Week 8 Flashcards
2 steps for a company to be succesful
- Developing strategy
2. Implementing it effectively and efficiently
SWOT analysis
The strengths-weaknesses-opportunities-threats analysis is essentially a procedure to identify critical success factors of a company.
● Strengths and weaknesses refer to the internal, core competencies of a company (or lack of it). They are identified through the resources a company possesses. This may include an evaluation of product lines, management, operations, marketing and the link with existing general strategy;
● Opportunities and threats are external, and are favourable and unfavourable environmental conditions. They are identified by analysing industry competitors. Porter’s five forces are examples of factors that are opportunities and threats.
SWOT analysis requires quantitative measures for the identified critical success factors, both to properly monitor progress and to have a defined condition of success. Management accountants might use the SWOT analysis to help gauge financial profitability, for example, which may be expressed quantitatively in the level of earnings.
Strategy 1 –> Cost leadership
Required resources: ● Heavy capital investment ● Process engineering ● Supervision of labour ● Products suited for the ease of manufacturing.
Execution: ● Tight cost control ● Frequent and detailed reports ● Structured policies and organization ● Incentives when quantitative targets are met.
Strategy 2 –> Differentiation
Required resources: ● Strong marketing abilities ● Product engineering ● Reputation for quality ● Unique skills or long tradition.
Execution:
● Strong coordination of research & development, manufacturing, and marketing.
Value Chain Analysis
The focus of value chain analysis is an identification of stages of the value chain in which customer value can be increased, and in which stages costs can be decreased. It also includes an evaluation of a firm’s relationships with parties upstream and downstream in the value chain, from suppliers to customers to distributors, its direct economic stakeholders. The value chain analysis brings an understanding of the firm’s overall sources of competitive advantage.
A key concept of the value chain analysis is that every activity should, in some way, add value to the product. Depending on the nature of the product and organization, value chain analysis will help management accountants decide which part of the value chain the organisation should concentrate its resources on improving.
Two primary steps to the the value chain analysis
- Identify value chain activities, which can be done for all kinds of firms for a variety of activities, from product design to physical manufacturing to customer service;
- Improve competitive advantage by adding value or reducing costs. This step consists of three specific parts:
● Determine the initial, overarching strategy, either cost leadership or differentiation, as this will help determine factors affecting competitive advantage.
● Identify opportunities for adding value.
● Identify opportunities for reducing cost.
Balanced Scorecard
Performance measurements are categorized into four perspectives: financial, customer, internal, learning and growth perspectives. The balanced scorecard aligns these four perspectives and helps to identify which of the perspectives is most relevant. This gives the firm a tangible clear method of implementation for improvements, better coordination and a framework for change and overall objectivity and accountability when it comes to performance measurement.
To keep the balanced scorecard and its performance indicators relevant, it should not be treated as a static document. Rather, different performance indicators from the four perspectives should be adjusted based on individual relevant timelines. If, for instance, factors affecting cash flow from the financial perspective change, so should the performance indicators as well.
Strategy Map
Complement to the balanced scorecard is the strategy map, which is simply a cause and effect diagram, showing the relationships of the four perspectives previously discussed. The map helps to design and disseminate strategy throughout the organization, by posing the question “How does each perspective contribute to the overall success of the firm?”.
Sustainability can expand the strategy map, providing another method of defining success. It is primarily achieved by engaging in sustainable practices and demonstrating this with sustainability reports to shareholders, showing a balance of social, economic and environmental factors in firm practices.
Sustainability includes considerations for things like climate change, health, labour and safety of employees. Broadly speaking, a firm considering sustainability issues will have improved public perception, which improves its brand reputation, competitive advantage and access to markets.
Performance measurement
Process by which managers gain information about the performance of tasks within the firm and judge that performance against pre-established criteria as set out in budgets, plans, and goals. Performance is evaluated at different levels in the firm.
Management control
Refers to the evaluation of the performance of mid-level managers by upper-level managers, while operational control is mid-level managers evaluating operating-level employees.
