issue for corporate parents whether they:
• Add value to organization and give business unit advantages that they would not otherwise have
• Add cost and so destroy the value that the business unit has created.
Ways of adding value:
There are number of ways in which the corporate parents can add value.
• By providing the resources which the business units would not otherwise have access to, such as investment and expertise in
different markets.
• By providing access to central services such as information technology and human resources that can be made available more
cheaply on an organization-wide basis due to economies of scale.
• By providing access to markets, suppliers and source of finance that would not be available to individual units.
• By improving performance through monitoring performance against targets and taking corrective actions.
•
Sharing expertise, knowledge and training across business units.
• Facilitating co-operation and collaboration between business units.
• Providing strategic direction to the business and clarity of purpose to business unit and external stakeholders such as
shareholders.
• By helping business units to develop either through assisting with specific strategic developments or by enhancing the
management expertise.
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Destroying value:
It not uncommon for corporate parents to be criticized for destroying value such that business unit would fare better on their own.
There are a number of ways in which this can happen.
• The high administrative cost of the center may exceed the benefits provide to the business units.
• The added bureaucracy resulting from the organizational structure may slow decision and limit the organization’s flexibility
and speed of response to customers and environmental changes.
• If organization becomes very complex, this can prevent clarity and make it difficult for managers within the organization and
external stakeholders to understand the strategic direction.
Rationales for adding values:
A well-managed corporate parent should be able to add value. In their book, exploring corporate strategy, Johnson, Scholes and
Whittington identify three corporate rationales or role adopted by parents in order to do this:
• Portfolio managers
• Synergy managers
• Parental developer
Portfolio managers:
•
•
Identify and acquire under-valued business and improve them, perhaps by divesting low-performance business or improving
the performance of others.
May manage a large number of businesses, which may be unrelated.
Synergy managers:
•
•
•
•
Enhance value by sharing resources and activity, such as distribution systems offices or brand names.
May however bring substantial costs as managing integration across business can be expensive.
May have difficulty in bringing synergy as cultures and systems in different business units may not be compatible.
May need to be very hands-on and intervene at the business unit’s level to ensure that synergy is actually achieved.
Parental developer:
•
•
•
Use their own central competences to add value to the business by applying specific skills required by business units for a
particular purpose, such as financial management or research and developments.
Need to have a clear understanding of the value-adding capabilities of the parent and the need of business units in order to
identify how these can be used to add value to business units.
Need to ensure that they are able to add value to all businesses or be prepared to divest those to which they can offer no
advantages.
Portfolio Analysis:
The Boston consulting group (BCG) growth share matrix:
•
•
•
The two-by-two matrix classifies businesses, divisions or products according to the present market share and future
growth of that market.
Growth is seen as the best measure of market attractiveness.
Market share is seen to be a good indicator of competitive strength.
Relative Market Share
High
Market
Growth (%)
PROBLEM
CHILD
STAR
DOG
CASH COW
Low
Low
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The Ashridge portfolio model:
The matrix considers two particular questions.
• How good the match between perceived parenting opportunities and the parent’s skills?
•
How good is the match between the CSFs of the business units and the skills and resources that the parent can bring?
High
Ballast
Edge of
Heartland
Heartland
Ability to
Add value
Alien
Tertiary
Value trap
Businesses
Low
Low
Opportunities to add value
High
Heartland business units:
•
•
These are where there is a high degree of match and the parent company has the capabilities and experience to add value
by providing the support required by the business unit.
These businesses should be central to future strategy.
Edge of heartland business:
•
•
These are those where there is a good fit in some area where the parent can bring particular skills that add value to the
business unit, but not in others, where the parent may destroy value.
However, if parent develops sufficient understanding of the business to avoid this, then the business may move into the
heartland.
Ballast business:
•
•
There are those where the parent understands the business well but there are limited opportunities to offer help,
sometimes because the business has been owned for a long time and has no further support needs.
These businesses would do better if left alone or indeed divested.
Value trap business:
•
•
These are those where there appears to be many operating parenting opportunities but there is a poor fit with the critical
success factors of business.
There appears to be good potential but in practice because of the lack of fit with the strategy there is a high possibility of
destruction of value.
Alien business:
•
•
These are those where there is a complete mismatch.
These should not remain part of corporate portfolio.
Using the Ashridge portfolio display indicates which types of companies should be divested and why. Businesses that may be
candidates for disinvestment are:
• Alien businesses- the parent can do good to these organizations and they would achieve more in another group
• Value trap businesses-despite potential a lack of fit leads to a high possibility of a loss of value
• Ballast businesses- may do better as the parent has little to offer.
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Chapter 21
Organisation Structure, Culture and Change Management
5 Building Blocks or Elements of Organisation Structure:
Strategic Apex: top management in the organisation (Directors)
Middle Line: managers and management structure between the apex and operating core
Operating Core: represents the basic operations and individuals who carry out this work
Techno-Structure: highly skilled individuals provide technical support to organisation include accounts and IT specialists
Support Staff: staff who provide support for the operating core, such as secretarial staff, cleaning staff, repair and maintenance
staff etc.
Mintzberg’s Organisational configuration steereotypes/ Types of organisation
Entrepreneurial Organisation/ Simple Structure: Strong apex, most of the decisions taken by the leader.
Machine Organisation/Bureaucracy: techno-structure is dominant, characteristics of bureaucracy
Professional Organisation/Professional Bureaucracy: dominated by operating core, basic workers are highly skilled e.g
universities, hospitals, lawyer firms etc
Divisional Organisation: local managers have authority to run their own division, middle line is dominant
Adhocracy: complex and disordered structure, use of team work and project based work, exist in complex and dynamic
environment, support staff element is very important
Missionary Organisation: members shared common beliefs and values, no conflict of interest.
Organizational culture:
Introduction:
For change to be effective an organization will often have to change its culture. The extent of the change required will be
influenced by the type of change that is planned. For example, revolution is likely to require a greater cultural change than
adoption.
Culture: is the set of value, guiding beliefs, understanding and ways of thinking that are shared by the number of an organization
and is taught to new members as correct. It represents the unwritten, feeling part of the organization.
Culture: is ‘the way we do things around here’ (Charles Handy).
Culture : is a set of ‘taken-for-granted’ assumptions, views of the environment, behaviors and routines(Schein).
Cultural web:
The cultural web consists of six interrelated elements of culture within an organisation.
• Routines and rituals. Routines are ‘the ways things are done around here’. Individuals get used to the established ways of
doing things, and behave towards each other and towards ‘outsiders’ in a particular way.
Rituals are special events in the ‘life’ of the organisation, which are an expression of what is considered important.
•
Stories and myths. Stories and myths are used to describe the history of an organisation, and to suggest the importance of
certain individuals or events. They are passed by word of mouth. They help to create an impression of how the organisation
got to where it is, and it can be difficult to challenge established myths and consider a need for a change of direction in the
future.
•
Symbols. Symbols can become a representation of the nature of the organisation. Examples of symbols might be a company
car or helicopter, an office or building, a logo or a style of language, dress code and the common words and phrases (‘jargon’)
that employees use.
•
Power structure. The individuals who are in a position of power influence organisations. The most powerful groups within
an organisation are most closely associated with the core beliefs and assumptions in its culture.
•
Organisation structure. The culture of an organisation is affected by its organisation and management structure.
Organisation structure indicates the important relationships and so emphasises who and what is the most important parts of it.
Hierarchical and bureaucratic organisations might find it particularly difficult to adapt to change.
•
Control systems. Performance measurement and reward systems within an organisation establish the views about what is
important and what is not so important. Individuals will focus on performance that earns rewards.
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Handy’s Culture Models (Types of Culture)
Power culture
In a power culture, there is one major source of power at the centre of the organisation. Power, authority and influence spread
out from this central point, along functional or specialist lines, but control remains at the central point.
A power culture is often found in small entrepreneurial organisations, where the boss is usually the founder of the business and
also a dominant personality, who exercises close control over activities.
• A power culture is based on trust.
•
The ‘boss’ maintains freedom of manoeuvre, and retains power, by writing very little down and relying on the spoken
word.
•
The ‘boss’ tries to influence other people through the force of his personality, and personal charm.
Role culture
A role culture is probably the most readily-understood of the four corporate cultures. It exists in a bureaucracy, where the
responsibilities of each individual are defined by the job that he or she has, the job definition and its position in the organisational
structure. There is a traditional hierarchical structure to the organisation, and each job (role) has a specific function. The
organisation relies on formal communications rather than informal communication.
A role culture is probably best-suited to a large organisation in a fairly stable business environment, where employees are
expected to do the job that they have been given, and where enterprise and initiative are relatively unimportant.
People in organisations with a role culture are ‘managed’ rather than ‘led’.
Task culture
In a task culture, the focus is on tasks and getting tasks completed in the most efficient and effective way, and the main
aim is the successful solution of problems.
In a task culture, organisation is flexible. Work teams can be formed, disbanded when a task is completed, and then re-formed into
new workgroups to deal with new tasks. Individuals gain respect and authority from their knowledge and skills, rather than from
their ‘official role’ within a work team. A task culture is typically found in project teams and development groups.
A task culture is well-suited to an organisation that is continually facing new problems and challenges. In a team culture, personal
relationships matter, and individuals are ‘led’ rather than ‘managed’.
Person Culture
In a person culture, the entire organisation structure is built around one individual or a group of individuals. The rest of
the organisation exists to serve the needs of the central individual. The culture is based on the view that the organisation exists to
serve the talented individual or individuals.
It is unusual for an entire organisation to have a person culture, but small parts of an organisation might be structured in this way.
Examples are organisations built around individuals in the sports or entertainment industries, small management consultancies, or
parts of investment banks. Firms of lawyers and small hospitals might also have a person culture.
In an organisation with a person culture, the central individuals may share some common resources, such as a small administrative
support function.
Lewin’s 3 Stages:
Models for Managing Change
The change process needs to go through three stages.
Unfreeze:
The process of ‘unfreezing’ is persuading employees that change is necessary. Individuals will not want to change anything if
they think that the current situation is acceptable. Employees should be ‘unfrozen’ out of their acceptance of the current situation
Management must therefore discuss the problems with the employees affected, and communicate their ideas.
Unfreezing is therefore the process not only of making employees dissatisfied with the current situation, but also persuading them
about the nature of the changes that should be made.
Move (change):
The changes should then be made. The change managers should try to involve the employees affected and get them to participate
in making the changes. Participation in making changes helps to reduce the resistance to change.
Re-freeze:
Lewin argued that even if change is implemented, there is a risk that before long, employees will go back to their old ways of
doing things, and the benefits of the change might be lost.
It is therefore essential that once change has happened, employees should be encouraged to carry on with the new way of doing
things.
One way of doing this might be to reward employees for performance based on the desired behaviour and results.
The process of getting employees to carry on with the new system is called refreezing.
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Lewin’s Force Field Analysis:
Kurt Lewin was a social psychologist. He developed a theory, which he called force field analysis, to describe the forces that came
into conflict over planned changes. He suggested that there are two opposing forces:
• the driving forces that support the need for change, and
•
the restraining forces that oppose and resist the change.
Lewin also argued that:
• Change will not occur if the forces resisting the change are stronger than the driving forces for change.
•
Change is only possible when the driving forces for change are stronger than the restraining forces against change.
A key task of the change manager is therefore to ensure that the strength of the driving forces is stronger than the strength of the
restraining forces. There are two ways that this might be done:
1. Strengthen the driving forces for change
It might seem that the best answer is to strengthen the driving forces for change. However, Lewin argued that by increasing the
driving forces, management run the risk that the restraining forces against the change will also grow stronger.
2. The best approach is therefore to try to reduce the restraining forces against change. Management should therefore:
a.
identify the main restraining forces against change and
b.
consider ways (levers for change) of reducing their strength, for example by discussing the issues and
difficulties with the individuals concerned, or by trying to win the support of key individuals who currently
oppose the change.
Reasons for resistance to change:
Resistance is ‘any attitude or behavior that reflects a person’s unwillingness to make or support a desired change’.
Job factors
• Fear of technological
unemployment
• Fear of change to
working conditions
• Fear of demotion or
reduced pay
Reasons for assisting
change
Social factors
• Dislike need to break up
current social environment.
• Personal dislike of people
implementing change
• Lack of consultation leading
to rejection of change
Personal factors
• Implied criticism of current working method.
• Feel less valued
• Work become more monotonous
Tools / Tactics for managing change:
Education and communication – used as a background factor to reinforce another approach. This strategy relies upon the
hopeful belief that communication about the benefit of change to employees will result in their acceptance of the need to exercise
the change necessary.
Facilitation and support- employees may need to be counseled to help them overcome their fears and anxieties about change.
Management may find it necessary to develop individual awareness of the need for change.
Participation- aims to improve employees, usually by allowing some input into design making. This could easily result in
employees enjoying raised level of autonomy, by allowing them to design their jobs, pay structures, etc.
Negotiation- is often practiced in unionized companies. Simply, the process of negotiation is exercised, enabling several parties
with opposing interest to bargain. This bargaining leads to a situational of compromise and agreement.
Manipulation and co-optation- involves covert attempts to sides step potential resistance. The information that is disseminated is
selective and distorted to only emphasis the benefit of the change. Co-optation involves giving key people access to the decisionmaking process.
Power/coercion- involve the compulsory approach by management to implement change. This method finds its roots from the
formal authority that management possesses, together with legislative support.
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Balogun & Hope Matrix
Extent of change
Transformation
Incremental
Speed of change
Big Bang
Realignment
Evolution:
Transformational changes implemented
gradually through inter-related initiatives;
likely to be proactive change undertaken in
participation of the need for future change.
Adaptation:
Change undertaken to realign the way in
which the organization operates:
implemented in a series of steps
Revolution:
Transformational change that occur via
simultaneous initiatives on many fronts:
• More likely to be forced and reactive
because of the changing competitive
conditions that the organization is
facing.
Reconstruction:
Change undertaken to realign the way in
which the organization operates with
many initiatives implemented
simultaneously:
• Often forced and reactive because of
a changing competitive context.
