MA Week 9 Flashcards
Divisionalisation in organisations:
4 Responsibility centres & what are they?
Should be established in accordance to __ principle?
A responsibility centre is a part of an organisation whose manager is ACCOUNTABLE for a specified set of activities
- Cost centre, eg. bank’s back office dept.
- Revenue centre, eg. hotel restaurant, pharmacy of a hospital
- Profit centre, responsible for costs + revenues
eg. sales dept. w/ sales salaries - Investment centre (cost, revenues + capital expenditure, ie. assets)
Controllability. but often difficult to control.
Performance reports for responsibility centres may include UNcontrollable items.
6 advantages of decentralisation in organisations
3 disadvantages of decentralisation
- Timely decisions
- Specialist knowledge
- Exploiting market information
- Mgmt development (in case top managers leave job/die)
- Strategic role for top mgmt (rather than grassroots issues)
- Mgmt motivation
- Dysfunctional decision making.
eg. service-providing dept compromises on quality to save costs, so service-receiving dept doesn’t get what it should - Duplication of services (purchase from diff. sources vs buy in bulk ← seem as more powerful purchaser to supplier)
- Senior mgmt may LOSE CONTROL of org.
Why do we use measures of divisional profit that include investments?
regular Profit measures IGNORE differences in size of investments
Return on investment (ROI)
*net assets = Assets - CL
= pre-tax profit / net assets * 100%
= (pre-tax profit / sales) * (sales/net assets) *100%
= operating profit margin * asset turnover ratio *100%
> A division can achieve high ROI through working on either strategy (High operating profit margin or high asset turnover)
but Pre-tax profit needs to outperform b/c sales is also the denom.
% measure of divisional PROFITABILITY
- relates divisional profits to size of INVESTMENT made in the division
- allows for COMPARISON across divisions
6 issues with ROI
- ROI appears more satisfactory if investment is REDUCED, ie. may induce short-term investment & avoid long-term investment. May therefore be HARMFUL to company in long-run
- Divisions performing above average could REJECT an investment even if its ROI is good (behavioural effect; agency theory/moral hazard)
- % return or the size of investment?
- A biz has to invest TODAY to obtain +ve cash flows & PROFITS in FUTURE
- ROI & earnings mgmt/quality
- see how cash flow is doing. if cash flow similar to profit, good earnings quality. - Intra-group transfers
- biz w/ high asset base would want to charge high internally to look profitable
Residual income (RI)
= income - required rate of return*investment
^rrr is the minimum acceptable return on investment, eg. cost of capital
RI > 0 great b/c giving investors more than what they expect
RI = 0 still worth it b/c can meet what ppl want from you
3 pros + 2 cons of RI
- Bigger motivation to keep Cost of Capital low, so that RI is high
- Better GOAL CONGRUENCE - all investments whose rate of return exceed the organisational minimum will be accepted
- Removes manager’s temptation to increase GEARING through excess borrowing
- b/c rrr will have to be adjusted upwards for higher risk.
- interest would leave low profits - Can’t be used to compare performance of divisions of diff. sizes (ie. smaller divisions, smaller profits)
- Can’t solve ‘SHORT-TERMISM’
- b/c income (accounting profit) still remains important for performance measurement
Economic Value Added (EVA)
NOPAT - (WACC * Net assets)
where NOPAT = net operating profit after tax
WACC = weighted average cost of capital
> draws on underlying principle of RI; looks at economics of firm rather than traditional accounting model
5 limits of financial accounting-based performance measures
- Lack of timeliness
- Backward orientation - financial indicators are lagging indicators, historic & cannot make changes. Need leading indicators that are forward-looking
- Fails to incorporate non-financial items, eg. skills, culture, ideas, relationships
- Focuses within accounting entity only. Society, ESG(!), economy, are more important in life & make business sense + competitors, customers
- Behavioural implications - eg. long-term investments are important in future although result in lower ROI
Transfer pricing
5 Objectives
Min price to be charged
Max price to be paid
The price that a sub-unit charges a product/service supplied to another sub-unit within the same organisation
Main objective: Align the divisional manager’s OBJECTIVES w/ the overall objective & strategy of the organisation
- Tax minimisation
- Independence of divisions -> motivate divisional managers
- Assessment of divisional performance
- Allocating divisional resources
Min price by selling div manager: MARGINAL COST + opportunity cost (usually 0)
Max price for buying div manager: lowest MARKET PRICE LESS internal costs for packaging and delivery
*Transfer pricing is important b/c of tax implications, saving costs unethically
Non-financial performance measurement:
Critical success factors & KPIs (key performance indicators)
CSFs are areas needed for business to succeed in to achieve its strategic objectives
eg. profitability, market share, productivity, employee attitudes, personnel development, product leadership
KPIs are used to measure performance/CSFs
eg. no. of customer complaints, no. of injuries (mfg industry), assets under management (financial sector)
Purpose of Balanced scorecard
4 areas
Integrates financial & non-financial measures
> Retains measures of financial performance but supplements these w/ measures of the DRIVERS of future financial performance
BSC covers:
- Learning and growth (innovation; employee TRAINING)
eg. time taken to generate new products
- employee retention - Internal business process
eg. improvement of after-sales service
- quality of information systems, predictor of productivity - Customer measures
- satisfaction is predictor of revenue. Customer loyalty predicts stable revenue
- a drop can quickly help identify drop in quality - Profitability
4 critiques and issues of BSC
- Does not validate CAUSALITY links
eg. sales did not go down b/c of poor customer service;
will customer loyalty cause profitability?
will employee satisfaction lead to profitability? - Difficult to get non-financial data quick enough -> can’t use in BSC
- Lack of ownership of non-financial data within organisations -> no use if can’t capture data carefully
- BSC is a top-down model
What is benchmarking?
External vs internal benchmarking
- Identifying best practice and adopting it, in hopes of improving performance
- Achieve competitive ADVANTAGE by learning from others’ successes & failures
External:
- COMPETITIVE benchmarking w/ the best in the same industry/business type
- In case data is lacking, FUNCTIONAL benchmarking compares biz functions w/ the BEST, irrespective of differences in industry
Internal (functional):
Comparing 1 part of biz w/ another part of the biz
4 pros of benchmarking
- Focuses on improvements that are challenging but achievable
- Focuses on gaining COMPETITIVE ADVANTAGE
- Assists w/ cross-functional LEARNING & teamwork
- Encourages OPENNESS to CHANGE & culture becomes less rigid
