Value Chain. & VBM

Question 1

Arkaigs

Answer 1

Summary: Advanced Performance Management Concepts at Arkaig

EVA™ vs ROCE

• EVA™ (Economic Value Added):
  
  • Measures if a business generates returns above the cost of capital.
  • Encourages future investments by treating costs like advertising and R&D as capital expenditures.
  • Reduces short-term decision-making temptations.
  • Aligns with NPV (Net Present Value) and aids communication due to NPV’s widespread use.
• ROCE (Return on Capital Employed):
  
  • Requires setting a target level, often based on industry benchmarking.
  • May be subjective in setting targets.
  • Relies on unadjusted capital employed figures, which can discourage long-term investments.

Recommendation: For a large entity like Arkaig, EVA™’s alignment with shareholder wealth creation and its fit within a value-based management framework may justify its complexity over ROCE.

Performance Hierarchy

• Strategic Level:
  
  • Involves top management (e.g., board).
  • Focus on long-term (3-10 years) strategies.
  • Information is externally focused, qualitative, and heavily aggregated.
  • Used mainly for planning and setting broad targets.
• Tactical Level:
  
  • Involves middle management.
  • Focus on shorter-term (quarterly/yearly) objectives.
  • Information collected on resource deployment and functional activities.
  • Used for short-term planning and controlling operations.
  • Mostly internal information combined with strategic targets.
• Operational Level:
  
  • Focus on day-to-day activities.
  • Information is detailed and task-specific.
  • Regular updates (daily/weekly).
  • Aimed at achieving short-term plans (e.g., sales or profit targets).

Value Chain

• Concept:
  
  • Emphasizes activities over traditional functional departments.
  • Activities create value and incur costs.
  • Primary activities are customer-facing; secondary activities support them.
• Integration:
  
  • Requires seamless information flow across activities and departments.
  • Information systems must ensure good communication across functional boundaries.
  • Job descriptions and reporting hierarchies should reflect activities rather than being department-contained.
• Arkaig’s Concerns:
  
  • Inbound/Outbound Logistics:
    
    • Old warehousing and distribution systems lead to inefficiencies.
    • A modern system integrated with production and sales would improve stock control and reduce errors.
  • After-Sales Service:
    
    • Potential issue with product reliability affecting revenue.
    • Important to ensure customers see the service as necessary and not due to product failure.
• Human Resources:
  
  • Important for achieving Arkaig’s entrepreneurial culture.
  • Rewards through share ownership or share option schemes.
  • Impact measured through profitability and innovation.

Recommendation: Addressing these areas with a focus on modernizing logistics and ensuring after-sales service aligns with customer expectations will support Arkaig’s strategic goals.

Answer 2

Summary: Selection of Appropriate Measures and Targets for Totaig

Value Drivers and Targets:
- Key Value Drivers: Totaig’s long-term value drivers are unit production cost and product quality.
- Competition: Overseas businesses will soon match Totaig’s unit cost and quality, making these critical areas for improvement.
- Targets: Financial and non-financial targets should be set to balance immediate and future-focused goals, aligning with value-based management (VBM) principles.
- Existing Targets: Current targets like return on investment (ROI) and operating margin are backward-looking and may discourage investments in new products, adversely affecting long-term performance.
- Balanced Focus: Emphasizing product quality targets ensures a balanced focus, preventing cost-cutting measures that might compromise quality.

Timescales for Targets:
- Short-term Targets: Immediate focus should be on reducing unit production costs as competitors will catch up within a year.
- Long-term Targets: Longer-term targets should focus on maintaining and improving product quality over three to five years, anticipating competitors’ improvements.
- Investment Needs: Heavy investments in product development and potential acquisitions necessitate long-term target setting.

Levels in the Business:
- Operational Managers: Targets for unit production costs and product quality should be set at the operational level, as these are within the control of operational managers.
- Directors: Strategic targets, such as those related to acquisitions, should be under the purview of directors.

Difficulties in Measuring and Managing Performance with VBM:
- Information Requirements: Effective VBM implementation requires robust information systems. Currently, Totaig’s outdated IT systems may hinder the identification of value drivers and performance measurement.
- Investment in IT: Upgrading IT systems to support VBM will require significant investment and management time.
- Training and Culture Change: Operational managers lack experience with VBM, necessitating extensive training. A cultural shift towards shareholder value creation is required, with strong commitment from directors to motivate managers.
- Measurement Challenges: Accurately measuring economic depreciation and the value creation from investments in product development can be challenging, affecting the reliability of performance measures like EVA™.

In summary, for Totaig to effectively implement VBM, it must set appropriate short-term and long-term targets focusing on key value drivers like production cost and quality. This will require investment in IT systems, training for managers, and a cultural shift within the organization. Challenges in measuring performance must be addressed to ensure the successful adoption of VBM.