Contextual Factors / Model:
For change to be successful, implementation efforts need to fit the organization context. There is no simple ‘off the shelf’
approach that will work for all organizations.
The change kaleidoscope was developed by Julia Balogun and Veronica Hope Hailey to help manages design such a ‘context
sensitive’ approach change.
The kaleidoscope has three rings:
•
•
•
The outer ring relates to the wider strategic change context.
The middle ring relates to specific contextual factors that need to be considered when formulating a change plan.
The inner circle gives a menu of choices and interventions (‘design choices’) available to change agents.
Contextual Factors
Time-is there time for longer term strategic development or does the firm have to react quickly to a crisis?
Scope- hoe much of the organization will be effected? Is the change best described as realignment or transformation?
Preservation- which aspects of working, culture, competences and people need to be retained?
Diversity – the need to recognize that different departments (e.g. marketing and R &D) may have different sub-cultures.
Capability – whether abilities exist to cope with the change. These can be on an individual, managerial or organizational level.
Capacity - are resources (e.g. money, managerial time) available to invest in the change process?
Readiness – are staffs aware of the need for change and are they committed to the change?
Power- how much authority and autonomy do change agents have to make proposed changes?
Each of these factors can be assessed as positive, negative or neutral in the context of change. Positive features facilities change
and negative ones restrict change.
Design choices:
Design choices represent the key features of a change management approach:
Change path- clarifying the types of change in terms of timescales, the extent of change and the desired outcomes.
Change start point- where the change is initiated (e.g. top-down or bottom up).
Change style- which management style should be adopted (e.g. collaborative, participative, directive or coercive)?
Change interventions- which mechanisms should be deployed (e.g. education, communication, cultural interventions?)
Change roles- assigning roles and responsibilities (e.g. leadership, use of consultant, role of change action teams).
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Chapter 22
Business process change
What is a business process?
At its most generic, a business a process is any set of activities performed by a business that is initiated by an event, transforms
information, materials or business commitments, and produces an output.
• Value chain and large- scale business processes produce outputs that are valued by external customers.
• Other processes generate outputs that are valued by ‘internal’ customers and other users.
Harmon’s process strategy matrix:
According to Paul Harmon a process-strategy matrix is a matrix form by estimate of:
• The strategic importance of a process on the horizontal axis.
• The process complexity and dynamics on the vertical axis.
The matrix can be used to determine how to manage individual processes.
H
Outsource
Redesign
Complex processes but not Complex dynamic processes
part of company’s core
of high value and strategic
competency
importance. they provide
competitive advantage.
- Undertake process improvement
effort that focuses on people.
Complexity/
Dynamism
L
Automate/Outsource
Minimum Effort
Straightforward, static
commodity processes
-Use automated ERP type
of application and/or
outsource.
Use minimum resources
necessary efficiency.
Automate
Straightforward, static and
and valuable.
- Automate to gain efficiency
L
H
Strategic Importance
Improving the process of an organization:
Process redesign, often called business process Re-engineering or redesign (BPR), business process management (BPM) or
business process improvement (BPI) take a ‘clean sheet’ approach to the process which is usually either broken, or so slow that it
is no longer competitive in delivering the company’s value to its customer.
Business process redesign/re-engineering:
Harmon recommends a five-stage generic process redesign mythology:
1 Planning a process redesign effort
• Identify goals
• Define scope
• Identify personnel
• Develop plan and schedule
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2
Analysis of an existing process
•
•
•
Document work flow
Identify problems
Devise a general plan for the redesign
3
Design of a new or improved process
•
Explore alternatives and choose best redesign to achieve goals.
4
Development of resource for an
improved process
•
•
Make product better, easier to manufacture and maintain
Redesign managerial and supervisory jobs and develop
measurement system to monitor new process
Redesign jobs, work environment and incentive systems; develop
training ; hire new employees if necessary
•
5
Transition - Managing the
implementation of the new process
•
•
•
Integrated and test
Train employees, arrange management
Maintain process and modify as needed
POPIT Model
The POPIT (or four-view) model provides details of the key aspects that should be considered in managing changes within any
business system.
Organization
Information
technology
People
Process
The business system’s success will depend upon:
• People: staff needs to have the right skills and motivation to carry out the task. They need to understand tasks and their roles
within the organization. Staffs need to be developed to support business changes and resistance to change has to be managed
and overcome. This will involve understanding and sometimes shifting the organization culture.
• Organization: success must be organized. Job roles needs to be clearly defined and understood, lines of command and
communication needs to be effective, the organizational structure need to support the organization strategy, there needs to be
flexibility in changing environments and bureaucracy needs to be kept to a minimum. Organization will be an important link
between the other elements of the business system.
• Processes: these must be well defined, efficient, documented and understood. Those of high strategic importance and
complexity should have undergone process improvement. Opportunities for improvement in other areas must have been
explored in order to maximize efficiency and support the organization strategy.
• IT: IT needs to support the changes that are taking place within the system. It needs to provide the relevant information at the
point that it is needed. IT can replace some manual tasks and improve the efficiency of others. IT may facilitate organization
changes, process change and staff development and it therefore it bind all of the other elements together. IT must be
explained in order to maximize business benefits.
Software solutions:
New software plays a key role in many redesign efforts. There are a number of areas to consider when buying new software:
• Establishing what we need the software to do
• Deciding between generic and bespoke solution
• Choosing a supplier of our chosen solution
• Implement the software solution
Using generic software solutions:
There are many ways to produce a solution.
• Purchasing a standard (‘generic’) software package and:
o Use without nay modification
o Make suitable amendments to customize this for the organization’s specific requirements
o Add company specific modules as necessary
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•
Pay for a bespoke system to be developed using existing hardware.
The advantage and disadvantage of generic solutions are as follows:
Advantage
Disadvantage
•
•
•
•
•
•
•
•
They are generally cheaper to buy than bespoke solutions
are to develop.
They are likely to be available almost immediately.
Any system bugs should have been discovered by the
vendors before sale.
Good packages are likely to come with good training
programs and excellent documentation and on-screen
help facilities.
New updated versions of the software are likely to be
available on a regular basis.
The experience of a great number of users with similar
needs to those in the organization has been incorporated
into the design of the package.
Different packages will be available for different
operating systems or data structures.
•
•
•
They do not fit precisely the needs of the
organization- the user may need to compromise
what they want is available.
The organization is dependent upon an outside
supplier for the maintenance of the software; many
software suppliers are large than most of their
customers, and therefore difficult to influence.
Different packages used by the organization may
have incompatible data structures.
Using the same packages as rival organization
removes the opportunity of using IS for
competitive advantage.
Evaluation and selection a generic software solution:
Selection criteria:
In evaluating different options, both the software and the supplier need to be assessed. Key factors are thus:
Software
Supplier
•
•
•
•
•
•
•
•
•
•
•
•
Meeting user requirements
Costs
Interface design
Controls
Updates
User manuals
Compatibility with existing hardware and software
Support and maintenance
•
Length of time in business
Financial stability
Third party references
Availability of demonstration copies of
software
Ethical issues-e.g. are they a good global
citizen?
Change over technique:
Parallel running
Direct changeover
Phased
Parallel running:
This is when the new and old system runs side by side for a period of time, e.g. several weeks, until the analyst is satisfied with
the operation of the new information system.it is known as the high-cost low-risk approach.
Direct changeover:
This approach is when the old system immediately finishes and the new takes over; confidence will be high in the new
information system. For example, the old finishes at8.59.59 seconds and the new starts at 9.00.00 seconds. It is known as the highrisk low-cost approach.
Phased:
This is when the new information system can be introduced part by part or stage by stage. This may be useful if the organization is
implementing an information system in a number of departments, as it will help to limit the impacts of the new system. It must be
remembered that the phase can be either direct or parallel in each of the stage.
Boundaryless organisations
Organisations are working together, often as a network, more than ever before. Organisations often find themselves working more
collaboratively with suppliers and customers as well as relying more heavily on the outsourcing of many business activities.
The aim of a boundaryless organisation is to remove barriers to growth and change and ensure that employees, the organisation,
customers and suppliers can collaborate, share ideas and identify the best way forward for the organisation. Typical boundaries
found in organisations are:
• Vertical boundaries
• Horizontal boundaries
• External boundaries
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Vertical boundaries: these are the levels of authority that exist within an organisation and the pathway through which decision
making takes places. The more levels of authority that exist then the slower and more bureaucratic decision making becomes. It
also limits communication and interaction between employees at different levels within the organisation. This could, for example,
limit the ability to share ideas within the organisation. A boundaryless organisation will aim to have fewer levels of authority,
more communication and interaction between all employees, and create a more collaborative decision making process. It often
means that rank and role become much less important within the organisation. There is often a less formal management style, a
greater desire to transform and improve staff, and a move towards a culture that embraces change more readily so that the
organisation is better prepared for change (these ideas are explored further in later chapters).
Horizontal boundaries: these are the boundaries that exist between functions in an organisation. Functions may follow their own
goals rather than organisational goals and it may be that there is poor communication between employees who work within each
function. The communication may be driven by bureaucracy and controls such as the budgeting system. In turn these may create
cultural and knowledge boundaries – there may be different working methods in each function and it may well be that there is less
sharing of knowledge that could create better performance in each function. For example, the sales function may understand well
what types of components that customers would like to see in a finished product, but if this knowledge is not shared with the
purchasing or production team then the organisation will underperform. To overcome these boundaries, boundaryless
organisations will often have crossfunctional teams, encourage staff to make secondments between departments, have more
regular and quicker communications (e.g. by using more digital communications) as well as having better controls in place to
ensure improved goal congruence. Areas such as knowledge management and redesigned job roles, explored elsewhere in the
syllabus, can play a part in overcoming these boundaries.
• External boundaries: these are boundaries that exist between the organisation and the outside world, including customers and
suppliers. These boundaries can affect the two way communications that are vital for an organisation’s success. For example, it
may well be that customers are not informed of what the organisation is planning or what new developments are taking place.
Likewise, it may also mean that the organisation is not gathering information from customers that will require the organisation to
change if it is to be successful. Similar problems can accrue if communications with suppliers are poor. Boundaryless
organisations aim to collaborate with their customers and suppliers. For example, communications with customers can be
improved through user contributions (reviews, expertise, feedback) and crowdsourcing (for example, asking motorists to phone in
with reports of traffic hold ups). Information is provided through internet forums and regular electronic communications. Supplier
collaboration is improved through systems such as e-procurement (explored later in the syllabus), strategic alliances and
outsourcing.
There are three main types of boundaryless organisation:
• The hollow structure – where non-core activities are outsourced
• The modular structure – where some parts of product production are outsourced
• The virtual structure – where the organisation is made up of a collaboration of other organisational parts
Hollow structure: hollow organisations focus on their core competencies and outsource all other activities. Typically, processes
such as human relations, information technology and event management are outsourced to a specialist provider. This leaves the
company free to focus on what it considers to be its core value-adding activities. Critical to the success of this structure is the
ability of the organisations to identify which core processes are critical to its mission, create a current or future competitive
advantage and drive growth. It will also be important to align the suppliers’ incentives and the company’s strategic goals. The
choice of supplier will be vital to the structure’s success. As some processes become commoditised, these decisions become easier
to take.
• Modular structure: modular organisations divide their product into manageable chunks and then order different parts from
internal and external providers which the organisation then assembles into an overall finished product. For example, a cellular
phone company might design the product and build the chip, the software and the built-in apps themselves, but then outsource the
production of the glass, the chassis, the gyroscope etc. This can lead to a faster and improved production process as well as using
market forces to drive down the production cost of each module of the product. It can also force internal production functions to
become more efficient. Ultimately, it may well be that internal production can in turn produce elements to be sold externally.
Samsung, for example, have made screens for other companies such as Apple and Sony.
• Virtual structure: virtual organisations rely heavily on information technology to link people, assets and ideas to form an (often
temporary) organisation. Links are formed with external partners (which may be whole organisations, a part of an organisation or
simply a team of experts) where each partner brings their own domain of expertise. This expertise is combined together to achieve
common goals. A virtual organisation appears as a single entity from outside to its customers, but it is in fact a network of
different organisational nodes created to respond to an exceptional, and often temporary, market opportunity. Over time, the parts
(or members) of the virtual organisation might change. Once the market opportunity evaporates or is fully exploited, the virtual
organisation either disbands or is absorbed into the larger organization.
This is a way of responding quickly to the market without having to develop new areas of expertise or new production capacity,
say. It makes use of valuable expertise that may exist outside the organisation.
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Chapter 23
Project Management
Project features:
A project can be defined simply as an activity, which has a start, middle and end, and consumes resources. It will:
• Have a specific objective.
• Have a defined start and end dates.( timescales)
• Consume resources (people , equipment, and finance)
• Be unique (a one- time-only configuration of these elements)
• Have cost constraints that must be clearly defined and understood to ensure the project remain viable
• Require organization
In general, the work which organisations undertake involves either operations or projects. Operations and projects are planned,
controlled and executed. So how are projects distinguished from 'ordinary work'?
Projects
Operations
Have a defined beginning and end
Have resources allocated specifically to them, although often
on a shared basis
Are intended to be done only once
Ongoing
Resources used 'full-time'
A mixture of many recurring tasks
Goals and deadlines are more general
Often cut across organisational and functional lines
Usually follows the organisation or functional structure
A mixture of many recurring tasks
An activity that meets the first four criteria above can be classified as a project, and therefore falls within the scope of project
management. Whether an activity is classified as a project is important, as projects should be managed using project
management techniques.
Common examples of projects include:
▪
▪
▪
▪
Producing a new product, service or object
Changing the structure of an organisation
Developing or modifying a new information system
Implementing a new business procedure or process Operations
What is project management?
Project management is the combination of systems, techniques, and people used to control and monitor activities undertaken
within the project. It will be deemed successful if it is completed at the specified level of quality, on time and within budget.
Achieving this can be very difficult: most projects present a range of significant challenges.