Since upper-level managers are more directly responsible for implementing the organization’s strategy, control at this level is also called Strategic Performance Measurement. Control at the operating level is called Operational Performance Measurement.
Operational control
Focuses on short-term performance measures.
Operational control has a management-by-exception approach, meaning it identifies units or individuals whose performance does not comply with expectations, and corrects the problems.
Management control
A management-by-objectives approach prioritizes long-term objectives, providing a more future-oriented view to strategy and decision-making than the previously discussed operational control.
Top-management assigns a set of responsibilities to each mid-level manager. The nature of these responsibilities depends on the functional area involved (e.g. operations) and on the scope of authority of the mid-level manager (i.e. the extent of the resources under the manager’s command). These areas of responsibility are often called strategic business units (SBUs). A strategic business unit (SBU) is composed of a set of controllable operating activities, overseen by a relevant SBU manager.
Main objectives of management control are:
● Motivate managers to achieve the goals set by top management.
● Provide the right incentive for managers to make decisions consistent with the goals set by top management (i.e. align managers’ efforts with desired strategic goals).
● Determine fairly the rewards earned by managers for their effort and skill, and the effectiveness of their decision-making.
Employment Contracts
The principal–agent model entails the key elements that contracts must contain in order to achieve the desired objectives. It sets out three important aspects of management performance that affect the contracting relationship: uncertainty, risk aversion, and lack of observability.
Each manager operates in an environment that is influenced by factors beyond the manager’s control (e.g. fluctuations in market prices), which implies that there is some degree of uncertainty about the effectiveness of the manager’s actions.
Design of Management Control Systems for Motivation and Evaluation
Developing a management control system involves clearly identifying:
● Who is interested in evaluating the organization’s performance, which can either be owners, creditors, community or government, or employees. Each has a different position about what performance is desired.
● What is being evaluated. Generally, it is on the individual manager, but the focus could also be on the SBU to determine whether to expand or to divest. Performance is usually compared to that of other managers or to its own previous performance.
● When the performance evaluation is conducted, which can be done based on resources input to the manager through a master budget, or outputs of the manager’s efforts through a flexible budget. The focus is on inputs when measuring the outputs of the manager’s efforts is difficult or the nature and extent of the manager’s control over the outputs is not clear. This approach is common in service and not-for-profit organizations.
Informal Control Systems
Informal systems are used both at individual and team levels. Performance is influenced by the drives and aspirations that each employee brings to the firm, separate to any incentives that the management gives them. Team informal systems, such as positive attitude, team norms etc.
Formal Control Systems
There are 4 formal management control systems that can be applied at the individual level:
● Hiring policies;
● Promotion policies;
● Leadership development;
● Strategic performance measurement systems.
Hiring and promotion policies can be crucial, as they aid strategic performance measurement systems. Training courses, readings or meetings are part of leadership development, and strategic performance measurement systems are commonly used for evaluating managers.
Strategic performance measurement
System used by top management to evaluate SBU managers. Before designing such systems, top managers assess when to delegate responsibility (called decentralization) is desirable.
Decentralization
Decentralization is a decision-making approach in which top management chooses to delegate a significant amount of responsibility to SBU managers.
The strategic benefit of the centralized approach is that top management retains control over key business functions, ensuring a desired level of performance, and that its expertise is exploited. However, in some cases, decentralization is better.
Advantages of Decentralization
Decentralization allows for quicker and more effective responses to customers via in-depth local knowledge.
It also gives managers more autonomy, again contributing to quickly and effectively serving customers.
Disadvantages of Decentralization
Difficulty in coordinating among different business units and inciting the potential for conflict as decision-making power is dispersed.
Types of Strategic Business Units
There are four types of strategic business units:
● Cost centres, solely including production or support SBUs.
● Revenue centres, segmented by product or location and the focus is on sales.
● Profit centres, which involve a combination of both sales and costs.
● Investment centres, which have a high level of autonomy and responsibility for its own assets, costs and revenues.
To evaluate centres, firms use multiple measures of performance – rather than focus on financial performance only – usually in the form of a balanced scorecard.