Stages in project life cycle:
Every project is different, but each will include at least the following five stages:
1. Initiation
2. Planning
3. Execution
4. Control
5. Completion
1. Project Initiation- Building the Business Case:
The business case is a fundamental component of the PRINCE2 methodology, which is built on the assumption that a
project is, in fact, driven by its business case. The contents of a business case document assesses what benefit might be derived
from a project and how these benefits should be managed, it assesses potential project costs, and it finishes by matching up the
project costs and benefits in project appraisal techniques.
Reason for building a business case:
• To obtain funding from the project
• To compete with other projects for resources
• To improve planning
• To improve project management
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The formal business case document:
Introduction:
This sets the scene and explains the rationale behind why the project has been considered.
Executive summary:
This is the most important part of the document as it is likely that this will be the part that is read in most details by the senior
management team. It will include the considerations that have been made, the options considered, the rationale behind the
recommendation and a summary of the key numbers (e.g. the output from a financial project appraisal)
Description of current situation:
This will be a strategic and operational assessment of the business. It will include a SWOT analysis and aim to identify the
problems that the business is facing and the opportunities available to solve those problems.
Options considered:
This will have an assessment of each option that has been considered and provide reasons for the rejection of options that have not
been recommended.
Analysis of cost and benefits:
This will have the key elements for project assessment. The detail will be provided in the appendices. This section will provide
quantifiable benefits and costs but will also make some attempt to quantify intangible benefits and costs such as the impact on
customer satisfaction and staff morale. The output from any project appraisal techniques will also be provided.
Impact assessment:
This will examine the impact on element of the cultural web (studied in a later chapter) such as the organization culture, the
management style, staff role and routines etc.
Risk assessment:
This section will aim to identify the risks to successful project performance and suggest how each risk should be managed. It may
also contain some contingency planning to give guidance on different possible directions for the project in the face of these risks
arising (though this is often left until the detail planning stage).
Recommendations:
This will involve the justification for the suggested path that the project has pursued. It will pull a lot of the other sections of the
business case together.
Appendices:
This will lay out the detailed costs and benefits and schedules for areas such as project appraisal.
Pre-initiating tasks
Pre-initiating tasks are the responsibility of the senior managers who decide that the project should be undertaken.
(a) Determination of project goals and constraints. This involves setting the project scope, but also identifying time or cost
constraints
(b) Identification of the project sponsor
(c) Selection of the project manager
2. Planning - The Project Plan:
Alongside the benefit realization plan and business case, the project team will also need a detailed plan for resources, timings,
interim targets etc. This will be the project plan.
Content of a project plan:
For a large project the content of the plan will be made up of several parts:
An overview of
the project
The exit and
sustainabilit
y plan
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The project
resources
The detailed
plan
Project plan
The
dissemination
plan
The
evaluation
plan
78
To provide an overview of the project the project plan will include the following:
Background to the project - A summary of the background to the project (and how it build on previous work) and the need for it
(and why it is important).
Aims and objectives – A list of the board aim or purpose of the project, and the specific objectives you intend to achieve.
Overall approach – A description of the overall approach you will take to achieve the objectives outlined above including:
Strategy and/or methodology and how the work will be structured.
Important issues to be addressed, e.g. interoperability.
Scope and boundaries of the work, including any issues that will not be covered.
Link to critical success factors.
• Project outputs – A list of the tangible deliverables (including reports) your projects will create, and the less tangible
knowledge and experience you hope to build and share.
• Project outcomes – A list of the outcomes you envisage and what change they will stimulate or enable.
• Stakeholder analysis using Mendelow’s power-interest matrix –a list of the stakeholder groups and individuals that will
be interested in your project outcomes, will be affected by them, or whose support/approval is essential , both within your
organization and in the community, and assess their importance (low/ medium/high).
• Risk analysis- a list of the factors that could pose a risk to the project’s success and an assessment of their likelihood and
severity, and how you will prevent them from happening (or manage them if they occur).cover the types of risks listed and
any others that apply.
• Standards- a list of the standards the project will use.
• Intellectual property rights- an indication of who will own the intellectual property create by the project and a list of any
owed by third parties that will be incorporated into project outputs, when/how you will obtain permission to use them, and
any implication for project to output after the project ends.
The project resources part of the plan will contain detail o0f the project partner and project management with the brief
description of the project management framework, including:
• Organization
• Reporting relationships
• Decision process
• The rule of any local management committee
The detail part of plan with outline:
• The project deliverables and reports
• When they are due
• The phasing of the work and any dependencies.
The evaluation plan will indicate how you will evaluate the quality of the project outputs and the success of the project. It will
list the factors you use, and how success will be measured.
The dissemination plan will explain how the project will share outcomes and learning with stakeholders. It will list the important
dissemination activities planned throughout the project- indicating.
• Purpose
• Target audience
• Timing
• Key message
The exit and sustainability plans should explain what will happen to project outputs at the end of the project (including
knowledge and learning). They will focus on the work needed to ensure their taken up by the owners and any work needed for
project closedown, e.g. preservation, maintenance, documentation.
Importance of a project plan:
A project plan aims to ensure that the project objectives are achieved within the constraints of quality, cost and time. Planning is
essential - it helps to
• Communicate what has to be done, when and by whom.
• Encourage forward thinking.
• Provide the measures of success for the project.
• Make clear the commitment of time, resources (people and equipment), and money required for the project.
• Determine if targets are achievable
• Identify the activities the resources need to undertake
The plan is likely to be recorded as an element of project initiation Document (PID). This is not a one-off, pre project document
like the business case document. It will contain the business case document and project plan, but it is also likely to be constantly
revised and updated through the project life to reflect key changes and project completion phases.
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Project Initiation Document (PID) / Project Charter:
•
•
•
•
The PID is a formal, detail document which contains planning information extracted from other resources such as:
Business case
The dissemination plan
The risk assessment
Gantt charts, etc.
It contain all the information necessary for the execution of the project
It is more operational than a business case document and its focus is very difficult. The business case is aimed at gaining project
approval whereas the PID is aimed at ensuring that an approval project is successfully completed.
It will give guidance to the project team on what is expected from the project, when it is expected, and what level of performance
is expected. It will have detailed plans (such as Gantt charts), control plans for when risk arise, responsibilities for task etc.
The PID is likely to be constantly revised and updated throughout the project life to reflect key changes and project completion
phases. However, this can be a problem in a project as often the PID is updated and changed but it move further away from the
original business case and objective. Benefits management becomes even more important when this occurs.
3. Project Execution:
Executing consists of the processes use to complete the work defined in the project management plan to accomplish the
project’s requirements. Execution process involves coordinating people and resources, as well as integrating and performing the
activities of the project in accordance with project management plan. The deliverables are produce as outputs from the processes
performed as defined in the project management plan.
Matrix structure:
Projects are often interdisciplinary and cross organizational reporting lines. The project team is likely to be made up of members
drawn from a variety of different functions or divisions: each individual then as it dual role, as he or she maintains
functional/divisional responsibilities as well as membership of the project team.
Team members:
A team member is elected to join the core team because of their specialist knowledge or expertise.
• Specialist an technical experts
• Representative
• Monitor
• Change manager
• Problem solver
Project Sponsor:
The project sponsor project facilitator will normally be a senior member of the management team.
• They are often chosen as the person with the most to gain from the success of the project and the most to lose from the failure
of it.
• Their job is to direct the project, and allow the project manager to manage the project.
The project manager:
The project manager is the person appointed by the organization to lead the team, and manage it on a day to day basis. Primarily
the project managers responsibility is to deliver the project and to ensure the effectiveness and efficiency are achieved across the
entire project.
Typical roles of a project manager:
•
•
•
•
•
•
•
•
Team leader
Planner and coordinator
Task manager
Communicator and relationship manager
Problem solver
Monitor and charge manager
Budget manager
Meeting manager
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4. Control - Monitoring the project:
The purpose of the project monitoring, reviewing and controlling process is to track all major project variables and to ensure the
team is making satisfactory progress to the project goals.
Performance measurement can include:
• Expenditure ( cost)
• Schedule ( time) performance- avoiding schedule slippage is a key objective
• Scope measures- both product scope and project scope
• Functional quality
• Technical quality performance
• Issue management performance
• Client satisfaction measures
Project Gateways:
The process is aided by specific project gateways. This will be review points that are planned for critical points in the projects.
The reviews will also ensure that the business case which justifies the project is still valid at this stage.
If problems are identified then project control measures and corrective action will be necessary.
The purpose of the gateway review is to help increase the chances of success delivery for projects. It is not an audit but is a realtime assessment of the potential project success. It allows the projects to change course or address issues that have the potential to
undermine the objectives or affect the projected benefits.
It can also provide evidence to stop projects that are severely off course or badly misaligned with business objective. Gateway
reviews provide important assurance to benefit owners that rigorous independence assessment of the project is taking place.
Gateway reviews are normally carried out by person/persons who are not involving in the actual project. This gives independence
to the review. In a larger organizations and projects a specialist review team may be created.
A review can only be a snap-shot of the programmers or project as it is at the point at which the review takes place. As such,
recommendations are based on the evidence presented and on the interviews that take place. The review process is intended to be
supportive and forward looking and will take future plans into account but only as future intentions, rather than actualities.
5. Project Completion:
The final stages of a broadly successful project can be most rewarding. It is at this stage that people can finally see the realization
of the plans and objectives.
A post project review (PPR):
This happened at the end of the project and allows the project team to move on to other projects. 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 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 organization.
Post implementation review( PIR):
A PIR is an essential component of the management process. A post-implementation review focuses on the product
deliver 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 an experience the product or service and to feedback their observations into 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 these instances these lessons learnt are fed back into the product production process. Without a PIR, a business cannot
demonstrate that its investment in the project was worthwhile.
PIRs can some time be an on-going element of project management that may be used at project gateways to examine changes
implemented to data.
Comparing the PPR and PIR:
For most projects, A PIR is undertaken when there has been sufficient time to demonstrate the business benefits of the
new project. For a major programmer of a change there may be several PIRs overtime. The review will normally involve the
project manager, senior management, representatives and, where used, internal benefits management experts.
The PPR and PIR are related but have different objectives. The PPR is a one-off exercise at the end of the project with the key
objective of learning lessons and feeding them into the organizations project management process and procedures for the benefits
of future projects.
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The objective of the PIR is to ensure that the maximum benefit is obtained for the organization through the new project, and to
make recommendations if the benefits are not obtained. Every project is different, but it is typical to perform a PIR two to twelve
month after completion of project.
The PPR focuses on the performance of the project, whilst the PIR focuses on the performance of the product of the project.
Project success and failure:
Successful project management can be defining as having achieved the project objectives and benefits.
• Within the allocated time period.
• Within the budgeted cost.
• At the desire performance or specification level.
• While utilizing the assign resources effectively and efficiently.
• With customer conformation of expectations.
• Without disturbing the main work flow of the organization.
Reason why project succeed:
•
•
•
•
•
•
•
Project sponsorship at executive level
Good PID and business case
Strong project management
The right mix of team players
Good decision making structure
Good communication
Team members are working toward common goals
Reason for project failure:
•
•
•
•
•
•
•
Failure to align project with organizational objectives
Poor scope
Unrealistic expectations
Lack of executive sponsorship
Lack of true project management
Inability to move beyond individual conflicts
Internal politics
The barriers to project management success are:
•
•
•
•
•
Project complexity
Customer special requirements and scope changes
Organizational structural and systemic resistance
Project risk
Change in technology
Project constraints:
Dimensions of project management:
Cost:
•
•
Initial budget for project
Need to prove the benefits of project exceed costs.
Time:
•
•
Overall time constraints on completion of project
Time budget- amount of man-hours, etc. available for project
Scope:
•
•
Series of tasks to be performed
Quality level expect of each task
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Project costs:
In order to properly assess a project the potential benefits need to be measured against the potential costs. Typical projects cost
might be:
• Capital investment.
• Development costs.
• Externally allocated costs/infrastructure cost.
• External consultancy costs.
• Resource costs.
• Quality costs.
• Flexibility costs.
• Disruption costs.
Project benefits:
Strategic management:
A new project might be a way to gain a competitive advantage as already seen with areas such as business process redesign and
supply chain management.
Productivity gains:
A project may make operations more efficient or remove non value adding activities from the value chain In order to increase
overall productivity of the business. This may be tied-in to be strategic benefit such as cost leadership.
Management benefits:
A project makes the organization more flexible and reactive to its environment.it might give more up-to-dates information to the
managers so that they can make more agile decisions. These benefits often arise from projects which involve organization
redesign or investment in new IS/IT systems.
Operation benefits:
These involve benefits seen in areas such as resource and assets. The project may lead to better management and utilization of
these areas- for example, it may simplify job roles or reduce staff turnover.
Functional and support benefits:
Other areas of the value chain may also see benefits such as HRM, marketing, services etc.
Intangible benefits:
These can only be measured subjectively. A benefit of a project might be to improve staff morale or customer satisfaction. These
benefits should be included in the business case, and many organizations try to put some value on them regardless of how
subjective that value might be.
Emergent benefits:
Often referred to as secondary or unexpected benefits these benefits might not be expected at the outset of a project but they
‘emerge’ over time. For example, we’ve seen how change to a divisional structure for a business might lead to greater focus and
responsibility accounting, but it might also provide opportunities for further diversification that was not envisage as part of the
original change project. The benefits might only emerge as the organization become more comfortable with its new structure.
Benefit management, (discussed later) aims to manage for these benefit as well as for planned benefits.
The benefits can often be classified along the following scale:
1.
2.
3.
4.
Observable
Measureable
Quantifiable
Financial
Observable:
Intangible benefits (such as improvements in staff morale) often fall into this category. Individuals or groups in the organizations
with a level of expertise in this area will often use agreed criteria to determine whether or not this benefit has been realized.
Measureable:
A measure may exist for this type of benefits, but it may not be possible to estimate by much performance will improve when the
changes are completed. This means that the business can often tell where it is at the movement but cannot specify where it will be
post project.
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Quantifiable:
These benefits should be forecast able in term of benefits that should result from the changes. This mean that their impact can be
estimated before the project commences (unlike measurable benefits where the impact can only be assessed after the project has
been completed). Often, productivity gains and operational benefits will fall into this category. For example, it may be possible to
estimate that new machines will be able to produce 20 % more units per hours.
Financial:
These benefits can be given a financial value- either in term of a cost reduction or a revenue increase. The aim should be to have
as many benefits as possible in this category so that a financial appraisal of the project is possible.
Benefit management:
The purpose of the benefit management process is to improve the identification of achievable benefits and to ensure that decisions
and actions taken over the life of the investment lead to realizing all the feasible benefits.
(Benefits management, Ward and Daniel, 2006)
The benefit management process:
Ward and Daniel suggest the following stages to ensure that the benefits management process realizes the maximum set of
benefits from the project:
1. Identify and structure benefits
2. Plan benefit realization
3. Execute benefits plan
4. Review and evaluate results
5. Establish potential for further benefits
A benefit dependency framework:
A benefit dependency framework is aimed at ensuring that the business drivers and investment objectives are achieved
by ensuring there are appropriate business changes in area such as work methods, structure, culture etc.
The network should be established in the following orders:
1. Identify business drivers
2. Establish investment objectives
3. Identify business benefits
4. Identify required business changes
5. Associate further enabling changes
Business Drivers:
Business drivers, investment objectives and business benefits have been discussed earlier in this chapter. The changes required in
the business to facilitate a successful project have been further divided into two categories:
Business changes:
These are permanent changes to working methods that are required in the business in order to achieve and sustain the proposed
benefits. This might include new roles and responsibilities, new performance measures, new information system, new reward
scheme etc.
Although such changes should be seen as permanent changes, they may not necessarily be long term. As further projects are
introduced further business changes may be needed.
Enabling changes:
These are one-off changes that are necessary to allow the business changes to be brought about. Example include staff training,
migration of data, data collection etc.
These may be further extended into enabling IS/IT changes that are required. This could include the purchase of a new IT system,
for example.
A benefit owner should be assigned to each individual benefit. Change owners may also be required to
ensure benefits are fully realised.
A benefit owner should be assigned to each benefit. A benefit owner is an individual or group who will gain advantage from a
business benefit and who will work with the project team to ensure that benefit is realised.Ideally it should be someone who gains
an advantage from benefit and is therefore motivated to ensure that the benefit is realized.
A change owner will be appointed for each enabling and business change. A change owner is an individual or group who will
ensure that an identified business or enabling change is successfully achieved. It will be their job to ensure that the job is
successfully achieved. For example, if an enabling change is to train staff in new production techniques, then perhaps an HR
manager will be given ownership of this change and responsibility for its success or failure.
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Advantage of a benefit dependency network:
•
•
•
•
•
•
•
It clearly illustrate the why (business drivers), what (business benefits) and how (business and enabling changes) for the
project.
Linkage can be clearly identified.
Enabling changes can be followed through to the business drivers.
If some business benefits require too many enabling and business changes then they may be dropped from the project.
It can feed into the project plan and improve the efficiency of that stage of project management.
It may form the basis of project SWOT analysis.
The impact of a failure to make an enabling change, for example, can be followed through to discover the overall impact on
the project.
Disadvantages of a benefits dependency framework:
•
•
•
It can be complicated to illustrate.
Not all links enabling changes to business changes and so forth may be identified.
It may not be complete.
Project Management Software:
The planning and control of the project will be assisted through the use of appropriate software. The type of output produced by
the package will vary depending upon the package being used e.g. Fast PLAN and Win project.
They may be used in variety of ways:
Planning:
The ability to create multiple diagrams
The ability to create Gantt charts
The ability to aid in the creation of the PID
Estimating:
The ability to consider alternative resource allocation
The ability to create and allocate project budget
The ability to allocate time across multiple tasks
Monitoring:
Network links to all project team members
A central store for all project results and documentation
Automatic comparison to be plan, and plan revision
Reporting:
Access to team members
Ability to create technical documents
Ability to create end of stage reports
Advantages:
Improved planning and control
Improved communication
Improve quality of systems developed.
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Chapter 24
The Role of Information Technology
E-Business:
The meaning and use of e-business:
E-business has been defined as the transformation of key business process through the use of internet technologies.
E-commerce is a subset of e-business. The most generic description of e-commerce is trading on the internet, buying and selling
products and services online.
Categories of e-business function:
Delivery by
Business
Consumer
Business
Exchange
Initiated by
Consumer
•
•
•
•
•
•
B2B Business model
e.g. vertical Net
B2C Business models,
e.g. amazon.com
C2B Business models,
e.g. priceline.com
C2C Business models,
e.g. eBay.com
B2B (business to business). For example, a super market IS system automatically placing orders into suppliers’ IS system.
B2C (business to consumer). Selling over the internet-books, flights, music, etc.
C2B (consumer to business). Some internet sites display a selection of suppliers’ offerings from which the user can choose a
model that largely depends on the internet.
C2C (consumer to consumer). Auction sites, such as eBay, putting consumers in touch with each other. Amazon does the
same by offering second-hand books. This model largely depends on the internet.
‘Buy side’ e-commerce focuses on transactions between a purchasing organization and its suppliers.
‘Sell side’ e-commerce focuses on transactions between a purchasing organization and its customers.
Benefits of e-business:
Most companies employee e-business to achieve the following:
• Cost reduction-e.g. lower overheads, cheaper procurement.
• Increased revenue - e.g. online sales, better CRM.
• Better information for control – e.g. monitoring website sales
• Increased visibility
• Enhanced customer service- e.g. via extranets
• Improve marketing- e.g. e mailing customers with special offers
• Market penetration- e.g. even small suppliers can gain a global presence via the internet.
• The combination of the above should be to enhance the company’s competitive advantage.
Barriers to e-business:
Barriers to e-business can only be seen in both the organization itself and it its suppliers and customers. They include:
• Technophobia
• Security concerns
• Set-up cost
• Running costs
• Limited opportunities to exploit e-business
• Limited IT resources in house
• Customers not likely to be interested in e-business
Intranet and extranet:
Intranets are internal internets. Hey exit inside the organization only, using website and browser technology to display
information.
Extranets are intranets that are connected to external intranets.
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Controls in an information system:
The combat the type of risks discussed above companies will put in place control procedures. These must be assessed for cost
effectiveness and should reduce risk to an acceptable level.
CONTROLS
GENERAL
CONTROLS:
Ensure appropriate
systems and security
from loss of data.
Application controls:
Network controls:
Software control:
Design for each individual
application, and aim to
prevent, detect and correct
translation processing errors.
Arisen in response to
distributed processing and
e-commerce.
To ensure that the
software used is
authorized.
Security controls: controls designed to ensure the prevention of unauthorized access, modification or destruction of stored
data.
Integrity control: controls to ensure that the data are accurate, consistent and free from accidental corruption.
Contingency control: in the event that security or integrity control fail there must be a back-up facility and a contingency
plan to restore business operations as quickly as possible.
Physical access:
There are various basis categories of controlling access to sensitive areas.
These include:
• Security guard in building
• Working area to which access is through a locked door or a door with an ID card entry system or entry system requiring the
user to enter a personal identification code (PIN NUMBER)
• Using safes and lockable filing cabinets
• Closed circuit TV used to monitor what is happening in a particular part of a building – this may be backed up by security
video cameras
• Doors automatically locked in the event of a security alarm.
Disaster recovery plans:
An unexpected disaster can put an entire computer system out of action. For large organizations, a disaster might involve damage
from a terrorist attack. There could also be threat from fire and flood damage. A disaster might simply be a software or hard ware
breakdown within a system.
System back-ups:
All files containing important information should be backed up on a regular basis. Backing up provides protection against the loss
or corruption of data due to:
• Faults in the hardware (e.g. hard disk)
• The accidental deletion of a file by a computer operator
• Damage to data file by a hacker
A back-up is simply a copy of files. If the original file is lost or become corrupt, the back-up can be substituted in its place, and
the master file can be re- created.
Application controls:
These are controls to ensure that data are correctly input, processed and correctly maintained, and only distributed to authorized
personnel.
Application controls are specific to each application, but can be grouped as follows:
Input controls:
•
•
•
Checking and authorizing source documents manually.
The use of batch controls.
Pre-numbered forms.
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Processing controls:
•
•
Computer verification and validation checks
Error detection controls such as
Control totals
Balancing.
Output controls:
•
•
Monitoring of control logs
Physical checking of output.
Software controls might be applied to:
•
•
Ensure the completeness of input data
Improve the accuracy/correctness of input data.
Controls over the completeness of input.
This is only possible if there is a way of checking how many transactions should be processed, or whether a transaction has been
omitted.
Control over the accuracy of data input:
Controls over the accuracy of data. In computer systems, a combination of two techniques are used to ensure that data is accurate:
Data validation checks:
Software validation checks might be written into the software to identify logical errors in the input. Commonly used checked are:
• Existence checks
• Length checks
• Format checks
• Type checks
• Check digital verification
• Spell checks
Data verification: Validation checks ensure that data is valid but it may still contain errors.
Supply chain management: (SCM)
Many businesses prosper or fail depending on success of their relation with the suppliers and with those who they supply.
Businesses that rely on other businesses to this extent are in what is called a supply chain – each supplying each other right up to
the final link in the chain, the consumer. The internet can help make this relationship work more effectively and efficiently.
Upstream SCM:
The key activity of upstream SCM is e-procurement.
What is e-procurement?
The term ‘procurement’ covers all the activities needed to obtain items from a supplier: the whole purchases cycle.
E-procurement is the term used to describe the electronic methods used in every stage of the procurement process, from
identification of requirement through to payment. It can be broken down into the stages of e-sourcing, e-purchasing and epayment.
E-sourcing covers electronic methods for finding new suppliers and establishing contracts.
E-purchasing covers product selection and ordering.
Buying and selling online streamlines procurement and order reduces overheads through spending less on administration time and
cutting down on bureaucracy. E-purchasing transfers effort from a central ordering department to those who need the products.
E-payment includes tools such as electronic invoicing and electric fund transfers. Again, e-payment can make the payment
processes more efficient for both the purchaser and supplier, reducing cost and errors that can occur as a result of information
being transferred manually from and into their respective accounting systems. These efficiency savings can results in cost
reductions to be shared by both parties.
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Downstream SCM:
Downstream supply change management is about managing relationships with both customers and consumers, as well as any
other intermediaries along the way.
Examples of downstream supply chain management actions are:
• Providing display for retailer
• Creating a website for end users
• Creating user forums on websites
• Determining which retailers and distributors to use
• Use of different logistical methods/providers
• Changes to finished goods inventory policies
• Setting recommended retail prices
• Giving retail exclusivity rights
• Forward integration.
Dealing with intermediaries:
•
•
•
E – Commerce can lead to disintermediation. In this process intermediate organizations (middlemen) can be taken out
of the supply chain.
The process of reintermediation is also found, i.e. new intermediaries are introduced to the value chain, or at least to
some aspects of it.
Countermediation is where established firms create their own new intermediaries to
Push and pull supply chain models:
One key element in supply chain management is choosing between having a ‘push’ and ‘pull’ model.
Push model:
• Products are built, distributed, and ready for the customer demand.
• Product design is lead by manufacturer.
• Product quality is often determined by raw material supplier and component manufactures.
• There is little product personalization to customers.
• Low set-up costs and economies of scale are possible.
• Inventories are built up waiting for customers to demand them (a push system is sometimes referred to as a make to stock
(MTS system)).
Pull model:
•
•
•
•
•
•
Planning for a product starts when the customer places the order and creates firm demand.
Product design is often customer led (a pull system is sometimes referred to as a make to order (MTO system)).
Personalization of the product by customer is possible.
Inventory levels are minimized (system such JIT and TQM can be used).
Lead time can be much higher.
Set-up costs are higher and economies of scale are not always possible.
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Big Data
The ability of organisations to extract valuable information from Big Data is becoming a strategic capability. Like any capability,
it requires investment in technologies, processes and governance.
What is Big Data?
Traditionally, organisations collected data that was mainly of a transactional nature. They stored data in a database that recorded
details such as customer and supplier transaction history, identifying information and they may occasionally have asked customers
the question ‘How did you hear about us?’ This data was used primarily to keep track of operations or forecast needs.
Laney suggested that Big Data has the following characteristics, known as the 3V’s:
• Volume – there is lots of it
• Velocity – it is generated very quickly
• Variety – it can take many varied forms
Volume
Big Data is characterised by its sheer volume.
But this volume of Big Data causes problems for businesses. In order to perform meaningful analysis of this volume of data
organisations will require new skill sets, large investments and a deliberate focus on Big Data. It is also likely that organisations
will have to collaborate and share databases on Big Data.
Velocity
The problem is worsened by the speed at which Big Data is created. The UK magazine, Baseline, reports that there are over 570
new websites created every minute. It also reports the commonly held belief that 90% of the world's data that is in existence has
been created in the last two years.
Big Data is created quickly and moves around quickly. There are 300 hours of new content uploaded and shared to YouTube
every minute, for example. For businesses wishing to exploit Big Data, they will have to obtain the information quickly, analyse it
quickly and exploit it quickly. If, for example, there is a road crash or traffic build up on a particular major road, providers of
satellite navigation systems for roads will want to get that information as quickly as possible (by, for example, measuring the
average road speed for vehicles on a particular road), assess whether the cause is a temporary one, and then suggest an alternative
route for road users. The more quickly that this can be done then the better the navigation system, and users of the system will be
much more satisfied with its use.
Software systems will play a significant role in dealing with the volume and velocity of Big Data. New systems such as inmemory analytics mean that the analysis can happen in real time without the need to even store the data onto disks on computer
servers.
Variety
Big Data is also characterised by its variety. Consider the data that might exist and be stored about yourself, for example. You
might have banking transactions, you might be following particular organisations on Twitter, you may have recorded your
interests on LinkedIn, you might have a store card or loyalty card that has recorded your past transactions, you might have saved
photographs in the cloud, you might have given a thumbs up to a music video on YouTube etc. The types and sources of Big Data
are many fold.