Type 1 of SBU –> Cost Centres
Cost centres include manufacturing plants or direct manufacturing departments (e.g. assembly department). The direct manufacturing and manufacturing support (service) departments are often evaluated as cost centres, since their managers have considerable control over costs, but little control over revenues or decision-making for investment in facilities.
Issues of cost centres
● Cost shifting, which occurs when a department replaces its controllable costs with non-controllable costs. This occurs because managers are generally not responsible for increases in non-controllable fixed costs. Top management should be able to anticipate and prevent cost shifting by requesting an analysis and justification of equipment upgrades and any changes in work patterns that affect other departments.
● Excessive short-term focus, which motivates managers to attend only to short-term costs and to neglect long-term strategic issues.
● Role of budget slack (i.e. the difference between budgeted and expected performance), which occurs because managers want to allow for unexpected unfavourable events. Otherwise, it can also be an attempt to make their performance goals easier to achieve.
Implementing Cost Centres in Departments
There are two methods for implementing cost centres:
● The discretionary-cost method is an input-oriented approach, preferable when costs are predominantly fixed. Costs are considered to be largely uncontrollable, and discretion is applied at the planning stage.
● The engineered-cost method is an output-oriented approach. In this case, costs are predominantly variable and therefore controllable (or engineered).
Outsourcing or Consolidating Cost Centres
Outsourcing can be an effective way to obtain reliable products at reasonable costs, without bearing the risk of obsolescence and other management issues. It can also introduce firms to new technologies or new ways of doing things.
But the option of outsourcing should be analysed thoroughly, as the firm will lose control over the strategic resource, as well as rely on an outsider’s competence.
Cost Allocation
The criteria on choosing the best allocation method are the same as the objective of management control:
● Motivate managers to a high level of effort.
● Provide incentives for managers to make decisions that align with top management goals.
● Provide a basis for fair evaluation of managers’ performance.
Dual allocation is useful when trying to achieve all three criteria, and it is a method that separates fixed and variable costs.
Type 2 of SBU –> Revenue Centres
Revenue drivers are commonly used in evaluating the performance of revenue centres, and are factors that affect sales volume (e.g. price changes, promotions).
In service firms, the revenue drivers focus on many of the same factors, with a special emphasis on the quality of the service (e.g. timeliness). The marketing and sales departments can be viewed as both revenue and cost centres. These two departments can incur two types of costs:
● Order-getting costs are expenditures to advertise and promote the product (e.g. samples, advertising). It is difficult to assess how these costs have affected sales. Therefore, these are often viewed as a discretionary-cost centre and focus on planning these expenditures rather than evaluating their effectiveness.
● Order-filling costs (e.g. freight, warehousing) generally have a clear relationship to sales volume and as a result, they can often be effectively managed as an engineered-cost centre.
Type 3 of SBU –> Profit centres
Profit centres have the advantage of aligning the manager’s incentives with those of top management, which is to improve the firm’s profitability.
Three strategic issues cause firms to choose profit centres rather than cost or revenue centres:
● They provide the incentive for the desired coordination between marketing, production and support functions.
● To motivate managers to consider their product or service as marketable to outside customers. Production departments, that provide products and services primarily for other internal departments, might find that they can market their products or services profitably outside the firm or that the firm can purchase the product or service at a lower price outside the firm.
● To motivate managers to develop new ways to make profit from their products and services. For example, an increasing number of companies think that service contracts provide a significant source of profit in addition to the sale of the product. In a profit centre, managers have the incentive to develop creative new products and services because the profit centre evaluation rewards the incremental profits.
The Contribution Income Statement
The contribution income statement, which is based on the contribution margin developed for each profit centre and for each relevant group of profit centres, is a common form of evaluation. This contribution income statement is an extension of the income statement.
The contribution by profit centre (CPC)
Given by the contribution margin minus traceable fixed costs. It is a more complete and fair measure of performance than the operating income or the normal contribution margin.
Controllable fixed costs
Fixed costs that the profit SBU manager can influence in approximately a year or less (e.g. sales promotions, data processing).