These types are often subdivided into two categories:
Structured data:
Structured data resides in a fixed field within a record or file (such as a database or spreadsheet). Your banking transactions, your
contact list or your past store purchases are therefore likely to be stored as structured data. This type of data is easier to access and
analyse, as long as the model is well designed (for example, past store purchases on a store card may be less useful if the file does
not record quantity, timing and value).
Unstructured data:
The vast majority of Big Data is unstructured. It does not have set fields or sizes and includes data such as your personal interests,
your photographs and videos, your likes and dislikes etc. Organisations need to find ways to make the most use of this type of
data. For example, an organisation might attempt to monitor and react to user actions so that if, say, you upload lots of holiday
photographs then you could be presented with holiday promotions on your next visit to a website. Or an organisation might ask
employees to record their skills and interests in a central database in order to best use these to exploit opportunities in future
projects.
Big data is unlocking the ability of businesses to understand and act on what are typically their biggest environmental impacts –
the ones outside their control. Organisations that previously had limited information on consumers now have many opportunities
to collect and leverage data.
Software for big data
Without getting too technical on this issue, a library of software known as Apache Hadoop is specifically designed to allow for the
distributed processing of large data sets (ie big data) across clusters of computers using simple programming models. (Clusters of
computers are needed to hold the vast volume of information.) Hadoop IT is designed to scale up from single servers to thousands
of machines, each offering local computation and storage.
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Big data analytics
Big data analytics refers to the ability to analyse and reveal insights in data which had previously been too difficult or costly to
analyse, due to the volume and variability of the data involved. The aim of big data analytics is to extract insights from
unstructured data or from large volumes of data. Being able to extract insights from the data available is crucial for organisations
to benefit from the availability of big data – for example, to help them understand the complexity of the environment in which
they are operating, and to respond swiftly to the opportunities and threats presented by it; or to develop new insights and
understanding into what customers need or want.
The processing of big data is generally known as big data analytics and includes:
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.
Criticisms of big data
An article in The Financial Times entitled 'Big data: are we making a big mistake', raised a number of criticisms over the ability of
big data to deliver the anticipated benefits.
Critics argue:
(a) Big data is simply a buzzword, a vague term that has turned into an obsession in large organisations and the media. Very few
examples exist where analysing vast amounts of data have resulted in significant new discoveries.
(b) There is a focus on finding correlations between data sets and less of an emphasis on causation. Critics suggest that it is easier
to identify correlations between two variables than to determine what is actually causing the correlation.
(c) A failure to understand the factors giving rise to a correlation mean that analysts have no idea what factors may cause the
correlation to break down.
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.
Disruptive technology
Disruptive technology relates to instances where technology is used to fundamentally change and ‘disrupt’ the existing business
model in an industry.
An example of a disruptor is the passenger service Uber which created a business model using technology which avoided the need
for licensed drivers, a vehicle fleet, local booking services etc. Instead, customers use their internet connected device to hail a ride
and all payments are handled by a smartphone app.
Uber has disrupted the existing business model for traditional passenger services. Uber was set up in San Francisco in the United
States and its initial key competitor was the Yellow Cab Co-operative, but whilst Uber has grown to a business worth over $60bn,
the Yellow Cab Co-operative has since filed for bankruptcy.
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The key reason for the growth of new disruptive businesses is from technology. Not only from the technology that they employ in
order to cut costs and improve efficiency, but also in the access that consumers now have to technology in the modern on-demand
economy. For example, many disruptive businesses rely on smartphone applications or have internet-only based transactions.
The two largest growth sectors for disruptive technology are in health services and financial services. Financial technology
(commonly known as Fintech) is, for example, completely disrupting the traditional banking sector – long seen as a highly
technical, highly regulated industry dominated by giant banks.
Fintech businesses exist which can provide investment advice, offer banking services, transfer money internationally, provide
mortgages and loans, exchange currency etc. These are typically big earners for traditional financial institutions. Goldman Sachs
estimates that upstarts could steal up to $4.7 trillion in annual revenue, and $470 billion in profit, from established financial
services companies.
The advantages that Fintechs have are:
• better use of data – providing better understanding of their customer and giving customers a wider choice
• a frictionless customer experience using elements such as smartphone apps to provide a broad and efficient range of services
• more personalisation of products/services to individual customers
• the lack of a physical presence (with associated overheads and operating costs)
• access to cheap capital to fund growth – much like when internet based businesses first came to prominence in the 1990’s,
investors want to get in on the growth potential that Fintechs offer. This gives Fintechs a wide scope for raising cheap finance in
order to fund their future expansion.
Cloud and mobile computing
Cloud and mobile computing is computing based on the internet. It avoids the needs for software, applications, servers and
services stored on physical computers. Instead it stores these with cloud service providers who store these things on the internet
and grant access to authorised users.
Benefits of cloud and mobile computing
• Sharing data
• Collaboration
• Reduced maintenance
• On-demand self-service
• Flexibility
• More competitive
• Easier scaling
• Back-ups
• Disaster recovery
• Better security
More detail:
Store and share data – cloud services can often store more data than traditional, local physical drives and the data can be shared
more easily (regardless of physical location).
On-demand self-service – customers and users can gain access to technology on demand. For example, every time you download
an app from iTunes or the Play store you are downloading it from a cloud service where it is stored.
Better workforce flexibility – employees no longer need to be ‘plugged into’ work networks or facilities to access the data.
The cloud facilitates better workforce collaboration – documents, plans etc. can be worked on concurrently by many numbers
of staff all at the same time.
Smaller firms can get access to technology and services that, without significant financial investment, may otherwise only be
available to the largest organisations. This can allow small organisations to compete better with larger rivals.
Cloud services provide high levels of flexibility in terms of size, number of authorised users etc. – this means that the service can
grow as the business grows and allows businesses to scale up much more easily.
There is no longer need for regular maintenance and (security or software) updates of IT services – the cloud provider will take
care of this.
It can be used to back up data – this adds an extra layer of security and removes the need for physical devices to store backed-up
data.
This means that it can also aid disaster recovery – using cloud technology makes this faster and cheaper.
The cloud can increase security of data – in the past if an employee lost, say, a laptop with sensitive data stored on it then this
would be a high risk security event for the organisation.
Risks of cloud and mobile computing
• Reliance on the service provider
• Regulatory risks
• Unauthorised access of business and customer data
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Chapter 25
Marketing
Stages in the marketing process:
There are a number of techniques for making a product, but generally they follow a number of distinct stages:
1. Market analysis- used to identify gaps and opportunities in business’ environment
2. Customer analysis- examining customers so that potential customers can be divided into segments with similar purchasing
characteristics.
3. Market research- determining characteristics of each segments such as size, potential, level of competition, unmet needs etc.
4. Targeting – deciding which segments to target
5. Marketing mix strategies- developing a unique marketing mix for each segment in order to exploit it properly.
Marketing mix strategies:
The original 4ps model:
•
•
•
•
Price – principal strategies include price skimming, when a premium price is changed because the product has a
technological advantage or brand loyalty that outweighs a price different and market penetration, a deliberately low price to
dominate the market and block competition entry.
Promotion- the promotion mix consists of four elements: advertising, sales promotion, public relations and personal selling.
Place – the design of a panel of distribution will be influenced by the type of product, the abilities of the intermediates and
the product expectation of customer.
Product- the product needs to be augmented if it is stand out from rivals’ products. This can be done by changing its brand
name, its aesthetics, it quality, it’s packaging, or by widening the product mix or increasing/improving the services that the
product comes with.
E marketing: the 7Ps:
E-marketing is marketing carried out using electronic technology.
Opportunities for e-marketing can be examined using the traditional 4Ps of
• Product
• Price
• Promotion and
• Place,
Plus an additional 3Ps
•
•
•
People/participants (for example, having adequately trained and support services)
Process (for example, payment and delivery processes) and
Physical evidences (for example, website layout and navigation).
The additional 3Ps are particularly relevant to the marketing of services.
People/participants:
• Service businesses usually have high person-to-person contact. It is important that these contacts are conducted well as there
is often no quality control intervene between employee and customer.
• A simple example of the use of electronics is to provide employees with an on-screen script for dealing with queries.
Depending on customers’ answers, the script branches to different options.
Processes:
• Again, in a service business, a customer is often exposed to more business processes. For example, a lot of information has to
be provided if a customer is buying online insurance. The process has to made high quality and easy to use.
• Many people become frustrated with e-commerce sites because small is only reported at the end of the process, and then the
customer has to start from the beginning again.
Physical evidence:
• Is the website well designed? Does it look good?
• The website frequently gives potential customers their first impression of the organization.
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Pricing:
Pricing should be determined with reference to 4 C’s factors:
Cost (i.e. we should ensure that all cost is covered)
Customers (we should consider how much customers are willing to pay)
Competitor (we should consider how much competitors are/will be charging)
Corporate objectives (we should considered what we are aiming to achieve- for example, A low price might be necessary when
we are trying to break into a market)
Practical pricing methods:
•
•
•
•
•
•
•
•
•
•
•
•
Penetrating pricing- a low price is set to gain market share.
Perceived quality (or prestige) pricing- a high price is set to reflect/create an image of high quality.
Periodic discounting- this is a temporary reduction in prices for a limited period such as ‘Holiday sale’
Price discrimination- different prices are set for the same product in different markets, e.g. peak/off-peak rail fares.
Going rate pricing- prices are set to match competitors.
Price skimming- high price are set when a new product is launched. later the price is dropped to increase demand once the
customer who are willing to pay more have been ‘skimmed off’
Negotiated pricing- the price is established through bargaining between the seller and customer.
Loss leaders- one product is sold at a loss with the expectation that customers will then go on and but other more profitable
products.
Captive product pricing- this is used where customers must but two products. The first is cheap to attract customers but the
second is expensive, once they are captive.
Bait pricing- this is used by the companies with wide products ranges, but often the lowest priced model is advertised in the
hope to attract customers to the line and the hope that they will actually decide to buy a higher priced item from the range.
Bundle pricing- two or more products, usually complementary, are packaged together and sold for one price.
Cost plus pricing- the cost per unit is calculated and then a mark-up added.
E-marketing: the 6Is
Interactivity:
• Traditional media are mainly ‘push’ media – the marketing message is broadcast from company to customer- with limited
interactions.
• In the internet it is usually a customer who seeks information on the web- it is ‘pull’ mechanism.
Intelligence:
• The internet can be used as a low-cost method of collection information about customer perceptions of product and services.
• The website also records information every time a user click on a link.log file analyzers will identify will identify the type of
promotions or products customers are responding to and low patterns vary over time.
Individualization:
• Communications can be tailored to the individual, unlike traditional media where the same message is broadcast to everyone.
•
Personalization is an important aspect of CRM and mass customization, e.g. every customer who visits a particular site is
profiled so that when they next visit information relevant to their product, and interest will be displayed.
Integration:
• The internet can be used as an integrated communication tool, e.g. it enables customers to respond to offers and promotion
publicized in other media;
• It can have a direct response or call back facility built in;
• It can be used to support the buying decision, even if the purchase does not go through the internet- with web-specific phone
number on websites.
Industry structure:
• The relation between a company and its channel partners can be dramatically altered by the opportunities available on the
internet. For example, disintermediation and reinter mediation
Independence of location:
• Electronic media gives the possibility of communication globally- giving opportunities of selling into markets that may not
have been previously accessible.
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E-branding:
A brand is a name, symbol, term, mark or design that enables customer to identify and distinguish the product of one supplier
from those offered by the competitors.
E-Branding has become more and more important as companies decide to offer their services and products online. Website design,
corporate branding, e-commerce and search engine optimization are critical components in building a company’s e-branding.
Customer Relationship Management (CRM):
The objective of CRM is to increase the customer loyalty in order to increase profitability and is thus a key aspect of e-business.
Definitions
• CRM is an approach to building and sustaining long-term business with customers.
• E-CRM is the use of digital communications technology to maximize sales to existing customers and encourage continued
usage of online services.
The customer lifecycle:
CRM involves four key marketing activities (the ’customer lifecycle’)
1. Customer selection – defining what types of customer is being targeted.
• Who are targeting?
• What is their value?
• Where do we reach them?
2. Customer acquisition- forming relationship with new customers.
• Need to target the right segment
• Try to minimize acquisition costs. Methods include traditional off-line technique (e.g. advertising, direct mail) and online
techniques interactive adverts, opt-in e-mail and viral marketing)
• Service quality is key here.
• Choice of distribution channel also very important.
3. Customer retention - keeping existing customers.
• Emphasis on understanding customer needs better to ensure better customer satisfaction.
• Use offers to reward extended website usage.
• Ensure on going service quality right by focusing on tangibles, reliability, responsiveness, assurance and empathy.
4. Customer extension (or’ customer development’)- increasing the range of products bought by the customer.
• “Re-sell” similar products to previous sales
• “cross-sell” closely related products.
• “up-sell” more expensive products.
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Chapter 26
Strategy and People
Human resources and organizational strategy
The strategic role of human resources:
People are the central importance in most organizations and their recruitment, management and motivation forms part of the
human resource management function.
HRM plays a role in all elements of the strategic planning process:
• In strategic analysis, HRM can generate strength and opportunities for a business (or poor HRM might create weakness and
threats).
• In making strategic choices, HRM can help a business to develop and sustain competitive advantage.
• In putting strategy into action (Implementation), we have seen in previous chapters that HRM can play a vital role in
creating good project managers, redesigning processes, achieving a flexible organizational structure etc.
The goal of HRM:
From the above analysis it can be seen that for strategies to be successful HRM must be effective in a number of areas. These can
be summarized into 4 areas (4C’s):
• Commitment (requires good motivation and leadership)
• Competence (requires good recruitment, assessment, training and staff development)
• Congruence (requires good job design)
• Cost-effectiveness (this normally comes from the achievement of the others)
Job design
Job design and motivation:
There are two major reasons for attention to job design:
1) To enhance the personal satisfaction that people derive from their work and,
2) To make the best use of people as a valuable resource of the organization and to help overcome obstacles to effective
performance.
Research suggests that it is primarily in the realm of job design that opportunity for constructive improvement of worker
satisfaction appears to be high. The level of job satisfaction experienced is affected by a wide range of variables:
• Individual factors - personality, education, intelligence and abilities, age, marital status, and orientation to work.
• Social factors – relationships with co-workers, group working and norms, opportunities for interaction, informal
organization.
• Cultural factors - attitudes, beliefs and values.
• Organizational factors - nature and size, formal structure, personnel policies and procedures, employee relations, nature of
work, technology and work organization, supervision and style of leadership, management system, and working conditions.
• Environmental factors - economic, social, technical and governmental influences.
The application of motivational theories, and a greater understanding of dimensions of job satisfaction and work performance, had
led to increase interest in job design. The nature of work organization and the design of job can have a significant effect on the job
satisfaction of staff and on the level of organization performance.
Job design is concerned with the relationship between workers and the nature and contents of jobs, and their task functions. It
attempt to meet people’s personal and social needs at work through re-organization or restructuring of work.
Direct approaches to job design:
There have been a number of different approaches to job design, which have been based on different theories of behavior of
individuals in the workplace. These include:
Scientific management
Frederick w Taylor is generally credited with the introduction of scientific management. He believed that workers would be
motivated by obtaining the highest possible remuneration and that this could be achieved by organizing work in the most efficient
way, based on a true science of work whereby what constitutes a fair’s day work and a fair’s day’s pay could be determined.
The scientific management approach to job design is to have very specific job roles, strict limits and control over employee
actions, and a standardization of job roles across staff levels: this had a huge impact on manufacturing jobs and resulted in:
• Job fragmentation where individual workers focused on one single task.
• The separation of planning from doing the work, and direct work from indirect.
• The minimization of requirements for skill and training time.
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•
•
•
•
•
The minimization of material handling.
The use of highly-specialized machinery and flow lines.
Deskilling of work, with jobs becoming repetitive and boring
Low commitment from employees
An adversarial industrial relations climate.
Job enrichment:
Job enrichment developed to address some of the drawbacks of scientific management and is the process of adding task to a job in
order to increase the amount of employee control or responsibility. The main deriver behind the development of job enrichment
was the belief that it could improve job satisfaction and hence performance by meeting the need for the factors identified by
Herzberg as motivators (achievement, recognition, attraction of the job itself, responsibility and advancement).Job enrichment is
often part of business process redesign and/or quality initiative and:
• Combines tasks vertically as employees undertake some supervisory tasks
• Leads to greater responsibility for individuals, with some control delegate downwards.
Example:
The enrichment of the job of a barman whose current duties only include serving drinks from a bar could involve adding further
responsibilities such as:
• Ordering supplier of drinks
• Dealing with customer complaints
• Cashing up at the end of a shift
• Drawing up menus for cocktails
Japanese management:
In the 1980s, business around the world began to introduce management techniques based on the production methods used by
large Japanese corporations. Particular characteristics of the model are:
• Total quality management, with every employee taking responsibility for quality, taking part in improvement activities and
carrying out quality control of their own work
• Cellular manufacturing to improve flexibility, with assembly of complete components carried out by a team of flexible, multiskilled workers.
• Just-in-time manufacture to minimize inventory and waste by having the right materials, at the right time, at the right place,
and in the exact amount required
• Interdependence of employees on each other, with a high degree of socialization at work and the organization becoming a
community.
• A high reliance on a skilled, flexible workforce
Business Process Re-engineering (BPR)
BPR was discussed in detail in the chapter on business process change. The key implications of HRM are that BPR:
• Views employees as an asset rather than a cost
• Involve the establishment of a more horizontal structure with work carried out by self-managed teams with the degree of
autonomy
• Makes extensive use of IT to enable new forms of working and collaborating within an organization and across organizational
boundaries
Self-managed works group have a number of key features
• Specific goals are set for the group but members decide the best means by which these goals are to be achieved.
• Group members have greater freedom and choice, and wider discretion over the planning, execution and control of their own
work.
• Collectively, members of the group have the necessary variety of expertise and skills to undertake successfully the task of the
group.
• The level of external supervision is reduced and the role of supervisor become more one of giving advice and support to the
group.
• Feedback and evaluation are related to the performance of the group as a whole.
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Human resource development:
The emergence of human resource development:
Human resource development encompasses the activities that are concerned with the skills and abilities of people within an
organization in order to ensure its success. Today, human resource development is seen as more than just a training activity, and it
scope has been extended so that:
• People are seen as a major source of competitive advantage, training and development is seen as an investment, not a cost.
• Learning is seen as essential and embedded in the organization as a means of coping with change and ensuring that strategic
objectives are met.
• Employees have the expectations that they will learn and change and retain as necessary as strategy demands.
• Development and training of their staff is seen as a key part of a manager’s role.
• Changes outside the organization are reflected in changes to training and development needs
• Human resource implications are considered as part of strategic planning.
Establish human resource development:
Most organizations establish human resource development in one of two ways:
•
•
•
•
•
Systematic approach
Focuses on needs
Often off- the job
Formal
Can be employee driven
Need a predictable environment
•
•
•
•
•
Integrated approach
Creates a learning culture
Happens within the organization itself
Uses coaching and mentoring
Uses competency frameworks
HRM closely linked with other key activities
Competency frame works:
Competence is the critical skills, knowledge and attitude that a job-holder must have to perform effectively. A competent
individual can perform a work role in a wide range of settings over an extended period of time.
The use of competency frame work
Organization are increasingly making use of competences framework as a way to link HRM process to the skills and behavior
required to meet strategic objectives. Systems using competency frame work may include many components each linking to a
different aspects of human resource activities within an organization:
• To provide an analysis of the behavior needed to achieve a given strategy.
• Recruitment - as a basis for person specifications and as a basis for comparison of applicants during selection.
• Identifying training and development needs to develop people to a level of performance expected at work.
• Managing performance, focusing on what people do at work and how well they do it, often as a basis for appraisal systems
such as behaviorally and anchored rating scales
A key point here is that the same competency framework can used for job design recruitment ongoing performance appraisal and
the design for reward systems.
The process for assessing competencies:
For any competence-based system the process is the same:
Establish the elements of competenceactivity, skill or ability required by the
job holder to do the job.
Corrective action for
deviation from standard
Establish the criteria of performance
of the skill or ability required and set
standard to measure it by
Measure
performance
against standard
Actual
Performance
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Chapter 27
Leadership
The nature and importance of leadership
Buchanan and Huczynski define a leader as ‘someone who exercises influence over other people’.
Another definition is: Leadership is an interpersonal influence directed tow ard the achievement of a goal or goals.
Three important parts of this definition are the terms interpersonal, influence, and goal:
Basically, this traditional definition of leadership says that a leader influences more than one person towards a goal.
Leadership can be viewed from these standpoints:
• Leadership is all about moving people and things on,
• improving performance, changing the way things are done,
• making a new product – and if the designated leader cannot communicate the why, how and when of moving from A to
B then he or she will neither behave like a leader, nor succeed in the task.
• Interpersonal – means between persons. Thus, a leader has more than one person (group) to lead.
• Influence – is the power to affect others.
• Goal – is the end one strives to attain.
• An attribute or a position, e.g. the managing director
• A characteristic of a person – a natural leader
• A category of behaviour.
What makes an effective leader?
In paper F1 (Accountant in Business) you learnt how there are a wide range of different theories, models and research that seek to
determine what the ideal leader or manager should be like.
Theories of leadership:
Trait theories
Early studies focused on the qualities required by effective leaders. Lists were compiled of required leadership qualities including:
Certain other writers selected other personal qualities which were thought to be desirable in leaders, who are ‘born and not made’.
Many great leaders were considered to have:
• physical traits, such as drive, energy, appearance and height
• personality traits, such as adaptability, enthusiasm and self-confidence; and
• social traits, such as co-operation, tact, courtesy and administrative ability.
• above-average intelligence • initiative – independence and inventiveness and the capacity to perceive a need for action
• motivation
• self-assurance and self-confidence
• the ‘helicopter factor’ – the ability to rise above the particulars of a situation and perceive it in relation to the surrounding
context
• Other ‘essential’ qualities included enthusiasm, sociability, integrity, courage, imagination, determination, energy, faith, even
virility.
The problem with personality or trait theories is that there are always counter-examples that can be given, for instance, when one
theorist suggested a good leader must be tall, a short yet effective leader was identified; when one theorist suggested a leader must
be tactful and courteous, a rude yet effective leader was found. Clearly good leadership is more than simply possession of
particular physical or psychological attributes.
Behavioural/style theories
The essence of leadership style theories is that a successful leader will exhibit a pattern of behaviour (i.e. 'style') in gaining the
confidence of those they wish to lead. Style is a difficult factor to measure or define. The style of a manager is essentially how he
or she operates, but it is a function of many different factors.
The research at Ashridge Management College distinguished four main management styles:
Tells (autocratic) – the manager makes all the decisions and issues instructions which are to be obeyed without question.
Sells (persuasive) – the manager still makes all the decisions, but believes that team members must be motivated to accept them in
order to carry them out properly.
Consults (participative) – the manager confers with the team and takes their views into account, although still retains the final say.
Joins (democratic) – the leader and the team members make the decision together on the basis of consensus.
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Ashridge discovered that most people preferred operating under the ‘consults’ style, though the most important thing was
consistency – staff disliked it when managers changed between different styles.
Classical theories of leadership:
Classical theories of leadership, which you should be familiar with from your previous studies, can be considered as a falling into
four main categories.
• Trait or personal characteristics, which see the individual as more important than the situation.
• Style theories, which are based on the assumption that the leadership style of a manager will affect the motivation of
employees.
• Contingency (or contextual) approaches that take into account other variables such as the nature of group in which the leader
operates and the position of the leader within the group.
• Situational theories that look at situations where leader are shown to be effective and consider the actions of leaders and the
context in which they led in order to suggest the appropriate style to match the requirements of the task, the group and the
individuals.
Example:
Likert developed the following ‘style’ theory which distinguished between four keys styles or ‘system’ of leadership:
System 1: exploitative autocratic
Here the leader has no confidence or trust in the subordinates, impose decisions, never delegates, motivates by threats, has little
communication with subordinates and does not encourage teamwork.
System 2: benevolent authoritative:
Under this system the leader has only superficial and condescending trust in subordinates, imposes decision, never delegate,
motivates by reward and, though he sometimes will involve others in solving problems, is basically paternalistic.
System 3: consultative
The leader has some incomplete confidence in subordinates, listen to them but controls decision making, motivate by reward and
level of involvement and will use the ideas and suggestions of subordinates constructively.
System 4: participative
The democratic leader has complete confidence in subordinates who are allowed to make decisions for themselves. Motivation is
by reward for achieving goals set by participants and there is a substantial amount of sharing of ideas and opinions and cooperation.
Likert’s research shows that effective managers are those who adopt either a system 3 or a system 4 leadership style. Both are
seen as being based on trust and paying attention to the needs of both the organization and employees.
Recent approaches to leadership:
More recent approaches to leadership have characterized leaders in one of two ways:
• Transformational or charismatic leaders, who provide a vision, inspire people to achieve it by instilling pride and gaining
respect and trust. These leaders appear to be particularly effective in times of change and uncertainty.
• Transactional leaders who focus on managing through systems and processes. These leaders are likely to be more effective in
securing improvement in stable situations.
The difference between transactional and transformational leadership are shown below:
Transactional leadership
Transformational leadership
•
Clarify goals and objectives and the focus is on
short term.
• Focus on control mechanisms.
• Solving problems.
• Maintain status quo or improve current situation.
• Plan, organize and control.
• Guard and defend existing culture.
• Position power exercised.
Suitability:
This is best suited to the static, predictable
environments.
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•
•
•
•
Establishing long-term vision.
Create a climate of trust.
Make people solve their own problems by empowerment.
Change the current situation. Every threat is seen as an
opportunity.
• Train, coach, counsel and mentor people.
• Change culture.
• Power comes from relationships and influencing people. The
pressure exerted is subtle and has greater finesse.
Suitability:
This is best suited to the environments where change is in inevitable
and may be unpredictable.
100
Entrepreneurship and Intrapreneurship
Many large businesses were set up by entrepreneurs who had new ideas and were willing to take risks to convert those ideas into
successful products. However, a growing trend within business is to encourage employees 'intrapreneurs' to come up with new
ideas and take risks to grow the business.
Major brands such as Sony PlayStation and the Post-it Note were developed in a culture of intrapreneurship. Even the idea of the
‘Like’ button on Facebook was developed by a junior member of staff at the company.
Ways to encourage such intrapreneurship include the following:
•
•
•
•
•
•
•
Set up a culture where employees are encouraged to explore new ideas, even if they are not related to their official roles. This
works even better if emloyees are given time to do this.
Managers should have open door policies making it easy for their staff to come and discuss new ideas.
Removing administrative barriers and bureaucracy so that new ideas can be presented.
Develop a culture where innovation is valued and failure is not the final word – calculated risk taking is essential to
commercial success.
Budget for resources to develop new ideas. Intrapreneurs should not be expected to finance development themselves.
Give employees a degree of ownership of new ideas – for example, allowing them to present the concepts to senior
management.
Try to identify intrepreneurs and give them more time and resources to develop ideas further.
Difference between Intra and Entrepreneurship
An entrepreneur is an individual that ‘starts-up’ a business and is the owner. Whereas, an intrapreneur is an employee of the
company and does not usually have any ownership.
However, some employees, likely the intrapreneurs among them, may hold shares in the company they work for in the form of
shares. Ownership of a company gives the entrepreneur the ultimate control over what the business does. The Entrepreneur is the
risk-taker of the business.
The intrapreneur may take ‘risks’ within the corporation where he works. However, the final risk comes down to the responsibility
of the business owner. There is no actual financial risk taken by the intrapreneur. In addition the difference between entrepreneurs
and intrapreneurs is with regards to the “ultimate sacrifice”. The entrepreneur will use his own money for his start-up business.
They may use their own assets (like their own home) to secure loans to finance their small business start-up and therefore the
ultimate sacrifice being made by an entrepreneur as one of potential financial loss. An intrapreneur will not usually be in a
position to raise funds for the organisation. The intrapreneur is therefore not risking any of their own money in any organisation
where they are involved.
Financial loss for the entrepreneur comes in two forms. Firstly, if the business makes a loss, and runs out of cash, the entrepreneur
is the one who has to make up the difference. Secondly, where a company collapses and goes into liquidation, the entrepreneur
could lose everything. This will depend on what monies are owned by the company, and what’s personally secured by the
entrepreneur.
Conversely, it is that the entrepreneur who will reap the rewards of success, firstly, where the company makes a profit, the
entrepreneur will be able to reward himself with profits in the way of dividends. Secondly, the final benefit to the entrepreneur is
on the sale of the business. Where the organisation has done exceptionally well, the entrepreneur could be in for a significant gain
from the sale proceeds.
It’s possible that due to the nature of an intrapreneur, they may have arranged a ‘profit share’ for themselves. This will mean they
receive a reward for their efforts. However, this will always only be a share of profits, compared to the entrepreneur, who is
entitled to 100% of the balance of the profits. Also, the intrapreneur will not gain from the sale of the business in the same way.
The exception to this is where they have an agreement in place with the business owner to take a share of the proceeds at the point
of sale.
All intrapreneurs are dependent on entrepreneurs in the first place to start the business. Without entrepreneurs there would be no
intrapreneurs to flourish. Good ‘entrepreneur-leadership’ will lead to having intrapreneurs within their businesses and
entrepreneurs will encourage intrapreneurship.
However, there’s always the worry that the intrapreneur will leave to set up in competition. The risk exists of losing a key
employee who acts as an intrapreneur, making it extremely difficult to replace that individual. It is the entrepreneur’s duty
therefore to not only encourage intrapreneurship, but also to support and look after their intrapreneurs within the business. An
entrepreneur carries with it a certain level of risk, whereas intrapreneurs can simply walk away when a business goes wrong.
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A small business’s survival can sometimes depend upon the entrepreneur’s ability and willingness to raise funds for example from
financial sources, like banks and other lenders. A loan will more than likely need personal security and personal guarantees.
Intrapreneurs never have to carry this level of risk. They are fully reliant on the entrepreneur to carry the burden of risk of things
going wrong. In addition in the case of cash flow problems, it is the entrepreneur, and not the intrapreneur that will have to
provide the funds.
Effectively the resources used by an entrepreneur are provided by him. Entrepreneurs have to be extremely resourceful. Whilst
intrapreneurs are resourceful, they are not required to provide the resources need by the company. The resources needed by the
intrapreneur are already provided to him by the company.
The resources we are referring to here are not just ‘cash’ and capital, as discussed above, but it’s all the other resources needed to
run a business. At no time is an intrapreneur expected to provide funds for the business. These resources are not necessarily
physical resources either. There are personal resources required to succeed in business also which include educational resources,
emotional resources and human resources.
An entrepreneur always also has the final say in what happens within a business. So although intrapreneurs do tend to have a high
level of autonomy and creativity, they are under the ultimate control and guidance of the entrepreneur who owns the business. The
exceptions to this rule are where a business is jointly owned and run, or whereby lenders are involved and have a certain amount
of say over certain business decisions within the business.
Intrapreneurs, by their very nature, are often extremely autonomous, and should be encouraged to be so. However, there will
always be certain larger decisions whereby the intrapreneur will need to seek approval and clear boundaries must be set.
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Chapter 28
Financial analysis
Aspect
Key concern
Acceptability
Achieving acceptable return to shareholders
Financial analysis
Risk
•
•
•
•
•
•
Cash flow forecasts to ensure dividend growth
requirements can be met.
NPV
ROCE
Valuation of real options
Cost benefit analysis
Ratio analysis(e.g. dividend growth yield, growth)
•
•
•
Sensitivity
Breakeven
Ratio analysis (e.g. gearing, dividend cover)
Feasibility
Resources
•
•
•
•
Cash flow forecasting to identify funding needs
Ability to raise finance needed
Working capital implications
Foreign exchange implications
Suitability
Getting the best returns from alternatives
•
•
Return on investment
Comparison of alternative
•
Profit margins
Alternative sources of finance:
Financing was covered in detail in paper F9. A brief summary of alternatives and considerations are given here.
Sources
of finance
Debt
Equity
Internally
generated (retain
earnings)
Ordinary
shares
Long term, e.g.
debentures,
preference
shares
Medium-term,
e.g. loans, HP
and leasing
Other
Short- term,
e.g. trade
credit and
overdrafts
Govt
grant
Factors to consider when choosing a financing package:
•
•
•
•
•
•
•
Cost
Control
Availability
Gearing
Security
Cash flow
Exit routes
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The standard cost card absorption rates:
A typical standard cost card for a product might look as follows:
$
Direct materials
(4kg x $8 /kg)
32
Direct labour
(3hrs x $12/hr)
36
Variable overheads
(3hrs x $4 / hr)
Marginal production cost
Fixed overheads
(3hrs x $5 /hr)
12
80
15
Full (absorption) production cost
Profit per unit
95
25
Selling price
120
Marginal costs are all variable.
It is relatively easy to estimate the cost per unit for direct materials and labour. In doing so we can complete the first two lines of
the cost card. However, it is much more difficult to estimate the production overhead per unit. This is an indirect cost and so, by its
very nature, we do not know how much is contained in each unit. Therefore, we need a method of attributing the production
overheads to each unit.
Decision making techniques
In this section we look at two areas:
• break even analysis
• marginal analysis
Contribution to sales ratios and break even points:
Cost-Volume-Profit (CVP) analysis
CVP analysis makes use of the contribution concept in order to assess the following measures for a single product:
• contribution to sales (C/S) ratio
• breakeven point
• margin of safety
(Contribution = selling price less all variable costs)
C/S ratio:
The C/S ratio of a product is the proportion of the selling price that contributes to fixed overheads and profits. It is comparable to
the gross- profit margin. The formula for calculating the C/S ratio of a product is as follows:
C/S ratio =
Contribution per unit
or
Total contribution
Selling price per unit
Total sales revenue
The C/S ratio is sometimes referred to as the P/V (Profit/Volume) ratio.
Breakeven point:
The breakeven point is the point at which neither a profit nor a loss is made
• At the breakeven point the following situations occur
Total sales revenue = Total costs, i.e. Profit = 0
or
Total contribution = Fixed costs, i.e. Profit = 0
• The following formula is used to calculate the breakeven point in terms of numbers of units sold.
Breakeven point
(in terms of numbers of units sold) =
•
Fixed costs
Contribution per unit
It is also possible to calculate the breakeven point in terms of sales revenue using the C/S ratio. The equation is as follows:
Breakeven point
Fixed costs
(in terms of sales revenue) = C/S ratio
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Margin of safety:
The margin of safety is the amount by which anticipated sales (in units) can fall below budget before a business makes a loss. It can
be calculated in terms of numbers of units or as a percentage of budgeted sales.
The following formulae are used to calculate the margin of safety:
Margin of safety
(in terms of units)
Margin of safety
(as a % of
budgeted sales)
= Budgeted sales - Breakeven point sales
=
Budgeted sales - Breakeven sales x 100%
Budgeted sales
[
Test Your Understanding 1:
A breakdown of KP's profit in the last accounting period showed the following:
$000
450
(220)
(160)
70
_____
Due to a downturn in market conditions the company is worried that next year may result in losses and would like to know the
change in sales that would make this happen.
Sales
Variable costs
Fixed costs
Profit
Required:
Calculate the break-even sales revenue for the business based on its current cost structure. Use this information to determine the
percentage fall in sales that would be necessary before the company would begin to incur losses
(5 marks)
More details on relevant cost principles:
Decision making involves making a choice between two or more alternatives. The decision will be ‘rational’ profit maximizing. All
decisions will be made using relevant costs and revenues.
‘Relevant costs are future cash flows arising as a direct consequence of the decision under consideration.’
There are three elements here:
Cash flows. To evaluate a decision actual cash flows should be considered. Non-cash items such as depreciation and interdivisional
- charges should be ignored.
Future costs and revenues. This means that past costs and revenues are only useful insofar as they provide a guide to the future.
Costs already spent, known as sunk costs, are irrelevant for decision making.
Differential costs and revenues. Only those costs and revenues that alter as a result of a decision are relevant. Where factors are
common to all the alternatives being considered they can be ignored; only the differences are relevant.
In many short run situations the fixed costs remain constant for each of the alternatives being considered and thus the marginal
costing approach showing sales, marginal cost and contribution is particularly appropriate.
In the long run (and sometimes in the short run) fixed costs do change and accordingly the differential costs must include any
changes in the amount of fixed costs.
Detailed technique
The usual objective in questions is to maximize profit. Given that fixed costs are unaffected by the production decision in the short
run, the U approach should be to maximise the contribution earned.
If there is one limiting factor, then the problem is best solved using key factor analysis.
Step 1: identify the bottleneck constraint.
Step 2: calculate the contribution per unit for each product.
Step 3: calculate the contribution per unit of the bottleneck resource for each product.
Step 4: rank the products in order of the contribution per unit of the bottleneck resource.
Step 5: allocate resources using this ranking and answer the question.
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Test your understanding 2:
X Ltd makes three products, A, B and C, of which unit costs, machine hours and selling prices are as follows:
Product A
Product B
Machine hours
Direct materials (5) 50c per kg
Direct wages @ $7.50 per hour
Variable overheads
Marginal cost
Selling price
Contribution
10
$
7 (14 kg)
9 (1.2 hours)
3_
19
25_
6_
Sales demand for the period is limited as follows.
Product A
Product B
Product C
Company policy is to produce a minimum of 1,000 units of Product A.
12
$
6 (12 kg)
6 (0.8 hours)
3_
15
20
5_
Product C
14
$
5 (10 kg)
3 (0.4 hours)
3_
11
15
4_
4,000
6,000
6,000
The supply of materials in the period is unlimited, but machine hours are limited to 200,000 and direct labour hours to 5,000.
Required:
Indicate the production levels that should be adopted for the three products in order to maximise profitability, and state the maximum
contribution.
Make-or-buy decisions:
A product should be made in-house if the relevant cost of making the product in-house is less than the cost of buying the product
externally.
Spare capacity exists:
Unless stated otherwise in the question, it should be assumed that there is spare capacity.
The relevant cost of making the product in-house = the variable cost of internal manufacture plus any fixed costs directly related to
that product.
No spare capacity exists:
The relevant cost of making the product in-house = the variable cost of internal manufacture plus any fixed costs directly related to
that product plus the opportunity cost of internal manufacture (e.g. lost contribution from another product).
Test your understanding 3
A factory’s entire machine capacity is used to produce essential components. The production costs of using the machines are as
follows
$
Variable
30,000
Fixed
40,000
Total
70,000
If all component production was outsourced, then the machines could be used to produce other items that would generate additional
contribution of $50,000. Assume the fixed costs will still be incurred if production is outsourced.
What is the maximum price that the company should be willing to pay to the outside supplier for the components?
Test your understanding 4
KRS Ltd is considering whether to administer its own purchase ledger or to use an external accounting service. It has obtained the
following cost estimates for each option:
Internal service department
Cost
Purchase hardware/software
Hardware/software maintenance
Accounting stationary
Part-time account clerk
© Zia Ul Haq
Volume
$320 pa
$750 pa
$500 pa
$6,000 pa
106
External services
Processing of invoices/credit notes $0.50 per document
Processing of cheque payments
$0.50 per cheque
Reconciling supplier accounts
$2.00 per supplier
per month
5,000 pa
4,000 pa
150 suppliers
Required:
Determine the cost effectiveness of outsourcing the accounting activities and identify the qualitative factors involved.
Dealing with risk in decision making:
There are many ways in which risk can be dealt with in decision making. The most common technique is to attach probabilities to
the potential range of outcomes and calculate expected values from this information.
Probabilities and expected values
An expected value summarises all the different possible outcomes by calculating a single weighted average. It is the long run average
(mean).
The expected value is not the most likely result. It may not even be a possible result, but instead it finds the average outcome if the
same event was to take place thousands of times.
Expected value calculations:
The following illustrates how calculations may be performed when using expected values.
Expected value formula
EV = Σpx
Where x represents the future outcome
And p represents the probability of the outcome occurring
Example:
A company expects the following monthly profits:
Monthly profit
Probability
£10,000
0.70
£20,000
0.30
Calculate the expected value of monthly profit.
Solution
Monthly profit
Probability
px
£10,000
£20,000
0.70
0.30
7,000
6,000
13,000
Expected profit is £13,000 per month.
Test your understanding 5
A company's sales for a new product are subject to uncertainty. It has determined a range of possible outcomes over the first two
years.
Year 1
Sales
$m
%
High
40
60
Low
20
Year 2
Sales
High
$m
Low
80
30
(if year 1 sales are high)
Sales
$m
High
30
40
90
10
%
20
Low
10
80
(if year 1 sales are low)
Required:
Calculate the expected sales for each year.
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Decision trees and multi-stage decision problems:
A decision tree is a diagrammatic representation of a decision problem, where all possible courses of action are represented, and
every possible outcome of each course of action is shown. Decision trees should be used where a problem involves a series of
decisions being made and several outcomes arise during the decision-making process.
Decision trees force the decision maker to consider the logical sequence of events. A complex problem is broken down into smaller,
easier-to-handle sections. The financial outcomes and probabilities are shown separately, and the decision tree is 'rolled back’ by
calculating expected values and making decisions. It is important that only relevant costs and revenues are considered, and that all
cash is expressed in present value terms.
Drawing decision trees:
In the exam it will be important that you can understand and interpret decision trees. .You may also be expected to draw a simple
decision tree.
Three-step method
Step 1: Draw the tree from left to right showing appropriate decisions and events/outcomes. (This is known as the forward pass).
Symbols to use:
A square is used to represent a decision point. At a decision point the decision maker has a choice of which course
of action he wishes to undertake.
A circle is used at a chance outcome point. The branches from here are always subject to probabilities.
Label the tree and relevant cash inflows/outflows. (discounted to present values) and probabilities associated with outcomes.
Step 2: Evaluate the tree from right to left carrying out these two actions:
Calculate an EV at each outcome point.
Choose the best option at each decision point.
(This is known as the backward pass.)
Step 3: Recommend a course of action to management.
Test Your Understanding 6:
A company is planning on drilling for oil. It can either drill immediately (at a cost of $50m) or carry out some preliminary tests
(cost ($10m).Alternatively, the company could sell the rights to the site to another company for $40m.
If it decides to drill now there is a 55% chance that it will find oil and extract it (with a value of $150m).
If further tests are carried out first there is a 70% chance that they will T- indicate the presence of oil. The sales rights would then
be worth $65m. Alternatively, the company could drill for oil itself at a cost of $50m. There is then an 80% chance that oil extraction
(worth $150m) is successful.
If further tests are carried out and indicate that no oil is present the value of any sales rights would fall to $15m. The company could
still decide to drill for oil itself- but there is only a 20% chance that it would successfully. Find and extract oil at that point.
Required:
Draw a decision tree of this problem and advise the company on how to proceed. Also, briefly discuss the benefits and
problems of using decision trees.
Budgeting:
A quantitative or financial plan relating to the future. It can be for the company as a whole or for departments or functions or
products or for resources such as cash, materials, labour, etc. It is usually for one year or less.
As part of ’strategy in action’, a business will create plans for each SBU, product, function etc. These plans are often in the form of
budgets. The budget sets out the short-term plans an targets necessary to fulfil the longer term strategic plans and objectives. The
budgets will also play a vital role in reviewing and controlling strategic: plans. They will be used to identify and investigate variances
and to highlight when a plan or process is out of control.
Budgets are distinct from forecasts. A forecast is a prediction of a future-outcome. A budget is a plan (usually in financial terms)
that looks to use and/or achieve that forecast.
Purposes of budgeting:
Budgets have several different purposes:
1. planning
2. Control
3. Co-ordination
4. Communication
5. Motivation
6. Evaluation
7. Authorisation
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Solution:
Test your understanding 1
Firstly we need to calculate the break even sales revenue.
Because we haven't been given any information on units, we must have to use the contribution sales revenue technique:
CIS ratio =
Total contribution
Total sales revenue
=
=
(450 - 220)
450
= 0.511 (or 51.1%)
Breakeven point =
(in terms of sales revenue) =
Fixed costs
C/S ratio
Breakeven point
(in terms of sales revenue) =
$160,000
0.511
Breakeven point
(in terms of sales revenue) =
$313,000
Now that we know the break-even position we can calculate the margin of safety (this is what is required in the second element of
the question).
Margin of safety
(as a % of
budgeted sales)
=
Margin of safety
(as a % of
budgeted sales)
=
Budgeted sales - Breakeven sales x 100%
Budgeted sales
450 - 313 x 100%
450
=
0.3044 (or 30.44%)
This tells us that for the company to fall into a loss making position its sales next year would have to fall by over 30.44% from their
current position.
Test your understanding 2
Step 1: Identify the bottleneck constraint.(this may be done for you in examination questions).
At potential sales level:
Sales
Total
potential
machine
units
hours
Total
labour
hours
Product A
4,000
40,000
4,800
Product B
6,000
72,000
4,800
Product C
6,000
84,000
2,400
196,000
12,000
Thus, labour hours are the limiting factor.
Step 2: calculate the contribution per unit for each product.
This has been done for us in the question
Step 3: calculate the contribution per unit of the bottleneck resource for each product, i.e. per labour hour
Product A $6/1.2 = $5.00
Product B $5/0.8 = $6.25
Product C $4/0.4 = $10.00
Step 4: rank the products in order of the contribution per unit of the bottleneck resource.
Thus, production should be concentrated first on C, up to the maximum available sales, then B, and finally A.
However, a minimum of 1,000 units of A must be produced.
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Step 5: allocate resources using this ranking and answer the question, i.e. state the maximum contribution.
Taking these factors into account, the production schedule becomes:
Units
Labour
produced
Hours
Cumulative
labour hours
Limiting
factor
Product A
1,000
1,200
1,200
Product C
6,000
2,400
3,600
Policy to produce
1,000 units
Sales
Product B
1,750
1,400
5,000
Labour hours
The maximum contribution is therefore as follows.
$
A (1,000 x $6)
6,000
B (1,750 x $5)
C (6,000 x $4)
750
24,000
38,750
Test your understanding 3
$
Variable costs saved
Contribution earned (= opportunity cost)
30,000
50,000
80,000
Test your understanding 4
Annual internal processing costs
Hardware and software
Hardware/software annual maintenance
$320
$750
Accounting stationery
Part time accounts clerk
$500
$6,000
Total
$7,570
Annual outsourcing costs
Processing of invoices/credit notes
$2,500
5,000 x $0.50
Processing of cheque payments
Reconciling supplier accounts
Total
$2,000
$3,600
$8,100
4,000 x $0.50
150 x $2 x 12
It would not be cost effective to outsource the .accounting activities. The present costs of $7,570 would rise to $8,100 pa
Qualitative factors include:
• predicted volumes - higher volumes will make outsourcing more expensive
• The quality of supply - will the external supplier make more errors?
• Security of information.
Test your understanding 5
Year 1
Expected value = ($40 x 60%) + ($20 x 40%) = $32m.
Year 2
Expected value = [($80 x 90%) + ($30 x 10%)] x 60% + [($30 x 20%) + ($10 x 80%)] x 40%
= [$75 x 60%] + [$14 x 40%] = $50.6m
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Test your understanding 6
A decision tree of the problem would look as follows;
Explanation
It is easier to start at the bottom of the tree. The first box shows the first decision to be made - to test, to drill or to sell the rights. If
we follow the 'drill' line/branch, we come a 'chance' point (represented by a circle).
This shows that if we drill there are two possible outcomes - there is a 55% that we find oil and make a positive net return of $150m.
There is also a 45% that no oil is found and that no return is made. The figure on the circle of $82.5m is the expected value calculated
from these two outcomes. However, the drill line has a cost of $50m so that the overall net expected return would be $32.5m - and
it is this figure that should be used to compare the drill option against the other options.
The middle branch of the tree shows the expected value from selling the rights - $40m.
The top branch shows the analysis of the testing decision. It can be seen that there are many more possible outcomes and also further
decisions to made based on whether or not the tests indicate the presence of oil.
Lines that have a double cross marking on them show the best choice is made based on expected values.
Advice
The company should undertake geological tests. If the tests indicate that oil is present then a drilling programme should be carried
out. However if the tests indicate that there is no oil then the company should sell the' drilling rights.
This strategy will maximise expected returns at £43.5m.
Benefits and problems
The main value of a decision tree is that it maps out clearly all the decisions and uncertain events and exactly how they are
interrelated. They are especially beneficial where the outcome of one decision affects another decision. For example in the above,
the probability of eventual success changes depending on the test outcomes. The analysis is made clearer by annotating the tree with
probabilities, cash flows, and expected values so that the optimum decisions (based on expected values) can be clearly seen.
However, drawing a tree diagram is only one way of undertaking's decision. It is based on the concept of expected value and as such
suffers from the limitations of this technique. For example, in this example, if the test drilling proves positive, the tree indicated the
company should drill, as opposed to selling the rights. But if it does there is a 20% chance of it losing £50 million. A risk-averse
company may well decide to accept the safer option and sell the rights and settle for £65 million.
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Chapter 29
The environment and Competitive forces
Quantitative Technique:
The technique covered so far has been ‘qualitative methods’ of forecasting what might happen to future volumes, costs, revenues
etc. they could be backed up by further qualitative techniques such as market research.
Business may also want to quantify these forecasts (for example, for budgeting, planning and evaluation purpose) and there are a
number of quantitative techniques with which you should be familiar such as linear regression and time series analysis.
In exam scenario students must be able to discuss the suitability, principles and uses of these techniques, but students will not be
asked to perform the mathematical calculations.
Liner Regression:
Regression is a simple statistical tool used to model the dependence of a variable (say, costs) on one (or more) explanatory
variables (say volumes). This functional relationship mat then formally stated as an equation, with associated statistical values that
describe how well this equation fits the data.
Linear regression equation:
The equation of a straight line is:
y= a +bx
Where
y= dependent variable
a=intercept (on y-axis)
b= gradient
x= independent variable
and
b= n∑xy - ∑x∑y
n∑x2 – (∑x)2
where
and
n=number of pairs of data
a= y - bx
Liner regression analysis can be used to make forecasts or estimates whenever a liner relationship is assumed between two
variables, and historical data is available for analysis.
EXAMPLE RELATIONSHIP:
Two such relationships are:
A time series and trend line: liner regression analysis is an alternative to calculating moving averages to establish a trend line
from a time series. (Time series is explained later in this chapter)
-The independent variables (x) in a time line series is time.
-the dependent variable (y) is sales, production volume or cost etc.
Total cost, where costs consist of a combination of fixed and variable cost (for example, total overheads or semi variable cost
item). Linea regression analysis is an alternative to using high-low method of cost behavior analysis. It should be more accurate
than the high-low method, because it is based on more items of historical data, not just a ‘high’ and ‘low’ value.
-the independent variables (x) in total cost analysis is the volume of activity.
-the dependent variable (y) is total cost.
-the value of ‘a’ is the value of fixed cost.
-the value of ‘b’ is the variable cost per unit of activity.
Correlation:
Regression analysis is attempts to find the liner relationship between two variables. Correlation is concerned with establishing
how strong relationship is.
The correlation coefficient:
The degree of correlation can be measured by the Pearsonian correlation coefficient, r (also known as the product movement
correlation coefficient).
R must always be between -1 and +1
If r=1, there is perfect positive correlation
If r=0, there is no correlation
If r=-1, there is perfect negative correlation
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For other values of r, the meaning is not so clear. It is generally taken that if r >0.8, then there is strong positive correlation and if
r<-0.8, there is strong negative correlation, however more meaningful information can be gathered from calculating the coefficient
of determination, r2.
r=
n∑xy - ∑x∑y
2
)
The coefficient of determination (r2):
This measure how good the estimated regression equation is, designated as r 2 (read as r-squared).the higher the r-squared; the
more confidence one can have in the equation. Statistically, the coefficient of determination represents the proportion of the total
variation in the y variable that is explained by the regression equation. It has the range of value between 0 and 1.
For example, if we read the following statement “factory overheads is function of machine-hours with r2 =0.80, “can be
interpreted as “80% of the total variation of factory overheads is explained by the machine hours and the remaining 20% is
accounted for by something other than machine-hours.”
The 20% is referred to as the error term.
Time series analysis:
Time series forecasting methods are based on analysis of historical data. They make the assumption that
Past patterns in data, such as seasonality, can be used to forecast future data points. This means that its future predictions are more
curved than linear.
Components of times series analysis:
Time series analysis has three basis components:
▪ Average: the mean of observations over time
▪ Trend: a gradual increase or decrease in the average over time
▪ Seasonal influence: predictable short-term cycling behavior due to time of day, week, month, season, year, etc.
These components can be used in different ways to produce future forecasts.
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Tips for Planning answers of SBL
Start by analysing the requirement itself:
• What role are you adopting?
• Who is the task addressed to and what do they want?
• What verbs have been used to express the requirement?
• Are there any limitations of scope highlighted?
• Are there any key issues mentioned that need addressing?
• Which professional skill is being explicitly tested?
Next you could assess what approach you will take:
• Are any calculations, ratios or other quantitative analysis required?
• Does the question lend itself to the use of a specific theoretical model?
The SBL syllabus has many frameworks and models that were developed to make analysis more focussed and effective, and to
help develop strategic responses. The exam task will not specify which model to use (if any), so you need to decide which is/are
the most useful. It is also perfectly reasonable to use parts of models if some aspects are less relevant – it is not an "all or nothing"
decision.
Given the above, you are now in a position to start writing up a plan:
• Start by setting up key headings – these should now be obvious from the wording of the requirement and the choice of model.
• Start filling in key issues under the headings, firstly from what you remember and then by looking again at your annotations on
the exam paper.
• Some students write too much detail on their plans, wasting time, whereas others do not have sufficient information in order to
take the plan and write up an answer. You will only find this balance through practice and experimentation.
Earning professional skills marks as you write up your answers
To demonstrate professionalism and earn skills marks you need to do the following:
• Address the requirements as written, taking particular notice (again!) of the verbs used
• Make sure you include the most important, relevant and crucial points relating to the requirement.
• Only make relevant points and try not to include superfluous information or make unsupported points.
• Show deep/clear understanding of underlying or causal issues and integrate or link different sources of information from various
parts of the scenario or different exhibits to make points
• Avoid repeating points already made.
• Show your ability to prioritise and make points in a logical and progressive way, building arguments rather than using a random
or ‘scattergun’ approach to answering the question.
• Structure and present your answers in a professional manner through faithfully simulating the task as would be expected of the
person being asked to carry it out and always have a clear stakeholder focus in mind when constructing the answer.
• Demonstrate evidence of your knowledge from previous learning or wider reading and apply this knowledge appropriately to
strengthen arguments and make points more convincing.
• In addition to being clear, factual and concise, you should express yourself convincingly, persuasively and with credibility.
The use of theories or models in the Strategic Business Leader exam
The Strategic Business Leader exam set by the ACCA Examining Team is a practical exam and, unlike other exams, will not test
individual theories or models in isolation or require for these theories or models to be quoted in answers to exam questions.
However, understanding the technical theories, models and knowledge is essential as these provide a framework for students to
help them approach the practical tasks that they will need to complete in the Strategic Business Leader exam.
The use of models in the exam will be a judgement made by students and is part of the ACCA Professional Skills for analysis and
evaluation. Students are advised to use models which they judge to be relevant for a particular task or scenario to generate the
scope of their answer. There is not a prescriptive list of theories and models, however, so this textbook focuses on the models that
it considers to be most relevant to the syllabus and to aid students in being successful in Strategic Business Leader.
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